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3. Terminology in Equity & Debt Market

Terminology in Equity Market

1. Face Value (FV)– The face value of a share is the original cost of the share stated by the company, which usually does not change over time unless the company decides to split or consolidate its shares. In such cases, the face value of the company’s shares would reduce (in case of the split) or increase (in case of consolidation).
The face value of a share is important for calculating the dividend payable on a share. When a dividend is mentioned as a percentage, that percentage is reckoned with regard to the face value.

2. Book Value of a company is the net worth of the company. To compute book value per share, the net worth of the company is divided by the number of outstanding shares.

3. the market price of a share. The market value of the entire equity of a company is termed market capitalization and is computed as the market price per share multiplied by the total number of outstanding shares. The market value of a share depends upon a host of factors like the expected performance of the company, market sentiments, and liquidity, among others.

4. Replacement Value- This refers to the market value of all the assets of a company at any point in time. If a new company were to set up with all the infrastructure/plants, which an already existing company has, then the cost which it would have to bear today is known as the ‘Replacement Value of the existing firm.

5. Intrinsic Value- The intrinsic value of an asset is the value that it has based on its underlying fundamentals rather than its market price. Intrinsic value is subjective and can be determined by an individual investor’s analysis of a variety of factors, such as the asset’s cash flows, the strength of its balance sheet, its competitive advantages, and other qualitative and quantitative factors. The intrinsic value should not be confused with fair market value, which is the price an asset would fetch in the open market. Warren Buffett defines intrinsic value as “the present value of all expected future cash flows, discounted at an appropriate interest rate.”

6. Market capitalization is a measurement of the market value of a company based on its current share price and the total number of outstanding shares. It is used to determine the size of a company relative to its peers in the industry. It is calculated by multiplying the current stock price by the total number of outstanding shares. Market capitalization is an indication of a company’s financial strength and market power.

Blue-chip stocks usually have higher market capitalization than smaller companies. This is because blue chips often have more stable business models and larger customer bases, making them more attractive to investors. Additionally, larger companies often have access to more capital and resources, which can help them to compete in the market. Market capitalization is an important factor when assessing a company’s potential for growth and financial performance.

Mid-cap stocks are companies with a market capitalization of between $2 billion and $10 billion. These companies are typically established and well-known, but not as large as the blue-chip stocks. They may have an established customer base, but they often lack the resources of larger companies. Mid-cap stocks may be more volatile than blue-chip stocks, but they can also offer more potential for growth.

Small cap stocks are companies with a market capitalization of less than $2 billion. These companies are typically young and less established than larger companies. They are often more risky investments as they lack the resources and customer base of larger companies. They may offer greater potential for growth, but they also come with higher levels of risk.

7. Enterprise value (EV) is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Whereas market capitalization only considers a company’s equity, EV considers both equity and debt.

EV = Value of common equity + value of non-controlling interest + Value of preferred capital + Debt – cash, cash equivalents, and financial investments

8. Earnings can refer to historical, trailing, or forward earnings. Historical earnings refer to the reported or audited earnings of a company in the past. It is typically reported in a company’s financial statements and is used to measure the performance of a company over time. Trailing earnings refer to the most recently reported earnings of a company, usually from the last four quarters. They are typically used to evaluate the current performance of a company and to make predictions about future performance. Forward earnings refer to expected earnings for future quarters and are typically used to make projections about the future performance of a company.

9. Earnings per share (EPS) is a financial ratio that measures the portion of a company’s profit that is allocated to each outstanding share of common stock. It is calculated by taking the company’s reported profits divided by the total number of outstanding shares of common stock. EPS is an indicator of a company’s profitability and is often used to compare companies within the same sector. Investors use EPS to determine how much they should pay for a share of a company’s stock.

10. Dividend is generally declared as a percentage of the face value of the shares. It is the portion of the profit that the company distributes amongst its shareholders. For example, a 40% dividend declared by the company will translate into a dividend of Rs.4 per share with a face value of Rs 10 (10*40% =4). This is known as Dividend Per Share (DPS).

11. The price to earnings ratio (PE Ratio) is a ratio used to measure the value of a stock by comparing its current price to its earnings per share. It is calculated by dividing the current share price of a stock by its earnings per share (EPS). The ratio is used to compare the current market value of a company to its earnings and is seen as an indicator of the company’s profitability and potential future value. PE Ratios can be used to compare the performance of companies within the same industry or to the overall market.

12. Price to Sales ratio is a valuation ratio that measures the price investors are willing to pay for each rupee of sales. It is calculated as:

P/S Ratio = Current Market Price (CMP) / Annual Net Sales per Share
Or
P/S Ratio = Market capitalization / Annual Net Sales

13. The Price-to-Book Value Ratio (P/BV) is a valuation metric used to compare a company’s market value to its book value. It is calculated by dividing the current market price of a company’s stock by its book value per share. The P/BV ratio is a measure of the market’s expectations of a company’s future performance and gives investors an indication of the value of the company relative to its assets. A lower P/BV ratio indicates that the stock is undervalued, while a higher P/BV ratio indicates that the stock is overvalued.

14. Differential Voting Rights (DVR) is a type of corporate governance structure which allows companies to issue two types of shares with different voting rights. This structure is most commonly used in India and is beneficial for companies that want to list on a stock exchange but want to retain control. The structure allows promoters to hold a majority of the voting rights while still granting a certain amount of voting rights to public shareholders. DVRs are designed to give promoters greater control over the company while still allowing public shareholders to have some say in the company’s affairs.

Terminology in Debt Market

Debt capital refers to the capital provided by lenders who are keen to be compensated regularly in the form of a pre-specified fixed rate of interest. They also expect the money they have lent to be returned to them after an agreed period of time. Debt can be created by borrowing from banks and other institutions or by issuing debt securities. For example, if a company wishes to borrow Rs.100 crore, it has two options.

    1. Face Value-which represents how much the loan is represented by that particular debt paper. This is the nominal or par value of the debt paper and interest, throughout the term of the paper, is paid as a percentage of this amount. The face value may be Rs.100 or Rs.1000 or any other denomination.

    2. The coupon rate is the interest rate paid out by a bond issuer to a bondholder, expressed as a percentage of the bond’s face or par value. Coupon rates are fixed and do not change over the life of the bond. The coupon rate is also referred to as the bond yield.
    3. Maturity is the date on which a debt instrument, such as a bond, note, or loan, comes due and must be repaid by the issuer to the holder. Maturity dates vary based on the type of debt instrument, with some having maturities of as little as 30 days and others having maturities of several decades.
    4. The principal is the face value or original amount of money borrowed or lent, on which interest is calculated. In a loan, the principal is the amount of money borrowed and on which interest is paid; in a bond, it is the face value of the bond and on which interest payments are made to the bondholders.

    5. Redemption of a bond is the process by which a bond issuer repays the principal amount of the bond to the bondholder at the maturity date. The bond issuer will typically redeem the bond by paying the bondholder the face value of the bond plus any accrued interest. If a bond is called for early redemption, the bond issuer will typically redeem the bond at a price above the face value.

    6. Holding period returns (HPR) is the rate of return earned on an investment over a specific period of time. This rate of return includes both capital gains and income earned on the investment. HPR is calculated by subtracting the purchase price of the investment from the sale price and dividing it by the purchase price.

    7. The current yield is the annual income from a bond divided by the current market price of the bond. It is a measure of yield that takes into account the price of the bond and is expressed as a percentage. Current yield is often used to compare the yields of different bonds of the same quality. Suppose the 8.24GS2018 is trading at Rs. 104, the current yield would be: Current Yield = (8.24/104) = 0.07923 = 7.92%.

    8. Yield to Maturity (YTM)- Yield to Maturity or YTM is a more comprehensive and widely used measure of return calculation of a debt security than current yield. This method takes into consideration all future cash flows coming from the bond (coupons plus the principal repayment) and equates the present values of these cash flows to the prevailing market price of the bond.

      The YTM can be calculated by trial and error method by plugging in different rates in the equation and arriving at the one that equates the market price of bond to the present value of the expected cash flows from the bond. It can also be calculated using the XIRR function in
      Excel. The calculations are shown below for the HDFC 9.70% 2017 bond issued on 19 July 2007 and maturing on 19 July 2017 with annual payment of interest, assuming the bond is trading at Rs. 103 on Nov 1, 2014:

    9. Duration- Duration measures the sensitivity of the price of a bond to changes in interest rates. Bonds with high duration experience greater increases in value when interest rates decline and greater losses in value when rates increase, compared to bonds with lower duration.

    Duration is the weighted average maturity of the bond, where the present values of the future cash flows are used as weights. Duration thus incorporates the tenor, coupon and yield in its calculation

    10. Types of Bonds– Bonds are securities that represent a loan. For a loan to be completely defined, the loan amount, the time for which the loan is taken, and the rate at which it is taken, must be known. These three are known as Principal, Maturity, and Coupon respectively in bonds.

    ZeroCoupon Bond is a type of bond which does not make any coupon payments. It is sold at a deep discount from its face value, and the investor earns a return in the form of the difference between the purchase price and the face value. The face value is paid out at maturity. This type of bond is attractive to investors who don‘t need or want regular income, but are instead happy to receive a lump sum at maturity. 

    Floatingrate bonds are bonds which have a coupon rate that changes periodically based on an index or benchmark rate. The coupon rate on these bonds is reset periodically, usually every 6 months. This means that the coupon payments received by the investor are a function of the current interest rate environment. Floatingrate bonds are attractive to investors who want to benefit from a changing interest rate environment.

    Convertible bonds are bonds which can be converted into a predetermined number of the issuer‘s common stock. Convertible bonds are attractive to investors who believe that the issuer‘s stock will increase in value. Investors can benefit from the appreciation in the stock price, while still receiving the coupon payments from the bond. 

    Principal Protected Note (PPN) is a relatively complex debt product which aims at providing protection of the principle amount invested by investors, if the investment is held to maturity. Typically, a portion of the amount is invested in debt in such a way that it matures to the principal amount on expiry of the term of the note. The remaining portion of the original investment is invested in equity, derivatives, commodities and other products which have the potential of generating high returns. 

    Inflation Protected Securities (TIPS) TIPS are a type of bond that provides investors with protection from inflation. The principal amount of TIPS is adjusted for inflation or deflation based on the Consumer Price Index (CPI). This ensures that the investor‘s purchasing power is maintained in the long run. TIPS are attractive to investors who are concerned about the potential for inflation to erode their purchasing power in the future. 

    Foreign currency bonds are bonds denominated in a currency other than the investor‘s domestic currency. These bonds are attractive to investors looking to diversify their portfolios or hedge against currency risks. Foreign currency bonds also provide investors with the potential for higher returns as the foreign currency may appreciate against the domestic currency. 

    External bonds, also referred to as Euro bonds, are bonds issued in a currency that is different from the currency of the country in which it is issued. For example, if a company issues a US dollardenominated bonds in Kuwait, it would be referred to as a Euro bond as the currency of the bond (USD) is different from the currency of the country in which it is issued (Kuwaiti Dinar). 

    Perpetual bonds are bonds with no maturity date. These bonds typically have a coupon rate and make regular payments to the investor, but do not have a fixed maturity date. Perpetual bonds are attractive to investors who are looking for a steady stream of income, as the payments are not dependent on the maturity date.

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    Chart Source– Tradingview.com

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