Session 1

BASICS OF INVESTMENT

Investment defined
A sacrifice in the present consumption with a hope of

deriving future benefit. So three major things are emerging..current sacrifice and future benefits and that too in course of time . It is postponed consumption Benefits occur in future so they are not certain. So Risk and return are two key determinants of investment process.

Why Invest ?
To improve our future welfare.

Foregoing the consumption today will enhance our

future consumption possibilities. Anticipated future consumption will give the direction of how much to invest now .. Child education , Daughters marriage , retirement planning or Buying a house will lead to investment decision. But regardless why we invest we must manage our wealth effectively and obtain the most for it.

Investment Goals
Near term high priority goal :-

These are goals which have a high emotional priority and

he wants to achieve it within a few years. (A new house) Fixed income securities with a fixed maturity date. Since the goal has a high priority investor will remain risk averse in this case. Low priority Goal :These goals are set at a lower end of the priority scale and not painful if not achieved. Having a World Tour with family Investment remains in risky instruments.

Investment Objective
Long term high priority goal : This goal is talking about financial independence at a

point some years ahead in future. Retirement Planning , Child Education etc. A diversified well calculated investment approach is adopted. Money Making Goal:Leads to wealth maximization for those investors who are not satisfied with conventional saving and investment approach. They build equity portfolio with all their spare money and leave it till it reaches to their satisfactory returns.

Constraint of investment
An investor seeking fulfillment of one of the above

goals operates under certain constraints. Liquidity. Age Need for regular income. Time horizon Risk tolerance Tax liability So one need to create a balance while choosing their investment options subject to their constraint.

Investment Vs Speculation
Basis INVESTMENT SPECULATION

Acquisition
Attitude Background Risk quantum Stability of income Time period Source of Income

Outright purchase
Cautious and conservative Small Very stable Long term Earning and dividend

Often on margin
Daring and careless

Research based (intrinsic) Tips , rumour Huge Uncertain Short period Change in market price

Gambling and Speculation

Gambling

is an act of betting on an uncertain outcome.a matter of luck by chance No rational economic reason .Artificial and unnecessary . Gamblers are risk lovers and the risk is quite disproportionate to the expected reward. In speculation risk is existing question is who is going to bear? Speculation is more reasoned anticipation of future conditions. It attempts to organize the relevant knowledge as a support for judgement.

Investment Strategies Over LifeTime

Changes in net worth and risk tolerance investment

strategies change over the life time. Following are the various phases of investment life cycle. Accumulation Phase Consolidation phase Spending Phase Gifting phase

Accumulation Phase
Early to middle years of working careers are in this

phase. Accumulation of asset to satisfy their immediate needs. Net worth is small and loan repayment is more Long investment horizon and has potential for future earning ability. So invest in high risk instruments to make above average nominal returns over time.

Consolidation Phase
Investor has passed the mid point of their career.

Paid of most of their debt burden .

Earning exceeds income creates investible surplus. Retirement Planning starts.

Moderately high risk instruments are welcome.

Spending phase
Typically begin when individual retire.

Living income comes from social security income

and other income from return on investment. Earning period is completed so remain very cautious while investing. Preservation of capital is priority so no risky investment.

Gifting phase
Concurrent with spending phase .

They have sufficient income to cover future expenses

and meet the future uncertainties. Excess assets can provide financial assistance to son and daughters or other relatives. Can create the charitable trust a common tool to go for estate planning .

Investment process
A typical investment decision undergoes a five step

procedure which forms the basis of investment process. Determine the investment objective and policy. Undertake Security Analysis Construct a portfolio. Review the portfolio Evaluate the performance of the portfolio. This five step process is relevant for both individual and institutional investors.

Investment Objectives and Policy.

Work out objective and then evolve a suitable policy

to attain the same. If your objective is large money it is not possible without the risk of large losses. So the objective must be decided in terms of risk and return. In framing policy decide the categories of asset you should concentrate.

Security Analysis
Now after the asset class is determined then one should

concentrate the securities to be included . One need to find out Mispriced securities and there are two ways to do the same. Technical Analysis :- Study past movement of prices to find out the future price trends and pattern of movements. CMP is compared to predicted price Fundamental analysis :- Working out the intrinsic value and comparing it with the CMP. The intrinsic value is the present value of all cash flows that the owner of the security expects to receive during and at the end of his holding period.

Portfolio construction
Once securities are identified now it will become

important to determine the proportion of the investors wealth to be invested in each asset . Aggressive and Conservative investors. Within the broad group also one need to pick the share of a specific company. The major problem is selectivity and their timing as it will involve a micro level forecast. All possible efforts should be made to minimize the risk of portfolio . So it should be properly diversified.

Portfolio Revision and Performance

Over the period of time stock will loose its flavour ..

And a new stock will emerge with promises of high

return with a relative low risk profile. Liquidate the unattractive and buy the new stars. A rational investor should examine the performance of his portfolio on the basis of average return and risk with respect to a well thought out benchmark.

Approaches to Investment decision making

There are four broad approaches .

Fundamental Approach
Psychological approach Academic approach

Eclectic Approach

Approaches to Investment decision making

Fundamental approach :- There is an intrinsic value of securities and this depends on economic and fundamental factors. There might be difference between intrinsic value of securities and its price and sooner or later the market will be in that line. Superior returns can be earned by buying an undervalued securities and selling an over valued securities.

Approaches to Investment decision making

Psychological Approach : stock prices are guided by

emotions rather than reason. It is based on the moods of the investors. When there is greed and euphoria in the market price rises to new high and price fall drastically when fear and despair envelope the market. It has been observed those subscribe to this approach goes for a technical analysis which shows that there is a price pattern which may be repeated in near future by analysing the market data .

Approaches to Investment decision making

Academic approach :- Stock markets are reasonably

efficient in reacting quickly and rationally to the flow of information. Market value =Intrinsic value. Stock price behaves like a random walk . Successive price changes are independent. Expected return is based on the risk factors.

Approaches to Investment decision making

Eclectic Approach :

more insight be given apart from Fundamental analysis . More fine tuning necessary. Excessive reliance on technical analysis can be hazardous also. Market discounts everything Conduct fundamental analysis to establish certain value .. Do technical analysis to assess the mood of the market Combine the both to determine which one to buy/sell/hold. Respect market prices do not show excessive zeal to beat the market. Always have a balanced approach on Risk return trade off.

Common errors made in an investment

Inadequate comprehension of Return and risk. Vaguely formulated investment policy. Nave extrapolation of the past past trend can not show

the future trend so no extrapolation. Cursory decision making Go by tips and rumors , Set aside various investment risk , Uncritically follow others. Untimely Entry and Exit irrational Start and stop. High costs :- transaction costs wipe out profit for frequent trading. Over diversification and Under diversification. Wrong attitude towards losses and profit.

Successful Investment Qualities

Contrary thinking : Do not follow the crowd.

Avoid stocks which have high P/E ratio.

Do not fall in temptation to play a wrong game. Sell to the optimist and buy from the pessimist. Discipline your buying and selling habits and work

on targets. Never look back after a sale or purchase whether you should have waited or not. Have patience - dont look for instant result and have faith and confidence on your investment.

Successful investing
Composure :- understand your own impulses and instincts towards

greed and fear. Control your emotions so that it does not change your conviction . Capitalize on the greed and fear of other investors . Maintain certain distance from market place. You can avoid those two virus. Rely more on numbers and less on judgement. Flexibility and openness :- Do not be over protective to your judgementskeep your mind open and embrace the changes. It should not be blocked by prejudices and biases. Decisiveness :- It means a creation of balance of factors some may be well understood and some may not and then act accordingly. Create some bold positions consistent with your own conviction.

We shall move to some more fundamentals.

Difference between banks & NBFCs NBFCs are

doing functions akin to that of banks, however there are a few differences:
(i) a NBFC cannot accept demand deposits (demand deposits are funds deposited at a depository institution that are payable on demand -- immediately or within a very short period -- like your current or savings accounts.) (ii)deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks. and (iii) it is not a part of the payment and settlement system and as such cannot issue cheques to its customers;

Investment Alternative
Non Marketable financial Asset

Bank deposit
Post office deposit Company deposit

Provident fund deposit

Insurance policies.

Equity share
It represents owners capital. One has a residual interest in income and wealth. Most romantic investment avenue Types of equity shares Blue Chip Large well established financially strong firms with an impressive
earning and dividend history

Growth Share Having an above average growth as well as profitability. Income share Fairly stable operation , limited growth opportunities with
high dividend payout ratios

Cyclical share having a cyclicality in their operation.

Speculative share shares that tends to fluctuate widely because of lot of
trading.

Rights of equity share holder

Equity shareholder has a residual claim to the firm.

Dividend at the hands of investor is tax free.

Equity shareholders have the voting right to the every

resolution passed in the company. They elect BOD. Equity shareholders enjoy pre-emptive rights to maintain their proportional ownership. They have the residual claim over the asset of the company in the event of liquidation. Authorized, Issued and paid up capital ,Par value , Book Value.

Bonds
They are long term debt instruments. Issuer of bond promises to pay a stipulated stream of cash

flow. Govt. securities Issued by the central govt , state govt

resemble like a debenture registered with PDOs. Or may be a promissory note promised by President of India to pay as per a given schedule .Or it can be a bearer security. Maturity -3 to 20 years and carries a rate 7 to 10%.

Saving Bonds Minimum amount 1000 and maturity period is 5 years and no maximum PSU Bonds They are debenture issued by PSU have two categories taxable and
tax free . No TDS , Stamp duty, traded in market and transferable

limit. Interest payable half yearly and taxable. Bonds are transferable having nomination facility and can be used as collateral.

Debenture of private companies Preference Share**

Debenture
Long term debt instrument. At the time of issue a trustee is appointed through a deed. Debentures are secured by mortgaging present and future

immovable properties. Compulsory credit rating if its more than 18 month of maturity. Debenture Redemption reserve is created for at least 50 % of the issue. Companies can decide freely the coupon rate. No restriction on redemption period. Debenture can have call and put option. They can be converted to equity shares as per pre specified terms.

Preference shares
Its a hybrid security

Carries a fixed rate of dividend .

Payable only out of distributable profit. Inadequate

profit will postpone the payment of dividend. Normally the dividend is paid cumulative. Dividend skipped one year must be paid in the subsequent year before any dividend is paid to equity holders. Preference dividend is tax exempt. Redemption period 7 to 12 years.

Company Deposits.
For a manufacturing company deposit can be of 1 to 3

years and for NBFC it will be 2 to 5 years. Deposit amount equal to 25% of its net worth from public and 10 % from its shareholders. Higher amount can be mobilized by NBFCs. Interest rates are normally higher than bank rates. Credit rating is compulsory. No tax benefit . TDS when interest income is more than 5000 in a financial year. Company offers some attractive incentives to promote the same.

Money market instruments

Securities which have a maturity of less than 1 year at the time of issue are called Money market Instruments. Treasury bill Issued by GOI its tenure varies fro 91 days to 364 days . Sold by RBI at a discount and redeemed at par. Having a very active secondary market. No credit risk and negligible price risk. Commercial paper Short term unsecured promissory note issued by credit worthy firms. Maturity period 90 to 360 days. Sold at discount and redeemed at par. Certificate of deposit Issued by bank and FIs is a short term deposit. Maturity period 3mth to 1 year and generally risk free Higher ROI than T Bills and easily transferable. Repo and Reverse Repo Repo Repurchase Agreement or Ready Forward.

Repo Sale and Repurchase ---Difference in sale and repurchase price is interest Reverse Repo Initial Purchase and subsequent sale

Mutual fund and life insurance

A special purpose vehicle channelizing domestic

investment into capital market. Equity Scheme, debt scheme , balanced scheme Life insurance is a mixture of both investment and insurance. Endowment Assurance policy Money back policy Whole life policy Term Assurance Policy.

Precious Objects and Real estate

Small in size but high in value.

Gold and silver

Precious stone Diamond and Other Gems. Art objects and collectibles Painting , Sculpture , Antiques. Nowadays the most important asset in an investors

portfolio is a residential house or a commercial plot Agricultural land Semi urban land Commercial property Resorts

Financial derivative
An instrument that derive its value from the value of

an underlying asset. Forward Future Option.

Criteria for evaluation

Rate of return calculation Risk - Variance , Standard Deviation , Beta Marketability :- Quick transaction , Low transaction cost

, Price change between two successive transaction is negligible. Depth When the volume of securities traded are very large . This ensures entry and exit at any point of time Breadth Large number of rational participants with homogenous expectations in the market. No one can influence the market . Resilience New order emerges in response to price changes. High marketability helps investors to change their mind.

Tax shelter and convenience

Initial tax benefit :- Tax relief enjoyed at the time of

making the investment . 80C of IT ACT. Continuing tax benefit : A tax shield associated with periodic return from the investment. Dividend income is tax free Terminal tax benefit :- A terminal tax benefit refers to relief of taxation when an investment is realised or liquidated . With drawl from PPF account. Convenience Can the investment made readily? Can the investment be looked after easily?

Financial Market
Financial

market facilitates price discovery Establishment of price of financial asset. It provides liquidity to financial market-Investors can readily sell their securities as and when they wish. Negotiability and transferability. Financial markets considerably reduce the cost of transacting Search Cost - You do not need to find a buyer or seller by advertisement. Information Cost Cost of information to evaluate the merit of an investment.

Assignments..
Read Appendix 1A Three approaches to succeed as

an investor and prepare a short note. Visit a bank and a post office and find the various options of Fixed Deposits along with their interest rate and features. Get details of EPF and PPF and understand how to open an account. You can open an account of PPF with Rs.100 only. Visit any insurance office get at least two products out of the four mentioned in the slide.