1.

Investment

: An investment is the purchase of an asset for generating income

Definition: According to Sharpe investment is sacrifice certain present value for some uncertain
future value

2. Objectives of Investment

- Return: investors expecting good returns on thier investment

- Liquidity: Ability to convert assets into cash quickly.
- Risk : delay on returns, non payments of returns law capacity for return
- Safety: Some investors seek low-risk investment for safety
- Tax Benefits: Some investments offer tax benefits

3. Process of Investment

1. Framing an investment policy

2. Investment analysis
3. Valuation
4. Portfolio construction
5. Portfolio evaluation

Types of Investments

1. Bonds – Fixed-income securities where you lend money to a company or government in

exchange for interest. Safe but offer low returns.

2. Stocks – Buying shares makes you a part-owner of a company. Stocks are volatile but have
high return potential.

3. Mutual Funds – A mix of stocks and bonds managed by professionals. They help diversify
investments and reduce risk.

Securities Market

A financial market where securities (stocks, bonds) are bought and sold.

It has two main types:

Primary Market – Where new securities are issued for the first time.

Secondary Market – Where existing securities are traded among investors.

Primary Market (New Issue Market)

Companies raise funds by issuing new securities.

Investors buy directly from the company.

Important for economic growth and capital formation.

Functions:

1. Organization of New Issues – Involves project evaluation and financial structuring.

2. Underwriting of New Issues – Guarantees sale of new securities to the public

Distribution of New Issues – Selling stocks to the public through:

1. Prospectus – A formal document offering securities to the public.

2. Encouragement to New Investment – Promoting investment in new securities.

Secondary Market (Aftermarket)

Market where previously issued securities are traded.

Investors buy from other investors, not the issuing company.

Major stock exchanges (e.g., NYSE, NASDAQ) facilitate trading.

Methods of Raising Capital

1. Right Issue – Existing shareholders get the right to buy additional shares at a discounted
price.
2. Book Building – A process to determine demand and price for securities during an IPO.

3. Private Placement – Securities are sold privately to selected investors (e.g., banks, mutual
funds).

Dematerialization

Conversion of physical share certificates into electronic form.

Steps:

1. Investor surrenders the physical certificate.

2. Depository updates electronic holdings.

3. Shares are credited to the investor’s account.

Stock Exchanges

A marketplace where stocks, bonds, and securities are bought & sold.

Functions:

Liquidity – Continuous trading of shares.

Price Determination – Based on demand and supply.

Fair Trading – Ensures transparency and investor protection.

Capital Raising – Companies use stock exchanges to raise funds.

Information Dissemination – Publishes stock prices and trading volumes.

Performance Indicator – Stock prices reflect company performance.

Listing of Securities

Companies must meet listing requirements to trade on an exchange.

Requirements include minimum equity, minimum shareholders, and listing fees

Listing of Securities

Companies list shares on stock exchanges (e.g., NYSE, Nasdaq).

Must meet listing requirements (e.g., minimum stockholder’s equity, shareholders, fees).

Merits:

Provides liquidity for investments.

Ensures fair pricing through open market trades.

Protects investors with regulated trading rules.

Helps banks offer loans using listed securities as collateral.

Provides tax advantages.

Settlement and Clearing

Ensures secure transactions by matching buyers & sellers.

Clearing agencies verify records and resolve discrepancies.

Settlement – Completing the trade by transferring cash & securities.

Bonds

Debt instruments used to raise capital.

Bonds promise repayment of principal + interest (coupons).

No ownership rights (unlike stocks).

Features:

Fixed interest rate (some zero-coupon bonds have none).

Maturity period – Fixed repayment time.

No voting rights for bondholders.

Collateral-backed bonds have security; others do not.

Book Value vs Market Value

Book Value – Original price of an asset; stays constant.

Market Value – Current price in the market; fluctuates.

Difference helps track profits/losses.

Intrinsic Value

True worth of a stock, currency, or company based on analysis, not market price.

Risk & Types of Risks

Market Risk – Fluctuation due to investor expectations.

Systematic Risk – Economy-wide factors affecting all stocks.

Interest Rate Risk – Changes due to fluctuations in interest rates.

Purchasing Power Risk – Inflation reducing real value of returns.

Unsystematic Risk – Industry-specific risks (e.g., strikes, inefficiency).

Expected Return of Portfolio

Weighted average of returns from individual securities in a portfolio.

Co-variance – Measures how securities interact within a portfolio.

Expected Return of Portfolio

Portfolio Return – Weighted average return of all securities in a portfolio.

Co-variance – Measures how two securities move together;

Positive → Move in the same direction.

Negative → Move in opposite directions.

Zero → No relation between their movements.

Fundamental Analysis (Evaluating intrinsic value of stocks)

Economic Analysis – Examines GDP, inflation, interest rates, etc.

Economic Forecasting – Sources: RBI reports, financial bulletins.

Industry Analysis – Studies demand-supply, competition, costs, etc.

Company Analysis – Evaluates trustworthiness, earnings, and financial performance.

Leading & Lagging Indicators

Leading Indicators – Predict economic activity (e.g., stock market, money supply, production).

Lagging Indicators – Confirm past economic trends (e.g., loan outstanding, employment rates).

Technical Analysis (Predicts stock trends using past prices)

Assumes market moves in trends and uses past data for forecasts.

Principles:

1. Security prices depend on supply & demand.

2. Rational & irrational factors influence prices.

3. Prices move in trends for a period of time.

Dow Theory (Stock Market Movements)

Primary Movements – Long-term market trends (bull or bear markets).

Secondary Movements – Short-term corrections (opposite to primary trend).

Minor Movements – Daily fluctuations with little significance.

Elliot Wave Theory

Stock prices move in waves – five waves in a bull market:

1. Wave 1 – Initial price rise due to demand.

2. Wave 2 – Investors sell, causing a decline.

3. Wave 3 – Strong upward movement as more investors buy.

4. Wave 4 – Small decline due to profit booking.

5. Wave 5 – Final surge before a major decline.

Charts (Technical Analysis)

1. Line Charts – Simple graph showing daily closing prices.

2. Bar Charts – Shows price movements and trading volume.

3. Point & Figure Charts – Identifies price trends, ignores time factor.

Market Indicators

Breadth of Market – Measures advancing vs. declining stocks.

Odd Lot Index – Tracks small investor trading patterns.

Efficient Market Hypothesis (EMH)

Market reacts to new info quickly; efficiency determines how fast prices adjust.

Three forms of market efficiency:

1. Weak Form – Prices reflect past data (history is not useful for prediction).

2. Semi-Strong Form – Prices reflect public information (financial reports, news).

3. Strong Form – Prices reflect all info, including insider knowledge.

Mathematical & Technical Indicators

Moving Averages (MA):

Simple Moving Average (SMA): Average of prices over a period.

Exponential Moving Average (EMA): Recent prices have more weight.

Rate of Change (ROC): Measures price change over time to identify trends.

Relative Strength Index (RSI): Identifies market strength & buy/sell signals.

Moving Average Convergence & Divergence (MACD):

Compares two moving averages.

Helps identify trend strength & reversals.

SEBI (Securities Exchange Board of India)

Established in 1988 to regulate stock markets.

Became a legal authority in 1992.

Purpose & Role:

1. For Issuers: Ensures a fair market for raising capital.

2. For Investors: Provides protection & transparency.

3. For Intermediaries: Ensures a professional environment.

Objectives:

1. Regulate stock exchange activities.

2. Protect investors.

3. Prevent fraud & malpractices.

4. Establish codes of conduct for market participants.

Functions:

1. Protective Functions: Prevent price manipulation & fraud.

2. Developmental Functions: Promote stock market efficiency.

3. Regulatory Functions: Enforce rules & regulations.

SEBI Functions

1. Protective Functions

Checks Price Rigging: Prevents artificial price manipulation.

Prohibits Insider Trading: Restricts unfair advantage from confidential company info.

Prevents Fraud & Unfair Trade Practices: Stops misleading statements by companies.

Investor Education: Helps investors analyze securities.

2. Developmental Functions

Training Programs: Educates market intermediaries.

Stock Market Flexibility: Allows internet trading & reduces costs.

IPO Regulation: Permits new companies to raise funds in stock exchange.

3. Regulatory Functions

Rules & Regulations: Enforces fair market practices.

Monitoring Intermediaries: Regulates brokers, bankers, & mutual funds.

Takeover Policies: Ensures fair mergers & acquisitions.

Stock Exchange Audits: Conducts inspections for transparency.

Mutual Funds & Types

A mutual fund pools money from investors for diversification, professional management, and
liquidity.

Benefits for Investors

Easy liquidity, diversification, low cost, tax benefits, risk reduction.

Benefits for Economy

Strengthens capital markets, boosts economic growth.

Types of Mutual Funds

Open-ended: Accepts investments anytime; repurchase available.

Close-ended: Fixed period investments; corpus remains unchanged.

Interval Schemes: Combination of open & close-ended; available during specific intervals

Classification of Mutual Funds (Based on Investment Objectives)

1. Income Schemes – Focus on generating steady income, investing in low-risk securities.

2. Growth Schemes – Aim for capital appreciation by investing in high-growth securities.

3. Balanced Schemes – Provide both income and capital growth through equity and fixed-
income securities.

4. Tax Saving Schemes – Offer tax benefits, e.g., Equity Linked Saving Schemes (ELSS).

5. Sector Funds – Invest in specific industry sectors, e.g., IT, healthcare, etc.

6. Index Funds – Track stock market indices to reflect overall market performance.

7. Money Market Funds – Invest in short-term securities (less than one year) for liquidity &
safety.

8. Gilt Funds – Invest in government securities with minimal risk.

Merchant Banking
Provides capital to companies through share issuance instead of loans.

Offers advisory services on corporate matters like mergers, acquisitions, and financial
structuring.

Differs from commercial banks – they do not accept deposits or provide loans.

Introduced in India in 1967 by National Grindlays Bank, followed by Citi Bank in 1970.

SBI set up India’s first commercial merchant bank in 1972.

Mainly operates as issue houses for corporate securities.

Merchant Banking Functions

1. Promotional Activities – Helps in project identification, feasibility reports, government

approvals, and financial collaborations.

2. Issue Management – Manages public issues of corporate securities, underwriting, and

compliance with stock exchange requirements.

3. Credit Syndication – Assists in raising short-term and long-term loans from financial
institutions and foreign sources.

4. Portfolio Management – Helps clients buy/sell securities, manage mutual funds, and diversify
investments.

5. Leasing & Financing – Provides financial solutions, venture capital funding, and corporate
finance assistance.

6. Servicing of Issues – Acts as a paying agent for debt securities, manages shareholder
registers, and arranges dividend payments.

7. Specialized Services – Offers corporate advisory services on mergers, tax matters, and
restructuring.
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Depository System in India

A Depository holds securities in electronic form and facilitates trade between investors.

NSDL (National Securities Depository Limited) – First Indian central depository (Mumbai-
based).

CSDL (Central Depository Services Limited) – Second central depository (Mumbai-based).

Depository Participants (DPs) – Intermediaries between investors and depositories, registered

under SEBI.

Services of a Depository:

Dematerialization (Demat) – Converts physical securities into electronic form.

Rematerialization (Remat) – Converts electronic securities back to physical form.

Transfer & Settlement – Handles ownership transfer and security pledging.

Dematerialization (Demat)

Converts physical securities into electronic form.

Reduces risk, improves efficiency, and ensures secure trade settlements.

NSDL & CDSL are India’s two major depositories.

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Portfolio Analysis

Two main approaches:

1. Traditional Approach – Focuses on income & capital appreciation. Investors select securities
based on objectives & risk minimization.
2. Markowitz Diversification – Focuses on reducing risk by selecting negatively correlated
stocks.

Steps in Traditional Approach:

1. Analyze Constraints – Identify investment limitations.

2. Set Objectives – Define income or growth goals.

3. Select Portfolio – Choose bonds & stocks.

4. Assess Risk & Return – Evaluate potential gains/losses.

5. Diversify – Spread investments to minimize risk.

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Diversification of Risk

Simple Diversification – Random selection of securities to reduce risk.

Superfluous Diversification – Excessive diversification leads to poor management & inefficiency.

Markowitz Diversification – Uses statistical methods to select negatively correlated assets,

reducing risk effectively.
Diversification of Risk

Simple Diversification – Randomly selecting securities to reduce risk up to a certain limit.

Superfluous Diversification – Over-diversification leads to inefficiency & poor performance.

Markowitz Diversification – Selecting negatively correlated stocks to minimize risk.

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Selection of Portfolio

An optimal portfolio has the highest return with the lowest risk.

1. Markowitz Efficient Frontier (Modern Portfolio Theory)

Investors are risk-averse.

Portfolio risk depends on expected returns' variability.

Goal: Maximize return with minimum risk.

Limitations:

Requires extensive data.

Complex calculations involved.

2. Risk-Free Asset

Assets with no default risk or interest risk (e.g., government securities, treasury bills).

Provides guaranteed return with zero standard deviation.

3. Sharpe’s Single Index Model

Uses market index to assess stock risk instead of comparing individual stocks.

Reflects overall market trends.

4. Capital Asset Pricing Model (CAPM)

A security’s return depends on its contribution to portfolio risk.

Only systematic risk (market risk) matters; unsystematic risk (diversifiable) can be eliminated.

Assumptions:

Investors are risk-averse.

They aim to maximize wealth with proper risk assessment.

Unlimited borrowing at risk-free interest rate is possible.

All securities are liquid (easily tradable).

Market is efficient & competitive.

5. Security Market Line (SML)

Represents the relationship between risk & return.

Shows the expected return of a security based on its risk premium.

Key Highlights of the PDF (Simplified Notes)

1. Security Market Line (SML)

Graphical version of CAPM showing the relationship between beta (risk factor) and expected
return.

Higher beta → Higher risk premium → Higher required return.

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2. Arbitrage Pricing Theory (APT)

Alternative to CAPM, developed by Stephen Ross.

Assumes investors use arbitrage to exploit differences in expected returns.

Unlike CAPM (which focuses on market sensitivity), APT considers multiple risk factors affecting
return.

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3. Portfolio Evaluation

Treynor’s Performance Index – Measures fund performance based on market return and risk.

Jensen’s Performance Index – Compares actual return vs. expected return based on a
manager’s predictive ability.

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4. Portfolio Revision

Adjusting portfolio to improve returns or reduce risk.

Includes buying/selling stocks based on price fluctuations and expected returns.

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5. Swaps (Financial Contracts)

Agreement between two parties to exchange cash flows over time.

Equity Swap – One party pays a fixed amount, while the other pays based on stock market
index movements.