Financial Market Know how
1
This session will help you understand
• The component and Structure of financial market.
• The working of the equity as an asset class.
• The working of the Fixed Income Securities.
• The working of mutual fund products.
• Economic Environment and indicators.
• How to recommend a investment portfolio.
2
Financial Markets
Organizations that facilitate the trade in financial products. i.e. Stock exchanges
facilitate the trade in stocks, bonds and warrants
3
Types of financial markets
The financial markets can be divided into different categories:
– Capital Market
• Stock markets, which provide financing through the issuance of
shares and enable the subsequent trading.
• Bond markets, which provide financing through the issuance of
Bonds, and enable the subsequent trading.
– Money markets, which provide short term debt financing and
investment.
– Derivatives markets, which provide instruments for the management of
financial risk.
– Foreign exchange markets, which facilitate the trading of foreign
exchange.
– Commodity markets, which facilitate the trading of commodities.
4
Capital Market
• The capital market is the market for securities, where companies and
governments can raise long-term funds.
• The capital market includes the stock market and the bond market.
• Financial regulators oversee the capital markets to ensure that investors
are protected against fraud.
• The capital markets consist of primary markets and secondary markets.
– Primary markets: Newly formed (issued) securities are bought or sold.
– Secondary markets allow investors to sell securities that they hold or
buy existing securities.
5
Primary Market
• It deals with the issuance of new securities. Companies, governments or
public sector institutions can obtain funding through the sale of a new stock
or bond issue.
• In the case of a new stock issue, this sale is an initial public offering (IPO).
• Features Of Primary Market are:
– Market for new long term capital.
– Securities are sold for the first time.
– Issued by the company directly to investors
• Methods of issuing securities in the Primary Market
– Initial Public Offer;
– Rights Issue (For existing Companies); and
– Preferential Issue.
6
Secondary Market
• It is the market for trading of securities that
have already been issued in an initial offering
• Once a newly issued stock is listed on a stock
exchange, investors and speculators can easily
trade on the exchange
• A stock exchange is an organization which
provides facilities for stock brokers and traders,
to trade company stocks and other securities.
7
Equity
8
Understanding Equity
Equity is the form of shares of common stock. As a unit
of ownership, common stock typically carries voting
rights that can be exercised in company decisions
9
Ordinary shares - Equities
• Part Owners of Company
– Voting
– receive annual report and accounts
– entitlement to residual assets in case of winding
up
• No Actual Ownership of Company Assets
10
Preference shares
• Fixed Dividend
• Priority for dividend
• Priority on liquidation of company
11
Terminology
12
EPS: Earning per Share
• Earning per share: PAT/ No of equity share
• PAT: Profit after tax of the company
It denote the how much the company has earned on per
share.
Particulars
ABC Co Ltd XYZ Co Ltd
No of shares
100
300
PAT( Last 4 quarters)
600
900
EPS
6
3
13
P/E Ratio
• Market price / number of shares outstanding
• P/E could be either trailing or forward,
depending on the type of earnings used in the
denominator.
Particulars
ABC Co Ltd
XYZ Co Ltd
Price
100
200
EPS (Earning per share)
5
20
P/E Computation
(100/5)
(200/20)
P/E Ratio
20
10
14
Dividend Yield
•
•
•
•
Dividend is declared on the face value of the share.
The market price and face value of the share differs
Divided yield: Dividend/ price
In case of a dividend paying company, there is a cut off
day – till the cut off day the price is CUM-dividend and
after that EX-dividend.
ABC Co Ltd
XYZ Co Ltd
Current Market price (Rs)
500
350
Dividend per share
20
5
Dividend yield
4
1.43
High D/Y paying
Company
Low D/Y paying
Company
15
Market capitalization
• It gives the idea as how big the company.
Price x No. of share
Where,
Price: Market price
No of share: No of fully diluted share
Example
Current Price
No of share (Cr)
Market Capitalization
Market cap
XYZ Co Ltd
ABC Co Ltd
200
230
10000
2000
200 x 10000
230 x 2000
2000000
460000
Large Cap
16
Small Cap
Index
• A broad-base index represents the performance
of a whole stock market — and by proxy, reflects
investor sentiment on the state of the economy.
– Meaning – represents the value of a set of stocks;
relative in value
– Importance
•
•
•
•
Barometer for market behavior
Benchmark portfolio performance
Underlying in derivative instruments like index futures
Passive fund management (index funds)
17
Index: Sensex
• Short form of the BSE-Sensitive Index
• Is a "Market Capitalization-Weighted" index of 30 stocks
representing a sample of large, well-established and
financially sound companies.
• Base period of SENSEX is 1978-79. Actual total market
value of the stocks in the Index during the base period is
equal to an indexed value of 100.
Calculation:
• Divide the total market capitalization of 30 companies in
the Index by the Index Divisor. The Divisor is the only link
to the original base period value of the SENSEX.
18
Types of equity research
• Fundamental analysis – Future earnings and
risk profile considered ( whether to buy or
not)
• Technical analysis – Study of historic data on
the company’s share price movements and
volume (To find timing)
19
Valuations
• Valuation - process of determining the fair value of a financial asset.
• Also referred to as ‘valuing’ or ‘pricing’.
• The fundamental principle of valuation - value is equal to present value of
expected cash flows.
• Valuations of financial assets involve the following three steps:
Step 1: Estimate the expected cash flows
Step 2: Determine the appropriate interest rate that should be used to
discount the cash flows.
Step 3: Calculate the present value of expected cash flows found in
Step 1, using the interest rate or interest rate determined in Step 2.
20
Equity Valuation
• The valuation of equity share is more difficult.
• The difficulties arise because of two factors
first the rate of dividend on equity share is not
known also the payment of equity dividend is
discretionary.
21
Valuation Process
• There are two general approaches to the valuation
process
– Top- Down (three step) Approach
– Bottom Up/ Stock Picking Approach
• Three step approach believe that the economy/ market
and the industry effect have a significant impact on the
total returns for the individual stock.
• The stock picking contend that it is possible to find
stocks that are undervalued relative to their market
price and these will provide superior returns regardless
of the market and industry outlook.
22
The Bulls
A bull market is when everything in the economy is great, people are finding
jobs, gross domestic product (GDP) is growing, and stocks are rising.
Picking stocks during a bull market is easier because everything is going up.
Bull markets cannot last forever though, and sometimes they can lead to
dangerous situations if stocks become overvalued.
If a person is optimistic and believes that stocks will go up, he or she is called
a "bull" and is said to have a "bullish outlook".
23
The Bears
A bear market is when the economy is bad, recession is looming and stock
prices are falling.
Bear markets make it tough for investors to pick profitable stocks.
One solution to this is to make money when stocks are falling using a
technique called short selling.
Another strategy is to wait on the sidelines until you feel that the bear market
is nearing its end, only starting to buy in anticipation of a bull market.
If a person is pessimistic, believing that stocks are going to drop, he or she is
called a "bear" and said to have a "bearish outlook".
24
Risk consideration
Investment Risk: It is the total risk of the
investment in stock which is measured by
Standard deviation. It can be separated into
systematic risk (non diversifiable risk) Plus
Unsystematic Risk (Diversifiable Risk)
A) Systematic Risk: It includes risks that affect the entire market e.g. market
risk, interest rate risk. Systematic risk cannot be eliminated through diversification
because it affects the entire market. Beta is a measure by which systematic risk is
determined.
B) Unsystematic risk: It is unique to a single business or industry, such as
operations and methods of financing. Unlike systematic risk, unsystematic risk can be
eliminated through diversification.
25
Beta
• Beta is a measure of the systematic risk of a
security that cannot be avoided through
diversification.
• Beta is a relative measure of risk-the risk of an
individual stock relative to the market portfolio of
all stocks.
• If the stock has a beta of 1, the implication is that
the stock moves exactly with the market.
• A beta of 1.2 is 20 percent riskier than the market
and 0.8 is 20 percent less risky than the market.
26
Return Computation
• Total return or Holding period return: The period
during which the investment is held by the investor is known as holding
period and the return generated on that investment is called as holding
period return during that period.
• Compounded Annual Growth Rate (CAGR): The
year-over-year growth rate of an investment over a specified period of
time.
27
CAGR Computation
• Suppose you invested Rs. 10,000 in a portfolio on Jan 1, 2005. Let's say by
Jan 1, 2006, your portfolio had grown to Rs. 13,000, then Rs. 14,000 by
2007, and finally ended up at Rs. 19,500 by 2008.
Your CAGR would be the ratio of your ending value to beginning value (Rs.
19,500 / Rs. 10,000 = 1.95) raised to the power of 1/3 (since 1/# of years =
1/3), then subtracting 1 from the resulting number:
1.95 raised to 1/3 power = 1.2493. (This could be written as 1.95^0.3333).
1.2493 - 1 = 0.2493
• Another way of writing 0.2493 is 24.93%.
Thus, your CAGR for your three-year investment is equal to 24.93%,
representing the smoothed annualized gain you earned over your
investment time horizon.
28
Risk Adjusted Return
• A higher return by itself is not necessarily
indicative of superior performance.
• Alternately, a lower return is not indicative of
inferior performance.
• There are composite equity portfolio measures
that combine risk and return to give quantifiable
risk-adjusted numbers.
• The most important and widely used measures of
performance are:
– The Sharpe Measure
– The Treynor Measure
29
The Treynor Measure
• Relative measure of the risk adjusted
performance of a portfolio based on the
market risk (i.e. the systematic risk).
• Treynor Index (Ti) = (Ri - Rf)/Bi.
• Where, Rp represents return on portfolio, Rf is
risk free rate of return and Bi is beta of the
portfolio.
30
The Sharpe Measure
• Relative measure of risk adjusted performance of a
portfolio based on total risk (systematic risk +
nonsystematic risk).
• Standard deviation is used as the measure for the total risk.
In comparing, bigger is better
Sharpe Index (SI) = (Rp - Rf)/SD
• Where, SD is standard deviation of the fund, Rp is the
portfolio rate of return and Rf is the risk free rate of return.
31
Long Term Investors Get Rewarded
PERFORMANCE OF BSE SENSITIVITY INDEX
#
YEAR END
SENSEX
Rolling 1
Yr Growth
Rolling 3
Rolling 5
Rolling 7
Yr Growth Yr Growth Yr Growth
High Risk
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
Mar-79
100
Mar-80
128.57
Mar-81
173.44
Mar-82
217.71
Mar-83
211.51
Mar-84
245.33
Mar-85
353.86
Mar-86
574.11
Mar-87
510.36
Mar-88
398.37
Mar-89
713.6
Mar-90
781.05
Mar-91
1167.97
Mar-92
4285
Mar-93
2280.52
Mar-94
3778.99
Mar-95
3260.96
Mar-96
3366.61
Mar-97
3360.89
Mar-98
3892.75
Mar-99
3739.96
Mar-00
5001.28
1-Mar
3604.38
2-Mar
3469
3-Mar
3049
4-Mar
5528
5-Mar
6492.82
6-Mar
11279.96
7-Mar
13072.1
8-Mar
15644.44
Probability of Loss
Investment Success
28.57%
34.90%
25.52%
-2.85%
15.99%
44.24%
62.24%
-11.10%
-21.94%
79.13%
9.45%
49.54%
266.88%
-46.78%
65.71%
-13.71%
3.24%
-0.17%
15.82%
-3.92%
33.73%
-27.93%
-3.76%
-12.11%
81.31%
85.14%
57.17%
15.89%
19.68%
29-Oct
66%
29.58%
18.05%
12.24%
17.56%
39.45%
27.66%
4.02%
7.51%
15.22%
43.12%
81.66%
42.88%
47.85%
-8.70%
13.85%
-3.83%
6.08%
3.57%
14.15%
-2.53%
-2.48%
-15.21%
15.32%
23.24%
54.66%
33.23%
34.06%
27-May
81%
Rolling 10
Yr Growth
Rolling 15
Yr Growth
Medium Risk
19.64%
22.43%
27.03%
18.57%
13.48%
23.79%
17.15%
15.25%
52.97%
41.73%
39.54%
33.07%
23.55%
-4.74%
11.28%
-0.21%
8.92%
1.37%
0.64%
-4.77%
8.13%
5.36%
25.63%
30.39%
38.69%
25-Mar
88%
28.33%
21.76%
12.60%
18.47%
20.50%
24.96%
42.76%
21.76%
33.08%
35.02%
24.79%
23.16%
18.75%
-1.92%
11.86%
-0.67%
0.89%
-1.41%
7.37%
10.34%
17.08%
14.71%
23.33%
23-Mar
87%
Rolling 20
Yr Growth
Safe
21.70%
19.76%
21.00%
34.68%
26.82%
31.43%
24.85%
19.33%
20.72%
25.59%
18.01%
20.39%
11.92%
-2.09%
2.95%
3.88%
2.64%
12.09%
14.19%
17.77%
20-Jan
95%
27.37%
24.04%
21.84%
20.00%
21.41%
19.90%
19.30%
13.02%
13.63%
14.53%
14.62%
15.16%
16.32%
7.72%
13.70%
0/15
100%
19.85%
20.09%
16.38%
14.85%
14.27%
16.85%
15.66%
16.06%
17.60%
20.14%
0/10
100%
32
Fixed Income Securities
33
Introduction to Bonds
A financial obligation to pay a specified sum of money at specified future
date- Fixed Income Investment
34
Basic Features
• Term to Maturity: The number of years the debt is outstanding.
• Par Value: The agreed repayment amount to the bondholder at or by
maturity date.
• Coupon Rate (Nominal Rate): The interest rate that the issuer agrees to
pay each year.
• Zero Coupon Bond: Bonds that are not contracted to make periodic
coupon payment.
35
Floating Rate Securities
• Coupon rate need not be fixed over the bond’s life.
• Floating rate securities - coupon payments reset periodically according to
some reference rate.
• Calculated as
– Coupon rate = reference rate x Quoted margin
• Quoted margin: additional amount that the issuer agrees to pay above the
reference rate.
Coupon rate = 1 month MIBOR +Quoted Basis point
36
Classification of Bonds
Market
Segment
Issuer
Instruments
Government
Securities
Central Government
Zero Coupon Bonds, Coupon Bearing Bonds, Treasury Bills,
STRIPS
State Governments
Coupon Bearing Bonds.
Government Agencies /
Statutory Bodies
Govt. Guaranteed Bonds, Debentures
Public Sector Units
PSU Bonds, Debentures, Commercial Paper
Public Sector
Bonds
Private Sector
Bonds
Corporate
Debentures, Bonds, Commercial Paper, Floating Rate
Bonds, Zero Coupon Bonds, Inter-Corporate Deposits
Banks
Certificates of Deposits, Debentures, Bonds
Financial Institutions
Certificates of Deposits, Bonds
37
Risk associated with Fixed Income Securities
• Interest rate risk: Inverse Relationship between Interest or Yield and bond
price.
• Following relationship will hold:
– Price of a bond = par if coupon rate = yield.
– Price of a bond can be < par (sell at discount) or > par (sell at a
premium) if the coupon rate is different from yield.
• Maturity Effect: All other factors constant, the longer maturity, greater the
price sensitivity to interest rates changes.
38
Risk associated with Fixed Income Securities
• Reinvestment risk: Risk of reinvestment of interest income or principal
repayments at lower rates in a declining rate environment.
• Credit risk: An investor who lends funds by purchasing a bond issue is
exposed to credit risk.
• There are two types of credit risk:
– Default Risk: Risk that the issuer will not meet the obligation of timely
payment of interest & principle.
– Downgrade Risk: Risk that one or more of the rating agencies will
reduce the credit rating of an issue or issuer.
39
What is a credit rating ?
•
•
•
•
•
Rating organizations evaluate credit worthiness of an issuer .
Evaluation on ability to pay back debt.
The rating is an alphanumeric code representing creditworthiness.
The highest credit rating - AAA & lowest - D (for default).
Short-term instruments* rating symbol - "P" (varies depending on the
rating agency).
• In India, we have 4 rating agencies:
CRISIL
ICRA
CARE
Fitch
*of less than one year
40
Credit Rating
• An important tool used to gauge the default risk of an issue - credit ratings
by rating companies.
Agency
Moody’s/ ICRA
S & Ps/ CRISIL
Description
Highest Quality
Aaa
AAA
Gilt edge, prime, Maximum
safety
High Quality
Aa
AA
High Grade, High Credit
quality
Upper Medium
A
A
Upper Medium Grade
Medium
Baa
BBB
Lower Medium Grade
Somewhat Speculative
Ba
BB
Low grade, Speculative
Speculative
B
B
Highly Speculative
Highly Speculative
Caa
CCC
Substantial risk, in poor
standing
Most Speculative
Ca
CC
May be in default, very
speculative
Imminent Default
C
C
Extremely speculative
Default
D
D
Default
41
Risk associated with Fixed Income Securities
• Inflation Risk/Purchasing power risk: Risk of decline in the real value of the
security due to inflation.
• Liquidity Risk: Liquidity risk is the risk that the investor will have to sell a
bond below its expected value.
42
Relationship between
parameters
• The relationship between coupon rate, yield, price and par value are as
follows:
– Coupon rate = Yield required by market, therefore price = par value
– Coupon rate < Yield required by market, therefore price < par value
(discount)
– Coupon rate > Yield required by market, therefore price > par value
(premium)
43
Yield Measures
• Investor should value bonds in terms of Yields and in not rupee terms.
• For fixed income instruments, returns can be from :
• Coupon interest payment
• Capital gain on sale or maturity
• Reinvestment of interim cash flow.
• Current Yield: relates coupon interest to bond’s market price.
• Same as dividend yield to stocks.
• Computed as follows
• Current yield= Annual coupon / market price
44
Yield to Maturity
• The Yield to maturity is interest rate that will make the present value of
the cash flow equal to price plus accrued interest. It is also known as IRR
of bond.
• It takes in to account all three sources of return.
• The most widely used bond yield figure as it indicates the fully
compounded rate of return promised to an investor who buys the bond at
prevailing prices, if two assumptions hold true.
• The first assumption is that the investor holds the bond to
maturity.
• Investors reinvest all the interim cash flows at the computed YTM
rate.
45
Debt Markets
• Capital Markets comprise of :
– Equities Market &
– Debt Markets.
• The Debt Market - where fixed income securities of various types and
features are issued and traded.
• Fixed income securities can be issued by:
– Central and State Governments,
– Public Bodies,
– Statutory corporations and corporate bodies.
46
Indian Debt Markets
• Indian Debt Markets - one of the largest in Asia today.
• Government Securities (G-Secs) market - the oldest & largest component
of Indian Debt Market in terms of capitalization, outstanding securities &
trading volumes.
• G-Secs- Benchmark for determining level of interest rates in the country
are the yields on government securities , referred to as the risk-free rate
of return.
• The Indian Debt Market structure was a wholesale market with
participation largely restricted to the Banks, Institutions and the Primary
Dealers.
• The Retail Debt Market in India has been created recently.
47
Segments in the secondary debt
market
• The segments in the secondary debt market based on the characteristics
of the investors and the structure of the market are:
– Wholesale Debt Market - investors are mostly Banks, Financial
Institutions, the RBI, Primary Dealers, Insurance companies, MFs,
Corporates and FIIs.
– Retail Debt Market involving participation by individual investors,
provident funds, pension funds, private trusts, NBFCs and other legal
entities in addition to the wholesale investor classes
48
Money Market Instruments
• Money markets - markets for debt instruments with maturity up to one
year.
• Money markets allow banks to manage their liquidity as well as provide
central bank a means to implement monetary policy.
• The most active part of the money market - call money market (i.e. market
for overnight and term money between banks and institutions) and the
market for repo transactions.
• The former is in the form of loans and the latter are sale and buyback
agreements - both are obviously not traded.
• The main traded instruments are Commercial Papers (CPs), Certificates of
Deposit (CDs) and Treasury Bills (T-Bills).
49
Commercial Paper
• A Commercial Paper is a short term unsecured promissory note issued by
the raiser of debt to the investor.
• In India; corporate & Financial Institutions (FIs) can issue these notes.
• Generally companies with very good ratings are active in the CP market,
though RBI permits a minimum credit rating of Crisil-P2.
• Tenure of CPs - anything between 15 days to one year, the most popular
duration being 90 days.
• Companies use CPs to save interest costs.
50
Certificates of Deposit
• Issued by banks in denominations of Rs.5 lakhs & have maturity ranging
from 30 days to 3 years.
• Banks are allowed to issue CDs with a maturity of less than one year
• Financial institutions are allowed to issue CDs with a maturity of at least
one year.
51
Treasury Bills (T-Bills)
• T- Bills: instruments issued by RBI at a discount to face value
• Form an integral part of the money market.
• In India treasury bills are issued in four different maturities—14 days, 90
days, 182 days and 364 days.
• Apart from these, certain other short-term instruments are also popular
with investors.
• These include short-term corporate debentures, bills of exchange and
promissory notes.
52
Mutual Fund
53
Introduction
• It is a pool of money, collected from investors, and is
invested according to certain investment objectives
• The ownership of the fund is thus joint or mutual, the fund
belongs to all investors.
• A mutual funds business is to invest the funds thus
collected, according to the wishes of the investors who
created the pool
• e.g. money market mutual fund seeks investors to invest
predominantly in Money Market Instruments
54
Important characteristics
• The ownership is in the hands of the investors
who have pooled in their funds.
• It is managed by a team of investment
professionals and other service providers.
• The pool of funds is invested in a portfolio of
marketable investments.
• The investors share is denominated by ‘units’
whose value is called as Net Asset Value (NAV)
which changes everyday.
• The investment portfolio is created according to
the stated investment objectives of the fund.
55
Advantages & Disadvantages
Advantage:
• Portfolio diversification
• Professional Management
• Reduction in Risk
• Reduction in Transaction costs
• Liquidity
• Convenience and Flexibility
• Safety – Well regulated by SEBI
Disadvantage:
• No control over the costs. Regulators limit the expenses of Mutual Funds. Fees
are paid as percentage of the value of investment.
• No tailor made portfolios.
• Managing a portfolio of funds. (Investor has to hold a portfolio for funds for
different objectives)
56
Type of mutual Fund: By Structure
Open Ended Fund:
Investors can buy and sell units of the fund, at NAV related prices, at any time,
directly from the fund.
Open ended scheme are offered for sale at a pre- specified price, say Rs. 10, in
the initial offer period. After a pre-specified period say 30 days, the fund is
declared open for further sales and repurchases
Investors receive account statements of their holdings,
The number of outstanding units goes up and down
The unit capital is not fixed but variable.
57
Type of mutual Fund: By Structure
Closed Ended fund:
• A closed -end fund is open for sale to investors for a
specified period, after which further sales are closed.
• Any further transactions happen in the secondary
market where closed-end funds are listed.
• The price at which the units are sold or redeemed
depends on the market prices, which are
fundamentally linked to the NAV.
58
Types of Funds - By Investment Objective
Equity
Debt
Equity Funds
Index Funds
Sector Funds
Fixed Income
Funds
GILT Funds
Money Market
Money Market
Mutual Funds
Balanced Funds
59
Gilt Funds
• Invests only in securities that are issued by the Government and therefore
do not carry any credit risk.
• Government papers are called as dated securities also.
• It invests in both long-term and short-term paper.
• Ideal for institutional investors who have to invest in Govt. Securities.
• Enables retail Participation
60
ELSS (Equity Linked Saving Scheme)
•
•
•
•
•
•
•
3 year lock in period
Minimum investment of 90% in equity markets at all times
So ELSS investment automatically leads to investment in equity shares.
Open or closed ended.
Eligible under Section 80 C
Dividends are tax free.
Benefit of Long term Capital gain taxation.
61
Fixed Term Plan Series
• FTPs are closed ended in nature.
• AMC issues a fixed number of units for each
series only once and closes the issue after an
initial offering period.
• Fixed Term plan are usually for shorter term – less
than a year.
• They are not listed on a stock exchange.
• FTP series are likely to be an Income scheme.
• Good alternate of Bank deposits/ corporate
deposits.
62
Money Market Mutual Fund
• Money funds provide investors with current income and are managed to
maintain a stable share price.
• Because of their stability, money funds are often used for cash reserves or
money that might be needed right away.
• Money funds typically invest in short-term, high-quality, fixed-income
securities, such as T-Bills, CDs and CPs
• Income from money funds is generally determined by short-term interest
rates.
63
How does a Mutual Fund work?
AMC
Savings
Investments
Trust
Units
Returns
Unit holders
Registrar
SEBI
Trust
Custodian
AMC
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Loads
• Load is charged to investor when the investor buys or redeems units. It is
primarily used to meet the expenses related to sale and distribution of
units
• Load charged on sale of units is entry load. It increases the price above the
NAV for new investor.
• Load charged on redemption is exit load. It reduces price.
• Maximum Entry load or Exit load is 7%.( For Open ended Funds)
• Max. Entry or Exit load for closed ended funds is 5%
• CDSC is an exit load that varies with holding period.
• Load is an amount which is recovered from the investor.
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Net Assets Value
• The net assets represent the market value of assets
which belong to the investors, on a given date.
• Net assets are calculated as:
Market value of investments
Plus(+) current assets and other assets
Plus(+) accrued income
Less(-) current liabilities and other liabilities
Less(-) accrued expenses
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NAV Computation
• Unit capital of a MF scheme is Rs.20 million.
The market value of investments is Rs. 55
million. The number of units is 1 million. The
NAV is
– Rs. 20
– Rs. 75
– Rs.55
– Not possible to say
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Fund Management
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Active fund management
Fund manager tends to look at specific attributes in selecting stocks.
Active fund manager believes, that his ability to buy right stock at the right
time, can translate into superior performance for his portfolio.
What are the basic active equity fund management style?
Growth Investment style – Objective is capital appreciation, look for companies
that are expected to give above average earnings growth, The shares are more
risky and thus expected to offer higher returns over a long investment horizons.
Relatively higher P/E ratio and have lower dividend yield
Value Investment Style – Look for companies that are currently undervalued but
whose worth will be recognized eventually.
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Passive fund management
• Fund manager believes, that holding a well diversified
portfolio is the cost efficient way ,to better returns, he
would tend to mimic the market index.
• It requires limited research and monitoring costs and is
therefore cheaper.
• Fund manager may choose to mimic a index, or a
subset of the index or choose a basket of shares from
multiple indices.
• A passive fund manager has to rebalance his portfolio
every time changes are made in the index.
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Performance Measurement
• Returns comes form dividend or capital gains.
• Rate of Return =(Income Earned/Amount invested)x100
• Simple total return=
{NAV(end) – NAV ( begin)}+ Dividend paid x100
NAV at beginning
• Rule of 72 is a thumb rule used in finding doubling period.
If Rate = 12%, then money will double in 72/12 = 6 years.
• CAGR
• While comparing funds performance with peer group
funds, size and composition of the portfolios should be
comparable.
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Investment Plans
• Broadly 2 options- Growth option and
Dividend Option
• Automatic Reinvestment Plans– Benefit of
Power of Compounding.
• Systematic Investment Plans – For regular
investment
• Systematic Withdrawal Plan – For regular
income ( it is not similar to MIP)
• Systematic Transfer Plan
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Wealth cycle for investors
Stage
Accumulation stage
Transition Stage
Reaping Stage
Financial needs
Investment preferences
Investing for long term identifed
Growth options and long term
financial goals
products.High risk appetite
Near term needs for funds as
Liquid and medium term investments.
pre-specified needs draw closer
Lower risk appetite
Higher liquidity requirements
Liquid and medium term investments.
Preference for income and debt
products
Inter Generational
Long term investment of
inheritance
Ability to take risk and invest for the
long term
transfer
Sudden wealth surge
Low liquidity needs.
Medium to long term
Wealth preservation.
Preference for low risk products
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Financial Planning Strategies
•
Power of Compounding
•
Buy and hold
•
Rupee cost averaging:
– A fixed amount is invested at regular intervals
– More units are bought when prices are low and fewer units are bought
when prices are high. Over a period of time, the average purchase price of
investor is lower than average NAV.
– Its disadvantage : Does not indicate when to sell or switch.
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Economic Environment and Indicators
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Importance of Economic and Business
Environment
• Significant implications on the investment
recommendation.
• Recommendations depend on a number of
assumptions about the future performance of the
economy.
• Financial advisors should always keep a track of
economic environment to make reasonable
assumptions.
• A thorough understanding of economic environment
helps in reviewing the existing financial situation.
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Gross Domestic Product
• There are three ways to derive GDP:
– The sum of all expenditures,
– The sum of all incomes, and
– The sum of all value added by business
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ECONOMIC FACTORS: GNP & GDP
This is the value of output of goods and services
produced by Indian companies, regardless of whether
the production is inside or outside the India
Gross National
Product (GNP)
The value of output of goods and services produced
in the country, regardless of whether businesses are
owned and operated by Indians or foreigners.
Gross Domestic
Product (GDP)
Gross National
Product (GNP)
=
Gross Domestic
Product (GDP)
-
profits on
foreign owned
businesses
+
profits on
Indian owned
businesses
outside India
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GDP
GDP is the measure of total value of final goods and services produced in the
domestic economy each year. The following is often used
GDP=
C+I+G+
(X- M)
C = personal consumption spending on goods and services
I = Private sector fixed capital expenditure
G = Government expenditure
(X-M)= Net of export receipts (X) and import payments (M)
The relationship highlights actual rupee expenditure for goods and services produced
in the economy for measuring GDP.
This equation includes all key players involved in the economy – consumers /
households, business (private sector) and government.
For living standards to rise in India, GDP must grow at a faster rate than the
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population. This way, there is greater quantity of goods and services per person.
Example
The following information is available for an economy.
Consumption (C) = Rs 3000
Private Investment (I) = Rs 500
Government Expenditure (G) = Rs 2000
Exports (E) = Rs 1000
Imports = Rs 1500
Calculate the GDP for the economy?
Answer:
GDP = 3000 + 500 + 2000 + (1000-1500)
= 5500 – 500
= 5000
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Inflation
•
A situation of rising prices. Inflation refers to a persistent rise in prices. Simply put, it
is a situation of too much money and too few goods.
•
The most popular measure of inflation in India is change in the Whole Price Index
(WPI) over a period of time.
•
The WPI is an index measure of the wholesale prices of a selected basket of goods
and services in the economy. The WPI is expressed as a percentage with reference to
some base year, according to a formula
•
WPI= (aggregate price for current year/aggregate price for the base year)* 100
•
An alternative measure is consumer price Index, which is concerned with the
consumer market for goods and services.
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Monetary Policy
• Monetary policy is the process by which the
central bank of a country controls the supply
of money, cost of money or rate of interest.
• The Reserve Bank of India (RBI) controls and
influences the economy by means of
monetary and credit policy.
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Some Monetary Policy terms
•
Bank Rate
– Bank rate is the minimum rate at which the central bank provides loans to the
commercial banks. It is also called the discount rate.
– Usually, an increase in bank rate results in commercial banks increasing their
lending rates. Changes in bank rate affect credit creation by banks through
altering the cost of credit.
– Bank Rate is at 6.0 per cent.
•
Cash Reserve Ratio
– All commercial banks are required to keep a certain amount of its deposits in
cash with RBI. This percentage is called the cash reserve ratio.
– It is cash as a percentage of demand and time liabilities that bank maimtain
with RBI
– Cash reserve ratio (CRR) of scheduled banks increased to 8.25 per cent with
effect from the fortnight beginning May 24, 2008.
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Some Monetary Policy terms
• Open Market Operations
– An important instrument of credit control, the Reserve Bank of India
purchases and sells securities in open market operations.
– In times of inflation, RBI sells securities to mop up the excess money in
the market. Similarly, to increase the supply of money, RBI purchases
securities.
• Statutory Liquidity Ratio
– Banks in India are required to maintain 25 per cent of their deposits in
government securities and certain approved securities.
– These are collectively known as SLR securities.
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