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Investment: Buying a financial product for a period of time in order to derive future returns that will compensate

 Time the funds are committed
 Sacrifice of a parting with funds
 Sacrificing current consumption
Investment involves making of a sacrifice in the present with the hope of deriving future benefits. Two most important
features of an investment are current sacrifice and future benefit. Investment is the sacrifice of certain present values
for the uncertain future reward. It involves numerous decision such as type, mix, amount, timing, grade etc, of
investment the decision making has to be continues as well as investment may be defined as an activity that commits
funds in any financial/physical form in the present with an expectation of receiving additional return in the future.

The layman uses of the term investment as any commitment of funds for a future benefit not necessarily in terms of
return. For example a commitment of money to buy a new car.

Economic investment includes the commitment of the fund for net addition to the capital stock of the economy.

Financial investment is the commitment of funds for a future return, thus investment may be understood as an activity
that commits funds in any financial or physical form in the presence of an expectation of receiving additional return in
future. In the present context of portfolio management, the investment is considered to be financial investment, which
implies employment of funds with the objective of realizing additional income or growth in value of investment at a
future date.

By investing (saving money now instead of spending it), individuals can tradeoff present consumption for a larger future
Investment Characteristics: Safety of Principal, Marketability, Stability of Income, Capital Growth, Purchasing Power
Stability Legality, Convenience, Tax Shelter, Tangibility and Conceal ability
Investment Objectives: Maximization of Return, Minimization of Risk, Safety, Liquidity, Hedge against Inflation, Tax

INVESTMENT VERSES SPECULATION: Often investment is understood as a synonym of speculation. Investment and
speculation are somewhat different and yet similar because speculation requires an investment and investment are at
least somewhat speculative. Probably the best way to make a distinction between investment and speculation is by
considering the role of expectation. Investments are usually made with the expectation that a certain stream of income
or a certain price that has existed will not change in the future. Whereas speculation are usually based on the
expectation that some change will occur in future, there by resulting a return. Thus an expected change is the basis for
speculation but not for investment. An investment also can be distinguished from speculation by the time horizon of the
investor and often by the risk return characteristic of investment. A true investor is interested in a good and consistent
rate of return for a long period of time. In contrast, the speculator seeks opportunities promising very large return
earned within a short period of time due to changing environment. Speculation involves a higher level of risk and a more
uncertain expectation of returns, which is not necessarily the case with investment. The investor can be said to be
interested in a good rate of return of a consistent basis over a relatively longer duration. For this purpose the investor
computes the real worth of the security before investing in it. The speculator seeks very large returns from the market
quickly. For a speculator, market expectations and price movements are the main factors influencing a buy or sell
decision. Speculation, thus, is more risky than investment.
An investor prefers low risk investments, whereas a speculator is prepared to take higher risks for higher returns.
Speculation focuses more on returns than safety, thereby encouraging frequent trading without any intention of owning
the investment. The speculator’s motive is to achieve profits through price change, that is, capital gains are more
important than the direct income from an investment. Thus, speculation is associated with buying low and selling high
with the hope of making large capital gains. Investment is long term in nature. An investor commits funds for a longer
period in the expectation of holding period gains. However, a speculator trades frequently; hence, the holding period of
securities is very short.
Investment Vs Gambling: Investment can also to be distinguished from gambling. Examples of gambling are horse race,
card games, lotteries, and so on. Gambling involves high risk not only for high returns but also for the associated
excitement. Gambling is unplanned and unscientific, without the knowledge of the nature of the risk involved. It is
surrounded by uncertainty and a gambling decision is taken on unfounded market tips and rumors. In gambling, artificial
and unnecessary risks are created for increasing the returns. Investment is an attempt to carefully plan, evaluate, and
allocate funds to various investment outlets that offer safety of principal and expected returns over a long period of
time. Hence, gambling is quite the opposite of investment.

Investment Options(Alternatives/Vehicles/Choices)

Direct Investments:
A. Bank Savings Account
To promote saving habit and felicitate safekeeping of money
 Fixed Return
 Safe Investment
 Full Liquidity
 Card Convenience
 Account Monitoring
B. Recurring Deposit (RD)
To promote regular systematic investment
 Fixed Return
 Safe Investment
 Lower Minimum Investment
C. Bank Fixed Deposit (FD)
To promote long term investment
 Fixed and Higher Return
 Tax Advantage
 Loan Facility
D. Post Office Savings
Only one account can be opened with one post office and can be transferred from one post office to another.
Schemes issued and managed by the Government of India
Risk-free investment avenues which are ideal for tax-saving too. If you are looking for a long-term guaranteed way of
generating wealth
Direct Investments
Kisan Vikas Patra (KVP):
Kisan Vikas Patra (KVP) comes in the denominations (face value) of Rs. 1,000, Rs. 5,000 and Rs. 10,000.
There is no maximum limit on the purchase of certificate. KVP double the money in 8.7 years that works out to a yield
of a little over 8 per cent. As tax concessions are not available on interest amount, for investors in higher tax brackets,
the yields are somewhat lower. Investors can also use money in emergencies by breaking it after 2.5 years. However,
early withdrawal lowers returns. Certificate can be encashed at the post-office of its issue.

E. Bonds
These are debt securities issued by the government, quasi-government, public enterprises and financial institutions

 The buyer lends money to the issuer for interest income

 Safe & Stable
 Fixed Rate of Return
 Tax savings, in case of tax savings bonds
 Nominal or Face Value—The amount over which the issuer pays interest, and which has to be
repaid at the end.
 Issue price—The price at which investors buy the bonds when they are first issued.
 Maturity date—The date on which the issuer has to repay the nominal amount.
 Coupon—The interest rate that the issuer pays to the bond holders.

Refer to a long-term debt instrument issued by corporate entities to raise funds
 Investors earn interest and capital gain
 The credit rating of the issuing companies- rating by independent agencies such as ICRA,
CRISIL, and CARE indicate the levels of safety of debt instruments.

F. Equity Shares
Equity shares represent ownership capital and its owners (equity shareholders) share the rewards and risks
associated with the ownership of corporate enterprises. These are also called, ordinary shares, in contrast with
preference shares, which carry certain preferences/prior rights in regard to income and redemption. Equity investors
have residual claim on income and assets besides enjoying rights to control and pre-emptive right. The return on
common stocks comes from either of two sources - the periodic receipt of dividends, which are payments made by
the firm to its shareholders, and increases in value, or capital gains, which result from selling the stock at a price
above that originally paid. Further, common stock can be bought in round (a 100 unit share of stock, or multiples
thereof) or odd (fewer than 100 shares of stock) lots. Denote an ownership interest in a corporation
Equity shareholders share the rewards and risks associated with the ownership of corporate enterprises
 Voting rights
 limited liability
 Investor cannot lose more than their investment whether the corporation fail
 Direct Investments
 Residual right on income & assets
 Preemptive Right-right to buy a proportional interest of any future issue of company’s common

Preference Shares:
Preference shares refer to a form that partakes some characteristics of equity shares (ownership) and some attributes
of debentures (fixed income). Generally, the dividend is cumulative and shares are redeemable. Redemption period is
usually 7-12 years. But, preference dividend is payable only out of distributable profits. It does not carry voting rights.
Investors, though enjoy the assurance of a stable dividend but generally receive modest returns and vulnerable to
arbitrary managerial actions. It is, however, not a popular capital market instrument in India. Preference shares also
get traded in the market and give liquidity to investors. Though trading in preference shares is not quite frequent,
investors can opt for this type of investment when their risk preference is very low.
 Hybrid security: features of both debt and equity
 Fixed rate of dividend
 Preferred stockholders paid after bondholders and debenture holders but before common
 Often convertible into equity stock
 Generally, the dividend is cumulative, and shares are redeemable. But preference dividend is
payable only out of distributable profits.
 It does not carry voting rights.
 Investors, though enjoy the assurance of a stable dividend but generally receive modest returns
and vulnerable to arbitrary managerial actions.

Life Insurance Policies:

 Promote savings and additionally provide insurance cover.

 Insurance policies, while catering to the risk compensation to be faced in the future by investors,
also have the advantage of earning a reasonable interest on their investment
 Also eligible for exemption from income tax.

Public Provident Fund

Mutual Fund Schemes:
A Mutual Fund is a trust that pools together the savings of a number of investors who share a common financial goal.
The Fund Manager then invests this pool of money (called a corpus) in securities ranging from shares to debentures to
money market instruments depending on the objective of the scheme.
The income earned through this investment and the capital appreciation realized by the scheme, are distributed
amongst the investors in proportion to the number of units they own by way of dividend or Net
Asset Value (NAV) appreciation.

Mutual Fund Schemes:

The Unit Trust of India is the first mutual fund in the country.
A number of commercial banks and financial institutions have also set up mutual funds.
Fund Managers perform consistently, assuring the investor better returns and lower risk options.

Benefits of purchasing a mutual fund

 Professional Management: The fund company hires talented money managers; including a team
of people dedicated to researching, tracking, determining trends, and doing thorough analysis,
and who work full time on your behalf.
 Diversification: each unit purchased is made up of many different investments.
 Liquidity: Mutual funds can be sold anytime, and easily
 Flexibility: Mutual funds allow you to purchase as much or as little as you want, and offer a
variety of purchase plans.

SBI Mutual Fund was the first non UTI mutual fund established in June,1987; followed by
CanBank MF (1987), Punjab National Bank MF (1989), Indian Bank MF (1989), Bank of India MF (1990), Bank of Baroda
MF (1992).

Instruments whose value depends upon the value of some underlying security (Commodity, Stock, Rate, Index,
Currency etc.)
 The financial markets are marked by a very high degree of volatility.
 Risk-averse investors to guard themselves against uncertainties arising out of fluctuations in asset
 Through the use of derivative products, it is possible to partially or fully transfer price risks by
locking-in asset prices.
 Minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of
risk-averse investors.

Forward Contract
 An agreement made today between a buyer and seller to exchange the commodity or instrument
for cash at a predetermined future date at a price (forward price) agreed upon today.
 The transfer of ownership occurs on the spot, but delivery of the commodity or instrument does
not occur until some future date.
 For example, a wheat farmer may wish to contract to sell their harvest at a future date to
eliminate the risk of a change in prices by that date.
 Problems in Forward Contracting
 Lack of centralisation of trading
 Illiquidity, and
 Counter party risk.
Futures Contract
 A futures contract is a financial security, issued by an organised exchange to buy or sell a
commodity, security or currency at a predetermined future date at a price agreed upon today.
 The agreed upon price is called the ‘futures price’.
 Subject to the rules and regulations of the exchange.
 Standardised contracts
 Facilitates the secondary market trading.
Let's say there are two traders - Bunny the buyer and Sunny the seller.

 Contracts that give the holder the option to buy/sell specified quantity of the underlying assets at a
particular price on or before a specified time period.

 The word “option” means that the holder has the right but not the obligation to buy/sell
underlying assets.
 Types of Options
 Two types – call and put.
 Call option give the buyer the right but not the obligation to buy a given quantity of the
underlying asset, at a given price on or before a particular date by paying a premium.

 Put option give the buyer the right, but not obligation to sell a given quantity of the underlying
asset at a given price on or before a particular date by paying a premium.

 Swaps are derivative instruments that represent an agreement between two parties to exchange a
series of cash flows over a specific period of time.
 Interest Rate Swaps
 Currency Swaps
 Commodity Swaps
 Credit Default Swaps

An Example of an Interest Rate Swap:

Consider this example of a “plain vanilla” interest rate swap.
Bank A is a AAA-rated international bank located in the U.K. and wishes to raise $10,000,000 to finance floating-rate
Eurodollar loans.
Bank A is considering issuing 5-year fixed-rate Eurodollar bonds at 10 percent.
It would make more sense for the bank to issue floating-rate notes at LIBOR to finance floating-rate Eurodollar loans.
Firm B is a BBB-rated U.S. company. It needs $10,000,000 to finance an investment with a five-year economic life.
Firm B is considering issuing 5-year fixed-rate Eurodollar bonds at 11.75 percent.
Alternatively, firm B can raise the money by issuing 5-year floating-rate notes at LIBOR + ½ percent.
Firm B would prefer to borrow at a fixed rate.

 Real Estate,
 Commodities, Gold, Silver, sugar etc.
 Currency
 Art
 Antiques
 Wines
 Precious Stones
Money Market Instruments
 The term “money market” refers to the market to meet the short term requirements of the
borrowers & providing opportunity to the lenders for deployment of their funds and liquidity to
the market.
 Money market instruments are those instruments, which have a maturity period of less than one
 This is the market for short term assets that are close substitutes of money.
 “Money market” is a collective name given to the various firms and institutions that deal with
various types of near money
 Mostly money market instruments are discounted instruments i.e. they are issued at a discount to
their maturity value and the difference between the issuing price and the maturity/face value is
the implicit interest.
 These are also mainly unsecured instruments.
 These instruments have high liquidity and tradability.
Money Market Instruments
 Commercial Paper (C.P)
 Certificate of Deposit (CD)
 Treasury Bills
 Bills of Exchange
 Call Money
 Repurchase Agreements
 Inter Bank Participation Certificates
 Banker’s Acceptance
 Money Market Mutual Funds

Commercial Papers
 Commercial paper, or CP, is a short-term debt instrument issued by companies to raise funds.
 It is an unsecured money market instrument issued in the form of a promissory note
 Maturity period- 7 days to one year from the date of issue.
 Denominations- ₹ 5 lakh or multiples
 Issued to cover short-term receivables & meet short-term financial obligations, such as funding
for a new project.
 The tangible net worth-not less than Rs.4 crore
 Any company keen to raise funds through CP needs to obtain the credit rating either from
CRISIL, ICRA, CARE(Credit Analysis & Research) etc.
 The minimum credit rating shall be A-2 as per SEBI guidelines.
 CPs are not backed by collateral
 CPs are usually sold at a discount from face value,
 CPs are Transferable by endorsement & delivery.
 Compulsory to be Issued in Demat form
 Interest rates tend to fluctuate with market conditions
 Typically, the longer the maturity on a note, the higher the interest rate
 Who can invest in CP?
 Individuals, banking companies, other corporate bodies (registered or incorporated in
 Non-resident Indians and foreign institutional investors etc.
 Debt mutual fund schemes hold commercial paper (CP) as instruments in their portfolios.

 Who can issue?

 Highly rated corporate borrowers, Banks
 Primary dealers (PDs)
 Satellite dealers (SDs)
 All-India financial institutions (FIs)

Certificate of Deposit (CD)

 A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks.
 Introduced in 1989 to increase the range of money market instruments in India
 Can be issued by all scheduled commercial banks except RRB’s
 CDs are similar to savings accounts in that they are insured "money in the bank" and thus
virtually risk free.
 A certificate of deposit can be issued at a discount on its face value.
 Banks and financial institutions can issue certificates of deposits on a floating rate basis.
 However, the method of calculating the floating rate should be market-based.
 Transferable by endorsement & delivery
 Minimum size and maturity of a Certificate of Deposit

 A certificate of deposit can only be issued for a minimum of Rs.1 lakh by a single issuer and
in multiples of Rs.1 lakh.
 For instance, for a certificate of deposit issued by banks, the maturity period is not less
than 7 days and not above one year while for financial institutions, a certificate of deposit
should not be issued for less than 1 year and not above three years.
 CRR(4%) & SLR(18.75%) are to be maintained

Treasury Bills (T-Bills):

 Short term borrowing instruments of the Govt. of India which enable investors to park their short
term surplus funds while reducing their market risk.
 Maturities ranging between 14 to 364 days.
 They are auctioned by RBI at regular intervals and issued at a discount to face value.
 At present, T-Bills are issued for maturity of 91 days, 182 days and 364 days.
 Treasury bills are zero coupon securities and pay no interest, rather, they are issued at a discount.
For example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20, that is,
at a discount of say, Rs.1.80 and would be redeemed at the face value of Rs.100/-.
 The return to the investors = maturity value or the face value - the issue price. i.e.100- 98.20= 1.80
 Sovereign zero risk instruments.
 Available in primary and secondary market.
 No Tax Deduction at Source (TDS)
 Investments in T-Bills- Individuals, Firms, Trusts, Institutions and banks purchase T-Bills. The
commercial and cooperative banks use T-Bills for fulfilling their SLR requirements.
 Treasury bills are available for a minimum amount of Rs. 25,000 & in multiples of 25000.
 Treasury bills are issued at a discount and are redeemed at par.
 91-day T-bills are auctioned every week on Wednesdays.
 182-day and 364-day T-bills are auctioned every alternate week on Wednesdays
 Advantages of Treasury Bills
 Fulfills the short term money borrowing needs of the government.
 Zero Risk weightage associated with them.
 High liquidity because 91 days and 364 days are short term maturity.
 Rates: (July 26, 2019)
 91-Day Treasury Bill (Primary) Yield 5.74%
 182-Day Treasury Bill (Primary) Yield 5.95%
 364-Day Treasury Bill (Primary) Yield 5.98%

Bills of Exchange
 A bill of exchange is a written order once used primarily in trade that binds one party to pay a
fixed sum of money to another party on demand or at a predetermined date
 Bills of exchange are promissory notes issued for commercial transactions involving exchange of
goods and services.
 Bill of exchange is issued by the creditor to the debtor when the debtor owes money for goods or
 Parties involved in the bills of exchange
 Drawer: The person who issues the bill is the drawer. The drawer is the creditor who is yet to
receive money from the debtor.
 Drawee: The person to whom the bill is issued. Drawee is also the purchaser of goods on credit.
We can say that drawee is the debtor who needs to pay the amount to the creditor.
 Payee: The person to whom the payment is made is called the payee. Usually, the payee and
the drawer are the same person.

Features of Bills of Exchange

 It should be in writing format. No verbal note would be considered as valid.

 It would be an order for the debtor to pay the amount within a certain period of time. And the
order would have no other conditions.
 The amount that needs to be paid and the date within which the amount must be paid should be
precise in the bills of exchange.
 The payment should be made to the issuer of the bill by the bearer of the bill.

Call Money Market

 Deals in loans at call and short notices.
 Deals with extreme form of short term loans; 24 hours, 7-15 days maturity.
 Recalled on demand or shortest possible notice.
 Money at call is a loan that is repayable on demand, and money at short notice is repayable within
14 days of serving a notice.
 In the Indian money market the money is lent/borrowed between participants, permitted to
operate in the Call/Notice money mar-ket, for tenors ranging from overnight to a maxi-mum of
fourteen days.
 Normally, collaterals are not insisted upon.
 Call Money Rate 5.59%
 Banks borrow in this market for the following purpose:
 To fill the gaps in funds.
 To meet CRR & SLR mandatory requirements.
 To meet sudden demand for funds
Repurchase Agreements
Repurchase agreement (often referred to as a repo) is the sale of security with a commitment by the seller to
buy the security back from the purchaser at a specified price at a designated future date. Basically, a repo is a
collectivized short-term loan, where collateral is a security. The collateral in a repo may be a Treasury security,
other money-market security. The difference between the purchase price and the sale price is the interest cost of
the loan, from which repo rate can be calculated. Because of concern about default risk, the length of maturity
of repo is usually very short. If the agreement is for a loan of funds for one day, it is called overnight repo; if the
term of the agreement is for more than one day, it is called a term repo. A reverse repo is the opposite of a repo.
In this transaction a corporation buys the securities with an agreement to sell them at a specified price and time.
Using repos helps to increase the liquidity in the money market.
 Repo or Reverse Repo are transactions or short term loans in which two parties agree to sell and
repurchase the same security.
 Mainly interbank and Bank-RBI dealings take place
 They are usually used for overnight borrowing
 Repo/Reverse Repo transactions can be done only at Mumbai between the parties approved by
RBI and in RBI approved securities
Policy Repo Rate: 5.75%
Reverse Repo 5.5%

Inter-Bank Participation Certificates (IBPCs):

 IBPC is a short-term money market instrument whereby the banks can raise money/deploy short-
term surplus.
 In the case of IBPC the borrowing bank passes/sells on the loans and credit that it has in its book,
for a temporary period, to the lending bank.

Banker's Acceptance
Banker‘s acceptances are the vehicles created to facilitate commercial trade transactions. These vehicles are called
bankers acceptances because a bank accepts the responsibility to repay a loan to the holder of the vehicle in case the
debtor fails to perform. Banker‘s acceptances are short-term fixed-income securities that are created by non-financial
firm whose payment is guaranteed by a bank. This short-term loan contract typically has a higher interest rate than
similar short –term securities to compensate for the default risk. Since bankers’ acceptances are not standardized,
there is no active trading of these securities.
 A banker's acceptance is a short-term investment plan created by a company or firm with a
guarantee from a bank.
 It is a guarantee from the bank that a buyer will pay the seller at a future date.
 A good credit rating is required by the company or firm drawing the bill.
 This is especially useful when the credit worthiness of a foreign trade partner is unknown.
 The terms for these instruments are usually 90 days, but this period can vary between 30 and 180
 Companies use the acceptance as a time draft for financing imports, exports and trade.
 In India, there are neither specialized acceptance agencies for providing this service on a
commission basis nor is it provided to any significant extent by commercial banks.
Money Market Mutual Funds
 A money market mutual fund (MMF) is a type of mutual fund that invests in high-quality, short-
term debt instruments, cash, and cash equivalents.
 Though not exactly as safe as cash, money market funds are considered extremely low-risk on the
investment spectrum, and thus carries close to the risk-free rate of return.
 A money market fund generates income