Investments

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Q. Explain rights issue, bonus issue and private placement. Ans. A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. More specifically, this type of issue gives existing shareholders securities called "rights", which, well, give the shareholders the right to purchase new shares at a discount to the market price on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price. Troubled companies typically use rights issues to pay down debt, especially when they are unable to borrow more money. But not all companies that pursue rights offerings are shaky. Some with clean balance sheets use them to fund acquisitions and growth strategies. For reassurance that it will raise the finances, a company will usually, but not always, have its rights issue underwritten by an investment bank. Bonus issue refers to giving the existing shareholders fully paid shares free of cost, thereby capitalizing the company’s accumulated profits and reserves. The number of shares an existing shareholder gets is based on the number of shares that the shareholder already owns. While a bonus issue increases the total number of shares issued and owned, it does not change the value of the company. Although the total number of issued shares increases, the ratio of number of shares held by each shareholder remains constant. When a company issues financial securities such as shares and convertible securities to a particular chosen group of investors (not more than 49 in number) it is known as private placement. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market. In many cases, detailed financial information is not disclosed and the need for a prospectus is waived. Finally, since the placements are private rather than public, the average investor is only made aware of the placement after it has occurred.

Mutual Funds - Investment alternatives that pull in the savings of many investors and invests an manages the fund on their behalf. The entire fund is divided into uniform parts called units and units cannot be purchased in fractions. - Each unit is assigned the same share composition, the same asset composition, same profits and the same market value - The current market value of each unit is called net asset value and the value of the entire fund is called fund value - 1st issue of a fund is called New Fund Offer (mutual fund equivalent of an IPO) and all funds are managed by a dedicated fund manager - Mutual funds are good investments for people who do not know or do not like to trade, who do not expect flexibility and who are content with very stable unexceptional returns

Insurance Insurance is a contract whereby a company agrees to financially reimburse a person for risk suffered. This contract is known as a policy and the price of the policy can be paid in lumpsum or in instalments over a period of time. The price is known as premium. The financial reimbursement that the company gives the policy – holder is known as the claim amount. Insurance works on the law of numbers and the law of statistical averages. This means that a company covers many people but not all of them suffer a loss. In general insurance, the risk is a contingent liability, while in life insurance, death is certain but the time of death is uncertain. Life insurance in addition to risk cover has now become an investment option. Insurance companies now refund the claim or claim + profits, whichever is higher. The principles of insurance are as follows:1. Utmost good faith states that all facts relating to the contract have to be true and fair from both parties. In case a discrepancy is found the contract can be cancelled. 2. Insurable Interest states that a person can only insure a person / goods if they have legal relationship or a blood relationship. 3. Indemnity states that all insurance contracts have to be taken for protection and not for profit (except life insurance). 4. Subrogation In this principle, any goods that have suffered damage cannot be retained by the policy holder. This is because he may sell the damaged scrap goods and make a profit which goes against the principle of indemnity. This principle does not apply to life insurance. 5. Causa Proxima In this principle if there is a series of events that lead up to the loss, the cause which is closest to the loss is considered and claim is paid only if that cause is covered in that policy. 6. Contribution In this principle the treatment of claims for life insurance and general insurance are different. In life insurance, a person can take as many policies of any amount as he sees fit and insurance companies have to pay the entire amount and do not follow the principle of indemnity. However, in general insurance if many policies are taken for the same goods and loss is suffered, all the companies will pay only up to the claim on a pro-rated basis.

Types of Life – Insurance: Insurance policies are now considered as an attractive avenue of investment because of the returns as well as the tax benefits. ULIP (Unit Linked Insurance Policies) have become very common and refer to policies that operate on the principle of mutual funds The main life insurance policies are as follows: 1. Term Insurance – in this policy a person is covered for a fixed term (eg. 40 years) If he dies during this term, the claim will be paid to the family and if he survives through the contract, all his premiums are forfeited and no refund is given. This type of policy is extremely cheap and gives large amount of cover / claim. This policy was almost extinct because people saw it as losing money with no returns. However, the concept of term insurance linked home loans revived this concept. 2. Endowment – In this kind of policy the premium and the company either pays a claim to the family on his death or refunds the amount with profit in case he survives the contract. This policy is an insurance + investment. 3. Money back – Endowment policies were considered as a good avenue of investment but there were complaints of lack of liquidity. To overcome this, money back plans were created. In this type of plan, the policy-holder gets a refund of a pre-determined amount at a pre-determined time. (eg. 25% of the payment and pro-rated profits every 10 years) Insurance policies have 2 concepts called surrender value and paid – up value. In the event that a policy holder cannot afford to pay his premiums he can go in for either of these depending on the number of premiums already paid. Surrender value – In this facility if a policy-holder cannot afford to pay he can discontinue the contract and ask for a refund of the premium paid – the charges by the company. This can be done only once he has paid the premiums of the lock-in period (eg. 3 years) If he wishes to break the contract before that, no premiums will be refunded. Paid-up value – Once a policy-holder pays around 80% of the premium paying term, he has the facility of making the policy paid – up. In this facility, the customer can stop paying premiums but the policy remains in force because the company will deduct his premiums from the profits of the company. In case this cannot be done, the premium account and the cover can be reduced accordingly. Paid-up can only avail if the clause mentions it in the contract.

Home loan linked term insurance Year Balance Outstanding 1 20 2 19 3 18 4 17 5 16 6 15 7 14 8 13 9 12 10 11 11 EMI 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 Premium EMI remains constant; premium goes on reducing as per the outstanding balance. 100 The outstanding balance on loan is the 95 cover amount of the insurance policy. In 90 case of death, the insurance company will 85 pay the remaining balance on the loan by 80 75 giving the claim directly to the bank. In our 70 example suppose death occurs in the 11th 65 year, the insurance company will pay the 60 bank a claim of 10000 and the bank will not 55 approach the guarantor or cease the property. If the person survives the term and pays the entire loan he gets no benefit from the term insurance.

Real Estate Investments in real estate can be done in two methods, income generation and capital appreciation. When a person buys a house and gives it on rent it is ideal income generation. When property is bought, held for some time and sold when the price rises it is known as capital appreciation. In addition to this property can be used as social security in the form of reverse mortgage. For example, if a 25 year old takes a 1 Crore rupees home loan and pays of EMIs till the age of 55,he edns up owning the house but having no savings. With retirement a few years away he cannot save up enough for post – retirement years. In this case he goes in for a reverse mortgage. In reverse mortgage the bank will value the property at the current market price and pay the man its value over the next few years until his death or the death of his spouse. By the end, the ownership of the house is completely the banks and if the family wants to retain the house they have to adjust for inflation and current value. Reverse mortgage can only be availed when the property has clear ownership and when the owners are past the age of 60 - 65.

Deposits There are 3 different types of deposits as follows: 1. Fixed Deposit Issued by a bank, initial lump – sum investment, fixed term, pentalty for early withdrawal 2. Recurring Deposit Periodic investment, fixed rate of interest, encourages small savings 3. Company Deposit Collected by companies who have a good reputation in the market and who need capital. Companies sometimes do not want to take a loan since the interest is too high and do not want to accept equity investment since it dilutes ownership. Companies therefore issue a certificate of deposit offering a rate of interest higher than a bank fixed deposit, but lower than a loan thus making it beneficial for both the parties. This is a process known as disintermediation (removing the middle man: bank).

Art Investment in art refers to investments in paintings, sculptures, installations, etc. This avenue of investment is one of the newest forms in India and can be done for capital appreciation (buying low selling high) or income generation (renting out artwork to museums, governments, individuals etc).

Precious Metals and Stones A majority of the precious metals investments around the world are in gold and silver. Gold has traditionally been one of the most popular investments in India for not only its increasing value and ornamental importance but also its tangible character. Silver is also now gaining popularity because of its renewed demand for industrial purposes. Other precious metals include platinum, palladium, etc. In precious stones diamonds are the most popular followed by other stones (emeralds, rubies, etc).

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