Chapter 3: Terminology in Equity and Debt Markets – Outline
| Section | Topic | Description |
|---|---|---|
| 3.1 | Terminology in Equity Market | Explains key equity terms like face value, book value, market capitalization, dividend yield, and more. |
| 3.2 | Terminology in Debt Market | Covers core debt-related terms such as coupon rate, maturity, yield to maturity (YTM), accrued interest, and credit rating. |
| 3.3 | Types of Bonds | Describes classifications of bonds: fixed-rate, floating-rate, zero-coupon, convertible, inflation-indexed, green, etc. |
3.1: Terminology in Equity Market
The equity market uses a variety of financial terms that help investors understand company valuation, returns, ownership, and risk. Below is a detailed explanation of the 14 most important terms in equity market analysis.
1. Face Value
Face value is the nominal value of a share, fixed at the time of issue by the company. Common face values in India include ₹1, ₹2, and ₹10. It plays a role in calculating dividend payouts and is used for accounting purposes, not for trading valuation.
Example: A stock with a face value of ₹10 and a market price of ₹120 means the shareholder owns equity worth ₹120 for a nominal value of ₹10.
2. Book Value
Book value indicates the value of a company’s assets after deducting liabilities. It reflects the net worth of the company per share.
Formula: Book Value = (Total Assets – Total Liabilities) / Total Outstanding Shares
Example: If total assets are ₹10 crore and total liabilities are ₹4 crore with 1 crore shares, then Book Value = ₹6/share.
3. Market Value
Market value is the current price at which the share is trading in the market. It represents what investors are willing to pay at that moment.
Example: If the market price of a share is ₹150, this is its market value irrespective of the face or book value.
4. Replacement Value
The amount it would cost to replace a company’s assets at current market prices. It reflects what it would cost to rebuild the business from scratch using the current cost structure.
Example: If machinery cost ₹10 crore ten years ago and today the same setup costs ₹15 crore, then the replacement value is ₹15 crore.
5. Intrinsic Value
The perceived or calculated true value of a stock based on fundamentals. It is often estimated through discounted cash flow (DCF) or other models.
Example: A stock trading at ₹120 might have an intrinsic value of ₹140 based on future cash flow expectations, indicating it is undervalued.
6. Market Capitalization
The total value of a company’s outstanding equity shares based on current market price.
Formula: Market Cap = Current Share Price × Total Outstanding Shares
Example: ₹200 (share price) × 1 crore shares = ₹200 crore market cap.
7. Enterprise Value (EV)
Enterprise Value is the theoretical takeover cost of a company. It includes market cap, debt, and minority interest, minus cash and cash equivalents.
Formula: EV = Market Cap + Debt – Cash
Example: Market Cap = ₹200 crore, Debt = ₹50 crore, Cash = ₹20 crore ⇒ EV = ₹230 crore.
8. Earnings
The net profit a company earns after taxes. Earnings are essential in assessing profitability and are the basis for calculating EPS and valuation ratios.
Example: If a company earns ₹5 crore in net profit, this figure is used to determine its earnings-based metrics.
9. Earnings Per Share (EPS)
EPS indicates the portion of a company’s profit allocated to each outstanding share.
Formula: EPS = Net Profit / Total Outstanding Shares
Example: ₹5 crore profit and 1 crore shares ⇒ EPS = ₹5.
10. Price to Earnings (P/E) Ratio
This valuation metric shows how much the market is willing to pay for each rupee of earnings.
Formula: P/E Ratio = Market Price per Share / EPS
Example: ₹100 market price / ₹5 EPS = P/E of 20.
11. Dividend per Share (DPS)
The amount of dividend paid on each share during a financial year.
Example: If the company pays ₹2 crore in dividends and has 1 crore shares, then DPS = ₹2.
12. Price to Sales Ratio (P/S)
Indicates how much investors are paying for every rupee of the company’s sales.
Formula: P/S = Market Capitalization / Total Sales
Example: Market Cap = ₹200 crore; Sales = ₹100 crore ⇒ P/S = 2.
13. Price to Book Value (P/BV)
This ratio compares the market price of a stock with its book value. It reflects how much investors are willing to pay relative to company’s net assets.
Formula: P/BV = Market Price / Book Value per Share
Example: Market Price = ₹100; Book Value = ₹50 ⇒ P/BV = 2.
14. DVR (Differential Voting Rights)
DVR shares are like ordinary equity shares but with lower voting rights. To compensate, they are often issued at a discount or offer higher dividends.
Example: A DVR share may have 1/10th of voting rights but offer 5% higher dividend than regular shares.
3.2: Terminology in Debt Market
The debt market comprises instruments like bonds and debentures that represent borrowed capital. Below are the key terms used to evaluate and understand debt instruments:
1. Face Value
The nominal value of a bond or debt instrument mentioned on the certificate. It is the amount that will be repaid to the bondholder at maturity.
Example: A bond with face value ₹1,000 will repay ₹1,000 at maturity regardless of the purchase price.
2. Coupon Rate
The fixed interest rate paid by the issuer on the face value of the bond. It determines the annual interest income.
Formula: Coupon = (Coupon Rate × Face Value)
Example: A 10% coupon on ₹1,000 = ₹100 annual interest.
3. Maturity
The date on which the principal amount (face value) is repaid to the investor. Debt instruments can have short-, medium-, or long-term maturities.
Example: A bond with a 5-year maturity will repay principal after 5 years.
4. Principal
The original sum invested or the face value of the debt instrument which will be returned at maturity.
Example: If you buy a ₹10,000 bond, that ₹10,000 is the principal.
5. Redemption of a Bond
Redemption is the process of returning the principal to the bondholder at maturity. Early redemption may occur through call/put options.
Example: A bond redeemed on its maturity date is a normal redemption.
6. Holding Period Return (HPR)
The total return (income + capital gains) earned from holding the bond over a specific period.
Formula: HPR = [(Coupon + Price Change) / Initial Price] × 100
Example: Buy at ₹950, sell at ₹1,000, receive ₹50 coupon ⇒ HPR = [(50 + 50)/950] × 100 ≈ 10.5%
7. Current Yield
The annual return from a bond based on its current market price and coupon income.
Formula: Current Yield = (Annual Coupon / Market Price) × 100
Example: ₹100 coupon / ₹950 market price = 10.53%
8. Yield to Maturity (YTM)
The total return anticipated if the bond is held till maturity. It considers the present value of future coupon payments and principal repayment.
YTM is calculated using a trial-and-error or financial calculator method.
Example: A bond purchased at ₹950 with a ₹100 coupon and ₹1,000 redemption value may have a YTM around 11.1%.
9. Duration
Duration measures a bond’s sensitivity to changes in interest rates and indicates the average time (in years) to receive cash flows from the bond.
Example: A bond with a duration of 5 years will lose about 5% in value if interest rates increase by 1%.
3.3: Types of Bonds
Bonds can be categorized based on features like coupon, issuer type, convertibility, and risk characteristics. Here’s a closer look at the common types of bonds in the debt market:
1. Zero Coupon Bonds
These bonds do not pay periodic interest. Instead, they are issued at a discount to face value and redeemed at full value on maturity. Investors earn returns from the difference between issue price and redemption value.
Example: Issued at ₹800 and redeemed at ₹1,000 after 5 years.
2. Floating Rate Bonds
The coupon rate of these bonds is not fixed. It is linked to a benchmark rate (e.g., repo rate, LIBOR), and it fluctuates over time based on market conditions.
Example: Coupon = Repo rate + 1%. If repo rate = 6%, bond pays 7%.
3. Convertible Bonds
These bonds can be converted into equity shares of the issuing company at a later date, usually at a pre-decided price and ratio. Investors benefit from both debt returns and potential equity appreciation.
Example: 1 bond = 10 equity shares after 3 years.
4. PPN (Principal Protected Note)
A structured financial product that protects the principal investment while offering returns linked to equity or other asset performance. These are often used by conservative investors seeking market exposure with limited risk.
5. Inflation-Protected Securities
These bonds provide protection against inflation by adjusting the principal or coupon with inflation indices like CPI. Returns maintain real purchasing power.
Example: A ₹1,000 bond adjusted for 5% CPI becomes ₹1,050 principal in the next year.
6. Foreign Currency Bonds
Bonds issued in a currency different from the issuer’s domestic currency. These are used to raise funds from international markets and carry currency risk for both issuers and investors.
Example: An Indian firm issues a bond in USD to global investors.
7. External Bonds (Masala Bonds)
Rupee-denominated bonds issued outside India. The issuer bears the currency risk, not the investor. They allow Indian companies to access overseas capital markets.
Example: Issued in London, payable in INR.
8. Perpetual Bonds
These bonds have no maturity date. Issuers pay interest forever, and the principal is never repaid unless recalled. They are considered hybrid instruments with features of both equity and debt.
Example: Issuer pays 8% interest yearly forever unless it chooses to call the bond.
