Meaning of Investments

Investment is a word of many interpretations and basically there are 3 concepts of investments. They are: 1. Economic investment 2. General investment and 3. Financial investment

Contd..
Investment decisions are generally done on the following factors: 1. Factual / informational premises 2. Expectational premises and 3. Valuational premises

Investment Alternatives
There are 2 main investment alternatives. They are: 1. Financial assets and 2. Real assets

Financial Assets
These are paper claims on some issuer like government or a corporate body. The important financial assets are equity shares, corporate debentures, government securities, bank deposits, mutual fund shares, insurance policies and derivative instruments.

Contd..
The following are the different financial assets: 1. Non-marketable financial assets: These assets represent personal transactions between the investor and the issuer. They include: a. Bank deposits b. POTDs

Contd..
c. MISPO d. KVP e. NSC f. Company deposits g. EPF h. PPF

Contd..
2. Money market securities: Debt instruments which have a maturity of less than one year at the time of issue are called money market instruments. They are: a. Treasury bills b. Certificates of deposits c. Commercial paper and d. Repos

Contd..
3. Bonds / fixed income deposits: The represent long-term instruments which involves periodic interest payment over life and principal payment at the time of redemption. They are: a. Government deposits b. Savings bonds c. Private security debentures

Contd..
d. Public sector undertaking bonds e. Preference Shares 4. Equity shares: Equity capital represents ownership capital. They are the bearers of the risk and also the owners of the profits.

Contd..
5. Mutual Fund Schemes: A mutual fund represents a vehicle for collective investment. UTI was the only mutual fund in India till 1986, offering very few # schemes. Presently there are about 30 mutual funds offering over 1000 schemes.

Contd..
Mutual fund schemes are broadly categorized into 3. They are: 1. Equity schemes 2. Hybrid schemes and 3. Debt schemes

Contd..
6. Financial derivatives: A derivative is an instrument whose value depends on the value of an underlying asset. Derivatives are of 2 types: a. Futures: A future contract is an agreement between 2 parties to exchange an asset for cash at a predetermined future date for a price that is specified today

Contd..
b. Options: It gives its owner the right to buy or sell an underlying asset on or before a given date at a predetermined price. There are 2 types of options: - Call option and - Put option

Contd..
7. Life insurance: Life insurance policies are meant to protect the policyholder from the financial consequence of undesirable events like death, long-term sickness / disability.

Real Assets
Real assets are represented by tangible assets like residential house, commercial property, agricultural farm, gold, precious stones and art objects.

OBJECTIVES OF FINANCIAL INVESTMENTS

OBJECTIVES OF FINANCIAL INVESTMENTS: SAFETY OF PRINCIPAL AMOUNT STABILITY OF INCOME CAPITAL GROWTH TAX BENEFITS PURCHASING POWER STABILITY ADEQUATE LIQUIDITY

Investment process

Investment policy
Investible funds: The entire investment procedure revolves around the availability of funds. Funds may be generated through savings or from borrowings. Borrowed: investor has to be extra careful in the selection of invst alternatives, the return should be higher than the interest he pays.

Objectives & knowledge

Required rate of return Regularity of income Risk perception & the need for liquidity Earn high rate of return in the form of capital appreciation Primary: safety of the principal The knowledge about invst alternatives & markets helps in policy formulation Aware of the stock market & the function of brokers

Security analysis
Market analysis Industry analysis Company analysis

valuation
Helps the investor to determine the risk expected from an invst in the common stock. Intrinsic value of the share is measured through the book value of the share & P.E. ratio. Simple discounting models also can be adopted to value the shares Real worth of share is compared with the market price & then the invst decisions are made.

Construction of portfolio
Portfolio is a combination of securities. It is constructed in such a manner to meet the investors goals & objectives. Investor should decide how best to reach the goals with the securities available. Attain MAXIMUM RETURN WITH MINIMUM RISK.

Contd
Diversification: reduction of risk in the loss of capital & income Debt & equity diversification: debt instrument provide assured return with limited capital appreciation. Stocks provide income & capital gain but with uncertainty Industry diversification: industries growth & their reaction to govt policies differ from each other. Company diversification: reduces risk selection

Evaluation
Appraisal: return & risk performance of the security vary from time to time. The variability in returns of the security is measured & compared. Revision: low yielding securities with high risk are replaced with high yielding securities with low risk factor

Securities
Equity shares Sweat equity Non-voting shares Right shares Bonus shares Preference shares Debentures bonds

Non-security forms of invst

National Savings Scheme National savings certificate Provident Fund - Statutory Provident Fund - Recognized Provident Fund - Unrecognized Provident Fund - Public Provident Fund Life Insurance Policies - Whole Life Policy - Jeevan Mitra - The Special Endowment Plan with Profits

Contd..
Unit Schemes of UTI - Unit schemes,1964 - Reinvestment Plan, 1966 - Unit Linked Insurance Plan,1971 Post Office Savings Bank account - Recurring deposits - Time deposits - Monthly Income scheme - Social security certificate

Contd..
Others: - Indira Vikas Patra - Deposits in Bank - Recurring deposits - Time deposits

Sources Of Investment Information

Exchanges Indexes Government sources

Bond
A Bond is a long term contract under which a borrower agrees to make payment of interest and principal ,on specific dates to the holders of bond. Types: (1) Treasury (Government) (2) Corporate (3) Municipal (4) Foreign

YTM
Is the discount rate that equates the PVs of Bonds cash flows to the Bonds Current market price. Draw the Diagram: Yield(%) Coupon rate Current yield YTM Bond Price (%of face value)

FUNCTIONING OF STOCK EXCHANGES

BOMBAY STOCK EXCHANGE

The origin of BSE dates back to1875. It was organized under the name of The Native Stock and Share Brokers Association as a voluntary and non-profit making association. The premier stock exchange is one of the oldest stock exchanges in Asia.

OBJECTIVES To safeguard the interest of investing pubic having dealings on the exchange. To establish and promote honorable and just practices in securities transactions. To promote, develop and maintain wellregulated market for dealing in securities. To promote industrial development in the country through efficient resource mobilization by the way of investment in corporate securities.

TRADING SYSTEM

In March 1995, the BSE has introduced screen based trading called BOLT(BSE on-line Trading). The BOLT is designed to get best bids and offers from jobbers book as well as the best buy and sell orders from the order book. BOLT is a nation wide network. Trading Work Stations are connected with the main computer at Mumbai through WAN.

NATIONAL STOCK EXCHANGE(NSE) The NSE of India became operational in the capital market segment on 3rd, November 1994 in Mumbai. The genesis of the NSE lies in the recommendations of the Pherwani Committee(1991).

OBJECTIVES
To establish a nation wide trading facility for equities, debt instruments and hybrids. To ensure equal access to investors all over the country through appropriate communication network. To provide a fair, efficient and transparent securities market to investors using an electronic communication network To enable shorter settlement cycle and book entry settlement system. To meet current international standards of securities market.

TRADING SYSTEM
The companies with the minimum paid up capital of Rs.10 crores are listed in NSE. The software in the NSE trading system is known as National Exchange for Automated Trading (NEAT). NSE has two segments: The Capital Market segment and The Wholesale Debt Market segment. The trading members in the Capital Market segment are connected to the central computer in Mumbai through a satellite link-up, using VSATs (Very Small Aperture Terminals). The trading members in the Wholesale Debt Market segment are linked through dedicated high speed lines to the central computer at Mumbai. Communication is carried out with the help of satellites. Network management centre is set up to enable remote diagnosing and solving problems related to network throughout the day. This helps the traders to carry out their activities with minimum interruption.

INTER-CONNECTED STOCK EXCHANGE(ISE) The ISE of India started trial runs from August 29, 1998. The main objective of ISE is to inter link the regional stock exchanges of the country to ensure liquidity. Because of poor liquidity at the regional exchanges, there has been a lot of shift in business to BSE and NSE. The second objective is to minimize the cost of the regional exchanges as they were incurring huge costs by supporting a very illiquid market.

MODE OF FUNCTIONING
ISE enables a trading member of one exchange to deal with his counter-part in other exchanges from his local Trader Work Station using the ISE established Central System. The central computer is in Mumbai and all the regional stock exchanges are linked to the central computer through VSAT. Once these are linked, each broker who has a terminal for the local market, will be given an additional segment of ISE. The broker will have two trading options, viz. he will be able to trade on the local market and the moment he switches over to ISE segment , he will have an easy access to a national market. Whenever he enters an order in the national market, it will immediately come to the central order book maintained in Mumbai, gets matched and reporting will be done. Trading will be done through the same trader work station. Settlement period will be from Thursday to Wednesday and payout will be seven days from the last date of settlement.

OVER THE COUNTER EXCHANGE OF INDIA (OTCEI) OTCEI was started in 1992 after the role models of NASDAQ (National Association of Securities Dealers Automated Quotation) and JASDAQ (Japanese Association of Securities Dealers Automated Quotation). The OTCEI was setup with the objective of providing a market for the smaller companies that could not afford the listing fees of the large exchanges and did not fulfill the minimum capital requirement for listing. It aimed at creating a fully decentralized and transparent market.

TRADING SYSTEM
The OTCEI dealers screen has a left and right half for the sell and buy counters. The sell counter gives: the rate, the number of shares offered and the name of the market maker. It is always in an ascending order with the lowest buy quote given at first. The sell quote prices are displayed in the descending order and the seller can decide to unload at the highest price displayed. Once the deal is struck, it is entered into the computer. To confirm the transaction, on line message appears on the screen. The confirmation slip or trading document is generated through the computer in duplicate. One copy is retained and the other is sent to the OTCEI counter. This is known as the counter receipt. The counter receipts are used for further transaction

NATIONAL SECURITIES DEPOSITORY LIMITED (NSDL)

NSDL is an organization to provide electronic depository facilities for securities traded in the equity and the debt market.

THE FUNCTIONING
NSDL performs the following functions: Enables surrender and withdrawal of securities to and from the depository. Maintains investors holdings in the electronic form. Effects settlement of securities traded on exchanges Carries out settlements of trader that have not been done on the stock exchanges. NSDL makes use of VSAT network of the NSE for communications. After ascertaining its requirement on the volume of trade, NSDL would setup its own network.

TRADING AND SETTLEMENT PROCEDURES IN NSE, BSE

Traditional
Open outcry system. Minimal technology. Time consuming, inefficient. No transparency. Manual proceedings.

NSE SBTS screen based trading system

Members of NSE can enter the price and the number of shares he wants to buy or sell and the transaction gets executed as soon as the system finds a matching order. Matches orders Strict price/Time priority. Faster trade execution. NEAT National Exchange for Automated Trading

Trading cycle
Earlier 14 to 30 days. Long duration, price fluctuations, capital held up. Then T+5, Later T+2, Now T+1.

Activity
Trading Clearing Rolling settlement trading Custodian confirmation Delivery generation T

Day
T+1 working day T+1 working day

Settlement

Securities and funds pay in Securities and funds pay out

T+2 working day T+2 working day

NSE Order Driven Market

An investor places the order and the system executes the order the moment it finds a matching order. Elimination of jobbers or specialists from the market and in the process reduced the transaction cost.

NSE Quote Driven Market

A specialist gives two way quote Bid rate Ask rate

BSE
BOLT BSE On Line Trading. Market reach. Order driven market from Aug 13, 2001

Types of Orders
Market orders. Limit orders. Market orders - Buy or sell orders that are to be executed immediately at current market price. Bid ask spread difference between bid price and ask price

Limit Orders
Investors specify prices at which they are willing to buy or sell a security. If the stock falls below the limit on a limit-buy order then the trade is to be executed. Inside quotes buy and sell orders at top of the list. Inside spread diff b/w buy & sell price.

Limit Orders
Condition A c t i o n
Price below the limit Price above the limit

Buy

Limit Buy order Stop Loss Order

Stop Buy Order Limit Sell order

Sell

The objectives of listing

provide liquidity to securities; mobilize savings for economic development; protect interest of investors by ensuring full disclosures.

Types of Risks
Interest rate risk: Purchasing power risk: Business risk: Financial Risk: Inflation risk: Taxation risk: Government policy:

Beta( )
Simply, it is the ratio of %change in the scrip return & % change in market return. Appreciation in the scrip price relating to the market price index is measured by Beta. Systematic risk is measured by Beta Ready information about beta is available in Journals and publications such as .. Dalal Street, ICFAI , Capital Market etc. Beta value varies from 0.5 to 1.5, If is = 1 , scrip risk is the same as market risk If is < 1, scrip risk is less than market risk If is > 1, scrip risk is more than market risk.

Portfolio
Invest in Diversified scrips.. Study reveals that the aggregate of the risks is less than the individual investment risk. Therefore , spread the capital investment Is it possible to eliminate the risk ?? Answer ---- No You can only reduce the risk .

Macro Analysis
1. Global economy --a. Economic performance varies widely b.Turmoil stock market crash c. Exchange Rate international competitiveness

3.Macro-Economic Analysis
GDP Industrial Growth Rate Agriculture & Monsoon Savings & Investment Budget & Deficits Price level & inflation Interest rates BOP, Forex reserves, & Exchange rates Infrastructural facilities Sentiments

Dow Theory
Three movements: A. Daily fluctuations B .Secondary Movements or Corrections C .Primary Trends- Bulls & Bears

APT THEORY
APT holds that the expected return of a financial asset can be modeled as a linear function of various macro-economic factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factor-specific beta coefficient. The model-derived rate of return will then be used to price the asset correctly - the asset price should equal the expected end of period price discounted at the rate implied by model. If the price diverges, arbitrage should bring it back into line.

Efficient Market Hypothesis

An investment theory that states that it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, this means that stocks always trade at their fair value on stock exchanges, and thus it is impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. Thus, the crux of the EMH is that it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Basic Assumptions of CAPM

Individuals are risk averse They seek to maximise the expected utility of their portfolio over a single period planning horizon They have homogeneous expectations They can borrow or lend freely at a riskless rate of interest. The market is perfect: no transaction cost,no taxes, securities are completely divisible,the market is competitive The quantity of risky securities in the market is given

Security Market Line(SML)

What about individual securities & Inefficient portfolios? Their ERs & SDs will be below CML ,reflecting the inefficiency. Such points are found throughout feasible region. However,there is a linear relationship between their SRs & Covariance with Market portfoilo. This relationship is called SML

SML Graph
When plotted on the graph:
Security Market Line
18% Required Return 12% 6% 0% 0.00

0.50

1.00 Beta

1.50

2.00

2.50

Impact on SML
1. Changes in interest rates 2. Investors aversion to risk 3. Individual companys Betas

Alpha ( )
Securitys Alpha= = The difference between the actual expected return on a security & its fair return as per SML
P SML Return

Beta P is under priced security & O is Over priced security

Concept of Beta
Beta Coefficient : The amount of risk that the stock contributes to the market portfolio.
Covar j, m
2 m j m m

Fj = =

Cor j, m v
m

j m

v Cor j, m

Beta explained
A stock with high SD will tend to have a high beta A stock with high stand alone risk will contribute more to the portfolio risk A stock with high correlation with market , will make portfolio more risky High correlation means that diversification does not help much An average risk stock will have beta = 1

Morkowitz Model
Risk is measured by SD, Variance Portfolio risk is measured by co variance , correlation coefficient Diversification reduces the risk Efficient management of securities is required.

BOOK BUILDING PROCESS

The Issuer who is planning an offer nominates lead merchant banker(s) as 'book runners'. The Issuer specifies the number of securities to be issued and the price band for the bids. The Issuer also appoints syndicate members with whom orders are to be placed by the investors. The syndicate members input the orders into an 'electronic book'. This process is called 'bidding' and is similar to open auction. The book normally remains open for a period of 5 days. Bids have to be entered within the specified price band. Bids can be revised by the bidders before the book closes. On the close of the book building period, the book runners evaluate the bids on the basis of the demand at various price levels. The book runners and the Issuer decide the final price at which the securities shall be issued. Generally, the number of shares are fixed, the issue size gets frozen based on the final price per share. Allocation of securities is made to the successful bidders. The rest get refund orders.