INVESTMENT ALTERNATIVES

Introduction
Now-a-days a wide range of investment opportunities are available to the investor. These are primarily
bank deposits, corporate deposits, bonds, units of mutual funds, instruments under National Savings
Schemes, pension plans, insurance policies, equity shares etc. All these instruments compete with
each other for the attraction of investors. Each instrument has its own return, risk, liquidity and safety
profile. The profiles of households differ depending upon the income-saving ratio, age of the
households head, number of dependents etc. The investors tend to match their needs with the
features of the instrument available for investment. They do have varying degrees of preferences for
savings vehicles.
Every investor tends to keep some cash balance and maintain a certain amount in the form of bank
deposit to meet his/her transaction and precautionary needs. In the case of salaried people,
contributions to Employees Provident Fund become compulsory. Life Insurance is widely preferred to
meet situations arising out of untimely deaths of the bread earner. Besides these needs, the surplus
income (savings) awaits investment in alternative financial assets. Investors have to take decisions
relating to their investment in competing assets/ avenues. An investor has a wide array of investment
avenues, which may be classified as shown in the Exhibit 8.1.
Investment Avenues
Equity shares
A share is a single unit of ownership in a corporation, mutual fund, or other organization. A joint stock
divides its capital into shares, which are offered for sale to raise capital, termed as issuing shares.
Thus, a share is an indivisible unit of capital, expressing the proprietary relationship between the
company and the shareholder. The denominated value of a share is its face value: the total capital of a
company is divided into number of shares. In financial markets, a share is a unit of account for various
financial instruments including stocks (ordinary or preferential), and investments in limited
partnerships, and real estate investment trusts. The common feature of all these is equity participation
(limited in the case of preference shares).The income received from shares is known as a dividend. A
shareholder, also known as a stockholder, is a person who owns shares of a certain company or
organization, and is thus a part-owner of the company. The process of purchasing and selling shares
often involves going through a stockbroker as a middle man. A firm's total assets minus its total
liabilities. Equivalently, it is share capital plus retained earnings minus treasury shares. Shareholders'
equity represents the amount by which a company is financed through common and preferred shares.
Shareholder' Equity = Total Assets - Total Liabilities OR Shareholders' Equity = Share Capital +
RetainedEarnings - Treasury Shares
Also known as "share capital", "net worth" or "stockholders' equity". Shareholders' equity comes from
two main sources. The first and original source is the money that was originally invested in the
company, along with any additional investments made thereafter. The second comes from retained
earnings which the company is able to accumulate over time through its operations. In most cases, the
retained earnings portion is the largest component. EQUITY SHARE is a. a share or class of shares
whether or not the share carries voting rights, b. any warrants, options or rights entitling their holders
to purchase or acquire the shares referred to under (a), or c. other prescribed securities. An equity
share is a perpetual liability because it signifies an owner legal demand upon the assets of the entity
in which the equity share if held.
Stock typically takes the form of shares of either common stock or preferred stock. As a unit of
ownership, common stock typically carries voting rights that can be exercised in corporate decisions.
Preferred stock differs from common stock in that it typically does not carry voting rights but is legally

entitled to receive a certain level of dividend payments before any dividends can be issued to other
shareholders. Convertible preferred stock is preferred stock that includes an option for the holder to
convert the preferred shares into a fixed number of common shares, usually anytime after a
predetermined date. Shares of such stock are called "convertible preferred shares" (or "convertible
preference shares" in the UK).Although there is a great deal of commonality between the stocks of
different companies, each new equity issue can have legal clauses attached to it that make it
dynamically different from the more general cases. Some shares of common stock may be issued
without the typical voting rights being included, for instance, or some shares may have special rights
unique to them and issued only to certain parties. Note that not all equity shares are the
same.Preferred stock may hybrid by having the qualities of bonds of fix return and common stock
having voting right. They also have preference in the payment of dividend over prefer stock and also
have given the preference at the time of liquidation over common stock. They have other features of
accumulation in dividend.
The investor, however, has to bear in mind that the shares of a blue chip comany, though issued at a
premium, could have a far greater demand in the market for various reasons. When there is an over
subscription on the issue, many small investors might not get an allotment of the shares. Hence,
demand for the shares goes up immediately when the shares are traded in the secondary market. In
India, the investments into shares and debentures including mutual funds units (except UTI units) as a
percentage of household financial savings has dropped significantly from 23.3 per cent in 1991-92 to
1.4 per cent in 2003-04.
Household sector investment pattern in financial assets

Fixed income securities

Preference shares:
Capital stock which provides a specific dividend that is paid before any dividends are paid to common
stock holders, and which takes precedence over common stock in the event of liquidation. Like
common stock, preference shares represent partial ownership in a company, although preferred stock
shareholders do not enjoy any of the voting rights of common stock holders. Also unlike common
stock, preference shares pay a fixed dividend that does not fluctuate, although the company does not
have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preference
shares are that the investor has a greater claim on the company assets than common stockholders.
Preferred shareholders always receive their dividends first and, in the event the company goes
bankrupt, preferred shareholders are paid off before common stockholders.
Debentures and bond:
A type of debt instrument that is not secured by physical asset or collateral. Debentures are backed
only by the general creditworthiness and reputation of the issuer. Both corporations and governments
frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are
documented in an indenture. Debentures have no collateral. Bond buyers generally purchase
debentures based on the belief that the bond issuer is unlikely to default on the repayment. An
example of a government debenture would be any government-issued Treasury bond (T-bond) or
Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at
worst, can print off more money or raise taxes to pay these type of debts Bonds and debentures are
fixed income instruments which are taken by investors looking for regular, fixed income through
payment of interest on the principal purchase. Bonds and debentures are debt instruments with
different types of exposure. In general terms bondholders are secured by access to the underlying
asset in case of default by the issuer. Debentures, on the other hand, are unsecured, and debenture
holders do not have recourse to assets in the case of default by the debenture issuer.
Convertible debentures:

A type of loan issued by a company that can be converted into stock by the holder and, under certain
circumstances, the issuer of the bond. By adding the convertibility option the issuer pays a lower
interest rate on the loan compared to if there was no option to convert. These instruments are used by
companies to obtain the capital they need to grow or maintain the business. Convertible debentures
are different from convertible bonds because debentures are unsecured; in the event of bankruptcy
the debentures would be paid after other fixed income holders. The convertible feature is factored into
the calculation of the diluted per-share metrics as if the debentures had been converted. Therefore, a
higher share count reduces metrics such as earnings per share, which is referred to as dilution.

Government securities:
A government bond is a bond issued by a national government, generally promising to pay a certain
amount (the face value) on a certain date, as well as periodic interest payments. Bonds are debt
investments whereby an investor loans a certain amount of money, for a certain amount of time, with
a certain interest rate, to a company or country. Government bonds are usually denominated in the
country's own currency. Bonds issued by national governments in foreign currencies are normally
referred to as sovereign bonds, although the term "sovereign bond" may also refer to bonds issued in a
country's own currency. The first ever government bond was issued by the English government in 1693
to raise money to fund a war against France. It was in the form of a tontine. Later, governments in
Europe started issuing perpetual bonds (bonds with no maturity date) to fund wars and other
government spending. The use of perpetual bonds ceased in the 20th century, and currently
governments issue bonds of limited duration.
Government bonds are usually referred to as risk-free bonds, because the government can raise taxes
or create additional currency in order to redeem the bond at maturity. Some counter examples do exist
where a government has defaulted on its domestic currency debt, such as Russia in 1998 though this
is very rare. Another example is Greece in 2011. Its bonds were considered very risky, in part because
Greece did not have its own currency.
Public sector undertakings bonds:
Public Sector Undertakings (PSUs) issue debentures that are referred to as PSU bonds. Minimum
maturity of PSU bonds is generally 5 years for taxable bonds and 7 years for tax-free bonds. The
maturity of some bonds is also 10 years. The typical maturity of a corporate debenture is between 312 years. Debentures with lower maturity are normally issued as debenture convertible partly or fully
into equity. The interest income from bonds and debentures is classified under the heading income
from business or profession. The difference between face value and issue price in the case of Deep
Discount Bonds can be classified as interest to be accrued on field basis every year. The incidence of
TDS on bonds and debentures depend on the terms and structure thereof. The interest on taxable
bonds is exempt only up to a certain limit as per section 80L of the Income-Tax Act, whereas the
interest on tax-free bonds is fully exempt. While PSUs are free to set the interest rates on taxable
bonds, they cannot offer more than a certain interest rate on tax-free bonds, which is fixed by the
Ministry of Finance. More important, a PSU can issue tax-free bonds only with the prior approval of
Ministry of Finance.
In general, PSU bonds have the following investor-friendly featuresThere is no deduction of tax at source on the interest paid on these bonds;
They are transferable by mere endorsement and delivery;

There is no stamp duty applicable on transfer; and

They are traded on the stock exchanges.
In addition, some institutions are ready to buy and sell these bonds with a small price difference.
Kisan Vikas Patra (KVP): Kisan Vikas Patra (KVP) comes in the denominations (face value) of Rs.
1,000, Rs. 5,000 and Rs. 10,000. There is no maximum limit on the purchase of certificate. KVP double
the money in 8.7 years that works out to a yield of a little over 8 per cent. As tax concessions are not
available on interest amount, for investors in higher tax brackets, the yields are somewhat lower.
Investors can also use money in emergencies by breaking it after 2.5 years. However, early withdrawal
lowers returns. Certificate can be encashed at the post-office of its issue.

Money market instruments

The major purpose of financial markets is to transfer funds from lenders to borrowers. Financial market
participants commonly distinguish between the capital market and the Money market. The money
market refers to borrowing and lending for periods of a year or less.
Treasury bills
Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells bills at regularly
scheduled auctions to refinance Eagle Traders issues. It also helps to finance current federal deficits.
They further sell bills on an irregular basis to smooth out the uneven flow of revenues from corporate
and individual tax receipts.
A certificate of deposit is a document evidencing a time deposit placed with a depository institution.
The following information appears on the certificate:
the amount of the deposit
the date on which it matures
the interest rate; and
the method under which the interest is calculated.
Large negotiable CDs are generally issued in denominations of $1 million or more.
Commercial Paper
commercial Paper is a short-term unsecured promissory note issued by corporations and foreign
governments. It is a low-cost alternative to bank loans, for much large, credit worthy issuers. Issuers
are able to efficiently raise large amounts of funds quickly and without expensive Securities and
Exchange Commission (SEC) registration. They sell paper, either directly or through independent
dealers.
Deposits
Among non-corporate investments, the most popular are deposits with banks such as savings accounts
and fixed deposits. In fact, deposits are similar to fixed income securities as they earn a fixed return.
However, unlike fixed income securities, deposits are not represented by negotiable instruments. The

important types of deposits in India include- bank deposits, company deposits, post office time
deposits, post office recurring deposits, and monthly income scheme of post office.
A bank deposit, which is a safe, liquid and convenient option, can be made by opening a bank account
and depositing money in it. There are various kinds of bank accounts: current account, savings
account, and fixed deposit account. While a deposit in current account does not earn any interest,
deposits in other kinds of bank accounts earn interest. Deposits in scheduled banks are very safe
because of the regulations of RBI and the guarantee provided by the Deposit Insurance Corporation.
While saving bank account gives an interest of 3.5 per cent per annum, bank fixed deposits give
interest from 5 to 11 per cent depending on duration from 30 days to 5 years and above. The interest
rates on bank deposits are generally slightly higher than those on post office time deposits. No
withdrawal is permitted before six months from post office time deposits (POTD). Interest on POTDs is
tax-exempt within certain limits under section 80L of the Income-Tax Act. Deposits with banks have
always been the most preferred investment alternative in India. The tenure of recurring deposits is 5
years and can be extended for another five years. It presently gives an interest of 8 per cent
compounded quarterly. Deposits may be made a minimum of Rs. 10 once in a calendar month, in
multiples of Rs. 5. There is no ceiling on deposit. Loan up to half of the deposit may be taken one year
before maturity.

Monthly Income Scheme of the Post Office (MISPO)- This scheme appeals to conservative
investors with traditional values, and for good reason. This scheme offers monthly income and is a
safe, guaranteed-by-the-government option. For retirees, widows and others looking for a steady
income, it can be ideal. The Post Office Monthly Income Scheme, or PO MIS, is offered by Indian Post
Offices. A lump sum amount is deposited with the post office and monthly interest earned each month
is paid out to you. As the scheme is offered by post offices, it is backed by the government. Thus, the
PO MIS is one of the safest investments available.
Post-office Time Deposits (POTD)- is another attractive opportunity for savings. These deposits
give an interest of 8 per cent compounded quarterly. A deduction under Section 80L of Income Tax Act,
is also allowed on interest up to a certain limit. However, the depositor cannot make any withdrawals
before six months. Different accounts for different maturity periods may be opened in one name.
Deposits may be made of Rs. 50 or multiples thereof up to any amount. The premature closure after
six months before one year from the date of deposit will be allowed without payments of interest. The
current rates of interest payable annually on different maturity period are as follows:
1 year-6.25%,
2 year- 6.50%,
3 year- 7.25%,
5 year- 7.50%.
Government of India Saving Bond- Taxable 8% Savings Bonds, 2003 are issued by Government of
India with effect from 21st April 2003. The bond will be issued in cumulative and non-cumulative form,
at the option of the investor. The Bond will bear interest at the rate of 8% per annum. Interest to the
holders opting for non-cumulative Bonds will be paid from date of issue up to 31st July/31st January, as
the case may be and thereafter at half-yearly for period ending 31st July/31st January on 1st August
and 1st February. Interest on cumulative bonds will be compounded with half-yearly rests and will be
payable on maturity along with the principal. The maturity value of the Bonds shall be Rs.1601/- (being
principal and interest) for every Rs.1000 (Nominal). Interest on Bond in the form of Bond Ledger
Account will be paid, by cheque/warrant or through ECS credit to bank account of the holder as per

the option exercised by the investor/holder. Income-tax: Interest on the Bonds is taxable according to
the tax status of the bond holder. However, tax would not be deducted at source from the interest
payment. Wealth tax: The Bonds will be exempt from Wealth-tax Post-office Saving Account (POSA)The account can be opened by an individual with minimum amount of Rs. 20. Maximum ceiling of
deposit in a single account is Rs. 1 lakh and joint account Rs. 2 lakh Rate of interest is 3.5 per cent
annum in case of both single and joint accounts. The introduction of depositor will be necessary for
opening of new account.
Senior Citizen Savings Scheme (SCSS)- An individual who has attained the age of 60 and above or
of the age of 55 years but less than 60 years who has retired under VRS, are eligible to open the
account. The joint account can also be opened with spouse. There can be only one deposit in the
account. The minimum limit is Rs. 1,000 and maximum is 15 lakh. The maturity period is five years,
which may be extended for another three years on the option of depositor. Rate of interest is 9 per
cent per annum payable quarterly. Account can be closed after one year and before second year. The
amount equal to 1.5 per cent on the balance amount will be deducted and balance will be paid to
depositor. The scheme has special features-(i) nomination facility available; (ii) may be transferred
from one post office to another post office; (iii) automatic credit of interest in POSA; (iv) SAS agency
facility can be availed; and (v) 0.5 per cent commission is payable to SAS agents.
Company deposits- Many companies, large and small, solicit fixed deposits from the public. Fixed
deposits mobilized by manufacturing companies are regulated by the Company Law Board and those
mobilized by Finance Companies (more precisely NBFCs) are regulated by RBI. The company fixed
deposit market is a risky market. However, credit rating services are available to rate the risk of
company fixed deposit schemes.

For a manufacturing company the term of deposit can be one to three years, whereas for a finance
company the term of deposit may be 25 months to 5 years. Fixed deposits represent unsecured loans
taken by the borrowing companies. Should a company go into liquidation, the depositors, as unsecured
creditors, rank after the secured creditors and lenders. The interest on company deposits is fully
taxable. The maximum interest rate payable on fixed deposits is 14 per cent. Companies pay interest
annually, semi-annually, quarterly and monthly. Company also offers cumulative deposit schemes.
Table indicates some of the fixed deposit schemes (2003) offered by corporate houses.
Fixed deposit schemes (2003)
Tax sheltered saving schemes
Tax-sheltered saving schemes provide significant tax benefits to those who participate in them. The
most important tax-sheltered saving schemes in India are

Employees Provident Fund

Public Provident Fund Scheme
National Saving Scheme, 1992
National Saving Certificate VIII Series
Employees Provident Fund Scheme (EPF):

Employees' Provident Fund Scheme takes care of following needs of the members:

Retirement
Medical Care
Housing
Family obligation

Education of Children
Financing of Insurance Polices

How the Employees' Provident Fund Scheme works:

As per amendment-dated 22.9.1997 in the Act, both the employees and employer contribute to the
fund at the rate of 12% of the basic wages, dearness allowance and retaining allowance, if any,
payable to employees per month. The rate of contribution is 10% in the case of following
establishments:
Any covered establishment with less than 20 employees, for establishments cover prior to 22.9.97.
Any sick industrial company as defined in clause (O) of Sub-Section (1) of Section 3 of the Sick
Industrial Companies (Special Provisions) Act, 1985 and which has been declared as such by the Board
for Industrial and Financial Reconstruction,
Any establishment which has at the end of any financial year accumulated losses equal to or
exceeding its entire net worth and
Any establishment engaged in manufacturing of (a) jute (b) Breed (d) coir and (e) Guar gum Industries/
Factories. The contribution under the Employees' Provident Fund Scheme by the employee and
employer will be as under with effect from 22.9.1997.
Public Provident Fund Scheme (PPF): Public Provident Fund F(PPF) is a savings-cum-tax-saving
instrument in India. It also serves as a retirement-planning tool for many of those who do not have any
structured pension plan covering them. Individuals and Hindu Undivided Families can open the PPF
account. Even in the name of a minor account can be opened. A person can have only one account in
his name. The account can be opened in designated post offices, State Bank of India branches and
branches of some nationalized bank.
Non-resident Indians (NRIs) are not eligible to open an account under the Public Provident Fund
Scheme. If a resident who subsequently becomes NRI during the currency of maturity period
prescribed under Public Provident Fund Scheme, may continue to subscribe to the fund till its maturity
on a non-repatriation basis.
Rate of Return on PPF is 8.8 % p.a. (Compounded annually). Interest is calculated on the lowest
balance between the close of the fifth day and the last day of every month.
The contribution to the account can vary from year to year, from a minimum of Rs 500 to a maximum
of Rs 100,000 in any given year.
Investments in a PPF account can be made in multiples of Rs 5, either lumpsum, or in installments (not
exceeding 12 in a year and more than one deposit can be made in a month). The credit to the PPF
account is made on the date of presentation of the cheque and not on the date of its clearance. This
allows flexibility in savings.
The tenure of the PPF account is 15 years, which can be further extended in blocks of 5 years each for
any number of blocks. The extension can be with or without contribution. An account holder,
continuing with fresh subscription, can withdraw up to 60% of the balance to his credit at the
commencement of each extended period in one or more installments but only once in a year.
Every subscription shall be made in cash or through a crossed check or draft or postal order, in favor of
the accounts office, at the place at which that office is situated. In case of any check, draft or postal
order should be drawn at a bank or post office at that place.
Nomination facility is available. In the case of joint nominees, it is possible to allocate the percentage
of benefits to each nominee.

National Saving Certificate VIII Series (NSC):

The reliable National Savings Certificate (NSC) looks like it may have lost popularity with countless
competing investment options available such as equities, mutual funds, unit linked insurance and fixed
maturity plans. However, there is no ignoring the instrument's respectable returns, which are not only
assured, but also tax-exempt (under 80C) and government guaranteed. Compared with the NSC, the
Public Provident Fund (PPF) has traditionally been more popular on account of its 8% tax-free interest.
However, the PPF has a maximum investment limit of Rs 70,000 per annum (this means the maximum
amount one can invest in PPF every year is capped at Rs 70,000). NSCs do not have a limit of how
much one can invest. What's more, interest up to Rs 1 lakh is tax-free. You read that correctly. NSCs
offer you the possibility of earning up to Rs 1 lakh fully tax-free. This is because NSC is the only small
saving scheme wherein not only the initial deposit, but also the interest for the first five years, out of
its term of six years, is eligible for a deduction under section 80C.
Life insurance policies
Till recently, life insurance in India was provided primarily by the Life Insurance Corporation of India
(LIC), which was established by an Act of Parliament in 1956. However, the insurance sector has now
been opened for private players also. Some of the life insurance policies are briefly described as
follows:
Endowment assurance policyInsures the life of the policy-holder as well as provides him a lump-sum amount at the time of maturity.
Amount assured is payable at the end of endowment period or at the time of death, if it occurs earlier.
Money back policy, the second most popular scheme, is of special interest to persons who feel the
need for lump-sum benefits at periodic intervals. Unlike the ordinary endowment assurance policy
where the full sum assured in the event of survival is payable only at the end of the endowment
period, under this scheme part payments are made periodically. Under the whole life policy, the
assured is required to pay insurance premiums throughout his life and, on his death, the assured
amount is payable to his beneficiaries.

Unit Linked Insurance Plans (ULIPs)A type of insurance vehicle in which the policyholder purchases units at their net asset values and also
makes contributions toward another investment vehicle. Unit linked insurance plans allow for the
coverage of an insurance policy, and provide the option to invest in any number of qualified
investments, such as stock, bonds or mutual funds. A unit linked insurance plan acts just like a savings
vehicle, but also has the benefits of an insurance contract. When an investor purchases units in a ULIP,
he or she is purchasing units along with a larger number of investors, just like an investor would
purchase units in a mutual fund. Different ULIPs offer different qualified investments. Be sure to read
the plan's prospectus before purchasing any ULIP.
The most widely held policy in India is the Money-back policy followed by a traditional endowment
policy. Endowment policies are the ideal vehicle for retirement savings because, in addition to the sum
assured, they provide a fat bonus at the time of retirement. Moreover, the insured does not have to
track his investments and has to merely pay his installments in time.
Innovative Products- With the entry of new players, the insurance market has been flooded with many
new innovative products. While sales of traditional life insurance products like individual, whole life and

term assurance will remain popular, sales of new products like single premium, investment-linked
retirement products, variable life and annuity products are also on the rise. In fact, these products
already have a significant share in the portfolios of companies that have introduced them.
LIC has launched two new products- Jeevan Anurag and Jeevan Nidhi. Jeevan Anurag is designed to
provide parents for their childs education requirement. It is an endowment plan, under which lump
sum benefits are payable at pre-specified duration irrespective of whether the life assured survives at
the end of the term. Jeevan Nidhi on the other hand, is a comprehensive pension plan providing lump
sum amount for pension payment at old age with insurance coverage. This is also an endowment plan.
Another innovative insurance product from LIC, Jeevan Anand, combines the benefits of an
endowment policy and a whole life policy. Under this plan, premiums are paid for a limited period.
During the premium paying period, insured is covered to the extent of sum assured and the bonuses
that vest on this policy. After the premium term is over the sum assured together with accumulated
bonuses and final additional bonus (if any) become payable to the insured free of any income tax. The
highlight of this plan is that even after the maturity of the policy the coverage on life continues for life
time to the extent of the sum assured without the payment of any future premiums, thus clearly
justifying the concept Zindagi ke saath bhi, zindagi ke baad bhi. As a part of the ongoing reforms, the
government of India has recently launched the Varishta Pension Bima Yojna (VPBY) for the benefit of
the senior citizens. The scheme is to be administered by the LIC and it offers an assured return of 9 per
cent per annum to the policyholder against one-time payment of a minimum amount of Rs. 33,335 and
a maximum of Rs. 2,66,665. It provides regular income for life with return of purchase price to the
nominee in the event of pensioners death. Pensions will be monthly, quarterly, half-yearly or yearly as
desired. Exit option after 15 years available. The scheme, offering an assured return of 9 per cent,
particularly in the current falling interest rate scenario, is no doubt a boon to the senior citizens.
Financial derivatives
Financial derivatives have crept into the nation's popular economic vocabulary on a wave of recent
publicity about serious financial losses suffered by municipal governments, well-known corporations,
banks and mutual funds that had invested in these products. Congress has held hearings on
derivatives and financial commentators have spoken at length on the topic. Derivatives however
remain a type of financial instrument that few of us understand and fewer still fully appreciate,
although many of us have invested indirectly in derivatives by purchasing mutual funds or
participating in a pension plan whose underlying assets include derivative products. In a way,
derivatives are like electricity. Properly used, they can provide great benefit. If they are mishandled or
misunderstood, the results can be catastrophic. Derivatives are not inherently "bad." When there is full
understanding of these instruments and responsible management of the risks, financial derivatives
can be useful tools in pursuing an investment strategy. This brochure attempts to familiarize the
reader with financial derivatives, their use and the need to appreciate and manage risk. It is not a
substitute, however, for seeking competent professional advice before becoming involved in a financial
derivative product.

The introduction of derivative products has to a derivative contract should be able to identify all the
risks that are being assumed (interest rate, currency exchange, stock index, long or short-term bond
rates, etc.) before entering into a derivative contract. Part of the risk identification process is a
determination of the monetary exposure of the parties under the terms of the derivative instrument.
As money usually is not due until the specified date of performance of the parties' obligations, the lack
of an up-front commitment of cash may obscure the eventual monetary significance of the parties'
obligations. While investors and markets traditionally have looked to commercial rating services for an
evaluation of the credit and investment risk of issuers of debt securities. Lately, some commercial
firms have begun issuing ratings on a company's securities which reflect an evaluation of that
company's exposure to derivative financial instruments to which it is a party. , the creditworthiness of

each party to a derivative instrument must be evaluated independently by each counter party. In a
derivative situation, performance of the other party's obligations is highly dependent on the strength
of its balance sheet. Therefore, a complete financial investigation of a proposed counterparty to a
derivative instrument is imperative. Some derivative products are traded on national exchanges.
Regulation of national futures exchanges is the responsibility of the U.S. Commodities Futures Trading
Commission. National securities exchanges are regulated by the U.S. Securities and Exchange
Commission (SEC). Certain financial derivative products, like options traded on a national securities
exchange, have been standardized and are issued by a separate clearing corporation to sophisticated
investors pursuant to an explanatory offering circular. Performance of the parties under these
standardized options is guaranteed by the issuing clearing corporation. Both the exchange and the
clearing corporation are subject to SEC oversight.
Other derivative products are traded over-the-counter (OTC) and represent agreements that are
individually negotiated between parties. If you are considering becoming a party to an OTC derivative,
it is very important to investigate first the creditworthiness of the parties obligated under the
instrument so you have sufficient assurance that the parties are financially responsible.
Stock futures are traded in the market regularly and, in terms of turnover, have succeeded that of
other derivative instruments. The distribution of turnover among various derivatives products
(February 2004) is given in Table.
Derivatives turnover at NSE (February, 2004)
Real estate
Buying property is an equally strenuous investment decision. Real estate investment generally offers
easy entry and good hedge against inflation. But, during deflationary and recessionary periods, the
value of such investments may decline. Real estate investments are classified as direct or indirect. In a
direct investment, the investor holds legal little to the property. Direct real estate investments include
single-family dwellings, duplexes, apartments, land and commercial property. In case of indirect
investment, investors appoint a trustee to hold legal title on behalf of all the investors in the group.
The more affluent investors are likely to be interested in the following types of real estate: agricultural
land, semi-urban land, and time-share in a holiday resort. The most important asset for individual
investors generally is a residential house or flat because the capital appreciation of residential
property is, in general, high. Moreover, loans are available from various quarters for
buying/constructing a residential property. Interest on loans taken for buying/constructing a residential
house is tax-deductible within certain limits. Besides, ownership of a residential property provides
psychological satisfaction.
However, real estate may have the disadvantages of illiquidity, declining values, lack of diversification,
lack of tax shelter, a long depreciation period and management problems. Reasons for investing in real
estate are given below:
High capital appreciation compared to gold or silver particularly in the urban area.
Availability of loans for the construction of houses. The 1999- 2000 budget provides huge incentives to
the middle class to avail of housing loans. Scheduled banks now have to disburse 3 per cent of their
incremental deposits in housing finance.
Tax rebate is given to the interest paid on the housing loan. Further Rs. 75,000 tax rebate on a loan up
to Rs. 5 lakhs which is availed of after April 1999. if an investor invests in a house for about Rs. 6-7
lakh, he provides a seed capital of about Rs. 1-2 lakh. The Rs. 5 lakh loan, which draws an interest rate
of 15 percent, will work out to be less than 9.6 per cent because of the Rs. 5,000 exempted from tax
annually. In assessing the wealth tax, the value of the residential home is estimated at its historical
cost and not on its present market value.

The possession of a house gives an investor a psychologically secure feeling and a standing among his
friends and relatives.
Precious objects
If one believes investing in real estate is too risky or too complicated, one might want to consider
other-tangible investments, such as gold and other precious metals, gems and collectibles. Such
investments may entail both risk and reward. Precious objects are items that are generally small in
size but highly valuable in monetary terms. The two most widely held precious metals that appeal to
almost all kinds of investors are gold and silver. Historically, they have been good hedges against
inflation. Also, they are highly liquid with very low trading commissions. Investment in gold and silver,
however, has no tax advantage associated with them. When the economy picks up, some investors
predict higher inflation and therefore, may think precious metals such as gold and silver will regain
some of their glitter. Precious stones include diamonds, sapphires, rubies and emeralds.
Precious stones appeal to investors because of their small size, ease of concealment, great durability
and potential as a hedge against inflation. Collectibles include rare coins, works of art, antiques,
Chinese ceramics, paintings and other items that appeal to collectors and investors. Each of these
items offers the knowledgeable collector/ investor both pleasure and the opportunity for profit. It does
not provide current income, and may be difficult to sell quickly.