Investment and Investment

Products

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Concept of Investment
• act of putting in tangible or intangible with expectation of getting returns, profit, income,
interest, appreciation.
• Tangible- Capital investment, working capital investment, financial assets, real estate,
Invest commodities, etc.
• Intangible- Mother cooking food, Help in cleaning dishes, get flowers for spouse, sharing
food with colleagues, buying a new car for family, etc.

Investment • Commitment to act of putting in tangible or intangible with expectation of

getting returns, profit, income, interest, appreciation.

•Set of financial and/or nonfinancial instruments formed

by the fund manager through defined process
Portfolio •Examples: shares, derivatives, ETF, FoF, Commodities,
Real Estate, Private Investment, Art.

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Investment Objective from Investor perspective

Investment
Objectives

Safety Income Growth Liquidity Tax Savings

More than 1 objective – Success of 1 comes at the expense of other.

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Safety

• Safety of investment
• Low risk Low return
• Gsecs
• Secured corporate bonds
• Money Market instruments
• FDs by banks

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Income
• Sacrifice their degree of safety in order to get uptick in yields
• To match near the inflation
• Corporate bonds with lesser risk
• Low quality Junk Bonds
• Dividend income

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Growth
• Less concerned with safety
• Highly volatile
• High risk higher return higher loss
• Equity
• Blue chip stocks offer greater safety compared to mid and small cap

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Liquidity
• Assets/ products easy to cash in
• Meet short term or long term objectives
• Meet immediate needs/emergencies
• Better price
• Transparency
• Quality papers

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Tax Savings
• Income/ interest income- higher
• Capital gain –lower
• Optimal tax planning under Sec 80C – maximum deduction upto rs.
1.5 lacs per year.
• Schemes under Sec 80C
Life insurance premium, EPFO, NSC, ULIP, Housing Loan, ELSS, Tuition
fees for two children, Bank FD tax saver, Senior citizen saving schemes

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Investment Objective from Fund Manager perspective

• The Investment Objective for the fund segment focuses towards

safety / capital preservation while optimizing returns.
• It defines a disciplined approach to investing in securities
• Employs a combination of top- down and bottom- up process.
• All investments are subject to SLR Process where:

o S stands for Safety of Investment

o L stands for Liquidity of the portfolio and
o R stands the returns of the portfolio

• For any financial instrument, Fund Manager first looks at the

safety of the investments, and then at the liquidity of the
instrument and finally the returns of the portfolio. Thus creating
Value Creation through process implementation.

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 Investment Goals
• Is to create value for investors by keeping the objective of the fund
intact and beating the inflation over a defined period.
• It is to enhance the return on investment of the investors
• Meet the personal needs or requirements of the investors over a
planned period.
Investment
Goals

Capital Regular Short Term

Personal Tax Savings
Appreciation Income Gains

Portfolio Managment and Mutual Funds IBS Sem IV 2021 10

 Client Categorization- Investor based on Age_Life Cycle
Planning
20- 30 years

• These are new earners and with many starting their careers in their early 20s. The lifestyle,
spending habits and financial commitments are different for these individuals as compared to
those in their 30s and 40s.

• Major percentage of this group has student loans to repay, and a fast moving lifestyle to keep up
with.

• They are low or almost zero in terms of liability i.e. EMIs are avoided.

• With the promise of regular income, the risk appetite of the this age group is the highest which
allows them the opportunity to be highly aggressive with their financial risk profile.

• They can have luxury of having a major portion of your asset class invested in equity. 75 percent
or more equity investment and balance in debt and cash investments.

• it will be their very first time investing so it is important to understand that investments in equity
carries market risk and must be navigated carefully.
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31-40 years
• The financial goals of this age group is more inclined towards making big
decisions pertaining to marriage expenses, buying of a house or property, etc.

• By this time period, most people will have a stable job with their career on the
right course having accumulated a certain number of work experience as well.

• This is good news as it allows you to have an appetite for risky investments with
an aggressive approach. With the scale of your income and its regularity, you
have the bandwidth to allocate a good portion of your investment, about 60
percent, towards equity investments while the remaining can be distributed
between debt and cash.
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41-50 years

• This group is probably are loaded with responsibilities, like; supporting your
parents, funding the education of your children or just making adjustments to
your new role as a parent, etc.
• These responsibilities stretch your income, and your investments tend to focus
slightly more towards less riskier assets compared to when they were in 30s . It
will be moderate riskier asset mix..
• Equity still remains the major occupant of your portfolio, its allocation must be
brought down to a safe level to 50 percent, while 50 percent will be in debt and
cash.

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51 – 60 years
• The pre-retirement age is that crucial junction in any investors life when their
investment focus is based on the knowledge that very soon their regular income
would halt and that provisions need to be made for a comfortable retirement.

• It is in this phase of your investment journey that you replace the dominance of
equity from your portfolio with cash investments.

• An approximate allocation of 60 percent debt and 40 percent equity or more

conservative with 75 percent debt and 25 percent equity would be of ideal
scenario as risk profile will be moderate with a low risk appetite

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60 years and above

• This is the time when people have retired and do not earn a regular income from
their jobs as they did in the preceding decades.
• This is also an affirmation to the fact that your financial plan must focus on
maintaining the lifestyle that you have and having provisions for unforeseen
contingencies.
• As a retiree, your risk appetite should be at the lowest when compared to your
regular income earning days. Even the risk profile for your investments should be
conservative with your asset classes having an approximate cash and a debt
exposure of 80 percent or 100% and balance minimal part of not more than 20%
in equity.
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Client categorization based on occupation

• Salary Earners – Government/ private

• Self employed/ Entrepreneurs/traders
• Professionals
• Others- students/ housewives/retired individuals

All above can be classified based on age/ investment strategy

Beginners
Middle level
Final level
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Salary Earners
• Every moth salary is wealth accumulation
• Rule of Thumb: Atleast 3 months salary should be in cash
• Beginners: More aggressive
• Mid Career people: moderate ( more liabilities and commitments)
• HNIs and above – A balance of moderation and aggressive

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Self employed
• Investment- Own funds/ borrowed funds
• Insurance cover for business
• Surplus funds on savings
• Funds for further investment in business
• Loan repayment

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Professionals
• Loans for setting up professional practice and repayment
• Monthly commitments
• Surplus savings
• Fund for further investment
• Investment in real estate
• Sole proprietorship/firm/company

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Others-students, housewives, retired individuals

• Housewives and retired individuals choose safe with returns and

liquidity in mind. Tax savings is less important.
• Students should invest in very safe security also yield them higher
return.
• Liquidity and tax saving is not the priority for them.

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Asset Allocation for different age group depending upon the risk appetite
• Rule of 100

• subtract the investor’s age from 100, and the result suggests the maximum percentage
amount of the investor’s portfolio that should be exposed to equities.
• For eg 25 year old investor, this rule suggests that 75% of his or her portfolio should be
invested in equities, and so on
• This is the conventional asset allocation model, and is ideally suited for a passive
investor. The table below shows the asset allocation guidance for different age groups.
Age Equity(%) Fixed income(%)
20 80 20
25 75 25
30 70 30
35 65 35
40 60 40
45 55 45
50 50 50
55 45 55
60 40 60
65 35 65
70 30 70
75+ 25 75
Other Asset Allocation strategies
• Risk Averse Allocation Of Assets- Ideally will be 50:50 i.e. 50% in Debt and 50% in equity

• Preservation of capital over higher portfolio return/yield.

• The degree of risk aversion is different for different investors. Investors with a higher risk appetite will be
more comfortable with short term volatility than investors with low risk appetite.

• If your risk appetite is zero, then you should avoid equities.

• if your risk appetite and risk tolerance is moderate, you should go for an appropriate mix of equity and fixed
income in your portfolio, in line with their short term and long term cash flow requirements,

• Risk Loving Allocation of Assets- 100% in equity irrelevant of age

• While nobody wants to lose their money, investors who can rely on income from sources other than their
own investments for their living and other expenses, can afford to take higher risks.

• As per the fundamental rule of Finance, higher risk also translates into higher returns. Investors with a
higher risk appetite will be more comfortable with short term volatility than investors with low risk appetite.

• (1) Investors with high net worth, with a very long time horizon for equity investments. (2) Investors with
low net worth and who are willing to risk.
 Investment Process
Investment Process consists of selecting the right asset mix based on
various parameters/ criteria set by the Investment Manager by balancing
between Risk- Return keeping in mind the Investment Philosophy.

 Defined  Research and

Investment Analysis on Shortlisting of Portfolio
Policy basket of securities Construction
securities/papers

 Churning of Evaluation of Comparing to

portfolio Portfolio benchmark

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Investment Philosophy
• It is formulated on the basis of investible funds, objectives and
knowledge about investment.
• The entire investment procedure revolves around the availability of
investible fund. The fund may be generated through savings or from
borrowings
• The objectives are framed on the required rate of return, regular
income, risk and liquidity.
• The knowledge about investment alternatives and markets plays a key
role in the formulation of policy

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Security Analysis
• Economic. Industry and company analysis are carried out for purchase
of securities.
• Valuation of securities is determined by return and risk expected from
an investment in papers
• BV and PE determine value of securities
• There are various models available to determine the real worth of
share compared to market price like; trend analysis, discounting
models

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Portfolio Construction
• It is a combination of securities.
• The portfolio constructed in such a manner to meet the investor’s
goals and objectives.
• The investor tries to attain maximum return with minimum risk by
• Debt and equity diversification
• Industry diversification
• Company diversification
• Selection

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Evaluation
• The portfolio has to be managed efficiently
• It consists of portfolio appraisal and revision
• Appraisal – The return and risk performance of the security vary from time
to time. The variability in returns of the securities is measured and
compared. The developments in the economy. Industry and relevant
companies from which the stocks are brought have to be appraised. The
appraisal warns the loss and steps can be taken to avoid such losses.
• Revision- It depends on the result of appraisal. The low yielding securities
with high risk are replaced with high yielding securities with low risk. To
maintain the targeted return the necessitates to revise the components of
portfolio periodically.
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Investment Avenues/Alternatives
• Assets used to produce goods and services.
Real
• Land and building, Machinery, furniture
Asset • Tangible assets
s

• Claims on real assets

Finan • Shares, debentures, bonds, derivatives, Loans
cial • Alternative it is called paper securities that claim on issuer
Asset
s

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Non Marketable Financial Assets
• Bank Deposits
• Post office deposits
• Corporate deposits
• PF Deposits

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Equity Shares
• Common stocks or ordinary shares are most commonly known as
equity shares
• It represents ownership capital.
• Stock is a portion of share capital of a company divided into small
units of equal value.
• Advantages of shares are:
• Capital gains
• Limited liability
• Hedge against inflation
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Sweat equity and ESOP
• Sweat Equity
• The directors or employees involved in setting up the company
• Those involved from inception an achieve IPR, market share and
alliance

• ESOPs
• Employees and directors in the form of incentives
• As a joining incentive too
• Retain employees
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Preference Shares/ Non voting shares
• A preference share is an equity security that combines the features of both equity
and a debt instrument.
• The term ‘preference’ is with respect to the payment of profits and sale, implying
that dividends/ profits and proceeds from the sale of company assets are
disbursed first to the preference shareholders since they are given preference
over equity shareholders.
• These do not carry voting rights
• They provide fixed return in place of voting rights
• They can be listed and traded on stock exchanges.
• Perpetual liability on the company
• It is generally considered a hybrid instrument. Preference shares can be
convertible (into ordinary shares) orWMthey may be non-convertible.
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Bonus Shares
• Shares to existing shareholders in addition to dividends
• It is issued without any payment
• This increases the reserves of the company

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Debentures
• It is a debt instrument issued by a company which carries fixed rate or
interest.
• It I s issued by private companies in order to acquire loan
• Types:
• Secured bonds or unsecured debentures
• Fully convertible debenture
• Partly convertible debenture
• Non convertible debenture
• MLD
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Bonds
• It is s debt security issued by government, quasi govt., public sector enterprises and Fis
• Features:
• Interest rate is fixed
• Traded on securities market
• Maturity date
• Types:
• Secured and unsecured bonds
• Perp bonds
• Fixed interest rates
• Floating interest rates
• Zero coupon bonds
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Money Market Instruments
• Less the an 1 year maturity
• Tbills
• CPs
• CDs

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Mutual Funds
• A mutual fund is an investment vehicle which pools money from investors and invests
on their behalf in multiple assets like stocks and bonds. The profits made from the
assets are then distributed to the investors
• Instead of directly buying shares/ fixed income securities, participate through schemes
floated by mutual funds
• 5 categories
• Equity- large , mid, mid and small, flexi, thematic funds,elss
• Debt- liquid, ultra short term, money market , savings, banking n psu debt, low duration
fund.STf, Gilt fund, Medium, long, credit, corporate bond funds
• Hybrid- aggressive, conservative,balanced. Arbitrage.
• special situation fund-retirement and children fund
• other funds-etf, fof,index
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Types of Mutual Fund based on the format of fund
• close ended schemes
• These schemes have fixed maturity periods.
• Investors can buy into these funds during the period when these funds are open in the initial issue.
• Once that window closes, such schemes cannot issue new units except in case of bonus or rights issues.
• After that period, you can only buy or sell already-issued units of the scheme on the stock exchanges where
they are listed.
• The market price of the units could vary from the NAV of the scheme due to demand and supply factors,
investors' expectations and other market factors.
• Open ended schemes
• These funds, unlike close-ended schemes, do not have a fixed maturity period.
• Investors can buy or sell units at NAV-related prices from and to the mutual fund, on any business day.
• This means, the fund can issue units whenever it wants. These schemes have unlimited capitalization, do not
have a fixed maturity date, there is no cap on the amount you can buy from the fund and the total capital
can keep growing.
• These may not be listed on exchange
• Higher liquidity
• Transparency
• AUM can fluctuate depending upon units buy/sell
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Life Insurance
• Insurance premiums represent sacrifice to achieve assured sum which
is benefit
• Types:
• ULIP
• Endowment
• Money back
• Term insurance

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Real Estate
• Majority of investors into it
• Types:
• Agriculture
• Semi urban land
• Commercial property
• Residential
• Second home

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Precious objects
• Small in size but highly valuable
Types
Gold and silver
Precious stones
Art objects

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Investment Attributes
Risk
Return
Liquidity
Tax savings
Convenience

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Structure of Indian Financial System

Indian Financial
System

Financial
Regulators Financial Market Financial Instruments Financial Services
Intermediaries

Debt VC, Merchant Banking,

SEBI Debt Banking and Non- Underwriting, credit
And Equity banking rating, Leasing,
RBI Equity
Instruments Factoring

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 Equity Market
Regulated by SEBI
Equity
Markets

Cash Derivatives
Derivatives
 Futures – Weekly and monthly expiries. It can be in premium or discount to cash price. Losses are
unlimited if it is open.
 Options –
a. Put- Buying of Put is bearish on the underlying asset and vice versa. Loss is limited to premium for
buying of contract.
b. Call- Buying of Call is bullish on the underlying asset and vice versa. Loss is limited to premium for
buying of contract.
 Market Capital of the Market-$2.27 trn (NSE) and $1.60 trn (BSE) for Fy19-20. Both are in Top 10
globally.
 Classification of shares by Mcap- Reliance, TCS, HDFC Bank, HUL, Infosys, HDFC.
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 Opportunities During Crisis

Source: Tata Mutual Fund WM IBS Sem 3 45

 Fixed Income Market
Regulated by SEBI
Fixed Income
Markets

Money Debt
Instruments in Money Market (<= 1 year) Market Market
 Call Money - Short term borrowing to meet their CRR and SLR requirement by banks and Primary Dealers.
The duration is 1 day.
 CBLO- Collateral Borrowing and Lending Obligation- Window for MFs and NBFCs
 Repo- Repurchase agreement. Banks borrow from RBI at repo rate .
 Reverse Repo- Banks park money with RBI at reverse repo rate
 TREPS- Triparty repo from 1 day to 365 days where Custodian is holding securities like; CDSL.
 Notice Money- Borrowing for 14 days
 Treasury Bills- Issue by RBI for 91 days, 182 days and 364 days maturity
 Commercial Papers- Issued by corporates, 3 mths, 6 mths and 12 mths
 Certificate of Deposits- Issued by Banks upto 1year maturity. They are at a premium compared to CPs.
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 Fixed Income Market

Instruments/elements of Debt Market (>1 year)

Gsecs SDL Bonds NCDs

 Government State Issued by Issued by corporates/
Securities issued Development corporates/ PSUs/ PSUs/ Public Financial
Institutions to meet
by RBI for Loans issued by Public Financial
their Capex/ long term
meeting states. Institutions to meet
borrowing. They are
their Capex/ long
Government Maharashtra, term borrowing.
rated by rating
borrowing. These Gujarat and Tamil agencies. They carry
They are rated by higher interest rates
are sovereign . Nadu are most rating agencies. They compared to Bonds.
Highly rated. preferred. can be securitized. Spread is more.

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Understanding Fixed Income Securities
• What are Fixed Income Securities?
The coupon attached which gives fixed interest to the investor which
determined at the beginning of the transaction.
It can be bank fixed deposit too.
It is like a loan, whose features are inscribed on a paper, the holder is
entitled to receive interest and principal amounts.
Issuers- government, FIs and companies.
• Difference between bonds and debentures
Bonds are issued by government and semi-government bodies.
Debentures issued by companies.
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• Difference between fixed income securities and equity shares
Fixed income securities represent a promise, by the borrowing entity,
to provide a pre-determined stream of income on a periodic basis and
return the amount invested at the time of maturity/ redemption.
Equity shares, the investors receive dividend only if the company whose
shares he is holding, decides to do so. There is no obligation for
company to make a periodic dividend payment. The principal shares are
linked to market price.

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• How do investors benefit from investing in fixed income securities?
Regular income
Receiving lumpsum payment
Price movement of equity market and fixed income mkt are not synchronized
Savings form fixed income sec can give some diversification to invest in equity mkts
• What does the interest received on a fixed income security represent?
The interest is cost money lent to the issuer/borrower.
Price/rate which borrower has to pay, to be able to use the lender’s money
Interest varies with the tenure
• Factors determining interest rates.
Tenure
Credit risk

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• How are interest rates and inflation connected?
The rate of inflation indicated the rate at which purchasing power of money falls.
Higher rate of inflation will lead to higher interest rate.
Nominal interest rate
Real interest rate
• Yield
It is termed as accurate rate earned by us on an investment.
Yield = coupon rate if investment price=face value
• If we receive more than one interest payment, can we add all the coupons and
compare it with the price we paid?
No. Earlier interest payment can earn for a longer period than the later one. Using
the principle of discounted cash flows technique. Thus , simply adding all interest
income received by the investor, over varying periods of time is not right technique.

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• How can we classify fixed income securities?
Based on the type of borrower
Based on the tenor of the instrument
Based on periodicity of interest payment
• What are government securities?
Government is the largest issuer of fixed income securities. The government issues
short term fixed securities where maturity is less than a year. These instruments
are called T Bills (91,182 and 364 days maturity). Long term bonds are issued by
government for periods over a year upto 30 years.
RBI issues these securities on behalf of government through auctions.
Trading is on NDS.

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• Corporate Debt Market
Lower Penetration
Higher cost of borrowing
Rating is a challenge
Economies of scale
Defaulters in last couple of
years
Limited access

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Activity in Corporate Debt Market

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• What are corporate fixed income securities?
Companies in private and public sectors also issue fixed income securities, which are of two kinds.
The short term fixed income securities, with maturity less than 1 year are called Commercial Papers.
The most commonly used is 90 days. Longer term fixed income securities are called Dentures.
Companies have been giving these instruments a variety of innovative names, like; millionaire bonds,
municipal bonds, perp, etc
• Why do some bonds have a put and a call options?
Bonds have put and call options to enable a revision of interest rates, if during the tenor of the bond,
interest rate changes drastically. If interest rate goes up the borrower is happy to be servicing cheaper
debt, but investor is losing the opportunity to earn higher interest. On the other hand if interest rate
falls, the lender wants to keep the bond, but the borrower would like to avail the opportunity of
reducing the cost of his borrowings. A put option is given to the lender and call option is given to the
borrower, to enable altering the term of bond, depending on how interest rate changes.

A put option is a right given to the lender to ask the bond to be redeemed.
A call option is the right of the borrower, to redeem a bond.

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• Can put and calls options can be exercised any time?
• What does call option mean to investors?
• What is bond has both the options?
• Why are gsec called risk-free?
• How can we know default risk of a borrower?
• How investors should use credit ratings?
• How is rate of interest rate on debt instruments determined?
• Floating interest rate
• Risks with fixed income securities
• What are the options to directly invest in debt securities
• Indirect routes to invest in fixed income securities and it’s advantages

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 Bond Rating
• Credit Rating –Credit rating agencies assess and assign credit ratings to entities- including
individuals, companies, state governments, countries, non-profit organisations, local
government bodies, securities and special purpose entities. Several factors such as financial
statements, type and level of debt, lending and borrowing history, debt repayment ability, past
credit repayment behaviour, etc.
• It is an estimate of an organization to fulfil their financial commitments by timely payment of
interest and principal based on industry/business and financial analysis.
QUALITATATIVE AND QUANTITATIVE ANALYSIS
Rating agencies
• International- Country rating
• Fitch, Moody’s and S&P
• Domestic -Organization rating
•CRISIL(Credit Rating Information Services of India Limited)
• CARE (Credit Analysis and Research Limited)
• ICRA (Investment Information and Credit Rating Agency of India Limited)
•Acuite Ratings & Research (earlier SMERA Ratings Limited)
• Birckworks rating WM IBS Sem 3 62
Bond Rating

A. Rating agencies
• International- Country rating
• Fitch, Moody’s and S&P
• Domestic -Organization rating
•CRISIL(Credit Rating Information Services of India Limited)
• CARE (Credit Analysis and Research Limited)
• ICRA (Investment Information and Credit Rating Agency of India Limited)
•Acuite Ratings & Research (earlier SMERA Ratings Limited)
• Birckworks rating
• Fitch rating (India Ratings and Research Pvt. Ltd.)
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 Bond Rating

B. Use of Credit Rating

• Regulatory requirement
• Pricing
• Trading
• Building portfolio

C. Factors affecting credit rating

• Payment history
• Amount owed
• New credit
• Type of credit in use

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D. Rating Structure/ Grade
Instruments with this rating are considered to have the highest degree of safety
CRISIL AAA
regarding timely servicing of financial obligations. Such instruments carry lowest
(Highest
credit risk.
Safety)

Instruments with this rating are considered to have high degree of safety regarding
CRISIL AA
timely servicing of financial obligations. Such instruments carry very low credit risk.
(High Safety)

Instruments with this rating are considered to have adequate degree of safety
CRISIL A
regarding timely servicing of financial obligations. Such instruments carry low credit
(Adequate
risk.
Safety)

Instruments with this rating are considered to have moderate degree of safety
CRISIL BBB
regarding timely servicing of financial obligations. Such instruments carry moderate
(Moderate
credit risk.
Safety)

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D. Rating Structure/ Grade

CRISIL BB Instruments with this rating are considered to have moderate risk of default
(Moderate regarding timely servicing of financial obligations.
Risk)

CRISIL B Instruments with this rating are considered to have high risk of default regarding
(High Risk) timely servicing of financial obligations.

CRISIL C
Instruments with this rating are considered to have very high risk of default
(Very High
regarding timely servicing of financial obligations.
Risk)

CRISIL D
Instruments with this rating are in default or are expected to be in default soon.
Default

How can borrowers benefit from a good credit rating?

A good credit rating indicates a higher credit worthiness and lower risk of default for the lender/
investor and can thus help the borrowing entity access funds more easily and on better terms such as a
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reasonable rate of interest.
Credit Rating of Individuals-Credit Score
• Credit score is given to an individual after taking a look at his credit
history and repayment behaviour.
• A credit score is a measure of an individual’s ability to pay back the
borrowed amount. It is the numerical representation of their
creditworthiness. A credit score is a 3-digit number that falls in the
range of 300-900, 900 being the highest.
• Credit scores are calculated by the credit bureaus in the country after
taking into consideration several factors like the length of your credit
history, repayment records, credit inquiries, among others.
• When you apply for a credit card or a loan from a bank or NBFCs, having
a higher credit score may entitle you to receive further benefits such as
a higher loan amount, lower interest rate and your choice of tenure to
repay the loan.
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CIBIL
• TransUnion CIBIL Limited formerly known as Credit Information
Bureau (India) Limited (CIBIL).
• It is a credit bureau or a credit rating agency which maintains the
records of all the credit-related activities of companies as well as
individuals including credit cards and loans.
• Other bureaus include Experian, CRIF High Mark and Equifax.

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 Credit Score
• NA/NH – This score is assigned to your profile when you have no
credits and remains until you do.
• 350-549 – It indicates a poor credit history. Must have defaulted. Little
experience in handling credit.
• 550-649- Average credit score. Look at why your score is deteriorating
• 650-749- This score is good. Have healthy credit history. Good chance
of getting loan approved. Couldn’t get lower interest rates as enjoyed
by top notch individuals.
• 750-900- excellent history of credit. Have sound repayment record.
Subsidised interest rates as risk associated is negligible.

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CIBIL Score Calculation
• Repayment History -35% weightage to CIBIL Score
• Type of credit taken and repayment duration -25% weightage
• Existing Debt and credit utilization -30% weightage
• Number of credit enquiries (new credits)- 10% weightage

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 Features of bond
a. Current yield:
Interest earned on the bond divided by current price of the bond.
Formula;

CY= Annual Interest / Current price

E.g. If an investors invests in a bond having maturity of 10 years with a FV of Rs.

100 having coupon rate of 6% at a price of Rs. 99.

CY= 6/99=0.0606= 6.06%

WM IBS Sem 3 71
b. Yield to Maturity:
It is discount rate that makes present value of future cash flows equal the current bond price. It
is rate of return that investors expect to earn if held upto maturity.

It is the interest rate which satisfies the below equation.

P= C/(1+r) + C/(1+r)2+… +C/(1+r)n + M/(1+r)n

P= Σ t= 1 to n C/(1+r)t + M/(1+r)n
= C(PVIFA r,t) +M(PVIFr,n)

Where; PVIFA is an abbreviation for Present Value Interest Factor of Annuity. It is an idea
based on the time value of money; the money you have now is worth more than the same
amount of money a few years from now.
PVIFA= (1-(1+r)-n)/r
The present value interest factor (PVIF) is a formula used to estimate the current worth of a
sum of money that is to be received at some future date.
PVIF= M/(1+r)n

Approximately;
WM IBS Sem 3 72
YTM= C+(M-P)/n / 0.4M+0.6P
E.g. If a bond has Rs. 100 face value carrying a coupon of 7% and maturing
after 10 years. The bond is currently selling at Rs. 95. What is the YTM?

YTM= C+(M-P)/n / 0.4M+0.6P

YTM = 7+ (100-95)/10 / 0.4*100+0.6*95 =7.73%

Where C is coupon amount, P is current Price, M is maturity value and n is no.

of years left to maturity.

WM IBS Sem 3 73
c. Yield Curve: It is a graphical representation of how YTM changes with maturity of
the security.
Normal Yield Curve

YTM increases with maturity of the security

Inverted Yield Curve

YTM increases in shorter duration and decreases in longer duration. It is a sign

of impending recession.

WM IBS Sem 3 74
d. Yield to Call
• P= Σ t= 1 to n C/(1+r)t + M*/(1+r)n*
• Where M* is the Maturity price and n* is the call price
e. Duration
• It is a concept; which means weighted average time period of bond’s life.
• Duration= (PV(c1)*1+PV(c2)*2+…..+PV(cn*n)/V0
• Where PV(c1) is the present value of the cashflows at the end of year t(t-1,2,
…n) and V0 is the current value of the bond.
• Duration of in effect represent the length of time elapses before actual
realization of PV of cash flows. It also shows the change in yield to change in
price.

WM IBS Sem 3 75
f. Modified Duration
It is measurable change in price of the bond to change in interest rate. Change in price is
opposite to change in interest rate.
Formula;
MD= D/1+y
Where D is duration, y is bond yield

Eg. D is 4.257 years

MD= 4.257/ 1.18 = 3.608

Suppose for a small change in yield , the price change is proportional to MD as follows;

Delta P/ P =– MD* Delta Y

Negative MD is because yield and price changes are inversely related.

Eg.

MD is 3.608, change yield is 0.2%

Delta P/P = -3.608*0.02= -0.007204= -0.7204%
WM IBS Sem 3 76
Bond Management Strategies
1. Passive Strategy
a. Buy and Hold Strategy
- Hold till maturity
- Long term investors who are looking to maximize profit by investing in large
coupon rate.
b. Indexing strategy
• – ETF which are benchmarked against index.
• -Avoid timing of the market; as outperforming market is unlikely.
2. Semi Active Strategy/ Hybrid/ Immunisation Strategy
- Elimination of interest rate risk with change in term structure(duration)
- It is a strategy where change in interest rate is immunized provided your average
duration of assets is equal to average duration of liabilities.
- Interest rate risk – Price risk and coupon reinvestment risk

WM IBS Sem 3 77
3. Active Strategy
- Churning of assets based on:
- Sector and asset adjustment
- Maturity adjustment
- Coupon/ ytm adjustment
- Quality diversification
4. Interest Rate Swaps
• - Swaps are useful when one company wants to receive a payment with a variable
interest rate, while the other wants to limit future risk by receiving a fixed-rate
payment instead.
• - For example, one company may have a bond that pays the London Interbank Offered
Rate (LIBOR), while the other party holds a bond that provides a fixed payment of 5%.
If the LIBOR is expected to stay around 3%, then the contract would likely explain that
the party paying the varying interest rate will pay LIBOR plus 2%. That way both
parties can expect to receive similar payments. The principal investment is never
traded, but the parties will agree on a base value to use to calculate the cash flows
that they’ll exchange.
WM IBS Sem 3 78
•- RIL Company and AMAZON Company enter into one-year interest rate swap
with a nominal value of $1 million. RIL offers AMAZON a fixed annual rate of 5% in
exchange for a rate of LIBOR plus 1%, since both parties believe that LIBOR will be
roughly 4%. At the end of the year, RIL will pay AMAZON $50,000 (5% of $1
million). If the LIBOR rate is trading at 4.75%, AMAZON then will have to pay RIL
Company $57,500 (5.75% of $1 million, because of the agreement to pay LIBOR
plus 1%).

•Therefore, the value of the swap to RIL and AMAZON is the difference between
what they receive and spend. Since LIBOR ended up higher than both companies
thought, RIL won out with a gain of $7,500, while AMAZON realizes a loss of
$7,500. Generally, only the net payment will be made. When AMAZON pays
$7,500 to RIL, both companies avoid the cost and complexities of each company
paying the full $50,000 and $57,500.

WM IBS Sem 3 79
•Advantages
- Banks, which need to have their revenue streams match their liabilities. The bank may choose
to hedge against this risk by swapping the fixed payments it receives from their loans for a
floating rate payment that is higher than the floating rate payment it needs to pay out.
Effectively, this way bank will have guaranteed that its revenue will be greater than it expenses
and therefore will not find itself in a cash flow crunch.
- Hedge funds, which rely on speculation and can cut some risk without losing too much
potential reward. More specifically, a speculative hedge fund with an expertise in forecasting
future interest rates may be able to make huge profits by engaging in high-volume, high-rate
swaps.
- Companies can sometimes receive either a fixed- or floating-rate loan at a better rate than
most other borrowers. However, that may not be the kind of financing they are looking for in a
particular situation. A company may, for example, have access to a loan with a 5% rate when
the current rate is about 6%. But they may need a loan that charges a floating rate payment. If
another company, meanwhile, can gain from receiving a floating rate interest loan, but is
required to take a loan that obligates them to make fixed payments, then two companies could
conduct a swap, where they would both be able to fulfill their respective preferences.

WM IBS Sem 3 80
•Risk involved

•- Interest rate risk

•-Counter party risk

WM IBS Sem 3 81
Model Investment Process for Equity Funds

WM IBS Sem 3 82
 Investment philosophy

Active management backed by independent thinking can add

value

Deployment of client’s hard earned money, FM takes care about

management quality, return on capital employed, and
governance

Bottom up Bias: Most of the value created through stock

selection Not biased on macro, but rather treat macro
exposures as risk factors to be checked

Investment process that is designed to look through

current market perception and focus on the intrinsic value

WM IBS Sem 3 83
 Check List for Selection of Papers/ Securities
Qualitative Quantitative
Business of the company Equity Capital and Market Cap
Stock Classification Balance Sheet
Management Income Statement
View on the industry Cashflow Statement
Story Ratio Analysis
Buzz/News Capex needs, funding plans
Key variables to be tracked Working Capital Management
Chairman/Director Report + MD&A
Auditor's Report - Any qualification

WM IBS Sem 3 84
 Portfolio construction

Universe (BSE500)

Research Coverage
180
(ROE, Momentum, Dividend Yield, etc.)
Stocks
Detailed Financial Modelling and
Discussion
110-120
Stocks
liquidity, financial stress

Fit to the 1. Growth investing & Value investing

Mandate 2. Market capitalization criteria
Final
30-40
Stocks Portfolio 1. Achieve differentiation through active bets
2.Manage risk with adequate diversification

Final Portfolio to provide diversificationWMandIBSmaintain

Sem 3 a balance of risk & return 85
 Risk Management : Challenges/ Hurdles
Types of Risk

Unsystematic
Systematic Is applicable to a particular
company or industry. Revenue,
Is applicable to entire market.
margins, cost impact, labour
Economical, Geopolitical, Natural
unrest, Climatic changes, seasonal
calamities, interest rates, currency.
demand, product cycle, regulatory.


• Return has huge elements of how external factors pan out in economy and
therefore more returns are created by these parameters than internal
management
• Risk has to be managed by the fund managers so as to balance between returns
and risk and outperform on both quality and returns compared to peers.
WM IBS Sem 3 86
 Credit Risk Assessment Process
Safety aspect of the Investment, requires assessment of credit risk considering the following factors

Broad Industry Parameters Qualitative Factors Quantitative Factors

• Competitive intensity of the
industry
• Government intervention
and control
• Entry barriers
• Impact of imports on the
Industry
• Sensitivity of industry to
economic downturn
• Parentage and support from
parent
• Management Quality and
Corporate Governance
• Reputation and track record
• Rating upgrade/ downgrade
history
• Diversification of business
• Position of Company within
industry
• Capital and Net worth
• Leverage (Debt)
• Sales & profits growth,
• Earnings Sustainability
• Repaying Capability
• Asset Quality and liquidity
• Cash flows

WM IBS Sem 3 87
 Interest Rate Risk

• The Fund Manager undertakes the Market

liquidity
analysis of all the variables that
affect the investment climate to
Inflation Brent Crude
arrive at the investment decision. data Price

• A consolidated analysis of data/ Interest rate

information is used to arrive on risk
the interest rate view, before Other
Global
making debt investments. macro-
Interes
economic
t rates
data
Govt
borrowing
plan
88
WM IBS Sem 3 88
 Risk Management and Control

Risk Monitoring and Control Evaluate risk parameters for

portfolio
 Performance Monitor
 Risk Monitor Portfolio Construction
 Tracking Error
Process outline

 Global Macro
 Gross Active Position  Currency and Interest Rate
 Company Wide Position  Regulatory & political risks
 Compliance Check  Industry Trend
⚫ Investment Process Review  Size of the position

Investment Risk
Bottom-up Research

Process risk  Identified Opportunities

 Valuation

WM IBS Sem 3 89
Thank you for your kind attention

WM IBS Sem 3 90