BONDS

DERIVATIVES :
Derivatives are nothing but a kind of security whose price or value is
determined by the value of the underlying variables. It is more like a
contract of future date in which two or more parties are involved to
alleviate future risk. Usually, derivatives enjoy high leverage. Its value
is affected by the volatility in the rates of the underlying asset. Some
of the widely known underlying assets are:

 Indexes (consumer price index (CPI), stock market index,

weather conditions or inflation)
 Bonds
 Currencies
 Interest rates
 Exchange rates
 Commodities
 Stocks (equities)

TYPES OF DERIVATIVES :
The range of derivatives is really wide. But some of the most
commonly derivatives known as :

Forwards-This is a tailor-made contract between two parties. In case

of this contract, a settlement is done on a scheduled future date at
today's pre-decided rate is known as forward contract in derivatives.

Futures-When two entities decide to purchase or sell an asset at a

given time in the future at a given price, it is called futures contract.
Futures contracts can be said to be a special kind of forward
contracts, as they are customized exchange-traded agreements.

Options-It is of two different kinds such as calls and puts. Those who
take calls option, they are not obligated to purchase given quantity of
the underlying variable, at a mentioned price on or prior to a
BONDS
scheduled future date. On the other hand, buyers in case of puts
option may not necessarily sell a mentioned quantity of the underlying
variable at a mentioned price on or prior to a given date.

Swaps-These are private contracts between two entities to deal in

cash flows in the future following a pre-decided formula. They are
somewhat like forward contracts' portfolios. Swaps are also of two
types such as interest rate swaps and currency swaps.

Interest rate swaps-in this case, only interest related cash flows can
be exchanged between the entities in one currency.

Currency swaps-in this case of swapping, principal and interest can

be exchanged in one currency for the same in other form of currency.

IMPORTANCE OF SWAPS
Financial transactions are fraught with several risk factors. Derivatives
are instrumental in alienating those risk factors from traditional
instruments and shifting risks to those entities that are ready to take
them. Some of the basic risk components in derivatives business are:

 Credit Risk: When one of the two parties fails to perform its role
as per the agreement, this is called the credit risk. It can also be
referred to as default or counterparty risk.
 Market Risk: This is a kind of financial loss that takes place due
to the adverse price movements of the underlying variable or
instrument.
 Liquidity Risk: When a firm is unable to devise a transaction at
current market rates, it can be referred to as liquidity risk. There
are two kinds of liquidity risks involved in the scenario. First is
concerned with the liquidity of separate items and second is
related to supporting the activities of the organization with funds
comprising derivatives.
 Legal Risk:Legal issues related with the agreement need to be
scrutinized well, as one can deal in derivatives across the
different judicial boundaries.
BONDS
BONDS
Bonds are debt instruments that are issued by companies,
municipalities and governments to raise funds for financing their
capital expenditure. By purchasing a bond, an investor loans money
for a fixed period of time at a predetermined interest rate. While the
interest is paid to the bond holder at regular intervals, the principal
amount is repaid at a later date, known as the maturity date. While
both bonds and stocks are securities, the principle difference between
the two is that bond holders are lenders, while stockholders are the
owners of the organization.

Types of Bonds
The main types of bonds are:

 Government Bonds: These are fixed-income debt securities

issued by the government. Government bonds are further categorized
on the basis of the term (maturity duration). (a) Government Bills:
These are government bonds with a maturity period of less than one
year. (b) Government Notes: These are government bonds with a
maturity period from one year to ten years. (c) Government Bonds:
These are government bonds with a maturity period that exceeds ten
years.
 Municipal Bonds: These are debt securities issued by state
governments and their agencies. The interest is exempt from federal
income tax or local tax.

 Corporate Bonds: These are debt instruments issued by a

company and backed by its ability to generate profits or by the current
value of its physical assets.
BONDS
How Bonds Trade
Bond trading is usually done through bond dealers and can take place
anywhere where a buyer and seller strike a deal. Unlike for equities,
there is no exchange for bond trading, which mostly takes place in an
'over-the-counter' market. The exceptions for this are certain corporate
bonds, particularly in the US, that are listed on an exchange.
Moreover, derivatives, such as bond futures and certain bond options,
are traded on exchanges.

Bond Price Variations

A bond's price refers to the amount investors are willing to pay for an
existing bond. The bond’s price is important if you wish to trade the
bond with another investor. The main factors that impact bond prices
are:

 Interest rate: When interest rates in the market rise, newly

issued bonds become more lucrative (offer higher yields). This
makes existing bonds less competitive and exerts pressure on
the price of existing bonds. Thus interest rates and bond prices
move in opposite directions.
 Inflation: High inflation erodes the value of the return that is
earned when the bond matures. Thus inflation and bond prices
also move in opposite directions.
 Financial health of the issuer: The financial health of the
company or government that has issued the bond impacts bond
prices. If the issuer is financially healthy, investors have greater
confidence in receiving the interest payments and principal
amount at maturity. Investors typically stay in touch with the
ratings issued by reputed credit rating agencies, such as
Moody’s and Standard & Poor’s.
BONDS
Mutual fund
A mutual fund is a professionally managed type of collective
investment scheme that pools money from many investors and invests
it in stock bonds, short-term money market instruments, and/or other
securities.The mutual fund will have a fund manager that trades the
pooled money on a regular basis. The net proceeds or losses are then
typically distributed to the investors annually.

Types of mutual funds

Most funds have a particular strategy they focus on when investing.
For instance, some invest only in Blue Chip companies that are more
established and are relatively low risk. On the other hand, some focus
on high-risk start up companies that have the potential for double and
triple digit growth. Finding a mutual fund that fits your investment
criteria and style is important.

Types of mutual funds are:

Value stock
Stocks from firms with relative low Price to Earning (P/E) Ratio,
usually pay good dividends. The investor is looking for income
rather than capital gains.

Growth stock
Stocks from firms with higher low Price to Earning (P/E) Ratio,
usually pay small dividends. The investor is looking for capital
gains rather than income.

Based on company size,large,mid, and small cap

Stocks from firms with various asset levels such as over $2
Billion for large; in between $2 and $1 Billion for mid and below
$1 Billion for small.
BONDS
Income stock
The investor is looking for income which usually come from
dividends or interest. These stocks are from firms which pay
relative high dividends. This fund may include bonds which pay
high dividends. This fund is much like the value stock fund, but
accepts a little more risk and is not limited to stocks.

Index funds
The securities in this fund are the same as in an Index fund such
as the Dow Jones Average or Standard and Poor's. The number
and ratios or securities are maintained by the fund manager to
mimic the Index fund it is following.

Stock market sector

The securities in this fund are chosen from a particular marked
sector such as Aerospace, retail, utilities, etc.

Defensive stock
The securities in this fund are chosen from a stock which usually
is not impacted by economic down turns.

International
Stocks from international firms.

Real estate
Stocks from firms involved in real estate such as builder,
supplier, architects and engineers, financial lenders, etc.

Socially responsible
This fund would invests according to non-economic guidelines.
Funds may make investments based on such issues as
environmental responsibility, human rights, or religious views.
BONDS
PORTFOLIO MANAGEMENT
Portfolio management involves deciding what assets to include in
the portfolio, given the goals of the portfolio owner and changing
economic conditions. Selection involves deciding what assets to
purchase, how many to purchase, when to purchase them, and what
assets to divest. These decisions always involve some sort of
performance measurement, most typically expected return on the
portfolio, and the risk associated with this return (i.e. the standard
deviation of the return). Typically the expected return from portfolios of
different asset bundles are compared.

The unique goals and circumstances of the investor must also be

considered. Some investors are more risk averse than others.

Returns
There are many different methods for calculating portfolio returns. A
traditional method has been using quarterly or monthly money-
weighted returns. A money-weighted return calculated over a period
such as a month or a quarter assumes that the rate of return over that
period is constant. As portfolio returns actually fluctuate daily, money-
weighted returns may only provide an approximation to a portfolio’s
actual return. These errors happen because of cashflows during the
measurement period. The size of the errors depends on three
variables: the size of the cashflows, the timing of the cashflows within
the measurement period, and the volatility of the portfolio . A more
accurate method for calculating portfolio returns is to use the true
time-weighted method. This entails revaluing the portfolio on every
date where a cashflow takes place (perhaps even every day), and
then compounding together the daily returns.
BONDS
Portfolio analysis

A company's portfolio is the sum of its business, assets and products.

A perfect portfolio analysis is shaped to meet and suit the cofolio
analysismpany's potency and also enable it to exploit the best
opportunities available to it. Analysis of a portfolio involves deciding on
the relative importance of available business and investment
opportunities. This analysis also involves formulating strategies that
would add to the portfolio in terms of new business opportunities and
products.

The best portfolio analysis takes into account the locations of the
different Strategic Business Units (SBU) present in the portfolio.
These SBU's have business objectives and missions independent of
the other business objectives of the company. SBU's can be:

 Individual brands
 Product lines
 Company divisions

The basic postulates that are involved in portfolio analysis are

common to all companies. Determining market attractiveness may be
the most important part of portfolio analysis. The following are the
ways to determine market attractiveness:

 Market growth
 Market size
 Market profitability
 Intensity of competition in the market
 Pricing trends
 Segmentation
 The risks involved in returns in industry
 The distribution structure; that is, wholesale, retail or direct
BONDS

CORPORATE GOVERNANCE
It is a system of structuring, operating and controlling a company with
a view to achieve long term strategic goals to satisfy shareholders,
creditors, employees, customers and suppliers, and complying with
the legal and regulatory requirements, apart from meeting
environmental and local community needs.

Principles
Key elements of good corporate governance principles include
honesty, trust and integrity, openness, performance orientation,
responsibility and accountability, mutual respect, and commitment to
the organization.

Of importance is how directors and management develop a model of

governance that aligns the values of the corporate participants and
then evaluate this model periodically for its effectiveness. In particular,
senior executives should conduct themselves honestly and ethically,
especially concerning actual or apparent conflicts of interest and
disclosure in financial reports.

Commonly accepted principles of corporate governance include:

 Rights and equitable treatment of shareholders:

Organizations should respect the rights of shareholders and help
shareholders to exercise those rights. They can help
shareholders exercise their rights by effectively communicating
information that is understandable and accessible and
encouraging shareholders to participate in general meetings.
BONDS
 Interests of other stakeholders: Organizations should
recognize that they have legal and other obligations to all
legitimate stakeholders.

 Role and responsibilities of the board: The board needs a

range of skills and understanding to be able to deal with various
business issues and have the ability to review and challenge
management performance. It needs to be of sufficient size and
have an appropriate level of commitment to fulfill its
responsibilities and duties. There are issues about the
appropriate mix of executive and non-executive directors.

 Integrity and ethical behaviour: Ethical and responsible

decision making is not only important for public relations, but it is
also a necessary element in risk management and avoiding
lawsuits. Organizations should develop a code of conduct for
their directors and executives that promotes ethical and
responsible decision making. It is important to understand,
though, that reliance by a company on the integrity and ethics of
individuals is bound to eventual failure. Because of this, many
organizations establish compliance and ethics programme to
minimize the risk that the firm steps outside of ethical and legal
boundaries.

 Disclosure and transparency: Organizations should clarify and

make publicly known the roles and responsibilities of board and
management to provide shareholders with a level of
accountability. They should also implement procedures to
independently verify and safeguard the integrity of the
company's financial reporting. Disclosure of material matters
concerning the organization should be timely and balanced to
ensure that all investors have access to clear, factual information
BONDS
BONDS