📘 4.1 Warrants
📌 Definition
Warrants give investors the right to buy shares of a company at a pre-determined price in the future. The number of shares and the exercise price are specified at the time of the warrant’s issuance. Warrants may be traded as a separate security on the stock exchange.
💡 Key Features of Warrants
📅 Exercise of Warrants
Warrants are exercised when the market price of the share exceeds the exercise price. If the share price is lower, the investor can choose to buy the shares from the market instead.
Example: If a warrant allows purchasing shares at ₹100 and the market price is ₹120, the warrant is exercised.
🔗 Long-Term Investment
Warrants typically have a longer lifetime than options and may be exercised at a future date. They provide flexibility to the investor while being linked to the underlying company’s growth.
📊 Benefits of Warrants
📈 Capital Appreciation
If the company’s share price increases significantly, the warrant holder can benefit from capital appreciation by exercising the warrants at the pre-determined price.
📉 Limited Downside
Warrants allow investors to gain upside potential with limited downside risk, as they are only exercised if beneficial to the holder.
📝 Example of Warrants
For example, an investor has a warrant to buy shares of a company at ₹100 each. If the share price rises to ₹150, the investor can exercise the warrant and buy the shares at ₹100, realizing a ₹50 profit per share. If the share price is below ₹100, the investor would let the warrant expire or choose not to exercise it.
⚖️ Regulations and Guidelines
Warrants are regulated by SEBI, and their issuance is subject to approval by shareholders. SEBI guidelines include requirements for upfront payment and a lock-in period for conversion.
📘 4.2 Convertible Debentures
📌 Definition
Convertible debentures are debt instruments that can be converted into equity shares of the company at a future date. These securities combine features of both debt and equity. They pay periodic coupon interest just like any other debt instrument, but at redemption, the investor can choose to receive equity shares instead of cash.
🔑 Features of Convertible Debentures
📅 Conversion Date
The issuer specifies the date on which the debenture will be converted into equity shares. This can be a specific date or based on a predefined schedule.
🔢 Conversion Ratio
The ratio determines how many shares an investor will receive for each debenture upon conversion. This is typically set by the company at the time of issuance.
💸 Conversion Price
📉 Price at Conversion
The price at which shares are allotted upon conversion is usually at a discount to the market price. This provides an incentive for the investor to convert the debentures into equity.
🔄 Fully or Partly Convertible
Convertible debentures can be fully or partly converted into equity. If fully converted, all the debenture principal is exchanged for shares. Partly convertible debentures (PCDs) allow only a portion of the principal to be converted into shares.
📈 Advantages of Convertible Debentures
📉 Low Coupon Rate
Convertible debentures typically offer a lower coupon rate than regular debt instruments. Investors are willing to accept this lower rate due to the potential upside from capital appreciation once the debentures are converted into equity.
📈 Cash Flow Savings
For the issuer, convertible debentures offer a cash flow advantage. Instead of repaying the principal in cash at maturity, the issuer issues shares, saving on cash outflows.
💡 Example:
For instance, an investor holds a convertible debenture that can be converted into equity shares at ₹100 per share, when the market price is ₹150. The investor is incentivized to convert the debenture into equity, receiving shares at a discount, while the company saves on cash outflows by issuing shares instead of repaying the principal in cash.
⚖️ Shareholding Dilution
When convertible debentures are converted into equity, the existing shareholders’ stake gets diluted, as new shares are issued. As a result, convertible debentures are usually issued with shareholder approval, often through rights issues.
📜 SEBI Regulations
The issuance of convertible debentures is governed by SEBI regulations. These regulations ensure that the conversion terms are fair and transparent for both issuers and investors.
📘 4.3 Depository Receipts
📌 Definition
Depository Receipts (DRs) are financial instruments that represent shares of a local company, but are listed and traded on a stock exchange outside the country. DRs provide an opportunity for overseas investors to invest in companies that are not listed in their home country.
DRs are issued in foreign currency, usually in US Dollars, and allow investors to gain access to foreign companies without directly purchasing their local stocks. DRs can be converted into equity shares based on the terms of the issuance.
💡 Types of Depository Receipts
🇺🇸 American Depository Receipts (ADRs)
ADRs are DRs listed on US stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ. These allow investors in the US to invest in foreign companies.
🌍 Global Depository Receipts (GDRs)
GDRs are DRs listed on any stock exchange outside the USA. They provide an international platform for foreign companies to raise capital globally.
🇮🇳 Indian Depository Receipts (IDRs)
💡 What are IDRs?
IDRs are DRs listed on stock exchanges in India with foreign stocks as the underlying shares. They provide Indian investors access to foreign company shares in the Indian market.
📜 Requirements for IDRs
- Compliance with the listing requirements of Indian stock exchanges
- Approval from market regulators
- Appointment of a depository bank to hold and issue DRs
🔑 Benefits of DRs
🌍 Global Investor Base
DRs allow companies to access a wider investor base from international markets. Investors gain easy access to foreign companies’ shares.
💵 Dividend & Capital Appreciation
Holders of DRs are entitled to dividends and capital appreciation from the underlying shares, but they do not have voting rights.
💡 Example:
A company like Infosys may issue ADRs in the US, allowing US investors to buy shares in Infosys without directly trading on the Indian stock market. Similarly, a company based in the UK may issue GDRs, allowing investors in various countries to invest in it.
📜 Steps to Issue DRs
The process for issuing DRs involves the following steps:
- The company must meet the listing requirements of the stock exchange and market regulators.
- A depository bank is appointed to hold the underlying shares and issue DRs.
- If the DR issuance is sponsored, shares from existing shareholders are acquired; otherwise, new shares are issued for the DRs.
- Once shares are confirmed by the custodian bank, the DRs are issued to brokers for trading on the exchange.
📘 4.4 Foreign Currency Convertible Bonds (FCCB)
📌 Definition
Foreign Currency Convertible Bonds (FCCBs) are bonds issued by Indian companies to investors in foreign currencies. They carry a fixed interest rate or coupon and are convertible into ordinary shares at a predetermined price, providing a hybrid form of financing combining debt and equity features.
💡 Key Features of FCCBs
💵 Fixed Coupon
FCCBs offer a fixed interest rate or coupon, providing regular income to investors until conversion or maturity. The interest payments are made in foreign currency.
🔄 Conversion to Equity
FCCBs can be converted into equity shares at a predetermined price, usually set at a premium to the current market price of the shares at the time of issuance.
📊 Advantages of FCCBs
📉 Lower Interest Rates
Since the bonds are convertible into equity, companies can raise debt at lower interest rates compared to traditional debt instruments, as investors are compensated with the potential for capital appreciation through conversion.
💡 Cash Flow Protection
FCCBs protect the company’s cash flows, as the repayment of debt may be made through the conversion of bonds into equity, reducing the need for cash outflows at maturity.
📜 Regulatory Framework
FCCBs are regulated by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act (FEMA). The issue of FCCBs must comply with RBI guidelines, including limits on issuance and conversion.
💡 Example:
An Indian company issues FCCBs to raise $10 million, with a coupon rate of 5% and a conversion price of ₹200 per share. The company uses this capital to fund expansion. After 5 years, the bondholders may choose to convert their bonds into equity at the conversion price if the market price of the shares is higher than ₹200.
📘 4.5 Exchange Traded Funds and Index Funds
📌 Definition
Exchange Traded Funds (ETFs) are a type of mutual fund listed and traded on a stock exchange. ETFs are passive funds that mirror the returns of an index or benchmark. Unlike actively managed funds, ETFs do not use investment strategies to outperform the market.
Index Funds are also passive funds, but unlike ETFs, they are not traded on stock exchanges. They aim to replicate the performance of a market index by investing in the same securities in the same proportions as the index.
🔍 Key Differences Between ETFs and Index Funds
📈 ETFs
- Traded on stock exchanges like individual stocks
- Track the performance of a specific index or benchmark
- Low-cost investment option
- Offer intra-day trading with real-time NAV (Net Asset Value)
📊 Index Funds
- Not traded on exchanges
- Track the performance of a market index
- Invest in a portfolio replicating the index
- Trading at end-of-day NAV (Net Asset Value)
📋 Comparative Summary of ETFs, Index Funds, and Mutual Funds
📑 Open-ended Mutual Funds
- Flexible unit capital
- Daily NAV
- Fund as liquidity provider
- Transactions based on NAV price
- Monthly portfolio disclosure
📑 Close-ended Mutual Funds
- Fixed unit capital
- Daily NAV
- Stock market as liquidity provider
- Transactions at significant premium/discount to NAV
- Monthly portfolio disclosure
📑 Index-based ETFs
- Flexible unit capital
- Real-time NAV
- Fund and stock market as liquidity provider
- Possible intra-day trading at low costs
- Low-cost investment options
💡 Example:
Index-based ETFs, like the Nifty 50 ETF, track the performance of the Nifty 50 index. Investors can buy shares of this ETF on the stock exchange, and its price fluctuates throughout the trading day based on the underlying assets in the index.
📘 4.6 Investment Trusts
📌 Definition
An Investment Trust pools the funds of investors/shareholders and invests them in a diversified portfolio of securities. Typically, these are closed-ended funds that can be traded on a stock exchange. In India, two types of investment trusts operate under SEBI regulations.
💡 Types of Investment Trusts
🏢 Real Estate Investment Trusts (REITs)
REITs are trusts registered with SEBI that invest in commercial real estate assets. They raise funds through initial offers, follow-on offers, rights issues, and institutional placements. The total value of assets in a REIT’s initial offer must be at least ₹500 crore.
🏗️ Infrastructure Investment Trusts (InvITs)
InvITs are trusts also registered with SEBI, but they focus on investments in the infrastructure sector. They raise funds through public offerings, with the value of proposed assets needing to be at least ₹500 crore, and the minimum subscription amount between ₹10,000 and ₹15,000.
📊 Key Features of Investment Trusts
📅 Fundraising Process
Both REITs and InvITs raise funds through initial public offerings (IPOs) and follow-up placements. The minimum subscription amount in both cases ranges between ₹10,000 and ₹15,000.
📈 Asset Value
The total value of assets owned or proposed to be owned by a REIT or InvIT must meet certain minimum thresholds, ensuring that the fund is of substantial size and can attract adequate investment.
📈 Example:
For example, a REIT may issue units through an IPO where the funds will be used to acquire commercial real estate. The value of these assets should not be less than ₹500 crore, and the minimum amount that an investor can subscribe to is ₹10,000.
