Valuation and Pricing: Ammar Hafeez

Valuation and Pricing
Ammar Hafeez
These slides would detail in about
the instruments floated in
A) Money market
B) Capital market
Money market instruments
Money market
instruments
Certificate
Promissory Commerci Treasury Call Commerci
Note
of
al Bills Bills Money al Papers
Deposits
Promissory Note
• A promissory note is one of the earliest type of bills of
exchange.
• It is a financial instrument which has a written promise
by one party, to pay to another party, a definite sum of
money by demand or at a specified future date.
• Typically, a promissory note includes all the terms
pertaining to the indebtedness, such as the principal
amount, date and place of issuance, interest rate, date
of maturity, and issuer's signature.
• Firms and individuals can issue them to any source of
financing, other than a bank.
Commercial Bills
• Commercial bills are essentially bills of exchange.
• Commercial bills are used in cases where sales are
made in credit. In this scenario, the seller of the goods
would draw a bill of exchange. The buyer of the goods
will accept that bill. Once this is accepted, it is
thereafter also called a trade bill. It now becomes a
marketable financial instrument.
• If required, the seller can then go to his bank and get
the bill discounted. Here the bank will promise to pay
the amount if the buyer is unable to do so. And this
way, a trade bill becomes a commercial bill.
• The general term for such bills is 30, 60, or 90 days. It is
a negotiable instrument and is also self-liquidating.
• The bills of exchange can be compared to the
promissory note; besides it is drawn by the creditor
and is accepted by the bank of the debtor.
Treasury Bills
• The Treasury bills are issued by the Central
Government and are known to be one of the safest
money market instruments.
• The central government issues them at a lesser price
than their face-value.
• Since they carry zero risk, the returns are not as
attractive.
• They come with different maturity periods like 1 year,
6 months or 3 months.
• The difference between the maturity value of the
instrument and the buying price of the bill, which is
decided with the help of bidding done via auctions, is
basically the interest earned by the buyer.
Call Money
• Banks have to maintain certain ratios such as liquidity
ratio. At times, they may also need to borrow funds.
• This, they can do so by relying on other commercial
banks, say for instance a short term loan.
• Such instrument of the money market is known as call
money.
• This interbank transaction has no maturity date.
However, it is payable on demand.
• The commercial banks and cooperative banks are the
participants.
• Funds are borrowed and lent for one day only.
Commercial Papers
• Commercial papers are one of the most popular
money market instruments.
• They are a type of promissory notes, which are of
short-term and unsecured.
• They are issued by top rated firms with a purpose of
raising capital to meet requirements directly from
the market.
• They usually have a fixed maturity period which can
range anywhere from 1 day up to 270 days.
• In relation to the treasury bills, they offer higher
returns, but are less secured.
• Commercial papers are also traded actively in
secondary market.
• Unlike some other types of money-market
instruments, in which banks act as intermediaries
between buyers and sellers, commercial papers are
issued directly by well-established firms, as well as by
financial institutions.
• Their maturity date lies between 15 days to 1 year.
Certificate of Deposits
• Certificates of deposit are certificates issued by banks
against deposited funds that earn a specified return
for a definite time period.
• They are one of several types of interest-bearing
"time deposits" offered by banks.
• An individual or firm lends the bank a certain amount
of money for a fixed period of time, and in exchange
the bank agrees to repay the money with specified
interest at the end of the time period. The certificate
constitutes the bank's agreement to repay the loan.
• The Certificate of Deposit are different from a Fixed
Deposit receipt in two ways :
i. Certificate of deposits are issued only when the sum of
money is huge.
ii. Certificate of deposits are freely negotiable.
• They carry low risk whilst also providing higher interest

rates than the Treasury bills and term deposits.
• They are also issued at discounted prices like the
Treasury bills and they range between a span of 7 days
up to 1 year.
Capital market instruments
• Securities are in general, classified as either
A. ownership securities, or
B. creditorship securities
• Equity shares and preference shares are

ownership securities. They are also known as
capital stock.
• Creditorship securities are bonds, debentures etc.

They are referred to as debt capital.
Equity shares
• Equity shares are the instruments of capital,
which guarantee a residual interest in the assets
of a firm, after deducting all its liabilities-
including dividends to be paid on preference
shares.
• Equity shares are considered as the cornerstones
of the capital structure of a firm. They are the
source of permanent capital which do not have a
maturity date.
• Equity holders are the legal owners of a firm.
They participate in the management of the firm
through the elected board of directors, and
through the voting rights in important decisions.
They share the profits and assets in proportion to
their holding in the net assets of the firm.
Preference shares
• Preference shares are those which carry a
preferential right to payment of dividend during
the life time of a firm.
• They also carry a preferential right for the
repayment of capital, in the event of liquidation
of the firm.
• Preference shareholders are paid a fixed dividend
before any dividend is declared to the equity
holders.
Types of Preference Shares
1. Redeemable Preference Shares
• These shares are redeemed after a given period.
• A company may opt for redeemable preference
shares in order
 to avoid fixed liability of payment,

 to increase the earnings of equity shares, or
 to simplify the capital structure.
2. Irredeemable Preference Shares
These shares are non redeemable, except on the
occasion of liquidation of the firm.
3. Convertible Preference Shares
• Such preference shares can be converted to
equity shares at the option of the holder. Hence,
these shares are also known as quasi equity
shares.
• Conversion of preference shares in to bonds or
debentures is also permitted if the firm wishes
so.
The conversion feature makes preference shares
more acceptable to investors.
4. Participating Preference Shares
• Participative preference shares entitle its holders
to receive regular dividends at a fixed rate.
5. Cumulative Preference Shares
• Cumulative preference shares gives the holder, the
right to receive dividends that may have been
missed, or reduced, in the past.
• Firms may pay reduced dividends, or even halt
paying dividends for a time, and when they resume,
the cumulative preferred shareholders must receive
all the dividends in arrears, before holders of the
common shares can receive dividends once more.
6. Fully Convertible Cumulative Preference Shares
• These shares have two parts. The first part, gets
automatically converted into equity shares on the
date of allotment.
• The second part is redeemed at par or converted
into equity shares, after a lock in period at the
option of the investors.
Debentures
• They are an instrument used to raise long term
finances.
• Debentures could either be secured or unsecured.
• They are usually issued by private firms.
• At the time of liquidation of the firm, once the
bondholders are paid first, then comes the
number of debentureholders to receive their due.
• Debentures also have an option of converting
them into equity shares.
Types of debentures
1. Secured Debentures
• Debentures which create a charge on the
property of the firm are called secured
debentures.
• The charge may be floating or fixed.
2. Unsecured Debentures
• These are not protected through any charge by
any property or assets of the firm.
• Unsecured debentures are also known as naked
debentures.
• Well established and credit worthy firms can
issue such type of debentures.
3. Redeemable Debentures
• Redeemable debentures are those which have a
fixed date of maturity.
Once the date arrives, the debenture is called off
from the market and the principal amount is paid
back.
• The firm also has the right to call them before
maturity, if required.
4. Convertible Debentures
• Convertible debentures are those which provide
investors the option of getting a normal
debenture converted into equity shares, after a
certain period of time.
Bonds
• Bonds are financial instrument which highlight
the debt taken by the issuing authority towards
the holders.
• It is secured through collateral.
• Bonds are issued by financial institutions,
corporations or government agencies.
• At the time of liquidation, they receive priority,
before dealing with debentureholders’ money.
Basically there are two types of bonds viz.:
1. Government Bonds – are fixed income debt
instruments issued by the government to finance
their capital requirements (fiscal deficit) or
development projects.
2. Corporate Bonds – are debt securities issued by

public or private corporations that need to raise
money for working capital or for capital
expenditure needs.
Types of bonds
i. Zero Coupon Bonds
Zero Coupon Bonds are issued at a discount to
their face value and at the time of maturity, the
principal/face value is repaid to the holders. No
interest (coupon) is paid to the holders. The
difference between issue price (discounted
price) and redeemable price (face value) itself
acts as interest to holders. These types of
bonds are also known as Deep Discount Bonds.
ii. Mortgage Bonds
One of the most common bonds issued by
corporate firms.
Mortgage bonds are secured by physical assets of

the firm such as their building or equipment.
iii. Convertible Bonds
These type of bonds allow the bondholders to
convert their bonds into shares of stock of the
issuing firm.
Conversion ratio (number of equity shares in lieu

of a convertible bond) and the conversion price
(determined at the time of conversion) are pre-
specified at the time of bonds issue.
iv. Step-Up Bonds
A bond that pays a lower coupon rate for an
initial period which, then increases to a higher
coupon rate.
v. Callable and Non-Callable Bonds
If a bond can be called (redeemed) prior to its
date of maturity, the bond is said to be callable.
If a bond cannot be called prior to maturity, it is

said to be non-callable.
vi. Option Bonds
These type of bonds give the investors an option
to choose between cumulative or non-cumulative
bonds.
In the case of cumulative bonds interest is

accumulated and is payable on maturity only.
In non-cumulative type interest is paid

periodically.
vii. Bonds with Warrants
These are like ordinary bonds, except that they
are issued with warrants.
A warrant allows the holder to buy a number of

bonds at a pre-specified price in future.
Bonds are issued with warrants to make it more

attractive.
viii. Floating Rate Bonds
Floating rate bonds are bonds wherein the
interest rate is not fixed and is linked to a
benchmark rate.
That benchmark rate may either increase or

decrease depending on a number of inter related
factors.

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Valuation and Pricing

• They carry low risk whilst also providing higher interest

• Equity shares and preference shares are

• Creditorship securities are bonds, debentures etc.

 to avoid fixed liability of payment,

2. Corporate Bonds – are debt securities issued by

Mortgage bonds are secured by physical assets of

Conversion ratio (number of equity shares in lieu

If a bond cannot be called prior to maturity, it is

In the case of cumulative bonds interest is

In non-cumulative type interest is paid

A warrant allows the holder to buy a number of

Bonds are issued with warrants to make it more

That benchmark rate may either increase or

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