Professional Documents
Culture Documents
AND
PORTFOLIO MANAGEMENT
Module 1
St. ALOYSIUS INSTITUTE OF MANAGEMENT
AND INFORMATION TECHNOLOGY
(AIMIT)
MANGALORE
Investment:
Investment is an activity that is engaged in by people who have
savings and investments are made from savings. But all savers are not
investors so investment is an activity which is different from saving.
If one person has advanced some money to another, he may
consider his loan as an investment. He expects to get back the money
along with interest at a future date.
Another person may have purchased one kilogram of gold for
the purchase of price appreciation and may consider it as an
investment.
Yet another person may purchase an insurance plan for the
various benefit it promises in future. That is his investment.
Investment involves employment of funds with the aim of
achieving additional income or growth in values or the commitment of
resources which have been saved in the hope that some benefits will
accrue in future.
Characteristics of Investment:
Return:
Investments are made with the primary objective of deriving a return. The
return may be received in the form of capital appreciation plus yield. The
difference between the sales price and the purchase price is capital appreciation.
The dividend or interest received from the investment is the yield.
Risk:
Risk may relate to loss of capital, delay in repayment of capital, nonpayment of interest, or variability of returns. While some investments like
government securities and bank deposits are riskless, others are more risky.
The risk of an investment depends on the following factors :
1)
2)
The lower credit worthiness of the borrower, the higher is the risk.
3)
Risk and return of an investment are related. Normally, the higher the risk, the
higher is the return.
Safety:
Safety is another feature which an investor desires for his investments.
Liquidity:
An investment which is easily saleable or marketable without loss of
money and without loss of time is said to possess liquidity. Some investments
like company deposits, bank deposits, P.O. deposits, NSC, NSS etc are not
marketable. Some investment instruments like preference shares and
debentures are marketable but there are no buyers in many cases and hence
their liquidity is negligible. Equity shares of companies listed on stock
exchanges are easily marketable through the stock exchanges.
An investor generally prefers liquidity for his investments, safety of his
funds, a good return with minimum risk or minimisation of risk and
maximisation of return.
Objectives of Investment:
The main objectives of investments are:
Maximisation of return
Minimisation of risk
Maintaining liquidity
Increasing safety
Saving tax
Maximisation of return:
The rate of return could be defined as the total income the investor receives
during the holding period, stated as a percentage price at the beginning of the
holding period.
Maintaining Liquidity:
Liquidity depends upon marketing and trading facilities. If a portion of
the investment could be converted into cash without much loss of time, it helps
the investor to meet emergencies. Stocks are liquid only if they command a
good market by providing adequate returns through dividends and capital
appreciation.
Hedging against inflation:
The rate of return should ensure a cover against inflation to protect against a
rise in prices and fall in the purchasing value of money. The rate of return
should be higher than the rate of inflation otherwise the investor will experience
loss in real terms.
Increasing safety:
The selected investment avenue should be under the legal and regulatory
framework. If it is not under the legal framework, it will be difficult to represent
grievances. Approval of the law itself adds a flavour of safety. From the safety
point of view, investments can be ranked as follows: bank deposits, government
bonds, UTI units, nonconvertible debentures, convertible debentures, equity
shares and deposits with non-banking financial companies.
Speculator
Time
horizon
Risk
Willing to undertake
high risk.
Return
Decision
Consider inside
information, hearsays
and market behavior.
Funds
Safety
Investment Process:
Investment Process
Investme
nt Policy
Investible
fund
Objectives
Knowledge
Analysis
Market
Industry
Compa
ny
Valuatio
n
Intrinsic
value
Future
value
Portfolio
Constructio
n
Diversificati
on
Selection
and
allocation
Portfolio
Evaluati
on
Appraisa
l
Revision
b) Objectives:
The objectives are framed on the premises of the required rate of return,
need for regular income, risk perception and the need for liquidity. The risk
takers objective is to earn a high rate of return in the form of capital
appreciation whereas the primary objective of the risk-averse is the safety of
principal.
c) Knowledge:
Knowledge about investment alternatives and markets plays a key role in
policy formulation. Investment alternatives range from security to real estate.
The risk and return associated with investment alternatives differ from each
other.
The investor should be aware of the stock market structure and functions
of the brokers. The modes of operations are different in the BSE, NSE and
OTCEI. Brokerage charges are also different. Knowledge about stock
exchanges enables an investor to trade the stock intelligently.
2) Security Analysis:
Securities to be brought are scrutinized through market, industry and
company analyses after the formulation of investment policy.
a) Market analysis
The growth in Gross Domestic product and inflation is reflected in stock
prices. Recession in the economy results in a bear market. Stock prices may
fluctuate in the short run but in the long run, they move in trends. The investor
can fix his entry and exit points through technical analysis.
b) Industry analysis:
An analysis of the performance, prospectus and problems of an industry of
interest is known as industry analysis. The risk factors related to the automobile
industry are different from those related to the information technology industry.
The performance of an industry reflects the performance of the companies it
consists of.
c) Company analysis:
The purpose of company analysis is to help the investors make better
decisions. The company's earnings, profitability, operating analysis, capital
structure and management have to be screened. A company with a high product
market share is able to create wealth for investors in the form of capital
appreciation.
3) Valuation:
Valuation helps the investor determine the return and risk expected from an
investment in common stock.
Intrinsic value of the share is measured through the book value of the share
and price earning ratio. Simple discounting models can be adopted to value the
shares.
Future value of securities can be estimated by using a simple statistical
technique like trend analysis. The analysis of the historical behavioral of price
enables the investor to predict the future value.
4) Construction of a portfolio:
A portfolio is a combination of securities. By constructing a portfolio,
investors attempt to spread risk by not putting all their eggs into one basket and it
also helps to meet their goals and objectives.
a) Diversification:
The main objective of diversification is the reduction of risk in the form of
loss of capital and income. A diversified portfolio is comparatively less risky than
holding a single portfolio. Several models are available to diversify a portfolio.
i) Debt and equity diversification:
Debt instruments provide assured returns with limited capital appreciation.
Common stock provide income and capital gain but with a flavor of uncertainty.
ii) Industry diversification:
Banking industry shares may provide regular returns but with limited capital
appreciation. Information technology stocks yield higher returns and capital
appreciation.
iii) Company diversification:
Securities from different companies are purchased to reduce the risk.
Technical and fundamental analysts suggest the investors to buy the securities.
Investment Avenues:
Investment Avenues
Securitie
s
Stocks
Bonds/Secu
rities
G-securities
Money
market
instruments
Derivatives
Mutual
Funds
Deposit
s
Bank
Deposits
NonBanking
Financial
Company
(NBFC)
deposits
Postal
Schemes
Monthly
Income
Scheme(MIS
)
National
Saving
Scheme(NSS
)
Vikas
Patras
Public
Provident
Fund(PPF)
Insurance
Life
Insurance
policies
Unit Linked
Insurance
Plan (ULIP)
Real
Assets
Real
estate
Precious
metals
Art and
antiques
Investment Avenues:
1) Negotiable investments
2) Non-negotiable investments
I) Negotiable investments:
a) variable income securities
b) Fixed income securities
Variable income securities - Equity shares
Equity shares are commonly referred as common stock or ordinary shares.
The most common classification under this shares are:
a) Large-cap, mid-cap and small-cap stocks:
The large-cap stocks are shares of high market capitalization, the smallcap ones have a low market capitalization and the mid-cap ones fall in between
these two.
g) Speculative shares:
Shares that have a lot of speculative trading in them are referred to as
speculative shares.
Fixed Income Securities:
Fixed income shares are categorized as follows:
a) Preference shares:
The biggest advantage is the tax-exempt status of the preference shares
dividend.
b) Debentures / Bonds:
Debentures are generally issued by the private sector companies as a longterm promissory note for raising loan capital. The company promises to pay
interest and principal as stipulated whereas bond is a long-term debt instrument
that promises to pay a fixed annual sum as interest for a specified period of time.
Public sector companies and financial institutions issue bonds.
c) Government Securities:
The securities issued by the central government, state government and quasigovernment agencies are known as government securities or gilt-edged securities.
It is a secure financial instrument, which guarantees the income and capital.
Life Insurance:
It is contract for payment of a sum of money to the person assured on the
happening of the event insured against. The core feature of the is protection and
elimination of risks. Insurance emerge as a combination of both investment and
assurance. The major advantages it includes are : protection, easy payment,
liquidity and tax relief.
Unit Linked Insurance Plan (ULIP):
This is a market-linked insurance plan. It provide life insurance combined with
savings at market-linked returns. The premiums is mainly invested in risk-free
securities like government securities and fixed income securities.
Real Assets:
Gold
Silver
Real estate refers to various fixed assets which can be classified into three
categories: Residential Property, Commercial property, Land.
Art
Antiques
Capital Market:
Capital market deals with medium term and long term funds. It refers to all
facilities and the institutional arrangements for borrowing and lending term funds
(medium term and long term). The demand for long term funds comes from private
business corporations, public corporations and the government. The supply of
funds comes largely from individual and institutional investors, banks and special
industrial financial institutions and Government.
It is the market segment where securities with maturities of more than one
year are bought and sold. Equity shares, preference shares, debentures and bonds
are the long-term securities traded in the capital market.
Capital market isclassified in two ways:
1) Primary Market ( New Issue Market)
2) Secondary Market ( Stock Market)
Primary Market:
Primary market is the new issue market of shares, preference shares
and debentures.
Stocks available for the first time are offered through the new issue
market. The issuer may be the new company or the exit company.
The issuing houses, investment bankers and brokers act as the
channels of distribution for a new issue. They take responsibility for
selling the stocks to the public.
The issuer can be considered as manufacturer.
Types of Issues:
Public Issue which is a method of raising a funds through the issue
of shares to investors in the primary market by companies.
Preferential issue means when listed companies issue securities
to a selected group of persons. It may be financial institutions, mutual
funds or high net worth individuals.
Rights issues means an issue of capital offered by a company to
its existing shareholders through a letter of offer. In other wards, a
listed company issues fresh securities only to its existing
shareholders.
Secondary Market:
Secondary market deals with securities which have already been issued and
are owned by investors. The buying and selling of securities already issued and
outstanding take place in stock exchanges. Hence, stock exchanges constitute the
secondary market in securities.
Stock Exchange:
The stock exchange were once physical market places where the agents of
buyers and sellers operated through the auction process. These are being replaced
with electronic exchanges where buyers and sellers are connected only by
computers over a telecommunication network.
Auction trading is giving way to screen-based trading where bid prices
and offer prices are displayed on the computer screen. Bid price refers to the price
at which an investor is willing to buy the security and offer price refers to the
price at which an investor is willing to sell the security.
A stock exchange may be defined in different ways. In simple terms, stock
exchange is A centralized market for buying and selling stocks where the price is
determined through supply-demand mechanisms.
According to the Securities Contracts Act, 1956, Stock exchange means
any body of individuals, whether incorporated or not, constituted for the purpose
of assisting, regulating or controlling the business of buying, selling or dealing in
securities.
Dissemination of Information
Stock exchanges provide information through their various
publications. The publish the share prices traded on daily basis
along with the volume traded. Directory of Corporate
information is useful for the investors assessment regarding the
corporate. Handouts, handbooks and pamphlets provide
information regarding the functioning of the stock exchanges.
Performance Inducer
The prices of stock reflect the performance of the traded
companies. This makes the corporate more concerned with its
public image and tries to maintain good performance.
Self-regulating Organization
The stock exchanges monitor the integrity of the members,
brokers, listed companies and clients. Continuous internal audit
safeguards the investors against unfair trade practices. It settles
the disputes between member brokers, investors and brokers.
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