## Capital market

Capital markets are place where investor buy and sell company and government securities with their trading decision reflecting information on company performance insight provided by financial analyst, dividend announcement by companies expectation on the future levels of interest rate and inflation the investment decision of financial managers and so on.

At both levels, companies and investor will want the capital markets to assign fair prices to the financial securities being traded.

In the language of corporate finance. Companies and investor want the capital markets to be efficient. It is possible to describe the characteristics of an efficient capital market by considering the relationship between market prices and the information available to the market.

Whether capital market are infact efficient has been studied extensively for many years.

Capital markets bring investor lender and firms (borrowing) together. Hence the financial manager has to deal with capital markets. He or she should fully understand the operations of capital market and the way in which the market value securities. He or she should also know-how risk is measured and how to cope with it in investment and financing decision.

For example, if a firm uses excessive debt to finance its growth investor many perceive it as risky. The value of the firm’s share may therefore decline. Similarly investor may not like the decision of a highly profitable growing firm to distribute dividend.

They may like the firm to reinvest profits in attractive opportunities that would enhance their prospects for making high capital gains in the future.

Investments also involve risk and return. It is through their operations in capital markets that investor continuously evaluate the actions of the financial manager.

Investor financial managers and capital market obtain a great deal of information about companies from their financial statements from financial database from the financial press, and so on.Through the application of ratio analysis financial statements can be made to yield useful information concerning the profitability, solvency performance, efficiency of operation and risk of individual companies.

This information will be used for example by investor when reaching decision about whether, and at what price to offer finance to companies by financial manager in making decisions in the key area of investment financing and dividend and by share holders making decision on which securities to add or remove from their portfolio.

The capital markets are markets for trading in long-term financial instrument or securities , but the most important ones for companies are ordinary shares or ordinary equity preference share and debt securities such as debenture, unsecured loan stock and convertible loan stock.

## For companies capital market have two main function.

1) They act as a means whereby long-term funds can be raise by companies from those with fund to invest such as financial institutions and private investment.

In the fulfilling this function they act as primary market for new issue of equity or debt.

2) Second function  capital provide a ready means for investor to sell their existing holdings of share and bonds or to increase their portfolios by buying additional ones.

Here, they act as secondary market for dealing in exciting securities. The secondary market plays an important role in corporate financial management, because by facilitating the ready buying and selling of securities it increase their liquidity and hence their value.

Investor would pay less for security that was difficult to dispose of.

The secondary market is also a source  of pricing information for the primary market, increasing the efficiency with which new funds are allocated.

## Foreign exchange market

The foreign exchange market where the currency of one country is exchanged for the currency of another country. Most currency transactions are channelled through the world wide. Interbank market is the whole sale market in which major banks trade with each other.

Forex market is a world wide market of an informed network of telephone, taler,satellite facsimile and computer, communication as between the forex market participants.

Which include banks, foreign exchange, dealers , arbitrageurs and speculators. The foreign market operates are guided by different motives when they deal in the foreign exchange market.

## Understanding of forex market

The foreign exchange markets in view of their critical role in overall growth and development of the economy. Particular in the transmission mechanism of  monetary policy.

The pace of reforms was contingent upon putting in place appropriate system and procedures, technologies and market practice. Initiatives taken by the Reserve bank have brought about a significant transformation of various segment of the financial markets. These developments by improving the depth and liquidity in domestic financial markets. Its contributed to better price discovery of interest rates and exchange rates.

The increase in size and depth and liquidity and freedom to market participants have also strengthened the integration of various segments of the financial market.

Increased integration not only leads to more efficient dispersal of risks across the spectrum but also increases the efficacy of monetary policy impulses.

Financial market reforms in India have enabled a greater integration of various segments of the financial market, reducing arbitrage opportunities, achieving higher level of efficiency of monetary policy in the economy.

### Integration of the foreign exchange market

The degree of integration of the foreign exchange market with other markets is largely determined the degree of openness.

In the Indian context the forward price of the rupee is not essentially determined by the interest rate differentials but is also significantly influence by

a) Supply and demand of forward US dollars

b)Interest differentials and expectation of future interest rates.

C) Expectations of future us-dollar rupee exchange rate.

##### Participants of foreign exchange market

1)Arbitrageurs- Arbitrageurs seek to earn risk less profit by taking advantage of differences in exchange rates among countries.

2)Traders- Traders engage in the export or import of goods to a number of countries. They operate in the foreign exchange market because exporters receive foreign currencies which they have to convert into local currencies .They purchase by exchanging the local currency. They also operate in the foreign exchange market to hedge their risk.

3)Hedgers- Multinational firms have their operation in a number of countries and their assets and liabilities are designed in foreign currencies. The foreign exchange rates fluctuations can cause diminution in the home currency value of their assets and liabilities.

They operate in the foreign exchange market as hedges to protect themselves against the risk of fluctuation in the foreign exchange rates.

4)Speculators- Speculators are guided purely by the profit motive.They trade in foreign currencies to benefit from the exchange rate fluctuations. They take risks in the hope of making profits.

#### Foreign exchange rates

A foreign exchange rate of two currencies ,we can find the exchange rate for the third currency.

1) Cross rate -Cross rate is an exchange rate between the currencies of two countries that not quoted against each other.

Currencies of many countries are not truly traded in the forex market. Therefore all currencies are not quoted against each other . Most currencies are quoted against the US dollar. The cross rates of currencies that are not quoted against each other can be quoted in terms of the US dollar.

2) Spot exchange rate- The spot exchange rate is the rate at which a currency can be bought a sold for immediately delivery. Delivery can be within two business days after the day of the trade. In the spot market, currencies are traded for immediate delivery within two days. Financial news papers generally provide information an exchange rates.

3) Bid-ask spread- The foreign exchange dealers are always ready to buy or sell foreign currencies.  The quotations are given as a bid-ask price.

The difference between the buying(bid) and selling(ask) rates is the forex operator’s,(say,bank) spread.

Bid ask spread is the difference between the bid and ask rates of a currency.It is based on the breadth and depth of the market for that currency and its volatility. This spread is a cost transaction in the foreign exchange market.It is computed as a given below.

Spread =$\frac{Ask&space;price-Bid&space;price}{Ask&space;price}$

4)Forward exchange rates- The forward exchange rate is the rate that is currency paid for the directory of a currency some future. In the forward market currencies are traded for the future delivery. In terms of the volume of currency transaction. The spot exchange market is much larger than the forward exchange market.

Forward rates (30 day,90 day or 180 day forward rates) for a few currencies are quoted in forex market. Most banks will however,quote currency forward rates to the traders.

## Systematic risk

Systematic risk arises an account of the economy-wide uncertainties and the tendency of individual securities to move together with changes in the market. Also known as market risk.This is the risk can not be reduced through diversification.

Investor are exposed to market risk. Even when they hold well-diversified portfolio of securities systematic risk of the security.It can not be diversified because like other securities it also moves with the market.

As mention in paragraph systematic risk is not diversifiable. Investor do not pay any premium for diversifying total risk via reduction in non-systematic risk.They can do on their own, cheaply and quickly.

Add in the last of part example of systematic risk.

->The government changes the interest rate policy. The corporate tax rate increased.

->The government result to massive deficit financing.

->The RBI promulgates a restrictive credit policy.

->The government relaxes the foreign exchange contracts and announces full convertibility of the Indian rupee.

->The government withdrawal tax on dividends payment by companies.

->The government eliminates reduces the capital gain tax rate.

All securities have some systematic risk, whether bonds or stocks.I have systematic risk directly compasses interest rate risk, market risk,and inflation risk. In this discussion, however the emphasis will be on the systematic risk of common stock.

In this case, systematic risk is that part of the variability correlated with the variability of the stock market as a whole.

## Measuring systematic risk.

A measure needed of this unavoidable systematic or nondiversifiable based on modern portfolio theory. The beta has emerged as such a measure. Beta’s usefulness as a measure of risk is briefly discussed here.

Beta is a relative measure of risk of an individual stock in relation to the overall market, as measure by the volatility of its returns by statistically relating the return for a security to the returns.

By statistically relating the returns for the stock market as whole (using a regression equation) it is possible to determine how the security’s returns move in relation to the market’s returns move  more( less) then the markets returns.

If the security’s returns move more(less) than the market’s returns. As  the latter changes, the security is said to be more (less) volatile than the market for example. A security whose returns rise or fall an average 15% when the market return rise or falls 10% is said to be volatile security.

Beta is the slope of the regression line relating a securities returns to those of the market. If the slope of this relationship for a particular security is a 45- degree angle. This means that for every 1% change in the market return, on average this security’s returns change 1%  if the line is higher, beta is higher,managing that the volatility( market risk) is greater

For Example, security A’s beta of 1.5 indicate that, on average security returns are 1.5 as volatile as market returns Both up and down. If the line is less steep than the 45 degree line beta is less than 1.0. This indicate that, on average, a stock’s returns have less volatility than the market as a whole. For example security c’s beta of 0.6 indicate that stock returns move up or down generally only 60% as much as the market as a whole.

The aggregate market has beta of 1.0. More volatile (risky) stock have betas small than 1.0 as a relative measure of risk, beta is very convenient if an investor is considering a particular stock and is informed that is beta 1.0,this investor can recognize immediately that the stock is very risky.

In relation to the average beta for all stock is 1.0 many brokerage houses and investment advisory services report betas as part of the total information given for individual stocks.

### Estimating systematic risk

Betas are estimated from historical data, regressing for the individual security against the for some market index. As result, the usefulness of betas will depend on, among other factors, the volatility of the regression equation. Regardless of how good the fit it, however beta is an estimate subject to errors.

It is important to note that most calculated betas are ex post betas. What is actually needed in investment decision is an ex ante beta measuring expected volatility.

The common practice of many investor is simply to calculate the beta for a security and assume it will remain constant in the future . A risky assumption in the case of individual securities similar to standard deviations portfolio betas often are quite stable across time whereas individual security betas often are notoriously unstable.

However, this is not an unfavorable outcome for investors because the basic premise of portfolio theory is the necessity of holding a portfolio of securities rather than only on or a few securities.

Substantive evidence has been presented that betas tend to move toward 1.0 overtime. Betas substantially larger( smaller) than 1.0 should tend to be followed by betas that are lower, and closer to 1.0 .

Thus, forecasted betas should be closer to 1.0 thus, forecasted betas should be closer 1.0 than the estimates based solely on historical data would suggest. Several models have been advocated for adjusting betas for this tendency to ” regress toward the mean. As a result it is not unused to find ” adjusted ” betas rather than historical betas.

## Beta

A measure is needed of this unavoidable systematic or non diversification risk. Based on modern portfolio theory, the beta has emerged as such as measure Beta’s usefulness as a measure of risk is briefly discussed here.

Beta is a relative measure of risk -the risk of an in individual stock in relation to the overall market. As measured by the volatility of its return. By statistically relating the returns for a security to the returns for the stock market as a whole. It is possible to determine how the security’s return move in relation to the market’s return move more(less) volatile than market.

For example a security whose returns rise or fall on average 15% when the market return rise or falls 10% is said to be volatile security.

Beta is the slope of the regression line relating a security’s returns to those of the market. If the slope of this relationship for a particular security is a 45 degree angle for security B beta is 100.

This means that for every 1% change in the market’s return,on average this security’s returns change 1%. If the line is higher. Beta is higher meaning that the volatility (market risk) is greater.

For example security A’s beta of 15 indicate that, on average security return are 1.5 times as volatile as market return both up and down.

If line is less steep than the 45 degree line. Beta is less than 1.0 this indicate that, on average a stock’s return have less volatility than the market as a whole.

For example, security’s beta of 0.6 indicates that stock returns move up or down generally only 60% as much as the market as whole.

In summary, the aggregate market has a beta of 1.0. More volatile(risky) stock have larger bets and lets volatile(risky) stocks have bets smaller than 1.0. As a relative measure of risk, beta is very convenient.

If an investor is considering a particular stock and is if informed that its beta is 1.9. This investor is considering a particular stock and is informed that its beta is 1.9.

This investor can recognize 7immediately that the stock is very risky. In relation to the average stock because the average beta for stock is 1.0.

Many brokerage house and investment advisory services report beta as part of the total information given for individual stock

Beta (estimating systematic risk)

Betas are estimated from historical data, regressing for the individual security against for the some market index. As a result, the usefulness of beta will depend among other factors the validity of the regression equation. Regression of how good the fit is, Beta is an estimate subject to errors.

It is important note that most calculated betas are ex post betas what is actually needed in investment decision is a beta measuring expected volatility.

The common practice of many investor is simply to calculate the beta for a security and assume it, will remain constant in the future, a risky assumption in the case of individual securities similar to standard deviations.

Portfolio betas after are quite stable across time whereas individual security betas often are notoriously unstable. However this is not an unfavorable  outcome for investor because the basic premise of portfolio theory is the necessity of holding a portfolio of securities rather than only one or a few securities.

One method of estimating beta is to employ the historical regression estimate but subjectively modify it for expected as known change. Infact, it is logical to begin the estimation of beta using the best estimate of the historical beta.

Substantive evidence has been presented that betas tend to move toward too over time. Betas substantially larger (smaller) then too should tend to be followed by betas that are lower(higher) and closer to 1.0 than the estimate based solely a historical data would suggest.

Several models have been advocated for advertising beta for this tendency to “regrets forward the mean”as result ,it is not unusual to find “adjusted” betas rather than historical betas.

Investor who obtain beta information from such sources are actually  using estimated betas.

## Government securities in India

The government securities market in the pre-reforms period was characterized by administered (and often artificially low) rates of interest the participants were captive investors due to high SLR requirements there was an absence of a liquid and transparent secondary market for G-sec resulting in the lack of a smooth and robust yield curve for pricing of the instruments.

The volume of debt expanded considerably,particularly short-term debt, due to automatic accommodation to the central government  by the reserve bank of the India, through the mechanism of ad hoc Treasury Bills with a captive investor base and interest below the market rate,the secondary market for government bonds remained dormant.Non market related yields on government securities affected the yield structure of financial assets in the system and led to higher lending rate.

The yield structure of the government securities.

A loan Carries a yield as a compensation for the loss of liquidity which ready money can provide.In an integrated market under equilibrium situation therefore,the yield on a loan should be a direct function of its liquidity and an index series of relative liquidity of different maturities should be nothing but the ratios of the reciprocal of such yield.

The market price of a loan need not be at par nor should the coupon rate have any definite relationship with its remaining terms to maturity the coupon was decided up on at the time.

## The concept of yield curve

In the market,there is nothing like the rate of interest, nor for that matter, is there anything like the long- term or the short term rate of interest.Each rate of interest is at least two-dimensional.It is related on the one hand to the type of asset or loan for which it is being quoted and on the other to its term to maturity.Thus at any point of time the whole system of interest rate in the market can be represented in the form of a set of vector of interest rates in such a way that each vector pertains to one particular asset and consist of rates quoted for that asset for different maturities.

One such vector of interest rate is called a term structure of interest rates-it is a set of interest rates that pertain, at any point of time t, to a given type of assets such that the rate differentials within this set are solely due to the differences in the  term to maturity.In the case of public debt,we have a term structure of yield rates-where yield refers to the yield to redemption inclusive of capital gain/loss.The theory of term structure of interest rates in such a term structure as also the rate differentials contained theirn.It does not explain,however,the rate differentials between different types of  assets of a given maturity.

### Shape of the Yield Curves

While the interest rate measure the price the borrower is agreed to pay for a loan, the yield or rate of return on the loan, from the lender’s point of view, may be quite different since it depends on the total rate of return on the transaction yield takes into account number of factors example change in market value of the security, default rate, deferring of payment etc.

The relationship between the rates of return or yield on financial instruments and their maturity is labeled the term structure of interest rates.The term structure of rates may be represented visually by drawing a yield curve for all securities of equivalent grade or quality.The yield curve consider only the relationship between the maturity or term of a loan and its yield at one moment in time, with all other factor held constant.

Yield Curves change their shape over time in response to change in the public’s interest- rate expectation,  fluctuations in the demand for liquidity in the economy, and other factors.

Sensitivity of the Yield Curve

This bring us to the question of the sensitivity of the yield curve to debt management operation and policies,the yield curve could be expected to be sensitive to such exogenous changes if

a)the market was a completely segmented one, or if

b)there were maturity habits in the market.

In the absence of a complete integration of the market, the authorities should be able to “twist the yield structure and thereby effect the relative liquidity of different maturities.The extent of such “twisting” ability of the authorities is a function of many factors including the constitution of the market,the expectation that the debt management policies generate in the market,the scale of operations and the sensitivity of the liquidity premiums to the level of the yield curve and so on.

#### Uses of the yield     curve

1)Forecasting interest rates-First, if the expectation hypothesis is correct the yield curve gives the investor a clue concerning the future course of interest rates.If the curve has an upward slope,the investor may be well advised to look  for opportunities to move away from bonds and other long term securities.A downward sloping yield curve, suggest the likelihood of near term decline in interest rates and a rally in bond prices.

2)Uses for financial intermediaries-The slope of the yield curve  is critical for financial intermediaries,especially commercial banks,saving and loan associations,and saving banks.A rising yield curve is generally favorable for the these institution because they borrow most of their funds by selling short-term deposits and lend a major portion of those funds long term.

The more steeply the yield curve slopes upward, the wider the spread between borrowing and lending rates and the greater the potential profit for a financial intermediary.

3)Indicating tradeoffs between maturity and yield-Still another use of the yield curve is to indicate trade-off between maturity and yield confronting the investor.

With an upward-sloping yield curve an investor may be able to increase a bond portfolio’s expected Annual yield by extending the portfolio’s average maturity.The investor must weigh the gain in yield from extending the maturity of his or her portfolio against added price,liquidity,and marketability risk.

4)Riding the yield curve-Finally ,some active security investor, especially dealers in government securities.have learned ti “ride” the yield curve for profit. If the curve is positively sloped,with slope steep enough to offset transaction costs from buying and selling securities,the investor may gain by timely .

## Inflation and interest rate(Fisher effect)

Inflation is defined as a rise in the  average level of prices for all goods and services.Some prices of individual goods and services are always rising,while others are declining.

However, inflation occurs when the average level of all prices in the economy rises.Interest rates represent the “price” of credit.

## The Nominal and Real Interest Rate

To examine the relationship between inflation and interest rates, several key terms must be defined.First, we must distinguish between nominal and real interest rates.The nominal rate is the published or quoted interest rate on security or laon.In contrast, the real rate of interest is the return to the lender or investor measured in terms of its actual purchasing power.In period of inflation,of course,the real rate will be lower than the nominal rate.Another important concept is the inflation premium, which measures the rate inflation expected  by investor in the marketplace during, the life of financial instrument.

These three concepts are all related to each other.Obviously,a lender of funds is most interested in the real rate of return on a loan.that is purchasing power of any interest earned.In general,lenders will attempt to charge nominal rates of interest which give them desired real rates of return on their loanable funds.And nominal interest rates will change as frequently as lenders alter their expectations regarding inflation.

### The Fisher Effect

In a classic article written just before the turn of the century,economist living fisher argued that the nominal interest rate was related to the rate by the following equation:

Nominal interest rate=(Real rate)+(Inflation premium)+(Real rate×Inflation premium)

The cross-product term in this equation is normally ignored because it is usually quite small.

Fisher argues that the real rate of return tends to be stable over time because it depends on such long-run factors as the productivity of capital and the volume of saving in the economy.Therefore, a change in the inflation premium is likely to influence only the nominal interest rate.The nominal rate will rise as the expected rate of inflation increases, and decline with a drop in expected inflation.For example,the real rate is 3 percent and the drop rate of inflation is 10 percent.Example,suppose the real rate is 3 percent and the expected rate of inflation is 10 percent.Then the nominal rate will be calculated as follows

Nominal interest rate= 3%+10%=13

According to Fisher’s hypothesis, if the expected rate of inflation now rises to 12 percent,the real rate will remain unchanged at 3 percent, but the nominal rate will rise to 15 percent.

If this view is correct, it suggests a method of judging the direction of future interest rate changes.To the extent that rise in the actual rate of inflation causes investor to expect greater inflation, in the future, higher nominal may causes investors to revise downward their expectation of future inflation, leading to lower nominal interest rates.

#### Another view on Fisher effect

The Fisher effect conflicts with another view of the inflation-interest rate phenomenon,developed originally by the British economist Sir Roy Harrod.It is based upon the liquidity preference theory of interest, Harrod argues that the real rate will be affected by inflation,but the nominal rate is determined by the demand for and supply of money.Therefore ,unless inflation affects either the demand for and supply of money,the nominal rate must remain unchanged regardless of what happens to inflationary expectations.

In liquidity preference theory,the real rate measures the real rate of interest.In liquidity preference theory,the real measures the inflation adjusted return on bonds. However,conventional bonds,like money,are not a hedge against inflation,because their rate of return is fixed by contract.

However,conventional bonds,like money,are not a hedge against inflation,because their rate of return is fixed by contract.Therefore,a rise in the expected rate of inflation lowers investors’ real return from holding bonds..While the nominal rate of return on bonds remains unchanged,the real rate is squeezed by expectations of rising prices.

While theories of interest rate determination typically assume there is a single interest rate in the economy,in point of fact there are thousand of different interest rates confronting investors at any one time.The investors must focus upon several factors the maturity or term of a loan,the risk of borrower default,and inflationary expectations.

## Efficient market

Market Efficiency implies that all known information is immediately discounted by all investors and reflected in share prices in the stock market. As such, no one has an information edge, in the ideal efficient market. As such, no one has information simultaneously, interprets it similarly, and behaves rationally. But, human beings what they are, this of course rarely
happens.

In such a world, the only price changes that would occur are those which result from new information. Since there is no reason to expect that information would be non-random in its appearance, the period-to-period price changes of a stock should be random movements, statistically independent of one another.
The efficient market will provide ready financing for worthwhile business ventures. Corporations that are poorly managed or producing obsolete products. Capital drain away from that market.
The requirements for a securities market to be efficient market are:-
1) To supply new inventories to the firm, prices must be efficient.
2) Across the nation information freely and quickly must be discussed. All investors can react to new information.
3)Transaction costs as sales commission on securities are ignored.
4) No noticeable effect on investment policy, taxes are assumed
5)Every investor is allowed to borrow or lend at the same rate and finally.
6)Investors must be rational and able to recognize efficient assets and that will want to invest money where it is needed most.

## Preference share

A preference share is a hybrid security, It combines some of the characteristics of debt and some of the equity. It represents a position of the ownership of the capital stock or equity interest.

## The terminology of preference share

Dividend-Preference share has dividend provision which is either cumulative or non-cumulative. Cumulative provision of dividend which means any dividend not paid by the company accumulates. The firm must pay these cumulative dividends prior to the payment of the common stock dividend.

An investor contemplating the purchase of preference shares with a non-cumulative dividend. Provision needs to be especially diligent in the investigation of the company because of the investor’s potentially weak position.

Participating preference share-Preference shares mostly non-participating. The preference shareholder receives only the stated dividend. It has surrendered claim to the residual earnings of his company in return for the right to receives his dividend.  Dividends paid to common shareholders.

Voting rights-Preference shares do not normally confer voting rights preference shareholders. Not allowing to vote is that they are in a relatively secure position.  They should not right to vote to expect in the special circumstances.

Convertible-Convertible means that the owner has the right to exchange a preference share for a share of the equity. The holder of convertible preference share usually has a stronger claim .the holder of an equity share to earnings and assets.
A company earnings increase, the convertible preference share will rise in value. The company might call preference share, the preference shareholder given the required number of days notice this will enable him to either convert into equity or sell the stock.

Par value- Most of the preference share has a par value at the dividend right. A call price usually stated in terms of the par value.

Sinking fund retirment-Preference share are often a certain percentage of earnings allocated for redemption each year. Sinking fund share called a lot or purchased in the open market.The owner of preference share called for sinking fund purposes must seek alternative investment.Sinking fund requirements reduce preference share outstanding which will give the remaining shares a strong income position.

### Features of preference share

The following are the features.
->Claims-Preference shareholders have a claim on assets and income prior to ordinary shareholders. Equity shareholders have a residual claim on a company’s income and assets. They are the legal owners of the company.

->Dividend-The dividends rate is fixed in the case of preference share. It may be issued with cumulative rights. In the case of equity shares neither the dividend rate known nor does dividend accumulate. Dividends paid on preference and equity shares are not taxed deductible.

->Redemption- Both redeemable and irredeemable preference shares have a maturity date while irredeemable preference shares are perpetual equity shares have no maturity to date.

->Conversion- A company can issue convertible preference shares. That is after a stated period. Such shares converted into ordinary shares.

#### Valuation of preference share

A company may issue two types of shares.
a)Ordinary shares
b)Preference shares

Preference shares have preference cover ordinary shares in terms of payment of dividend and repayment of capital. If the company is wound up. They issued with or without a maturity period.

Redeemable preference shares with maturity. Irredeemable preference shares are shares with maturity.

Irredeemable preference shares are shares without any maturity. The holders of preference shares get dividends at a fixed rate with regards to dividends. Preference shares get dividends at fixed rate with regard to dividends. It issued with or without cumulative features.

In the use of cumulative preference shares, unpaid dividends accumulate and are payable in the future. Dividends in arrears accumulate in the case of non-cumulative preference shares.

## Bonds

Investment media includes bonds and debentures. This form of investment needs of a risk avertor who is primarily interested in steady returns. Coupled with the safety of the principal sum.
Definition of bond
A debenture is a legal document containing an acknowledgment of indebtness by a company. It contains a promise to pay a stated rate of interest for a defined period. Repay the principal at a given date of maturity.
Bond is a formal legal evidence of a debt and are termed as the senior securities of a company.

## Why issuing bonds

The government has no choice but he borrows when they are unable to meet their express from the current revenue corporation. On the other hand, have a wider choice in the matter of financing their operation. Retained earnings, new equity issues, etc. They still prefer to go in for borrowing for the following reason.

1) To reduce the cost of capital ->Bonds are the cheapest source of financing. A corporation is willing to incur the risk of borrowing in order to reduce the cost of capital. Financing a portion of its assets with securities bearing a fixed rate of return of increasing the ultimate return to the equity holder.

2)To gain the benefit of leverage->Presence of debt and preference share in the company’s financial leverage. When financial leverage is used changes in earnings before interest and tax(EBIT) translate into the larger changes in earning per share. If EBIT falls and financial leverage is used the equity holders endure negative changes in EPS that are larger than the negative decline in EBIT.

3)To effect tax-saving-> The interest on bonds is deductible in figuring up corporate income for tax purposes, Hence the Eps increase. If the financing is through bonds rather than with preference or equity share.

4) To wider, the source of a funds->The corporation can attract fund from individual investor and especially from those investing institutions which are reluctant or not permitted to purchase equity share.

5)To preserve control->An increases in debt does not diminish the voting power of present owners since bonds ordinarily carry no voting right.

### Types of Bonds

1) Sinking fund bonds->Sinking fund bonds arise when the company decides to retire its bond issue systematically by setting aside a certain amount each year for the purpose.This person the users the money to call the bonds annually at some call premium or to purchase then or the open market if they are selling at discount.

2)Mortgage or secured bonds ->The term mortgage generally refers to a lien on real property or buildings mortgage bonds may be an open-end close end and limited open-end. An open-end mortgage means that a  corporation under the mortgage may issue additional bonds.
In close end mortagage the company agrees to issue at one time a stated amount of bonds.
In a limited open-end mortagage.The indenture provides that corporation may issue a stated amount of bonds over a period of years in series.

3)A convertible and non-convertible bonds->A convertible bond is a cross between a bond and a stock.The holder can at his option convert the bonds into a predetermined number of shares of common stock at a predetermined price. In all convertible bonds, the indenture contract specifies the term of conversion and the period during which the conversion privilege can be exercised.

4)Serial bonds->Serial bonds are appropriate for companies that wish to divide their issues into a series each point of the series maturing at a different time ordinarily the bonds are not callable and the company pay each part of the series as it matures.|

5)Collateral trust bonds->Collateral trust issues are secured by a pledge of intangibles usually in the form of stocks and bonds of a corporation collateral trust issue are thus secured by
a)Shares, representing ownership incorporation.
b)Bonds, representing the indirect pledge of assets or a combination of both, usually, the pledged securities are those of other corporations. The shares pledged frequently represent a contract of a subsidiary corporation and such control often materially adds to or detracts from the intrinsic value of collateral issues secured thereby.

6)Convertible and Non-convertible bonds-Convertible bonds can be one of the finest holdings for the investor looking for both appreciations of investment and income of bonds. A convertible bond is a cross between a bond and a stock. Convert the bond into a predetermined number of shares of common stock at a predetermined price.

7)Income bonds->Income bonds on which the payment of interest is mandatory only to the extent of current earnings.If earnings are sufficient to pay only a portion of the interest that portion usually required to be paid. Income bonds are not offered for sale as new financing but are often issued in reorganization or recapitalization to replace other securities.

8)Adjustment Bonds->Adjustment issued in the reorganization of companies in financial difficulties. In practically all cases, interest is payable only if earning permits. They are the leading type of income bond.

9)Assumed bonds->Assumed bonds issued in the reorganization of companies in financial difficulties. In practically all cases, interest is payable only if earning permits. They are a leader type of income bond.

10)Adjustment bonds->Adjustment bonds issued in the reorganization of companies in financial difficulties. In practically all cases interest is payable only if earning permit. They are lading types of income bonds.

11)Joint bonds->Joint bonds are loan certificates that is jointly secured by two or more companies,two companies that use a common facility, and have raised money to finance. It through the sale of debt would provide a good example of a situation where the bonds might jointly secure.

12)Guaranteed bonds->Bonds may be guaranteed by a firm other than the debtors. Some guarantors assure payment of both principal and interest only. A guaranty or lease contract will add assurance to a bond if the guarantor or lessee is financially strong.

13)Redeemable and irredeemable bonds->A redeemable debenture is a bond which issued for a certain period on the expiry of which its holder will be repaid the amount thereof with or without premium. A bond without the redemption period is termed as an irredeemable debenture.

14)Participating bond->Companies with poor credit position issue participating bonds. They have a guaranteed rate of interest but may also participate in earning up to an additional specified percentage.

## Active equity management

The security analyst always faced with the problem of buy hold or sell decision.He/she must evaluate the past performance of the security for forecasting the future performance.

Valuation of preference share and bond is straight forward because return generally constant and certain.Equity valuation is different because return on equity is uncertain and it can change time to time.therefore analysis and forecasting of equity is crucial.Stock market is not totally efficient.

Active Equity investment style:
Active equity management has two styles top-down and bottom-up.In top-down equity management style begins with overall  economic environment forecasting near term outlook and make a general asset allocation decision.Top-down managers analyses the stock market is an attempt to identify economic sector after identifying attractive and unattractive sectors and industries top-down managers finally select a portfolio of individual stock.

Bottom-up equity management style:
In bottom-up styles managers focuses analysis of individual security instead economic and environmental analysis using financial analyst or computer screening bottom-up managers analyses company performance ratio analysis,price earning ratio other financial ratio,management efficiency.