AXIS INSTITUTE OF HIGHER EDUCATION

INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT

NOTES UNIT 2.1.

TYPES OF INVESTORS
INVESTMENT AND SPECULATION

GAMBLING
• The time Horizon in gambling is shorter than speculation and investment.
• People gamble as a way to entertain themselves.
• Gambling employs, artificial risks, whereas commercial risks are present in investment
activity.
• There is no risk and return trade off in gambling and negative outcomes are expected.
But in investment, there is analysis of risk and return.

INVESTMENT ALTERNATIVES
Variety of investment avenues are open to investors to suit their needs and nature. Knowledge
about the different avenues enables the investors to choose investment intelligently.
I. Financial Markets
• They play an important role in the allocation of capital resources.
• Allows individuals to ‘time their consumption.’
• Enables allocation of risk.
• Financial instruments and markets allow for separation of ownership and management.
 • A good financial market should provide transparency and allow investors to make
informed decisions.

FINANCIAL MARKET
Financial markets are traditionally segmented into
1. Money Market
2. Capital Market

MONEY MARKET
• The money market is a component of the economy that provides short-term funds. The
money market deals in short-term loans, generally for a period of a year or less.
• High liquidity and safety due to government backing.
• RBI has a major influence on the money markets and ensures that interest rates and
liquidity compliment the fiscal objectives.
• Short term maturity instruments.
• Major participants: Governments, Banks, Corporations, Government sponsored
enterprise, Money market funds, Brokers and dealers.

IMPORTANCE OF MONEY MARKET

• It helps to strengthen the balance between the demand and supply of short-term
monetary transactions in the market.
• It helps businesses grow, which can positively affect economic development.
• The money market provides finances for working capital requirements.
• The money market can serve as a guide to enacting new policies as it concerns short-
term money supply.
 • It helps with the active functioning of a central bank and the implementation of its
policies.
• It can help governments raise short-term funds to help fund projects and solve other
major concerns.
• It helps in the smooth functioning of commercial banks.

CHARACTERISTICS OF MONEY MARKET INSTRUMENTS

• It is a financial market and has no fixed geographical location.
• It is a market for short term financial needs, for example, working capital needs.
• It’s primary players are the Reserve Bank of India (RBI), commercial banks and
financial institutions.
• It is highly liquid as it has instruments that have a maturity below one year.
• Most of the money market instruments provide fixed returns.

MONEY MARKET INSTRUMENTS

• Treasury Bills
• Certificates of Deposit
• Commercial papers
• Banker’s Acceptance
• Call, Notice and Term money
• Repurchase Agreement (Repo/Reverse repo)

TREASURY BILLS
• Issued at a discount to the face value and redeemed at a face value
• No need to hold till maturity
• Fund short term requirements of the Government of India.
• Central Govt issues-three types of T-bills 91-days,182- days, 364-days
• Available in the denominations of Rs 25000 and multiples of Rs 25000
• Government backed security-safety investment tool
• High liquidity, No default risk, No tax deducted at source
• Good returns in short term

CERTIFICATE OF DEPOSIT (CD)

• These Deposits issued by the commercial banks with specific maturity periods and
interest rates.
• CD’s can be issued to individuals, corporations, non-resident Indians etc.
• Also, the CD’s can be issued by scheduled commercial banks at a discount.
• Commercial Banks issue CDs which have a tenure ranging from 7 days to one year.
 • However, financial institutions issue Certificate of deposits with different maturity
dates. They can be 1year CD upto 3year CD.
• Minimum amount is Rs 1 lac.
• Premature withdrawals or redemptions are penalized.
• Available in any denomination.

COMMERCIAL PAPERS
• Short term unsecured loans issued in the form of a promissory note by a company, to
finance its day-to-day operations
• They are issued by Highly rated Companies to meet short term capital needs.
• Traded in the secondary market
• Freely transferable
• Issued for short term maturities between a minimum of 7 days and a maximum up to
one year
• Available in higher denominations
• Issued in denominations of Rs 5 lakhs and multiples thereafter.

BANKER’s ACCEPTANCE
• Banker's Acceptance or BA is basically a document promising future payment which is
guaranteed by a commercial bank.
• Banker's Acceptance is often used in money market funds and specifies the details of
the repayment like the amount to be repaid, date of repayment and the details of the
individual to which the repayment is due.
• Banker's Acceptance features maturity periods ranging between 30 days up to 180 days.
• Short term instrument, guaranteed by a bank, formed by a non financial firm.

CALL, NOTICE AND TERM MONEY

• The call/notice/term money market facilitates lending and borrowing of funds between
banks and other entities. An institution which has surplus funds may lend them on an
to an institution which is short of funds.
• Borrowing/Lending for 1 day is known as Call Money
• Borrowing/Lending for 2-14 days is known as Notice Money
• Borrowing/Lending for more than 14 days is known as Term Money
• Banks borrow to– fill the temporary mismatches in finances or to meet the cash reserve
ratio (CRR) and statutory liquidity ratio (SLR) requirements. Help in maintaining the
liquidity positions of the market
• These are Unsecured funds.
• Interest rate depends upon the demand and supply of the funds amongst the players
REPURCHASE AGREEMENT (Repo/reverse repo)
• A short term exchange of cash and securities a sale of securities with an agreement to
repurchase these at a specified price and on specific date.
• Ranging from overnight to 30 days
• Major players - Financial institutions –commercial banks, primary dealers-PNB Gilts
LTD, Insurance companies, Mutual fund companies, RBI and Government backing.
• The RBI charges the repo rate when commercial banks borrow funds by leveraging
securities.
• The reverse repo rate is the rate at which banks earn interest when they park surplus
funds with the RBI.
• The repo rate helps control inflation, and the reverse repo rate increases liquidity.
• The repo rate set by the RBI is always higher than the reverse repo rate.
• The RBI uses those excess funds to create liquidity in the economy. Lowering the
reverse repo rate also helps the RBI increase the purchasing power in the nation.

CAPITAL MARKET
• A capital market is a financial market in which long-term debt and securities are bought
and sold.
• It provides all with a series of channels through which savings of the community are
made available for industrial and commercial enterprises and for the public in general.
• Divided into Primary and Secondary Markets
• The instruments would include:- Debentures and Bonds, Preferential Shares, Common
Shares(Equity shares) and Derivatives.

FEATURES OF CAPITAL MARKET

It unites entrepreneurial borrowers and savers.
It is meant for Medium and Long-term funds, a period of 365days or more.
It deals with long-term investments.
It is controlled by government rules and regulations.
It operates with the help of intermediaries like brokers and underwriters.
It has a wide variety of investors like general public, institutional buyers etc.
It has foreign investors and Non-resident Indians in the securities market.
DIFFERENCES BETWEEN MONEY AND CAPITAL MARKET

CAPITAL MARKET INSTRUMENTS

EQUITY SHARES
Equity shares are defined as long-term financing options for firms to raise capital. Each equity
share represents a unit of part ownership in the company. Equity shares are also referred to as
common stock, or common shares and ordinary shares, and are offered as an investment
opportunity to the public.

ADVANTAGES OF EQUITY SHARES

Higher Return on Investment - Equity shares are high risk investment options. As is the rule
of the market, the higher the risk factor, the higher the returns. This is also a wise investment
option as any shareholder also benefits from dividends and profit made by the company.
Voting Rights - When an investor purchases equity shares of a company, they also claim a
stake in the ownership of the company. Which means that the investor also gets a voting right
in the decision-making process of the company. The higher the number of equity shares, the
more they have power in an organization.
Lack of Legal Obligations - Any equity shareholder of a company is not liable to be involved
in the legal obligations of a company. The company operates as a separate legal entity from the
investor. So in case the company is involved in any legal issues, the shareholder is not
responsible for it in any way.
Diverse Portfolio - Diversifying your portfolio by investing in equity shares of different
sectors, you can receive increased dividend payments. This creates a well balanced portfolio
offering stable returns for a long time.
Easy and Efficient - An investor can easily invest in the share market with the help of a
financial advisor or stockbroker. An individual can also open a Demat account and invest in
the equities of companies of their choice.

DISADVANTAGES OF EQUITY SHARES

Dividend Payments are not Prioritized - Equity shareholders receive dividend payments
when a company makes a profit. The equity shareholders have the last claim to these profits.
The dividends are first distributed among bond holders and then among preference
shareholders. The remaining amount is then distributed among the equity holders.
Market Risks - The profit returns from equity investment are volatile and are subject to the
changes in the market. This means that investing in the equity market does not guarantee
assured returns.
Company’s Performance - The performance of the share largely depends on the company’s
performance. When the company is not performing and is unable to make profits, the equity
shareholder will not receive any dividends.

TYPES OF EQUITY SHARES

Authorized Share Capital - It is the maximum amount of capital that a company can issue.
The companies can increase it from time to time. For that, we need to comply with some
formalities and pay some fees to the legal bodies.
Issued Share Capital - It is part of the authorized capital that the company offers to investors.
Subscribed Share Capital - An investor accepts and agrees upon that part of the issued capital.
Paid Up Capital - It is the part of the subscribed capital that the investors pay. Normally, all
companies accept complete money in one shot and therefore issued, subscribed, and paid
capital becomes the same. Paid-up capital is the amount of money that investors pay and a
company invests in the business. It is also known as contributed capital.
Bonus Shares - Bonus shares are a type of equity shares that a company issues from its retained
earnings. In other words, a company distributes its profits in the form of a bonus issue.
However, this doesn’t increase the company’s market capitalization, like how other equity
shares do.
Rights Shares - Rights shares are not for everyone. The company issues these shares only for
specific premium investors. As a result, the equity stake of such holders increases. The rights
issue is done at a discounted price. The motive is to raise money to meet financial requirements.
Sweat Equity shares - Directors and employees of a company receive sweat equity shares.
They get the shares at a discount for their excellent work in providing intellectual property
rights, know-how, or value additions to the company.
Employee Stock Options (ESOPs) - A company gives ESOPs to its employees as an incentive
and as a retention strategy. Employees are given the option to purchase shares at a
predetermined price at a future date under the terms of an ESOP. Employees and directors who
exercise their ESOP grant option receive these shares.

PREFERENCE SHARES
preference shares are those shares that are given importance over other equity shares and carry
special or priority rights.
ADVANTAGES
Preference in dividends: Preferred stocks pay high dividends in comparison to common
stocks in this current low-interest-rate environment and companies can pay dividends to equity
shareholders only after paying debenture holders and preference shareholders.
Advance access to assets of the company: If the company goes bankrupt and insolvent, the
preference shareholders are given first preference to get paid from the liquidated money.
Preferred stocks can be convertible: Preference shareholders can take advantage of
converting their preference shares into common shares.
Appeal to Cautious Investors: Preference shares are purchased by investors who prefer
reasonable safety of their capital and want a regular and fixed return on it.

DISADVANTAGES
No voting rights: Preference shareholders do not have any voting rights and decision making
power.
Low Return: When the earnings of the company are high, fixed dividend on preference shares
becomes unattractive. Preference shareholders generally do not have the right to participate in
the prosperity of the company.
Fear of Redemption: The holders of redeemable preference shares might have contributed
finance when the company was badly in need of funds. But the company may refund their
money whenever the market is favourable. Despite the fact that they stood by the company in
its hour of need, they are shown the door unceremoniously.
TYPES OF PREFERENCE SHARES
Cumulative preference shares: Cumulative preference shares are types of shares where
shareholders are given the right to receive dividends for those years where dividends could not
be paid due to insufficient profits. For instance, if a company does not make enough profit in a
year, then it will not pay any dividends to its shareholders in that particular year but it pays
cumulative dividends in the next year as arrears.
Non-cumulative preference shares: Non-cumulative preference shares do not have the right
to receive dividend payments for a year when the company does not have sufficient profits to
pay dividends to its shareholders. So if a company does not pay dividend payments to its
shareholders, the shareholders are not entitled to claim dividends in the coming year.
Redeemable preference shares: Redeemable preference shares are those shares that can be
redeemed by the issuing company to fulfil its purpose.
Non-redeemable preference shares: Non-redeemable preference shares are shares that cannot
be redeemed by the company. The company can redeem shares only on shutting down of
operation although Indian companies cannot issue irredeemable preference shares.
Participating preference shares: Participating shares have the right to partake in the surplus
profit of the company during liquidation after the company had paid to other shareholders.
Participating preference shareholders have the right to receive dividends as well as a share in
the extra earnings of the company.
Non-participating preference shares: non-participating preference shares do not have the
right to participate in the extra profit made by the company, however, non-participating
preference shareholders are entitled to receive fixed dividends offered by the company.
Convertible preference shares: These shareholders may convert the shares into equity shares
but only after a specified time period as stated in the memorandum.
Non-convertible shares: non-convertible shares cannot be converted into equity shares of the
company; however, they enjoy preferential rights when it comes to payment of capital in case
of winding-up of the company.

DEBENTURES
If a company needs funds for extension and development purpose without increasing its share
capital, it can borrow from the general public by issuing certificates for a fixed period of time
and at a fixed rate of interest. Such a loan certificate is called a debenture.
FEATURES OF DEBENTURES
1.Debenture holders are the creditors of the company carrying a fixed rate of interest.
2. Debenture is redeemed after a fixed period of time.
3. Debentures may be either secured or unsecured.
4. Interest payable on a debenture is a charge against profit and hence it is a tax-deductible
expenditure.
5. Debenture holders do not enjoy any voting rights

ADVANTAGES
(a) Issue of debenture does not result in dilution of interest of equity shareholders as they do
not have right either to vote or take part in the management of the company.
(b) Interest on debenture is a tax deductible expenditure and thus it saves income tax.
(c) Cost of debenture is relatively lower than preference shares and equity shares.
(d) Issue of debentures is advantageous during times of inflation.
(e) Interest on debenture is payable even if there is a loss, so debenture holders bear no risk.

DISADVANTAGES
(a) Payment of interest on debenture is obligatory and hence it becomes burden if the company
incurs loss.
(b) Excess dependence on debentures increases the financial risk of the company.
(c) Redemption of debenture involves a larger amount of cash outflow.
(d) During depression, the profit of the company goes on declining and it becomes difficult for
the company to pay interest.

TYPES OF DEBENTURES
Non-convertible Debentures - A non-convertible debenture is a debenture where there is no
option for its conversion into equity shares. Thus the debenture holders remain debenture
holders till maturity.
Partly Convertible Debentures - The holders of partly convertible debentures are given an
option to convert part of their debentures. After conversion they will enjoy the benefit of both
debenture holders as well as equity shareholders.
Fully Convertible Debenture - Fully convertible debentures are those debentures which are
fully con-verted into specified number of equity shares after predetermined period at the option
of the debenture holders.
Redeemable Debentures - Redeemable debenture is a debenture which is redeemed/repaid on
a prede-termined date and at predetermined price.
Irredeemable Debenture - Such debentures are generally not redeemed during the lifetime of
the com-pany. So, it is also termed as perpetual debt. Repayment of such debenture takes place
at the time of liquidation of the company.
Secured and Unsecured debentures - Secured debenture creates a charge on the assets of the
company. In case of default the trustee can take hold of specific assets. Unsecured debenture
does not carry any charge or security on the assets of the company.

BONDS
“A Bond is a fixed income instrument that represents a loan made by an investor to a borrower.”
In simpler words, bond acts as a contract between the investor and the borrower. Mostly
companies and government issue bonds and investors buy those bonds as a savings and security
option.
A bond issued by the Government of a country at a fixed rate of interest is called Government
Bonds. These kinds of bonds are considered to be low-risk investments. Examples of
Government bonds include Municipal Bonds, Zero-coupon Bonds.

COMPONENTS OF BONDS
Principal – It’s the bondholder's purchasing value, which is repaid to the bondholder when the
bond matures.
Maturity – It’s the period when a bond matures, or when the terms end as per the agreement. It
can range from one day to 30 years.
Coupon rate – The rate of interest at which a bond is issued and the Company is liable to pay
the Investor is called the coupon rate.
The coupon is the interest rate paid to the bondholder at specific intervals. Usually, it’s paid
semi-annually or annually.

ADVANTAGES OF BONDS
1. Fixed Returns on Investment - Fixed investment in Bonds give regular interests at timely
intervals. Also, once a bond matures, you receive the principal amount invested earlier. The
best advantage of investing in Bonds is that the investors know exactly how much the returns
will be.
2. Less Risky - Although Bonds and stocks are both securities, the clear differences between
the two are that the former matures in a specific period, while the latter typically remain
outstanding indefinitely. Also, the bondholders are paid first over stockholders in case of
liquidation.

DISADVANTAGES
1.Market Volatility - Bond markets are highly volatile. Market volatility and macroeconomic
factors can lead to a fall in bond prices. An unexpected downgrade can lead to a fall in bond
prices. Such external factors do not impact the coupon or interest payment of the bond; instead,
it affects the market prices of bonds.
2.Reinvestment Risk - Callable bonds are subject to reinvestment risk. The issuer may decide
to pay off callable bonds before their maturity date. Generally, issuers recall bonds in case of a
fall in interest rates. Investors then have to reinvest the principal at lower rates.

TYPES OF BONDS
Traditional Bond: A bond in which the entire principal amount can be withdrawn at a single
time after the bond’s maturity date is over is called a Traditional Bond.
Callable Bond: When the issuer of the bond exercises his right to redeem the bond even before
it reaches its maturity is called a Callable Bond. Through this type of bonds, the issuer can
convert a high debt bond into a low debt bond.
Puttable Bond: When the investor decides to sell their bond and get their money back before
the maturity date, such type of bond is called a Puttable bond.
Fixed-Rate Bonds: When the coupon rate remains the same through the course of the
investment, it is called Fixed-rate bonds.
Floating Rate Bonds: When the coupon rate keeps fluctuating during the course of an
investment, it is called a floating rate bond.
Zero-Coupon Bond: When the coupon rate is zero and the issuer has to repay only the
principal amount to the investor, such type of bonds are called zero-coupon bonds.
Sovereign Gold Bonds (SGBs) - The Central Government issues sovereign Gold Bonds,
wherein entities can invest in gold for long periods, without the burden of investing in physical
gold. The interest earned on such bonds is exempted from tax. Prices of such bonds are linked
with gold’s prices.
Inflation-Indexed Bonds - It is a unique financial instrument issued by Government of India,
wherein the principal, as well as the interest earned on such bond, is linked with inflation.
Mainly issued for retail investors, these bonds use the Consumer Price Index (CPI) or
Wholesale Price Index (WPI) as index.