security analysis and investment management

1

SECURITY ANALYSIS &

INVESTMENT MANAGEMENT

Vipin k, Asst Prof. VJIM

Vipin k, Asst Prof. VJIM 2

Syllabus1. Investment Environment

2. Security analysis (2,3,4 & 5)

*Securities market

*Risk & return

*Fundamental analysis

*Technical analysis

3. Derivatives (portfolio protection) (6)

4. Mutual funds (7)


Warren Buffett

Most successful investor of the 20th century

4

INVESTMENT• Meaning • Characteristics• Objectives • Investment & Speculation • Investment & Gambling• Types of investors• Investment process• Investment alternatives

Vipin k, Asst Prof. VJIM


INVESTMENT Employment of fund on assets

with the aim of earning income or capital appreciation.

Financial activity by people with savings.

“commitment of funds made in the expectation of some positive rate of return”


Financial & Economic meaning

Financial :

Commitment of person’s fund to derive future income in the form of interest , dividend , pension benefit or appreciation in the value of their capital.

eg:- purchase of shares, debentures, post office savings certificates etc…..

These investment generate financial assets


Economic:

Net additions to the economy’s capital stock – goods & services that are used in the production of other goods and services.

eg:- new constructions, plant & machinery, inventories etc…..

These investment generate physical assets.


All investment results in the

acquisition

of some assets either FINANCIAL or

physical.


Real/Physical Assets &

FINANCIAL ASSETS


Real Assets

Assets which are tangible or physical in nature

Real Assets

Real Estates

Other tangible Assets


1. Real Estates :-

Residential land, building, apartments, farm land etc


2. Other tangible Assets :-

Precious metals like gold, silver,

platinum. Precious stones like

diamonds, colored stones.

Antiques


FINANCIAL ASSETS

An intangible asset that derives

value because of a contractual claim.

eg:- Stock, bonds, bank deposits etc.


Characteristics Investment

Return

Risk

Liquidity

Safety

Contribution to capital formation.


Objectives …

Maximization of Return

Minimization of Risk

Tax minimization

Liquidity


Speculation

o Buying & selling of securities within a very short period of time (less than one year)

o Speculator

o Need capital gain only

eg:- a person who buy a security at 9’o clock & sell at 9:30 for the quick gain (may be loss)


Investment Vs Speculation

Bases Investment Speculation

1. Risk assumed low to High always high

2. objective Regular return + capital gain

capital gain

3. Time period long term Always short term

4. Funds His own fundUse borrowed fund to supplement his own fund

5. Nature of return Consistent & long term Quick & short term


GAMBLING

Taking high risk not only for high return but

also for thrill & excitement.

Unscientific & unplanned

Based on tips & rumors

eg:- horse race, lotteries, card games etc


Investment Vs Gambling Bases Investment Gambling

1. Nature Carefully planned & scientific Unplanned &unscientific

2. Risk & return Risk match with return Taking high risk for high return

3. Motive For regular income & capital gain

For thrill & excitement

4. Period Long term Very short term

5. Action Detailed analysis Based on tips & rumors


INVESTORS

Individual investors

Institutional investors


Individual investors

Large in number

Investible resources are smaller

Lacks extensive evaluation & analysis

eg:- Mr. A purchases the shares of X limited.



Organization with surplus fund who engage

in investment activities.

Fewer in numbers

Investible resources are much larger.

Professional approach

eg:- mutual fund, insurance companies etc


Investment process

1

•Framing investment Policy

2

•Investment / security Analysis

3

•Valuation

4

•Portfolio Construction

5

•Portfolio Evaluation


1. Framing investment Policy:- i. Investible funds ii. Objectives iii. knowledge


2. Investment / security Analysis:- i. Market analysis ii. Industry analysis iii. Company analysis


3. Valuation:- Intrinsic value Future value


4. Portfolio Construction:- i. Diversification a) Debt & Equity diversification

b) Industry diversification c) Company diversification

ii. Selection


5. Portfolio Evaluation:-

i. Appraisal

ii. Revision


INVESTMENT ALTERNATIVES


INVESTMENT ALTERNATIVES

Equity Shares

Deposits

Bonds & Debentures

Money market Instruments

Mutual Funds

Insurance Products

Retirement Products

Government savings Schemes

Precious objects

Real estates

Financial Derivatives


I. Equity Shares

Stock market analysts classify equity shares are:

Blue chip shares

Growth shares

Income shares

Cyclical shares

Defensive shares

Speculative shares


II. Deposits

Bank deposits

Post office deposits

Company fixed deposits


III. Bonds & Debentures

Government securities

PSU bonds

Debenture of private sector

companies


IV. Money market Instruments

Treasury Bills

Certificate of deposits

Commercial paper


V. Insurance Products

Types of insurance plan

Term assurance plan

Traditional investment linked

plan

Unit-Linked Insurance Plans

(ULIPS)


VI. Retirement Products

1.Mandatory retirement

schemes

i. Employees’ Provident

Fund(EPF) scheme

ii. Employees’ Pension schemes

(EPS)

iii. New pension schemes

2. Voluntary retirement

schemes


VII. Precious objects

1. Precious metals

gold, silver etc

2. Precious stones

Diamonds, colored stones etc

3. Art objects and collectibles

paintings, antiques etc


VIII. Real estates

• Agricultural land, semi-urban land , commercial property etc


IX. Mutual Funds

Invest in three broad categories of financial assets ie stocks, bond & cash

Three broad categories of mutual fund schemes:

a)Equities schemeb)Hybrid schemec) Debt scheme


X. Financial Derivatives

• Futures and

• options


Tax sheltered savings scheme

• Public provident fund scheme• National savings scheme• National savings certificate


MODULE - II


SECURITIES MARKET


Identify the Building….


SEBI Bhavan, Mumbai Headquarters


SECURITIES MARKET

• Securities market• Primary market• Secondary market• Listing, trading & settlement• Important international stock

exchanges• Depositories • Stock market indices- BSE SENSEX,

NIFTY etc


Securities market

Market for equity, debt and derivatives.

Securities Market

Equity Market

Debt Market

Government Securities

Market

Corporate debt Market

Money Market

Derivatives Market

Options Market

Futures Market


Participants In The Securities Market

Regulators – CLB, RBI, SEBI etc..

Stock exchanges

Depositories

Brokers

Underwriters

Listed securities

Credit rating agencies etc……..


PRIMARY MARKET &

SECONDARY MARKET


PRIMARY MARKET

The market where new securities are issued

Market in which shares, debentures and other securities are sold for the first time for collecting long-term capital.

NEW ISSUE MARKET


Modernize the plant, machinery and buildings, for extending business, and for setting up new business unit etc……….


Identify the LOGO


FUNCTIONS OF PRIMARY MARKET

• Origination

• Underwriting

• Distribution


1.Origination

• Introduction of the basic idea of issuing securities and related spread work before the actual issue of the securities.

• Analysis of economic condition, investment climate etc

• Assessing the feasibility of the project, technical, economic, financial etc should be conducted.


1. Time of floating the issue

2. Type of issue- Equity, preference etc

3. Price of the issue – at par or

premium, (discount)


2.Underwriting

• The act of assuring the sale of shares or

debenture even before offering to the

public.

• Underwriters

Eg:- LIC,ICICI,IDBI etc……


3.Distribution

• Final sale of securities to prospective

investors.

• Function is carried out by brokers,

sub-brokers


Primary market instruments

1) Equity shares

2) Preference shares

3) Debentures

4) Bonds


1.Equity shares

Shares do not carry any preferential right in

respect of dividend or repayment of capital.

Rate of dividend on equity shares is not fixed.

Equity shareholders are the ultimate owners of

the company.


CLASSIFICATION OF EQUITY SHARES

1.BLUE CHIP SHARES

• Share issued by blue chip companies

• Price of shares of blue chip companies is

high.

2.GROWTH SHARES

• Share issued by growing companies.

• Expand their business by reinvesting their

earnings in profitable channels.• Growing higher than the industrial growth


3.INCOME SHARES

Companies are not going to reinvest their earnings for future expansion. These companies distribute the entire earnings as dividend.

4.CYCLICAL SHARES

If the value of the shares are fluctuating due to cyclical fluctuations in the market.

5.SPECULATIVE SHARES

Risky class of shares. It requires special technical expertise & deep knowledge of market movement to deal in them


METHODS OF FLOATING NEW ISSUES...

• PUBLIC ISSUE

• RIGHT ISSUE

• PRIVATE PLACEMENT


Identify the logo


Tokyo Stock Exchange


Secondary market

Market for already issued

securities

Securities includes equity

shares, preference shares etc..

Also called stock exchange


• Securities Contract Regulation Act 1956 define stock exchanges as,

" an association, organisation or body of individuals whether incorporated or not, established for the purpose of assisting, regulating & controlling business in buying, selling & dealing in securities”


Functions of stock exchanges

• Ready market

• Liquidity & marketability of securities

• Fair price determination

• Sources of long term fund

• Reflection of business cycle

• Promotion of investment

• Flow of capital to profitable venture


Difference between primary & secondary market

Dealing

Physical existence

period


Control over secondary market

Control is exercised through three important process

1) Recognition of stock exchange

2) Listing of securities

3) Registration of stock brokers


1.Recognition of stock exchange

According to SCRA 1956 only recognized stock exchanges can function in the country.

In India it is done by Central Government

Any stock exchanges requires recognition under SEBI Act has to submit an application in prescribed manner to the Central Government.


2.Listing of securities

Enrolment of a name of

company in an official list

maintained in the stock

exchange.


3.Registration of stock brokers

• A commission agent who transact business in securities on behalf of his client who are non member of stock exchange.

• To deal in recognized stock exchanges the broker should register his name as a broker with the SEBI


SPECULATION ON THE STOCK EXCHANGE

• Stock exchange transactions are made either for the purpose of investment or speculation.

• The volume of speculative transaction far exceed that of investment transaction on a stock exchange.


Speculation is necessary to ensure

sufficient volume and continuity of

business in the stock exchange.


Types of Speculator:

1.BULL

2.BEAR

3.STAG


1.BULL

Is a speculator who buys shares in

the expectation of selling it at a

higher price.


2.BEAR

Sells securities in the expectation of a fall in their prices in future.


3.STAG

Neither buys nor sells but applies for

subscription to the new issues

expecting that he can sell them later

at a premium.


LISTING OF SECURITIES


LISTING OF SECURITIES

• Admission of the security of a public limited

company on a recognized stock exchange for

trading.

• Marketability, liquidity & transferability


• Section:73 of the companies Act states that any

company intending to offer shares or debentures

to the public through the issue of prospectus

should make an application to one or more

recognized stock exchanges for permission to be

traded in the respective stock exchange.


Merits of Listing

• Liquidity

• Trading platform

• Fair price for securities

• Protect the investors

• Wide publicity

• Transferability


De-merits of Listing

• Information to competitors

• Subject to various regulatory

measures of the stock exchanges

& SEBI

• Speculation

• Listing fees


TRADING & SETTLEMENT


TRADING

• Trading in stock exchanges takes place in two phases:

1. The member brokers execute their buying or selling orders on behalf of their client.

2. The securities and cash are exchanged ( with the help of clearing houses and depositories).


TRADING SYSTEM

• Floor Trading ( open outcry system)

• Screen–based system


FLOOR TRADING ( OPEN OUTCRY SYSTEM)

• Trading took place through an open outcry

system on trading floor or ring of the

exchange during official trading hours.


SCREEN–BASED SYSTEM

• The trading ring is replaced by the computer screen

and distant participants can trade with each other

through a computer network.

• A large number of participants, geographically

separated, can trade simultaneously.


SCREEN–BASED SYSTEM

• Enhance the informational efficiency of the market as

more participants trade at a faster speed.

• Permits the market participants to get a full view of

the market, which increases their confidence in the

market .


• Till 1994, trading on the stock market in India was

based on the open outcry system with the

establishment of National Stock Exchange in

1994, India entered the era of screen based

trading.


• The kind of screen-based trading system adopted in

India is referred to as the open electronic limit

order book (ELOB) market system.


Features ELOB

1. Buyers and sellers place their order on

the computer. These order may be limit

order or market orders.


(a)Limit order Pre-specifies the price limit.eg:- a limit order to buy at a price of

Rs.100 means the trader want to buy at a price not greater than Rs.100.

a limit order to sell at a price of Rs. 150 means that the trader want to sell at a price not less than Rs.150


(b) Market orders

an order to buy or sell at the best

prevailing price. A market order to sell

will be executed at the highest bid price

where as a market order to buy will be

executed at the lowest ask price.


2. The limit order book, i.e. the list of unmatched

limit orders is displayed on the screen. It is open

for inspection to all traders.

3. The computer constantly tries to match different

orders. Matching is done on Price-Time priority.

( price is given preference over time in the

process of matching)


SETTLEMENT

• Traditionally trades were settled by physical

delivery.

• Securities had to physical move from the seller to

the seller’s broker, from the seller’s broker to the

buyer’s broker and from the buyer’s broker to the

buyer.

• Takes too much time.


Depositories

• An institution which dematerializes physical

certificates and effects transfer of

ownership by electronic book entries.

• National Securities Depositories Ltd (NSDL)

India’s first depository, was set up in 1996.

• SEBI has made dematerialized trading

compulsory for all the stock exchanges in

the country.


Settlement process involving delivery of

securities and payment of cash is carried out

through a separate agency known as the clearing

house which functions in each stock exchange.

Member –brokers who buy securities will have

to pay cash to the clearing houses and receives

the securities from clearing houses.


Types of settlement

Account period settlement

Rolling settlement



• Purchase and sales during an account

period could be settled at the end of

account period on a net basis.

• Eg:- if ‘A’ bought 100 shares of Infosys on BSE on

Monday at Rs.5000 a share and sold 95 shares of

Infosys at 5050 on Friday of that week, ‘A’ were

required to take delivery for only 5 shares by paying

20250 at the end of account period.



On BSE the account period was Monday to

Friday & on the NSE the account period was

Wednesday to Tuesday


Rolling settlement

• Under rolling settlement, all trades executed on a trading day are settled X days later. This is called ‘T+X’ rolling settlement, where ‘T’ is the trade date and ‘X’ is the number of business days after trade date on which settlement takes place.

• The rolling settlement has started on T+2 basis in India, implying that the outstanding positions at the end of the day ‘T’ are compulsorily settled 2 days after the trade date.


• The stock exchanges now follow a settlement procedure known as Compulsory Rolling Settlement (CRS). As mandated by SEBI


Compulsory Rolling Settlement

• All transactions in all groups of

securities in the Equity segment and

Fixed Income securities listed on BSE

are required to be settled on T+2

basis (w.e.f. from April 1, 2003). The

settlement calendar, which indicates

the dates of the various settlement

related activities, is drawn by BSE in

advance and is circulated among the

market participants.


STOCK

EXCHANGES IN

INDIA

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http://en.wikipedia.org/wiki/File:S&P_BSE_SENSEX.jpg


STOCK EXCHANGES

A centralized market for buying

and selling of stocks where the

price is determined through

supply demand mechanism.


• Stock exchanges in a country have been

organized in various forms:

1. voluntary non-profit making associations.

2. public limited company

3. company limited by guarantee


• In India the earliest stock exchanges were organized as voluntary non-profit making association of persons.

• Later on, stock exchanges began to organized as companies.


LIST OF STOCK EXCHANGES IN

INDIA


&


BOMBAY STOCK EXCHANGE [ BSE ]

• Oldest stock exchange in Asia

• Established in 1875

• “Native shares and Stock Broker’s

Association”

• In march 1995, BSE has introduced BOLT

(BSE Online Trading)

• Working time 9.30 am to 3.30 pm

• More than 5000 companies are listed.


BOMBAY STOCK EXCHANGE [ BSE ]

• Located on Dalal street, Mumbai,

Maharashtra.

• 11 th largest stock exchange in the world

by market capitalization as of 31/12/12.

• World’s No.1 exchange in terms of

listed members.

• Provide depository services through CDSL

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• BSE ‘s popular Equity Index- S & P

BSE SENSEX ( Formerly SENSEX).

• On Tuesday, 19 February 2013, BSE

has extended into strategic

partnership with S & P Dow Jowes

Indices and the SENSEX has been

renamed as “S & P BSE SENSEX”


STOCK INDEX OR STOCK MARKET INDEX

• Method of measuring the value of section of the stock

market.

• Computed from the prices of selected stocks.

• Tool used by the investors & financial managers to

describe the market.

eg:- S&P BSE SENSEX, S&P CNX NIFTY Index, BSE 500, S&P

CNX Nifty Junior, TOPIX(Tokyo Stock Price Index), etc


S&P BSE SENSEX [SENSEX]

• Calculated since 1986.

• Index composed of 30 stocks.

• Initially based on total market capitalization.

• 2003 onwards free float market

capitalization.

• Base value for calculating SENSEX is 100

(1978-79)

• Calculated for every 15 seconds.


Free float market capitalization

Value of all the shares available for public trading excluding:

Promoters equity, holding by founders, directors.

Holding by FDI route

Holding by private corporate.

Government holdings

Equity holdings by employees welfare trust

Equity held by associate/group companies.


SELECTION OF STOCKS TO CALCULATE

SENSEX

• Listing history

• Trading frequency

• Historical records

• Industry/sector they belong

etc….


Formula for calculating SENSEX

SENSEX = Sum of free float market capitalization of 30 stocks x Index factor

Index factor = 100 / market capitalization in 1978-79

where 100 is the index value during 1978-79


NATIONAL STOCK EXCHANGE[NSE]

• Setup in November 1992

• India’s first fully automated electronic exchange

[NEAT]

• National Exchange for Automated Trading[NEAT]

• Started functioning in June 1994.

• 1635 companies are listed as of July 2013


S & P CNX NIFTY

• Index is built by Indian Index Service

Product Ltd [IIST] and Credit Rating

Information Service of India Ltd [CRISIL]

• CRISIL has strategic alliance between S&P

Rating services.

• Hence the Index is named as S&P CNX

NIFTY.

• 'CNX' in its name stands for 'CRISIL NSE Index'.


• NIFTY reflects the price movements of 50 stocks.

• Base date selected for NIFTY is November 3,1995.

• Base value of NIFTY -1000

• Earlier calculation based on full market

capitalization.

• Now it was constructed on free float market

capitalization.


NIFTY = Sum of free float market capitalization of 50 stocks x Index factor

Index factor = 1000 / market capitalization in 1995

where 1000 is the index value during 1995


INTERNATION

AL Stock

Exchanges

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Tokyo Stock Exchange

TSE is the third largest stock exchange all over

the world and first largest stock exchange among

the Asian countries.

Established in the year 1878.

More than 2,000 companies are listed in Tokyo

Stock Exchange.

Market functions between 9.00 am and 3.00 pm.

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• The Tokyo Stock Exchange, which is called Tōshō or TSE for short, is a stock exchange located in Tokyo, Japan.

• Third largest stock exchange in the world by aggregate market capitalization of its listed companies.


NASDAQ Stock Exchange

• NASDAQ stands for National Association of

Securities Dealers Automated Quotations.

• stock exchange was constituted in the year of

1971.

• Headquarters at New York.

• Market functions between 9.30 am and 4.00pm


NASDAQ Stock Exchange

• Second largest stock exchange in North America


New York Stock Exchange(NYSE)

• Stock exchange based in new york city.

• Largest equity based exchange in the world

• About 2,800 companies are listed on the NYSE.


London Stock Exchange

• one of the world’s oldest stock exchanges and can trace its history back more than 300 years.

• located in the City of London in the United Kingdom

• Established in the year of 1801.• Nearly 3,000 companies from 70

different countries are listed. • Trading occurs between 8.00 am

to 4.30 pm.


Hong Kong Stock Exchange

• Largest stock exchange in China.

• Initially It was named Association of

Brokers, Hong Kong in 1891 but later it was

renamed as Hong Kong stock exchange in

1914.

• Functions between 9.15 am and 4.00 pm.

• Nearly 1,470 companies listed in this

exchange.


Hong Kong Stock Exchange

• Asia's second largest stock exchange in terms of market capitalization behind the Tokyo Stock Exchange.


Deutsche Borse Stock Exchange• Stock exchange of Germany

located at Frankfurt.

• Nearly 765 companies listed in

the market.

• Formed in the year of 1994.

• Market functions between 8.00

am and 10.00 pm.

• largest of Germany’s seven stock

exchanges.


BOOK BUILDING


BOOK BUILDING

• price discovery method

• The company doesn't fix up a

particular price for the shares, but

instead gives a price range


BOOK BUILDING

• The issue price is not fixed in

advance.

• Determined by the offer of potential

investors about the price which they

are willing to pay for the issue.


BOOK BUILDING

• The price of the security is determined as the

weighted average at which the majority of

the investors are willing to buy the security.

• Under book building process, the issue prices

of security is determined by the demand &

supply forces in the capital market.


BOOK BUILDING

• When bidding for the shares, investors have to

decide at which price they would like to bid for the

shares, for e.g. Rs 80, Rs 90 or Rs 100. They can

bid for the shares at any price within this range.

• Based on the demand and supply of the shares,

the final price is fixed


• The lowest price (Rs 80) is known as

the floor price and the highest price

(Rs 100) is known as cap price.

• The price at which the shares are

allotted is known as cut off price


SEBI GUIDE LINES

Issuing companies can select any of the following method:

a) 100% of the offer to the public through the book

building

b) 75% of the offer through the book building & 25%

through the fixed price method at the price

determined through book building.

c) 90% of the offer through the book building & 10%

through the fixed price method.


BOOK BUILDING VS FIXED PRICE1. The main difference between the book building method and the

fixed price method is that in the former, the issue price is

not decided initially.

2. The investors have to bid for the shares within the price range

given and based on the demand and supply of the

shares, the issue price is fixed. On the other hand, in the fixed

price method, the price is decided right at the start.


BOOK BUILDING VS FIXED PRICE

3. In fixed price, Investors cannot

choose the price, but must buy the

shares at the price decided by the

company.


Book building Process:The Issuer who is planning an offer nominates lead merchant banker(s) as 'book runners'.

• The Issuer specifies the number of securities to be issued and the price band for the bids.

• The Issuer also appoints syndicate members with whom orders are to be placed by the investors.

• The syndicate members input the orders into an 'electronic book'. This process is called 'bidding' and is similar to open auction.

• The book normally remains open for a period of 5 days. • Bids have to be entered within the specified price band. • Bids can be revised by the bidders before the book closes. • On the close of the book building period, the book runners evaluate

the bids on the basis of the demand at various price levels. • The book runners and the Issuer decide the final price at which the

securities shall be issued. • Generally, the number of shares are fixed, the issue size gets frozen

based on the final price per share. • Allocation of securities is made to the successful bidders. The rest get

refund orders.


RETURN • REWARD FOR UNDERTAKING INVESTMENT

Components of investment return

A. Current return

B. Capital return


Current return

• Period cash flow.

• eg:- dividend or interest generated by

investment.

• Measured as the period income in relation

to the beginning price of the investment.

• May be +ve or zero


Capital return

• It reflects the price changes

• Price appreciation or depreciation

• May be +ve,-ve or zero


TOTAL RETURN

Total return = Current Return + Capital Return


EXPECTED RETURN

&

REALIZED RETURN


EXPECTED RETURN

• Return likely to expect from the

investment.

• Weighted average of all possible

returns multiplying their respective

probabilities.• ( If things are uncertain)


EXPECTED RETURN

• If the possible return denoted by Xi,

and the related probabilities as P(xi).

Expected return represented as .

= ∑Xi P(Xi)


EXPECTED RETURN

• If things are certain

E(Ri) = D1+(P1-P0) P0

D1 = Expected dividend

P1 = Stock price at the end

P0 = Current market price


Defining RiskDefining Risk

What rate of return do you expect on your investment this year?

What rate will you actually earn? The chance that the actual return on an investment

may be different than the expected return. Variability in the expected return is technically called as risk.

What rate of return do you expect on your investment this year?

What rate will you actually earn? The chance that the actual return on an investment

may be different than the expected return. Variability in the expected return is technically called as risk.

Possibility of incurring losses in a financial transaction.

Possibility of incurring losses in a financial transaction.


• “Risk is the potential for variability in return”

• An investment whose return are fairly stable is considered to be a low-risk investment.

• An investment whose return fluctuate significantly is considered to be a high risk investment.

Defining RiskDefining Risk


Elements Of Risk/

Components Of Risk/

Types Of Investment Risk


Types Of Risk

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A. SYSTEMATIC RISK

• Risk arises from uncontrollable factors.

• Affects entire market(macro in nature)

• Occurrences of certain event can affect all

companies, firms at the same time.

• Also called uncontrollable risk or un-

diversifiable risk.

• Eg:- economic condition, political situation etc



SYSTEMATIC RISK

• Risk that caused by external factors such as

economic, political and sociological conditions.

• Risk arises due to external factors they are

beyond the control of the company affected,

and hence are uncontrollable or referred to as

undiversifiable risk.



Types Of Systematic Risk

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(a)Market risk

• Variations in return caused by the volatility of the stock market is referred to as the market risk.

• Occurs due to the reactions of investors in the stock market

• Either upward or downward• Upward –bullish trend• Downward – bearish trend the movement

can easily seen with indices like BSE SENSEX, NSE index etc.



Market risk

• Referred as stock variability due to changes in investors attitude and expectations.

• At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences.

• Investors reaction towards tangible and intangible events is the chief cause for Market risk.



For e.g.

Investors perception towards Mergers and acquisitions

Dividends declaration

Bulk buying and selling by FII


and other economic issues like government policy etc.,



(b) Interest Rate Risk

• Variability in securities return resulting from

changes in the level of interest rate.

• It is the risk caused by the variations in the

market interest rate.

• Affects debt securities like debentures,

bonds.

• Extensive use of borrowed fund in the stock

market.



Interest Rate Risk

Causes of interest rate risk are:

• Changes in the Government’s monitory policy

• Changes in the interest rate of treasury bills

• Changes in the interest rates of Government

Bonds. Etc…………..



(c) Purchasing Power Risk• Variations in return are caused by the loss of

purchasing power of the currency.

• Purchasing Power Risk is the chance that changing

price levels (inflation or deflation) will adversely affect

investment returns.

• Inflation is the reason behind the loss of purchasing

power.

• Inflation may be – Demand-Pull

or

Cost-Push inflation



Demand-Pull Inflation When demand is increasing but

supply cannot be increased, the price of the goods increases there by forcing out some of the excess demand and bringing the demand and supply into equilibrium.

Cost-Push inflation When the cost of production

increases prices of the product will also increase



B. UNSYSTEMATIC RISK

• Unsystematic risk is due to the influence of internal

factors prevailing within an organization.

• Such factors are normally controllable from an

organization's point of view

• It is a micro in nature as it affects only a particular

organization

• It is avoidable through diversification ( Diversifiable

Risk)

• Eg:- managerial inefficiency, labor problems etc….



Unsystematic Risk

• Sources –

Operating environment of the company

& Financing pattern adopted by

the company



Types Of Unsystematic Risk

• Business Risk

• Financial Risk



(a) Business Risk

• Risk caused by the operating environment of the

business.

• Risk associated with a particular company or industry.

• Business risk can be caused by changes in a

company’s sales due to operating problems, such as a

strike, technical obsolescence etc……..

• Risk arising from the inability to maintain its

competitive edge and growth or stability of earnings.



(b) Financial Risk

Variability in EPS due to the presents

of debt in the capital structure of a

company.

Associated with the capital structure

of the company.



TOTAL RISK = Systematic Risk + Unsystematic Risk


Total Risk = Systematic Risk + Unsystematic Risk


TotalRisk

Unsystematic risk

Systematic risk

STD

DEV

OF

PORT

FOLI

O R

ETU

RN

NUMBER OF SECURITIES IN THE PORTFOLIO




TotalRisk

Unsystematic risk

Systematic risk

STD

DEV

OF

PORT

FOLI

O R

ETU

RN

NUMBER OF SECURITIES IN THE PORTFOLIO


Fundamental

Analysis

&

Technical

Analysis


Fundamental Analysis

• Detailed analysis of fundamental factors

affecting the performance of the companies.

• Analysis used to evaluate the present and

future earnings capacity of shares based on

economy, industry and company

fundamentals.



• Fundamental analysis studies the basic facts affecting a stock’s value.

“The practice of evaluating the information contained

in financial statements, industry reports, and

economic factors to determine the intrinsic value of

a firm”



AIM OF FUNDAMENTAL ANALYSIS

Assessing the intrinsic value of

shares

Comparing the intrinsic value with

current market price and makes

decision.



• Intrinsic value refers to the actual value of a

company or stock determined through

fundamental analysis without reference to its

market value.

• Frequently called fundamental value.

• It is ordinarily calculated by summing the

future income generated by the asset, and

discounting it to the present value.



• An investor can compare the intrinsic value of

share with the prevailing market price to arrive at

an investment decision.

• The market price of the share is lower than its

intrinsic value the investor would decide to buy

the share as it is under price.

• The market price of the share is higher than its

intrinsic value, it is perceived to be overpriced.

Investor would sell such shares.



Fundamental analysis provides an analytical

framework for rational investment decision.



Fundamental analysis { EIC ANALYSIS}


Fundamental analysis involves

A. Economic Analysis

B. Industry Analysis

C. Company Analysis


A. Economic Analysis

• Performance of a company depends on the performance of economy.

• When the economic activity is low, stock prices are low, and when the level of economic activity is high, stock prices are high.

• Essential to understand the behavior of stock prices.


Key economic variable that an investor must consider as a part of fundamental analysis are:

• Growth rate of national income• Inflation• Interest • Government revenue, expenditure

and deficit• Exchange rate• Infrastructure• Economy and political stability

etc……


B. Industry Analysis

• An evaluation of relative strengths and

weakness of particular industries.

• Performance of companies will

depends up on the state of industry to

which they belong.

• If the industry grow company also

grow & vice versa


Industry Life cycle

• PIONEERING STAGE

• RAPID GROWTH STAGE

• MATURITY AND STABILIZATION

STAGE

• DECLINING STAGE


Factors to be considered :

• Growth of the industry

• Cost structure and profitability

• Nature of the product

• Nature of the competition

• Government policy

• Research and development etc……….


C. Company Analysis

• Final stage of fundamental

analysis.

• Deals with the estimation of

return and risk of individual

shares.

• Information regarding companies

: Internal and External


• Internal information consists of data and events made public by companies concerning their operation.

• Internal information sources: annual report to shareholders, the company’s financial statements etc…

• External information- generated independently outside the company, prepared by investment services and the financial press.


Analysis of financial statements

• Comparative financial

statements

• Trend analysis

• Fund flow analysis

• Cash flow analysis

• Ratio analysis etc……….


Ratio analysis

• Liquidity ratios – Current ratio, quick ratio

• Leverage ratios – Debt-equity ratio, debt to

asset ratio

• Profitability ratios – Gross profit ratio, net profit

ratio

• Activity ratios – Current asset turnover ratio,

fixed asset turnover ratio, total asset turnover

ratio


Technical Analysis


Meaning:

• Study of market generated data like price and

volume to determine the future direction of price

movement.

• A study of past or historical price and volume

movement so as to predict the future stocks

price behavior.

• Forecasting techniques that utilize historical share

price data.


• Technical analysts believe that past patterns of market

action will recur in the future and that past patterns can

be used for predictive purposes.

• Some of the tools used by chartists to measure supply

and demand and to forecast security prices are the Dow

theory chart, odd-lot theory, confidence index,

breadth-of-market indicators, relative-strength

analysis, and trading-volume data.


Assumptions/basic principles/premises of technical analysis

Market prices are determined by the interactions of

supply and demand forces.

Supply and demand are influenced by variety of

factors, both rational and irrational. Includes

fundamentals as well as psychological factors.

Shift in demand & supply bring about changes in

trends.

Shift in demand & supply detected with the help of

charts of market action.

Analysis of past market data can be used to predict

the future price behavior.


Difference between Fundamental & Technical Analysis


THEORIES OF TECHNICAL ANALYSIS

•Dow theory

• Elliot wave theory


Dow theory

• Charles .H. Dow

• Editor of wall street journal, in USA

• Popularly known as Theory of

Technical analysis


According to Charles .H. Dow

• “ 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 its

duration”


• The Dow theory is used to indicate reversals and trends in the market as a whole or in individual securities.

• According to the theory, there are three movements going on in the markets at all times:

1. daily fluctuations (the narrow movement from day-to-day)

2. secondary movements (short-run movements over two weeks to a month or more)

3. primary trends, major movements covering at least four years in duration


• Dow formulated a hypothesis is that the

stock market does not move on a

random basis but is influenced by three

distinctive cyclical trends that guides its

direction.

1)Primary / main movements

2)Secondary reaction / correction

movement

3)Minor / narrow movements


According to Dow theory

• Price movements in the market can be

identified by means of line chart.

• In the line chart, closing price of shares or the closing value of the market index may be plotted against the corresponding trading day.

• The charts helps in identifying the primary,

secondary and minor movements.


* Primary or main movements /trend

• Long range cycle that carries the entire market up

or down long term trend in the market.

* Secondary reaction or correction movement/trend

• These are the opposite direction to the primary

movements

• Only for a short period• Eg:- when the market is moving upward continuously,

this upward movement will be interrupted by downward movement of short duration.


Minor or Narrow movements/trend

Day today fluctuations in the market

Not significant & have no analytical

value

Very short duration


THREE MOVEMENTS

• Primary movements – Tides

• Secondary/ correction movements –

Waves

• Minor/ Narrow movements – Ripples


Trend

• Trend is the direction of movement.

• Share price can either increase, decrease or remain in flat.

• The three directions :


• Share price do not rise or fall in a straight

line.

• Every rise or fall in price experience a

counter moves

• Share price move in a zigzag manner.


Trend lines

• Straight line drawn connecting either

the top or bottom of the price

movement

• To draw a trend line, the technical

analyst should have at lest two tops

or bottoms.


(1) Rising/up trend


(2) Falling/down trend


(3) Flat trend


Trend Reversal

• Changes in the direction of trend is referred to

as trend reversal.

• A share that exhibits a rising trend may start to

move narrowly or fall after some times, this change

in the direction of movement represent trend

reversal.

• Technical analyst tries to identify the trend reversal

at an early stage so as to trade profitably.


• When the trend begins to rise the

technical analyst would recommend

purchase of the shares.

• When the trend begins to fall, sale is

indicated.

• During a flat trend the investor should stay

away from the market.


Trend Reversal


Elliot wave theory

• Ralph Elliot

• Theory was formulated in 1934

• After analyzing 75 years of stock market

price movements and charts.

• According to this theory – market movement

was quite orderly and followed a patter of

waves.


According to this theory

• The market moves in waves

(A wave is a movement of the stock price from

one change in the direction to the next change in

the same direction. Depending on the demand &

supply pressure waves are generated)


According to this theory

• A movement in a particular direction can be

represented by five distinctive waves.

• Of these five waves, three waves are in the

direction of the movement & are called impulse

waves.

• Two waves are against the direction of the

movement & are termed as corrective waves or

reaction waves


Graph


• Waves 1,3 & 5 are the impulsive waves

• 2 & 4 are the corrective waves

• The wave 1 is upwards and wave 2 correct

the wave 1.

• Waves 3 & 5 are impulsive and 4 corrects

wave 3


• Correction involves correcting the earlier rise

• Wave 2 would correct the rise of wave 1

• Wave 4 would correct the rise of wave 3 & after

the completion of wave 5, there would come a

correction which would be labeled ABC

• This correction would be in three waves in

which the waves ‘A & C’ will be against

the trend and wave ‘B’ will be along the

trend.


• The ABC correction following the fifth wave would correct the entire rise from the starting of wave 1 to the end of the fifth wave.

• One complete cycle consist of waves made up of two distinctive phases, bullish & bearish. One full cycle of waves is completed after the termination of 8 waves movement, there will be a fresh cycle started.

• The theory is used for predicting the future price changes & in deciding the timing of investment.


Support and Resistance Level

• Support and resistance define natural boundaries for rising and falling prices.


Support and Resistance Level


Support Level

• Level that the technical analyst believes a stock price will not fall below. Some times called “Floor”.


Resistance Level

• Opposite of support level.• Technical analyst believe that stock

price will not exceed.


Breakout

• The security price moves out of the

previous trading range (breaching the

resistance or support level)


BREADTH OF THE MARKET• Term used to study the advance and decline that

have occurred in the stock market.

• Advance means – Number of shares whose

prices have increased from the previous day’s

trading.

• Decline means – Number of shares whose prices

have fallen from the previous day’s trading.

• The net difference between the number of

stock advanced & declined during the same

period is the breadth of the market.

• A cumulative index of net differences measure

the market breadth.


BREADTH OF THE MARKETDay advance decline Net Breadth

21-02-12 1486 774 712 712

22-02-12 1310 966 344 1056

23-02-12 898 1225 -327 729

24-02-12 1108 1091 17 746

25-02-12 931 1279 -348 398


Types of charts


Types of charts

• Line Chart

• Bar Charts

• Candlestick Charts


Line Chart

The most basic of the four charts – because it represents only the

closing prices over a set period of time.

The line is formed by connecting the closing prices over the time

frame.

Do not provide visual information of the trading range for the

individual points such as the high, low and opening prices.

The closing price is often considered to be the most important price in

stock data compared to the high and low for the day and this is why it

is the only value used in line charts.


Line Chart


Bar Charts

• The chart is made up of a series of vertical lines

that represent each data point. This vertical line

represents the high and low for the trading period,

along with the closing price.

• The close and open are represented on the vertical

line by a horizontal dash.

• The opening price on a bar chart is illustrated by the

dash that is located on the left side of the vertical

bar.

• Conversely, the close is represented by the dash on

the right.


Bar Charts

• Generally, if the left dash (open) is lower than the

right dash (close) then the bar will be shaded

black, representing an up period for the stock,

which means it has gained value.

• A bar that is colored red signals that the stock

has gone down in value over that period. When

this is the case, the dash on the right (close) is

lower than the dash on the left (open).


Bar Charts


Candlestick Charts

• Similar to a bar chart, but it differs in the way that it is visually constructed.

• The difference comes in the formation of a wide bar on the vertical line, which

illustrates the difference between the open and close. And, like bar charts,

candlesticks also rely heavily on the use of colors to explain what has happened

during the trading period.

• There are two color constructs for days up and one for days that the price falls.

• When the price of the stock is up and closes above the opening trade, the

candlestick will usually be white or clear.

• If the stock has traded down for the period, then the candlestick will usually be

red or black, depending on the site.

• If the stock's price has closed above the previous day's close but below the day's

open, the candlestick will be black or filled with the color that is used to indicate

an up day


Candlestick Charts


oscillators

• Mathematical indicators calculated with the help of the closing price data.

• Helps to identify overbought and over sold conditions of the scrip.

• Helps to identify possibility of trend

reversal.


oscillators

• RSI (Relative Strength Index)

• ROC (Rate of Change Indicator)

• MACD (Moving Average

Convergence/Divergence)


RSI (Relative Strength Index)

RSI = 100 – 100 (1+RS)

RS = Average gain per day Average loss per day


• Most commonly used time period for the

calculation of RSI is 14 days.

• RSI value ranging from 0 – 100

• RSI value above 70 are considered to denote

overbought condition.

• RSI value below 30 considered to denote oversold

condition.


RSI Chart


ROC (Rate of Change Indicator)

• ROC measures the rate of change of the current price as compared to the price a certain number of days or weeks back.

• ROC = Current price - 1

price ‘n’ period ago


ROC (Rate of Change Indicator)

• Value may be +ve,-ve or zero

• When the ROC line is above the zero

line, the price is rising & when it is

below zero line ,the price is falling.


MACD (Moving Average Convergence Divergence)

• Short term & long term exponential

moving average are calculated with the

help of closing price data.

• A 12 day & 48 day exponential moving

average are popular combination

• Difference between short term & long term

EMA represent MACD



• MACD line (blue line): difference between the 12 and 26 days

EMAs

• signal (red line): 9 day EMA of the blue line

• histogram (bar graph): difference between the blue and red lines

Mathematically:

• MACD = [stockPrices,12]EMA - [stockPrices,26]EMA

• signal = [MACD,9]EMA

• histogram = MACD – signal


ODD - LOT

• Shares are generally sold in a lot of hundreds

• Shares are sold in smaller lots fewer than 100 are called odd lot.

• Buyers & sellers of odd lots are called odd lotters.

• Odd lot purchases to odd lot sales ( purchase %) is the odd lot

index.

( Odd lot purchases divided by odd lot sales)

• Increases the odd lot purchases results in an increase in the index.

(selling leads to fall the index)


Random walk theory

• Basic assumption of technical analyst is that price trends

occur in an orderly manner & not random.

• Random walk theory gained popularity in 1973 when

Burton Malkiel wrote "A Random Walk Down Wall

Street", a book that is now regarded as an investment

classic.

• Theory that states that the past movement or

direction of the price of a stock or overall market

cannot be used to predict its future movement.


Random walk theory

• Random walk theory states that market price evolve at random and do

not follow any regular pattern.

• According to this theory future stock price

are completely independent of past stock

prices.

• The Random Walk Hypothesis is a financial theory stating that stock

market prices evolve according to a random walk and thus the prices of

the stock market cannot be predicted by analyzing the past stock prices.


Assumption of Random walk theory

Market is supreme and no investor or group can influence

it.

Stock price discount all information quickly.

Markets are efficient and that the flow of information is

free and unbiased.

All investors have free access to the same information and

nobody has superior knowledge or expertise.

Market quickly adjusts itself to any deviations from

equilibrium level due to the operations of free forces of

demand and supply.

Nobody has better knowledge or insider information.


Efficient market hypothesis

• Hypothesis states that the capital market is efficient in

processing information.

• Efficient capital market is one in which security prices equal

their intrinsic value at all time, and where most securities

are correctly priced.

• According to Elton and Gruber,” when some one refers to

efficient capital markets, they mean that securities prices

fully reflect all available information”


Forms of market efficiency

• There are three forms of the efficient market hypothesis

• The "Weak" form asserts that all past market prices and data

are fully reflected in securities prices. In other words, technical

analysis is of no use.

• The "Semi strong" form asserts that all publicly available

information is fully reflected in securities prices. In other words,

fundamental analysis is of no use.

• The "Strong" form asserts that all information is fully

reflected in securities prices. In other words, even insider

information is of no use.


The EMH Graphically• In this diagram, the circles

represent the amount of

information that each form of

the EMH includes.

• Note that the weak form

covers the least amount of

information, and the strong

form covers all information.

• Also note that each

successive form includes the

previous ones.

Strong Form

Semi-Strong

Weak Form

All information, public and private All public information

All historical prices and returns


Assumptions Of Efficient Market Hypothesis

• Information is free and quick to flow

• All investors have the same access to information.

• Every investor has access to lending and borrowing at

the same rate.

• Market absorbs the information quickly and the market

responds to new technology, new trends, change the

tastes, etc efficiently and quickly.

• Investors are rational and behave in a cost effective

competitive manner for optimization of returns


DERIVATIVE

S


In the financial marketplace some

instruments are regarded as

fundamentals, while others are regarded

as derivatives.

Financial Marketplace

Derivatives Fundamentals


Financial Marketplace

Derivatives Fundamentals

•Stocks •Bonds •Etc.

•Futures•Forwards•Options•Swaps


Derivative

Options

Swaps

ForwardsFutures

The value of the derivative instrument is DERIVED from the underlying security

Underlying instrument such as a

commodity, a stock, a bond, another

derivative etc..

Swaps

Futures


What do derivatives do?

Derivatives attempt either to minimize the

loss arising from adverse price movements of

the underlying asset Or maximize the profits

arising out of favorable price fluctuation.

Derivatives derive their value from the

underlying asset they are called as derivatives.


Options

Options An option is the right, not the obligation to buy or sell

something on a specified date at a specified price. In the

securities market, an option is a contract between two

parties to buy or sell specified number of shares at a

later date for an agreed price.

Three parties are involved in the option trading,

1. The option seller

2. The option Buyer

3. Broker


Types of Options

•Call option

•Put option


Call option

• When an option grants the buyer the right to purchase

the underlying assets/stock from the seller a particular

quantity at a specified price within a specified

expiration date.

• An option contract giving the owner the right to buy

a specified amount of an underlying security at a

specified price within a specified time.


Call Option

• A call option gives you the right to buy

within a specified time period at a

specified price.

• The owner of the option pays a cash

premium to the option seller in exchange

for the right to buy.


Eg:-

An investor buys a call option to purchase 100 SBI shares

Strike price Rs.320 per shareCurrent stock price Rs.310 per sharePrice of an option to buy one share Rs.20The initial investment 100x Rs.20=2000

Outcome: assume at the expiration of the option, SBI share price is Rs.350.

At this time option is exercised for a gain of (Rs.350-320)x100=Rs3000.When the initial cost is taken, the net gain is Rs3000-Rs.2000=Rs.1000


Put Option

• An option contract giving the owner the

right to sell a specified amount of an

underlying security at a specified price

within a specified time.


Put Option

• A put option gives you the right to sell within a specified time period at a specified price.

• It is not necessary to own the asset before acquiring the right to sell it.


An investor Purchases a put option to sell100 SBI shares

Strike price Rs.320 per shareCurrent stock price Rs.310 per sharePrice of put option to sell one share Rs.15The initial investment 100x Rs.15=1500

• Outcome: at the expiration of the option, SBI share price is Rs300.at this time, the investor buy 100 SBI shares at Rs.300 and then sell at Rs320 to the option buyer to realize Rs20 per share, being Rs2000 in total.

• When initial cost is taken, net gain is Rs2000- Rs1500=500


ATM, ITM & OTM

ATM – AT THE MONEY

ITM – IN THE MONEY

OTM – OUT OF THE MONEY


Call Option ATM Exercise Price = Market

Price ITM Exercise Price < Market

PriceOTM Exercise Price > Market

Price

PUT OPTION ATM Exercise Price = Market

Price ITM Exercise Price > Market

PriceOTM Exercise Price < Market

Price


European vs American Options

• European style of options

The European kind of option is the one which can be

exercised by the buyer on the expiration day only & not

anytime before that.

• American style of options

An American style option is the one which can be

exercised by the buyer on or before the expiration

date, i.e. anytime between the day of purchase of the

option and the day of its expiry.


Exercise price / strike price

• The fixed price at which the option holder

can buy and/ or sell the underling asset is

called exercise price or strike price.


OPTION PREMIUM

Premium is the price paid by the buyer to

the seller to acquire the right to buy or

sell. It is the total cost of an option.


Expiration date

• The date on which the option expires is

known as Expiration Date.


VALUATIONS OF

OPTION


VALUATIONS OF OPTION

I. THE BLACK–SCHOLES OPTION PRICING MODEL

II. BINOMIAL OPTION PRICING MODEL


THE BLACK–SCHOLES OPTION PRICING MODEL (B-S Model)

• Initially developed in 1973 by two

academicians, Fisher Black & Myron

Scholes.

• Designed to price European options.


Assumptions of B-S Model• The call option is the European option

• The stock price is continuous and is distributed

normally

• There are no transaction costs and taxes

• Stock trading is continuous

• The short term risk free interest rate R is constant

• The stock pays no dividend


THE BLACK–SCHOLES OPTION PRICING MODEL

1 2

2

1

2 1

( ) ( )

ln( / ) ( / 2)

rtC S N d Ke N d

S K R td

t

d d t



• Variable definitions:

C = theoretical call premium/value of the call option

S = current stock pricet = time in years until option expirationK = option striking priceR = risk-free interest rate



Variable definitions:

N(d1) , N(d2) = value of the cumulative normal density function.

In(S/K)= is the natural logarithm = standard deviation of stock

returnse = base of natural logarithm

(2.7183)


Mutual Funds


Mutual Fund

• A Mutual Fund is a trust that pools the savings of a number of investors

who share a common financial goal.

• Anybody with an investible surplus of as little as a few thousand rupees

can invest in Mutual Funds.

• These investors buy units of a particular Mutual Fund scheme that has a

defined investment objective and strategy.

• The money collected is invested by the fund manager in different types

of securities. These could range from shares to debentures to money

market instruments, depending upon the scheme’s stated objectives.

• The income earned through these investments and the capital

appreciation realized by the scheme are shared by its unit holders in

proportion to the number of units owned by them.

Mutual Funds

• What are the advantages of Mutual Fund Investing?– Diversification

• While owning a single stock or bond is very risky, owning a mutual fund which holds numerous securities can reduce risk significantly

– Professional management• Picking your own stocks and bonds to put in

your portfolio and beating your benchmarks is difficult and time consuming. Hiring a mutual fund to make those decisions for you can be beneficial and save time

Mutual Funds• Minimal transaction costs

– Buying individual stocks and bonds is expensive in terms of transactions costs. Mutual funds enjoy economies of scale in purchases and sales due to size

• Liquidity

– Buying and selling individual stocks and bonds takes time. Money from open-end mutual funds can be received in two business days

• Flexibility

– Individual stocks and bonds are not flexible. With many mutual funds, you have more flexibility and can often write checks on your account


Mutual Funds (continued)

• Low cost

– “No-load” mutual funds are sold without a sales charge and are redeemed without a charge as well



• In addition, they may include:– Automatic investment and withdrawal plans– Automatic reinvestment of interest, dividends,

and capital gains– Wiring and funds express options– Phone switching– Easy establishment of retirement plans– Check writing– Bookkeeping and help with taxes



• What are the disadvantages of Mutual Fund Investing?– Risk of lower-than-market performance• From 1986-2011, the average annual

returns of actively managed stock funds underperformed the return of the S&P 500 stock index. Not all mutual funds outperform their benchmarks, and taxes take a significant part of investor returns



– High costs • Unless analyzed carefully, management and

other fees can be significant.



• Other Risks

– Mutual funds are subject to both market and stock related risks, particularly in concentrated portfolios

• Inability to plan taxes

– Mutual funds pass through 95% of all capital gains and dividends to the shareholders• Even if you do not sell your mutual fund, you

can have a significant tax bill each year if your mutual fund trades often and has dividends, interest or capital gains

– It is difficult to plan for taxes when the tax decision is taken by the portfolio manager, not you


Asset Management Company (AMC)

• A Company registered with SEBI,

which takes investment/divestment

decisions for the mutual fund, and

manages the assets of the mutual

fund.


Asset Management Company [AMC]

• An asset management company is a company registered

under the Companies Act, 1956. The Sponsor creates the

asset management company and this is the entity, which

manages the funds of the mutual fund (trust).

• The mutual fund pays a small fee to the AMC for

management of its fund. The AMC acts under the

supervision of Trustees and is subject to the regulations

of SEBI.

Mutual Fund Operation Flow Chart


Organisation of a Mutual Fund



Advantages of Mutual Funds

• Professional Management

• Diversification

• Convenient Administration

• Return Potential

• Low Costs

• Liquidity

• Transparency

• Flexibility

• Choice of schemes

• Tax benefits

• Well regulated


Types of Mutual Fund Schemes

• Wide variety of Mutual Fund Schemes exist

to cater to the needs such as financial

position, risk tolerance and return

expectations etc.

• The figure in the next slide gives an

overview into the existing types of

schemes in the Industry.


Types of Schemes• By Structure

– Open Ended Schemes

– Close Ended Schemes

– Interval Schemes

• By Investment Objectives

– Growth Schemes

– Income Schemes

– Balance Schemes

– Money Market Schemes

• Other Schemes

– Tax Saving Schemes

• Special Schemes

– Index Schemes

– Sector Specific Schemes


Frequently Used Terms• Net Asset Value (NAV)

•

Net Asset Value is the market value of the assets of the scheme

minus its liabilities. The per unit NAV is the net asset value of

the scheme divided by the number of units outstanding on the

Valuation Date.

• Sale Price•

Is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load.

• Repurchase Price

Is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.

security analysis and investment management

Economy & Finance