Professional Documents
Culture Documents
Security Analysis - Investment Management
Security Analysis - Investment Management
Internal Marks : 30
UNIT - I
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External Marks : 70
Time : 3 hrs.
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UNIT - II
Information system for strategic advantage, strategic role for information system,
breaking business barriers, reengineering business process, improving business
qualities.
UNIT - III
Information system analysis and design, information SDLC, hardware and software
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UNIT - IV
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UNIT I
Q.
Define Investment.
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Ans. Meaning of Investment : Investment involves making of a sacrifice in the present with
the hope of deriving future benefits. Investment has many meanings and facets. The two
most important features of an investment are current sacrifice and future benefit.
We can now give a simple yet a broad definition of investment. We can define investment as
postponed consumption.
When you postpone consumption, sacrifice takes place n the present and is certain whereas
the benefits occur n future and are uncertain. Therefore, risk and expected return from the
investment are the two key determinants of investment process.
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Define Risk. What are the different types of risk influences on investment?
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Ans : Meaning of Risk : Risk can be defined as the probability that the expected return from
the security will not materialize. Every investment involves uncertainties that make future
investment returns risk-prone. Uncertainties could be due to the political, economic and
industry factors.
Non-Systematic Risk
Market Risk
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Systematic Risk
Regulation Risk
Regulation Risk
Regulation Risk
Business Risk
Bull-Bear Risk
Management Risk
Default Risk
International Risk
Industry Risk
Country Risk
Liquidity Risk
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Dividing total risk into its two components, a general (market) component and a specific
(issuer) component, we have systematic risk and non-systematic risk, which are additive:
(A)
Systematic Risk : Variability in a securitys total returns that is directly associated with
overall movements in the general market or economy is called systematic risk.
Virtually all securities have some systematic risk because systematic risk directly
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Non-Systematic Risk : The variability in a securitys total returns not related to overall
market variability is called the non-systematic (non-market) risk. Non-systematic risk
is specific to an industry or the company individually. This risk is unique to a particular
security and is associated with such factors as business and financial risk as well as
liquidity risk. Different types of non-systematic risks are explained as under:
(1) Regulation Risk : Some investments can be relatively attractive to other
investments because of certain regulations or tax laws that give them an
advantage of some kind. Municipal bonds, for example, pay interest that is
exempt from local, state and federal taxation. As a result of that specific tax
exemption, municipals can price bonds to yield a lower interest rate since the net
after-tax yield may still make them attractive to investors.
(2) Business Risk : The risk of doing business in a particular industry or
environment is called business risk. For example, as one of the largest steel
producers, U.S. Stee faces unique problems.
(3) Bull-Bear Market Risk : This risk arises form the variability in the market returns
resulting from alternating bull and bear market forces.
When security index rises fairly consistently from a low point, this upward
trend is called a bull market. The bull market ends when the market index
reaches a peak and starts a downward trend.
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(B)
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encompasses interest rate, market, and inflation risks. Systematic risk is attributable
to broad macro factors affecting all securities. Different types of systematic risk are
explained as under:
(1) Market Risk : The variability in a securitys returns resulting from fluctuation in
the aggregate market is known as market risk. Market risk is sometimes used
synonymously with systematic risk. All securities are exposed to market risk
including :
Recession
Wars
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The period during which the market declines, this downward trend is
called a bear market.
Management Risk : Management, all said and done, is made of people who are
mortal, fallible and capable of making a mistake or a poor decision. Errors made
by the management can harm those who invested in their firms.
(5)
Default Risk : It is that portion of an investments total risk that results from
changes in the financial integrity of the investment. For example, when c
company that issues securities moves either further away from bankruptcy or
closer to it, these changes in the firms financial integrity will be reflected in the
market price of its securities. The variability of return that investors experience,
as a result of changes in the credit worthiness of a firm in which they invested, is
their default risk.
(6)
International Risk : International risk can include country risk and exchange
rate risk.
(i)
Exchange Rate Risk : All investors who invest internationally in todays
increasingly global investment arena face the prospect of uncertainty in
the returns after the convert the foreign gains back to their own currency.
(ii) Country Risk : Country risk, also referred to as political risk, is an
important risk for investors today. With more investors investing
internationally, both directly and indirectly, the political and therefore
economic stability and viability of a countrys economy need to be
considered.
(7)
(8)
Liquidity Risk : Liquidity risk is the risk associated with the particular secondary
market in which a security trades. An investment that can be bought or sold
quickly and without significant price concession is considered liquid. The more
uncertainty about the time element and the price concession, the greater the
liquidity risk.
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(4)
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(1)
Volatility : Volatility may be described as the range of movement (or price fluctuation)
from the expected level of return. For example, the more a stock goes up and down in
price, the more volatile that stock is.
(2)
(i)
s
P
= Standard deviation of portfolio consisting securities A and B
WA WB = Proportion of funds invested in Security A and B
AB s
As
B
s
s= W s
+W s
+2 WA WB r
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s
As
B = Standard deviation of returns of Security A and Security B
AB
= Correlation coefficient between returns of Security A and Security B
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(ii)
Cov AB
=
s
As
B
s
P= W 2s
2 + W 2s
2 + W 2 s 2 +2 WxWy r
yz s
ys
z+ WxWz r
xz s
xs
z
W 1, W2, W3= Proportion of amount invested in securities X, Y and Z
s
xs
y s
z = Standard deviation of Securities X, Y and Z
r
xy
= Correlation coefficient between Securities X and Security Y
r
yz
= Correlation coefficient between Securities Y and Security Z
r
xz
= Correlation coefficient between Securities X and Security Z
Beta : Beta is a measure of the systematic risk of a security that cannot be avoided
through diversification. Beta is a relative measure of risk- the risk of an individual stock
relative to the market portfolio of all stocks. For example, a security with a beta of 1.5
indicates that, on average, security returns are 1.5 times as volatile as market returns,
both up and down.
Q.
(3)
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Ans. Meaning of Return : Return is the amount or rate of produce, proceeds, profits which
accrues to an economic agent from an undertaking or investment. It is a reward for and a
motivating force behind investment, the objective of which is usually to maximize return.
Determinants of Return : Three major determinants of the rate of return expected by the
investor are:
(i)
(ii)
(iii)
The risk associated with the investment, which is unique to the investment.
Component of Return : The rate of return from an investment consists of the two:
(i)
Yield : The interest or dividend received is called yield.
(ii) Capital Appreciation : The difference between the sale price and the
purchased price is the capital appreciation.
It + [Pt Pt-1]
Pt-1
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Formula:
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It
[Pt Pt-1]
+
Pt-1
Pt-1
It
Where is called the current yield,
Pt-1
[Pt Pt-1]
And is called the capital gain yield
Pt-1
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It + [Pt Pt-1]
Pt-1
The return of 21% consists of 15% current yield and 6% capital gain yield
Return of Portfolio (Two Assets) :
The expected return from a portfolio of two or more securities s equal to the weighted
average of the expected returns from the individual securities.
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S
(Rp) = WA (RA) + WB (RB)
S
(Rp) = Expected return from a portfolio of two securities
WA
= proportion of funds invested in Security A
WB
= Proportion of funds invested in Security B
RA
= Expected return of Security A
RB
= Expected return of Security B
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WA+WB = 1
Example : A Ltd.s share gives a return of 20% and B Ltd.s share gives 32% return. Mr.
Gotha invested 25% in A Ltd.s share and 75% of B Ltd.s shares. What would be the
expected return of the portfolio?
Solution :
Internal Rate of Return : The internal rate of return (IRR) is the rate of discount which
makes the present value of all the revenues (cash flows) from the investment equal to
the total cost of that investment. This is also known as the yield or yield rate.
(2)
Bond Rate : It is the interest rate received on the face value or the par value of the
bond. If a company or the government issues a 10-ear bond with Rs. 100 as face value
and 15 per cent rate of interest, it would be described as 15 per cent bond.
(3)
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(1)
(4)
Holding Period Return/Return : Holding period yield (HPY) measures the total
return from an investment during a given time period in which the asset is held b the
investor. It is to be noted that HP does not mean that the security is actually sold and
the gain or loss is actually realised by the investor. The concept of HPY is applicable
whether one is measuring the realized return or estimating the future return. It can be
calculated as follows:
Any cash payments received + price change over the holding period
HPY =
Price at which the asset is purchased (beginning price)
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Dividend Yield : Dividend yield is the ratio of per share expected dividends, to the
current market price of the share.
(7)
Earnings Yield : Earnings yield is the ratio of expected earnings per share of the firm
to the current marker price of the share. The dividend yield and earnings yield do not
differ if the firm distributes all net earnings in the form of dividends i.e. if it practices 100
per cent dividend payout ratio.
(8)
Nominal and Real Return : While the nominal return is the return in nominal rupees,
the real return is equal to the nominal return adjusted for changes in prices i.e. rate of
inflation.
(9)
Gross and Net Yield : While gross yield refers to the yield realized by the investor
before paying taxes, the net yield is what remains with him after paying the taxes. The
net yield can be calculated as follows:
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(6)
Ans. Meaning of Stock Exchange : Stock exchange means an organized market where
securities issued by companies, government organizations and semi-organisations are sold
and purchased. Securities include:
(i)
Shares
(ii) Debentures
(iii) Bonds etc.
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Stock Exchange are market places where securities that have been listed thereon,
may be bought and sold for either investment or speculation.
Features of Stock Exchange : The main features of stock exchange are as follows:
(1)
(2)
Dealing only through Authorised Members : Investors can sale and purchase
securities in stock exchange only through authorized members. Stock exchange is a
specified market place where only the authorized members can go. Investor has to
take their help to sale and purchase.
(4)
Necessary to obey the Rules and Bye-Laws : While transacting in stock exchange,
it is necessary to obey the rules and bye-laws determined by stock exchange.
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(3)
Functions of Stock Exchange : The main functions performed b stock exchange are as
follows:
Providing Liquidity and Marketability to existing securities : Stock exchange is a
market place where previously issued securities are traded. Various types of
securities are traded here on regular basis. Whenever required, investor can invest his
money through this market into securities and can reconvert this investment into cash.
(2)
(3)
Safety of Transactions : Stock exchanges are organized markets. The fully protect
the interest of investors. Each stock exchange has its own laws and be-laws. Each
member of stock exchange has to follow them and any member found violating them,
his membership is cancelled.
(4)
(5)
Spreading Equity Cult : Share market collects every types of information in respect
of the listed companies. Generally this information is published or otherwise n case of
need anybody can get it from the stock exchange free of any cost. In this way, the stock
exchange guides the investors by providing various types of information.
(6)
Providing Scope for Speculation : When securities are purchased with a view to
getting profit as a result of change in their market price, it s called speculation. It is
allowed or permitted under the provisions of the relevant Act. It is accepted that in
order to provide liquidity to securities, some scope for speculation must be allowed.
The share market provides this facility.
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(1)
Stock Exchange in India : There are 24 stock exchanges functioning currently in India. The
names are given below:
(1) Mumbai Stock Exchange OR
(13) Cochin Stock Exchange
Bombay Stock Exchange-BSE
(2) National Stock Exchange (NSE)
(14) Coimbatore Stock Exchange
(3) Over the Counter Exchange of India (OTCEI) (15) Guwahati Stock Exchange
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Ans. New Issue Market OR Primary Market : New issue market is the segment in which
new issues are made. In the new issue market, new issues may be made in three ways
namely:
(i)
Public Issue
(ii) Rights Issue
(iii) Private Issue.
Classification of New Issue Market : The new market can be classified as:
(i)
A market where firms go to the public for the first time through initial public offering
(IPO).
(ii) A market where firms which are already trade raise additional capital through
seasoned equity offering (SEO).
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Functions of New Issue Market : The main function of new issue market is to facilitate
transfer resources from savers to the users. The savers are individuals, commercial banks,
insurance company etc. the users are public limited companies and the government. The
new issue market plays an important role in mobilizing the funds from the savers and
transferring them to borrowers for production purposes, an important requisite of economic
growth. The main function of new issue market can be divided into three service functions:
(1) Origination
(2) Underwriting
(3) Distribution
(1)
(i)
(ii)
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Type of issue
Magnitude of issue
Methods of issue.
The function of origination is carried out by merchant banker, who may be commercial
banks, and Indian financial institutions, or private firms.
Underwriting : Underwriting is an agreement whereby the underwriter promises to
subscribe to a specified number of shares or debentures or a specified amount of
stock in the event of public not subscribing to the issue. If the issue is fully subscribed
then there is no liability for the underwriter. If a part of share issues remains unsold, the
underwriter will buy these shares. Thus underwriting is a guarantee for the
marketability of shares.
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(2)
(ii)
Standing behind the issue: Under this method, the underwriter guarantees
the sale of a specified number of shares within a specified period. If the public do
not subscribe to the specified amount of issue, the underwriter buys the balance
in the issue.
Consortium Method: Underwriter is jointly done by a group of underwriters in
this method. This method is adopted for large issue.
(i)
(i)
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(ii)
(iii)
(iv)
Provide expect advice with regard to timing of security issue, the pricing of issue,
the size and type of securities to be issued etc.
(v)
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(i)
Non-Institutional Underwriters
(3)
Q.
Define New Issue Market. What are the methods of floating new issues? Explain
in detail.
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(ii)
Ans : New Issue Market OR Primary Market : New issue market is the segment in which
new issues are made.
Classification of New Issue Market : The new market can be classified as:
(ii)
A market where firms go to the public for the first time through initial public offering
(IPO).
A market where firms which are already trade raise additional capital through
seasoned equity offering (SEO).
(i)
Public Issues : Under this method, the issuing company directly offers to the general
public/institutions a fixed number of shares at a stated price through a document
called prospects. This is the most common method followed by join stock companies
to raise capital through the issues of securities. The following information are given in
the prospectus:
(1)
Methods of Floating New Issues : The various methods which are used in the floating of
securities in the new issue market are:
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(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
Offer of Sale: The method of offer of sale consists in outright sale of securities through
the intermediary of issue houses or share brokers. In other words, the shares are not
offered to the public directly. This methods consists of two stages:
(i)
The first stage is a direct sale by the issuing company to the issue house and
brokers at an agreed price.
In the second stage, the intermediaries resell the above securities to the
ultimate investors. The issue houses or stockbrokers purchase the securities at
a negotiated price and resell at a higher price. The difference between in the
purchase and sale price is called turn or spread.
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(ii)
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(2)
According to the Companies Act, 1956 every application form must be accompanies
by a prospectus.
Advantages : One chief advantage of this method is that the company is relieved from
the problem of printing and advertisement of prospectus and making allotment of
share. Offer of sale is not common in India.
Placement : Under this method, the issue houses or brokers buy the securities
outright with the intention of placing them with their clients afterwards. Here, the
brokers act as almost wholesaler selling them in retail to the public. The brokers would
make profit in the process of reselling to the public. The issue houses or brokers
maintain their own list of client and through customer contact sell the securities.
(3)
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(4)
(ii)
(i)
(ii)
Q.
To Companies : The company benefits from lower issue costs, in that administration
and underwriting costs are lower and the issue is made at the discretion of the
directors rather than via a general meeting of the company.
To the Shareholders : The main attraction of the rights issue for current shareholders
is that they are able to maintain their original proportion of share ownership.
What do you mean listing of securities? Explain.
(i)
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Any company
(i)
Which has completed two years after its incorporation or
(ii) Which has completed one year from the first allotment of shares after its
incorporation
Those further shares shall be first be offered to the existing shareholder in proportion
to the shares held by them in the paid up capital, on the date of such offer.
At least 15 days notice shall be given from the date of offer. The notice shall specify the
number of shares offered and the limiting time of the offer.
The notice shall mention that if the offer is not accepted within the time of offer, will be
deemed to have been declined.
When listing is granted to a company, it means that the securities are included in the official
list of the stock exchange for the purpose of trading. Security listing ensures that a company
is solvent and its existence is legal. Government security is not required to be listed.
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(iii)
(iv)
(v)
(vi)
(vii)
Documents to be Attached :
(ii)
(iii)
(iv)
(v)
(vi)
(2)
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(i)
Criteria for Listing : The stock exchange has to direct special attention to the
following particulars while scrutinising the application:
Articles:
Whether the Articles contain the following provisions:
Calls paid in advance may carry interest, but shall not confer aw right to
dividend.
Unclaimed dividends shall not be forfeited before the claim becomes time
barred.
Whether at least 49% of each class of securities issued was offered to the public
for subscription through newspapers for not less than three years.
Whether the company is of a fair size, has a broad-based capital structure and
there is sufficient public interest in its securities.
(i)
(a)
(1)
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Rules for Listing of Securities : The following statutory rules have been laid down for the
listing of securities under SEBI. A company requiring a quotation for its shares must apply in
the prescribed form supported b the documentary evidence given below:
(b)
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(c)
(3)
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(iv)
(v)
(vi)
(x)
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(iii)
Q.
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A company enlisting the securities of a company for the purpose of trading insists that all
applicants for shares will be treated with equal fairness in the matter of allotment. Infact, in
the event of over-subscription, the stock exchange will advise the company regarding the
basis for allotment of shares. It will try to ensure that applicants for large blocks of shares are
not given undue preference over others.
What are the main features of OTCEI? Explain the trading process of OTCEI.
Ans. Over the Counter Exchange of India (OTCEI): The OTCEI is a completely
computerized and special ringless stock exchange which is different from the traditional
stock exchange and on which the buying and selling of securities is absolutely transparent
and moves at a great speed. Its counters are spread all over the country where transactions
are made with the help of telephone.
The OTCEI was established under section 25 of the Companies Act, 1956 in October, 1990.
The promoters of the OTCEI are the following financial and other institutions:
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Features or Nature of OTCEI : The main features of the OTCEI are the following:
(1)
Nation Network : The OTCEI has its network all over the country. All the counters are
linked with the central terminal through the medium of computers. Therefore, the
facility of nationwide listing is available here. In other words by listing on one
exchange, one can have transactions with all the counters in the whole country.
(3)
Exclusive List of Companies : On the OTCEI only those companies are listed whose
issued capital is 30 lakhs or more. In the old share markets this amount used to be ten
crores on the BSE and three crores on the other exchanges and hence, listing was not
possible in case the issued capital was less than three crores. Those companies
which have been listed on the old share markets cannot be listed on the OTCEI.
(4)
Fully Computerised : This exchange is fully computerized. It means that all the
transactions done on this exchange are done through the medium of computers.
(5)
Sponsorship : In order to get listed on the OTCEI, a company has to find a member to
sponsor it. The main job of a sponsor is market making. T means a sponsor has to be
read to buy or sell the shares of that company at least for a period of 18 months. In this
way, a sponsor creates liquidity in securities.
(6)
Investors Registration : All the investors doing transactions on the OTCEI have got
to register themselves compulsorily. Registration can be got done b giving an
application at an counter. The registration is called the INVESTOTC CARD. On the
basis of this card, one can do transactions of securities at any counter throughout the
country.
(7)
Greater Liquidity : There is greater liquidity in securities because of the sponsors job
of market making.
(8)
Transparency in Transactions : All the transactions are done in the presence of the
investor. The rates of buying and selling can be seen on the computer screen. The
operator cannot do any fraud or mischief with the transactions.
(9)
Faster Delivery and Payment : On the OTCEI, delivery in case of buying and
payment in case of selling are both very fast. The work of delivery and payment in case
of listed securities and permitted securities is completed within seven days and 15
days respectively.
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(2)
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(10) Two ways of Public Offer : A company listed on the OTCEI can issue security n two
was. Firstly, the company can go directly to the public. This is called Direct Offer
System. Secondly, the company sells its securities to the sponsor at a particular price.
Then the sponsor sells them to the public. This is called Indirect Offer System.
(11) Easy Access : In the big cities the counters of the OTCEI can be seen like ordinary
shops. Any body can go the counter and do buying and selling of securities.
Trading Process : One can trade in securities b going to any counter of the OTCEI. All the
counters are linked with the central computer at the OTCEI headquarter. This office is in
Mumbai. There can be three types of trading on the OTCEI:
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(2)
Buying in the Secondary Market : For the purpose of buying shares listed on the
OTCEI, a person has to get himself registered (if he is not already registered). After
this, he informs the counter operator about the number of the shares to be purchased.
The counter operator displays the rates on the screen. After getting himself satisfied
with the rate, the investor hands over the cheque to the operator. On the encashment
of the cheque, the CR is handed over to the investor. This procedure takes about a
week.
(3)
Selling in the Secondary Market : An investor who has purchased shares from the
OTCEI can sell his shares at any counter of the OTCEI. After getting himself satisfied
with the rate displayed on the screen, the investor hands over the Counter Receipt and
the Transfer Deed to the Operator. The operator prepares the Sales Confirmation Slip
(SCS) and a copy of it is handed over to the seller. The operator sends the CR, TD and
SCS to the Registrar for confirmation. After confirming every detail the Registrar sends
them back to the counter operator. In the end the operator issues a cheque to the seller
and receives back the SCS from the seller.
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(1)
Purposes of OTCEI : The objects of the establishment of the OTCEI may be described as
under:
Liquidity : The first object for the establishment of the OTCEI is o maintain liquidity in
the securities of the small companies. The sponsor has got to do the job of market
making.
(2)
(3)
(4)
Quick Settlement : In the traditional share markets both the delivery and payment
take time. This problem has been overcome with the help of the OTCEI.
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(5)
(1)
(6)
Access : This stock exchange is of the ringless type and therefore, has its counters all
over the country.
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UNIT II
Q.
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Ans. Introduction : An investor must have some knowledge of how the securities markets
operate. The marketing of old or new securities on the stock markets can be done only
through members of the Stock Exchange. These members are either individuals or
partnership firms. An individual; must use the facilities of these members for trading
insecurities unless he himself is a registered dealer or member of an organized stock
exchange. Trading among the members of a recognized stock exchange is to be done under
the statutory regulations of the stock exchange. The members carrying on business are
known as brokers and can trade only on listed securities. These members execute
customers orders to buy and sell on the exchange and their firms receive negotiated
commissions on those transactions.
Finding a Broker: The selection of a broker depends largely on the kind of services
rendered by a particular broker as well as upon the kind of transaction that a person
wishes to undertake. An individual usually prefers to select a broker who can render
the following services:
(i)
Provide information
(ii) Availability of Investment literature.
(iii) Appoint competent representatives
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(1)
Process of Investing in Securities : There are the following steps involved in the process
of investing in securities:
(2)
(i)
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Commission Broker : All brokers buy and sell securities for earning a
commission. From the investors point of view, he is the most important member
of the exchange because his main function and responsibility is to buy and sell
stock for his customers. He acts as an agent for his customer and earns a
Opening an Account with Broker : After a broker has been selected, the investor
has to place an order on the broker. The broker will open an account n the name of the
investor in his books. He will also ask the investor for a small sum of money called
margin money advance. In case, the investor wishes to sell his securities, he will have
to deposit with the broker share certificates and transfer deeds. He will also have to
sign in the transferors column on the transfer deed. The physical preference of share
certificates is not required any more in India if shares have been through the demat
process.
Order: Brokers receive a number of different types of buying and selling orders from
their customers. Brokerage orders very as to the price at which the order may be filled,
the time for which the order is valid, and contingencies which affect the order. The
customers specifications are strictly followed. The broker is responsible for getting the
best price for his customer at the time of the order is placed.
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(4)
(3)
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(5)
(i)
Spot Delivery : Spot delivery means delivery and payment on the same day as
the date of the contract or on the next day.
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Hand Delivery : Hand delivery is the transaction involving delivery and payment
within the time of the contract or on the date stipulated when entering into the
bargain, which time or date is usually not more than 14 days following the date of
the contract.
(iii)
(iv)
Market Orders : Market orders are instruction to a broker to buy or sell at the
best price immediately available. Market orders are commonly used when
trading in active stocks or when a desire to buy or sell is urgent.
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(ii)
(7)
Execution of order in the Stock Exchange : When the broker receives the margin
money and is clear about the order received by him, he puts the details n the order
book. The broker in the beginning of his career makes the deal himself. Once his
business grows, he employs clerks to transact his orders.
(8)
Preparing Contract Note in the Stock Exchange : The clerk takes the details of the
days transaction to the broker at the end of the working day. The broker scrutinizes all
transactions of the day and prepares a contract note and signs it on a prescribed form.
The contract note gives the details of the contract for the purchase or sale of securities.
It records the number of shares, rate and date of purchase or sale.
(9)
Settlement of Contracts : The last step is the settlement of the contract by the broker
for his client. The procedure for settlement is to be made for (a) ready delivery
contracts and (b) for forward delivery contracts.
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(6)
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(i)
(ii)
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Ans. Broker : Stock broker means a member of a stock exchange. Trading on stock
exchanges is carried out through brokers and dealers. All members can act as brokers and
for this purpose the have to maintain security deposits. Brokers act as agents buying and
selling or other for which they receive brokerage commission at stipulated rates. Dealers act
as principals and sell securities on ther own accounts.
Commission Broker : All brokers buy and sell securities for earning a commission.
From the investors point of view, he is the most important member of the exchange
because his main function and responsibility is to buy and sell stock for his customers.
He acts as an agent for his customer and earns a commission for the service
performed. He is independent dealer in securities. He purchases and sells securities
in his own name. He is not allowed to deal with the non-members. He can either deal
with a broker or another jobber.
(2)
Floor Broker : Floor brokers are not many in number. They execute orders for fellow
members and receive a share brokerage commission charged by a commission
broker to his/her constituent. He helps other brokers when they are busy and as
compensation, receives a portion of the brokerage charged by the commission agent
to his customer.
(3)
(4)
Dealer in Non-cleared Securities : He/she deals in securities that are not on the
active list.
(5)
Odd-lot Dealer : He/she specializes in buying and selling in amounts that are less
than present trading units. They buy and sell odd lots, make them up into marketable
trading units. These dealers receive commission. The odd-lot dealer has become an
important operator since the growth of new issues.
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(6)
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(1)
(7)
Q.
TE
R
Ans. Meaning of Investment Companies : Investment companies are firms that invite
individual investors to subscribe to their capital, combine the capital thus collected into a
common pool of investible resources and then seek to accomplish the investment objectives
of the investors by investing these resources in an appropriate portfolio of securities.
Investment companies may have a number of different schemes catering to the specific
investment objectives of different classes of investors.
M
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Unit Trust of India (UTI) : The UTI was established in 1964 with the objective of
making available the benefits of industrial growth to small savers. The UT collects
investible resources from investors through the sale of securities called units. These
funds arte then invested by UTI in various financial assets. Holders of units received
dividends from UTI. Since its inception, UTI has offered various schemes to cater to
the need of different classes of nvestors. Most of these schemes are:
(1)
Income Oriented Schemes : These funds offer a return much higher than the
bank deposits but with less capital appreciation. The emphasis being on regular
returns, the pattern of investment in general is oriented towards fixed income
yielding securities like non-convertible debentures of consistently good
dividend paying companies, etc.
Example : Income-Oriented Scheme issued by UTI:
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(i)
(ii)
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Growth Oriented Schemes : These funds do not offer fixed regular returns but
provide substantial capital appreciation in the long run. The pattern of
investment in general is oriented towards shares of high growth companies.
Master Share
Master Gain
UGS-200
(iv)
Close-ended Scheme : These funds are fixed in size as regards the corpus of
the fund and the number of shares. In close-ended funds, no fresh units are
created after the original offer of the scheme, expires.
(v)
Tax Planning Schemes : The investments made under these schemes are
deductible from the taxable income up to certain limits, thus providing
substantial tax relief to the investors.
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(iii)
Example: Tax planning schemes issued by UTI is Unit Linked Insurance Plan of
UTI.
(ii)
Close-ended schemes
(iii)
(i)
Swarna Pushpa
PNBRIPS
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(2)
(iv)
(v)
Growth and Income Funds : Example of Growth and Income Funds are:
Canstock, Can Double
TE
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(vi)
Life Insurance Corporation (LIC) : The premium collected by the LIC from its
insurance policy holders is administered b LIC and invested in the capital markets. LIC
has been one of the largest players in the stock market of India. Of late, it has started
floating specific investment schemes targeted at different investors groups, which
provide both an insurance cover and a share in the returns from the investments made
by LIC. Schemes issued by LIC are:
M
PU
Q.
Schemes of LIC Mutual Fund : These offer some or all of the following
benefits:
(a) Life Insurance Cover
(b) Accident Insurance Cover
(c) Safety of Capital
(d) Reasonable Capital Appreciation
(e) Units are not transferable, but bank loan facility is available
(f)
Tax exemption on dividends
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Ans. Indices : An index is used to provide information about the price movements of
products in the financial, commodities or any other markets. Financial indices are
constructed to measure price movements of stocks, bonds, T-bills and other forms of
investments. Stock market indices are meant to capture the overall behaviour of equity
markets. A stock market index is created by selecting a group of stocks that are
representative of the whole market or a specified sector or segment of the market. An index
is calculated with reference to a base period and a base index value.
Usefulness of Stock Market Indices : Stock market indices are useful for a variety of
reasons. Some of them are:
(1)
(2)
(4)
(5)
TE
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(3)
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M
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The stock market index captures the behaviour of the overall market. The ups and downs of
an index reflect the changing expectations of the stock market about future dividends of the
corporate sector. When the index goes up, it is because the stock market thinks that the
prospective returns in the future will be better than previously anticipated. When the
prospects of dividends in the future become pessimistic, the index drops. Every stock price
moves for two possible reasons :
(a) News about the company e.g. a product launch, closure of the factory etc.
(b) News about the country e.g. budget announcement etc.
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UNIT III
Q.
TE
R
M
PU
Ans. Meaning of Investment : Investment involves making of a sacrifice in the present with
the hope of deriving future benefits. Investment has many meanings and facets. The two
most important features of an investment are current sacrifice and future benefit.
We can now give a simple yet a broad definition of investment. We can define investment as
postponed consumption.
When you postpone consumption, sacrifice takes place n the present and is certain whereas
the benefits occur n future and are uncertain. Therefore, risk and expected return from the
investment are the two key determinants of investment process.
(A)
(B)
Investment Alternatives
Further classification of Investment can be presented with the help of following diagram
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Investment in
Financial Assets
Securitized
Investment
Investment in
Physical Assets
Non-Securitized
Investment
Gold,
Silver,
Fixed Income
Preference Shares
Equity
Bond
Government Securities
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Real
Estate
Mutual Funds
Others
(1)
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(a)
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(A)
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(b)
Non-Securitized Investments : In India, the household sectors investment in nonsecurity forms constitutes a major proportion of its total investment in financial assets.
There are a large number of non-security forms of financial assets that are available to
investors in India. Most of the investments are illiquid but are generally accepted as
good collateral for borrowing from banks.
Bank Deposit
Mutual Funds
Others
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(2)
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(c)
Equity : On equity shares, there is no fixed rate of dividend. First of all dividends
are paid on preference share, after that dividend is paid on equity shares. Equity
share are more risky in comparison to bonds and preference shares.
Money Market Instruments : A money market is the market in which short-term
funds are borrowed and lent. The money market does not deal in cash or money
but in trade bills, promissory notes and government papers, which are drawn for
short periods. These short-term bills are known as near money.
Types of Money Market Instruments : The major short-term credit instruments
dealt with in a money market include:
Trade Bills : These are bills exchange arising out of bona fide commercial
transactions. They include both inland bills and foreign bills.
Zero Coupon Bonds : These securities are issued at discount to the face
value and redeemed at the par i.e. they are issued at below face value and
redeemed at face value.
(B)
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Q.
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TE
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Residential House
Commercial Property.
Agricultural Land.
Suburban Land
Unimproved Land
Vacation homes
Office Buildings
Shopping Centres
Ans. Fixed Income Securities : Fixed income securities contains a promise to pay a stated
rate of interest for a defined period and then to repay the principal at a given date of maturity.
Therefore, their primary role in an investment portfolio is to provide continuity of income
under all reasonably conceivable conditions.
1)
Valuation of Fixed Income Securities : For the purpose of valuation we include the
following two securities:
Valuation of Bond :
Meaning of Bond : A Bond contains a promise to pa a stated rate of interest for a defined
period and then to repay the principal at a given date of maturity.
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Bond Features :
Maturities : Maturities vary widely. Bonds are usually grouped by their maturity
classes.
Types of Bonds :
Convertible Bonds
Non-Convertible Bonds
Income Bonds
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Redeemable Bonds
Irredeemable Bonds
Participating Bonds
Secured Bonds
TE
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Bond Valuation : Debt securities issued by governments, government and quasigovrnment organizations, and private business firms are fixed income securities. Bonds and
debentures are the most common examples.
The intrinsic value of bond or debenture is equal to the present value of its expected cash
flows. The coupon interest payment, and the principal repayment are known and the
present value is determined by discounting these future payments from the issuer at an
appropriate discount rate.
Preference Shares
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Formula : The usual present value calculation are made with the help of the following
equation:
n
C
C
PV = S
+
t = 1 (1+r)t
(1+r) n
PV =
C=
R=
N=
Example :
Where
Solution:
Consider a Rs. 1000 bond issued with a maturity of five years at par to yield 10%. Nterest s
paid annually and the bond is newly issued.
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100
100
100
100
100
PV =
+
+
+
(1+.10)1
(1+.10)2
(1+.10)3
(1+.10)4
(1+.10)5
= 100 x .90.91 + 100 x .8264 + 100 x .7513 + 100 x .6830 + 100 x .6209
= 90.91 + 82.6 + 75.13 + 68.30 + 682.99
= 999.97 or approx.
TE
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2)
30
Current Yield = = 13.64%
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Meaning of Preference Shares : Preference shares are a hybrid security. They have some
features of bonds and some of equity shares. Preference dividends are specified like bonds.
This has to be done because they rank prior to equity share for dividends. Preference shares
are less risky than equity because their dividends are specified and all arrears must paid
before equity holders get dividends. They are, however, more risky than bonds because the
latter earn priority in payment and liquidation.
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Valuation Formula : The intrinsic value of shares will be estimated from the following
equation:
D
VP =
Kps
VP
D
Kps
=
=
=
Solution :
Example : What s the value of a preference share where the dividend rate is 18% on a Rs.
100 par value. The appropriate discount rate for a stock of this risk level is 15%.
Q.
18
VP = = 120
0.15
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Ans. Variable Income Securities : Variable income securities are those on which rate of
return is not fixed. In variable income securities we include equity shares because return on
equity shares is depend on the volume of profitability after taxes. If profits are more, then
more dividend is paid on equity and vice-versa.
Equity Valuation Model : The actual models of equity valuation are:
(1)
Dividend Valuation Model : A difficult problem in using the dividend valuation model
is the timing of cash flows from dividends. Since equity shares have no finite measure,
the investor must forecast all future dividends. This might imply a forecast of intently
long stream of dividends. Clearly, this would be almost impossible. An therefore, in
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(a)
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order to manage the problem, assumptions are made with regard to the future growth
of the dividend of the immediately previous period available at the time the investor
wants to determine the intrinsic value of his/her equity shares. The assumptions can
be:
(i)
Dividends do not grow in future i.e., the constant or zero growth assumption.
(ii) Dividends grow at a constant rate in future i.e., the constant assumption.
The dividend valuation model is now discussed with these assumptions:
The Zero-growth Case : In zero-growth case, the formula will be:
D1
V =
K
=
=
=
Value of Share
Dividend per share
Required rate of return
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V
D1
K
Example : Assume that the dividend per share is estimated to be Rs. 4.00 per year
indefinitely and the investor requires a 20% of return.
4
V = - = Rs. 20
0.20
Constant Growth Case : When dividends grow in all future periods at a uniform rate
g, the formula will be :
=
=
=
=
V
D1
K
g
(b)
D1
V =
K-g
Value of Share
Dividend per share
Required rate of return
Growth Rate
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Example : A ltd. Paid a dividend of Rs. 2.00 per share for the year ending March 31, 1991. A
constant growth of 10% income has been forecast for an indefinite future period. Investors
required rate of return has been estimated to 15%. You want to buy the share at a market
price quoted on July1, 1991 in the stock market at Rs. 60.00. What would be our decision?
Solution : This is a case of constant growth rate situation. The above equation can be used
to find out the intrinsic value of the equity share as under:
D1
2(1.10)
2.20
V = - = = = Rs. 44.00
K-g
0.15-0.10
0.05
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(2)
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The P/E ratio is an important ratio frequently used by analyst in determining the value of an
equity share. It is frequently reported in the financial press and widely quoted in the
investment community.
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This approach seems quite straight and simple. There are, however important problems
with respect calculation of both P/E ratio and EPS. Pertinent question often asked are:
(i)
How to calculate the P/E ratio?
(ii) What is the normal P/E ratio?
(iii) What determines P/E ratio?
(iv) How to relate company P/E?
Decision Rule :
(i)
Higher the P/E ratio, other things remaining the same, higher would be the value of an
equity share.
(ii) Lower the P/E ratio, other things remaining the same, lower would be the value of an
equity share.
Q.
Q.
Ans. Meaning of Risk : Risk can be defined as the probability that the expected return from
the security will not materialize. Every investment involves uncertainties that make future
investment returns risk-prone. Uncertainties could be due to the political, economic and
industry factors.
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Meaning of Return : Return is the amount or rate of produce, proceeds, profits which
accrues to an economic agent from an undertaking or investment. It is a reward for and a
motivating force behind investment, the objective of which is usually to maximize return.
Risk-Return Relationship : The objective of maximizing return can be pursued only at the
cost of incurring higher risk. The financial markets offer a wide range of assets from very safe
to very risky. While selecting the asset for investment, the investor has to consider both its
return potential and the risk involved. The empirical evidence shows that generally there is a
high correlation between risk and return over longer periods of time. The securities are
generally priced such that high risk is rewarded with high return, and low risk is accompanied
by a corresponding low return. This relationship is known as risk-return trade-off.
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The risk and return are directly variable, i.e., an investment with higher risk should produce
higher return.
Low levels of uncertainty (low risk) are associated with low potential returns. High levels of
uncertainty (high risk) are associated with high potential returns. The risk-return trade-of is
the balance between the desire for the lowest possible risk and the highest possible return.
High Risk
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Return
Low Risk
Average
Risk
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Degree of Risk
The slope of market line indicates the return per unit of risk required by all investors. Highly
risk-averse investors would have a steeper line, and vice-versa.
Rate of Return
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Ordinary Shares
Preference Shares
Subordinate loan stock
Unsecured loan
Debenture with floating charge
Mortgage loan
Degree of Risk
Q.
TE
R
Q.
The risk-return trade-off tells us that the higher risk gives us the possibility of higher returns.
But there are no guarantees. Just as risk means higher potential returns, it also means
higher potential losses.
Dated Securities : These securities generally carry a fixed interest rate and have a
fixed maturity period.
For example an 11.40% GOI 2010 G-sec. In this case, 11.40 is the interest rate and it is
maturing in the year 2010.
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1)
Zero Coupon Bonds : These securities are issued at discount to the face value and
redeemed at the par i.e. they are issued at below face value and redeemed at face
value.
Features of Zero Coupon Bonds : The salient features of zero coupon bonds are:
Partly Paid Stock : In these securities, the payment of principal is made in installment
over a given period of time.
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3)
2)
Features of Partly Paid Stock : The salient features of partly paid stock are:
(i)
These types of securities are issued at face value and the principal amount is
paid in installment over a period of time.
(ii) The rate of interest and tenure of the security is fixed at the time of issuance and
does not change till maturity.
(iii) The interest payment is made on half yearly rest.
(iv) These are redeemed at par on maturity.
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4)
Floating Rate Bonds : These types of securities have a variable interest rate, which is
calculated as a fixed percentage over a benchmark rate.
Features of Floating Rate Bonds : The salient features of floating rate bonds are:
(ii)
The interest rate is fixed as a percentage over a predefined benchmark rate. The
benchmark rate may be a bank rate, Treasury bill rate etc.
(iii)
(iv)
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5)
(i)
Capital Indexed Bonds : These securities carry an interest rate, which is calculated
as a fixed percentage over the wholesale price index.
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Features of Capital Indexed Bonds : The salient features of capital indexed bonds
are:
The interest rate changes according to the change in the wholesale price index,
as the interest rate is fixed as a percentage over the wholesale price index.
The maturity of these securities is fixed and the interest is payable on half yearly
rates.
(ii)
Financial Institutions
(iii)
Primary Dealers
(iv)
Partnership firms
(v)
Mutual Funds
(vi)
(i)
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(ix)
Trusts
(x)
Research Organizations
(xi)
Minimal Default Risk : The main advantage of investing in G-secs is that there is a
minimal default risk, as the instrument is issued b the GOI.
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(3)
(2)
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Minimum amount for investing in Government Securities : The minimum amount for
investing in G-secs varies depending on the primary dealer. For example, in case of IDBI
Capital markets, which are primary dealers, the minimum amount for investing in G-secs is
Rs. 10,000.
Coupon Rate : Every government security carries a coupon rate also called interest
rate, which is fixed.
(2)
Face Value : The par value of the security is the face value.
(3)
Current Price : As these G-secs traded in the secondary market, the price of these Gsec fluctuations according to the demand/supply in the market for that security. The
current price is the prevailing price in the secondary market.
(4)
(5)
Primary Dealer : Primary dealer is an intermediary who buys and sells government
securities and treasury bills, He is authorized by the RBI.
Secondary Market : Like the stock market where stocks are traded there is a
secondary market where the debt instruments like gilts, bonds and treasury bills can
be bought and sold.
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(6)
(1)
Q.
1.
Bank Deposit:
(i) Saving Bank A/c
(ii) Fixed Deposits
(iii) Recurring Deposits
Post Office Schemes :
(i)
(ii)
(iii)
(iv)
(v)
(vi)
3.
NSC
Short
Long
Long
Long
Long
Long
12%
Long
Variable
Variable
Variable
Long
Long
Long
Variable
Long
Others :
Q.
5.5%
12%
11%
9-11%
13%
11%
UTI/Mutual Funds:
(i) US 64
(ii) Units of Mutual Funds
(iii) ELSS
5.
Short
Medium
Medium
4.
Term
5%
9-12%
9-12%
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2.
Name of Investment
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S.No.
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Ans. Meaning of Real Estate Investment : Real estate has historically has been useful n a
portfolio for both income and capital gains. Home ownership, in itself, is a form of equity
investment, as is the ownership of a second or vacation home, since these properties
generally appreciate in value. Other types of real estate, such as residential and commercial
rental property, can create income streams as well as potential long term capital gains.
Real estate investments can be made directly, with a purchase n your own name or through
investments in limited partnerships, mutual funds, or Real Estate Investment Trusts. Real
Estate Investment Trust s a company organized to invest in real estate.
Types of Real Estate Investments : There are many kinds of investments. Some are very
speculative while others are more conservative. The major classifications are:
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Residential House
Source of Housing Finance
Features of Housing Finance
Guidelines for buying a flat.
Commercial Property.
Agricultural Land.
Suburban Land
Time share in a holiday resort
Unimproved Land
Improved real Estate
New and used residential property
Vacation homes
Other Income-Producing real estate such as:
Office Buildings
Shopping Centres
Industrial or Commercial Properties.
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1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
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(2)
Lack of Liquidity : There s also a lack of liquidity, in that there is no guarantee that the
propert can be disposed of at its original value, especially if it must be done within a
short period of time.
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Large Initial Investment : A relatively large initial investment often is required to buy
real estate.
(4)
High Risk : Real estate is often considered high risk because it is fixed in location and
character.
(5)
The Tax Reform Act of 1986 eliminated many of the previously-available tax
advantages relating to real estate.
Q.
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(3)
Ans. Meaning of Money Market : A money market is a mechanism that makes it possible
for borrows and lenders to come together. Essentially it refers to a market for short-term
funds. It meets the short-term requirements of the borrowers and provides liquidity of cash to
the lenders.
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A money market is the market in which short-term funds are borrowed and lent. The money
market does not deal in cash or money but in trade bills, promissory notes and government
papers, which are drawn for short periods. These short-term bills are known as near money.
Types of Money Market Instruments : The major short-term credit instruments dealt with
in a money market include:
Trade Bills : These are bills exchange arising out of bona fide commercial
transactions. They include both inland bills and foreign bills.
(2)
(3)
Treasury Bills (T-Bills) : Treasury bills are short-term money market instruments,
which are issued by RBI on behalf of the GOI. The GOI uses these funds to meet its
short-term financial requirements of the government.
(1)
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(i)
These are zero coupon bonds, which are issued at discount to face value and
are redeemed at par.
(ii)
(iii)
(4)
(5)
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(6)
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Features of Zero Coupon Bonds : The salient features of zero coupon bonds are:
(i)
The tenure of these securities is fixed.
(ii) No interest is paid on these securities.
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UNIT IV
Q.
TE
R
M
PU
Ans. Introduction : Investment decisions are a part of our economic life. Everybody makes
such decisions in different contexts at different times. Some are able to reap more profits
through them; while other simply lose their money. Attempts should, therefore, be made to
understand and know the way sound investments decision can be made in order to improve
the change of making profit through them. Thus, investment decision-making is an important
area probing further.
(A)
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The price prevailing in market is called market price (MP) and the one justified b its
fundamentals is called intrinsic value (IV).
The fundamental factors mentioned above may relate to the economy or industry or
company or all some of this. Thus Fundamental Approach includes three analysis:
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Economic Analysis
Industry Analysis
Company Analysis
Economic Analysis
Industry
Economic Analysis : In actual practice, you must have noticed that investment
decisions of individuals and the institutions made in the economy set-up of a particular
country. It becomes essential, therefore, to understand the star economy of that
country at the macro level. The analysis of the state of the economy at the macro level
incorporates the performance of the economy in the past, how it is performing in the
present and how it is expected to perform in future.
(1)
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Company
Analysis
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Fundamental Analysis :
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(i)
Macro Economic Analysis : The analysis of the following factors indicates the trends
in macro economic changes that effect the risk and return on investment:
(ii)
Industrial Growth Rate : The GDP growth rate represents the average of the
growth rates of the three principal sectors of the economy, viz. the services
sector, the industry sector, and the agricultural sector.
Publicly listed companies play a major role in the industrial sector but only a
minor role in the service sector and the agricultural sector. Hence stock market
analyst focus more on the industrial sector. They look at the overall industrial
growth rate as well as the growth rates of different industries.
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The higher the growth rate of the industrial sector, other things being equal, the
more favourable it is for the stock market.
Monsoons : Agriculture accounts for about a quarter of the Indian economy and
has important linkages, direct and indirect, with industry. Hence, the increase or
decrease of agricultural production has a significant bearing in industrial
production and corporate performance. Companies using agricultural raw
materials as inputs or supplying inputs to agriculture are directly affected by the
changes in agricultural production. Other companies also tend to be affected
due to indirect linkages.
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(iii)
A spell of good and monsoons imparts dynamism to the industrial sector and
buoyancy to the stock market. Likewise, a streak of bad monsoons casts its
shadow over the industrial sector and the stock market.
Fiscal Deficit : Government play an important role in most economies,
including the Indian economy. The central budget as well as the state budgets
prepared annually provides information on revenues, expenditures and deficit
or surplus.
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(iv)
In India, governmental revenues come more from indirect taxes such as excise
duty and custom duty and less from direct taxes such as income tax. Th bulk of
the government expenditures goes toward administration, interest pament,
defence and subsidies etc.
Favourable
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Unfavourable
(v)
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Interest Rate : A rise in interest rates depresses corporate profitability and also
leads to an increase in the discount rate applied by equity investors, both of
which have an adverse impact on stock prices. On the other hand, a fall in
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(vi)
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A balance of payments deficit depletes the forex reserves of the country and has
an adverse impact on the exchange rate; on the other hand a balance of
payments surplus augments the force reserves of the country and has a
favourable impact on the exchange rate.
Unemployment
(x)
Institutional Lending
(xi)
(ix)
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(2)
Industry Analysis : After conducting an analysis of the economy, the analyst must
look into various sectors of the economy in terms of various industries. An industry is a
homogeneous group of companies. That is, companies with similar characteristic can
be divided into one industrial group. There are man bases on which grouping of
companies can be done.
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Classification of Industries :
(i)
Growth Industry : This is an industry that s expected to grow consistently and
its growth may exceed the average growth of the economy.
(ii) Cyclical Industry : In this category of the industry, the firms included are those
that move closely with the rate of industrial growth of the economy and fluctuate
cyclically as the economy fluctuates.
(iii) Defensive Industry : It is a grouping that includes firms, which move steadily
with the economy and less than the average decline of the economy in a cyclical
downturn.
Key Indicators in Analysis : The analyst is free to choose his or her own indicators for
analyzing the prospectus of an industry. However, many commonly adopt the
following factors.
Performance Factors : Performance factors like:
Past Sales
Past Earnings
(ii)
Attitude of government
Labour conditions
Competitive conditions
Technological progress
(iii)
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(i)
(ii)
Expansion Stage : This is characterized by the hectic activity of firms surviving the
pioneering stage. The market continues to grow but slowly, offering steady and slow
growth in sales of the industry. It is a phase of consolidation wherein companies
establish durable policies relating to dividends and investments.
(iii)
Stabilization Stage : This stage shows signs of slow progress and also prospects of
decay.
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Decay Stage : An industry reaches this stage when it fails to detect the death signal
and implement- proactively or reactively-appropriate strategies. Obsolescence
manifests itself, effecting a decline in sales, profit, dividends and share prices.
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Implications to the Investor : This approach is useful to the analyst as it gives insights, not
apparent merits and demerits of investment in a given industry at a given time. What the
investor has to do is.
(i)
Collect relevant data to identify the industry life cycle stage.
(ii) Forecast the probable life period of the stage.
(iii) Decide whether to buy, hold or sell.
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Although the industry life cycle theory appears to be very simple, it is no so in practice.
Proper identification of the life cycle stage is difficult. The internal analysis can be done
periodically to evaluate strengths and weaknesses either by inside company executives or
outside consultants. This can be done b using a form such as the on shown in the following
table:
Strengths Weaknesses Analysis
Factor
Performance
Neutral
Major
High
Medium
MARKETING :
(i)
Popularity and regard
(ii) Relative market share
(iii) Quality image
(iv) Service reputation
(v) Distribution costs
(vi) Sales force
(vii) Market location
FINANCE :
(i)
Cost of Capital
(ii) Funds availability
(iii) Financial Stability
(iv) Profitability
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(B)
(A)
Minor
Importance
(C)
MANUFACTURING :
(i)
Facilities
(ii) Economies of scale
(iii) Capacity Utilisation
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Labour productivity.
Manufacturing costs
Raw material availability
Technology of process
(iv)
(v)
(vi)
(vii)
HUMAN RESOURCES :
(i)
Leadership
(ii) Management capabilities
(iii) Worker attitudes
(iv) Skill development
(v) Structural flexibility
(vi) Industrial Relations
(3)
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=
=
=
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V
D1
K
Constant Growth Case : When dividends grow in all future periods at a uniform rate g, the
formula will be :
D1
V =
K-g
=
=
=
=
Value of Share
Dividend per share
Required rate of return
Growth Rate
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K
g
Models Based on Price Ratio Analysis : According to this method, the price of an
equit share is calculated by the following formula:
P = EPS X P/E ratio
The P/E ratio is an important ratio frequently used by analyst in determining the value
of an equity share. It is frequently reported in the financial press and widely quoted in
the investment community.
Ratio Analysis : Based in the financial data available in income statement and
balance sheets relevant ratios ma be calculated and analyzed to appraise the financial
soundness of a company
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(c)
Decision Rule :
Higher the P/E ratio, other things remaining the same, higher would be the value
of an equity share.
Lower the P/E ratio, other things remaining the same, lower would be the value
of an equity share.
S. No.
Indicator
Ratios
(A)
Technical Solvency
(i)
(ii)
Current Ratio
Liquid Ratio
(B)
Actual Solvency
(i)
(ii)
(iii)
(iv)
Debt-equity Ratio
Return on Investment
Profit Margin
Fixed assets to total assets
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(i)
(ii)
(iii)
(iv)
(v)
(vi)
To management team
Collaboration agreements
Product range
(b)
Statutory Controls
Government Policy
Environmentalism
Consumerism, etc.
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(ii)
Profitability
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(C)
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Dow Theory : The Dow Theory is one of the oldest and most famous technical tools. T
was originated by Charles Dow, who founded the Dow Jones company and was the
editor of The Wall Street.
According to Dow
(1)
The market is always considered as having three movements, all going at the same
time. The first is the narrow movement from day-to-day. The second is the short swing
running from two weeks to a month or more, the third is the main movement covering at
least four years in duration.
These movements are called :
Daily Fluctuations (Minor Trends) :The minor trends have little analytical value,
because of their short duration and variations in amplitude.
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(a)
(b)
(c)
Primary Trends : The primary trends are the long range cycle that carries the entire
market up or down (bull or bear markets).
Types of Averages : The Dow Theory is build upon the assertion that measured of stock
prices tend to move together. It employs two of the Dow Jones Averages.
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(a)
(b)
(b)
(c)
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(a)
Criticism of Dow Theory : Several criticisms are leveled against the Dow Theory:
(b)
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Upward Trend : As the name imply, when each successive peak and trough s
higher, its referred to as an upward trend.
(b)
Downward Trend : If the peaks and troughs are getting lower, its a downtrend.
(c)
Horizontal Trend : When there is little movement up or down in the peaks and
troughs, its a sideways or horizontal trend.
(a)
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(4)
Chart Pattern : A chart pattern is a distinct formation on a stock chart that creates a
trading signal, or a sign of future price movements. Chartists use these patterns to
identify current trends and trend reversals and to trigger buy and sell signals. There
are various types of chart patterns:
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(a)
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Double Top : It represents a bearish development, signaling that the price is expected
to fall.
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Double Bottom : It reflects a bullish development signaling that the price is expected
to rise.
(g)
Triangles : Triangles are some of the most well-known chart patterns used in
technical analysis.
(5)
Moving Averages : Most chart patterns show a lot of variation in price movement.
This can make it difficult for traders to get an idea of a securitys overall trend. One
simple method traders use to combat this is to apply moving averages.
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A moving average is the average price of a security over a set amount of time. It simple
takes the sum of all of the past closing prices over the time period and divides the
results by the number of prices used in the calculation. For instance, in a 10-day
moving average, the last 10 closing prices are added together and then divided by 10.
Criticism of Technical Analysis : The various limitations of technical analysis were pointed
out by its critics are as given under:
(i)
Difficult in interpretation : Technical analysis is not as simple as it appears to be.
While the charts are fascinating to look at, interpreting them correctly is very difficult.
(ii) Frequent Changes : With changes in market, chart patterns keep on changing.
Accordingly, technical analysts change their opinions about a particular investment
frequently. One day they put signal. A couple of weeks later, the see a change pattern
and put up a sell signal.
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(iii)
(iv)
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(v)
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Fundamental
Analysis
Technical
Analysis
S. No. Basis of
Difference
Difference
between
current
income
and capital
gains
3.
Base of
Analysis
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2.
Nature
1.
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Q.
Tools
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Ans. Introduction : An efficient capital market is one in which security prices adjust rapidly
to the arivale of new information and, therefore, the current prices of securities reflect all
information about the security. You need to understand the meaning of the terms efficient
capital market and efficient market hypothesis because of its importance and controversy
associated with it.
Why Should Capital Market be Efficient : As noted earlier, in an efficient capital market,
security prices adjust rapidly to the infusion of new information, and therefore currency
security prices fully reflect all available information. To be absolutely correct, this is referred
to as an informationally efficient market. Although the idea of an efficient capital market is
relatively straightforward, we often fail to consider why capital markets should be efficient.
What set of assumptions imply an efficient capital market?
(1) An initial and important premise of an efficient market requires that a large number of
profit maximizing participants analyze and value securities, each independently of the
others.
(2) A second assumption is that new information regarding securities comes to the market
in a random fashion, and timing of one announcement is generally independent of
others.
(3) The third assumption is especially crucial: profit maximizing investors adjust security
pries rapidly to reflect the effect of new information.
Weak-form EMH : The weak form EMH assumes that current stock prices full reflect
all security market information, including
Rates of Return
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(1)
Alternative Efficient Market Hypotheses (EMH) : There are three types of efficient market
hypotheses:
This hypotheses implies that past rates of return and other historical market data
should have no relationship with future rates of return (that is, rates of return should be
independent).
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P/E ratio
Political news.
(3)
The Strong-form EMH : The strong form EMH contends that stock prices full reflect
all information from public and private sources. The strong form EMH extends both the
weak form and the semi-strong form EMH.
Q.
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(2)
Ans. Recent Development in Indian Stock Market : The recent development in Indian
Stock Market are studied in two section:
A.
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(1)
(2)
(3)
(4)
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Modification in Foreign Exchange Control Act : The Foreign Exchange Control Act
has been modified and rechristened the Foreign Exchange Management Act,
symbolic of the present times, which seek to promote development rather than control
of inflow and outflow of investments.
(6)
Delegation of Powers : The laws of securities in India were originally contained in the
Capital Issues (Control) Act, 197, Securities Contracts (Regulation) Act, 1956 and the
Companies Act, 1956. The Government exercising the delegated powers under these
laws, prescribed detailed procedures n rules and regulations. With the promulgation of
the securities of the Securities and Exchange Board of India Act, 1992, the Capital
Issue Act, 1947 and delegated legislation thereunder were repealed and SEBI was
empowered to regulate all matter relating to capital issue in respect of listed
companies. These developments significantly changed the face of the Indian Capital
Market.
(7)
The market was thrown open to foreign investors with Indian Companies being
allowed to raise capital abroad and receive investments from foreign institutional
investors, in order to integrate Indian capital market with the global market, many
evolutionary efforts have been taken.
(8)
The changes in the capital market are not a one-shot affair and have to go through a
learning curve.
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(5)
Conclusion : The process of financial reforms is still under way and is likely to brng about
even more drastic changes that ma make the markets healthier and stronger. Indias
approach to financial sector reforms, in general and to the management of the external
sector, n particular has erved the country well, in terms of
Aiding Growth
Avoiding Crisis
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B.
(1)
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The private sector, in turn will be tapping the capital market to meet its
requirements.
(3)
Since the mid-1990s, equity prices showed a sharp rise in the market, leading to
substantial increase in market capitalization and diversion of attention by the
household sector from traditional targets towards since capital market. The ratio
of shares and debenture held by the household sector has increased
substantially since 1990.
(4)
(5)
Mutual Funds came to play a significant role in the mobilization of resources for
the corporate sector. Earlier there were only 8 players in the mutual fund
segment, comprising of UTI and subsidiaries of investment institutions and
nationalized banks, prior to the entry of the private sector. More players arrived
on the mutual fund scene to mop up savings from the household sector and
invest them in corporate securities.
(6)
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(2)
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