NISM Investment Adviser: Study from POV of an individual / household

Financial Planning: Streamlining I&E, A&L for present and future needs for funds
Assessing current financial position, identifying the future goals and bridging the gap
between the two (via alignment of finances) is financial planning
IA must understand 2 things: dynamics of investment products & financial needs of client
Elements of financial planning:
- Personal FA: Goal setting (with priorities): Realistic, value-ascribed, time-bound
- Cash flow budgeting: Ensuring enough inflows to meet outgoes
- Insurance Planning
- Debt Management Counselling
- Investment Management and asset allocation
- Tax Planning
- Retirement Planning
- Estate Planning

 Differentiating between adviser & distributor – distributor to earn from product /

service provider AND adviser from client + compulsorily register with SEBI
 Three types of business models – advisory fee, execution-commission. and wraps &
platforms

 1 365
450

1/1/450/365

365/450

 Annuity – series of payments at regular intervals (payment at start: annuity due; payment at
end: ordinary annuity; payment goes on forever: Perpetuity {PV = C/r%})
 Cash flow – starting point of personal finance process
 Total income – total expenses = savings -> allocation -> investments and emergency funds
 For budget – first enlist heads of income (regular, etc.), followed by expenses (mandatory,
essential, discretionary – that can be cut down in case required)
 Budget calculations: Gross salary + investment income – (fund contro. + taxes) = Net Income

Total income – (total expenses + investments) = Monthly surplus

Investments + contributions + monthly surplus = Total Net Savings

Total Net Savings / Total Gross Income = Savings Ratio or Velocity

 Balancing the need and availability of cash – Cash Management

 Total Gross Income – Mandatory Expenses = Disposable Income
 Best way to expand savings: Controlling expenses & rationalizing debt
 Budget is prepped basis forecasting
 Financial assets represent a claim on the benefits underlying the asset (not the property)
 Savings ratio + expenses ratio = 1
 Non-recurring expenses EXCLUDED from the expense-ratio equation
 Leverage ratio: Total liabilities / total assets
 Net worth: TA – TL
 Solvency Ratio: NW / TA
 Leverage + solvency ratio = 1
 Keep balance between liquidity and long-term superior returns
 Liquidity Ratio: Liquid assets / Monthly expenses (ideal 4-6)
 Liquidity Ratio (Goals POV): Liquid assets / NW
 M&M theorem – leverage benefits in improving real RoI
 Windfall Gains: Draw down debts & invest for the future
 No PPC on home loans as per RBI mandate
 Mortgage: ImP- home loan; pledge (wrt contract): MP (possession with lender)- gold loan;
hypothecation: MP (possession with borrower)- car loan
 Decision on loan restructuring depends upon: affordability and PV of future cash outflows
 Calculating EMI: PMT function; calculating P+I EMI breakup: PPMT / IPMT
 Decision to deploy additional money/ windfall: Cost of retaining debt v RoI over longer term
 Money & bond markets – largely dominated by large players and institutions
 Total margin: VaR (upfront) + ELM (post execution) + M2M (post hrs. in case of c/f)
 Clearing house – deemed counterparty in all trades on the SE; takes on CP risk; if trading
member defaults, CH honours; if CH defaults, Core SGF is used to honour
 ESH are residual owners and residual claim holders
 Equity investment: 2 rewards – DD + capital appreciation
 The most important question: Do I understand the business?
 FCFF: CFs to both equity and debt (prior to interest) – use WACOC as disc. rate
 FCFE: CFS to only equity (after interest) – use cost of equity as disc. rate
 TTM P/E: MP/(sum of EPSs of last 4 quarters); forward P/E: MP/(sum of next 4Q EPS
estimates)
 P/B – used in valuing BFSI stocks as, in BFSI, A&L are recorded on an M2M basis
 P/S ratio: MCap/TTM sales (reliable – sales can’t be manipulated; good for loss making cos.)
 PEG: P/E ratio / Annual EPS Growth rate (more reliable and complements P/E ratio)
- PEG = 1  Aptly valued; PEG < 1  undervalued; PEG > 1  Overvalued
 DCF and relative valuation complement each other
 Technical analysis: assumption of efficient market hypothesis (all the info. already been
discounted) – three key variables: price, volume, time; looking at trends, graphs, charts and
diagrams. Identifying support and resistance level (buying and selling interest, respectively)


 CG acts as cornerstone for valuing companies and forming investment universe

 Corporate debt market is cheaper v traditional banking credit
 Bond characteristics: pays periodic interest + principal (FV) on maturity
 If mkt rate of i > bond coupon rate: Bond MP < Bond FV (and vice-versa)
 Company can only issue one class of equity; and multiple bond classes
 Typical FV of G-sec: 100; typical FV of corporate bond: 10,000
 Interest paid on face value
 Bond prices may be at premium or discount to the FV, however, at the end, FV is redeemed
 T-bills & CPs – no interest. Par redemption value – discounted purchase price is the returns
 Bond price: sum total of the present values of all the future cash flows of a bond


 ZCB produces single cash flow, at maturity (FV redemption – discounted acquisition price)
 Dirty price = clean price + accrued interest
 Day count convention in the Indian bond/ G-sec market – 30 days per month/360 days in a
year
 Day count convention in the Indian money market – actual days in month/365 days in a year
 Effective yield = nominal yield + compounded reinvested returns (effective yield takes in
account power of compounding)
 Yield curve is the relationship between yield and time-series of a bond – upward sloping
curve (YTM increases as the HTM period increases)
 4 types of yield curve:
- Normal – upward sloping; long term yield > short term yield
 - Inverted – downward sloping; short term yield > long term yield
- Flat – no slope, flat line parallel to time-series X axis; yields constant across maturities
- Humped – Medium term yield > short & long-term yields
 Money market – primary source of transmission channel for central bank to pass on the
effects of changes in monetary policies
 G-sec market: most active segment in the Indian fixed income securities market
 STRIPS: Converting a regular G-sec into a ZCB by stripping and trading as independent
securities, the principal STRIP and coupon STRIPS; attractive for retail/NIIs as no re-
investment risk
 Derivatives: Contract that derives its value from the asset which it is based upon (underlying)
- Future: Obligation to execute (buy/sell) at agreed-over price in the future, irrespective of
the market price at the time, for both the counter-parties
- Option (Call / Put): Option buyer has no obligation to execute (buy/sell) a transaction in the
underlying asset; can decide by comparing the agreed-over price with the MP at the time. If
chose to let the option to expire, the only maximum possible loss is the premium paid to the
seller/writer of the option who has/had an obligation all along to execute the transaction
without any choice and for whom, the maximum possible gain would be the premium on a
forfeited option, while the maximum possible loss could be indefinite depending upon MP
 Derivatives used for three purposes: Hedging, arbitrage, speculation: help in transfer of risk
from investors with low-risk appetite (hedgers) to traders/ speculators
 The underlying for a commodity option is commodity futures – that is, a commodity option
buyer gets the right to take a position on the said commodity’s future contract rather than
the actual commodity (a.k.a. ‘exotic option’)
 Price of futures contract: Spot price + net carry cost until maturity (based on interest
rate/time value of money)
 An option has an asymmetric pay-off: the upside and the downside are not the same, a lot
depends upon extent of price movements; Futures, as a hedge, has a symmetric payoff
(what is lost in the cash portfolio value is made up for, by the gains in futures position and
vice-versa)
 MF NFO subscription period: max 15 days
 Units allotment to an NFO subscriber: 5 business days post closure of NFO subscription
 Investors can invest in fund post closure of NFO subscription in case of open-ended funds
 Cut-off timings: The phase of the day by which an order is placed and received by the MF
house decides NAV applicable on a purchase/sale/switch-over order
 M2M: When the portfolio gains and losses are settled on a day-to-day basis i.r.t. market
value when the positions are carried over. The settlement takes place daily/periodically to
reflect the fair value of an asset/investment
 M2M for MF: Process of valuing the MF scheme portfolio on daily basis at the current
market prices/values is Marking to Market.
 Association of Mutual Funds in India (AMFI): Oversees the entire functioning of the MF
industry and represents the interests of the MF industry
 Short term debt funds: focus on coupon streams – less volatile
 Long term debt funds: focus on coupon streams + capital appreciation – more volatile as
affected by inverse correlation between bond’s market prices and market yields and interest
 Corporate debt portfolio earns higher interest income v sovereign debt portfolio thanks to
the associated credit risk levels
 Greater the macaulay duration/maturity, greater the impact of interest rate risk
 Watermark principle: Once a ‘x’ gain has been achieved, then the performance linked fee
would apply (for subsequent periods) only when the past milestone ‘x’ gets crossed

 Catchup/no-catchup concept: Catchup clause says, in case of achieving hurdle rate, profit
sharing to apply on the entire gain amount; NO catchup: Profit sharing only on amount over
and above the hurdle rate

 Regular / Direct Plan of MF & PMS: Regular means thru broker or distributor (higher cost as
commissions to be paid out, lower returns); Direct means no intermediary (no commissions,
greater returns)

 VC – AIF that provides early stage financing after angel round; PE – AIF that typically invests
in later stages of financing, provides growth capital to cos. that have established a proven
business model

 Harry Markowitz – Nobel laureate in Economics 1990, for Portfolio Selection Theory/Modern
Portfolio Theory that quantified benefits of diversification through covariance and
correlation between investment assets, and portfolio construction that lead to modern
portfolio theory

 3 types of investors: Risk-averse, risk-seeker, risk-neutral

- Risk-averse: Assign a lower Certainty Equivalent Rate (CER is the rate any risk-free
investment MUST offer to be equally attractive as a risky portfolio) to a risky portfolio v a
risk-free portfolio and reject risky investments
- Risk-seeker: Assign a higher CER to risky-portfolio v a risk-free portfolio and reject risk-free
- Risk-neutral: Risk does not matter. The decision between alternate investment classes
depends upon rate of return only. The CER for them is the expected rate of return on risky

 Risk-seeker makes an upward adjustment to their utility, while the risk-averse makes a
downward adjustment to their utility
 ERR for individual stocks: Sum of potential returns in different scenarios * probability of
those returns
 Risk is the variance in return. Standard deviation and variance may be used
 Correlation Coefficient varies between +1 and -1; +1 means perfect positive correlation,
movement of variables in the same direction in a linear manner; -1 means perfect negative
correlation, movement of two variables happens in opposite directions in a linear manner
 Variables that affect the portfolio risk are:
- Weightage of investments
- Risks inherent in each of them
- Co-movements between investments within the portfolio
 For portfolio analysis, the number of covariance terms to be found out, for n = number of
securities, is:

(N2 – N) / 2

 Optimum portfolio is a basket of securities with individual and combined desired risk-return
profile given a set of constraints
 Variables to be considered to apply Modern Portfolio Theory for portfolio construction:
- Expected rates of return
- SD & Variance i.e. risk i.r.t. estimated rates of return
- Correlation coefficient between and among various asset classes
 Asset allocation: Distribution of wealth between, into and among various asset classes (debt,
equity, real estate, etc.)
 Correlation measures, both, direction and strength/magnitude of the relationship between
two variables
 Correlation is the most relevant factor to reaping the benefits of diversification and reducing
the portfolio systemic risk
 Investment objectives: Risk-return-liquidity based
 Sustainable investing: Investing to earn financial returns while at the same time ensuring
positive impact on the society. Based on ESG. Converges with set of broadly accepted
guidelines and principles.
 Ethical investing: Investing as per personal moral values. Need not converge with ESG,
necessarily.
 Understanding and helping the investors chart out a goal-sheet:
Sr. No. Goal Time horizon/frame Amount reqd. Priority ranking

 Psychographic analysis of investor: Helps bridge the gap b/w rational and irrational side of
the investor. Treats them as animals capable of making errors in judgments driven by biases,
prejudices, notions, personality traits and behavioral characteristics.
 BB&K psychographic analysis: Classification of investor personalities on 2 factors: level of
confidence AND method of action
 Life cycle analysis of investor: accumulation, consolidation, spending, gifting
 2 most important factors leading to asset allocation: interaction between 2 sets of variables
– about the investor and the risk-return profiling carried out in light of capital/financial
market conditions
 Portfolio rebalancing: ensuring the original risk-return profile is maintained. Need for
rebalancing arises on account of changes in prices and market conditions as a result of which
original asset allocation may have gotten disturbed. Or there’s been a change in the
investor’s needs and objectives, risk appetite etc. Investor Policy Statement should include a
sub-policy providing for such rebalancing along with frequency and extent
 A proper portfolio performance measurement and evaluation incorporates risk-return both
 Calculating single holding period return: use Holding period return (beginning value, ending
value, incomes earned in the interim)
 Calculating return across multiple holding periods: Time weighted / money-weighted rate of
return (MWRR = IRR – influenced by timing of cashflows)
 TWRR – Not influenced by timing of cash flows; the returns are calculated each time there’s
an external cash flow, otherwise the TWRR is same as HPR; uses the concept of relative
wealth; SEBI PMS Regulations require discretionary PMS to report performance using TWRR
for the last 3 years
 Arithmetic return v Geometric return: Arithmetic only focuses on yearly return; GM focuses
on overall compounded return and is therefore a more holistic approach to calculating
returns (process to calculating TWRR is same as GM)
 Gross return: Returns prior to deducting the fees, taxes, commissions, brokerages and any
other related costs associated with the investments; helps in gauging the operational
performance of a portfolio
 Net return: GR – all the cost; what the investor actually receives in hand
 Cash drag adjusted return: The denominator to have entire capital
contribution/commitment while calculating returns, instead of only the invested amount,
even if some portion lies uninvested in long term intended investment and instead is idle /
deployed into liquid funds or other C&CE not earning much returns. Ignoring the uninvested
portion will lead to a deceptive increase in the returns %
 Capital Commitment – Upfront fee = AUM +/- P/L = PV at the end – other expenses = PV
after other expenses – Fixed Management fee – performance fee (see catchup / no-catchup
& whether hurdle crossed in the first place) – exit load (in case of premature exit) = Portfolio
value at the end/ exit portfolio – benchmark return = Alpha return
 Beta: Measure of risk; compares how much an asset moves when the whole market moves
up/down and the amount of volatility it adds to the entire portfolio
 Alpha return: reward for bearing non-market risk; beta return: reward for bearing market
risk
 Portfolio return: Sum total of weighted average returns of all individual securities in a
portfolio
 Total risk: Talks about the variability in the expected returns of the portfolio, measured by
standard variation and variance
 Downside risk: Talks about the possibility of losses in a portfolio as measured by semi-
variance/ semi - SD
 Standard deviation and variance are used as a measure of risk
 Lesser the correlation between investments in a portfolio, lesser the portfolio risk
 Tracking error: Difference in the returns of market index v portfolio returns on account of
mismatches in the risk profiling
 Systemic risk: Related to beta; can’t do it away, only hedge; due to DD-SS across many
markets. Factors beyond the control of anyone
 Non-systemic risk: Related to alpha; can do it away, diversify; factors are generally
co./industry/sector specific
 Sharpe ratio: Measures excess return generated as a result of bearing the risk of volatility of
an asset (risk-adjusted return measure; relative to standard deviation); ignores
diversification
 Treynor ratio: Measures excess return relative to systemic/ beta risk; does NOT ignore
diversification
 Use sharpe for non-diversified/ concentrated portfolio; treynor for diversified portfolio
 Sortino ratio: Measures excess return relative to semi-SD; i.e. in relation to downside risk
 FOREX/ Currency risk comes into play when investments are made in more than one
jurisdiction in multiple currencies.
 KYC is done to ensure prevention of ML under PMLA
 Client onboarding involves PAN, KYC, allotment of UCIC
 The limit for PAN-less transactions: 50k
 KYC involves verification of proof of identity and proof of address
 C-KYC: KRA; E-KYC: UIDAI
 Only the joint holders can make changes to nomination, a power of attorney holder cannot
 Option is an example of ‘assignment’
 Once a minor has turned major, they’ll have to surrender the old PAN card, in return for
which they’ll be issued a new one with the same number
 For change in status from RI to NRI, close the resident savings account and transfer the
balances to NRE/ NRO/ FCNR account; surrender existing FD receipt, and get a new one
issued
 Any capital market debit/ credit happens only through the primary/ first holder’s bank
account
 In case of intra-bank transfer of funds, internet banking maybe used; for inter-bank transfer
of funds, NEFT/ RTGS to be used (provided, both, the sending and receiving banks have it)
 Limit for cash-based MF investments – 50k per investor per MF per FY. Any payment out of
MF to the investor must be through banking channel
 Amount being invested should come only from the investor/ first holder’s bank account
 Making MF investments through the SE platform is the best way to render IA
 Insider: either a connected person, or have possession of / access to UPSI
 Any IA given through broadcasting medium and available to the public at large is not to be
construed as IA under SEBI IA regulations
 Minimum net worth requirement for individual RIA: 5L; for non-individual RIA: 50L
 An individual RIA with a client base of more than 150: Deemed non-individual RIA
 NO transaction contrary to the advice given to the client for a period of 15 days.
Loophole: Give revised assessment to the client at least 24h prior to entering the transaction
during the said period of 15 days
 Any change in the control / management of the IA, shall require prior approval of SEBI
 The exercise of analyzing all the relevant information of the investor and assessing the risk
appetite is risk-return profiling
 Document and record preservation period by IA: 5Y
 An IA may provide even execution/ implementation services to the client at zero cost
 IA regulations also for advisors setup shot in the IFSC
 Negotiable instruments act: bills of exchange, promissory note, cheque (payable to order or
to bearer)
 Number of five parts in the IBC: 5
 Ethics are moral principles – define a person’s behavior – go beyond what has been
prescribed in the letter of law
 Ways to solve a dilemma: developing a set of specific principles, applying those to the
situations and taking decisions as to produce maximum good for all, or least damage to all
 IA must act on the principle of utmost good faith – uberrimae fidei
 Compliance audit to be done by a PCA on a yearly basis; the IA to disclose material audit
observations to the clients
 IA offices must give clearly the details of compliance officer, managing partner/ CEO /
proprietor. In case the response of an IA on a grievance raised is inadequate, issue could be
escalated by registering the same through SEBI Scores Portal
 Banking ombudsmen are appointed by the RBI
 Bank has 1 month to resolve before ombudsman can be approached
 Insurance ombudsmen are appointed by GoI
 Insurer has 2 weeks before ombudsman can be approached
