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Risk: Risk is inherent in any investment. Risk may relate to loss of capital, delay in repayment of capital, non-payment of interest, or variability of returns. While some investments such as government securities and bank deposits are almost without risk, others are more risky. The risk of an investment is determined by the investments maturity period repayment capacity, nature of return commitment, and so on. The longer the maturity period, greater is the risk. When the expected time in which the investment has to be returned is a long duration, say 10 years, instead of five years, the uncertainty surrounding the return flow from the investment increases. This uncertainty leads to a higher risk level for the investment with longer maturity rather than on an investment with shorter maturity. Safety: The safety of investment is identified with the certainty of return of capital without loss of money or time. Safety is another feature that an investor desires from investments. Every investor expects to get back the initial capital on maturity without loss and without delay. Investment safety is gauged through the reputation Established by the borrower of funds. A highly reputed and successful corporate entity assures the investors of their initial capital. For example, investment is considered safe especially when it is made in securities issued by the government of a developed nation. Liquidity: An investment that is easily saleable or marketable without loss of money and without loss of time is said to possess the characteristic of liquidity. Some investments such as deposits in unknown corporate entities, bank deposits, post office deposits, national savings certificate, and so on are not marketable. There is no well-established trading mechanism that helps the investors of these instruments to subsequently buy/sell them frequently from a market. Investment instruments such as preference shares and debentures (listed on a stock exchange) are marketable. The extent of trading, however, depends on the demand and supply of such instruments in the market for the investors. Equity shares of companies listed on recognised stock exchanges are easily marketable. A well-developed secondary market for securities increases the liquidity of the instruments traded therein. An investor tends to prefer maximization of expected return, minimization of risk, safety of funds, and liquidity of investments
INVESTMENT ALTERNATIVES
Now-a-days a wide range of investment opportunities are available to the investor. These are primarily bank deposits, corporate depositsbonds, units of mutual funds, instruments under National Savings Schemes, pension plans, insurance policies, equity shares etc. All these instruments compete with each other for the attraction of investors. Each instrument has its own return, risk, liquidity and safety profile. The profiles of households differ depending upon the incomesaving ratio, age of the households head, number of dependents etc. The investors tend to match their needs with the features of the instrument available for investment. They do have varying degrees of preferences for savings vehicles.
SHSH CLASSES
Equity shares
Equity shares represent ownership capital and its owners (equity shareholders) share the rewards and risks associated with the ownership of corporate enterprises. These are also called, ordinary shares, in contrast with preference shares, which carry certain preferences/prior rights in regard to income and redemption. Equity investors have residual claim on income and assets besides enjoying rights to control and pre-emptive right. The return on common stocks comes from either of two sources - the periodic receipt of dividends, which are payments made by the firm to its shareholders, and increases in value, or capital gains, which result from selling the stock at a price above that originally paid. Further, common stock can be bought in round (a 100 unit share of stock, or multiples thereof) or odd (fewer than 100 shares of stock) lots. Basically an investor incurs two types of transaction costs when buying or selling shares viz. STT (Security Transaction Tax) and brokerage. The major component is, of course, the brokerage paid at the time of transaction. As a rule, brokerage fees varies between 0.25 to 1 per cent of most transactions. The investor, however, has to bear in mind that the shares of a blue chip company, though issued at a premium, could have a far greater demand in the market for various reasons. When there is an over subscription on the issue, many small investors might not get an allotment of the shares. Hence, demand for the shares goes up immediately when the shares are traded in the secondary market Preference shares : Preference shares refer to a form that partakes some characteristics of equity shares (ownership) and some attributes of debentures (fixed income). Generally, the dividend is cumulative and shares are redeemable. Redemption period is usually 7-12 years. But, preference dividend is payable only out of distributable profits. It does not carry voting rights. Investors, though enjoy the assurance of a stable dividend but generally receive modest returns and vulnerable to arbitrary managerial actions. It is, however, not a popular capital market instrument in India. Preference shares also get traded in the market and give liquidity to investors. Though trading in preference shares is not quite frequent, investors can opt for this type of investment when their risk preference is very low. Debentures and bonds : These are essentially long-term debt instruments. Many types of debentures and bonds have been structured to suit investors with different time needs. Though having a higher risk as compared to bank fixed deposits, bonds and debentures do offer higher returns. Debenture investment requires scanning the market and choosing specific securities that will cater to the investment objectives of the investors. Investors also need to look into the following. The credit rating of the issuing companies- rating by independent agencies such as ICRA, CRISIL, and CARE indicate the levels of safety of debt instruments. The method of compounding by the companies- securities that offer more frequent compounding such as daily, monthly, quarterly, would result in higher returns. When all other parameters of risk, safety, liquidity, and so on are the same, the choice of a security should depend on frequent compounding of interest.
SHSH CLASSES
Real estate
Buying property is an equally strenuous investment decision. Real estate investment generally offers easy entry and good hedge against inflation. But, during deflationary and recessionary periods, the value of such investments may decline. Real estate investments are classified as direct or indirect. In a direct investment, the investor holds legal little to the property. Direct real estate investments include single-family dwellings, duplexes, apartments, land and commercial property. In case of indirect investment, investors appoint a trustee to hold legal title on behalf of all the investors in the group. The more affluent investors are likely to be interested in the following types of real estate: agricultural land, semi-urban land, and time-share in a holiday resort. The most important asset for individual investors generally is a residential house or flat because the capital appreciation of residential property is, in general, high. Moreover, loans are available from various quarters for buying/constructing a Residential property. Interest on loans taken for buying/constructing a residential house is tax-deductible within certain limits. Reasons for investing in real estate are given below: High capital appreciation compared to gold or silver particularly in the urban area. Availability of loans for the construction of houses. The 1999- 2000 budget provides huge incentives to the middle class to avail of housing loans. Scheduled
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banks now have to disburse 3 per cent of their incremental deposits in housing finance. Tax rebate is given to the interest paid on the housing loan. Further Rs. 75,000 tax rebate on a loan up to Rs. 5 lakhs which is availed of after April 1999. if an investor invests in a house for about Rs. 6-7 lakh, he provides a seed capital of about Rs. 1-2 lakh. The Rs. 5 lakh loan, which draws an interest rate of 15 percent, will work out to be less than 9.6 per cent because of the Rs. 75,000 exempted from tax annually.
Precious objects
If one believes investing in real estate is too risky or too complicated, one might want to consider other-tangible investments, such as gold and other precious metals, gems and collectibles. Such investments may entail both risk and reward. Precious objects are items that are generally small in size but highly valuable in monetary terms. The two most widely held precious metals that appeal to almost all kinds of investors are gold and silver. Historically, they have been good hedges against inflation. Also, they are highly liquid with very low trading commissions. Investment in gold and silver, however, has no tax advantage associated with them. When the economy picks up, some investors predict higher inflation and therefore, may think precious metals such as gold and silver will regain some of their glitter. Precious stones include diamonds, sapphires, rubies and emeralds. Precious stones appeal to investors because of their small size, ease of concealment, great durability and potential as a hedge against inflation. Collectibles include rare coins, works of art, antiques, Chinese ceramics, paintings and other items that appeal to collectors and investors. Each of these items offers the knowledgeable collector/ investor both pleasure and the opportunity for profit. It does not provide current income, and may be difficult to sell quickly.
SHSH CLASSES
premature closure after six months before one year from the date of deposit will be allowed without payments of interest. The current rates of interest payable annually on different maturity period are as follows: (i) 1 year-6.25%, (ii) 2 year- 6.50%, (iii) 3 year- 7.25%, (iv) 5 year- 7.50%. Government of India Saving Bond- These bonds provide a high yield or investors. However, with the income here taxable, the effective rate of return for the investor dips. The only saving grace is that the interest here could qualify for Section 80L deduction. Post-office Saving Account (POSA)- The account can be opened by an individual with minimum amount of Rs. 20. Maximum ceiling of deposit in a single account is Rs. 1 lakh and joint account Rs. 2 lakh Rate of interest is 3.5 per cent annum in case of both single and joint accounts. The introduction of depositor will be necessary for opening of new account. Senior Citizen Savings Scheme (SCSS)- An individual who has attained the age of 60 and above or of the age of 55 years but less than 60 years who has retired under VRS, are eligible to open the account. The joint account can also be opened with spouse. There can be only one deposit in the account. The minimum limit is Rs. 1,000 and maximum is 15 lakh. The maturity period is five years, which may be extended for another three years on the option of depositor. Rate of interest is 9 per cent per annum payable quarterly. Account can be closed after one year and before second year. The amount equal to 1.5 per cent on the balance amount will be deducted and balance will be paid to depositor. The scheme has special features(i) nomination facility available; (ii) may be transferred from one post office to another post office; (iii) automatic credit of interest in POSA; (iv) SAS agency facility can be availed; and (v) 0.5 per cent commission is payable to SAS agents. Company deposits- Many companies, large and small, solicit fixed deposits from the public. Fixed deposits mobilized by manufacturing companies are regulated by the Company Law Board and those mobilized by Finance Companies (more precisely NBFCs) are regulated by RBI. The company fixed deposit market is a risky market. However, credit rating services are available to rate the risk of company fixed deposit schemes. For a manufacturing company the term of deposit can be one to three years, whereas for a finance company the term of deposit may be 25 months to 5 years. Fixed deposits represent unsecured loans taken by the borrowing companies. Should a company go into liquidation, the depositors, as unsecured creditors, rank after the secured creditors and lenders. The interest on company deposits is fully taxable. The maximum interest rate payable on fixed deposits is 14 per cent. Companies pay interest annually, semi-annually, quarterly and monthly. Company also offer cumulative deposit schemes
Mutual funds
While some of the investors prefer to build their own portfolio of stock market instruments, according to their own ability, knowledge and experience, many people do not have the inclination, time or knowledge to handle their own investments. Mutual funds provide this service to the latter. In fact, small investors face many handicaps in the share market. They cannot afford professional advice and also
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cant invest in a balanced and diversified portfolio with limited resources and incur huge expenses on buying and selling of shares. Mutual funds have come as a boon to the small and medium investors. Mutual fund is a special type of investment institution, which pools the savings of the community and invests large funds in a fairly large and well-diversified portfolio of sound investments for the mutual benefit of the members. So, its a media through which investors can reap all benefits of good investing. In brief, there is no other way out for small investors to enter the capital market, except the mutual funds. Open-ended mutual fund accepts funds from investors by offering its units or shares on a continuing basis. It permits investors to withdraw funds on a continuing basis under a re-purchase agreement. Such schemes have no maturity period and are ordinarily not listed. Contrarily, the subscription to a close-ended scheme is kept open only for a limited period (usually one month to three months). It does not allow investors to withdraw funds as and when they like. It has a fixed maturity period (usually five to fifteen years). Such schemes are listed on the secondary market.
SHSH CLASSES
SHSH CLASSES
Generally, purchasing-power risk has come to be identifiedinflation (rising prices); the incidence of declining prices in most countries has been slight. The anticipated purchasing power changes manifest themselves on both bond and stocks. With Unsystematic risk Market, purchasing-power, and interest-rate risks are the principal sources of systematic risk in securities; but we should also consider another important category of security risks unsystematic risks. The portion of total risk that is unique or peculiar to a firm or an industry, above and beyond that affecting securities markets in general is called unsystematic risk. Factors such as management capability, consumer preferences, and labour strikes can cause unsystematic variability of returns for a companys stock. (i) Business risk: Business risk relates to the variability of the sales, income, profits etc., which in turn depend on the market conditions for the product mix, input supplies, strength of competitors, etc. The business risk is sometimes external to the company due to changes in government policy or strategies of competitors or unforeseen market conditions. They may be internal due to fall in production, labour problems, raw material problems or inadequate supply of electricity etc. The internal business risk leads to fall in revenues and in profit of the company, but can be corrected by certain changes in the companys policies. (ii) Financial Risk: This relates to the method of financing, adopted by the company; high leverage leading to larger debt servicing problems or short-term liquidity problems due to bad debts, delayed receivables and fall in current assets or rise in current liabilities. These problems could no doubt be solved, but they may lead to fluctuations in earnings, profits and dividends to share holders. Sometimes, if the company runs into losses or reduced profits, these may lead to fall in returns to investors or negative returns. Proper financial planning and other financial adjustments can be used to correct this risk and as such it is controllable. (iii) Default or insolvency risk: The borrower or issuer of securities may become insolvent or may default, or delay the payments due, such as interest instalments or principal repayments. The borrowers credit rating might have fallen suddenly and he became default prone and in its extreme form it may lead to insolvency or bankruptcies. In such cases, the investor may get no return or negative returns. An investment in a healthy companys share might turn out to be a waste paper, if within a short span, by the deliberate mistakes of Management or acts of God, the company became sick and its share price tumbled below its face value.
SHSH CLASSES
distinguishing feature of these payments is that they are paid in cash by the issuer to the holder of the asset. Total return = Income + Price change (+/-) Thus, a measure of return must consider both dividend/interest income and price change. Returns over time or from different securities can be measured and compared using the total return concept. The total return for a given holding period relates all the cash flows received by an investor during any designated time period to the amount of money invested in the asset. Total return is defined as Total return= Cash payments received + Price change over the period Purchase price of the asset 100 r= (P P ) + D P where, r = total return, Pt = price of an asset at time (t), Pt1 = price of an asset at time (t-1), D = dividend or interest income in simple terms. Calculation of average returns The total return is an acceptable measure of return for a specified period of time. But we also need statistics to describe a series of returns. For example, investing in a particular stock for ten years or a different stock in each of ten years could result in 10 total returns, which must be described mathematically. There are two generally used methods of calculating the average return, namely, the arithmetic average and geometric average. The statistics familiar to most people is the arithmetic average. The arithmetic average, customarily designated by the symbol X = X n, or the sum of each of the values being considered divided by the total number of values.
Risk measurement
Understanding the nature and types of risk is not adequate unless the investor or analyst is capable of measuring it in some quantitative terms. The quantitative expression of the risk of a stock would make it comparable with other stocks. However, the risk measurements cannot be considered fully accurate as it is caused by multiplicity of factors such as social, political, economic and managerial aspects. Risk is measured by the variability of returns. The statistical tool often used to measure risk is the standard deviation. We know, standard deviation is a measure of the values of the variables around its mean or it is the square root of the sum of the squared deviations from the mean divided by the number of observations The standard deviation is an absolute measure, which can be applied when the mean is the same. But the coefficient of variation is the relative measure of the degree of uncertainty The concepts of variance, standard deviation, covariance and beta coefficients etc., are also used to explain the measure of risk. In the context of portfolio of assets, or investment in any assets risk is inherent in all such dealings. This risk primarily arises first out of parting of your funds or loss of liquidity. Money lent or parted is always having an element of risk. This element is the same as the concept of total risk.
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