security analysis and investment management

Syllabus
1. Investment Environment
2. Security analysis (2,3,4 & 5)
*Securities market
*Risk & return

*Fundamental analysis
*Technical analysis
3. Derivatives (portfolio protection) (6)
4. Mutual funds (7)
Vipin k, Asst Prof. VJIM

2

Warren Buffett

Most successful investor of the 20th century

3

INVESTMENT
•
•
•
•
•
•
•
•

Meaning
Characteristics
Objectives
Investment & Speculation
Investment & Gambling
Types of investors
Investment process
Investment alternatives

4

INVESTMENT
Employment of fund on assets with the aim of
earning income or capital appreciation.

Financial activity by people with savings.
“commitment of funds made in the expectation of some
positive rate of return”

5

Financial & Economic meaning
Financial :
Commitment of person’s fund to derive future income
in the form of interest , dividend , pension benefit or
appreciation in the value of their capital.
eg:- purchase of shares, debentures, post office
savings certificates etc…..
These investment generate financial assets

6

Economic:
Net additions to the economy’s capital stock – goods
& services that are used in the production of other
goods and services.
eg:- new constructions, plant & machinery, inventories
etc…..

These investment generate physical assets.

7

&


9

Assets which are tangible or physical in nature

Real Assets

Real Estates

Other tangible
Assets


10

Residential land, building, apartments, farm land etc


11

2. Other tangible Assets :-

Precious metals like gold, silver, platinum. Precious
stones like diamonds, colored stones. Antiques


12

An intangible asset that derives value because of a
contractual claim. eg:- Stock, bonds, bank deposits
etc.


13

Characteristics Investment
 Return
 Risk
 Liquidity
 Safety
 Contribution to capital formation.

14

Objectives …
 Maximization of Return
 Minimization of Risk

 Tax minimization
 Liquidity


15

Objectives …
 Maximization of Return
 Minimization of Risk

 Tax minimization
 Liquidity


16

o Buying & selling of securities within a very short period of
time (less than one year)
o Speculator
o Need capital gain only
eg:- a person who buy a security at 9’o clock & sell at 9:30 for the quick gain (may
be loss)

17

Bases

Investment

Speculation

1. Risk assumed

low to High

always high

2. objective

Regular return + capital gain

capital gain

3. Time period

long term

Always short term

4. Funds

His own fund

5. Nature of return

Consistent & long term

Use borrowed fund to
supplement his own fund

Quick & short term
18

 Taking high risk not only for high return but also for
thrill & excitement.
 Unscientific & unplanned
 Based on tips & rumors
eg:- horse race, lotteries, card games etc

19

Investment Vs
Bases

Investment

1. Nature

Carefully planned &
scientific

2. Risk & return

Risk match with return

3. Motive

For regular income & capital For thrill & excitement
gain

4. Period

Long term

Very short term

5. Action

Detailed analysis

Based on tips & rumors


Gambling
Unplanned &unscientific
Taking high risk for high
return

20

 Large in number
 Investible resources are smaller
 Lacks extensive evaluation & analysis
eg:- Mr. A purchases the shares of X limited.


22

 Organization with surplus fund who engage in investment

activities.
 Fewer in numbers
 Investible resources are much larger.
 Professional approach

eg:- mutual fund, insurance companies etc

23

1

2
3
4
5

• Framing investment Policy
• Investment / security Analysis
• Valuation
• Portfolio Construction
• Portfolio Evaluation

24

1. Framing investment Policy:i. Investible funds
ii. Objectives
iii. knowledge


25

2. Investment / security Analysis:i. Market analysis
ii. Industry analysis
iii. Company analysis


26

3. Valuation:Intrinsic value
Future value


27

4. Portfolio Construction:i. Diversification
a) Debt & Equity diversification
b) Industry diversification
c) Company diversification

ii. Selection

28

5. Portfolio Evaluation:i. Appraisal

ii. Revision


29

Equity Shares
Deposits
Bonds & Debentures
Money market Instruments
Mutual Funds
Insurance Products
Retirement Products
Government savings Schemes
Precious objects
Real estates
Financial Derivatives

31

Stock market analysts classify equity shares are:

 Blue chip shares
 Growth shares
 Income shares
 Cyclical shares
 Defensive shares
 Speculative shares

32

Bank deposits
Post office deposits

Company fixed deposits


33

Government securities
PSU bonds

Debenture of private sector companies


34

Treasury Bills
Certificate of deposits

Commercial paper


35

Types of insurance plan
 Term assurance plan
Traditional investment linked plan
Unit-Linked Insurance Plans (ULIPS)


36

1. Mandatory retirement schemes
i. Employees’ Provident Fund(EPF) scheme
ii. Employees’ Pension schemes (EPS)
iii. New pension schemes
2. Voluntary retirement schemes

37

• Agricultural land, semi-urban land , commercial
property etc


39

Invest in three broad categories of financial assets
ie stocks, bond & cash
Three broad categories of mutual fund schemes:
a) Equities scheme
b) Hybrid scheme
c) Debt scheme

40

• Futures and
• options


41

Tax sheltered savings scheme
• Public provident fund scheme
• National savings scheme
• National savings certificate


42

MODULE - II


43

SEBI Bhavan, Mumbai Headquarters


46

•
•
•
•
•
•
•

Securities market
Primary market
Secondary market
Listing, trading & settlement
Important international stock exchanges
Depositories
Stock market indices- BSE SENSEX,
NIFTY etc

47

Market for equity, debt and derivatives.
Securities
Market

Equity
Market
Government
Securities
Market

Derivatives
Market

Debt Market

Corporate
debt Market

Money
Market

Options
Market

Futures
Market
48

 Regulators – CLB, RBI, SEBI etc..
 Stock exchanges
 Depositories
 Brokers
 Underwriters
 Listed securities
 Credit rating agencies etc……..

49

PRIMARY MARKET
&
SECONDARY MARKET


50

PRIMARY MARKET
The market where new securities are issued
Market in which shares, debentures and other
securities are sold for the first time for
collecting long-term capital.
NEW ISSUE MARKET


51

Modernize the plant, machinery and buildings, for
extending business, and for setting up new business
unit etc……….


52

Identify the LOGO


53

FUNCTIONS OF PRIMARY MARKET


55

• Introduction of the basic idea of issuing securities and
related spread work before the actual issue of the
securities.
• Analysis of economic condition, investment climate etc

• Assessing
the
feasibility
of
the
project, technical, economic, financial etc should be
conducted.

56

1. Time of floating the issue
2. Type of issue- Equity, preference etc

3. Price of the issue – at par or premium,
(discount)


57

•

The act of assuring the sale of shares or debenture
even before offering to the public.

•

Underwriters

Eg:- LIC,ICICI,IDBI etc……


58

• Final sale of securities to prospective investors.
• Function is carried out by brokers, sub-brokers


59

1) Equity shares
2) Preference shares

3) Debentures
4) Bonds

60

1.Equity shares
Shares do not carry any preferential right in respect of

dividend or repayment of capital.

Rate of dividend on equity shares is not fixed.

Equity shareholders are the ultimate owners of the

company.

61

CLASSIFICATION OF EQUITY SHARES
1.BLUE CHIP SHARES

• Share issued by blue chip companies
• Price of shares of blue chip companies is high.

2.GROWTH SHARES
• Share issued by growing companies.
• Expand their business by reinvesting their

earnings in profitable channels.
• Growing higher than the industrial growth

62

3.INCOME SHARES
Companies are not going to reinvest their earnings for
future expansion. These companies distribute the entire
earnings as dividend.
4.CYCLICAL SHARES
If the value of the shares are fluctuating due to cyclical
fluctuations in the market.
5.SPECULATIVE SHARES
Risky class of shares. It requires special technical expertise
& deep knowledge of market movement to deal in them


63

Identify the logo


65

Tokyo Stock Exchange


66

Secondary market
Market for already issued securities
Securities includes equity shares, preference

shares etc..
Also called stock exchange


70

• Securities Contract Regulation Act 1956
define stock exchanges as,
" an association, organisation or body of
individuals whether incorporated or not,
established for the purpose of assisting,
regulating & controlling business in buying,
selling & dealing in securities”


71

Functions of stock exchanges
• Ready market
• Liquidity & marketability of securities
• Fair price determination
• Sources of long term fund
• Reflection of business cycle
• Promotion of investment
• Flow of capital to profitable venture

72

Difference between primary &
secondary market
Dealing
Physical existence
period


73

Control over secondary market
Control is exercised through three
important process
1) Recognition of stock exchange

2) Listing of securities
3) Registration of stock brokers


74

1.Recognition of stock exchange
According to SCRA 1956 only recognized
stock exchanges can function in the country.
In India it is done by Central Government
Any stock exchanges requires recognition
under SEBI Act has to submit an application
in prescribed manner to the Central
Government.

75

2.Listing of securities

Enrolment of a name of company in an
official list maintained in the stock

exchange.


76

3.Registration of stock brokers
• A commission agent who transact business in
securities on behalf of his client who are non
member of stock exchange.

• To deal in recognized stock exchanges the broker
should register his name as a broker with the SEBI


77

• Stock exchange transactions are made
either for the purpose of investment or
speculation.
• The volume of speculative transaction far
exceed that of investment transaction on a
stock exchange.

78

Speculation is necessary to ensure sufficient
volume and continuity of business in the stock
exchange.


79

Is a speculator who buys shares in the
expectation of selling it at a higher price.


81

Sells securities in the expectation of a fall in
their prices in future.


82

Neither buys nor sells but applies for
subscription to the new issues expecting that
he can sell them later at a premium.


83

• Admission of the security of a public limited
company on a recognized stock exchange for

trading.

• Marketability, liquidity & transferability

85

• Section:73 of the companies Act states that any company

intending to offer shares or debentures to the public
through the issue of prospectus should make an
application to one or more recognized stock exchanges
for permission to be traded in the respective stock
exchange.


86

• Liquidity
• Trading platform
• Fair price for securities

• Protect the investors
• Wide publicity

• Transferability

87

• Information to competitors
• Subject to various regulatory measures of the stock
exchanges & SEBI
• Speculation
• Listing fees

88

• Trading in stock exchanges takes place in two
phases:
1. The member brokers execute their buying or selling orders
on behalf of their client.
2. The securities and cash are exchanged ( with the help of
clearing houses and depositories).


90

• Floor Trading ( open outcry system)
• Screen–based system


91

• Trading took place through an open outcry
system on trading floor or ring of the exchange
during official trading hours.


92

• The trading ring is replaced by the computer screen
and distant participants can trade with each other
through a computer network.

• A large number of participants, geographically

separated, can trade simultaneously.

93

• Enhance the informational efficiency of the market
as more participants trade at a faster speed.

• Permits the market participants to get a full view of
the market, which increases their confidence in the
market .


94

• Till 1994, trading on the stock market in India was
based on the open outcry system with the
establishment of National Stock Exchange in
1994, India entered the era of screen based trading.


95

• The kind of screen-based trading system adopted in
India is referred to as the open electronic limit
order book (ELOB) market system.


96

Features ELOB
1. Buyers and sellers place their order on the computer.
These order may be limit order or market orders.


97

(a) Limit order
Pre-specifies the price limit.
eg:- a limit order to buy at a price of Rs.100
means the trader want to buy at a price not
greater than Rs.100.
a limit order to sell at a price of Rs. 150 means
that the trader want to sell at a price not less
than Rs.150

98

(b) Market orders
an order to buy or sell at the best prevailing price.
A market order to sell will be executed at the highest
bid price where as a market order to buy will be
executed at the lowest ask price.


99

2. The limit order book, i.e. the list of unmatched limit orders

is displayed on the screen. It is open for inspection to all
traders.

3. The computer constantly tries to match different orders.
Matching is done on Price-Time priority. ( price is given

preference over time in the process of matching)

100

• Traditionally trades were settled by physical delivery.

• Securities had to physical move from the seller to the
seller’s broker, from the seller’s broker to the buyer’s
broker and from the buyer’s broker to the buyer.

• Takes too much time.

101

Depositories
• An institution which dematerializes physical certificates

and effects transfer of ownership by electronic book
entries.
• National Securities Depositories Ltd (NSDL) India’s first
depository, was set up in 1996.
• SEBI has made dematerialized trading compulsory for all
the stock exchanges in the country.


102



Settlement process involving delivery of securities and

payment of cash is carried out through a separate agency
known as the clearing house which functions in each
stock exchange.



Member –brokers who buy securities will have to pay
cash to the clearing houses and receives the securities

from clearing houses.

103

Account period settlement
 Rolling settlement


104

Account period settlement
• Purchase and sales during an account period
could be settled at the end of account period on
a net basis.
• Eg:- if ‘A’ bought 100 shares of Infosys on BSE on Monday at
Rs.5000 a share and sold 95 shares of Infosys at 5050 on Friday
of that week, ‘A’ were required to take delivery for only 5
shares by paying 20250 at the end of account period.


105

Account period settlement
On BSE the account period was Monday to Friday &
on the NSE the account period was Wednesday to
Tuesday


106

Rolling settlement
• Under rolling settlement, all trades executed
on a trading day are settled X days later. This
is called ‘T+X’ rolling settlement, where ‘T’ is
the trade date and ‘X’ is the number of
business days after trade date on which
settlement takes place.
• The rolling settlement has started on T+2
basis in India, implying that the outstanding
positions at the end of the day ‘T’ are
compulsorily settled 2 days after the trade

107

• The stock exchanges now follow a
settlement
procedure
known
as
Compulsory Rolling Settlement (CRS).
As mandated by SEBI


108

Compulsory Rolling Settlement
• All transactions in all groups of securities
in the Equity segment and Fixed Income
securities listed on BSE are required to be
settled on T+2 basis (w.e.f. from April 1,
2003). The settlement calendar, which

indicates

the

dates

of

the

various

settlement related activities, is drawn by

109

A centralized market for buying
and selling of stocks where the

price is determined through supply
demand mechanism.


111

• Stock exchanges in a country have been
organized in various forms:
1. voluntary non-profit making associations.
2. public limited company
3. company limited by guarantee


112

• In India the earliest stock exchanges were
organized as voluntary non-profit making
association of persons.

• Later on, stock exchanges
organized as companies.


began

to

113

• Oldest stock exchange in Asia

• Established in 1875
• “Native shares and Stock Broker’s Association”
• In march 1995, BSE has introduced BOLT (BSE
Online Trading)
• Working time 9.30 am to 3.30 pm

• More than 5000 companies are listed.

117

[ BSE ]
• Located on Dalal street, Mumbai, Maharashtra.
• 11 th largest stock exchange in the world by market
capitalization as of 31/12/12.

• World’s No.1 exchange in terms of listed members.
• Provide depository services through CDSL


118

• BSE ‘s popular Equity Index- S & P BSE SENSEX

( Formerly SENSEX).
• On Tuesday, 19 February 2013, BSE has extended
into strategic partnership with S & P Dow Jowes
Indices and the SENSEX has been renamed as

“S

& P BSE SENSEX”

119

STOCK INDEX OR STOCK MARKET INDEX
• Method of measuring the value of section of the stock

market.
• Computed from the prices of selected stocks.
• Tool used by the investors & financial managers to
describe the market.
eg:- S&P BSE SENSEX, S&P CNX NIFTY Index, BSE 500, S&P

CNX Nifty Junior, TOPIX(Tokyo Stock Price Index), etc


120

• Calculated since 1986.

• Index composed of 30 stocks.
• Initially based on total market capitalization.
• 2003 onwards free float market capitalization.
• Base value for calculating SENSEX is 100 (1978-79)
• Calculated for every 15 seconds.


121

Value of all the shares available for public trading
excluding:

 Promoters equity, holding by founders, directors.
 Holding by FDI route

 Holding by private corporate.
 Government holdings

 Equity holdings by employees welfare trust
 Equity held by associate/group companies.

122

• Listing history
• Trading frequency

• Historical records
• Industry/sector they belong etc….


123

Formula for calculating SENSEX

SENSEX = Sum of free float market capitalization of 30 stocks x Index factor

Index factor = 100 / market capitalization in 1978-79
where 100 is the index value during 1978-79


124

• Setup in November 1992
• India’s first fully automated electronic exchange [NEAT]
• National Exchange for Automated Trading[NEAT]

• Started functioning in June 1994.
• 1635 companies are listed as of July 2013


126

• Index is built by Indian Index Service
Product Ltd [IIST] and Credit Rating
Information Service of India Ltd

[CRISIL]
• CRISIL has strategic alliance

between S&P Rating services.
• Hence the Index is named as S&P

127

• NIFTY reflects the price movements of 50
stocks.
• Base date selected for NIFTY is November
3,1995.
• Base value of NIFTY -1000
• Earlier calculation based on full market

128

NIFTY = Sum of free float market capitalization of 50 stocks x Index factor

Index factor = 1000 / market capitalization in 1995
where 1000 is the index value during 1995


129

 TSE is the third largest stock exchange all over the world and
first largest stock exchange among the Asian countries.
 Established in the year 1878.
 More than 2,000 companies are listed in Tokyo Stock
Exchange.
 Market functions between 9.00 am and 3.00 pm.

131

• The Tokyo Stock Exchange, which is called Tōshō or
TSE for short, is a stock exchange located in Tokyo,
Japan.
• Third largest stock exchange in the world by
aggregate market capitalization of its listed
companies.


132

• NASDAQ stands for National Association of Securities
Dealers Automated Quotations.
• stock exchange was constituted in the year of 1971.
• Headquarters at New York.
• Market functions between 9.30 am and 4.00pm

133

• Second largest stock exchange in North America


134

• Stock exchange based in new york city.
• Largest equity based exchange in the world
• About 2,800 companies are listed on the NYSE.


135

• one of the world’s oldest stock exchanges and can
trace its history back more than 300 years.
• located in the City of London in the United Kingdom
• Established in the year of 1801.
• Nearly 3,000 companies from 70 different countries
are listed.
• Trading occurs between 8.00 am to 4.30 pm.


136

• Largest stock exchange in China.
• Initially It was named Association of Brokers, Hong
Kong in 1891 but later it was renamed as Hong Kong

stock exchange in 1914.
• Functions between 9.15 am and 4.00 pm.

• Nearly 1,470 companies listed in this exchange.

138

• Asia's second largest stock exchange in terms of
market capitalization behind the Tokyo Stock
Exchange.


139

• Stock exchange of Germany located at Frankfurt.

• Nearly 765 companies listed in the market.
• Formed in the year of 1994.

• Market functions between 8.00 am and 10.00 pm.
• largest of Germany’s seven stock exchanges.


140

• price discovery method
• The company doesn't fix up a particular

price for the shares, but instead gives a
price range


142

• The issue price is not fixed in advance.
• Determined by the offer of potential investors
about the price which they are willing to pay
for the issue.


143

• The price of the security is determined as
the weighted average at which the majority
of the investors

are willing to buy the

security.
• Under book building process, the issue

prices of security is determined by the
demand & supply forces in the capital

144

• When bidding for the shares, investors have to decide at

which price they would like to bid for the shares, for e.g. Rs
80, Rs 90 or Rs 100. They can bid for the shares at any price
within this range.
• Based on the demand and supply of the shares, the final
price is fixed


145

• The lowest price (Rs 80) is known as the
floor price and the highest price (Rs 100)
is known as cap price.
• The price at which the shares are allotted
is known as cut off price


146

Issuing companies can select any of the
following method:
a) 100% of the offer to the public through the
book building

b) 75% of the offer through the book building &
25% through the fixed price method at the
price determined through book building.
c) 90% of the offer through the book building &
10% through the fixed price method.

147

1.

The main difference between the book building method and the
fixed price method is that in the former, the issue

price is

not decided initially.
2.

The investors have to bid for the shares within the price range
given and based on the

demand and supply of the

shares, the issue price is fixed. On the other hand, in the
fixed price method, the price

start.

is decided right at the


148

BOOK BUILDING VS FIXED PRICE
3. In fixed price, Investors cannot choose
the price, but must buy the shares at the
price decided by the company.


149

Book building Process:
•
•
•
•
•
•
•
•

•
•

The Issuer who is planning an offer nominates lead merchant banker(s)
as 'book runners'.
The Issuer specifies the number of securities to be issued and the price
band for the bids.
The Issuer also appoints syndicate members with whom orders are to be
placed by the investors.
The syndicate members input the orders into an 'electronic book'. This
process is called 'bidding' and is similar to open auction.
The book normally remains open for a period of 5 days.
Bids have to be entered within the specified price band.
Bids can be revised by the bidders before the book closes.
On the close of the book building period, the book runners evaluate the
bids on the basis of the demand at various price levels.
The book runners and the Issuer decide the final price at which the
securities shall be issued.
Generally, the number of shares are fixed, the issue size gets frozen
based on the final price per share.
Allocation of securities is made to the successful bidders. The rest get
refund orders.

150

Components of investment return


152

• Period cash flow.
• eg:- dividend or interest generated by
investment.
• Measured as the period income in relation
to the beginning price of the investment.
• May be +ve or zero

153

• It reflects the price changes
• Price appreciation or depreciation
• May be +ve,-ve or zero


154

Total return = Current Return + Capital Return


155

• Return likely to expect from the investment.
• Weighted average of all possible returns
multiplying their respective probabilities.
• ( If things are uncertain)


157

• If the possible return denoted by Xi, and the
related probabilities as P(xi). Expected return
represented as

.

= ∑Xi P(Xi)

158

• If things are certain

E(Ri) = D1+(P1-P0)
P0
D1 = Expected dividend
P1 = Stock price at the end
P0 = Current market price

159

Defining Risk
Possibility of incurring losses in a
financial transaction.
What rate of return do you expect on your
investment this year?
What rate will you actually earn?


162

Defining Risk

• An investment whose return are fairly stable is
considered to be a low-risk investment.
• An investment whose return fluctuate
significantly is considered to be a high risk
investment.

163

• Risk arises from uncontrollable factors.
• Affects entire market(macro in nature)
• Occurrences of certain event can affect all

companies, firms at the same time.
• Also called uncontrollable risk or un-

diversifiable risk.
• Eg:- economic condition, political situation etc

166

SYSTEMATIC RISK
• Risk that caused by external factors such as
economic, political and sociological conditions.

• Risk arises due to external factors they are
beyond the control of the company affected, and
hence are uncontrollable or referred to as
undiversifiable risk.

167

• Variations in return caused by the
volatility of the stock market is referred
to as the market risk.
• Occurs due to the reactions of investors in
the stock market
• Either upward or downward
• Upward –bullish trend
• Downward – bearish trend the movement
can easily seen with indices like BSE
SENSEX, NSE index etc.

169

•

Referred as stock variability due to changes
in investors attitude and expectations.

•

At times the prices or yields of all the
securities in a particular market rise or fall due
to broad outside influences.

•

Investors reaction towards tangible and
intangible events is the chief cause for Market
risk.

170

For e.g.
 Investors perception towards Mergers and acquisitions
 Dividends declaration
 Bulk buying and selling by FII
 Institutional investors
 and other economic issues like government policy etc.,


171

• Variability in securities return resulting from
changes in the level of interest rate.
• It is the risk caused by the variations in the market

interest rate.
• Affects debt securities like debentures, bonds.
• Extensive use of borrowed fund in the stock
market.

172

Causes of interest rate risk are:
• Changes in the Government’s monitory policy
• Changes in the interest rate of treasury bills
• Changes in the interest rates of Government Bonds.
Etc…………..


173

• Variations in return are caused by the loss of purchasing
power of the currency.
• Purchasing Power Risk is the chance that changing
price levels (inflation or deflation) will adversely affect

investment returns.
• Inflation is the reason behind the loss of purchasing
power.

• Inflation may be – Demand-Pull
or

Cost-Push inflation

174

Demand-Pull Inflation
When demand is increasing but supply cannot be
increased, the price of the goods increases there by
forcing out some of the excess demand and
bringing the demand and supply into equilibrium.

Cost-Push inflation
When the cost of production increases prices of the
product will also increase


175

B. UNSYSTEMATIC RISK
• Unsystematic risk is due to the influence of internal factors

prevailing within an organization.
• Such

factors

are

normally

controllable

from

an

organization's point of view

• It is a micro in nature as it affects only a particular
organization
• It is avoidable through diversification ( Diversifiable Risk)

• Eg:- managerial inefficiency, labor problems etc….

176

• Sources –
Operating environment of the company
&
Financing pattern adopted by the company


177

• Risk caused by the operating environment of the business.

• Risk associated with a particular company or industry.
• Business risk can be caused by changes in a company’s
sales due to operating problems, such as a strike,
technical obsolescence etc……..
• Risk arising from the inability to maintain its competitive

edge and growth or stability of earnings.

179

Variability in EPS due to the presents of debt in
the capital structure of a company.
Associated with the capital structure of the
company.


180

Systematic Risk + Unsystematic Risk


181

STD DEV OF PORTFOLIO RETURN

Unsystematic risk
Total
Risk
Systematic risk

NUMBER OF SECURITIES IN THE PORTFOLIO

182

STD DEV OF PORTFOLIO RETURN

Unsystematic risk
Total
Risk
Systematic risk

NUMBER OF SECURITIES IN THE PORTFOLIO

183

• Detailed analysis of fundamental factors affecting
the performance of the companies.

• Analysis used to evaluate the present and future
earnings

capacity

of

shares

based

on

economy, industry and company fundamentals.

185

• Fundamental analysis studies the basic facts
affecting a stock’s value.

financial statements, industry reports, and
economic factors


186

Assessing the intrinsic value of shares
Comparing the intrinsic value with current

market price and makes decision.


187

• Intrinsic value refers to the actual value of a
company or stock determined through fundamental
analysis without reference to its market value.
• Frequently called fundamental value.
• It is ordinarily calculated by summing the future
income generated by the asset, and discounting it to

the present value.

188

• An investor can compare the intrinsic value of share with
the prevailing market price to arrive at an investment

decision.
• The market price of the share is lower than its intrinsic
value the investor would decide to buy the share as it is

under price.
• The market price of the share is higher than its intrinsic
value, it is perceived to be overpriced. Investor would sell
such shares.

189

EIC


191

• Performance of a company depends on the
performance of economy.
• When the economic activity is low, stock prices are
low, and when the level of economic activity is
high, stock prices are high.
• Essential to understand the behavior of stock
193
prices.

Key economic variable that an investor must
consider as a part of fundamental analysis are:

•
•
•
•

Growth rate of national income
Inflation
Interest
Government revenue, expenditure and
deficit
• Exchange rate
• Infrastructure
• Economy and political stability etc……

194

• An evaluation of relative strengths and
weakness of particular industries.
• Performance of companies will depends up

on the state of industry to which they
belong.

• If the industry grow company also grow &
vice versa


195

Factors to be considered :
• Growth of the industry
• Cost structure and profitability
• Nature of the product

• Nature of the competition
• Government policy

• Research and development etc……….

197

• Final stage of fundamental analysis.
• Deals with the estimation of return and risk
of individual shares.
• Information regarding companies : Internal
and External


198

• Internal information consists of
data and events made public by
companies
concerning
their
operation.

• Internal
information
sources:
annual report to shareholders, the
company’s financial statements
etc…
• External

informationVipin k, Asst Prof. VJIM

generated
199

Analysis of financial
statements
• Comparative financial statements
• Trend analysis
• Fund flow analysis
• Cash flow analysis
• Ratio analysis etc……….

200

Ratio analysis
• Liquidity ratios –

Current ratio, quick

ratio
• Leverage ratios – Debt-equity ratio, debt
to asset ratio
• Profitability ratios – Gross profit ratio, net
profit ratio

201

Meaning:
• Study of market generated data like price and volume
to determine the future direction of price movement.
• A study of past or historical price and volume

movement so as to predict the future stocks price
behavior.
• Forecasting techniques that utilize historical share price
data.

204

• Technical analysts believe that past patterns of market action

will recur in the future and that past patterns can be used for
predictive purposes.

• Some of the tools used by chartists to measure supply and
demand and to forecast security prices are the Dow theory
chart, odd-lot theory, confidence index, breadth-of-market

indicators, relative-strength analysis, and trading-volume
data.

205

Assumptions/basic principles/premises of technical analysis
 Market prices are determined by the interactions of supply and
demand forces.

 Supply and demand are influenced by variety of factors, both
rational and irrational. Includes fundamentals as well as
psychological factors.

 Shift in demand & supply bring about changes in trends.
 Shift in demand & supply detected with the help of charts of
market action.
 Analysis of past market data can be used to predict the future price
behavior.


206

• Charles .H. Dow
• Editor of wall street journal, in USA

• Popularly known as Theory of Technical
analysis

211

According to Charles .H. Dow
• “ The market is always considered as having

three movements, all going at the same time. The
first is the narrow movement from day to day.
The second is the short swing, running from
two weeks to a month or more; the third is the
main movement covering at least four years in

its duration”

212

• The Dow theory is used to indicate reversals and trends in
the market as a whole or in individual securities.
• According to the theory, there are three movements going
on in the markets at all times:
1. daily fluctuations (the narrow movement from
day-to-day)
2. secondary movements (short-run movements over
two weeks to a month or more)
3. primary trends, major movements covering at
least four years in duration

213

• Dow formulated a hypothesis is that the stock
market does not move on a random basis but

is influenced by three distinctive cyclical
trends that guides its direction.

1) Primary / main movements
2) Secondary reaction / correction movement

3) Minor / narrow movements

214

According to Dow theory
• Price movements in the market can be identified by
means of line chart.
• In the line chart, closing price of shares or the closing
value of the market index may be plotted against the
corresponding trading day.
• The charts helps in identifying the primary, secondary
and minor movements.

215

* Primary or main movements /trend
• Long range cycle that carries the entire market up or
down long term trend in the market.
* Secondary reaction or correction movement/trend
• These are the opposite direction to the primary

movements
• Only for a short period
• Eg:- when the market is moving upward continuously, this
upward movement will be interrupted by downward
movement of short duration.

216

Minor or Narrow movements/trend


Day today fluctuations in the market



Not significant & have no analytical value



Very short duration


218

• Primary movements – Tides
• Secondary/ correction movements – Waves

• Minor/ Narrow movements – Ripples


219

• Trend is the direction of movement.
• Share price can either increase, decrease or
remain in flat.
• The three directions :


220

• Share price do not rise or fall in a straight line.

• Every rise or fall in price experience a counter moves

• Share price move in a zigzag manner.


221

Trend lines
• Straight line drawn connecting either the top or
bottom of the price movement
• To draw a trend line, the technical analyst
should have at lest two tops or bottoms.


222

(1) Rising/up trend


223

(2) Falling/down trend


224

(3) Flat trend


225

Trend Reversal
• Changes in the direction of trend is referred to as

trend reversal.
• A share that exhibits a rising trend may start to move
narrowly or fall after some times, this change in the
direction of movement represent trend reversal.
• Technical analyst tries to identify the trend reversal at

an early stage so as to trade profitably.

226

• When the trend begins to rise the technical analyst
would recommend purchase of the shares.
• When the trend begins to fall, sale is indicated.

• During a flat trend the investor should stay away
from the market.


227

Trend Reversal


228

• Ralph Elliot
• Theory was formulated in 1934
• After analyzing 75 years of stock market price
movements and charts.
• According to this theory – market movement was

quite orderly and followed a patter of waves.

229

According to this theory
• The market moves in waves
(A wave is a movement of the stock price from one change in
the direction to the next change in the same direction.
Depending on the demand & supply pressure waves are
generated)


230

According to this theory
• A movement in a particular direction can be

represented by five distinctive waves.
• Of these five waves, three waves are in the direction
of the movement & are called impulse waves.
• Two waves are against the direction of the movement
& are termed as corrective waves or reaction waves


232

Graph


233

Graph


234

Graph


235

• Waves 1,3 & 5 are the impulsive waves
• 2 & 4 are the corrective waves
• The wave 1 is upwards and wave 2 correct the wave

1.
• Waves 3 & 5 are impulsive and 4 corrects wave 3


236

• Correction involves correcting the earlier rise
• Wave 2 would correct the rise of wave 1

• Wave 4 would correct the rise of wave 3 & after the
completion of wave 5, there would come a correction
which would be labeled ABC
• This correction would be in three waves in which the
waves ‘A & C’ will be against the trend and wave ‘B’

will be along the trend.

237

• The ABC correction following the fifth wave would
correct the entire rise from the starting of wave 1 to the
end of the fifth wave.
• One complete cycle consist of waves made up of two
distinctive phases, bullish & bearish. One full cycle
of waves is completed after the termination of 8 waves
movement, there will be a fresh cycle started.
• The theory is used for predicting the future price
changes & in deciding the timing of investment.

238

Support and

Level

• Support and resistance define natural
boundaries for rising and falling prices.


239

Support Level
• Level that the technical analyst believes a
stock price will not fall below. Some times
called “Floor”.


241

Resistance Level
• Opposite of support level.
• Technical analyst believe that stock price will
not exceed.


242

Breakout
• The security price moves out of the previous
trading range (breaching the resistance or support
level)


243

• Term used to study the advance and decline that have occurred
in the stock market.
• Advance means – Number of shares whose prices have
increased from the previous day’s trading.
• Decline means – Number of shares whose prices have fallen

from the previous day’s trading.
• The net difference between the number of stock advanced
& declined during the same period is the breadth of the
market.
• A cumulative index of net differences measure the market

244

Day

advance

decline

Net

Breadth

21-02-12

1486

774

712

712

22-02-12

1310

966

344

1056

23-02-12

898

1225

-327

729

24-02-12

1108

1091

17

746

25-02-12

931

1279

-348

398


245

• Line Chart
• Bar Charts

• Candlestick Charts


247

Line Chart
 The most basic of the four charts – because it represents only the closing
prices over a set period of time.
 The line is formed by connecting the closing prices over the time frame.
 Do not provide visual information of the trading range for the individual
points such as the high, low and opening prices.

 The closing price is often considered to be the most important price in
stock data compared to the high and low for the day and this is why it is
the only value used in line charts.

248

Line Chart


249

Bar Charts
•

The chart is made up of a series of vertical lines that represent

each data point. This vertical line represents the high and low for
the trading period, along with the closing price.
• The close and open are represented on the vertical line by a
horizontal dash.
• The opening price on a bar chart is illustrated by the dash that is
located on the left side of the vertical bar.
• Conversely, the close is represented by the dash on the right.

250

Bar Charts
• Generally, if the left dash (open) is lower than the right

dash (close) then the bar will be shaded black,
representing an up period for the stock, which means it
has gained value.

• A bar that is colored red signals that the stock has gone
down in value over that period. When this is the case, the
dash on the right (close) is lower than the dash on the left

(open).

251

Bar Charts


252

Candlestick Charts
•

Similar to a bar chart, but it differs in the way that it is visually constructed.

•

The difference comes in the formation of a wide bar on the vertical line, which illustrates the

difference between the open and close. And, like bar charts, candlesticks also rely heavily on
the use of colors to explain what has happened during the trading period.
•

There are two color constructs for days up and one for days that the price falls.

•

When the price of the stock is up and closes above the opening trade, the candlestick will
usually be white or clear.

•

If the stock has traded down for the period, then the candlestick will usually be red or black,
depending on the site.

•

If the stock's price has closed above the previous day's close but below the day's open, the
candlestick will be black or filled with the color that is used to indicate an up day

253

Candlestick Charts


254

• Mathematical indicators calculated with the help of
the closing price data.
• Helps to identify overbought and over sold conditions
of the scrip.
• Helps to identify possibility of trend reversal.


255

• RSI (Relative Strength Index)
• ROC (Rate of Change Indicator)
• MACD (Moving Average Convergence/Divergence)


256

(Relative Strength Index)

RSI = 100 – 100
(1+RS)
RS = Average gain per day
Average loss per day

257

• Most commonly used time period for the calculation of RSI

is 14 days.
• RSI value ranging from 0 – 100
• RSI value above

70 are considered to denote overbought

condition.
• RSI value below

30

considered to denote oversold

condition.

258

ROC (Rate of Change Indicator)
• ROC measures the rate of change of the
current price as compared to the price a certain
number of days or weeks back.

• ROC =

Current price
price ‘n’ period ago


- 1

260

ROC (Rate of Change Indicator)
• Value may be +ve,-ve or zero
• When the ROC line is above the zero line, the price
is rising & when it is below zero line ,the price is

falling.


261

MACD (Moving Average Convergence Divergence)
• Short term & long term exponential moving average
are calculated with the help of closing price data.
• A 12 day & 48 day exponential moving average are

popular combination
• Difference between short term & long term EMA
represent MACD


262



263

• MACD line (blue line): difference between the 12 and 26 days EMAs

• signal (red line): 9 day EMA of the blue line
• histogram (bar graph): difference between the blue and red lines

Mathematically:
• MACD = [stockPrices,12]EMA - [stockPrices,26]EMA
• signal = [MACD,9]EMA
• histogram = MACD – signal


264

• Shares are generally sold in a lot of hundreds
• Shares are sold in smaller lots fewer than 100 are called odd lot.
•

Buyers & sellers of odd lots are called odd lotters.

• Odd lot purchases to odd lot sales ( purchase %) is the odd lot index.
( Odd lot purchases divided by odd lot sales)
• Increases the odd lot purchases results in an increase in the index.(selling
leads to fall the index)

265

• Basic assumption of technical analyst is that price trends

occur in an orderly manner & not random.
• Random walk theory gained popularity in 1973 when
Burton Malkiel wrote "A Random Walk Down Wall

Street", a book that is now regarded as an investment
classic.
• Theory that states that the past movement or direction
of the price of a stock or overall market cannot be used
to predict its future movement.

266

• Random walk theory states that market price evolve at random and do
not follow any regular pattern.

• According to this theory future stock price are

completely independent of past stock prices.
• The Random Walk Hypothesis is a financial theory stating that stock

market prices evolve according to a random walk and thus the prices of
the stock market cannot be predicted by analyzing the past stock prices.

267

 Market is supreme and no investor or group can influence it.
 Stock price discount all information quickly.

 Markets are efficient and that the flow of information is free
and unbiased.
 All investors have free access to the same information and

nobody has superior knowledge or expertise.
 Market quickly adjusts itself to any deviations from
equilibrium level due to the operations of free forces of
demand and supply.
Vipin k, Asst or insider information.
 Nobody has better knowledge Prof. VJIM

268

• Hypothesis states that the capital

market is efficient in processing

information.
• Efficient capital market is one in which security prices equal their
intrinsic value at all time, and where most securities are correctly priced.
• According to Elton and Gruber,” when some one refers to efficient capital
markets, they mean that securities prices fully reflect all available
information”

269

Forms of market efficiency
• There are three forms of the efficient market hypothesis
• The "Weak" form asserts that all past market prices and data are fully
reflected in securities prices. In other words, technical analysis is of no
use.
• The "Semi strong" form asserts that all publicly available information
is fully reflected in securities prices. In other words, fundamental
analysis is of no use.
• The "Strong" form asserts that all information is fully reflected in
securities prices. In other words, even insider information is of no use.

270

•

In this diagram, the circles
represent

the

amount

of All historical prices and returns

information that each form of the
S tro n g F o rm

EMH includes.
•

Note that the weak form covers

S em i-S tro n g

the least amount of information,

and the strong form covers all

W eak F o rm

information.
•

Also note that each successive
form includes the previous ones.

All information, public and
private


All public information
271

• Information is free and quick to flow
• All investors have the same access to information.
• Every investor has access to lending and borrowing at the same rate.
• Market absorbs the information quickly and the market responds to
new technology, new trends, change the tastes, etc efficiently and
quickly.

• Investors are rational and behave in a cost effective competitive
manner for optimization of returns

272

In the financial marketplace some instruments are
regarded as fundamentals, while others are regarded

as derivatives.

Financial Marketplace

Derivatives

Fundamentals


274

Financial Marketplace

Derivatives

Fundamentals

• Futures
• Forwards
• Options
• Swaps

• Stocks
• Bonds
• Etc.

275

Options

Futures
Futures

The value of the derivative
instrument is DERIVED from
the underlying security

Forwards

Swaps
Swaps

Underlying instrument such as a commodity, a
stock, a bond, anotherAsst Prof. VJIM
derivative etc..
Vipin k,

276

What do derivatives do?
 Derivatives attempt either to minimize the loss

arising from adverse price movements of the
underlying asset Or maximize the profits arising
out of favorable price fluctuation.
 Derivatives derive their value from the underlying
asset they are called as derivatives.

277

Options

An option is the right, not the obligation to buy or sell
something on a specified date at a specified price. In the
securities market, an option is a contract between two
parties to buy or sell specified number of shares at a

later date for an agreed price.
Three parties are involved in the option trading,
1. The option seller

2. The option Buyer
3. Broker

278

•Call option
•Put option


279

• When an option grants the buyer the right to purchase the

underlying assets/stock from the seller a particular quantity
at a specified price within a specified expiration date.

• An option contract giving the owner the right to buy a
specified amount of an underlying security at a specified
price within a specified time.


280

• A call option gives you the right to buy within a
specified time period at a specified price.

• The owner of the option pays a cash premium to the
option seller in exchange for the right to buy.


281

Eg:An investor buys a call option to purchase 100 SBI shares
Strike price
Current stock price
Price of an option to buy one share
The initial investment

Rs.320 per share
Rs.310 per share
Rs.20
100x Rs.20=2000

Outcome: assume at the expiration of the option, SBI share price is Rs.350.
At this time option is exercised for a gain of (Rs.350-320)x100=Rs3000.
When the initial cost is taken, the net gain is Rs3000-Rs.2000=Rs.1000


282

• An option contract giving the owner the right to sell a
specified amount of an underlying security at a
specified price within a specified time.


283

• A put option gives you the right to sell within a
specified time period at a specified price.
• It is not necessary to own the asset before acquiring
the right to sell it.


284

An investor Purchases a put option to sell100 SBI
shares
Strike price
Current stock price
Price of put option to sell one share
The initial investment

Rs.320 per share
Rs.310 per share
Rs.15
100x Rs.15=1500

• Outcome: at the expiration of the option, SBI share
price is Rs300.at this time, the investor buy 100 SBI
shares at Rs.300 and then sell at Rs320 to the option
buyer to realize Rs20 per share, being Rs2000 in total.
• When initial cost is taken, net gain is Rs2000Rs1500=500
285

Call Option
ATM
Exercise Price = Market Price
ITM
Exercise Price < Market Price
OTM
Exercise Price > Market Price
PUT OPTION
ATM
Exercise Price = Market Price
ITM
Exercise Price > Market Price
OTM
Exercise Price < Market Price

287

The European kind of option is the one which can be
exercised by the buyer on the expiration day only & not
anytime before that.

An American style option is the one which can be exercised by
the buyer on or before the expiration date, i.e. anytime
between the day of purchase of the option and the day of its
expiry.

288

• The fixed price at which the option holder can buy
and/ or sell the underling asset is called exercise price
or strike price.


289

Premium is the price paid by the buyer to the seller to
acquire the right to buy or sell. It is the total cost of
an option.


290

• The date on which the option expires is known as
Expiration Date.


291

• Initially

developed

in

1973

by

two

academicians, Fisher Black & Myron Scholes.
• Designed to price European options.


294

• The call option is the European option

• The stock price is continuous and is distributed
normally
• There are no transaction costs and taxes
• Stock trading is continuous
• The short term risk free interest rate R is constant

• The stock pays no dividend

295

C

S N (d1 )

ln( S / K )

Ke

R

d1
d2

rt

(

N (d 2 )

2

/ 2) t

t
d1

t

296

• Variable definitions:
C = theoretical call premium/value of the call option
S = current stock price
t = time in years until option expiration
K = option striking price
R = risk-free interest rate


297

Variable definitions:
N(d1) , N(d2) = value of the cumulative normal
density function.
In(S/K)= is the natural logarithm
= standard deviation of stock returns
e = base of natural logarithm (2.7183)


298

Mutual Fund
•

A Mutual Fund is a trust that pools the savings of a number of investors who share a
common financial goal.

•

Anybody with an investible surplus of as little as a few thousand rupees can invest in
Mutual Funds.

•

These investors buy units of a particular Mutual Fund scheme that has a defined
investment objective and strategy.

•

The money collected is invested by the fund manager in different types of securities.
These could range from shares to debentures to money market instruments, depending
upon the scheme’s stated objectives.

•

The income earned through these investments and the capital appreciation realized by

the scheme are shared by its unit holders in proportion to the number of units owned by
them.

300

Mutual Funds
• What are the advantages of Mutual Fund
Investing?
– Diversification
• While owning a single stock or bond is very risky,
owning a mutual fund which holds numerous
securities can reduce risk significantly

– Professional management
• Picking your own stocks and bonds to put in your
portfolio and beating your benchmarks is difficult
and time consuming. Hiring a mutual fund to make
those decisions for you can be beneficial and save
time

Mutual Funds
• Minimal transaction costs

– Buying individual stocks and bonds is expensive in
terms of transactions costs. Mutual funds enjoy
economies of scale in purchases and sales due to
size
• Liquidity

– Buying and selling individual stocks and bonds
takes time. Money from open-end mutual funds
can be received in two business days
• Flexibility

– Individual stocks and bonds are not flexible. With
many mutual funds, you have more flexibility and
can often write checks on your account

Mutual Funds (continued)
• Low cost

– “No-load” mutual funds are sold without a
sales charge and are redeemed without a
charge as well


304

• In addition, they may include:
– Automatic investment and withdrawal plans
– Automatic reinvestment of interest, dividends,
and capital gains
– Wiring and funds express options
– Phone switching
– Easy establishment of retirement plans
– Check writing
– Bookkeeping and help with taxes


305

• What are the disadvantages of Mutual Fund Investing?
– Risk of lower-than-market performance
• From 1986-2011, the average annual returns of
actively managed stock funds underperformed
the return of the S&P 500 stock index. Not all
mutual funds outperform their benchmarks, and
taxes take a significant part of investor returns


306

– High costs
• Unless analyzed carefully, management and
other fees can be significant.


307

• Other Risks

– Mutual funds are subject to both market and
stock related risks, particularly in concentrated
portfolios
• Inability to plan taxes

– Mutual funds pass through 95% of all capital
gains and dividends to the shareholders
• Even if you do not sell your mutual fund, you can
have a significant tax bill each year if your mutual
fund trades often and has dividends, interest or
capital gains

– It is difficult to plan for taxes when the tax
decision is taken by the portfolio manager, not
you

308

Asset Management Company
(AMC)
• A Company registered with SEBI, which takes
investment/divestment decisions for the mutual
fund, and manages the assets of the mutual
fund.


309

Asset Management Company
[AMC]
• An asset management company is a company registered

under the Companies Act, 1956. The Sponsor creates the
asset management company and this is the entity, which
manages the funds of the mutual fund (trust).

• The mutual fund pays a small fee to the AMC for
management of its fund. The AMC acts under the
supervision of Trustees and is subject to the regulations of
SEBI.

310

Mutual Fund Operation
Flow Chart


311

Organisation of a Mutual Fund


312

Advantages of Mutual Funds
•

Professional Management

•

Diversification

•

Convenient Administration

•

Return Potential

•

Low Costs

•

Liquidity

•

Transparency

•

Flexibility

•

Choice of schemes

•

Tax benefits

•

Well regulated


313

Types of Mutual Fund Schemes
• Wide variety of Mutual Fund Schemes exist to cater
to the needs such as financial position, risk tolerance
and return expectations etc.

• The figure in the next slide gives an overview into the
existing types of schemes in the Industry.


314

Types of Schemes
•

By Structure
–
–

Close Ended Schemes

–

•

Open Ended Schemes

Interval Schemes

By Investment Objectives
–
–

Income Schemes

–

Balance Schemes

–

•

Growth Schemes

Money Market Schemes

Other Schemes
–

•

Tax Saving Schemes

Special Schemes
–

Index Schemes

–

Sector Specific Schemes

315

Frequently Used Terms
•

Net Asset Value (NAV)

•

Net Asset Value is the market value of the assets of the scheme minus its
liabilities. The per unit NAV is the net asset value of the scheme divided by the
number of units outstanding on the Valuation Date.
•
•

Sale Price

•

Repurchase Price

Is the price you pay when you invest in a scheme. Also called Offer Price. It may
include a sales load.

Is the price at which a close-ended scheme repurchases its units and it may
include a back-end load. This is also called Bid Price.

316

security analysis and investment management

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