Basics of Investment PDF

ISM CH-1...VESTMENT 1 BASICS OF INVESTMENT CHAPTER LEARNING OUTCOMES After reading this chapter you will be able to Understand the concept (& features)of investment Differentiatebetween investment...

ISM CH-1...VESTMENT 1 BASICS OF INVESTMENT CHAPTER LEARNING OUTCOMES After reading this chapter you will be able to Understand the concept (& features)of investment Differentiatebetween investment and speculation > Know various types of investment Understand direct and indirect approach of investing Identify the various components of investment environnment Learn the process of making investment decision Know the two modes of making investment Ivestmentis the backbone ofany economy. Savings of an econony nust be channelized into productive investment togenerate incomne. An individual may keep his savings in a bank account or invest in financial and/or real assets. In Indiasavings bank account does not provide high interest income. Therefore the investors, who wish to earn higher returns, have to explore other avenues for ivestment such as equity shares, bonds,mutual funds, gold, property, derivatives, etc. Hence, the need for financial literacy on the part of individual investors. This chapter provides an overview of the basic concept of investment, types of investment and approaches of investing. Ivestmentrefers to commitmnent of funds in expectation of future gains or benefits. Every investment requiresthat current consumption isforegone so that in future some benefits or returns are generated. Different products have different levels of risk investment andreturn and hence theirestimation and analysis is an important aspect of investment decision making, An in vestor should make his investment decision depending preferences and analysis of upon his risk-return risk-return features of the investment options. 1  BASICS OF INVESTMENT Para 1.1 a cear understanding of the various chaper provides an investmen This of taking ofinvestmentandprocess i avemieSesavailable, modes investmen decision. 1.1 INVESTMENT employment of current funds to The term investment implies com- earn It implies sacrifice of current mensurate return in future. consunplio because thee amount which is not for expected income in future spernto consumption is saved land invested. An investor forcgoes current current consumption andinvests hissavingsin investments in anticipation of hivh future consumption. It is important to note here that investment does t alwaysguaranteehigher future returns. At timnes losses are also incurred Hence the environment of investment is quite uncertain. We are in tact facing a VUCA (Volatile, Uncertain, Complex, Ambiguous) environment in the context of investments. "In 1986,Microsoft Corporation first offered its stocks to public and within 10 vears, the stock'svalue had increased over 5000%. In the same vear Worlds of Wonder also offered its stock to public but ten years later the company was defunct." The word 'investment' connotes different meanings to different To a layman people. may mean purchase of shares, it bonds or others financial instruments. To an economist, it implies purchase of fixed assets(Capital assets) such as productive plant and machinery. To well investment refers a businessman as to purchase of fixed assets such as plant, machinery etc. land, building Irrespectiveof its context, the word funds in some assets at investment requires present so as to be commitment of in future. able to generate higher income 1.1.1 FinancialInvestment vs. Real Investment Depending upon the type of financial or real asset,all the investment. investments can be classified as Financial investment is cial investmment of funds in assetsare claims financial assets. Finan over some financialassets are real/physical assets.The shares, bonds, examplesof ol linancial nmutualfund units investment is in the etc. The retun appreciation in value. form of interest, dividend and o Real lnvestment (or Economic fundsare Investment) is an investedinrealortangible assets. investment where lerm (or fixed) Real assets are assets which are thoselong exanples ol real used in the assets are plant, production process, The cfc. machinery, equipments, builaing 2  FEATURES OF INVESTMENT 3 Para 1.2 An individual investor invests in financialassets (cquity shares, bond, etc) and commodity assets (e.g gold, silver etc.). Now-a-days real estate invest ment has also become an important part of individual investor'sportfolio. Real estate isinvestment in tangible house/commercial properties to get income in the form of rent and/or capital gain due to price appreciation. The subject matter of this book- "vesting in stock markets" is finan cial investment. Financial assets are primarily in the form of securities. A security as defined under the Securities Contacts (Regulation) Act, 1956 includes (0 shares, serips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; (i) derivative; (i) units or any other instrument issued by any collective investment scheme to the investors in such schemes; security receipt as defined in clause (zg) of section 2 of the Securiti (iv) Assets and Enforcement of sation and Reconstruction of Financial Security Interest Act, 2002 (54 of 2002): under any (v) units or any other such instrument issued to the investors mutual fund scheme; name called), issued to an (v) any certificateor instrument (by whatever purpose distinct entity which investor by any issuer being a special mortgage debt, assigned possesses any debt or receivable, including interestof such investor to such entity,and acknowledging beneficial in such debt or receivable including mortgage debt, as the case may be; (vi) Government securities; by the Central Govern (vii) such other instruments as may be declared ment to be securities;and (ix) rights or interests in securities. in stocks, mutual funds and This book primarily deals with investment derivative instruments. OF INVESTMENT 1.2 FEATURES (OR FACTORS AFFECTING) mind certain objectives. keeping in Individual investors make investment to avail of higherincome After all they forego current consumption in order and hence consumption in future. The ultimate objective of investment is fact that risk return. However due to the to minimize risk and maximize possible to get very high and return move hand-in-hand, it is not always becomes the primary fac return at very low risk. So risk-return trade-off 3  Para 1.2 BASICSOF INVESTMENT 4 Other factors by any individual. which must investment be tax benefits, be tor affecting investiment may while making safety and kept into mind capital, liquidity, etc. i while making of factors tobe considered investmen The giisthe list following 1. Return rate of returnover is expected toprovide certain a perid Everyinvestment is the income generated by investment expressed as in future. Return buvs. For example ifa person ,ancq of the costof investment. percentage at the end of 100 and gets 10as dividend the ycar, a cost of uity share at 10 be x100 = 10%.Here we assume no change return on share would his in share price at 100 the end of the year. If the share price also increases. 105 then his return would be 10+(105- 100) x100 15% = 100 Different investment instruments have different returns depending on their level Forexample Treasury bills (T-bills)and govt. securities carr of risk. low return as compared to equity shares and derivatives. 2. Risk Risk is defined as variability in expected return. If return from an invest ment is certain, fixed and 100% sure then there is no risk attached to it. Generally,Government securitiesare considered to be risk-free.However instancesof sovereign debt crisis (inwhich European Countries government failed to repay the public debt) cast doubton government securities being risk free.Risk can be calculated as standard deviation of the expected re turns from an investment. The objective of any investment is to risk. Different minimize individuals have different risk taking abilities.For example young entrepreneurs may take higher risk than old and Therefore investmentmust be retired people. of the investors. done keeping in mind the risk bearing ability 3. Liquidity It is the"moneyness" of investment Le. beconverted the easewith which into cash with investment can no or little risk of loss of capital. are highly liquid (egcquity shares, mutual Some asset (eg bonds, less liquid fund units etc.) and debentures). It is some a development and important to mention efficiency of here that on the financial markets liquidity of the securities traded depends to a great e 4. in it. Marketability A related aspect is bought orsold. An marketability Le.the ease asset with which an asset can be may be highly 4 marketable but less liquid (e.g dis- 5 FEATURES OF INVESTMENT Para 1.2 ress sale of property). For being marketable it is important that where it can be bought or sold. there is a ready market for the security, 5. Tax Benefits Availing tax advantage is another important objective of 80C of IncomeTax Act, 1961 investment nancial assets in India. Section in fi provides certain investment alternatives (e.g PPE, NSC, Mutual Funds, ELSS-Equity Linked Savings Schemes etc.) which qualify for deduction from taxable upto 1,50,000. Assessment of income tax benefits is important which undertaking investment because it affects the actual : For example Rural Electrification effective return from investment. Corporation (REC)has come out with tax-free bonds at a coupon rate of 8.12% p.a. for 10 years. It implies that interest income from these bonds will be exempt from tax. If an individ ual is in 30% tax bracket then the effective pre-tax interest rate would be 8.12% =11.6% 1-0.30 6. Hedge against Inflation Agood investment should provide hedge against the purchasing power risk or inflation. The investor must ensure that the return generated by his investment is higher than the prevailing inflation rate. Then only he is benefited by making investment, otherwise he is worse off. For example, if the prevailing inflation rate is 8%, the investor should look for investment options which provide more than 8% return otherwise his real worth of investment will go down.Inflation erodes purchasing power of money and hence hedge against inflation is an important consideration in investment. sareconsidered to be a good hedge against inflation Generally, equity shares: because of theirvarying return.It is expected that in times of inflation,equity shares generate higher return. On the other hand fixed income securities like bonds are not a good hedge against inflation due to the fact that their interest rate are fixed and do not increase in times of rising inflation. 7. Safety of Capital Safety of capital should come first. The investor must secure his principal amount which he invests. That ishe should not be impressed by very high rate of return on an investment if the amount invested is not safe. For this. credit rating agencies play an important role in providing bond-ratings. Generally bonds which have lowerthan AAA ratings are considered to be not so safe. For example many NBFC come out with fixed deposit schemes at an attractive interest rate but safety of investment is less. 5  BASICS OF INVESTMENT 1.3 Para Don'tsof Good investing market movement 1. Dont try to predict 2. expect quick returns Don't 3. Avoid chasing hot tips 4 Don't blindlyfollow thecrowd 5. Over or inadequate diversification Use of borrowed money to nake more money 6. 7. Don't fall in love with poor ivestnents 1.3 SPECULATION Speculation is investment in an asset that olfers a potentiallylarge retur but is also very risky; a reasonable probability that the investment will produce a loss. It can be defined as the assumption of considerable risk in obtaining commensurate gain. Considerable risk means that the risk sufficient to affect the decision. Commensurate gain means a higher risk premium. Speculative assets are high risk-high return assets and hence should be invested in with caution.Generally large investors hold specu lative assets so as to make quick gains. Stock market with two types of speculators - bulls and is identified bears. Bullspeculatorsexpect increase in stock prices while bear speculators ex pect decline in prices. It must be noted here that speculation, per se, is not bad. Rather it is essential for smooth functioning of stock market and to maintain price continuity and liquidity. However excessive bad as it takes the prices away spcculation is from their true fundamental fore SEBI keeps a check on values. There excessive speculation in through various rulesand Indian stock market, guidelinesunder SEBIAct, 1992. It must be noted here that the same asset can be held by an investment and by the other for investorfor if held by a speculation. For example small investor for long shares of RIL, term amounts to is held by an FIl for making quick investment but if it speculation. return over short run then it implies 1.3.1 Investment vs. Speculation Investment and speculationcan be distinguished on the following grounds Basis of DifferenceInvestment Time Speculation horizon Long generally exceed Short may be as short as ing oneyear 2. Risk intra-day Low to Moderate Very high 3. Return (expected)Low to moderate and consistent Very high and inconsistent 6  INVESTMENT ENVIRONMENI Para 1.4 7 Basis of DIfference Investment Speculation also borrow Own funds are used forpeculators funds and/or do margin Funds investment trading 5 Dividend, Interest etc. Change in price of asset Income Fundamental factors inside Source of Informa Subjcctive analvsis, of the companv are tion intormation etc. analysed TABLE 1.1: INVESTMENT VS. SPECULATION 1.3.2 Gambling eg horse race. Gambling is a game undertaken for someone's excitement winner makes big money but card games, lotteries. Here although the as return because is not consistent or regular. that cannot be classified it Gambling is a zero sum game someone's loss - is other party's gain. It is the other. Therefore gambling purely by chance that one party wins over loss of funds put in it. ishighly uncertain and may involve complete 1.4 INVESTMENT ENVIRONMENT types of securities which are The investment environment implies various mechanism or process through available for investment and the entire or sold. which these securities can be bought of three main aspects- securities The investment environment comprises securities mar (also referred as financial assets or financial instruments); The and intermediaries in securities markets. kets (ie. financial market) is characterized as VUCA (Volatile, investment environment now-a-days Uncertain, Complex, Ambiguous). i. Securities : shares, An investor can invest in a variety of securitiessuch as equity funds mutual funds, exchange traded bonds, debentures, derivatives, gold commodities and bullions (such as etc. One may also invest in currency derivatives are also getting and other precious metals). Even may avenue these days. These securities popular as an investment to the other without much difficulty. be transferred from one owner i#. Securities Market: buyer and seller of securities and Security market brings together to facilitate the exchange of securi provides operational mechanism ties. An efficient and developed security market is a prerequisite for in securities.There are many types in which increased investment securitiesmarket can be classified. 7  INVESTMENT BASICS OF Para 1.4 SECURITIES MARKET of Onthebasisof nature On the basis of time of securities securities Money Primary Capital Market Secondary Market Market Market FIGURE I.1: TYPES OF SECURITIES MARKET On the basis of Time, securitiesmarket is classified as: (a) Capital market is the market for long term financial investment and instruments (more than one year).It primarily deals with cquity shares,long term bonds and debentures. In ndia it furtherclassified into the following two segments- Equity and Wholesale Debt Market. Market (b) Money market with short term deals It dealswith securities (one year or less). Treasury bills,shortterm paper,certificates of deposits debts such ascommercial etc. On the basisof nature of securities,a classified as: security market can be further (a) Primary market is the market for the where new first time. IP0 is a securities are issued tool of (b) primary market. Secondary market which provides (orsecond hand) the platform IPO are traded insecuritiesare boughtor sold. where existing secondary market. Sharesissued in A well functioning primary investments in an market is essential ficient economy. At the secondary market sametime, a for the growth of of that transparent and et securities, is a ensures speedy For example prerequisitefor transferof in India, investment in a ownership developed and secondary particular hence market for security. hind as growth in bond bonds is not compared to market growth in other in India is properly Every security is countries bond lagging be positioned characterized by markets. its between the market brokers and buyer and market. sellerof intermediaries who are sub-brokers actas securities. il. market Stock Regulation of intermediariesin exchange. securltles secondary The Market: investment regulated. environment and hence Securities market is securities not a market is well laissez-faire market but 8 ade  Para 1.5 9 TYPES OFINVESTIMENT quately regulated by regulatory bodies such as SEBI(Securitiesand Exchange Board of India), RBI(Reserve Bank of India),Departnent of Company Affairs, Ministryof Finance ete. The nultiplicity of regulatory agencies sometines proves detrinmental to the growth and efficient regulation securities market. Hence there is a nove of towards reducing the number of regulatory bodies in India. On 28" September, 2015, Forwards Markets Commission has been merged with SEBI. 1.5 TYPES OF INVESTMENT (OR SECURITIES) can be classified into the Various types of securities or Investment option following categories on the basis of their peculiar features as well as risk return relationships: a Equity shares. "investment in stock markets": Equity shares are also known as Common stocks' in western economies. An equity share represents an ownership claim in a company. Th owner of the equity share is termed as equity shareholder in the company and enjoys all get future voting rights in corporate matters. Equity shareholders of profitdistributed benefits in the form of dividends (i.e. the amount capital gains). as dividends) and in the form of price appreciation (or However it is not obligatory on the part of the company tomay declare any, also dividends every year and the amount of dividends, if shares are also referred to as vary from year to year. Hence equity promise fixed return. Due to variable income securities'and do not are highly risky securities.They variabilityin returns, equity shares loss during the invest may generate a very high return or very high expected to generate ment horizon. Worldwide equity shares are over long term. higher returns (as they have higher risk) for the first time through Equity shares are offered togeneral public of public offer: a public offer. There are two types through which () IPO (InitialPublic Offering): IPO is the process sale of equity shares by a a company goes public. IPO is the time. It can be a public company to general public for the first trying to raise capital or an issue of shares by a new company to be listed on stock exchange old private company which wants opportunity and becomepublic company. IPO is a very lucrative through IPO, if heid for long for investment as shares bought E.g. Burger King has term, have potential to yield huge profits. 2020. come up with an IPO in the month of December filling the application An investor can subscribe to an IPO by money for the number form and paying the initial application of shares he wants to buy. An IPO is open only for a limited shares are listed number of days. Once the IP0 closes and the 9  10 BASICS OF INVESTMENT Para 1.5 buyers can easily buy or for trading, scll on thestock exchange these shares anytime. (i) FPO (Follow-on Public Offering): new equity shares to FPOisthe process of issuing public by an already lg additional or which has already brought by a company So, FPO is An FP is available to new as company. the IPO process. gone through of thecompany. (E.g. Facebo well as existing shareholders in December 2015 to raise money for it announced its FPO needs,] working capital the primary marke An investor can either buy equity shares in in the secondary market, ie st through an IPO/FPO or continuously traded. exchange where the shares are b Bonds and debentures: Bonds and debentures are fixed incone securities. A bond is an IOU (1 Owe You) of the borrower. It arises out of a lending-borrowing contract wherein, the borrower (or the issuer of the bond) promises to pay a fixed amount of interest to the lender (or the bond holder) periodically and repays the loan cither periodically or at maturity. Most of the bonds anddebentures are redeemed at maturity only and they carry a fixed coupon rate or fixed rate of interest. Bonds may be corporate bonds or government bonds, short term bonds or long term bonds, secured bonds or un secured bonds, etc. Bonds and debentures may also be convertible or non-convertible.Since bonds and debentures carry a fixed rate of interest, their future benefits are known in advance, therefore they have relatively lower risk than equity shares. At the same time they generaterelatively lowerreturn. upto a certain amountof Some bonds also offertax exemption investment depending upon the government.E.g. NABARD (National Bank for notification by Rural Development), Agricultural and REC NHAI(National Highway (Rural Electrification Corporation) and bonds. Authority of India) bonds, RBI tax relief c Treasury Bills: Treasury bills are the Government the context of a in securities issued by Central investor in lending- borrowing Treasury bills contract. An Government.This type of actually lends money to risk of security carries the Central non-payment of the amount minimum (or negligible) risk in case of as promised. Treasury bills is Hence the detault discount and negligible. These with redeemed at par and hence bills are certaintyin the the issued al very rate of this feature, return is know asset"in Treasury bills beginning are also of the research studies. referred toinvestment. d and used asBecause O Depositrelated "Risk tree availableto investments:There investors arevarious special term like fixed types of deposit deposits, deposit options schemes in recurring banks. These offer a deposits, return of 6-8 10  TYPES OF INVESTMENT Para 1.5 on the amount invested. This interest income is taxable p.a. interest also except for the tax-saving deposit schemes which provide rclief upto 1,50,000under section 80C ofIncome Tax Act, 1961.The post tax returns on these deposits are usually not adequate to incrcase the value of investment because inflation is higher than their post tax returns. e Governmentschemes: Government launches varioustypesof schemes from time to time with an objective of inculcating saving habit amongst citizens and for this purpose various tax benefits are also attached with these investment schemes. Following are the popular government schemes: ()National Savings Certificate (NSC): NSC is an Indian govern ment savings bond certificate issued by post offices. Currently, NSC VII (8.5%, 5 years) and NSC IX (8.8%, 10 years) are being offered. These are transferable once in their time horizon. One certificate costs 100 but there is no upper limit on amount of investment. Investment amount qualifies for rebate under section 80C of Income Tax Act. (H) Public Provident Fund(PPF):The Public Provident Fund Scheme, 1968 one of the most popular long-term, tax-freeinvestment is scheme of Ministry of Finance. It acts as a kind of compulsory saving and helps in developing saving discipline.It has aminimum investment limit of 500 anda maximum limit of 1,50,000 per annum.Investorsget an interest rate of around 7% p.a. on PPF a compounding basis. It has a maturity period of 15 years. account can be opened throughout the year with bank or post office.PPF is an Exempt, Exenpt, Exemptscheme,ie.,periodic on interest deposits provide tax deduction while no tax is levied income and withdrawals on maturity. No withdrawals are allowed till first 6 years. From 7h year (not more than 50% onwards, a person can withdraw amount provides a loan facility of the balance) every year. PPF also loan of up to 25% of the account wherein a person can take a year. This facility balance available at the end of first financial is available from third year onwards. Offices offer tax saving deposit (iii) Post office schemes: Indian Post investment peri schemes for different maturity periods and Deposit, Time Deposit, odicity. E.g.: Monthly Deposits, Saving Recurring Deposit, etc. and (iv) Infrastructure bonds: Government allows its undertakings to issue tax-free bonds someapproved infrastructure companies infrastructure bonds are the from time to time. Most popular and NHAI. These bonds haye a issued by NABARD, REC, PFC of by an investor before the expiry lock-in period and if sold 11  12 BASICS OF INVESTMENT Para 1.5 will I not be given. In the union the tax exemption Itthat onlyyinterest income lock-in period, had declared government be taxed and capital gains would budget 2016, istax free,the onthese bonds will not be eligible for tax deduction. invested the money Besides above, a number of new avenues: 1 Alternative investment introduced in securities maarket over the past have been mutual funds, exchange trad. securities two decades. These securitiesinclude- (financial derivatives como and (ETFS), derivatives ed funds deep discount mortgaged backed securities, derivatives), warrants, REIT. collective investment schemes, bonds, catastrophe bonds, etc. These securities have enriched (Real Estate Investment Trusts), a variety of choice to the the investment environment by providing investors. (0Mutual funds - Mutual funds collect money from investors and put the pool of money socollected into investment products like equity shares, bonds,debentures, money market instruments or combinations thereof. Most funds are launched with a predeter. mined investment nature such as debt funds, equity funds, or balanced funds. Mutual funds are professionally managed and provide diversification benefits to retail investors. Systematic nvestment Plan (SIP) - anew development in mutual fund in vestment - is a smart mode for investing money in mutual funds. It provides rupee cost averaging and compounding benefits. ()Equity Linked Savings Scheme (ELSS): mutual fund schemes with ELSS are diversified tax benefits under Income Tax Act. ELSS asthe section 80 C of name suggests invest in equity ucts along with debt prod investment. These funds invest thus offer long-term in cquities, growth opportunities. These lock-in period of three years; however, come with a tax freeand long term capital the dividend income is So, ELSS isalso gains are also anEEE (Exempt, exempt from tax. it has the shortest lock in Exempt, Exempt)option but period as (ii) ULIP (Unit Linked compared to PPF and NSC. Insurance Policy) - ULIP is product which offers a It provides life cover combination ofinsurance an insurance and investment and investment. portion goes for benefit. into an the life insurance policy and Some premium option chosen by the rest is highly linked investor. The invested or worth of insurance dependenton investmentis companiesoffer market varying performance. different types of Different havenotinvestment portfolio, ULIPschemes been able to different with ofnot so make mark fees andpremiums.ULIPs a consistent amongst investors premium iseligiblereturns andhigh because for 80C market risk deduction. involved. ULIP 12  TYPES OF INVESTMENT Para 1.5 13 i) Exchange-traded funds (ETFs) -ETEs are baskets of securities stocks. They track that are traded on an exchange like individual in same an index and money is invested in securitiesof the index The first ETF in India, "Nifty proportion as that in the index itself. on BeEs (Nifty Benchmark Exchange. Traded Scheme)" based S&P CNX Nifty, was launched in January 2002 by Benchmark the convenience Mutual Fund. Unlike index funds, ETFs offer on the Exchange. These days of intra-day purchase and sale gold we also have Gold ETFs which are referred to as 'paper but not in physical form. Investor because you invest in gold willemulate return on tangible gold. gets gold ETF units which acontract between two or more par (1) Derivatives - A derivative is ties, whose value is based on the value of the underlying asset/ bonds, commodities, currencies, assets which may be stocks, contracts on stocks and interest rates, etc. Futures and options late, used by traders and speculators.Of indices arevery popularly also been picked up commodity and currency derivatives have are highly leveraged instrumnents by Indian investors. Derivatives to investment in the underlying and thus too risky as compared equally high. asset. However, the expectations of returns are also Collective investment scheme (v) Collective investment schemes - made by a company to collect (CIS) is a scheme orarrangement form of contributions and invest money from investors in the or more) to earn income, profit, the pool of money ( 100 Crore However, investors produce or property for the contributors. a CIS. A CIS have a close say in day to day operations of with SEBI and obtain a crédit don't has to file an offer document investors. Units actually raise funds from rating before it can on stock exchanges. issued by CIS are compulsorily listed giving their hard need to be highly cautious before Investors becausea CIS is illegal schemes earnedmoney to these lucrative Despite if it is not registered with SEBI, the market regulator. in our country, ironically, of numerous such schemes running is registered with SEBI. India has only one CIS which offered plot of land or The SARADHA SCAM of 2013 which flat or very high rates of interest rates was one such CIS fraud. Itactually had no business and was totally a Ponzi scheme. In SEBI has issued more a bid to save small investors' money, from January 2014 onwards. stringent norms to govern CIS Trusts) REITs provide an (vi) REITs (Real Estate Investment properties for investment. REITs are alternative to purchasing and commercial companies which invest in real estate -residential 13  Para 1.7 BASICS OF INVESTMENT 14 and investors are ableto carnreal estate property, li through relatively smaller investments in REITS as to hefty sums of money required to buy property. compared Someof these investments like stocks, mutual funds, derivatives. ete discussed in detail in later chapters of this book. 1.6 OBJECTIVES OF INVESTMENT 1. Wealth creation by capltal appreciation - one of the primar. It is objectives of investment. Investors basicaly want to grow their mons and therefore park their funds in various investment instruments t accumulate more and morce wealth for their future. in the value of investment creates wealth for the The accreti investors. 2. Steady source of secondary income - Every rational being is risk averse and thus wants to secure his or her future from uncertainties Investment ensures a steady inflow of income in the form of interest dividend, etc. Such recurring inflows act as secondary the investor income fur apart from the primary income like salary, profits from business/profession, etc. 3. Hedge against inflation - Inflation is a usual non which reduces the economic phenome isessential that purchasing power of money. Therefore, your money grows at a it inflationso that inflation pace faster than the rate of doesn't eat up your hedge against wealth. So, creating a inflation is another objective of investment. 4. Financial goals - Investment is also done with the goal of aimslike house, car, meeting life marriage, children largeoutlay of funds. education, etc. which require Investment helps in of funds building the huge corpus necessary to fulfil these that the right financial goals and amounts of funds are also ensures 5. Reducing available at the right tax liability - time. Availing tax objective of investment in financial advantage is another assets in India. important Income-tax Act, 1961 Section 80-C of provides certain PPF, NSC,Mutual investment income. Funds, which qualify alternatives (e.g for deduction from taxable 1.7THE INVESTMENT DECISION The process of PROCESS investment broadly 1. Setting comprises of the up the 2. Building up an investment policy following steps : inventory of 3. securities Performing security 4. analysis Constructing portlolio portfolios, analyzing portfolios andselectingthe optimal 14  INVESTMENT DUSION PROUNs Para 1.7 15 5. Portfolio performance evaluation and management 6. Portfolio revision in detail bclow: These steps are discussed setting up Pollcy: The first step involves 1. Setting up the Investment investment policy is bascd theinvestment policy forthe investor. The lunds, tax statusand on investment goals or objcctives, investible objectives of an investor investmnenthorizons. Dillerent ivestnent income, tax benefits etc the may be capital appreciation, regular investmnent objectives are tramed as per the risk return prelerences has a dillerent risk appetite or risk of the investors. Every ivestor policy. The ingredient in investnent profile which is an essential or related to the period of investnent investment objeetive is also for policy sets the broad framework investment horizon. Investment by an individual investor. investment decision making step involves building inventory of securities: This 2. Building up an investor may make his securities wherein an up a listof all available upon investment objectives andan investors investment investment. Depending may be filtered. For example equity shares if horizon, the securities income at low risk, then objective is to receive regular may not be included in the list regular dividends which do not pay of securities where an investor may invest. of available Security Analysis: Once an inventory or list securities 3. Performing these made, the next step is to analyze securities has been This isknown to risk and return characteristics. primarily with respect is to estimate The main idea in security analysis as security analysis. This may also and risk of individual securities. the expected return securities and in detecting undervalued or overvalued help investors selldecision. timing of buy or Fundamental approaches of security valuation- There are various and eficient market hypothesis (EMH). analysis analysis, Technical the price of a security in the long term, of a secu As per fundamentalanalysis, worth. Intrinsic value its intrinsic value or true with the is equal to cash inflows associated value of all future of the rityis the present caleulates the intrinsic value investor first security. Hence the rate and then compares it discount security using some appropriate is to ascertain whether the security with the prevailing market price price) orovervalued ( intrin undervalued intrinsic ( value> The market investor should choose undervalued price). sic Value< Market Fundamental analysis comprises purposes. in or securities for investment and Company level factors of analysis ofEconomy, Industry from the security. This is expected cash inflows der to ascertain the framework of analysis. approach or ElF termed as Top Down 15  OF INVESTMENT l6 BASICS Para 1.7 hand, is based on the premise the other that analsi,on future price behaviouris predict:able Tichmical hence history repeatsitself'andand volume information.Hence past trend of past prices ofF technical indicators can onthe basis a number and be patterns basis of future prediction analvsis, chart On the prices. to predict future it is the right timeto buy may decide whether Used an investor markket timing. Elf prices, analysis helps aninvestorin Hence technical assumes that current security price, sell. hypothesis (EMH) cient market about that security. Hencethe available information fully reflect all price of a secui is nothing but the fair price or true market price to buy orsell as there is no consislen Hence anvtime is a good time market. in an efficient security overpricingor underpricing portfolio analysis and portfolio selection. 4. Constructing portfolios, or more securities in which A portfolio is a combination of two investor may prefer to holdinvestments ratherthan in all the securities available for investment. Therefore after security analysis, the next step is to constructall feasible portfoliosor portfolio opportunity set and selecting optimal portfolioforthe concerned investor. Porttol opportunity setis also termed as Investment opportunity Set. It must be noted that there may be many feasible portfolios by combining various indifferentproportions, but all of them may not securities be efficient. An efficient portfoliois one which provides maximum return for a given level of risk or which has minimum risk for a given level of return.Such efficient portfolios may also be large in numbers. Hence in order to selectthe optimal or best portfolio for the investor,one needs to consider risk return preferences of the investor. For example for a young person, who is willing to undertake risk to maximize return,we may have an optimal portfolio comprising of equity and 30% of bonds. On the other hand for a 70% investorthe optimal portfolio retired old aged may be 10% equity and 90 debentures or fixed bonds and deposits. 5. Portfolio Revision: The fifth step in investment portfolio It consists of revision. decision process is steps in the light of the repetition of the previous tour the investment changes in investment objectivesof the environment. Moreover and hence there investor may also is a need to change overtime revise the periodically. Due to originally selected changes in security porttolio portfolio may not prices, the remain optimal originally revise it or build up a and built hence the alsomake new investor needs to certain portfolio.Changes in due to higher securities security prices attractive,which may pricesor may were not selected in the portfolio, make certain eare portfolio. unattractive.All this securities already callsfor incluae periodic revision of the 16  MODES OF INVESTMENT Para 1.8 17 6 Portfolio performance Evaluatlon: The step in the investment last process is to evaluate the performance of the porttolios, Itimplies determining periodicallywhether the portfolio has performed better than thebenchmark portfolioor other similarportfolios or not. Port folio performance evaluationmay be domec using absolutereturn as well as various risk adjusted return measures such as Sharpe ratio, Treynor's ratioor Jensen'salpha.Sharperatiois calculated by dividing excess return (i.e. risk premium) by thetotal risk of the portfolio. It is a measure of excess return per unit of risk. The higher this ratio thebetter is the performance of the portfolio. 18 MODES OF INVESTMENT- DIRECT INVESTING AND INDIRECT INVESTING directly or indirectly. An investor can invest in securities Direct investing involves the purchase or sale of securities by the investors over the invest investor has the entire control themselves. In this case the as well as are to be purchased and sold ment decision ie. which securities of capital market securitiesmay be securities when to purchase orsell. The markets (such as shares, bonds, debentures),orof derivatives (such as equity astreasury bills, certificates of money market (such futures andoptions) or is required to perform all papers etc). The investor of deposits, commercial above, on his own. decision process, as explained the steps of Investment Moreover skills and expertise. direct investing requires investing investment, Therefore of investing.In case of direct it is a time consuming process by the investor directly. analysis and monitoring is incurred the cost of as well in mutual funds (open ended involves investing or collective investment Indirect investing - traded funds funds), exchange capi as closed-ended Investment Funds (such as venture schemes including Alternative case, the investor REITs, SME fund etc ). In this the tal funds, hedge funds, securities. He has no control over directly in various controls wheth does not invest investment; the investor only the fund's the investor composition of of the fund. Therefore, the shares or to invest in. The units er to buy or sell fund or investment company which mutual company only decides is made by the fund or investment(or shares) ultimate investment decision or sell the units The investor buys and build up indirect investing. if securities in case of investment makes The investor which in turn Fund orScheme. of the Fund, of the of objective in the asset asper investment and has ownership interest and portfolios in the Fund to interest,dividends become unit holder and is entitled investment company investing in a mutual fund, the fund or Indirect price appreciation or ( decline). Thus in alternative investment funds, is investment company or even ETF or 17  BASICS OF INVESTMENT Para 1.9 18 It is convenient for investor toinvest. and alternative route ideal an skilled enough or who do form of investing forinvestors who are not not have and portfolio management prOcess. security analysis time to perform funds or any other investment case of investment in mutual company costs are incurred by the fund or company but theinvestment ultimatc, passed on to the investors in terms of these costs are management fee These expenses or fee reduce the value of the or expenses. portfolio investment done by the fund or company. 1.9 APPROACHES TO INVESTING-ACTIVEINVESTING (INVESTMENT AND PASSIVE INVESTING (INVESTMENT) Apopular classificationof investingis active investing (orActive Investrnent and passive investing (or Passive Investment). 1. Activeinvesting implies making investment in securities after actiy. ly and carefully analyzing all the securities and portfolios. Such an approach to investing requires that the investor is actively engaged in the task of security analysis, selection and building up suitabe portfolios. Portfolios are then revised and their performance is as. sessed at regular intervals. The choice of securities is a manner that the investor made in such getsmaximum return for a of risk. The idea given level behind active investing is can yield superior that investment analvsis returns to the investors. investment skillsand is a Active investing requires time consuming and 2. Passive continuous process. Investing implies making investment in Exchange traded funds. An Index Funds or performance of a index funds is a fund that tracks the broad-based market termedas passive index. Buy and hold is also iscontent with investing. In caseof the market passive investing, the to earn return at market investor returns over and above the one that risk. He does not expet The idea is given by behind passive the returns in an investing is that market. efficient market.Hence it is nobody can earn market portfolio better superior or market to buy and theIndex index which is hold the Funds or ETFs. the Passive underlying asset o investment skillsand investing doesnot isnot a Once time require mue investment ismade in consumingor investment Index fund,the continuous process horizon. investor holds it overthe 18 19 TEST YOURSELE SUMMARY Investment is enployment of current funds to earn commensurate returns in future. Investment may be classified as Real investment and Financial invest ment. Real investment is investment in tangible assets which are used in production proces,eg.investment in plant, machinery, land, building, etc. Financialinvestment represents claims over real assets, e.g.shares, bonds, debentures, etc. While taking an investment decision, an investor should carefully analyse against factors like retun, risk, liquidity, marketability, tax it benefit, hedge against inflation and safety of capital. Speculation is taking high risk in expectation of high and quick returns. The investment environment comprises of securities,securities - mar ket and intermediaries in the securities market. shares, There are multiple investment options available like equity ULIP, REITS, bonds, debentures, T-bills, mutual funds, PPF, ELSS, financial derivatives and commodity derivatives. indirect There are two modes of investing - direct investing and investing Direct investing means buying and sellingof securities by the investor himself. a mutual fund, ETE, or invest Indirect investing means investment in ment company. by taxes and inflation. Investment decisions are affected TEST YOURSELF TRUE/FALSE in tangible physical assets. () Financial investment is done (i) Speculation is also a type of investment. tax exempt scheme, Le, neither (in) PPF (Public Provident Fund) is a totally tax liability. periodic income nor the redemption amount attract the debentures. ) 19 Equity shares are more risky than bonds or  BASICS OF INVESTMENT 20 (1) Direct investing means investment in mutual fund or ETFS. () Equity shares are considered to be a good hedge againstinflation (ri) It is mandatory for all Collective Investment with SEBI. Schemes to be registered (1ü) Active investing means investment in a mutual fund, ETF or company. investment (i1) Gambling is also a typeof speculation. (1) Same asset cannot be held for the purpose of investment and speculati. [Ans. (1) F (1) F ()T (v)T (v) F (vi) T (vii)T (viil) F (Ix)F (x) F THEORY QUESTIONS 1. Explain the term Investment' and its types. 2. What is financial investment? How is it different from real 3. Explainin investment? briefthenature of investment. What are the investment and speculation? differences between 4. DU, 2018, (B.Com (P), Differentiate between invéstment held for investment and speculation. Can the by one investor and same asset be speculation by other? (B Com (H), DU,2017) 5. "Investment (B.Com (P), DU, 2019) is wellgrounded light of the and carefully above statement, planned speculation". explain and In the and speculation. differentiate How do they difer between investment from gambling? 6. Whatdoyou Com(H),GGSIPU, 2016) (B. be kept in understand by theterm mind while Investment? What investing in objectives should securitiesmarket? 7. What principlesshould be kept in mind Com(H), DU,2019) (B option? while selecting 8. What an investment are the main features of (BCom (P),DU, 2016) should you equity shares? consider while As an investor investing in what factors equity shares? 9.Explain the following: (B.Com (H), DU, 2018) a. ELSS b. ULIP C. REITs d. Collective 10. Investment Explain the Schemes differenttypes of investment avenuesavailable toan investor. 20 21 THEORY QUESTIONS 11. An investor'smotives to invest are inherently different from those of a speculator yet both are key to cfficient functioning of the market. Explain. (BCom (H), GGSIPU, 2017) 12. Distinguish between Bond and Equity as investment alternative. (B.Com (P), DU, 2019) 13. Can investment be used to save tax? Mention some of the investment options which also provide tax shelter to investors. 14. Differentiate between active invest