undefined | unit 1 the investment environment

FOI

Unit 1

The Investment Environment

Q1) Define investment. What are the different types of investment decisions? 6

A1) Investment refers to assets that provide long term benefits like capital appreciation/creation of wealth to the investors. The investments are made in real estates, commodities, financial instruments and products like shares, debentures, bonds, mutual funds, insurance and purchase of assets like land and building, machinery, raw materials etc. Depending on the nature of investment in can be broadly divided into two parts- a) Investment in financial assets/financial market b) Investment in business assets. The following figure shows the types of investment-

Figure: Types of Investment

The investment decision process is discussed under the two heads-

a) Decisions of investment in financial assets: The process involved in investment decision process is highlighted in the following figure

Figure : Investment decision process in financial assets

1. Understanding the client: In the first step, the investor should understand the client by verifying their nature of business, location, gaols, risk bearing capability, previous year returns, financial statements etc. It helps them to get an insight about the company.

2. Asset allocation decision: In this step, the investor select the probable assets where the investment to be made in near future. Such assets may be fixed income bearing securities, real estates, domestic or foreign security etc.

3. Portfolio strategy selection: In this step, the investor selects an efficient portfolio which will provide maximum return with minimum risk. Portfolio refers to creation of a group of securities of with different risk and return and from different industry/company.

4. Evaluation of portfolio performance: In this step, the investors regularly evaluate the performance of portfolio by determining its market performance, net asset value, market price of securities. It helps them to decide whether to keep their investment or to withdraw the investment.

Q2. Write a brief note on investment in commodities. 8

Q3. What is investment in commodities? What are the avenues for investment in commodities?

A) to Q2 and Q3 The investors can make investment in commodities through commodities market. Commodity trading is managed by four major commodity exchanges in India-

Multi Commodity exchange (MCX)

Indian Commodity exchange (ICEX)

National Commodity and Derivatives exchange (NCDEX)

National Multi Commodity Exchange (NMCE)

Different types of commodities available for investment in the market/commodity exchange are-

a) Hard commodities:

Precious metals- Gold, platinum, copper, silver etc.

Energy-Crude oil, Natural gas, gasoline, etc.

b) Soft commodities:

Agriculture- Soybeans, wheat, rice, coffee, corn, salt etc.

Livestock and meat- Live cattle, pork, feeder cattle, etc.

Figure : Investment in commodities

Investment in Real estate

Investment in real estate involves purchase of land, building, management of estate, let out of the estate etc. Investment in real estate is popular trend in recent times due to its growing demand in urban are semi-urban areas due to rapid expansion on business and industry, migration from rural to urban areas for better education, health facility, banking facility, availability of job and livelihood etc. Investment in real estate can be made in following ways-

Buy real estate investment trust.

Use of real estate investing platform.

Investment in rental properties.

Letting out the property. Etc.

Investment in financial assets

Financial assets are money related assets the value of which is derived from the contract between the parties. Financial assets are traded in the stock exchanges for long term and short term. Different types of financial assets available for investment are-

Share: Shares are small portions in the owned capital of a company invested by shareholders. It may be equity share and preference share.

Debenture: It refers to investment in borrowed capital of a company.

Bond: It is issued by Government or Companies to make investment in their borrowed capital

Certificate of deposit: It is issued by companies against the fixed deposits kept by the investors with the bank.

Commercial paper: It is the financial instrument issued by blue chip companies for arranging short term funds from the market

Derivatives: It is a contract between the parties the value of which is derived from its underlying assets.

Figure: Investment in financial assets

Q4) Write a short note on Indian securities market. 5

A4) Indian securities market also known as capital market refers to the organised platform for purchase and sale of securities for. It is a long term market where companies and government issues shares, debentures and bonds to the public for arrangement of capital for business and the investors makes investment in such securities. Different stock exchanges like National Stock Exchange, Bombay Stock Exchange, OTCEI, regional stock exchanges, brokers, Merchant bankers’ etc. combinenly represent the capital market. It is strictly regulated by the Securities and Exchange Board of India. Depending on the nature of transactions Indian securities market is divided into two parts-

1) Primary market: It is the securities market where securities like shares, debentures and bonds are purchased and sold for the first time.

2) Secondary market: It is the securities market where the second hand securities like shares, debentures and bonds are traded.

Q5) What are the different methods of issuing securities under the new issue market? 5

A5) 1. Offer through Prospectus: Offer through prospectus is the most popular method of raising funds by public companies in the primary market. This involves inviting subscription from the public through issue of prospectus.

2. Offer for Sale: Under this method, securities are not issued directly to the public but are offered for sale through intermediaries like issuing houses or stock brokers. In this case, a company sells securities enbloc at an agreed price to brokers who, in turn, resell them to the investing public.

3. Private Placement: Private placement is the allotment of securities by a company to institutional investors and some selected individuals. It helps to raise capital more quickly than a public issue.

4. Rights Issue: This is a privilege given to existing shareholders to subscribe to a new issue of shares according to the terms and conditions of the company. The shareholders are offered the ‘right’ to buy new shares in proportion to the number of shares they already possess.

5. e-IPOs: A company proposing to issue capital to the public through the on-line system of the stock exchange has to enter into an agreement with the stock exchange. This is called an Initial Public Offer (IPO).

Q6) Discuss the functions of stock exchange. 5

A6) 1. Providing Liquidity and Marketability to Existing Securities: The basic function of a stock exchange is the creation of a continuous market where securities are bought and sold. It gives investors the chance to disinvest and reinvest. This provides both liquidity and easy marketability to already existing securities in the market.

2. Pricing of Securities: Share prices on a stock exchange are determined by the forces of demand and supply. A stock exchange is a mechanism of constant valuation through which the prices of securities are determined. Such a valuation provides important instant information to both buyers and sellers in the market.

3. Safety of Transaction: The membership of a stock exchange is well regulated and its dealings are well defined according to the existing legal framework. This ensures that the investing public gets a safe and fair deal on the market.

4. Contributes to Economic Growth: A stock exchange is a market in which existing securities are resold or traded. Through this process of disinvestment and reinvestment savings get channelised into their most productive investment avenues. This leads to capital formation and economic growth.

5. Spreading of Equity Cult: The stock exchange can play a vital role in ensuring wider share ownership by regulating new issues, better trading practices and taking effective steps in educating the public about investments.

Q7) Write a brief note on electronic trading of securities. 8

A7) Trading in securities is now executed through an on-line, screen-based electronic trading system. Simply put, all buying and selling of shares and debentures are done through a computer terminal. There was a time when in the open outcry system, securities were bought and sold on the floor of the stock exchange. Under this auction system, deals were struck among brokers, prices were shouted out and the shares sold to the highest bidder. However, now almost all exchanges have gone electronic and trading is done in the broker’s office through a computer terminal. A stock exchange has its main computer system with many terminals spread across the country. Trading in securities is done through brokers who are members of the stock exchange. Trading has shifted from the stock market floor to the brokers office. Every broker has to have access to a computer terminal that is connected to the main stock exchange. In this screen-based trading, a member logs on to the site and any information about the shares (company, member, etc.) he wishes to buy or sell and the price is fed into the computer. The software is so designed that the transaction will be executed when a matching order is found from a counter party. The whole transaction is carried on the computer screen with both the parties being able to see the prices of all shares going up and down at all times during the time that business is transacted and during business hours of the stock exchange. The computer in the brokers office is constantly matching the orders at the best bid and offer price. Those that are not matched remain on the screen and are open for future matching during the day. Electronic trading systems or screen-based trading has certain advantages:

1. It ensures transparency as it allows participants to see the prices of all securities in the market while business is being transacted. They are able to see the full market during real time.

2. It increases efficiency of information being passed on, thus helping in fixing prices efficiently. The computer screens display information on prices and also capital market developments that influence share prices.

3. It increases the efficiency of operations, since there is reduction in time, cost and risk of error.

4. People from all over the country and even abroad who wish to participate in the stock market can buy or sell securities through brokers or members without knowing each other. That is, they can sit in the broker’s office, log on to the computer at the same time and buy or sell securities. This system has enabled a large number of participants to trade with each other, thereby improving the liquidity of the market.

5. A single trading platform has been provided as business is transacted at the same time in all the trading centres. Thus, all the trading centres spread all over the country have been brought onto one trading platform, i.e., the stock exchange, on the computer.

It has been made compulsory to settle all trades within 2 days of the trade date, i.e., on a T+2 basis, since 2003. Prior to the reforms, securities were bought and sold, i.e., traded and all positions in the stock exchange were settled on a weekly/fortnightly settlement cycle whether it was delivery of securities or payment of cash. This system prevailed for a long time as it increased the volume of trading on the exchange and provided liquidity to the system.

Q8) Write a brief note on security market indices? 5

A8) A stock market index is an index number that measures the movement in share prices of stocks under consideration. Different types of security market indices are-

Figure : Classification of stock market indices

a) Indices based on size

SENSEX: Constituted of 30 scrips

BSE-100: Constituted of 100 scrips

BSE-500: Constituted of 500 scrips

Nifty: Constituted of 50 scrips

Nikkie: Index Constituted of 225 scrips

S & P 500: Constituted of 500 scrips

NASDAQ: Composite Constituted of around 4700 scrips

b) Indices based on Nature

SENSEX: Broad-based index representing all major industries from the listed universe

BSE IT Sector Index: Index representing the IT sector stocks

BSE TECk Index: Index representing the TMT sector stocks

BSE Healthcare Index: Index representing the Healthcare sector stocks

FTSE-TMT Index: Index based on telecom, media and IT sector stocks

Nasdaq-100 Index: Technology Index

c) Indices based on Calculation Methodology

Market value-weighted Method - Each stock is given a weighting proportional to its market capitalization

Price Weighted Method - Each stock is given a weighting proportional to its market price

Equal Weighted Method - Each stock is equally weighted in the index

Modified Market Capitalisation Weighted Index - Market capitalisation is considered partially on a predefined basis. For example the weightage of any one stock may be capped (at say 10%) or may be considered only to the extent of free-float.

Q9) Discuss about some of the existing security market indices. 10

A9)

SENSEX

The BSE SENSEX, first compiled in 1986 is a “Market Capitalization-Weighted” index of 30 component stocks representing a sample of large, well-established and financially sound companies. The index is widely reported in both, the domestic and international, print and electronic media and is widely used to measure the performance of the Indian stock markets. The BSE SENSEX is the benchmark index of the Indian capital market and one, which has the longest social memory. In fact the SENSEX is considered to be the pulse of the Indian stock markets. As the oldest index of the Indian Stock market, it provides time series data over a fairly long period of time. The SENSEX has over the years become one of the most prominent Brands in the Country. It can be rightly called the ‘Oldest barometer’ of the Indian equity markets. One can identify the booms and bust of the Indian equities from the SENSEX.

2. BSE-100

The Stock Exchange, Mumbai has been compiling and publishing BSE-100 Index numbers since 3rd January, 1989. BSE-100 index is more broad based than SENSEX as this index has 100 scrips in its basket. This index was earlier called BSE National Index (Natex), when the prices of its constituent scrips were collected from other major exchanges in the country. The base year for BSE-100 Index is 1983-84 and the base value is 100.

3. BSE-200

In order to provide a better representation of the industries in the universe, a more broad-based index- BSE-200 was constructed and launched on 27th May, 1994. The base year for BSE-200 Index is 1989-90 and the base value is 100. The BSE-200 index necessarily includes all BSE-100 companies.

4. DOLLEX-200

While BSE-200 index reflects the growth in market value over the base period 1989-90, with both the current market value and the base value expressed in rupee terms, a need was felt to design a yardstick by which these growth values are measured in dollar terms. Such an index would reflect, in one value, the changes in stock prices and the foreign exchange variation. In order to satisfy this need, The Stock Exchange, Mumbai introduced a new index called DOLLEX-200, i.e. a dollar linked version of BSE-200 index. Here the current and base market values are arrived by dividing the current rupee market value by the current rupee-dollar exchange rate and the base value by a constant average rupee-dollar conversion rate in the base year. Thus, DOLLEX-200 reflects not only the share price movements but also the rupee-dollar movement.

5. BSE-500

Although BSE-200 index is a broad-based index, it represents only 200 companies. Hence, a need was felt to construct BSE-500 index to represent all segments of listed stocks and to give more coverage in terms of number of scrips, market capitalisation and turnover. The BSE-500 Index has a base date of 1st February 1999 and a base value of 1000. The BSE-500 represents around 90% of the total listed market capitalisation of BSE. The selection criteria for the companies include Market capitalisation, Industry representation, Liquidity factors like traded value, trading frequency and average number of trades per day. The BSE-500 index necessarily includes all BSE-200 companies.

6. BSE-PSU INDEX

The Stock Exchange, Mumbai launched “BSE-PSU Index” on Monday, 4th June 2001. The index consists of 34 major Public Sector Undertakings listed on the Exchange. The BSE-PSU Index is displayed on-line on the ‘BOLT’ (BSE On-line Trading Terminal) nationwide. The BSE - Public Sector Undertaking (PSU) Index is a stock index that tracks the performance of the listed PSU stocks on the Exchange. The index constituents (currently 34) are part of the BSE-500 Index. The Base Date for the BSE-PSU Index is 1st February 1999 when the BSE-500 was launched. Being a subset of BSE-500, the BSE-PSU Index ensures a reasonable history of how the Central Government wealth fluctuates on the bourses. The Base Value for the BSE –PSU Index has been set at 1000 to ensure adequacy in terms of Daily Index movement. The BSE-PSU index consists of listed companies \ institutions \ corporations owned or controlled by the central government within the meaning of Section 619-B of the Companies Act, 1956.

7. DOLLEX-30

The Stock Exchange, Mumbai launched a new index ‘DOLLEX-30’ on July 18, 2001 to track the performance of SENSEX scrips in Dollar terms. Like SENSEX, the base-year for DOLLEX-30 is 1978- 79 and base value at 100 points. The exchange has computed historical index values of ‘DOLLEX-30’ since 1979. While SENSEX reflects the growth in market value of constituent stocks over the base period in rupee terms, a need was felt to design a yardstick by which these growth values are measured in dollar terms. Such an index would reflect, in one value, the changes in both the stock prices and the foreign exchange variation. DOLLEX-30 is the second dollar denominated index from The Stock Exchange, Mumbai. Earlier, BSE had launched a dollar version of BSE-200 index called DOLLEX-200 in 1994.

Q10) What are the different sources of financial information? 5

A10) Financial information is necessary for stakeholders in decision making process. It is used by existing investors, potential investor, Government, competitors, creditors, suppliers etc. Some of the popular sources of financial information are-

Media: Financial information about business organisations become publicly available in a variety of ways, including news releases reported on television and the internet, as well as in the newspapers and other financial publications. Publicly available information as presented in the media, especially the financial media. It may be used by investors as a basis for forecasting either a business’s success or failure. Although financial information as presented in the media is available to everyone, not everyone understands it.

Financial market: Financial markets are a valuable source of financial information. The financial market reacts quickly to developments or even rumours, while financial statements are presented in a fixed timeframe. However, some individuals might lack the financial literacy to understand the intricacies of financial markets and how to interpret the kind of information mentioned by Foster.

Financial statements: Profit and loss account, balance sheet, cash flow statement, fund flow statement of a company provides information about the performance of company, financial position, quality of asset and liability etc.

Journals and magazines: Journals and magazines are published by companies, Govt. etc. from time to time that consist of write ups about the current trend and overview about the company/industry etc.

Annual reports: Annual reports are published by Ministry of Commerce, companies and other related authorities that provide valid and reliable information to stakeholders.

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