Finance Investment Analysis & Portfolio Management , FM 01, MBA Notes unit 1
Unit
I
Investment Overview of Capital Market: Market of securities, Stock Exchange and New Issue Markets - their nature, structure, functioning and limitations; Trading of securities: equity and debentures/ bonds. Securities trading - Types of orders, margin trading, clearing and settlement procedures. Regularity systems for equity markets, Type of investors, Aim & Approaches of Security analysis.
It’s where trades
of securities such as stocks and bonds take place based on demand and supply.
Securities markets determine price and participants can be both professional
and non-professional.
The
securities market encompasses organized exchanges, as well as over-the-counter
markets where trading is done directly between brokers and dealers.
- Equity securities. This is just a posh name for stocks. When you buy shares, you own part of a company.
- Debt
securities. Also known as fixed-income securities, these are better known as bonds. When you buy them you're lending money to a company.
- Derivative securities. With these, you're granted the right to trade financial securities at pre-agreed terms instead of owning shares outright. Options contracts are a type of derivative security.
Functions
of securities markets
The three basic
functions of securities markets are:
1-Capital
formation
the companies that need capital to function, and the
investors with capital that are looking for a return on their investments. It
also connects investors together, those that are looking to liquefy and sell
their securities, and those who want to buy those same securities.
2-Liquidity,
The liquidity of securities is crucial to the buyer, and it can be
the decision-maker on whether or not the buyer will invest.
3- Risk
management.
These markets diminish the risk involved with purchasing
securities by diversifying and hedging their investments. They can purchase
groups of securities to lower the overall risk, despite some of the securities
having a higher individual risk. Derivatives are further measures
to eliminate risks; they create a maximum loss and secure investment gains.
STOCK EXCHANGES
IN INDIA
Stock Exchange (also known as the stock market or
share market) is one of the main integral parts of the capital market in India. It
plays a vital role in growing industries and commerce of a country which
eventually affects the economy. It is a well-organized market for purchase and
sale of corporate and other securities which facilitates companies to raise
capital by pooling funds from different investors as well as act as an
investment intermediary for investors. Moreover, it ensures that securities
should be traded according to some pre-defined rules and regulations. London
Stock Exchange is the oldest stock exchange in the world whereas the Bombay Stock
Exchange is the oldest one in India. In India, there are 7 Stock Exchanges out
of which NSE and BSE are the two main indices. Most of the trading in the Indian
Stock Market takes place on these two stock exchanges. Both the exchanges
follow the same trading hours, trading mechanism, settlement process etc. At
the last count, BSE comprises of 5800 listed firms whereas, on the other hand, its rival NSE consists of 1659 listed firms. Interestingly, out of all the firms
listed on BSE, only around 500 firms constitute more than 90 % of its market
capitalization.
Bombay Stock
Exchange
(BSE) is the leading and fastest stock
exchange in India as well as in South Asia established in 1875. Bombay stock
exchange is the world's 11th largest stock market by market capitalization at
$1.7 trillion as of 31 January 2015 (Monthly Reports, World Federation of
Exchanges). More than 5,000 companies are listed on BSE. The main index of
Bombay stock exchange is Sensex which comprises 30 stocks.
National Stock
Exchange
NSE was
incorporated in 1992 as a tax-paying company and was recognized as a stock
exchange in 1993 under the Securities Contracts (Regulation) Act 1956. NSE is
the 12th largest stock exchange in the world with a market capitalization of
more than US$ 1.65 trillion as on 31 January 2015 (Monthly Reports, World
Federation of Exchanges). Moreover, it was the first exchange to provide a fully
automated screen-based electronic trading system. Nifty is the indices to
measure the overall performance of the National Stock Exchange which comprises of
50 stock index.
Functions of
Stock Exchange
The Stock Exchange serves two critical
functions:
• It provides a critical link between companies that need funds to set up a new business or to expand
their current operations and interested investors.
• Stock Exchange
also acts as a guide for the investors that have excess funds to invest in such
companies.
SECTOR
INDICATORS by Stock Exchange
There are a number of sectors or industries
which are listed on the National Stock Exchange and Bombay Stock Exchange. In
addition to this, an individual sector comprises of a number of companies. There
are around 73 sectors listed on NSE and BSE separately. Some of the important
sectors present on both the exchanges are as follows:-
BANKING SECTOR
AUTOMOBILE SECTOR
INFORMATION
TECHNOLOGY SECTOR
METAL SECTOR
REAL ESTATE SECTOR
FMCG SECTOR
MEDIA &
ENTERTAINMENT SECTOR
PHARMACEUTICALS
SECTOR
POWER SECTOR
PSU BANK SECTOR
National Stock
Exchange
The National Stock The exchange is located in Mumbai. It was incorporated in 1992 and became a stock
exchange in 1993. The basic purpose of this exchange was to bring transparency to the stock markets. It started its operations in the wholesale
debt market in June 1994. The equity market segment of the National Stock
Exchange commenced its operations in November 1994 whereas, in the derivatives
segment, it started its operations in June 2000. It has a completely modern and
fully automated 3 screen-based trading system having more than two lakh trading
terminals, which provides the facility to the investors to trade from anywhere
in India. It is playing an important role to reform the Indian equity market to
bring a more transparent, integrated, and efficient stock market. As of July 2013,
it has a market capitalization of above than $989 billion.
The total of 1635
companies are listed on the National Stock Exchange. The popular index of NSE, The
CNX NIFTY is extremely used by the investor throughout India as well as internationally.
NSE was firstly introduced by leading Indian financial institutions. It offers
trading, settlement, and clearing services in equity and debt market and also in
derivatives. It is one of India’s largest exchanges internationally in cash,
currency, and index options trading. There are a number of domestic and global
companies that hold a stake in the exchange. Some domestic companies include GIC,
LIC, SBI, and IDFC Ltd. Among foreign investors, few are City Group Strategic
Holdings, Mauritius limited, Norwest Venture Partners FII (Mauritius), MS
Strategic (Mauritius) Limited, Tiger Global five holdings, have a stake in NSE.
The National Stock
Exchange replaced open outcry system, i.e. floor trading with the screen-based
automated system. Earlier, the price information can be accessed only by a few
people but now information can be seen by the people even in a remote location.
The paper-based
settlement system was replaced by an electronic screen-based system and settlement
of trade transactions was done on time. NSE also created National Securities
Depository Limited (NSDL) permitted investors to hold and manage their
shares and bonds electronically through Demat account. An investor can hold and
trade in even one share.
Now, the physical
handling of securities eliminated so the chances of damage or misplacing of
securities reduced to a minimum and to hold the equities become more convenient.
The National
Security Depository Limited’s electronically security handling, convenience,
transparency, low transaction prices and efficiency in trade which is affected
by NSE, has enhanced the reach of Indian stock market to domestic as well as
international investors.
The new issues market
The new issues,
placed first in the new issue market, can be disposed of subsequently in the
stock exchange. The stock exchange provides the mechanism for regular and
continuous purchase and sale of securities. This facility is of immense utility
to potential investors who are assured that they may be able to dispose of the
allotment of shares at any time. Thus the two markets are complementary in
nature. Both the markets are connected to each other even at the time of the new
issue. The companies, which make a new issue, apply for listing of shares on a
recognized stock exchange. Listing of shares adds prestige to the firm and
widens the market for the investors. The companies, which want stock exchange
listing, have to comply with statutory rules and regulations of the stock exchange to ensure fair dealings in them. The stock exchanges, thus, exercise
considerable control over the organization of new issues.
Functions of New
Issue Market
The main function
of the new issue market is to facilitate the transfer of resources from savers to the
users. The savers are individuals, commercial banks, insurance companies, etc. The
users are public limited companies and the government. The new issue market
plays an important role in transferring shares for production purposes, an
important requisite for economic growth. It is not only a platform for raising
finance to establish new enterprises but also for expansion/ diversification/
modernization of existing units.
New Issue Market
performs three main functions which include
1) Origination
It refers to the
work of investigation, analysis, and processing of new project proposals. This
function starts before an issue is actually floated in the market. There are
two aspects of this function. A careful study of the technical, economic and
financial viability is necessary to ensure the soundness of the project function
of origination is done by merchant bankers who may be commercial banks, all
India financial institutions or private firms.
2) Underwriting
It is an agreement
whereby the underwriter promises to subscribe to a specified number of shares
or debentures or a specified quantity of stock in the event of the public not
subscribing to the issue. If the issue is fully subscribed, then there is no
liability for the underwriter. If a part of share issues remain unsold, the
underwriter will buy the unsold shares.
3) Distribution.
Distribution is the function of the sale of
securities to ultimate investors. This service is performed by brokers and
agents who maintain regular and direct contact with the ultimate investors
Main
features of the primary market (a type of Capital Market) are as follow:
(1) It is related to New Issues:
The
first, an important feature of the primary market is that it is related to the
new issues. Whenever a company issues new shares or debentures, it is known as
Initial Public Offer (IPO).
(2) It has No Particular Place:
Primary the market is not the name of any particular place but the activity of bringing in
new issues is called the primary market.
(3) It has Various Methods of Floating Capital:
(i) Public Issue:
Under
this method, the company issues a prospectus and invites the general public to
purchase shares or debentures.
(ii) Offer for Sale:
Under
this method, firstly the new securities are offered to an intermediary
(general firms of stockbrokers) at a fixed price. They further resell the
same to the general public. The advantage of doing this is that the issuing
company feels free from the tedious work of making a public issue.
(iii) Private Placement:
Under
this method, the company sells securities to the institutional investors or brokers
instead of selling them to the general public. They, in turn, sell these
securities to the selected clients at a higher price. This method is preferred
as it is a cheaper method of raising funds as compared to a public issue.
(iv) Right Issue:
This method is used by those companies that have already issued their shares. When an
existing company issues new shares, first of all, it invites its existing
shareholders. This issue is called the right issue. In this case, the
shareholder has the right either to accept the offer for himself or assign a
part or all of his right in favor of another person.
(v) Electronic Initial Public Issue (e-IPOs):
Under
this method, companies issue their securities through the electronic medium
(i.e. internet). The company issuing securities through this medium enters into
a contract with a Stock Exchange.
(4) It Comes
before the Secondary Market:
The transactions
are first made in the primary market. The turn of the secondary market comes
later.
Advantages of Primary Market
§ Companies can raise
capital at relatively low cost, and the securities so issued in the primary
market provide high liquidity as the same can be sold in the secondary market
almost immediately.
§ The primary market is
an important source for mobilisation of savings in an economy. Funds are
mobilised from commoners for investing in other channels. It leads to monetary
resources being put into investment options.
§ Chances of price
manipulation in the primary market are considerably less when compared to the
secondary market. Such manipulation usually occurs by deflating or inflating a
security price, thereby deliberately interfering with fair and free operations
of the market.
§ The primary market
acts as a potential avenue for diversification to cut down on risk. It enables
an investor to allocate his/her investment across different categories
involving multiple financial instruments and industries.
§ It is not subject to
any market fluctuations. The prices of stocks are determined before an initial
public offering, and investors know the actual amount they will have to invest.
Disadvantages of Primary Market
§ There may be limited
information for an investor to access before investment in an IPO since
unlisted companies do not fall under the purview of regulatory and disclosure
requirements of the Securities and Exchange Board of India.
§ Each stock is exposed
to varying degrees of risk, but there is no historical trading data in a
primary market for analyzing IPO shares because the company is offering its
shares to the public for the first time through an initial public offering.
§ In some cases, it may
not be favorable for small investors. If a share is oversubscribed, small
investors may not receive share allocation.
The Secondary Market in Old
Issues:
This market deals in existing securities.
Its main function is to provide liquidity to such securities. Liquidity of an
asset means its easy convertibility into cash at short notice and with minimal
loss of capital value.
This liquidity is provided by providing a
continuous market for securities, that is, a market where a security cart be
bought or sold at any time during business hours at small transaction cost and
at comparatively small variations from the last quoted price.
This, of course, is true of only ‘active’
securities for which there are always buyers and sellers in the market.
‘Activeness’ is a property of individual securities, not of the market.
The function of providing liquidity to old
stocks is important both for attracting new finance and in other ways. The
secondary market provides an opportunity to all concerned to invest in
securities and when they like. This opens a way for continuous inflow of funds
into the market.
There are two segments of the secondary market:
(a) Organized stock exchange,
(b) Over-the-counter market.
Over-the-counter
market
Such securities as are not ‘listed’ on an
organized stock exchange. These are securities of small companies and have only
a limited market. Their prices are determined through direct negotiation
between stock brokers and not through open bidding as is the case with ‘listed’
securities on a stock exchange. The main action of the stock market is
concentrated on these exchanges.
Most Important
Functions of Stock Exchange/Secondary Market
1. Economic Barometer:
A stock exchange is a reliable barometer
to measure the economic condition of a country.
2. Pricing of Securities:
The stock market helps to value the
securities on the basis of demand and supply factors
3. Safety of Transactions:
In stock market only the listed securities
are traded and stock exchange authorities include the companies names in the
trade list only after verifying the soundness of company.
4. Contributes to Economic Growth:
In stock exchange securities of various companies
are bought and sold.
5. Spreading of Equity Cult:
Stock exchange encourages people to invest
in ownership securities by regulating new issues, better trading practices and
by educating public about investment.
6. Providing Scope for Speculation:
To ensure liquidity and demand of supply
of securities the stock exchange permits healthy speculation of securities.
7. Liquidity:
The main function of stock market is to
provide ready market for sale and purchase of securities and providing
liquidity facilities.
8. Better Allocation of Capital:
The general public hesitates to invest in
securities of loss making companies. So stock exchange facilitates allocation
of investor’s fund to profitable channels.
9. Promotes the Habits of Savings and Investment:
The stock market offers attractive
opportunities of investment in various securities.
Limitations
1.
Unethical
practices: Many unethical practices are rampant in Indian stock
markets. Prices of shares are artificially increased before rights issues by
circular trading .
2.
Misinformation: Funds are raised
from investors promising investment in projects yielding high returns.
3.
Absence of
Genuine Investors: A very small proportion of purchases and sales effected in a
stock exchange are by genuine investors. Speculators constitute a major portion
of the market. Many of the transactions are carried out by speculators who
plan to derive profits from short term fluctuations in prices of securities.
4.
Fake shares: Frauds involving
forged share certificates are quite common. Investors who buy shares
unfortunately may get such fake certificates.
5.
Insider
trading: Insider trading is a common occurrence in many stock
exchanges.
6.
Unofficial
transactions: Unofficial markets exist along with the regular stock exchange.
Trading takes place in these unofficial stock exchanges after trading hours of
the regular stock exchange.
7.
Prevalence of
Price Rigging: Price rigging is a common evil plaguing the stock markets in
India. Companies which plan to issue securities artificially try to increase
the share prices, to make their issue attractive as well as enable them to
price their issue at a high premium. Promoters enter into a secret agreement
with the brokers.
8.
Thin trading: Though many
companies are listed in stock exchange, many are not traded.
9.
Excessive
Speculation: There is excessive speculation in some shares which artificially
results in increasing or decreasing the prices.
10.
Underdeveloped
debt market: The debt market in India has not been developed to the required
extent. There is very little liquidity in the debt markets.
11.
Payment crisis: Market players
indulge in excessive speculation and trading to profit from the increase and
decrease in prices
12.
Poor liquidity: The
main objective of listing shares in a stock exchange is to provide
liquidity.
13.
Inadequate
instruments: The markets are dominated by equity. Convertible debenture
issues are very rare.
14.
Influence of
Financial Institutions: The equity markets are dominated by large players such as mutual
funds.
15.
Domination of
FII’s: Foreign institutional investors have come to play a major role
in the Indian markets. They have pumped in billions of dollars and buy and sell
in large quantities.
16.
Odd lots: Odd lots suffer
from poor liquidity. The number of odd lot dealers is very less and odd lots
have to be sold at a lower price.
17.
Poor services: The number of
brokers is less and many brokers provide very poor service to investors, There
are more than 50,000 sub-brokers and they are totally unregulated. There are
many instances of sub brokers committing fraudulent acts and investors losing
money.
Security -
The term "security" is
a fungible, negotiable financial instrument that holds some type
of monetary value. It represents an ownership position in a publicly-traded
corporation—via stock—a creditor relationship with a governmental body or a corporation—represented
by owning that entity's bond—or rights to ownership as represented by
an option.
Securities can be broadly categorized
into two distinct types:
1- Equities and 2-Debts.
However, you will also see hybrid
securities that combine elements of both equities and debts.
Equity
Securities
An equity security represents ownership
interest held by shareholders in an entity (a company, partnership or trust),
realized in the form of shares of capital stock, which includes shares of
both common and preferred stock. Holders of equity securities are typically not
entitled to regular payments—although equity securities often do pay out
dividends—but they are able to profit from capital gains when they
sell the securities (assuming they've increased in value, naturally). Equity
securities do entitle the holder to some control of the company on a pro
rata basis, via voting rights. In the case of bankruptcy, they share only
in residual interest after all obligations have been paid out to creditors.
They are sometimes offered as payment-in-kind.
Debt
Securities
A debt security represents money that is
borrowed and must be repaid, with terms that stipulates the size of the loan,
interest rate, and maturity or renewal date. Debt securities, which
include government and corporate bonds, certificates of deposit (CDs) and
collateralized securities (such as CDOs and CMOs), generally
entitle their holder to the regular payment of interest and repayment of
principal (regardless of the issuer's performance), along with any other
stipulated contractual rights (which do not include voting rights). They are
typically issued for a fixed term, at the end of which they can be redeemed by
the issuer. Debt securities can be secured (backed by collateral) or unsecured,
and, if unsecured, may be contractually prioritized over other
unsecured, subordinated debt in the case of a bankruptcy.
Hybrid
Securities
Hybrid
securities, as the name suggests, combine some of
the characteristics of both debt and equity securities. Examples of hybrid
securities include equity warrants (options
issued by the company itself that give shareholders the right to purchase stock
within a certain timeframe and at a specific price), convertible
bonds (bonds that can be converted into shares
of common stock in the issuing company) and preference shares (company stocks whose payments of interest,
dividends or other returns of capital can be prioritized over those of other
stockholders)
Preference Capital
The Preference
Capital is that portion of capital which is raised through the issue of the
preference shares. This is the hybrid form of financing that has certain
characteristics of equity and certain attributes of debentures.
Advantages
of Preference Capital
·
There is no legal obligation on the firm to pay a dividend to the
preference shareholders.
·
The redemption of preference shares is not distressful for a firm since
the shares are redeemed out of the profits and through the issue of fresh
shares (preference shares and equity shares).
·
The preference capital is considered as a component of net worth and
hence the creditworthiness of the firm increases.
·
Preference shareholders do not enjoy the voting rights, and thus, there
is no dilution of control.
Disadvantages
of Preference Capital
·
It is very expensive as compared to the debt-capital because unlike debt
interest, preference dividend is not tax deductible.
·
Although, there is no legal obligation to pay the preference dividends,
when the payment is made it is done along with the arrears.
·
The preference shareholder can claim prior to the equity shareholders,
in case the dividends are being paid or at the time of winding up of the firm.
·
If the company does not pay or skips the preference dividend for some
time, then the preference shareholders could acquire the voting rights.
The preference
capital is similar to the equity in the sense: the preference dividend is paid
out of the distributable profits, it is not obligatory on the part of the firm
to pay the preference dividend, these dividends are not tax-deductible.
The portion of the
preference capital resembles the debentures: the rate of dividend is fixed,
preference shareholders are given priority over the equity shareholders in case
of dividend payment and at the time of winding up of the firm, the preference
shareholders do not have the right to vote and the preference capital is
repayable.
Equity Capital
Invested money that,
in contrast to debt capital, is not repaid to the investors in the normal
course of business. It represents the risk capital staked by the owners through
purchase of a company’s common stock (ordinary shares).
The value of equity
capital is computed by estimating the current market value of everything owned
by the company from which the total of all liabilities is subtracted. On the
balance sheet of the company, equity capital is listed as stockholders’ equity
or owners’ equity. Also called equity financing or share capital.
Advantage
of Equity Capital
(i) Fixed Costs
Unchanged By Equity Capital
Equity financing has
no fixed payment requirements. As a result, the investments do not increase a
company’s fixed costs or fixed payment burden. In addition, dividends to be
paid to equity investors can be deferred and cash can be directed to business
opportunities and operating requirements as needed.
(ii) Collateral-Free
Financing
Equity investors do
not require a pledge of collateral. Existing business assets remain
unencumbered and available to serve as security for loans. In addition, assets
purchased with equity capital can be used to secure future long-term debt.
(iii) Long-Term
Financing
Equity investors are
focused on future earnings and increasing the value of a business rather than
the immediate return on their investment in the form of interest payments or
dividends. As a result, businesses can rely on equity capital to finance
projects for which the earnings or returns may not occur for some time, if at
all.
(iv) Convenant-Free
Financing
A lender is concerned
with the repayment of debt. The lender wants to ensure that loan proceeds
increase company assets, which generate cash to repay loans. Therefore, lenders
establish financial covenants that restrict how loan proceeds are used. Equity
investors establish no such covenants; they rely on governance rights to
protect their interests.
Disadvantage
of Equity Capital
(i) Investor
Expectations
Neither profits nor
business growth nor dividends are guaranteed for equity investors. The returns
to equity investors are more uncertain than returns earned by debt holders. As
a result, equity investors anticipate a higher return on their investment than
that received by lenders.
(ii) Business Form
Requirements
Legal restrictions
govern the use of equity financing and the structure of the financing
transactions. In fact, equity investors have financial rights, including a
claim to distributed dividends and proceeds from the sale of the company in
which they invest. The equity investors also have governance rights pertaining
to the board of directors' election and approval of major business decisions.
These rights dilute the ownership and control of a company and increase the
oversight of management decisions.
(iii) Financial
Returns Distribution
Each investor in a
company has a right to the cash flow generated by the business after all other
claims are paid. If the business is sold, the owners share cash equal to the
net proceeds of the business if again occurs on the sale. The investors’ net
return is equal to the net proceeds of the sale less the cash they invested in
the business. The legal restrictions that govern the use of equity financing
determine the return received by an individual.
Debentures/Bonds
Trading securities is a category of securities that includes both debt securities and equity securities, and which an entity intends to sell in the short term for a profit that it expects to generate from increases in the price of the securities. This is the most common classification used for investments insecurities.
Trading is usually done through an organized stock exchange, which
acts as the intermediary between a buyer and seller, though it is also possible
to directly engage in purchase and sale transactions with counterparties.
Trading securities are recorded in the balance sheet of the
investor at their fair value as of the balance sheet date. This type of
marketable security is always positioned in the balance sheet as a current
asset.
If there is a change in the fair value of such an asset from
period to period, this change is recognized in the income statement as again
or loss.
Other types of marketable securities are classified as
available-for-sale and held-to-maturity.
Debentures
Debentures are a debt instrument used by companies and the government
to issue the loan. The loan is issued to corporates based on their reputation at
a fixed rate of interest. Debentures are also known as a bond which serves as
an IOU between issuers and purchaser. Companies use debentures when they need
to borrow the money at a fixed rate of interest for its expansion. Secured and
Unsecured, Registered and Bearer, Convertible and Non-Convertible, First and
Second, are four types of Debentures.
Advantages of Debentures
·
Investors who want fixed income at lesser risk prefer them.
·
As a debenture does not carry voting rights, financing through
them do not dilute control of equity shareholders on management.
·
Financing through them is less costly as compared to the cost of
preference or equity capital as the interest payment on debentures is tax
deductible.
·
The company does not involve its profits in a debenture.
·
The issue of debentures is appropriate in the situation when the
sales and earnings are relatively stable.
Disadvantages of Debentures
·
Each company has a certain borrowing capacity. With the issue of
debentures, the capacity of a company to further borrow funds reduces.
·
With redeemable debenture, the company has to make provisions for
repayment on the specified date, even during periods of financial strain on the
company.
·
Debenture put a permanent burden on the earnings of a company.
Therefore, there is a greater risk when the earnings of the company fluctuate.
Types of Debenture
1.
Secured and Unsecured:
Secured debenture creates a charge on the assets of the company,
thereby mortgaging the assets of the company. Unsecured debenture does not
carry any charge or security on the assets of the company.
2.
Registered and Bearer:
A registered debenture is recorded in the register of debenture
holders of the company. A regular instrument of transfer is required for their
transfer. In contrast, the debenture which is transferable by mere delivery is
called bearer debenture.
3.
Convertible and Non-Convertible:
Convertible debenture can be converted into equity shares after
the expiry of a specified period. On the other hand, a non-convertible a debenture is those which cannot be converted into equity shares.
4.
First and Second:
A debenture which is repaid before the other debenture
is known as the first debenture. The second debenture is that which is paid
after the first debenture has been paid back.
TYPES OF ORDERS
The most common types of orders are market orders, limit orders, and
stop-loss orders.
·
A market order is an order to buy or sell security This type of
order guarantees that the order will be executed but does not guarantee the
execution price. A market order generally will execute at or near the current
bid (for a sell order) or ask (for a buy order) price. However, it is important
for investors to remember that the last traded price is not necessarily the
price at which a market order will be executed.
·
A limit order is an order to buy or sell a security at a specific price
or better. A buy limit order can only be executed at the limit price or lower,
and a sell limit order can only be executed at the limit price or higher.
Example: An investor wants to purchase shares of ABC stock for no more than
$10. The investor could submit a limit order for this amount and this order
will only execute if the price of ABC stock is $10 or lower.
·
A stop order also referred to as a stop-loss order is an order to buy or
sell a stock once the price of the stock reaches the specified
price, known as the stop price. When the stop price is reached, a stop order
becomes a market order.
·
A buy stop order is entered at a stop price above the current market
price. Investors generally use a buy stop order to limit a loss or protect a
profit on a stock that they have sold short. A sell stop order is entered at a
stop price below the current market price. Investors generally use a sell stop
order to limit a loss or protect a profit on a stock they own.
Margin Trading Facility (MTF)
Margin
Trading Facility (MTF) is a facility offered to an investor in buying of shares and
securities from the available resources by allowing him to pay a fraction of
the total transaction value called a margin. The margin can be given in the
form of cash or shares as collateral depending upon the availability with the
respective investor. In short, it can be termed as leveraging a position in the
market with cash or collateral by the investor. In this transaction, the broker
funds the balance amount.
Till last year MTF was allowed against the cash margin not against
shares as collateral. Now Securities Exchange Board of India (SEBI) has relaxed
the said criteria vide its circular no. SCIR/MRD/DP/54/2017 dated June 13,
2017. Investors are now allowed to create a position under MTF against shares
as collateral as well.
SEBI and Exchanges monitor tightly the securities eligible under the MTF
and margin required (through cash or shares as collateral) on such securities
are prescribed by them from time to time. Currently, the securities forming
part of Group 1 securities are included in MTF.
Features
of MTF:
·
Investors who wish to avail the MTF need to undertake by
signing/accepting additional Terms and Conditions. It ensures that investors
are completely aware of the risk and rewards of trading in it.
·
Allows investors to create leverage position in securities which are not
part of the derivatives segment.
·
The positions can be created against the margin amount which can be in
the form of cash or shares as collateral.
·
Position can be carried forward up to T+N days (T = means trading day
whereas N = means a number of days the said position can be carried forward).
The definition of N varies from broker to broker.
·
Securities allowed under MTF are predefined by SEBI and Exchanges from
time to time.
·
Only corporate brokers are allowed to offer MTF as per SEBI regulations.
Benefits
for Investors:
·
MTF is ideal for investors who are looking for benefit from the price
movement in the short-term but not having sufficient cash balance.
·
Utilization of securities available in portfolio/Demat account (using
them as shares as collateral).
·
Improve the percentage return on the capital deployed.
·
Enhance the buying power of the investors.
·
Prudently regulated by the regulator and exchanges.
Clearing and Settlement Process When You Buy a Share
Clearing and Settlement Process
When You Sell a Share
Using the example cited above, the process is as follows:
·
You sell shares on June 22, 2020 (Day 01 or T Day). The shares
are blocked in your Demat account immediately. Hence, you cannot sell the same
shares again.
·
On Day 02 (T+1 Day), the broker gives the shares to the
exchange.
·
On Day 03 (T+2 Day), you receive funds in your banking account
post deduction of all charges.
This is the core clearing and
settlement process in a stock exchange.
This process is divided into three
parts:
I.
Trade Execution – where the
buy or sell order is executed by you. This happens on T Day.
II.
Clearing – where the
responsible entity identifies the number of shares that the seller owes and the
amount of money that the buyer owes for every trade. It also determines the
obligation of all parties and assesses risk. This is done on T+1 Day.
III.
Settlement – where the shares
are moved from the seller’s account to the buyer’s account and the money is
moved from the buyer to the seller. This is done on T+2 Day.
To ensure that this process is smooth,
the Securities and Exchanges Board of India (SEBI) has created several entities as described below.
Entities Involved in the Clearing
and Settlement Process in The Stock Market
Here is a quick look at the entities
involved in the trade clearing and settlement process in stock
markets in India and their respective roles:
#1. Depository
While traditionally shares were held in
a physical certificate format, today it is mandatory to hold them in the
electronic or dematerialized form. Hence, a Demat account is mandatory for
share transactions. SEBI has created a structure to ensure optimum performance
and maximum control over Demat accounts by creating Depositories – entities
that hold your Demat accounts. All participants like investors, brokers, and
clearing members need to have a Demat account to trade in the stock exchange.
#2. Clearing Corporation
This is an entity associated with a
stock exchange that handles the confirmation, settlement, and delivery of
shares. It acts as a buyer for the seller and a seller for the buyer. In
simpler terms, it facilitates purchase on one end of the transaction and sale
on the other. It ensures that the settlement cycles are short and consistent
while keeping the transaction risks in check and providing a counter-party risk
guarantee.
#3. Clearing Members and Custodians
The clearing corporation fulfills its
role by transferring every trade to a clearing member or custodian. Their core
responsibility is ensuring that the funds and shares are available on T+2 Day.
They need to have a clearing pool Demat account with a depository for receiving
and sending shares pertaining to the trade.
#4. Clearing Banks
Since there is a movement of money, SEBI
has created a list of 13 clearing banks that aid in the settlement of funds.
Every clearing member has to open a clearing account with one of these banks.
If the clearing member is settling a purchase transaction, then it needs to
ensure that the funds are made available in this account before the settlement.
On the other hand, if it is settling a sale transaction, then the funds are received
by the clearing member in the clearing account. Here’s a list of clearing
banks.
·
HDFC Bank
·
ICICI Bank
·
Kotak Mahindra Bank
·
Axis Bank
·
State Bank of India
·
HSBC Bank
·
JP Morgan Chase Bank
·
Citibank
·
DBS Bank
·
Deutsche Bank
·
Stock Holding Corporation of India
·
Infrastructure Leasing and Financial Services Ltd.
·
Orbis Financial Corporation Limited |
·
How Trades are Cleared and
Settled in the Stock Market
Here is a quick overview of the actual
process of clearing and settlement in the stock market:
I.
The stock exchange transfers the details of every trade to the
clearing corporation on T Day.
II.
The clearing corporation informs the clearing members and
custodians about the details of the trade and ask them to confirm if they are
willing to settle the trade or not. Upon receiving the confirmation, the
clearing corporation determines the obligations of the clearing member or
custodian.
III.
The clearing corporation sends the details of the obligations
and pay-in advice of securities or funds to each clearing member/custodian.
IV.
Once the details are received, the clearing members or
custodians to:
o Clearing banks to
make the funds available; and
o Depositories to
make securities available by the pay-in time
V.
The clearing corporation receives funds and securities from the
clearing banks and depositories for purchase and sale transactions
respectively. So, if a clearing member is settling a purchase transaction, then
the corporation receives the money in its clearing account via the clearing
bank. Also, for sale transactions, the corporation receives securities in its
pool account via the depository.
VI.
Once this is done, it instructs the depositories and clearing
banks to transfer the securities and funds to clearing members/custodians for
purchase and sale transactions. So, if a clearing member is settling a purchase
transaction, then the corporation transfers securities to its pool account.
Also, for sale transactions, the corporation transfers money to the clearing
account via the clearing bank.
There are many ways in which SEBI
ensures that the clearing and settlement process ensures market integrity by
becoming the counterparty to each trade. This is essential to ensuring the
availability of liquid and effective markets.
Securities and Exchanges Board of India (SEBI) Act, 1992
The year 1991
witnessed a big push being given to liberalization and reforms in the Indian
financial sector. For some time thereafter, the volume of business in the
primary and secondary securities markets increased significantly. As part of
the same reform process, the globalization or internationalization of the
Indian financial system made it value able to external shocks. The multi-crore
securities scam rocked the IFS in 1992. All these developments impressed on the
authorities the need to have in place a vigilant regulatory body or an
effective and efficient watchdog.
Constitution and
Organization Chapter II of the SEBI Act
SEBI Chapter II deals with
establishment, incorporation, administration, and management of the Board of
Directors etc. The SEBI is a body of six members comprising the Chairman, two
members from amongst the officials of the ministers of the Central Government
dealing with finance and law, two members who are professionals and have
experience or special knowledge relating to the security market, and one member
from the RBI. All members, except the RBI members, are 145 appointed by the
government, who also lay down their terms of office, tenure, and conditions of
service, and who can also remove any member from office under certain circumstances.
Functions of SEBI
SEBI basically protects the interest of
the investors in the security market, promote the development of the security
market and regulates the business. The functions of the Security and Exchange
Board of India can primarily be categorized into three parts:
Protective
Function
Protective functions are used to protect
the interest of investors and other financial participants. These functions
are:
Protective
Function
Protective functions are used to protect
the interest of investors and other financial participants. These functions
are:
·
Prevent Insider Trading: When the people working in the market
like director, promoters or employees working in the company starts to buy or
sell the securities because they have access to the confidential price which
results in affecting the price of the security is known as insider trading.
SEBI restricted companies to buy their own shares from the secondary market and
SEBI also regulates regular check-ups to prevent insider trading and avoid
malpractices.
·
Checks price rigging: The malpractices which create unreasonable
fluctuations in the price of the securities with the help of increasing or
decreasing the market price of stocks which results in an immense loss for the
investors or traders are known as price rigging. To prevent price rigging, SEBI
keeps active surveillance on the factors which can promote price rigging.
·
Promotes fair trade practices: SEBI established rules and
regulations and a certain code of conduct in the securities market to restrict
fraudulent and unfair trade practices.
·
Providing awareness/financial education for investors: SEBI
conducts seminars both online and offline to educate the investors about
insights into the financial market and money management.
Regulatory
Function
Regulatory functions are generally used
to check the functioning of the financial business in the market. They
establish rules to regulate the financial intermediaries and corporates for the
efficiency of the market. These functions are:
·
SEBI designed guidelines and code of conduct for efficient
working of financial intermediaries and corporate.
·
Established rules for taking over a company.
·
Conducts regular inquiries and audits of stock exchanges.
·
Regulates the process of mutual funds.
·
Registration of brokers, sub-brokers, and merchant bankers is
controlled by SEBI.
·
Levying of fees is regulated by SEBI.
·
Restrictions on private placement.
Development
Function
The development functions are the steps taken by SEBI to improve
the security of the market through technology. The functions are:
·
By providing training sessions to the intermediaries of the
market.
·
By promoting fair trading and restrictions on malpractices of
any kind.
·
By introducing the DEMAT format.
·
By promoting self-regulating organizations.
·
By introducing online trading through registered stock
brokers.
·
By providing discount brokerage.
Objectives of SEBI
The objectives of SEBI are:
·
Protection of investors: The primary objective of SEBI is to
protect the rights and interests of the people in the stock market by guiding
them to a healthy environment and protecting the money involved in the
market.
·
Prevention of malpractices: The main objective for the formation
of SEBI was to prevent fraud and malpractices related to trading and to regulate
the activities of the stock exchange.
·
Promoting fair and proper functioning: SEBI was established to
maintain the functioning of the capital market and to promote the functioning of
the stock exchange. They are ordered to keep eyes on the activities of the
financial intermediaries and regulate the securities industry
efficiently.
·
Establishing Balance: SEBI has to maintain a balance between the
statutory regulation and self-regulation of the securities industry.
·
Establishing a code of conduct: SEBI is required to develop and
regulate a code of conduct to avoid frauds and malpractices caused by
intermediaries such as brokers, underwriters and other people.
Depository Institutions
In every economy, depositories play an important role in
developing the country, as the developing countries don’t have enough
investments to complete their schemes efficiently. A well functioning
securities market can stabilize economic growth. India needs investment for
growth, so they need to improve market efficiency and protect the interests of
investors to attract them to invest in our market. So, the capital market needs
to improve investment opportunities for investors and take care of their
interests and security.
In India, the depository institutions are governed under the
Securities and Exchange Board of India (SEBI). The depository must be formed
under the Companies Act and must receive a certificate from SEBI. Depositories
registered under SEBI are:
·
Central Depository Service Limited (CDSL)
·
National Securities Depositories Limited (NSDL)
NSDL was established in 1996 by the National Stock Exchange
(NSE). NSE introduced the rolling system which helped the investors to receive
their payment within 5 days of the sale as it was 8-12 days, before NSE. CDSL
was promoted by the Bombay Stock Exchange (BSE).
Advantages
Depository Systems play an important role as they help in
eliminating the risks of holding physical securities. Initially, the buyers had
to keep an eye on the transfer of shares but now the depository systems have
reduced the risks by involving technology in the process. This helped in
improving the chances of foreign investments in the Indian Capital Market. The
advantages of Depository Institutions are:
·
It reduced the chances of forgery and delay.
·
Unlike physical transfer, these transfers are immediate.
·
The securities are controlled by the stock exchange.
·
It reduced the chances of bad delivery, fake certificates, and
signature related issues.
·
The fear of losing the certificate is reduced as everything is
online.
·
This electronic system is time-saving.
·
It restricted the transfer of Benami properties.
Depository
Participants
The agents which provide services related to depositories to
investors is known as a depository participant. Any approved institution from
RBI which agrees on the rules prescribed by SEBI can be a depository
participant. For example stockbrokers, financial corporations, foreign banks, etc
Types
of Investors
Anyone can buy stocks on the stock exchange. Each person has individual
reasons for buying a stock, and each person has a trading personality. Your
trading personality depends on how much risk you can tolerate, what kind of
research you are willing to do, where you think the economy is headed and how
much of a hurry you are in. Despite all this individualism, trading styles boil
down to a few different types
Active-Investors
Active investors stay abreast of their stocks' performance, do a
lot of research and keep up with the daily financial news. They don't
necessarily buy one day and sell the next, but they do pay attention to changes
in trends and buy or sell based on those trends. This person is an avid
investor who takes a great deal of care with each investment decision and does
not necessarily hold an investment long term.
Passive Investors
This kind of investor doesn't try to go for the biggest possible
gains at all times. Instead, the passive investor accepts reasonable gains in
exchange for a lower stress level and more free time. This person may invest in
mutual funds so the funds' money managers can make buy and sell decisions. She
may buy individual stock in established companies and hold that investment for
a year or more. Passive investors tend to remove stress from investment
decisions by setting parameters for adding more stock to their portfolios. For
example, when their stocks rise 20 percent, they may sell some to take profits.
Speculators
Some investors look for a chance to make money fast. They search
the market for stocks that are poised to go up because of an impending deal.
They scour the news for announcements about mergers that could affect a company
positively, and then they pounce on the stocks of those companies. They tend to
sell after a stock makes them a little money, reasoning that they can repeat
the process of buying and selling frequently and therefore outperform the
market.
Retirement Investors
People investing for retirement tend to change their tactics as
they approach retirement age. They may choose an aggressive approach when they
are younger. This involves buying riskier stocks that have the potential for
growth. Such an investor may switch to more moderate-risk stocks during midlife
and then switch to dividend stocks that produce income during retirement.
Security
Analysis
Security analysis refers to the method of analyzing the value of
securities like shares and other instruments to assess the total value of a business which will be useful for investors to make decisions. There are three
methods to analyze the value of securities – fundamental, technical, and
quantitative analysis.
When it comes to choosing between the two, several factors
should be considered –
·
Time
horizon is essential to consider – Fundamental analysis is a long-term
strategy, whereas technical analysis, is more short-term in nature.
·
Understand
your investment approach – Are you an investor or a trader? Fundamental analysis is
investing in the business because you believe in the product/service and
believe the price to reach its intrinsic value over tie. On the other hand,
technical analysis is a trading strategy where you seek to drive returns out of
identified trends and opportunities.
·
How
much time you can give – Trading needs active time and management on the part of
the investor. On the other hand, the fundamental approach asks for patience.
#1 – Fundamental Analysis
This type of
security analysis is an evaluation procedure of securities where the major goal
is to calculate the intrinsic value of a stock. It studies the fundamental
factors that effects stock’s an intrinsic value like profitability statement &
position statements of a company, managerial performance, and future outlook,
present industrial conditions, and the overall economy.
fundamental
analysis
1.Background
It is the approach whereby an individual tries to compute the intrinsic value of a stock by looking at the fundamental economic factors that
are likely to impact the value.
2.Factors
important for the analysis
Following are the factors that are important for conducting the
fundamental analysis –
·
Parameters
from Balance Sheet and Profit & Loss – This includes
revenues, expenses, and profit
·
Growth
prospects of the company – This consists of an understanding of the market, product
profile, customer profile, concentration, and the likes.
·
Competitive
factors for the company – This includes an understanding of the competitive
landscape of the company, including competitors, market share, barriers to
entry, pricing power, etc.
·
Expected
return on equity or assets – This includes the industry average and is ideally higher
than the Sensex (or any other benchmark) returns since inception.
The purpose of this analysis is to establish a value of the
stock that would factor in all the underlying factors mentioned above.
The approach doesn’t look at the short-term pricing and doesn’t
take into account the short-term trade swings. The plan is for long-term
investment as it tends to make time for the intrinsic value to be realized.
In this
approach, the factors are forward-looking expectations, and the model is build
to arrive at the valuation based on
backward and forward-looking information.
How
is Fundamental Analysis Conducted?
As seen previously, the fundamental analysis seeks to find the
enterprise value of the company. Thus, the approach uses economic factors.
While conducting fundamental analysis, the following route is adopted –
·
Economic Analysis
·
Industry Analysis
·
Company Analysis
1.Assumptions
in the analysis
Over the long-term, the stock price tends to reach its intrinsic
value
Gain can be made by purchasing an under-valued stock and then
wait for the market to take it to its real value
The technique is adopted by value investors looking for buy and
hold strategy.
2.Steps to
carry out the fundamental analysis
Step 1:
Perform industry analysis –
An analyst/investor should dig out and find everything about the
sector in which the company operates. The study will give output such as –
·
Sector growth rate
·
Key drivers for growth
·
Contribution to the GDP by the industry
·
Sector trends
·
Demand and Supply analysis
Step 2:
Conduct a company analysis
In this step, an analyst is supposed to understand the inside
out of the company using different financial tools such as ratio analysis
horizontal analysis, vertical analysis, etc.
The study will give output such as –
·
Trend evaluation – percentage increase/decrease relative to the
base year
·
Areas where the company has applied its resources
·
Proportions in which the funds are distributed to different
heads
·
Understanding the changes in the financial situation
Step 3: Conduct
financial modeling
In this step, an analyst is required to forecast the future of
the company for the foreseeable future, i.e., Three to seven years. An analyst
may need a lot of information and assumptions in this step. This may be availed
with the help of the management interview.
The objective of the step is to analyze how the financial
statements and the stock price will look in the future.
Step 4:
Carry out Valuation
There are many techniques for valuation that can be used. Many
of the methods are dependent on the type of company and industry. Some of the
ways are – Discounted Cash Flow (DCF), Relative valuation (includes Price to
Earnings Multiple, Price to Book Value Multiple, etc.), and Sum of the parts
(SOTP).
Discounted
Cash Flow Analysis
In this,the method, the analyst arrives at the intrinsic value. The ways and procedures are
exciting, and an analyst can always be innovative with the approach. To
understand the basics of DCF, click here.
Once, you arrive at the intrinsic share price for the company; the following is
the interpretation.
·
If Market Price (MP) > Intrinsic Price (IP) = stock is
overvalued and the analyst should recommend sell or the investor should sell
the stock
·
If MP < IP = stock is undervalued, and the analyst should
recommend buy, or the investor should buy the stock
Relative
Valuation Analysis
In this approach, analyst/investor values the company by
comparing it to the peer group.
Following parameters are used in the approach –
·
PE Ratio (Price to Earnings Ratio)
·
Earnings Per Share (EPS)
·
EV/EBITDA
·
EV/Sales, etc.
Advantages and Disadvantages
1.Fundamental
Analysis
Advantages
·
The methods used in the fundamental analysis are based on
financial data and thus eliminates room for personal bias.
·
The approach considers long-term economic, demographic,
technological, and, consumer trends.
·
The analysis has a systematic approach with different
statistical and analytical tools that help in arriving at the final Buy/Sell
recommendation
·
Rigorous accounting and financial analysis allows an investor to
gauge a better understanding of the company and its practices
Disadvantages
·
Conducting industry analysis, valuation is not everyone’s cup of
tea and needs a good amount of hard work, patience, and time.
·
Assumptions play a vital role in forecasting financials. Thus,
things may go wrong if the assumptions are not rationale.
#2 – Technical Analysis
This type of
security analysis is a price forecasting technique that considers only
historical prices, trading volumes, and industry trends to predict the future
performance of the security. It studies stock charts by applying various
indicators (like MACD, Bollinger Bands, etc) assuming every fundamental input
has been factored into the price.
Technical
Analysis
1.Background
It is the approach in which an individual evaluates investments
purely on the market activity surrounding them. The method doesn’t involve
looking at the actual operations or value of the company.
2.Factors
important for the analysis
Following are the factors that are important for conducting the
technical analysis –
·
Historical price of the stock
·
Historical trading volume
·
Industry trading trends
3.Some
tools used in technical analysis
There are several tools available in technology such as simple
moving averages are indicators that help assess the stock’s trend by averaging
the daily price over a fixed period.
Besides, there are few momentum-based indicators, such as
Bollinger Bands, Chaikin Money Flow, Stochastics, and Moving Average
Convergence/Divergence (MACD).
Each of these unique tools provides buy and sell signals based
on their criteria.
4.The goal
of the analysis
The purpose of the analysis is to capitalize on pricing
opportunities and trends that are identifiable in the market for each share.
The methodology is based on the historical price of the stock, historical
market activity, past trading volumes to identify the pattern.
How
is a technical analysis conducted?
Technical analysis, as mentioned above, is a method of
evaluating securities. However, in this method, the game is dependent upon the
stats generated by the market.
Thus, charts and patterns are the bread and butter for such an
approach. Following are the characteristics of technical analysis are:
·
Uses past price movement to predict the future price movement
·
Trends and Patterns play a significant role
·
The market price is the bible
·
Fundamental factors may not impact
1.Rules of
technical analysis
Following are the three golden rules for technical analysis –
·
First
Rule: Prices
discount information available to the public
·
Second
Rule: Price
movement is generally based on the trend that can be predicted (to some extent)
using technical tools
·
Third
rule – Price
Trends are likely to repeat themselves
2.Steps to
carry out the technical analysis
Step 1: Identify the security that interest you
Basic research on trending sector shall help an analyst/investor
(trader) to decide on the stock to buy or sell.
Step 2: Identify the strategy
Remember, one approach doesn’t fit all the stocks, and thus you
must have variation based on the share, its characteristics.
Step 3: Select the right trading account
This step is essential to ensure that the brokerage or the
charges involved are within your budget and are reasonable.
Step 4: Understand the tools and interfaces
An analyst/investor (trade) is supposed to select the tools that
fit your trading requirements and strategies. You can always check the web for
freely available tools.
Step 5: Conduct trade on simulation first
While making investments by technical approach, an investor should
first try their strategy on the selected stock with the help of a simulation
tool or tools such as excel. Once the testing of the approach is conducted,
only then you should shift to trade with real money.
Step 6: Always have a stop loss
A stop-loss allows you to cut on your losses automatically if
the stock moves opposite than anticipated. This helps in holding a losing
trade. Having a stop loss enables an investor to remain disciplined.
Technical
Analysis of Advantages
Following are the benefits of the approach:
Provides
insights on volume – It goes on without saying that demand and
supply govern the market dynamics. Thus, knowing the volume helps you gauge how
the overall market works.
Tells about
the entry and exit points with the help of charts and patterns
·
Provides
Current Information – Price reflects information about an asset
·
Patterns give a directional view and act as a guide to direct
your buy and sell decisions.
Disadvantages:
·
Many indicators often spoil the chart thereby by producing confusing
signals that may affect the analysis
·
Fundamentals
remain ignored – The approach does not take into account the underlying
fundamentals of a company. This can prove risky over the long-term.
#3 – Quantitative Analysis
This type of
security analysis is a supporting methodology for both fundamental and the technical analysis which evaluates the historical performance of the stock
through calculations of basic financial ratios e.g. Earnings Per Share (EPS), Return on Investments (ROI) or complex valuations like
discounted cash flows (DCF).Why
Analyze Securities?
The basic target of every individual is to increase its Net Worth by
investing its earnings into various financial instruments i.e. creation of
money using the money. Security analysis helps people achieve their ultimate goal as discussed below:
#1 – Returns
The primary objective of the investment is to earn returns in the form of capital appreciation as well as yield.
#2 – Capital Gain
Capital Gain
or appreciation is the difference between the sale price and the purchase price.
#3 – Yield
It is the
return received in the form of interest or dividend.
Return =
Capital Gain + Yield
#4 – Risk
It is the
probability of losing the principal capital invested. Security analysis avoids
risks and ensures the safety of capital also creates opportunities to
outperform the market.
#5 – Safety of Capital
The capital
invested with proper analysis; avoids chances to lose both interest and
capital. Invest in less risky debt instruments like bonds.
#6 – Inflation
Inflation
kills one’s purchasing power. Inflation over time causes you to buy a smaller
percentage of good for every dollar you own. Proper investments provide you
hedge against inflation. Prefer common stocks or commodities over bonds.
#7 – Risk-Return relationship
The higher
the potential return of an investment, the higher will be the risk. But the
higher risk doesn’t guarantee higher returns.
#8 – Diversification
“just don’t
put all your eggs in one basket” i.e. do not invest your whole capital in a
single asset or asset class but allocate your capital in a variety of financial instruments and create a pool of assets called
a portfolio. The goal is to reduce the risk of volatility in a particular
asset.
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