Warrants: a right with a delay
A warrant is issued by a company and gives the holder the right, without any obligation, to buy the company's equity shares after a specified period at a price fixed in advance. Investors are institutional and individual, the medium is direct issuance through stock exchanges, and the regulator is SEBI. If the share price is above the fixed price when the period ends, the holder exercises and buys cheaply. If not, the holder walks away. It is the same asymmetry as a call option, covered later in this chapter, attached to newly issued shares.
Indices: a sample that stands for the whole
A market index tracks market movement by following the prices of a chosen sample of shares. Most leading indices weight each share by its market capitalisation, on the reasoning that a company with more shares outstanding sits in more portfolios and deserves more influence on the number. Index stocks are also chosen to be liquid, so that an investor can replicate the index cheaply.
The widely followed Indian indices are NSE's Nifty 50 (50 of the most representative NSE stocks), the S&P BSE Sensex (a market-cap weighted index of 30 chosen BSE stocks) and MSEI's SX40 (40 representative stocks on the Metropolitan Stock Exchange). Constituents are picked on liquidity, the availability of floating stock and the size of market capitalisation, and the composition is reviewed and changed from time to time so the index stays representative.
Beyond the headline indices there are broader ones (Nifty Next 50, Nifty 100, Nifty 500, S&P BSE 100 and 500), size buckets (S&P BSE MidCap and SmallCap) and sector indices for banking, information technology, pharmaceuticals, fast-moving consumer goods and others.
A reference point for comparing returns with other asset classes such as gold or debt. A benchmark for judging an actively managed equity fund or portfolio. A barometer of the economy or of a sector. A real-time indicator of market and investor sentiment. And an underlying for index funds and for derivatives such as index futures and options.
A narrow index is one made up of a small number of the most actively traded shares on an exchange, not an index of small companies. The Sensex, with 30 stocks, is narrow; the S&P BSE SmallCap is broad but made of small companies.
Mutual fund units: a pooled portfolio priced at NAV
A mutual fund pools money from many investors and invests it in a portfolio that reflects a stated objective. Each investor's share of the pool is a number of units, and the value of a unit, the net asset value or NAV, moves continuously with the value of the portfolio. Units are issued directly by the fund and SEBI regulates it.
| Open-ended scheme | Closed-ended scheme | |
|---|---|---|
| Buying and selling | With the fund itself, any time | On the stock exchange, where listing is mandatory |
| Price | NAV-linked | Market price on the exchange |
| Unit capital | Changes as investors enter and leave | Fixed; a specific number of units is sold |
| Maturity | None | Fixed term |
ETFs: a fund that trades like a share
An exchange traded fund also pools investor money, but to track something: an index, a commodity such as gold, or a basket of assets. In one respect it resembles an index fund, since its portfolio mirrors what it tracks. The difference is that ETF units are listed and traded in demat form on a stock exchange, with a price that changes through the day as the index or commodity moves.
The plumbing matters for the exam. An ETF is sponsored by an existing mutual fund or a global asset manager. Large broking houses and international banks act as authorised participants: they assemble the bundle of underlying assets, deliver it to the sponsor, receive ETF units in exchange, and sell those units into the market where they trade like ordinary shares.
An ETF has the open-ended feature of being created whenever demand appears, and the closed-ended feature of trading on an exchange with real-time prices. Investors get index-style diversification plus the ability to buy or sell a single unit at the live price. Because the portfolio is passive, expense ratios are typically lower than an actively managed scheme's.
Three investors want exposure to the Nifty 50. One buys an open-ended index fund: she transacts with the fund at the day's NAV. One buys a closed-ended scheme: she must find a seller on the exchange and pays whatever the market price is. One buys a Nifty ETF: she also buys on the exchange, but the units are created and redeemed through authorised participants, which keeps the market price close to the value of the basket.
- A warrant is a right, not an obligation, to buy the issuer's equity shares after a set period at a pre-decided price.
- Leading indices are market-cap weighted and built from liquid stocks; Nifty 50 (NSE, 50 stocks), S&P BSE Sensex (30 stocks) and MSEI SX40 (40 stocks) are the widely tracked ones, with constituents reviewed periodically.
- Indices serve as a reference point against other asset classes, a benchmark for active funds, an economic or sector barometer, a real-time sentiment gauge, and the underlying for index funds and derivatives.
- Open-ended funds transact with the fund at NAV-linked prices with no fixed maturity; closed-ended funds have fixed unit capital and trade on the exchange where they must be listed; ETFs track an index or commodity and trade in demat form at continuously changing prices, with authorised participants creating units.