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Unit-1

Investment Setting
Investment
Investment is the employment of funds on assets to earn income or capital
appreciation.
The individual who makes an investment is known as the investor.
In economic terms, investment is defined as the net addition made to the
capital stock of the country.
In financial terms, investment is defined as allocating money to assets with a
view to gain profit over a period of time.
Investments in economic and financial terms are inter-related where an
individual's savings flow into the capital market as financial investment, which
are further used as economic investment.
Financial Meaning of Investment
In finance, investment is putting money into
an asset with the expectation of
capital appreciation, dividends,
and/or interest earnings. Financial investment
involves of funds in various assets, such
as stock, Bond, Real Estate, Mortgages etc.
Investment is the employment of funds with
the aim of achieving additional income or
growth in value.
Economic meaning of Investment
Economic investment means the net additions to
the capital stock of the society which consists of
goods and services that are used in the
production of other goods and services.
Addition to the capital stock means an increase in
building, plants, equipment and inventories over
the amount of goods and services that existed. In
economics, investment is the accumulation of
newly produced physical entities, such as
factories, machinery, houses, and goods
inventories.

5
INVESTMENT ACTIVITY
(ACQUISITION OF ASSETS)
CASH



BANK DEPOSITS

P.F./LIC

PENSION

POST OFFICE
CERTIFICATES
&
DEPOSITS


INVESTOR
SAVER
SHARES, BONDS,
GOVT. SECURITIES,
M.F. SCHEMES, UTI
1. FINANCIAL ASSETS 2. PHYSICAL ASSETS
NEW
ISSUE
3. MARKETABLE
ASSETS
STOCK
MARKET
HOUSE
LAND
BUILDINGS
FLATS

GOLD
SILVER
OTHER METALS



CONSUMER
DURABLES



Investment Objectives
Return Income: The total income, the investor receives
during his holding period.



Risk: Variability in the return.
Liquidity: The ease with which the investment is
converted into cash.
Safety: It refers to the legal and regulatory protection
to the investment.
Hedge against inflation: The returns should be higher
than the rate of inflation.
End period value Purchase period value
+ Dividends
Return = 100
Purchase period value

Investment objectives
Tax Exemptions
Public provident fund
Unit linked Insurance Plans
Equity linked saving scheme
Fixed Deposit
Employee provident Fund
National Saving certificate
Health Premium
Tuition Fee
Post office saving scheme


Speculation
Speculation means taking business risks with
the anticipation of acquiring short term gain.
It also involves the practice of buying and
selling activities in order to profit from the
price fluctuations.
An individual who undertakes the activity of
speculation is known as speculator.
Difference between
Investor and Speculator

Base Investor Speculator
Time horizon Has a relatively longer planning
horizon. His holding period is
usually of one or more than one
year.
Has a very short planning
horizon. His holding period
may be few days to months.
Risk return His risk is less. His risk is high.
Decision Attaches greater significance to
fundamental factors and
carefully evaluates the
performance of the company.
Attaches greater significance
to market behavior and inside
information.
Funds Uses his own funds. Uses borrowed funds along
with his personal funds.
The Investment Process
The process of investment includes five stages:
1. Investment Policy: The policy is formulated on the basis of
investible funds, objectives and knowledge about investment
sources.
2. Security Analyses: Economic, industry and company analyses
are carried out for the purchase of securities.
3. Valuation: Intrinsic value of the share is measured through
book value of the share and P/E ratio.
4. Portfolio Construction: Portfolio is diversified to maximise
return and minimise risk.
5. Portfolio Evaluation: The performance of the portfolio is
appraised and revised.
Investment Process

Investment
Policy
Analysis Valuation
Portfolio
Construction
Portfolio
Evaluation
Investible
fund

Objective
Knowled
ge
-Market


Industry
Company
Intrinsic
Value

Future
Value
Diversific
ation

Selection
&
allocation
Appraisal

Revision
Securities
They are instruments which represent a claim over
an asset or any future cash flows.
Securities are classified on the basis of return and
source of issue.
Fixed income securities
Return
Variable income securities
Issuers
Public Sector Enterprises
Government companies
Financial institution

Equity Shares
Common stock or ordinary shares are most
commonly known as equity shares.
Stock is a set of shares put together in a bundle.
A share is a portion of the share capital of a company
divided into small units of equal value.
The advantages of equity shares are:
Capital appreciation
Hedge against inflation
Preference Stock
Preference stock provides fixed rate of return.
Preference stockholders do not have any
voting rights.
Preference stockholders do not have any
share in case the company has surplus profits.
No voting rights
Types of Preference share
Cumulative: These shares give their owners the right to
accumulate dividend payments that were skipped
due to Financial problems; if the company later
resumes paying dividends, cumulative shareholders
receive their missed payments first.
Non-Cumulative: These shares do not give their
owners back payments for skipped dividends.
Participating: These shares may receive higher than
normal dividend payments if the company turns a
larger than expected profit.
Convertible: These shares may be converted into a
specified number of shares of common share .

Sweat Equity
It is a new equity instrument introduced in the
Companies (Amendment) Ordinance, 1998.
It forms a part of the equity share capital as its
provisions, limitations and restrictions are same as
that of equity shares.
Sweat Equity is for:
The directors or employees involved in the process of
designing strategic alliances.
The directors or employees who have helped the company
to achieve a significant market share.
Non-voting Shares
The shares that carry no voting rights are
known as non-voting shares.
They provide additional dividends in the place
of voting rights.
They can be listed and traded on the stock
exchanges.
Bonus Shares
Distribution of shares, in addition to the cash
dividends, to the existing shareholders are
known as bonus shares.
These are issued without any payment for
cash.
Debenture
It is a debt instrument issued by a company, which carries a
fixed rate of interest.
It is generally issued by private sector companies in order to
acquire loan.
Bond
A bond is a debt security issued by the government, public
sector enterprises and financial institutions.
Various features of a bond are:
The interest rate is generally fixed
It is traded in the securities market
At the time of issue of bonds, maturity date is specified
Warrants
Warrants are securities that give the holder the right,
but not the obligation, to buy a certain number of
securities (usually the issuer's common stock) at a
certain price before a certain time.
Investment Alternatives
Negotiable securities
Variable income securities
Equity shares
Fixed income Securities
Bonds
Preference shares
Debentures
Money market securities
Non Negotiable securities
Bank deposit
Post office deposit
Deposit scheme by the company
Life insurance
Mutual fund
Real Asset
Gold and Silver
Real estate
Art
Antique


EQUITY SHARES
Represents ownership capital
They elect the board of directors and have a right to vote
on every resolution placed before the company
They enjoy the right which enables them to maintain their
proportional ownership
Risk: residual claim over income
Reward: partners in progress
The amount of capital that a company can issue as per its
memorandum represents authorized capital
The amount offered by the company to the investors is called
issued capital
The part of issued capital that is subscribed to by the investors
is called subscribed capital
Paid up capital


EQUITY SHARES
Par / Face / Nominal value of a share is stated in the
memorandum and written on the share scrip
Issue of shares at a value above its par value is called issue at
a premium
Issue of shares at a value below its par value is called issue at
a discount
The price at which the share currently trades in the market is
called the market value
EQUITY SHARES
Blue chip shares
Shares of large, well established and financially strong companies
with impressive record of earnings and dividend
Growth shares
Shares of companies having fairly strong position in the growing
market and having an above average rate of growth and
profitability
Income shares
Shares of companies having fairly stable operations, limited
growth opportunities and high dividend payouts
Cyclical shares
Shares of companies performing as per the business cycles
Defensive shares
Shares of companies relatively unaffected by the ups and downs
in the general economic conditions
Speculative shares
shares of companies whose prices fluctuate widely because of a
lot of speculative trading being done on them




BONDS
They are long term debt instruments issued for a fixed time period
Bonds are debt securities issued by the government or PSUs
Debentures are debt securities issued by private sector companies
They comprise of periodic interest payments over the life of the
instrument and the principal repayment at the time of redemption
Debt securities issued by the central government , state government and
quasi government agencies are referred to as gilt-edged securities
Callable bonds are the ones that can be called for redemption earlier than
their date of maturity. This right to call is available with the company
Convertible bonds are the ones that can be converted into equity shares
at a later date either fully or partly. This option is available with the bond
holder
Coupon rate is the nominal rate of interest fixed and printed on the bond
certificate. It is calculated on the face value and is payable by the company
till maturity


PREFERENCE SHARES
Represents a hybrid security that has attributes of both equity
shares and debentures.
They carry a fixed rate of dividend. However it is payable only
out of distributable profits
Dividend on preference shares is generally cumulative.
Dividend skipped in one year has to be paid subsequently
before equity dividend can be paid
Only redeemable preference shares can be issued


Debentures
A debenture is defined as a certificate of agreement of
loans which is given under the company's stamp and
carries an undertaking that the debenture holder will
get a fixed return (fixed on the basis of interest rates)
and the principal amount whenever the debenture
matures.
There are two types of debentures:

Convertible Debentures, which can be converted into
equity shares of the issuing company after a
predetermined period of time.
Non-Convertible Debentures, which cannot be
converted into equity shares of the liable company. They
usually carry higher interest rates than the convertible
ones
MONEY MARKET INSTRUMENTS
Debt instruments which have a maturity of less than a year at the time
of issue are called money market instruments
These are highly liquid instruments

Treasury bills
Types
Treasury bills (T-bills) offer short-term investment opportunities,
generally up to one year. They are thus useful in managing short-term
liquidity. At present, the Government of India issues three types of
treasury bills through auctions, namely, 91-day, 182-day and 364-day.
There are no treasury bills issued by State Governments.

T-bills
Amount
Treasury bills are available for a minimum
amount of Rs.25,000 and in multiples of Rs.
25,000. Treasury bills are issued at a discount
and are redeemed at par

MONEY MARKET INSTRUMENTS
Certificate of deposits
Negotiable instruments issued by banks / financial institutions with
a maturity ranging from 3 months to 1 year
These are bank deposits transferable from one party to another
The principal investors are banks, financial institutions, corporates
and mutual funds
These carry an explicit rate of interest
Banks normally tailor make their denominations and maturities to
suit the needs of the investors

Commercial papers
Issued in form of promissory notes redeemable at par by the holder
on maturity
Usually has a maturity period of 90 to 180 days
They are sold at a discount to be redeemed at par
CPs can be issued by corporates having a minimum net worth of Rs 5
crores Minimum issue size is Rs 25 lacs




Non Negotiable securities
These represent personal transactions between
the investor and the issuer.

Bank deposits
There are various kinds of bank accounts current,
savings and fixed deposit
While a deposit in a current account does not earn any
interest, deposit made in others earn an interest
Liquidity, convenience and low investment risks are
the common features of the bank deposits
Deposits in scheduled banks are safe because of the
regulations of RBI
NON- Negotiable Securities
Company deposits
Deposits mobilized by companies are governed by the
provisions of section 58A of Companies Act, 1956
The interest offered on this fixed income deposits is higher
than what investors would normally get from the banks
Manufacturing and trading companies are allowed to pay a
maximum interest of 12.5%.
The rates vary depending on the credit rating of the company
offering the deposit

Post Office Monthly Income Scheme
Investments
Minimum: Rs 1,500
Maximum: Rs 4.5 lakh in a single account
Maximum: Rs 9 lakh in a joint account
The tenure of the MIS scheme is six years.


Life Insurance
A protection against the loss of income that
would result if the insured passed away. The
named beneficiary receives the proceeds and
is thereby safeguarded from the financial
impact of the death of the insured.

Insurance that pays out a sum of money either
on the death of the insured person or after a
set period.
Types of Insurance
Basic Life Insurance
Endowment Insurance plan: under this plan, the sum
assured is payable on the date of maturity or on the death of the
life assured, if earlier
Term Assurance Plan:
In Pure Term Plans, if the Life Insured unfortunately dies within
the policy term then the nominee will get the entire MONEY that
has been promised as the Death Benefit for the life insured.
However, if he survives that period, then there is no payment at
the end of the term.
Mutual Fund
The money pooled in by a large number of investors is what
makes up a Mutual Fund. This money is then managed by a
professional Fund Manager, who uses his investment
management skills to invest it in various financial instruments.

As an investor you own units, which basically represent the
portion of the fund that you hold, based on the amount
invested by you. Therefore, an investor can also be known as a
unit holder. The increase in value of the investments along
with other incomes earned from it is then passed on to the
investors / unit holders in proportion with the number of units
owned after deducting applicable expenses, load and taxes.

Mutual Fund
Net Asset Value
Just like a share has a price, a mutual fund unit has
an NAV. To put it simply, NAV represents the market
value of each unit of a fund or the price at which
investors can buy or sell units. The NAV is generally
calculated on a daily basis, reflecting the combined
market value of the shares, bonds and securities (as
reduced by allowable expenses and charges) held by
a fund on any particular day.
Open ended Mutual fund
There are two types of these products on the
market. Open-end funds are what you know as a
mutual fund. They don't have a limit as to how
many shares they can issue. When an investor
purchases shares in a mutual fund, more shares
are created, and when somebody sells his or her
shares the shares are taken out of circulation. If a
large amount of shares are sold (called
a redemption), the fund may have to sell some of
its investments in order to pay the investor.
Open ended Mutual fund
You can't watch an open-end fund like you
watch your stocks, because they don't trade
on the open market. At the end of each
trading day, the funds reprice based on the
amount of shares bought and sold. Their price
is based on the total value of the fund or
the net asset value (NAV)
Closed-Ended fund
They are launched through an IPO in order to
raise money and then trade in the open
market just like a stock
They only issue a set amount of shares and,
although their value is also based on the NAV,
the actual price of the fund is affected by
supply and demand, allowing it to trade at
prices above or below its real value.
MUTUAL FUNDS
Also known as an instrument for collective investment
Investment is done in three broad categories of financial assets i.e. stocks,
bonds and cash
Depending on the asset mix, mutual fund schemes are classified as: Equity
schemes, hybrid schemes and debt schemes
On the basis of flexibility, Mutual fund schemes may be: Open ended or
Close ended
Open ended schemes are open for subscription and redemption throughout
the year
Close ended schemes are open for subscription only for a specified period and
can be redeemed only on a fixed date of redemption
On the basis of objective, mutual funds may be growth funds, income
funds, or balanced funds
NAV of a fund is the cumulative market value of the assets of the fund
SBI Mutual Fund
FINANCIAL DERIVATIVES
Derivative is a product whose value is derived from the value of the
one or more underlying assets. These underlying assets may be
equity, index, foreign exchange, commodity or any other asset
Derivative does not have a value of its own. Rather its value
depends on the value of the underlying asset.
Derivatives initially emerged as hedging devices against fluctuations
in commodity prices and commodity linked derivatives remained
the sole form of such products. Financial derivatives emerged post
1970 period.
Financial derivatives have various financial instruments as the
underlying variables
Futures and Options are two basic types of derivatives


Options are of two types:
Call option gives the buyer of the option a right
but not an obligation to buy a given quantity of
the underlying asset, at a given price, on or before
a given future date
Put option gives the buyer of the option a right
but not an obligation to sell a given quantity of the
underlying asset, at a given price, on or before a
given future date
FINANCIAL DERIVATIVES
Futures is a transferable contract between two
parties to buy or sell an asset at a certain date in the
future at a specified price
It is a standardized contract with a standard
underlying asset, a standard quantity and quality
of underlying instrument and a standard timing of
settlement
It may be offset prior to its maturity by entering
into an equal and opposite transaction
It requires margin payments and follow daily
movements

Forms of Risk
Business Risk
Business risk is the measure of risk associated
with a particular security. It is also known as
unsystematic risk and refers to the risk
associated with a specific issuer of a security.
Forms of Risk
Interest rate risk: when interest rates rise after
you lock in your money, meaning you don't earn
as much on your money as you would have if
you'd invested at the higher rate
liquidity risk: there might not be buyers
interested in your investment when you want to
sell
Credit risk: the organisation may not be able to
repay its debts, and you might lose your money

Forms of Risk
Economic risk: the economy may or may not be
doing well, which could affect the value of your
investment
Industry risk: risks affecting a particular industry,
like shortages of raw materials or changes in
consumer preferences
currency risk: your investment is affected by
changes in the value of the currency
Inflation risk: your investment doesn't earn
enough to keep up with inflation.

Unsystematic Risk
Company- or industry-specific hazard that is inherent in
each investment. Unsystematic risk, also known as non-
systematic risk, "specific risk," "diversifiable risk" or
"residual risk," can be reduced through diversification.

By owning stocks in different companies and in different
industries, as well as by owning other types of securities
such as Treasuries and municipal securities, investors will
be less affected by an event or decision that has a strong
impact on one company, industry or investment type.
Examples of unsystematic risk include a new competitor, a
regulatory change, a management change and a product
recall.

Systematic Risk


The risk inherent to the entire market or an
entire market segment. Systematic risk, also
known as undiversifiable risk, volatility or
market risk, affects the overall market, not just
a particular stock or industry. This type of risk is
both unpredictable and impossible to
completely avoid. It cannot be mitigated
through diversification, only through hedging or
by using the right asset allocation strategy.


51
RISK-RETURN RELATIONSHIP
RISK : Risk is inherent in any investment. This risk may relate
to loss or delay in repayment of the principal capital or loss or
non-payment of interest or variability of returns. While some
investments are almost risk less like Govt.securities or bank
deposits, others are more risky.
RETURN: Return differs amongst different instruments. The
most important factor influencing return is risk. Normally, the
higher the risk ,the higher is the return.
Risk and Return Relationship
ASSET RISK RETURN
Cash Investments
( Bank accounts)
Low Low
Debt Investments
(Bonds, Debenture)
Moderate Moderate
Equities (stocks) High High
Mutual Funds Low to High Low to High
Real Estate High High
Derivatives Very High

Very High






R
e
t
u
r
n

Deposits(FD,PPF,PO)(Low Risk)
Mutual Funds
Equity Shares
Risk and Return Relationship
Bonds , Debentures
Derivatives
Venture
Capital
(High Risk)
Risk
Real Estate
Security contraction Regulation Act,
1956
Introduction:
The Securities Contracts (Regulation) Act, 1956
Act was enacted in order to prevent
undesirable transactions in securities and to
regulate the working of stock exchanges in the
country. The provision of the Act came into force
with effect from 20th February, 1957.
Stock exchange [Section 2(j)]

Definition:
Any body of individuals, whether incorporated or
not, constituted before corporatisation and
demutualisation under sections 4A and 4B, or
A body corporate incorporated under the
Companies Act, 1956 whether under a scheme of
corporatisation and demutualisation or
otherwise,
For the purpose of assisting, regulating or
controlling the business of buying, selling or
dealing in securities.

Recognised Stock Exchange [Section 2(f)] means a
stock exchange which is for the time being recognized
by the Central Government under Section 4 of the Act.
Corporatisation [Section 2(aa)] means the succession
of a recognised stock exchange, being a body of
individuals or a society registered under the Societies
Registration Act, 1860 (21 of 1860), by another stock
exchange, being a company incorporated for the
purpose of assisting, regulating or controlling the
business of buying, selling or dealing in securities
carried on by such individuals or society.
Demutualisation [Section 2(ab)] means the
segregation of ownership and management
from the trading rights of the members of a
recognised stock exchange in accordance with
a scheme approved by the Securities and
Exchange Board of India (SEBI).
Recognised Stock Exchanges
Application for recognition of stock exchanges
(Section 3)
Grant of recognition to stock exchanges (Section 4)
Corporatisation and demutualisation of stock
exchanges (Section 4A)
Power of Central Government to call for periodical
returns or direct inquiries to be made (Section 6)
Annual reports to be furnished to Central
Government by stock exchanges (Section 7)
Power of recognised stock exchanges to make bye-
laws (Section 9)
Power of SEBI to make or amend bye-laws of
recognised stock exchanges (Section 10)


Power to suspend business of recognised stock
exchanges (Section 12)
Conditions for listing (Section 21)
Delisting of securities (Section 21A)
Section 22 Right of appeal against refusal of
stock exchanges to list securities of public
companies
Section 22A Right of appeal to Securities
Appellate Tribunal against refusal of stock
exchange to list securities of public companies
Section 22D Limitation



Penalties :

Section Contravention/Non-compliance Penalty Prescribed
23A
Failure to furnish information, return, etc
and maintain books of accounts and
records.
One lakh rupees for each
day during which such
failure continues or one
crore rupees, whichever
is less.
23B
Any person who is required under this
Act or bye-laws of a recognised stock
exchange to enter into an agreement
with clients, fails to enter into such
agreement
One lakh rupees for each
day during which such
failure continues or one
crore rupees, whichever
is less.
23C
Any stock broker or sub-broker or a company
whose securities are listed or proposed to be
listed in a recognised stock exchange, fails to
redress the grievances within the time
stipulated by the SEBI or a recognised stock
exchange
One lakh rupees for each
day during which such
failure continues or one
crore rupees, whichever is
less.
23D
Any stock broker or sub-broker who fails to
segregate securities or moneys of the
client(s) or uses the securities or moneys of a
client(s) for self or for any other client
Penalty not exceeding one
crore rupees.
23E
If a company or any person managing
collective investment scheme or mutual fund,
fails to comply with the listing conditions or
delisting conditions
Penalty not exceeding
twenty-five crore rupees