Q1) What is investment ? What are its characterterisitics ? What is Speculation?

How it differs from investment ?

Ans- An investment is an asset or item acquired with the goal of generating income or
appreciation. Appreciation refers to an increase in the value of an asset over time. When an
individual purchases a good as an investment, the intent is not to consume the good but rather
to use it in the future to create wealth.
An investment always concerns the outlay of some capital today—time, effort, money, or an
asset—in hopes of a greater payoff in the future than what was originally put in.
For example, an investor may purchase a monetary asset now with the idea that the asset will
provide income in the future or will later be sold at a higher price for a profit.
 An investment involves putting capital to use today in order to increase its value over
time.
 An investment requires putting capital to work, in the form of time, money, effort,
etc., in hopes of a greater payoff in the future than what was originally put in.
 An investment can refer to any medium or mechanism used for generating future
income, including bonds, stocks, real estate property, or a business, among other
examples.

Characterterisitics of Investment

The features of economic and financial investments can be summarized as return, risk,

safety, and liquidity.

1. RETURN : All investments are characterized by the expectation of a return. In fact,

investments are made with the primary objective of deriving a return.
The return may be received in the form of yield plus capital appreciation.
The difference between the sale price and the purchase price is capital appreciation.
The dividend or interest received from the investment is the yield.
The return from an investment depends upon the nature of the investment, the maturity period
and a host of other factors.

Return = Capital Gain + Yield (interest, dividend etc.)

2. RISK : Risk refers to the loss of principal amount of an investment. It is one of the major
characteristics of an investment.

The risk depends on the following factors:

The investment maturity period is longer; in this case, investor will take larger risk.
Government or Semi Government bodies are issuing securities which have less risk.
The risk of degree of variability of returns is more in the case of ownership capital compare
to debt capital.
The tax provisions would influence the return of risk.

SAFETY: Safety refers to the protection of investor principal amount and expected rate of
return. Safety is also one of the essential and crucial elements of investment. Investor prefers
safety about his capital. Capital is the certainty of return without loss of money or it will take
time to retain it. If investor prefers less risk securities, he chooses Government bonds. In the
case, investor prefers high rate of return investor will choose private Securities and Safety of
these securities is low.

LIQUIDITY: Liquidity refers to an investment ready to convert into cash position. In other
words, it is available immediately in cash form. Liquidity means that investment is easily
realizable, saleable or marketable. When the liquidity is high, then the return may be low. For
example, UTI units. An investor generally prefers liquidity for his investments, safety of
funds through a minimum risk and maximization of return from an investment.

Speculation
In the world of finance, speculation, or speculative trading, refers to the act of conducting a
financial transaction that has substantial risk of losing value but also holds the expectation of
a significant gain or other major value. With speculation, the risk of loss is more than offset
by the possibility of a substantial gain or other recompense.
The main difference between speculating and investing is the amount of risk involved.
Investors try to generate a satisfactory return on their capital by taking on an average or
below-average amount of risk.
Speculators are seeking to make abnormally high returns from bets that can go one way or the
other.
Speculative traders often utilize futures, options, and short selling trading strategies.
Q2 What are bond risks? Explain relationship between bond risks and bond
duration.
Ans - Bonds refer to debt instruments bearing interest on maturity. In simple terms,
organizations may borrow funds by issuing debt securities named bonds, having a fixed
maturity period (more than one year) and pay a specified rate of interest (coupon rate) on the
principal amount to the holders. Bonds have a maturity period of more than one year which
differentiates it from other debt securities like commercial papers, treasury bills and other
money market instruments. Thus a bond is like a loan: the issuer is the borrower (debtor), the
holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower
with external funds to finance long-term investments, or, in the case of government bonds, to
finance current expenditure . Bonds and stocks are both, securities but the major difference
between the two is that (capital) stockholders have an equity stake in the company (i.e., they
are owners), whereas bondholders have a creditor stake in the company (i.e., they are
lenders). Another difference is that bonds usually have a defined term, or maturity, after
which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is
a consol bond, which is a perpetuity (i.e., bond with no maturity).
Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a
change in interest rates. A bond's duration is easily confused with its term or time to maturity
because certain types of duration measurements are also calculated in years. However, a
bond's term is a linear measure of the years until repayment of principal is due; it does not
change with the interest rate environment. Duration, on the other hand, is non-linear and
accelerates as the time to maturity lessens.Duration measures a bond's or fixed income
portfolio's price sensitivity to interest rate changes. Modified duration measures the price
change in a bond given a 1% change in interest rates. A fixed income portfolio's duration is
computed as the weighted average of individual bond durations held in the portfolio .In
general, the higher the duration, the more a bond's price will drop as interest rates rise (and
the greater the interest rate risk). For example, if rates were to rise 1%, a bond or bond fund
with a five-year average duration would likely lose approximately 5% of its value.
Certain factors can affect a bond’s duration, including:
Time to maturity: The longer the maturity, the higher the duration, and the greater the interest
rate risk. Consider two bonds that each yield 5% and cost 1,00,000, but have different
maturities. A bond that matures faster—say, in one year—would repay its true cost faster
than a bond that matures in 10 years. Consequently, the shorter-maturity bond would have a
lower duration and less risk.
Coupon rate: A bond’s coupon rate is a key factor in calculation duration. If we have two
bonds that are identical with the exception of their coupon rates, the bond with the higher
coupon rate will pay back its original costs faster than the bond with a lower yield. The
higher the coupon rate, the lower the duration, and the lower the interest rate risk.
Q3 What are technical indicators ? How they can used for investment decision
making ? What are leading and lagging indicators ? Give suitable illustartions
and explain with the charts.
Ans Technical indicators are heuristic or pattern-based signals produced by the price,
volume, and/or open interest of a security or contract used by traders who follow technical
analysis. Technical analysis is a trading discipline employed to evaluate investments and
identify trading opportunities by analyzing statistical trends gathered from trading activity,
such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a
security’s intrinsic value based on financial or economic data, technical analysts focus on
patterns of price movements, trading signals, and various other analytical charting tools to
evaluate a security’s strength or weakness.
By analyzing historical data, technical analysts use indicators to predict future price
movements. Technical indicators are heuristic or mathematical calculations based on the
price, volume, or open interest of a security or contract used by traders who follow technical
analysis. Technical analysts or chartists look for technical indicators in historical asset price
data to judge entry and exit points for trades. There are several technical indicators that fall
broadly into two main categories: overlays and oscillators.
A leading indicator : is any measurable or observable variable of interest that predicts a
change or movement in another data series, process, trend, or other phenomenon of interest
before it occurs. Leading economic indicators are used to forecast changes before the rest of
the economy begins to move in a particular direction and help market observers and
policymakers predict significant changes in the economy. Leading indicators can be useful to
help forecast the timing, magnitude, and duration of future economic and business conditions.
A leading indicator may be contrasted with a lagging indicator.
A leading indicator is a piece of economic data that corresponds with a future movement or
change in some phenomenon of interest. Economic leading indicators can help to predict and
forecast future events and trends in business, markets, and the economy. Different leading
indicators vary in their accuracy, precision, and leading relationships, so it is wise to consult a
range of leading indicators in planning for the future. The index of consumer confidence,
purchasing managers' index, initial jobless claims, and average hours worked are examples of
leading indicators.
A lagging indicator : is an observable or measurable factor that changes sometime after the
economic, financial, or business variable with which it is correlated changes. Lagging
indicators confirm trends and changes in trends. Lagging indicators can be useful for gauging
the trend of the general economy, as tools in business operations and strategy, or as signals to
buy or sell assets in financial markets. A lagging indicator is an observable or measurable
factor that changes sometime after the economic, financial, or business variable with which it
is correlated changes. Some general examples of lagging economic indicators include the
unemployment rate, corporate profits, and labor cost per unit of output. A lagging technical
indicator is one that trails the price action of an underlying asset, and traders use it to generate
transaction signals or confirm the strength of a given trend. In business, a lagging indicator is
a key performance indicator that reflects some measure of output or past performance that
can be seen in operational data or financial statements and reflects the impact of management
decisions or business strategy. Lagging indicators differ from leading indicators, such as
retail sales and the stock market, which are used to forecast and make predictions.
Q4 Explain Arbitage Pricing Theory (APT) , The Return Generating Model,
Factors Affecting Stock Return, Expected return on Stock. Distinguish between
ATP V/s CAPM.

Ans The Arbitrage Pricing Theory (APT) is a theory of asset pricing that holds that an
asset’s returns can be forecasted with the linear relationship of an asset’s expected returns and
the macroeconomic factors that affect the asset’s risk. The theory was created in 1976 by
American economist, Stephen Ross. The APT offers analysts and investors a multi-factor
pricing model for securities, based on the relationship between a financial asset’s expected
return and its risks. The APT aims to pinpoint the fair market price of a security that may be
temporarily incorrectly priced. It assumes that market action is less than always perfectly
efficient, and therefore occasionally results in assets being mispriced – either overvalued or
undervalued – for a brief period of time.
However, market action should eventually correct the situation, moving price back to its fair
market value. To an arbitrageur, temporarily mispriced securities represent a short-term
opportunity to profit virtually risk-free.
The APT is a more flexible and complex alternative to the Capital Asset Pricing Model
(CAPM). The theory provides investors and analysts with the opportunity to customize their
research. However, it is more difficult to apply, as it takes a considerable amount of time to
determine all the various factors that may influence the price of an asset.
A return generating model is one that can provide investors with an estimate of the return of a
particular security given certain input parameters. The most general form of a return
generating model is a multi-factor model.
Earnings- Publicly traded companies typically report earnings about three weeks after each
quarter end. Investors punish the stocks of companies that cannot meet their own projections
or the consensus estimates of research analysts. Stock prices generally rise when companies
meet or exceed published estimates and provide optimistic guidance about upcoming
quarters. Investors are often willing to pay a premium for companies that can demonstrate
above-average earnings growth and cash flow. The reaction on the downside can often be
harsh. The markets can cut stock prices in half or more when companies fall short of
expectations, even by a few percentage points.
Economy - The economic factors that drive stock prices include interest rates, unemployment
and currency fluctuations.
Expectations- Stock markets tend to look ahead six months or more. The stock prices reflect
expectations about everything from revenues and profits to election outcomes. Companies
usually provide some guidance on their expectations for upcoming quarters. Research
analysts use this information, among others, to publish guidance on expected earnings and
target price ranges for hundreds of companies. Stock prices also factor in expectations about
global economies, because many companies rely on overseas markets to drive revenue
growth.
Emotion-Basic human emotions, such as fear and greed, also affect stock prices. An
unsubstantiated rumor about a revenue slowdown could lead to a sharp sell-off in a
company's stock, just as speculation over monetary easing can result in a euphoric rally.
These sharp price swings usually have nothing to do with the underlying fundamentals of
individual stocks or even of entire industries. Experienced investors ignore these periodic
market tantrums because they know that the underlying business fundamentals are going to
determine long-term price trends.

Differentiate between Arbitrage Pricing Theory (APT) and Capital Asset Pricing Model–
The context of differentiation is given below:
APT
1. It means arbitrage pricing theory.
2. APT is based on the factors model of returns and the approximate arbitrage
arguments.
3. It is based on mathematical and statistical data theory.
4. It is difficult to identify approximate factors.
5. It has several relevant data.
6. APT is a multifactor model.
7. There is no special role in the market portfolio in APT.
8. APT does not make any assumption about the distribution of asset returns.

CAPM
9. It means the capital asset pricing model.
10. CAPM is based on an investor’s portfolio demand and equilibrium arguments.
11. It is based on risk-return trade-off.
12. It is difficult to find a good proxy for market return.
13. It has a simple beta.
14. CAPM is a single factor model.
15. CAPM requires that the market portfolio be efficient.
16. CAPM assumes that the probability distributes of asset returns are normally
distributed.