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Introduction toInvestment and Securities
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Chapter Objectives
To understand the concept of investment
To explain process of investment
To learn about various types of securities
To analyze various sources of investmentinformation
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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.
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Speculation
Speculation means taking business risks with theanticipation of acquiring short term gain.
It also involves the practice of buying and sellingactivities in order to profit from the price fluctuations.
An individual who undertakes the activity of speculationis known as speculator.
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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 oneyear.
Has a very short planning
horizon. His holding period
may be few days to months.
Risk return His risk is less./Moderate Return His risk is high/ High Return.
Decision Attaches greater significance to
fundamental factors and
carefully evaluates theperformance of the company.
Attaches greater significance
to market behaviour and
inside information.
Funds Uses his own funds. Uses borrowed funds along
with his personal funds.
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Gambling
Fundamental difference from speculation & Investment
Quick Results
Normally for fun not for income
Highly Risky not based on any economic activity
No surety of return
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Why to Invest?
Longer Life Expectancy
Increase Rate of Taxation
High Interest rates
High Rate of Inflation
Large Income
Availability of a complex no. of investmentoutlets
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Investment ObjectivesReturn 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 cash.
Tax Shelter: It refers to the legal and regulatory protection tothe investment.
End period value Purchase period value+ Dividends
Return = 100Purchase period value
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Cont.
Hedge against inflation:
The returns should be higher than the rate of inflation.
Convenience:
Ease on making investment and Maintaining it further
Capital Appreciation
Aggressive growth, Speculation, Periodic cash
Receipts, Capital gains
Safety and security of Fund/Stability of Income
Concealability
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Portfolio Management Process
Specification of Investment Objectives/constraints: current
income, capital appreciation, safety of principal
Choice of the assets mix: risk tolerance and investment horizon
of investors
Formulation of portfolio strategy: active or passive
Selection of Securities: fundamental & technical analysis, yield
to maturity, credit rating tax shelter etc.
Portfolio Execution: implementation of the portfolio plans
Portfolio Revision: rebalancing of portfolio
Performance Evaluation: periodic performance evaluation
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Investment Alternatives
Equity
Preference Shares
Debentures
Bonds /Fixed Income Securities
Money Market Instruments
Non- Marketable Financial Assets
Real estate Precious Objects
Insurance Policies
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Securities
They are instruments which represent a claim overan 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 Government
Quasi-Government
Public Sector Enterprises
Corporates
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Types of Preference Stocks
There are different types of preferencestocks, which are:
Cumulative preference shares
Non-cumulative preference shares
Convertible preference shares
Redeemable preference shares Irredeemable preference shares
Cumulative convertible preference shares
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Equity Shares
Common stock or ordinary shares aremost 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 acompany divided into small units of equal value.
The advantages of equity shares are: Capital appreciation
Limited liability
Hedge against inflation
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Sweat EquityIt is a new equity instrument introduced in the
Companies (Amendment) Ordinance, 1998.
It forms a part of the equity share capital as itsprovisions, limitations and restrictions are sameas that of equity shares.
Sweat Equity is for:
The directors or employees involved in the process ofdesigning strategic alliances.The directors or employees who have helped the
company to achieve a significant market share.
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Non-voting Shares
The shares that carry no voting rights are knownas non-voting shares.
They provide additional dividends in the placeof voting rights.
They can be listed and traded on the stock
exchanges.
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Bonus SharesDistribution of shares, in addition to the cash
dividends, to the existing shareholders are
known asbonus shares.These are issued without any payment for cash.These are issued by cashing on the reserves of
the company.
A company builds up its reserves by retainingpart of its profit over the years.
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Preference Stock
Preference stock provides fixed rate of return.
Preference stockholders do not have any votingrights.
Like the equity, it is a perpetual liability of thecorporate.
Preference stockholders do not have any sharein case the company has surplus profits.
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DebentureIt is a debt instrument issued by a company, which
carries a fixed rate of interest.
It is generally issued by private sector companies inorder to acquire loan.The various features of a debenture are:
Interest Redemption Indenture
A company can issue various types of debentures, which
are: Secured or unsecured debenture
Fully convertible debenture
Partly convertible debenture
Non-convertible debenture
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Bonds/Fixed Income Securities
Government Securities
Saving bonds
Private Sector debentures
PSU bonds Preference shares
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Money Market Instruments Treasury Bills
Certificates of deposits Commercial papers
Repos
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Non Marketable financial assets
Bank deposits
Post Office time deposits
Monthly Income schemes of the Post office
Kisan Vikas Patra
National Saving certificates
Company Deposits Employees Provident fund scheme
Public Provident fund Scheme
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Real Estate
Residential House/Flats
Cooperative Group Housing Society Flats
Commercial property
Agricultural land
Suburban land
Time share in a Holiday resort
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Precious Objects
Gold & silver Precious stones/Gems
Art Objects
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Insurance Policies Endowment Policy
Money back Plan
Whole life Insurance
Unit Linked plan Term Insurance
Immediate Annuity
Deferred Annuity
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Decision Process
Finance(Spending) decisions and Investment(Savings)decisions have encompassed the three major areas of
spending in aggregate economy:
GNP = C+I+G+FGNP= Gross National Product
C= spending by Individual for personal consumptionI = Gross private domestic investment by business firms
G = Governmental purchases
F = Net Foreign spending
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Finance decisions: Sources of money
Quantum of money required
Duration of Time for which money needed
Cheapest source for obtaining the require sum of money
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Investment decisions: Budgeting of money Total money available to invest
Allocation of money between current consumption &reinvestment
Optimal rate of total investment
Choice of specific asset to be purchased
Proportion of total money to be invested in a particular asset
Frequency of evaluation of the performance of the portfolio
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Optimal investment decisions can be made only after thesource i.e. the cost of financing will be determined.
Vice versa, since the cost of financing depends upon theexpected profit and risk of the project to be financed, totalcost can be determined only after the investment decisionshas been made.
The investor reinforces his bargaining position by analysingthe investment opportunities offered to him by Businessfinance Manager
The power of selection or rejection forces the financemanager to offer only those opportunities that will meettheir requirements of the mass of investors who make up
market
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Approaches to investment Decision making
Fundamental approach: Based on Intrinsic
Value(undervalued & overvalued)
Psychological approach: Optimistic/Pessimistic
Academic approach: sophisticated methods of
investigation(Market Price, Risk & Return)
Electic approach: Combination of all three
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Investment decision Process
Basic standards & benchmarks Gauging the prevailing mood of investors and relative strengths ofsupply and demand forces
Perceiving that market is not so well ordered
Conduct of some Fundamental analysis to establish certain value
anchors Applying technical analysis to assess the state of the market
psychology
Combine both the above analysis to determine which securities
are of worth buying, worth holding, and worth disposing. Respecting the market price and should not showing excessivezeal in Beating the market
Acceptance of the fact that the research for a higher level of returnoften necessitates the assumption of a higher level of risk.
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Inadequate comprehension of Risk & Return
Vaguely formulated investment policy
Naive Extrapolation of the past
Cursory decision making
Untimely entries & exits
High Cost
Over Diversification & Under diversification
Wrong attitude towards losses & Profit
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Common Errors in Investment Management
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Contrary thinking
Patience
Composure
Flexibility & openness
decisiveness
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Qualities for successful investing
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The Investment Environment Financial Market:
Debt market, Equity Market, Capital Market, Money Market,
Primary Market, Secondary market, Spot market, FutureMarket, Exchange traded market, Off the countermarket(decentralized & customised) , etc.
Financial Instruments:
Creditorship securities, Public debt Instrument, Private debt
instrument, Special debt instrument(PSU Bonds, Certificateof deposits), Ownership securities, Indirect Equities
Financial Intermediaries:
Expedite transfer from one owner to another
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Investment Information
An investor must have adequate knowledgeabout the investment alternatives and marketsbefore making any kind of investment.The various sources from which an investor can
gather the investment information are:Newspapers, Investment dailiesMagazines and JournalsIndustry Reports
RBI BulletinWebsites of the SEBI, RBI and other private agenciesStock market information
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Questions
Discuss in detail the common errors in Investmentmanagement.
What qualities are required for successful investment
Discuss the attribute that one should consider while
evaluating an investment Discuss briefly the key steps involved in Portfolio
management process
Describe briefly the following approaches to investment
decision making: Fundamental
Psychological
Academic
Eclectic
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