Unit-I

Introduction to Investment Management

Meaning:

Investment means investing of money. The benefit from an investment is called a return. The
return may consist of a gain (or loss) realized from the sale of a property or an investment,
unrealized capital appreciation (or depreciation), or investment income such as dividends,
interest, rental income etc., or a combination of capital gain and income. The return may also
include currency gains or losses due to changes in the foreign currency exchange rates.
Investors generally expect higher returns from riskier investments. When a low risk
investment is made, the return is also generally low. Similarly, high risk comes with high
returns.

Characteristics of investment:
1. Risk: Every investment contains certain portion of risk. It is a key feature of investment
which refers to loss of principal, delay in payment of interest and capital etc. Most investors
prefer to invest in less riskier securities.
2. Return: Return expectation is the main objective of investment. Investors expect
regularity of high and consistent income for their capital.
3. Safety: Investors expect safety for their capital. They desire certainty of return and
protection of their investment or principal amount.
4. Liquidity: Liquidity means easily sale or convert the capital or investment into cash
without any loss. So, most investors prefer liquid investments.

5. Marketability: It is another feature of investment that they are marketable. It means

buying and selling or transferability of securities in the market.

6. Conceal ability: It means investment to be safe from social disorders, unacceptable levels
of taxation, Government rules etc.,

7. Stability of income: Investors invest their capital with high expectation of income. So,
return on their investment should be adequate and stable.

8. Tax benefits: It refers to plan an investment programme without regard to one’s status may
be costly to the investors for example the burden of income tax upon that income.

Objectives of Investment:

1. Money making objectives: Investors put their surplus money in these kinds of
investment. Their objective is to maximize wealth. Usually, the investors invest in
shares of companies which provide capital appreciation apart from regular income
from dividend.
2. Low priority objectives: These objectives have low priority in investing. These
objectives are not painful. After investing in high priority assets, investors can invest
in these low priority assets. For example, provision for tour, domestic appliances etc.

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 3. Long term high priority objectives: Some investors look forward and invest on the basis of objectiv
4. Short term high priority objectives: Investors have a high priority towards
achieving certain objectives in a short time. For example, a young couple will give
high priority to buy a house. Thus, investors will go for high priority objectives and
invest their money accordingly.
5. Safety and security of funds: Another important consideration in making
investments is that the funds so invested should be safe and secure.

Types of Investments:

1. Physical Investments: Physical investments are tangible assets like motorcars, ships,
buildings , plant and machinery etc.

2. Financial investments: Financial assets are those which are used for Consumption or for
production of goods and services or for further creation of assets. Examples are shares, bonds
etc

3.Marketable investments: which are listed on the stock exchanges are easily marketable
and can converted into cash over a short time example shares, bonds and instruments issued
by government.

4. Non-Marketable investments: non-marketable investments like bank deposits, provident

fund and insurance schemes etc. cannot be bought or sold in the open market in the stock
exchanges and thus are difficult to be converted into cash immediately.

5. Transferable investment: Instrument like shares, bonds can be transferred in the name of
others or can be sold or exchanged for cash or kind,

6. Non-transferable investment: whereas some instruments like insurance certificates,

NSCs, cannot be transferred.

Investment Alternatives/avenues:

1. Negotiable instruments or securities:

These investment alternatives can be traded in the market is called negotiable instruments.

1. Variable income securities:

a. Equity Shares: Shares which do not carry any preferential rights in repayment of
capital. The rate of dividend is not fixed and it varies depending upon the profitability,
financial position of the company.

2. Fixed Income securities:

a. Preference shares: shares which carry preferential rights in respect of dividend

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 payment and repayment of capital are preference shares. These shares carry a fixed rate of dividend an
b. Debentures: These are capital market instruments used to raise medium and long
term capital funds from the public. It comprises of periodic interest payments over the
life of the instrument and principle payment at time of its redemption. These are for
investors who wish to sacrifice liquidity for higher returns.
c. Bonds: They are similar to debentures but are issued by public sector companies.
Its value in the market depends upon the interest rate and maturity of the bond.
Example : retirement benefit bond.
d. Government Securities: These are secured securities issued by central and state
government. The rate of interest on these securities is relatively low but they are
highly liquid and safe.
e. Money market securities: These securities have very short term maturity usually
less than a year for example commercial paper, treasury bills and certificate of
deposit.
f. IVP’s and KVP’s :
These are savings certificates issues by the post officewith the name Indra Vikas Patra and
Kisan Vikas Patra. IVPs have afacevalue of 500,1000, 5000 and KVPs have a face value of
1000, 5000, 10000. The capital is doubled in 5.5 years with 13.47% rate of return. They do
notcarry any tax benefits but are transferable just like bearer bonds.

2. Non-negotiable instruments or securities: These investment alternatives cannot be traded

in the market.

Deposits:

Deposits earn a fixed rate of return.Deposits are as fallows,

a)Bank Deposits –

Banks usually offer three traditional facilities, theyare; current account facility (no interest is paid),
savings account (4-5%interest is paid) and fixed account (7-8% interest is paid).

b)Post Office Deposits –

Fixed deposit and Income schemes at Postoffices provide around 13% to 15% interest rate.

c)NBFC Deposits –

NBFC`s having bet owned funds over 25 lakh canaccept deposits with maturity ranging from 3-5
years and provideinterest rate higher than commercial banks.

d)Tax Sheltered Savings Scheme –

These are beneficial for tax-payingInvestors. They offer tax relief to its participants according to the
taxationlaws. E.g. Public Provident Fund Scheme, National savings scheme, NationalSaving
Certificate, Public Provident Fund Scheme, National Savings Scheme,National Savings Certificate

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e)Life Insurance –

It is a contract for payment of a sum of money to theperson assured or entitled on happening of an

insured event or at maturity.It also provides tax benefits to the person buying the insurance scheme.
E.g.Basic Life Insurance: Whole Life Assurance Plan, Endowment AssurancePlan, Term Assurance
Plans, Plans for Children, Pension Plans

(3) Mutual Funds

A mutual fund is a professionally-managed investment scheme, usually runby an asset management

company that brings together a group of peopleand invests their money in stocks, bonds and other
securities.An investor can buy mutual fund ‘units’ which represent.

There are two types of mutual fund are as follows:

* Open ended mutual fund

* Close ended mutual fund

(4) Non-Financial Instruments or Real Assets:

These Investment alternatives usually form the major part of the investor`sportfolio. They include:

a)Gold and Silver –

They provide best protection against inflationarytendencies in an economy.

b)Real Estate –

They provide high returns to investors but require highinvestment and long term commitment. This
investment alternativeincludes investment on land, buildings, any personal and property.

c)Antiques –

They usually guarantee safety of investment. A price riseis generally due to increased interest of
collectors or increased so.

Investment V/s Speculation:

Meaning of Speculation

Speculation involves trading a financial instrument involving high risk, in expectation of

significant returns. The motive is to take maximum advantage from fluctuations in the
market. The people involved are called speculators. Speculators are prevalent in the markets
where price movements of securities are highly frequent and volatile. They play very
important roles in the markets by absorbing excess risk and providing much needed liquidity
in the market by buying and selling when other investors don't participate.

Basis Investment Speculation

Meaning Purchase of an asset/Security Executing a risky financial

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 for securing stable returns. transaction with a hope of profit making.
Time Horizon Long Term Short term and generally less
than a year.
Risk levels Moderate High
Deployment of funds Investor using funds of self Borrowed funds
Investor attitude Cautious and conservative Aggressive and risk takers
Expectations of returns Fundamental and basic Technical charts, market
factors i,e financial psychology and individual
performance of the company opinion.
sector

Investment V/s Gambling:

Gambling refers to wagering money in an event that has an uncertain outcome in hopes of
winning more money, whereas speculation involves taking a calculated risk in an uncertain
outcome. Speculation involves some sort of positive expected return on investment—even
though the end result may very well be a loss.

Basis Investors Gambling

Funds availability Own funds and looking to Have wealth and looking to
create wealth have fun
Time Horizon Long term Short term
Basis of decision Analysis of fundamentals of Random
underlying asset and
company
Risk Reasonable and moderate Very high risks and odds of
risk winning are very less
Returns Reasonable returns over a Depends upon Luck and
longer period of time in most odds
of the cases investment will
earn profit
Stability of income/growth Stable No stability
Type of investors Cautious and conservatives Ready to lose original
investment/investing for
fun.zsde3

Types of Securities:

Securities refer to an investment that can be freely traded in the market and provides a right
or claim on an asset and all future cash flows generated by that asset.

A) Shares:

1. Equity shares: a company’s share capital is divided into a number of equal indivisible
units of fixed amount, each of which is called a share. Shares which do not carry any

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preferential rights in repayment of capital and dividend payments are equity shares. The rate of dividend is no

2. Preference shares: shares which carry preferential rights in respect of dividend payment
and repayment of capital are preference shares. These shares carry a fixed rate of dividend
and preference over equity share holders in dividend payment and they don’t have voting
rights in the management of the company.

3. Non-voting shares: these shares are entitled to the same stream of benefits of equity shares
but carry higher dividends as they do not have any voting rights. On non-payment of dividend
for 2 years these are automatically converted into voting shares.

4. Right shares: These shares are offered as additional shares after the original issue to the
existing shareholders of the company. Existing shareholders can subscribe to these in
proportion of their existing holdings. These are issued to finance fund requirements of the
company in times of need. They are usually offered at a discount. These can be issued only
after two years of the formation of the company or one year after the first share of allotment,
whichever is earlier.

5. Sweat Equity shares: these are equity shares that are issued by a company to its board of
directors and employees at a discount or for consideration other than cash for providing
managerial or technical knowhow or for providing or making available some intellectual
property rights or value additions to the company. They form a part of the existing equity
share capital of the company.

6. Bonus shares: Bonus shares are issued for free to existing shareholders of the company by
converting the reserves/profits of the company into share capital. It involves capitalisation of
the reserves of the company. These are issued for providing capital gains to shareholders out
of company profits, when the business is in a profitable position.

7. Share warrant-It is a document issued by a public company that provides the right to the
holder of the document to buy a specified number of shares at a specified time. The bearer
does not enjoy the same benefits as equity share holders. Share warrants can be freely traded
in the market but require a prior approval of the central government before it is issued.

B) Bonds and debentures: These are long term debt instruments consisting of a promise by
the issuer to pay a stipulated stream of cash flows in the future to the person holding the
security Example government securities, savings bonds. They are used to raise long term
capital funds from the public. Such a security comprises of periodic interest payments over
the life of the instrument and principle payment at time of its redemption.

C)Derivatives:The primary purpose of derivatives is to minimize your risk and earn profits.

1)Forwards:

Forwards are customized contracts between a buyer and a seller based on an underlying asset
at a pre-decided price, quantity, expiration date, etc. I am sure after reading the word
customized, you must have guessed that forwards are OTC instruments. You are absolutely

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right! Hence, forwards being a private transaction, do not trade on exchanges.

2)Futures:

Futures are standardized contracts between a buyer and a seller based on an underlying asset
at a pre-decided price for a later date. We can say that futures are an advanced version of
forwards. They are highly tradable due to the involvement of the exchanges. This also
removes the counterparty risk on the traders’ part. Investors and businesses use future
contracts to hedge and speculate against the volatility in pricing

3)Swaps:

swaps enable the buyer and the seller to exchange their revenue streams based on an
underlying asset. These are again OTC instruments so no exchanges are involved in the
transaction. Investors and businesses use swaps to hedge and speculate against the volatility
in pricing. The most common types of swaps are interest rate swaps and currency swaps.

4) option:

options are contracts that give the buyer a right but not the obligation to buy or sell the
underlying asset at a pre-decided price. The buyer of the option has to pay a premium to the
seller. You must have heard about the call and put options that are widely known amongst
traders. These are commonly used to hedge and speculate against portfolio risk.

There are two types of options are as fallows:

* American options

*European options

Various Types of Investors:

There are various types of investors such as individual investors, partnership/HUF,

companies, mutual funds, societies and trusts, financial institutions and foreign institutional
investors.

1. Individual investors: In India, individuals form a major part of the securities market in
terms of numbers. The individual investors in India are further divided into two categories in
case of initial public offering:

a. Retail Investors-one who can apply for shares of an amount less than Rupees 1, 00,000.

b. High net worth Individuals-One who can apply for shares of an amount of rupee1,00,000
or more.

2. Partnership/HUF: An association of members or group of peoples those who form a

partnership firm or a joint Hindu family who have their HUF business and wants to invest

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their surplus fund into securities market to earn returns on it, falls under this category of investors.

3. Companies: Also termed as corporate investors, companies can also operate as individual
investors for which the board should be authorised by the memorandum of articles.

4. Societies and trusts: These are also associations of members. But they have to be
empowered by their by-laws to invest in the security markets. Here the income earned by
such investment should be invested for the objectives for which the society is formed.

5 .Mutual Funders: It is a form of collective investment by investors. A mutual fund collects

money from many investors and invests such pooled fund in stock market. Income is received
in the form of capital gains, interests or dividends or securities.

6. Financial Institutions: They are the major investors in terms of volumes and values in the
securities market both in the primary and secondary market. This includes banks, insurance
companies, pension funds and venture capital companies.

7. Foreign Institutional Investors: This is an entity formed or incorporated outside India

with the purpose to invest in India. These entities are required to be registered with SEBI and
foreign institutional investors.

8. Sovereign wealth fund: Refers to a pool of funds by the government, they usually have
high risk tolerance, long investment horizon, and low liquidity needs.

9. Insurance companies: insurance companies have high liquidity needs with investment
horizons ranging from short to long. Insurance companies invest the premium of customers
and fund customers claim as they occur.

10. Bankers: They are investors with high liquidity needs and a short investment horizon.
The main aim of a bank’s investment is to earn more on the bank’s loans and investments
than what the bank pays for her deposits.

Meaning of portfolio:

It refers to collection of financial investments like stocks, bonds, commodities, cash and cash
equivalents, exchange traded fund etc., people generally believe that stocks, bonds and cash
comprise the core of a portfolio.

Meaning of Portfolio Management:

It refers to managing an individual’s investments in the form of bonds, shares, cash, mutual
funds etc., so that he earns the maximum profits within the stipulated time frame. Portfolio
management refers to managing money of an individual under the expert guidance of
portfolio Manager.

Diversification:

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It is a process of allocating capital in a way that reduces the exposure to any one particular risk. Diversificatio

Benefits of diversification:

1. Reduces Portfolio Risk:

The overall risk in any portfolio is a combination of two types of risks: systematic and
unsystematic. Systematic risk, also referred to as undiversifiable risk, is essentially the
overall market risk which all stocks are exposed to and which cannot be mitigated through
diversification.unsystematic risk is specific to a company and/or industry and can be
diversifiable.This risk could be mitigated if the portfolio was diversified into a number of
different stocks in different industries

2. Enhances Risk Adjusted Return:

When evaluating the return a portfolio, it isn’t enough to simply look at the final number.
Just as important is the need to look at the risk it took to get that return. For example, let’s
say two separate portfolios yielded 7% for the year; however one was diversified while the
other was concentrated in biotech stocks only.

3. Balancing your Economic Balance sheet:

Every individual’s assets are made up of two main components: financial capital and human
capital. Financial capital are all tangible (i.e. real estate) and intangible (i.e. stocks) assets
owned by an individual. Human capital, also called net employment capital, is an implied
asset; that is the net present value of an investor’s future income taking into account the
probability of survival. Combined, these two components make up the assets on an
individuals Economic Balance sheet.

4. Increase exposure = Opportunity:

A diversified portfolio strategy will expose an investor to assets, sectors, and stocks that the
investor may not otherwise be exposed to. Markets often experience a period of rotation
where certain sectors see an inflow of capital at the expense of another, resulting in one sector
outperforming another. This means that the worst performing sector – or market – could
potentially be one of the best performing in the following year.

5.Keep Calm & Diversify On:

A diversified portfolio reduces the time spent in monitoring the portfolio, helps better achieve
long-term investment, and in turn brings more peace of mind. A diversified portfolio is more
stable because not all investments will move in sync, making it less susceptible to huge
movements in the market. In addition, a more predictable return with less volatility can help
investors not to lose focus and/or get emotional, resulting in a bad investment decision.

Others benifits are as follows:

1. Minimising the risk of loss by investing the money in better performing investment

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 from poorly performing investment.
2. Some investors who are close to retirement have goals oriented towards preservation
of capital and diversification can help protect investors savings.
3. All investments always don’t perform as expected but diversifying the investment the
investors can generate returns.

4. A diversified portfolio is more stable and reduces the time spent in monitoring the
portfolio.

5. Diversification of the portfolio will balance the risk and return associated with different
funds. Example investing in fixed deposits, investors benefit from a fixed return and a low
risk.

6. Helps keep the capital safe by allowing investors to achieve their investment plan.

7. The biggest advantage of diversification is peace of mind because when the total
investment is guaranteed of repayment after maturity.

8. It helps to increase annual returns through spreading their investment across different
asset classes.

Meaning of Risk:

As the chance that an outcome or investments actual gains will differ from an expected
outcome or return. Risk includes the possibility of losing some or all of an original
investment. An investment whose returns are fairly stable is considered to be a low-risk
investment for example government bonds. Whereas an investment whose returns fluctuate
significantly is considered to be a high risk investment example equity shares.

Elements of risk: Risk in holding Securities such as shares, debentures has divided into two
groups:

First group: factors that are external to a company and affect a large number of securities
simultaneously. These are uncontrollable in nature.

Second group: Factors which are internal to companies and affect only those particular
companies. These are controllable to a great extent.

The risk produced by the first group is called systematic risk and that produced by the second
group is known as unsystematic risk.

Therefore Total risk=Systematic risk + Unsystematic risk.

Systematic Risk:

As society is dynamic, changes occur in the economic, political and social systems
constantly. These changes have an influence on the performance of companies and their by on
their stock prices. But these changes affect all companies and all securities in varying degrees
and are called systematic risk

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Types of systematic risk:

1. Interest rate risk: It particularly affects debt securities like bonds and debentures. The
market price of debt securities fluctuates in response to variations in the market interest rates.
This variation in bond prices caused due to the variations in interest rates is known as Interest
rate risk.

2. Market risk: It affects shares. Market prices of shares move up or down consistently for
some time periods. A general rise in share prices is referred to as bullish trend and general fall
in share prices is referred to as a bearish trend. Therefore stock market is seen to be volatile.
This volatility leads to variations in the returns of investors in shares. The variations in
returns caused by the volatility of the stock market are called the market risk.

3. Purchasing power risk: It refers to the variation in investor returns caused by inflation
(General increase in the prices of goods and services) or a rise in the cost of living.

4.Exchange Rate Risk

In a globalized economy, most companies have exposure to foreign currency. Exchange rate
risk is the uncertainty associated with changes in the value of foreign currencies. Therefore,
this type of risk affects only the securities of companies with foreign exchange transactions or
exposures such as export companies, MNCs, or companies that use imported raw materials or
products.

Unsystematic risk:

The returns from a security may sometimes vary because of certain factors affecting only the
company issuing such security. Examples are raw material scarcity, labour strike, and
management inefficiency.

Types of unsystematic risk:

1. Business risk: It is an unsystematic risk that is caused by external as well as internal issues
within a company for example regulations, economic environment, monetary policies by
governments, consumer preference, competition.

2. Financial risk: is applied to individual, business and government entities and relates to the
fact that there is a chance that stakeholders can lose their money. It actually relates to the
capital structure of the organisation. The manner in which a company raises required funds
for its growth has a direct impact on future earning and stability of a business entity.

3. Operational risk: can happen from negligent or unforeseen events like an error in the
production process.Operational risk is tied to operations and the potential for failed systems
or policies. These are the risks for day-to-day operations and can result from breakdowns in
internal procedures, whether tied to systems or employees.

4. Strategic risk: Occurs when the company is selling its products and services in unfruitful
industry.A company may also encounter this risk by entering into a flawed partnership with

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 another firm or competitor that hurts their future prospects for growth.

Measurement of risk:

1. Standard deviation:

Is a measure of the amount of variation or dispersion of a set of values? Portfolio standard

deviation is the standard deviation of the rate of return on an investment portfolio and is used
to measure the volatility of an investment. It measures the investments risk and helps in
analysing the stability of returns of a portfolio.

2. Probability Distribution: is a statistical function that describes all the possible values and
likelihood that a random variable can take within a given range for example If you flip a coin
the probability distribution has two possible outcomes (heads or tails) and each outcome has
a50% chance of occurring. To describe the single most likely outcome from a particular
probability it is necessary to calculate its expected value. The expected value is the average of
all possible return outcomes, where each outcome is weighted by its respective probability of
occurrence.

3. Beta: is a measure of the volatility or systematic risk of a security or portfolio compared to

the market as a whole. It is important to note that bet measures a security’s volatility or
fluctuations in price, relative to a benchmark, the market portfolio of all stocks. Stocks can be
ranked by their betas. Stocks with high betas are said to be high risk securities.

Expected return of stocks:

It is the profit or loss that an investor anticipates on an investment that has known as
historical rate of return. The expected return is the amount of profit or loss an investor can
anticipate receiving on an investment. An expected return is calculated by multiplying
potential outcomes by the odds of them occurring and then totalling these results.

Pros
 Gages the performance of an asset
 Weighs different scenarios

Cons
 Doesn't take risk into account
 Based largely on historic data

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