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F1 Notes 1
F1 Notes 1
INVESTMENTS
SPECULATION
Investment and speculation are somewhat different and yet similar because speculation
requires an investment and investments are at least somewhat speculative. Both are
leading to claim on money, aims at maximizing return. Investment is putting money in
an asset not necessarily in marketable in short run, where as speculation is selecting an
investment with higher risk in order to profit from an anticipated price movement.
If investment is done with long term objective, speculation is of short term objective.
GAMBLING
Gambling is a High risk venture, where the investor plays for high stakes. Reckless
venture to look for very quick profits in the short term. Gambling is based upon tips,
rumors , its un planned, unscientific, and without the knowledge of the exact nature of
risk.
Characteristics of gambling
ARBITRAGE
•Deliberate switching of funds between markets in order to maximize net gains on short
term investments. Such dealings may be in currencies, commodities, Arbitrage is not
considered as pure speculation
INVESTMENT •SPECULATION
Earnings
OBJECTIVES OF INVESTMENT
CHARACTARISTICS OF INVESTMENTS
INVESTMENT PROCESS
The following steps are involved in the process of investments. These steps are not only
applicable for individuals but also for institutions.
Investment objectives are determined in terms required rate of return, need for
regular income, risk perception and need for liquidity. Risk takers objective is to earn
higher rate of return, where as objective of risk averse investors is the safety of funds.
Investment policy calls for determining categories of financial assets, amount of
wealth, tax status. Acquiring the knowledge about the different opportunities available is
v important.
2) Security analysis
It is an examination of risk return characteristics of the individual securities identified
under the last step. It is done with an aim to know whether securities worthwhile to invest
There are different approaches involved in security analysis.
Technical analysis – This Studies the past and recent price movements of securities.
Fundamental analysis –This analyses the true or intrinsic value of securities, which are
worked out to compare with current market price.
Market analysis
Industry analysis
Company analysis
3) Construction of portfolio
4) Portfolio revision
Securities once attractive may ceases to be so. Therefore portfolio has to revised from
time to time. New securities may be available in the market with high returns and low
risk.
5) Portfolio evaluation
It is a continuous process. It is examining the portfolio for determining return and risk
characteristic continuously. Such risk return must be compared with a certain yardstick.
Proper portfolio evaluation leads to timely revision.
SOURCES OF INVESTMENT RISK
4) MARKET RISK
Market risk is more popular for securities especially equity shares. This risk is caused
due to variability of return caused by alternating force of bull and bear market.
These risks can be classified into systematic and unsystematic risk. A detailed
discussion about these risk is covered in second module
INVESTMENT ALTERNATIVES
The following is the list of different investment alternatives available for an investor
1)NEGOTIABLE SECURITIES
Preference shares
Debentures issued by corporate
Bonds
IVP and KVP
Government securities (gilt edged securities)
Money market securities ( which is issued for short duration) like, treasury bill,
CP, certificate of a deposits, etc.
A) DEPOSITS
Bank deposits
P O deposits
N B F C deposits
B) TAX SHELTERED SAVINGS SCHEMES
PPF
NSS ( PRESENTLY NOT AVAILABLE)
NSC
C) LIFE INSURANCE
3) MUTUAL FUNDS
( a detailed discussion is made relating to mutual fund later.)
4) REAL ASSETS
Gold and silver
Real estate
Art
Antiques
CREDIT RATING:
It is an old concept in USA. “It is essentially giving opinion by a rating agency on
the relative willingness and ability at the issuer of a debt instrument to meet the debt
servicing obligation in time and in full”.
It helps the investors to analyze the risk associated with the debt instruments.
Features of credit rating
1) Specificity:- credit rating is done specifically to a particular debt instrument.
2) Relativity:- It is based on the relative capability and willingness of the issuer of
the debt instruments to meet obligation.
3) Guidance: Credit rating is just a guidance given by the agency.
4) It is not a recommendation to buy the debt instruments.
5) It is based on the broad parameters.
6) No guarantee by credit rating agency on the debt instruments issued by the
company.
7) Uses both qualitative and quantitative information to give the rating.
1) To investors
3) Care (Credit analysis and Research Ltd):- set up in 1993 by IDBI and other
financial institutions.
There is a need to have a different credit rating for different instruments like,
debentures, bonds, medium term debt including FD’s and short term debt instruments
including commercial papers.
MUTUAL FUNDS
For the investors who does not have the expertise to to invest the money in equity market
, mutual funds have become the talk of the day. Mutual funds help the investors to reap
the benefit of equity investment without taking much risk and witout possessing much
expertise in capital market.
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial
goal. The money thus collected is then invested in capital market instruments such as shares,
debentures and other securities. The income earned through these investments and the capital
appreciation realised are shared by its unit holders in proportion to the number of units owned by them.
Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to
invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart
below describes broadly the working of a mutual fund:
The origin of mutual fund industry in India is with the introduction of the concept of mutual fund by
UTI in the year 1963. Though the growth was slow, but it accelerated from the year 1987 when
non-UTI players entered the industry.
In the past decade, Indian mutual fund industry had seen a dramatic imporvements, both
qualitywise as well as quantitywise. Before, the monopoly of the market had seen an ending
phase, the Assets Under Management (AUM) was Rs. 67bn. The private sector entry to the fund
family rose the AUM to Rs. 470 bn in March 1993 and till April 2004, it reached the height of 1,540
bn.
Putting the AUM of the Indian Mutual Funds Industry into comparison, the total of it is less than
the deposits of SBI alone, constitute less than 11% of the total deposits held by the Indian
banking industry.
The main reason of its poor growth is that the mutual fund industry in India is new in the country.
Large sections of Indian investors are yet to be intellectuated with the concept. Hence, it is the
prime responsibility of all mutual fund companies, to market the product correctly abreast of
selling.
1) MOBILISATION OF SAVINGS
Mutual funds mobilizes funds by selling its shares popularly known as units.
This in turn encourages the household savings and investment.
Mutual funds provides investment avenues for small and retail investors who does not
have the expertise of investing in equity market.
3) DIVERSIFICATION IN INVESTMENT
Mutual funds invest the funds collected from retail investors in securities of different
industries. This diversification leads to reduction in the risk associated with investment.
4) PROFESSIONAL MANAGEMENT
Panel of experts who possesses professional knowledge manages mutual funds. This
leads to professional and profitable management of mutual funds.
5) REDUCES RISK
Mutual funds reduces the risk associated with investment by going for better liquidity of
units, professional management and diversification.
6) BETTER LIQUIDITY
Mutual fund units can be sold/liquidated easily as they possess ready market.
There are many entities involved and the diagram below illustrates the organisational set
up of a mutual fund:
ADVANTAGES OF MUTUAL FUNDS
• Diversification: The best mutual funds design their portfolios so individual investments will
react differently to the same economic conditions. For example, economic conditions like a rise
in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other
securities in the portfolio will respond to the same economic conditions by increasing in value.
When a portfolio is balanced in this way, the value of the overall portfolio should gradually
increase over time, even if some securities lose value.
• Professional Management: Most mutual funds pay topflight professionals to manage their
investments. These managers decide what securities the fund will buy and sell.
• Regulatory oversight: Mutual funds are subject to many government regulations that protect
investors from fraud.
• Liquidity: It's easy to get your money out of a mutual fund. Write a check, make a call, and
you've got the cash.
• Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.
• Low cost: Mutual fund expenses are often no more than 1.5 percent of your investment.
Expenses for Index Funds are less than that, because index funds are not actively managed.
Instead, they automatically buy stock in companies that are listed on a specific index
• Transparency
• Flexibility
• Choice of schemes
• Tax benefits
• Well regulated
Mutual funds have their drawbacks and may not be for everyone:
• No Guarantees: No investment is risk free. If the entire stock market declines in value, the
value of mutual fund shares will go down as well, no matter how balanced the portfolio.
Investors encounter fewer risks when they invest in mutual funds than when they buy and sell
stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing
money.
• Fees and commissions: All funds charge administrative fees to cover their day-to-day
expenses. Some funds also charge sales commissions or "loads" to compensate brokers,
financial consultants, or financial planners. Even if investor don't use a broker or other financial
adviser, they will have to pay a sales commission in a Load Fund.
• Taxes: During a typical year, most actively managed mutual funds sell anywhere from 20 to 70
percent of the securities in their portfolios. If fund makes a profit on its sales, investors will have
to pay taxes on the income received, even
• Management risk: When investment is done in a mutual fund, investor depend on the fund's
manager to make the right decisions regarding the fund's portfolio. If the manager does not
perform as well as investor had hoped, they might not make as much money on investment as
you expected. Of course, if investor invest in Index Funds, they forego management risk,
because these funds do not employ managers.
Mutual funds have been a significant source of investment in both government and
corporate securities. It has been for decades the monopoly of the state with UTI
being the key player, with invested funds exceeding Rs.300 bn. (US$ 10 bn.). The
state-owned insurance companies also hold a portfolio of stocks. Presently,
numerous mutual funds exist, including private and foreign companies. Banks---
mainly state-owned too have established Mutual Funds (MFs). Foreign participation
in mutual funds and asset management companies is permitted on a case by case
basis.
UTI, the largest mutual fund in the country was set up by the government in 1964,
to encourage small investors in the equity market. UTI has an extensive marketing
network of over 35, 000 agents spread over the country. The UTI scrips have
performed relatively well in the market, as compared to the Sensex trend. However,
the same cannot be said of all mutual funds.
All MFs are allowed to apply for firm allotment in public issues. SEBI regulates the
functioning of mutual funds, and it requires that all MFs should be established as
trusts under the Indian Trusts Act. The actual fund management activity shall be
conducted from a separate asset management company (AMC). The minimum net
worth of an AMC or its affiliate must be Rs. 50 million to act as a manager in any
other fund. MFs can be penalized for defaults including non-registration and failure
to observe rules set by their AMCs. MFs dealing exclusively with money market
instruments have to be registered with RBI. All other schemes floated by MFs are
required to be registered with SEBI.
In 1995, the RBI permitted private sector institutions to set up Money Market Mutual
Funds (MMMFs). They can invest in treasury bills, call and notice money,
commercial paper, commercial bills accepted/co-accepted by banks, certificates of
deposit and dated government securities having unexpired maturity upto one year.
• Closed-end funds
• Open-end funds
• Large cap funds
• Mid-cap funds
• Equity funds
• Balanced funds
• Growth funds
• No load funds
• Exchange traded funds
• Value funds
• Money market funds
• International mutual funds
• Regional mutual funds
• Sector funds
• Index funds
• Fund of funds
Open-end funds keep some portion of their assets in short-term and money
market securities to provide available funds for
redemptions. A large portion of most open mutual
funds is invested in highly liquid securities, which enables the fund to raise
money by selling securities at prices very close to those used for valuations.
Different mutual funds have different criteria for classifying companies as large
cap. Generally, companies with a market
capitalisation in excess of Rs 1000 crore are known
large cap companies. Investing in large caps is a lower risk-lower return
proposition (vis-à-vis mid cap stocks), because such companies are usually
widely researched and information is widely available.
Big investors like mutual funds and Foreign Institutional Investors are
increasingly investing in mid caps nowadays because the price of large caps has
increased substantially. Small / mid sized companies tend to be under
researched thus they present an opportunity to
invest in a company that is yet to be identified by the market. Such companies
offer higher growth potential going forward and therefore an opportunity to benefit
from higher than average valuations.
But mid cap funds are very volatile and tend to fall like a pack of cards in bad
times. So, caution should be exercised while investing in mid cap mutual funds.
Balanced Fund
Balanced fund is also known as hybrid fund. It is a type of mutual fund that buys a
combination of common stock, preferred stock, bonds, and short-term bonds, to provide
both income and capital appreciation while avoiding excessive risk.
Growth Funds
Growth funds are those mutual funds that aim to achieve capital appreciation by
investing in growth stocks. They focus on those companies, which are
experiencing significant earnings or revenue growth, rather than companies that
pay out dividends.
In general, growth funds are more volatile than other types of funds, rising more
than other funds in bull markets and falling more in bear markets. Only
aggressive investors, or those with enough time to make up for short-term market
losses, should buy these funds.
On the other hand, no-load funds are those funds that can be purchased without
commission. No load funds have several advantages over load funds. Firstly,
funds with loads, on average, consistently underperform no-load funds when the
load is taken into consideration in performance
calculations. Secondly, loads understate the real
commission charged because they reduce the total amount being invested.
Finally, when a load fund is held over a long time period, the effect of the load, if
paid up front, is not diminished because if the money paid for the load had
invested, as in a no-load fund, it would have been compounding over the whole
time period.
Value Funds
Value funds are those mutual funds that tend to focus on safety rather than
growth, and often choose investments providing dividends as well as capital
appreciation. They invest in companies that the market has overlooked, and
stocks that have fallen out of favour with mainstream investors, either due to
changing investor preferences, a poor quarterly earnings report, or hard times in
a particular industry.
Value stocks are often mature companies that have stopped growing and that
use their earnings to pay dividends. Thus value
funds produce current income (from the dividends)
as well as long-term growth (from capital appreciation once the stocks become
popular again). They tend to have more conservative and less volatile returns
than growth funds.
Money market funds are generally the safest and most secure of mutual fund
investments. The goal of a money-market fund is to
preserve principal while yielding a modest return.
Money-market mutual fund is akin to a high-yield bank account but is not entirely
risk free. When investing in a money-market fund, attention should be paid to the
interest rate that is being offered.
These funds tend to be more volatile than funds holding a diversified portfolio of
securities in many industries. Such concentrated
portfolios can produce tremendous gains or losses, depending on whether the
chosen sector is in or out of favour.
Index Funds
An index fund is a type of mutual fund that builds its portfolio by buying stock in
all the companies of a particular index and thereby reproducing the performance
of an entire section of the market. The most popular index of stock index funds is
the Standard & Poor's 500. An S&P 500 stock index fund owns 500 stocks-all the
companies that are included in the index.
Fund of Funds
A fund of funds is a type of mutual fund that invests in other mutual funds. Just as
a mutual fund invests in a number of different securities, a fund of funds holds
shares of many different mutual funds.
• Investment Needs
It is essential to decide - why investment is being done.To what purpose investment is
being done? This is because depending on specific need, investors can choose a specific
investment avenue. For instance if an investor is investing for some future event like
retirement or children's marriage, and there's plenty of time left for both, it makes sense
for them to invest in equity-dominated funds. On the other hand, if they want to invest the
lump sum they get on retirement for a regular income that sees them through their
retired life, then a fixed income dominated fund would be best for an investor.
• Risk Profile
How much of a daredevil an investor is? Does thinking of even the slightest risk or
uncertainty make an investor break out in cold sweat? It is vital that they invest according
to their appetite for risk-taking! Thus, if investor is the kind who'd rather be safe than
sorry, equity funds would not be suitable for them as volatile equity markets can impact
fund returns, so they can imagine what effect they'd have on them.
• Time Frame
How long investor wants his funds to stay tied up? If investor are comfortable waiting for
the money to come to them at some future date or would rather have it as fast as
possible? Would they prefer it in a lump sum or in smaller, regular amounts? Different
funds meet different time-based needs. Generally, equity funds are considered to be
performers over a relatively longer period of time. In the short term, they are prone to
market fluctuations. Thus, if investors have invested in an equity fund, at the time of
withdrawal of their investment, they may not get any returns at all! In such a case, rather
than going for an equity fund, they might consider an income fund or a money market
scheme instead.
• Liquidity
This is linked to the above point. If the time frame of the investment is short, then it is not
really advisable to invest in close-ended schemes. Units of these schemes are generally
listed on stock exchanges, and past experience has shown that they quote at a heavy
discount to their value. So if investors are in a hurry, a close-end scheme may not be
their thing. On the other hand, if they willing to invest for a certain defined period, a
close-ended scheme may be perfect. Not just when investors will get your money - but
also how well the fund will be able to liquidate its portfolio - that's another thing an
investor should look into before choosing mutual fund.
• Transparency
How much investor know about the fund? For their peace of mind and for the safety of
their money, they have to choose a fund that is open about its investments, its investment
style, and has a history of clear and direct communication with its investors.