ASSIGNMENT No.

Course: Money and Capital Markets (8526)

Level: M.Com Semester: Spring, 2019
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Q.1
The modern economies involve a huge amount of financial assets which
are traded in the financial markets. Keeping this in mind, explain the
various types of financial assets. Also, highlight the different types of
financial institutions that facilitate the trading of financial assets.
Ans
Various types of financial assets
A financial asset is an intangible asset whose value is derived from a contractual
claim, such as bank deposits, bonds, and stocks. Financial assets are usually
more liquid than other tangible assets, such as commodities or real estate, and
may be traded on financial markets.

According to the International Financial Reporting Standards (IFRS), a financial

asset can be:

 Cash or cash equivalent,

 Equity instruments of another entity,
 Contractual right to receive cash or another financial asset from another
entity or to exchange financial assets or financial liabilities with another
entity under conditions that are potentially favorable to the entity,
 Contract that will or may be settled in the entity's own equity instruments
and is either a non-derivative for which the entity is or may be obliged to
receive a variable number of the entity's own equity instruments, or a
derivative that will or may be settled other than by exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity's
own equity instruments.

1 – Cash and Cash Equivalents

Cash and cash equivalents is a type of financial assets which include cash money,
cheques, and money available in bank accounts and investment securities which
are short term and easily convertible into cash with higher credit quality. Cash
equivalents are highly liquid assets while generating income during their short
term. US Treasury bills, high-grade commercial paper, marketable
securities, money market funds, and short term commercial bonds are highly
liquid assets.
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2 – Accounts Receivable / Notes Receivables
Companies follow the accrual concept and often sell to their customers on credit.
The amount that is to be received from customers is called Accounts Receivable
net of an adjustment for bad debts. It also generates interest if the payment is
not made within the credit days.

3 – Fixed Deposits
Fixed deposit facility is a service given to the depositor, to get interested along
with principal amount on the maturity date. Example: Depositor makes an FD of
$100,000 with a bank @ 8% simple interest for 1 year. On the maturity date, the
depositor will receive $100,000 and $8000 Interest.

4 – Equity Shares
An equity shareholder is a fractional owner who undertakes the maximum risk
associated with the business venture invested in. Equity shares are a type of
financial assets that give the owners the right to vote, right to receive the
dividends, right to capital appreciation of the stock being held, etc. However, on
the event of liquidation, equity shareholders have the last claim on assets and
may/ may not receive anything.

5 – Debentures/ Bonds
Debentures/bonds are a type of financial assets issued by a company giving the
holders the right to receive regular interest payments on a fixed date along with
the principal repayment on maturity. Unlike, dividend on equity share, interest
payments on debenture is compulsory even if the company makes a loss. During
liquidation, these instrument holders get preference over equity and preference
shareholders.

6 – Preference Shares
Preference shareholders are the holders of preference shares, which give the
holders the right to receive dividends; however, they do not carry any voting
rights. Similar to debenture, these holders receive a fixed rate of dividend
whether the organization earns a profit or incurs a loss. On the event of
liquidation, preference shareholders have their claim on assets earlier than equity
shareholders but later to debenture and bondholders.

7 – Mutual Funds
Mutual funds collect money from small investors and invest such collected money
in financial markets including equity market, commodity and debt market. The
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mutual fund holder receives units in exchange for their investment, which is
bought and sold in the market based on the market price. The return on
investment is simply the sum of its capital appreciation and any income
generated on the original amount of the investment. At the same time, the fair
value of the units may diminish which is a loss to the unitholder.

8 – Interests in subsidiaries, associates and joint ventures

A company whose more than 50% stock is controlled by another company
(parent company) is a subsidiary. A parent company will consolidate financials
from its own operations, and include operations of its subsidiaries, and carry
them on its own consolidated financial statements. A subsidiary provides the
parent with dividends & share of earnings.

9 – Insurance contracts
Based on IFRS 17, contracts under which a party (issuer) accepts significant
insurance risk and agrees to compensate the other party (policyholder) if a
specified uncertain future event which is also insured event, adversely affects the
policyholder, are insurance contracts. Hence, the value of the contract is derived
from the risks that the policy is covering.

Life insurance policies pay the insurance holder on maturity and are financial
assets as at the time of maturity these policies pay maturity amount of the policy.

10 – Rights and Obligations under leases

A lease is a contract under which one party allows another party to use the
property for a specified time, in return for a periodic payment. Such receivables
are financial assets as it generates an asset to the company for the assets being
used by another party.

Under IFRS, financial assets are classified into four broad categories which
determine the way in which they are measured and reported:

 Financial assets "held for trading" i.e., which were acquired or incurred
principally for the purpose of selling, or are part of a portfolio with evidence
of short-term profit-taking, or are derivatives — are measured at fair value
through profit or loss.
 Financial assets with fixed or with determinable payments and fixed
maturity which the company has to be willing and able to hold till maturity
are classified as "held-to-maturity" investments. Held-to-maturity
investments are either measured at fair value through profit or loss by
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 designation, or determined to be financial assets available for sale by
designation.
 Financial assets with fixed or determinable payments which are not
listed in an active market are considered to be "loans and receivables".
Loans and receivables are also either measured at fair value through profit
or loss by designation or determined to be financial assets available for sale
by designation.

All other financial assets are categorized as financial assets "available for sale"
and are measured at fair value through profit or loss by designation.

Examples of financial assets

An asset that is derives value because of a contractual claim. Stocks, bonds, bank
deposits, and the like are all examples of financial assets.
Examples of financial assets are cash, investments in the bonds and equity issued
by other entities, receivables, and derivative financial assets.
Different types of financial institutions that facilitate the trading of
financial assets
in today's financial services marketplace, a financial institution exists to provide a
wide variety of deposit, lending and investment products to individuals,
businesses or both. While some financial institutions focus on providing services
and accounts for the general public, others are more likely to serve only certain
consumers with more specialized offerings.

To know which financial institution is most appropriate for serving a specific need,
it is important to understand the difference between the types of institutions and
the purposes they serve.

Central Banks
Central banks are the financial institutions responsible for the oversight and
management of all other banks. In the United States, the central bank is
the Federal Reserve Bank, which is responsible for conducting monetary policy
and supervision and regulation of financial institutions.

Retail and Commercial Banks

Traditionally, retail banks offered products to individual consumers while
commercial banks worked directly with businesses. Currently, the majority of
large banks offer deposit accounts, lending and limited financial advice to both
demographics.

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Products offered at retail and commercial banks include checking and savings
accounts, certificates of deposit (CDs), personal and mortgage loans, credit cards,
and business banking accounts.

Internet Banks
A newer entrant to the financial institution market are internet banks, which work
similarly to retail banks. Internet banks offer the same products and services as
conventional banks, but they do so through online platforms instead of brick and
mortar locations.

Credit Unions
Credit unions serve a specific demographic per their field of membership, such as
teachers or members of the military. While products offered resemble retail bank
offerings, credit unions are owned by their members and operate for their benefit.

Savings and Loan Associations

Financial institutions that are mutually held and provide no more than 20% of
total lending to businesses fall under the category of savings and loan
associations. Individual consumers use savings and loan associations for deposit
accounts, personal loans, and mortgage lending.

Investment Banks and Companies

Investment banks do not take deposits; instead, they help individuals, businesses
and governments raise capital through the issuance of securities. Investment
companies, more commonly known as mutual fund companies, pool funds from
individual and institutional investors to provide them access to the broader
securities market.

Brokerage Firms
Brokerage firms assist individuals and institutions in buying and selling securities
among available investors. Customers of brokerage firms can place trades of
stocks, bonds, mutual funds, exchange-traded funds (ETFs), and some alternative
investments.

Insurance Companies
Financial institutions that help individuals transfer risk of loss are known as
insurance companies. Individuals and businesses use insurance companies to
protect against financial loss due to death, disability, accidents, property damage,
and other misfortunes.

Mortgage Companies

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Financial institutions that originate or fund mortgage loans are mortgage
companies. While most mortgage companies serve the individual consumer
market, some specialize in lending options for commercial real estate only.

Q.2
What is money market? Explain in detail the following instruments of the
money market:
i. Treasury Bills
ii. Commercial Paper
iii. Bankers Acceptance
iv. Large – Denomination negotiable CSs
v. Repurchase Agreements
Ans
Money market
The money market is the trade in short-term debt investments. At the wholesale
level, it involves large-volume trades between institutions and traders. At the
retail level, it includes money market mutual funds bought by individual investors
and money market accounts opened by bank customers.

In any case, the money market is characterized by a high degree of safety and a
relatively low return in interest.

An individual may invest in the money market by buying money market funds,
short-term certificates of deposit (CDs), municipal notes, or U.S. Treasury bills,
among other examples.

Traders and institutions are more commonly the buyers for other money market
products such as eurodollar deposits, banker's acceptances, commercial paper,
federal funds, and repurchase agreements.

Ans part I
Treasury Bills
A Treasury Bill (T-Bill) is a short-term debt obligation backed by the
U.S. Treasury Department with a maturity of one year or less. Treasury bills are
usually sold in denominations of $1,000. However, some can reach a maximum
denomination of $5 million on noncompetitive bids.The Treasury Department sells
T-Bills during auctions using a competitive and noncompetitive bidding process.
Noncompetitive bids also known as noncompetitive tenders have a price based on
the average of all the competitive bids received.

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T-Bills are issued at a discount to the maturity value. Rather than paying
a coupon rate of interest, the appreciation between issuance price
and maturity price provides the investment return.

For example, a 26-week T-bill is priced at $9,800 on issuance to pay $10,000 in

six months. No interest payments are made. The investment return comes from
the difference between the discounted value originally paid and the amount
received back at maturity, or $200 ($10,000 - $9,800). In this case, the T-bill
pays a 2.04% interest rate ($200 / $9,800 = 2.04%) for the six-month period.

T-bills are very short-term investments (as opposed to Treasury notes and
Treasury bonds) there is very little interest rate risk. When interest rates rise, the
price of fixed-income securities falls as the relative value of their
future income stream is discounted. However, short-term securities are much less
affected than long-term securities because higher rates will have a very limited
effect on future income streams.

Ans part ii

Commercial Paper

Commercial paper is a money-market security issued (sold) by

large corporations to obtain funds to meet short-term debt obligations (for
example, payroll) and is backed only by an issuing bank or company promise to
pay the face amount on the maturity date specified on the note. Since it is not
backed by collateral, only firms with excellent credit ratings from a
recognized credit rating agency will be able to sell their commercial paper at a
reasonable price. Commercial paper is usually sold at a discount from face value
and generally carries lower interest repayment rates than bonds due to the
shorter maturities of commercial paper. Typically, the longer the maturity on a
note, the higher the interest rate the issuing institution pays. Interest rates
fluctuate with market conditions but are typically lower than banks' rates.
Commercial paper though a short-term obligation is issued as part of a
continuous rolling program, which is either a number of years long (as in Europe)
or open-ended (as in the US).
Commercial paper though a short-term obligation is issued as part of a
continuous significantly longer rolling program, which is either a number of years
long (as in Europe), or open-ended (as in the U.S.). Because the continuous
commercial paper program is much longer than the individual commercial paper
in the program (which cannot be longer than 270 days), as commercial paper
matures it is replaced with newly issued commercial paper for the remaining
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amount of the obligation.[8] If the maturity is less than 270 days, the issuer does
not have to file a registrations statement with the SEC, which would mean delay
and increased cost.
Ans part iii
Bankers Acceptance
A banker's acceptance (BA) is a short-term debt instrument issued by a company
that is guaranteed by a commercial bank. Banker's acceptances are issued as
part of a commercial transaction. These instruments are similar to T-bills, are
frequently used in money market funds and are traded at a discount from face
value on the secondary market, which can be an advantage because the banker's
acceptance does not need to be held until it matures.

Considered negotiable instruments with features of a time draft, banker’s

acceptances are created by the drawer and provide the bearer with the right to
the amount noted on the face of the acceptance on the specified date. Unlike
traditional checks, banker’s acceptances function based on the creditworthiness of
the banking institution instead of the individual or business acting as the drawer.
Additionally, the drawer must provide the funds necessary to support the
banker’s acceptance, eliminating the risk associated with insufficient funds on the
part of the drawer.Banker's acceptances vary in amount according to the size of
the commercial transaction. The date of maturity typically ranges between 30 and
180 days from the date of issue, which generally classifies the banker's
acceptance as a short-term negotiable instrument. To create a banker’s
acceptance, the drawer must meet the eligibility requirements as set forth by the
banking institution that serves as the backer in the transaction.

Ans part iv
Large – Denomination negotiable CSs
A certificate of deposit (CD) is a financial asset issued by a depository institution
that indicates a specified sum of money that has been deposited with them.
Depository institutions issue CDs to raise funds for financing their business
activities. A CD bears a maturity date and a specified interest rate or floating-rate
formula. While CDs can be issued in any denomination,only CDs in amounts of
$100,000 or less are insured by the Federal Deposit Insurance Corporation. There
is no limit on the maximum maturity but Federal Reserve regulations stipulate
that CDs cannot have amaturity of less than seven days.
A CD may be either nonnegotiable or negotiable. If nonnegotiable, the initial
depositor must wait until the CD’s maturity date for the return of their deposits
plus interest. An early withdrawal penalty is imposed if the depositor chooses to
withdraw the funds prior to the maturity date. In contrast,a negotiable CD allows
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the initial depositor (or any subsequent owner of the CD) to sell the CD in the
open market prior to the maturity date.
Negotiable CDs were introduced in the United States in the early1960s. At that
time the interest rates banks could pay on various types of deposits were subject
to ceilings administered by the Federal Reserve(except for demand deposits
defined as deposits of less than one month that could pay no interest). For
complex historical reasons and misguided political ones, these ceiling rates
started very low, rose with maturity, and remained at below market rates up to
some fairly long maturity. Before the introduction of the negotiable CD, those
with money to invest for,say, one month had no incentive to deposit it with a
bank, for they would earn a below-market rate unless they were prepared to tie
up their capital for an extended period of time.With the advent of the negotiable
CD,bank customers could buy a three-month or longer negotiable CD yielding a
market interest rate and recoup all or more than their investment(depending on
market conditions) by selling it in the market.
This innovation was critical in helping depository institutions increase the amount
of funds raised in the money market. It also ushered in a newer a of competition
among depository institutions. There are two types of negotiable CDs. The first is
the large-denomination CD, usually issued in denominations of $1 million or
more. The second type is the small-denomination CDs (less than $100,000) which
is a retail-oriented product. Our focus here is on the large-denomination
negotiable CD with maturities of one year or less and we refer to them as simply
CDs throughout the later.
Ans part v
Repurchase Agreements
A repurchase agreement (repo) is a form of short-term borrowing for dealers
in government securities. In the case of a repo, a dealer sells government
securities to investors, usually on an overnight basis, and buys them back the
following day.

For the party selling the security and agreeing to repurchase it in the future, it is
a repo; for the party on the other end of the transaction, buying the security and
agreeing to sell in the future, it is a reverse repurchase agreement.

Q.3
By keeping in view the working of corporate equity market, explain the
following terms with examples:
i. Initial Public Offer
ii. Preferred Stock
iii. Price to Earnings Ratio
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 iv. Stock Market Indices
v. Types of Orders and Accounts
Ans part I
Initial Public Offer

An initial public offering (IPO) refers to the process of offering shares of a private
corporation to the public in a new stock issuance. Public share issuance allows a
company to raise capital from public investors. The transition from a private to a
public company can be an important time for private investors to fully realize
gains from their investment as it typically includes share premiums for current
private investors. Meanwhile, it also allows public investors to participate in the
offering.A company planning an IPO will typically select an underwriter or
underwriters. They will also choose an exchange in which the shares will be
issued and subsequently traded publicly.The term initial public offering (IPO) has
been a buzzword on Wall Street and among investors for decades. The Dutch are
credited with conducting the first modern IPO by offering shares of the Dutch East
India Company to the general public. Since then, IPOs have been used as a way
for companies to raise capital from public investors through the issuance of public
share ownership. Through the years, IPOs have been known for uptrends and
downtrends in issuance. Individual sectors also experience uptrends and
downtrends in issuance due to innovation and various other economic factors.
Tech IPOs multiplied at the height of the dot-com boom as startups without
revenues rushed to list themselves on the stock market. The 2008 financial crisis
resulted in a year with the least number of IPOs. After the recession following the
2008 financial crisis, IPOs ground to a halt, and for some years after, new listings
were rare. More recently, much of the IPO buzz has moved to a focus on so-
called unicorns startup companies that have reached private valuations of more
than $1 billion.

Investors and the media heavily speculate on these companies and their decision
to go public via an IPO or stay private.

Ans part ii
Preferred Stock
Preferred stock (also called preferred shares, preference shares or
simply preferred) is a form of stock which may have any combination of features
not possessed by common stock including properties of both an equity and a debt
instrument, and is generally considered a hybrid instrument. Preferred stocks are
senior (i.e., higher ranking) to common stock, but subordinate to bonds in terms
of claim (or rights to their share of the assets of the company) and may have
priority over common stock (ordinary shares) in the payment of dividends and

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upon liquidation. Terms of the preferred stock are described in the issuing
company's articles of association or articles of incorporation.
Like bonds, preferred stocks are rated by the major credit rating companies. The
rating for preferred stocks is generally lower than for bonds because preferred
dividends do not carry the same guarantees as interest payments from bonds and
because preferred-stock holders' claims are junior to those of all creditors.
Preferred stock is a special class of shares which may have any combination of
features not possessed by common stock. The following features are usually
associated with preferred stock:

 Preference in dividends.
 Preference in assets, in the event of liquidation.
 Convertibility to common stock.
 Callability (ability to be redeemed before it matures), at the option of the
corporation. Possibly subject to a spens clause.
 Nonvoting.
 Higher dividend yields.

In addition to straight preferred stock, there is diversity in the preferred stock

market. Additional types of preferred stock include:

 Prior preferred stock—Many companies have different issues of preferred

stock outstanding at one time; one issue is usually designated highest-priority.
If the company has only enough money to meet the dividend schedule on one
of the preferred issues, it makes the payments on the prior preferred.
Therefore, prior preferreds have less credit risk than other preferred stocks
(but usually offer a lower yield).
 Preference preferred stock—Ranked behind a company's prior preferred
stock (on a seniority basis) are its preference preferred issues. These issues
receive preference over all other classes of the company's preferred (except
for prior preferred). If the company issues more than one issue of preference
preferred, the issues are ranked by seniority. One issue is designated first
preference, the next-senior issue is the second and so on.
 Convertible preferred stock—These are preferred issues which holders
can exchange for a predetermined number of the company's common-stock
shares. This exchange may occur at any time the investor chooses, regardless
of the market price of the common stock. It is a one-way deal; one cannot
convert the common stock back to preferred stock. A variant of this is
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 the anti-dilutive convertible preferred recently made popular by investment
banker Stan Medley who structured several variants of these preferred for
some forty plus public companies. In the variants used by Stan Medley the
preferred share converts to either a percentage of the company's common
shares or a fixed dollar amount of common shares rather than a set number of
shares of common. The intention is to ameliorate the bad effects investors
suffer from rampant shorting and dilutive efforts on the OTC markets.
 Cumulative preferred stock—If the dividend is not paid, it will accumulate
for future payment.
 Exchangeable preferred stock—This type of preferred stock carries
an embedded option to be exchanged for some other security.
 Participating preferred stock—These preferred issues offer holders the
opportunity to receive extra dividends if the company achieves predetermined
financial goals. Investors who purchased these stocks receive their regular
dividend regardless of company performance (assuming the company does
well enough to make its annual dividend payments). If the company achieves
predetermined sales, earnings or profitability goals, the investors receive an
additional dividend.
 Perpetual preferred stock—This type of preferred stock has no fixed date on
which invested capital will be returned to the shareholder (although there are
redemption privileges held by the corporation); most preferred stock is issued
without a redemption date.

Ans part iii

Price to Earnings Ratio
The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that
measures its current share price relative to its per-share earnings (EPS). The
price-to-earnings ratio is also sometimes known as the price multiple or the
earnings multiple.

P/E ratios are used by investors and analysts to determine the relative value of a
company's shares in an apples-to-apples comparison. It can also be used to
compare a company against its own historical record or to compare aggregate
markets against one another or over time.

These two types of EPS metrics factor into the most common types of P/E
ratios: the forward P/E and the trailing P/E. A third and less common variation
uses the sum of the last two actual quarters and the estimates of the next two
quarters.The forward (or leading) P/E uses future earnings guidance rather than
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trailing figures. Sometimes called "estimated price to earnings," this forward-
looking indicator is useful for comparing current earnings to future earnings and
helps provide a clearer picture of what earnings will look like – without changes
and other accounting adjustments.However, there are inherent problems with the
forward P/E metric namely, companies could underestimate earnings in order to
beat the estimate P/E when the next quarter's earnings are announced. Other
companies may overstate the estimate and later adjust it going into their
next earnings announcement. Furthermore, external analysts may also provide
estimates, which may diverge from the company estimates, creating confusion.

Ans part iv
Stock Market Indices
A stock index or stock market index is a measurement of a section of
the stock market. It is computed from the prices of selected stocks (typically
a weighted average). It is a tool used by investors and financial managers to
describe the market, and to compare the return on specific investments.
Two of the primary criteria of an index are that it is investable and transparent:
the method of its construction should be clear. Many mutual funds and exchange-
traded funds attempt to "track" an index (see index fund) with varying degrees of
success. The difference between an index fund's performance and the index is
called tracking error
Stock market indices may be classified in many ways. A 'world' or 'global' stock
market index such as the MSCI World or the S&P Global 100 includes stocks
from multiple regions. Regions may be defined geographically (e.g., Europe, Asia)
or by levels of industrialization or income (e.g., Developed Markets, Frontier
Markets).
A 'national' index represents the performance of the stock market of a given
nation and by proxy, reflects investor sentiment on the state of its economy. The
most regularly quoted market indices are national indices composed of the stocks
of large companies listed on a nation's largest stock exchanges, such as the
American S&P 500, the Japanese Nikkei 225, the Indian NIFTY 50, and the
British FTSE 100.
Many indices are regional, such as the FTSE Developed Europe Index or the FTSE
Developed Asia Pacific Index. Indexes may be based on exchange, such as the
NASDAQ-100 or NYSE US 100, or groups of exchanges, such as the Euronext 100
or OMX Nordic 40.
The concept may be extended well beyond an exchange. The Wilshire
5000 Index, the original total market index, represents the stocks of nearly every
publicly traded company in the United States, including all U.S. stocks traded on

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the New York Stock Exchange (but not ADRs or limited
partnerships), NASDAQ and American Stock Exchange. Russell Investment
Group added to the family of indices by launching the Russell Global Index.
More specialized indices exist tracking the performance of specific sectors of the
market. Some examples include the Wilshire US REIT which tracks more than
80 American real estate investment trusts and the Morgan Stanley Biotech
Index which consists of 36 American firms in the biotechnology industry. Other
indices may track companies of a certain size, a certain type of management, or
even more specialized criteria one index published by Linux Weekly News tracks
stocks of companies that sell products and services based on the Linux operating
environment.
Ans part v
Types of Orders and Accounts
An order is an investor's instructions to a broker or brokerage firm to purchase or
sell a security on the investor's behalf. Orders are typically placed over the phone
or online through a trading platform. Orders fall into different available types
which allow investors to place restrictions on their orders affecting the price and
time at which the order can be executed. These order instructions will affect the
investor's profit or loss on the transaction and, in some cases, whether the order
is executed at all.
Generally, exchanges trade securities through a bid/ask process. This means that
to sell there must be a buyer willing to pay the selling price.To buy there must be
a seller willing to sell as the buyer's price. Unless a buyer and seller come
together at the same price, no transaction occurs.

The bid is the highest advertised price someone is will to pay for an asset, and
the ask is the lowest advertised price someone is willing to sell an asset at. The
bid and ask are constantly changing, as each bid and offer represents an order.
As orders are filled, the levels will change. For example, if there is a bid at 25.25
and another at 25.26, when all the orders at 25.26 have been filled, the next
highest bid is 25.25.

This bid/ask process is important to keep in mind when placing an order, as the
type of order selected will impact the price the trade is filled at, when it will be
filled, or whether it will be filled at all.

Here are the basic order types:

 A market order instructs the brokerage to complete the order at the next available price.
Market orders have no specific price and are generally always executed unless there is

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 no trading liquidity. Market orders are typically used if the trader wants in or out of a
trade quickly and is not concerned about the price they get.
 A limit buy order instructs the brokerage to buy a security at or below a specified price.
Limit orders ensure that a buyer pays only a specific price to purchase a security. Limit
orders can remain in effect until they are executed, expire, or are canceled.
 A limit sell order instructs the broker to sell the asset at a price which is above the
current price. For long positions, this order type is used to take profits when the price
has moved higher after buying.
 A sell stop order instructs the brokerage to sell if an asset reaches a specified price
below the current price.
 A buy stop order instructs the broker to buy an asset when it reaches a specified price
above the current price.

 A stop order can be a market order meaning it takes any price once triggered, or it can
be a stop limit order where it can only execute within a certain price range (limit) after
being triggered.
 A day order must be executed during the same trading day that the order is placed.
 Good till canceled orders remain in effect until they are filled or canceled.
 If an order is not a day order or a good til canceled order, the trader typically sets an
expiry for the order.

Q.4
By keeping in view the working of mutual funds, explain the following
concepts with examples:
i. Close ended and open ended mutual funds
ii. Debt, equity and hybrid mutual funds
iii. Asset allocation and money market funds
iv. Income and commodity funds
Ans part i
Close ended and open ended mutual funds
Closed-End Funds
Since closed-end mutual funds are traded among investors on an exchange, they
have a fixed number of shares. Like stocks, closed-end funds are launched
through an initial public offering (IPO) in order to raise money before they can
trade in the open market. Although their value is also based on the fund’s NAV,
the actual price of the fund is determined by supply and demand, so it can trade
at prices above or below the value of its holdings.

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Closed-end funds (CEFs) may look similar, but they're actually very different. A
closed-end fund functions much more like an exchange traded fund (ETF) than a
mutual fund. It is launched through an IPO in order to raise money and then
traded in the open market just like a stock or an ETF. It only issues a set amount
of shares and, although their value is also based on the NAV, the actual price of
the fund is affected by supply and demand, allowing it to trade at prices above or
below its real value.

At the end of 2017, more than $275 billion was held in the closed-end funds
market, yet it is not well known by retail investors. Some funds, like BlackRock
Corporate High Yield Fund VI (HYT), pay a dividend of around 8 percent, making
these funds an attractive choice for income investors.Investors have to know a
key fact about closed-end funds: Nearly 70 percent of these products use
leverage as a way to produce more gains. Using borrowed money to invest can be
risky, but it also may produce big returns. Closed-end funds had an average
return of 12.4 percent in 2017, reports CEF Insider. And "many CEFs are poised
to keep up the performance," predicts Michael Foster, the lead research analyst
for Contrarian Outlook, in Jericho, New York.

Open-End Funds
The most common type of mutual funds, including those offered by American
Funds, are known as open-end funds (while our funds are actively managed,
open-end funds also include passive index funds). Open-end mutual funds
typically do not limit the number of shares they can offer, and are bought and
sold on demand. When an investor purchases shares in an open-end fund, the
fund issues those shares and when someone sells shares, they are bought back
by the fund. When shares are sold (known as a redemption), the fund pays the
investor using cash on hand or it may have to sell some of its investments in
order to pay the investor.
Open-end mutual funds are also priced differently from closed-end mutual funds,
which trade on a market similar to a stock. Shares of open-end funds are bought
and sold directly from the fund at a price per share that is based on the value of
the fund’s underlying securities. On each trading day, typically at the end of the
day, the net asset value (NAV) is calculated by dividing the market value of the
fund’s assets (less expenses) by the number of shares held by investors.
Ans part ii
Debt, equity and hybrid mutual funds
The debt-to-equity ratio shows the proportions of equity and debt a company is
using to finance its assets and it signals the extent to which shareholder's equity
can fulfill obligations to creditors, in the event a business declines.
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A low debt-to-equity ratio indicates a lower amount of financing by debt via
lenders, versus funding through equity via shareholders. A higher ratio indicates
that the company is getting more of its financing by borrowing money, which
subjects the company to potential risk if debt levels are too high. Simply put: the
more a company's operations rely on borrowed money, the greater the risk of
bankruptcy, if the business hits hard times. This is because minimum payments
on loans must still be paid--even if a company has not profited enough to meet
its obligations. For a highly leveraged company, sustained earnings declines could
lead to financial distress or bankruptcy.

A hybrid fund is an investment fund that is characterized by diversification among

two or more asset classes. These funds typically invest in a mix
of stocksand bonds. They may also be known as asset allocation fundsHybrid
funds offer investors a diversified portfolio. The term hybrid indicates that the
fund strategy includes investment in multiple asset classes. In general it can also
mean that the fund uses an alternative mixed management approach.
Hybrid funds are commonly known as asset allocation funds. In the investment
market, asset allocation funds can be used for many purposes. These funds offer
investors an option for investing in multiple asset classes through a single
fund.Hybrid funds evolved from the implementation of modern portfolio theory in
fund management. These funds can offer varying levels of risk tolerance ranging
from conservative to moderate and aggressive.

Balanced funds are also a type of hybrid fund. Balanced funds often follow a
standard asset allocation proportion such as 60/40.Target date funds or lifecycle
funds also fit into the hybrid category. These funds invest in multiple asset
classes for diversification. Target date funds vary from standard hybrid funds in
that their portfolio portions begin with a more aggressive allocation and
progressively rebalance to a more conservative allocation for use by a specified
utilization date.

In all cases, hybrid funds will include some mix of two or more asset classes. In
risk targeted and balanced funds, allocations will typically remain at a fixed
proportion. In funds targeting a specified utilization date, the proportion of asset
mix will vary over time. In all of the funds, the investment manager may actively
mange the individual holdings within each asset category to respond to changing
market conditions and potential capital appreciation opportunitiesCompanies that
create mutual fund schemes are called Fund Houses or Asset Management
Companies (AMCs). The professionals who study the markets and pick companies
to invest in are called Fund Managers. Fund managers spend a great deal of time
analysing markets and studying different sectors of the economy to figure out
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which companies are most likely to turn a profit - in different time frames - and
choose the best option.

 - Equity mutual funds invest primarily in the stocks and equity shares of
companies and aim to generate capital appreciation. Thus, equity funds hold
the most potential to generate higher returns, but also carry more risk than
debt funds.
 - Debt mutual funds invest primarily in debt securities, money market
instruments, treasury bills, corporate bonds, etc. in order to generate
returns. Debt funds aim to generate a regular income and are far less risky
than equity funds (but don’t have the earning potential of equity funds).

This is where Hybrid Funds come into play. Hybrid mutual fund schemes diversify
the investment and attempt to get the best of both worlds - capital appreciation
through equity investing as well as stability and returns through investments in
debt instruments. Hybrid schemes use asset allocation, market analysis and
portfolio diversification to ensure maximum returns at minimal risk.
Ans part iii
Asset allocation and money market funds
Asset allocation is an investment strategy that aims to balance risk and reward by
apportioning a portfolio's assets according to an individual's goals, risk
tolerance and investment horizon. The three main asset classes - equities, fixed-
income, and cash and equivalents have different levels of risk and return, so each
will behave differently over time.
There is no simple formula that can find the right asset allocation for every
individual. However, the consensus among most financial professionals is that
asset allocation is one of the most important decisions that investors make. In
other words, the selection of individual securities is secondary to the way that
assets are allocated in stocks, bonds, and cash and equivalents, which will be the
principal determinants of your investment results.

Investors may use different asset allocations for different objectives. Someone
who is saving for a new car in the next year, for example, might invest her car
savings fund in a very conservative mix of cash, certificates of deposit (CDs) and
short-term bonds. Another individual saving for retirement that may be decades
away typically invests the majority of his individual retirement account (IRA) in
stocks, since he has a lot of time to ride out the market's short-term fluctuations.
Risk tolerance plays a key factor as well. Someone not comfortable investing in
stocks may put her money in a more conservative allocation despite a long time
horizon.A money market fund is a kind of mutual fund that invests only in highly
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 liquid instruments such as cash, cash equivalent securities, and high credit rating
debt-based securities with a short-term, maturity less than 13 months. As a
result, these funds offer high liquidity with a very low level of risk.

While they sound highly similar, a money market fund is not the same as
a money market account (MMA). The former is an investment, sponsored by an
investment fund company, and hence carries no guarantee of principal. The latter
is an interest-earning saving account offered by financial institutions, with limited
transaction privileges and insured by the Federal Deposit Insurance
Corporation (FDIC).Money market funds are classified into various types
depending upon the class of invested assets, the maturity period, and other
attributes.

 A Prime money fund invests in floating-rate debt and commercial paper of

non-Treasury assets, like those issued by corporations, U.S. government
agencies, and government-sponsored enterprises (GSEs).
 A Government money fund invests at least 99.5% of its total assets in cash,
government securities, and repurchase agreements that are fully
collateralized by cash or government securities.
 A Treasury fund invests in standard U.S. Treasury issued debt securities
such as bills, bonds, and notes.
 A Tax-exempt money fund offers earnings that are free from U.S. federal
income tax. Depending on the exact securities it invests in they may also
have an exemption from state income taxes. Municipal bonds and other
debt securities primarily constitute such types of money market funds.

Ans part iv
Income and commodity funds
Because of their unique makeup, commodity funds deliver several benefits to
investors, including:
 Portfolio diversification. Historically, commodity funds have had low
correlation with stock market movements, which makes them a valuable source
of diversification in a portfolio.
 Protection against inflation. Commodity prices tend to rise with inflation,
making commodities one of the few assets that benefits from inflation.
 Potential financial growth. Commodity prices rise and fall in tandem with
supply and demand. The more a commodity is in demand, the higher its price
will rise, delivering higher profits to the investor.Commodity funds have
historically provided investors with an opportunity for diversification, downside
protection and upside potential. However, as with all types of investment,
commodity funds carry risk, and may not be right for every portfolio.Commodity
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 markets can be volatile, which can expose investors to the possibility of
considerable price fluctuation. Commodities themselves and commodity
companies are also exposed to political, economic, foreign currency and
exploration risk.

Q.5
Keeping in view the investment theory in mind, explain the following
concepts: (20)
i. The capital asset pricing model
ii. The arbitrage pricing model
iii. Markowitz Portfolio theory
iv. Market segmentation theory

Ans part I
The capital asset pricing model
The Capital Asset Pricing Model (CAPM) describes the relationship between
systematic risk and expected return for assets, particularly stocks. CAPM is widely
used throughout finance for pricing risky securities and generating expected
returns for assets given the risk of those assets and cost of capital.
There are several assumptions behind the CAPM formula that have been shown
not to hold in reality. Despite these issues, the CAPM formula is still widely used
because it is simple and allows for easy comparisons of investment
alternatives.Including beta in the formula assumes that risk can be measured by
a stock’s price volatility. However, price movements in both directions are not
equally risky. The look-back period to determine a stock’s volatility is not
standard because stock returns (and risk) are not normally distributed.

The CAPM also assumes that the risk-free rate will remain constant over the
discounting period. Assume in the previous example that the interest rate on U.S.
Treasury bonds rose to 5% or 6% during the 10-year holding period. An increase
in the risk-free rate also increases the cost of the capital used in the investment
and could make the stock look overvalued.The market portfolio that is used to
find the market risk premium is only a theoretical value and is not an asset that
can be purchased or invested in as an alternative to the stock. Most of the time,
investors will use a major stock index, like the S&P 500, to substitute for the
market, which is an imperfect comparison.

The most serious critique of the CAPM is the assumption that future cash flows
can be estimated for the discounting process. If an investor could estimate the
future return of a stock with a high level of accuracy, the CAPM would not be
necessary.

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 Ans part ii
The arbitrage pricing model
The Arbitrage Pricing Theory (APT) is a theory of asset pricing that holds that an
asset’s returns can be forecasted with the linear relationship of an asset’s
expected returns and the macroeconomic factors that affect the asset’s risk. This
theory was created in 1976 by the economist, Stephen Ross. Arbitrage pricing
theory offers analysts and investors a multi-factor pricing model for securities
based on the relationship between a financial asset’s expected return and its
risks.

The theory aims to pinpoint the fair market price of a security that may be
temporarily incorrectly priced. The theory assumes that market action is less than
always perfectly efficient, and therefore occasionally results in assets being
mispriced either overvalued or undervalued – for a brief period of time. However,
market action should eventually correct the situation, moving price back to its fair
market value. To an arbitrageur, temporarily mis-priced securities represent a
short-term opportunity to profit virtually risk-free.The APT is a more flexible and
complex alternative to the Capital Asset Pricing Model (CAPM). The theory
provides investors and analysts with the opportunity to customize their research.
However, it is more difficult to apply, as it takes a considerable amount of time to
determine all the various risk factors that may influence the price of an asset.

Ans part iii

Markowitz Portfolio theory
In 1952, Harry Markowitz presented an essay on "Modern Portfolio Theory" for
which he also received a Noble Price in Economics. His findings greatly changed
the management industry, and his theory is still considered as cutting edge in
portfolio management.
There are two main concepts in Modern Portfolio Theory, which are;
 Any investor's goal is to maximize Return for any level of Risk
 Risk can be reduced by creating a diversified portfolio of unrelated assets
Other names for this approach are Passive Investment Approach because you
build the right risk to return portfolio for broad asset with a substantial value and
then you behave passive and wait as it growth.
Return is considered to be the price appreciation of any asset, as in stock price,
and also any Capital inflows, such as dividends.

In general Standard Deviation is a fair measure of risk as we want a steady

increase and not big swings which might possibly end up as loss.
Risk is evaluated as the range by which the asset’s price will on average vary,
known as Standard Deviation. If an asset's price has 10% Deviation from the

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mean and an average expected Return of 8% you may observe Returns between
-2% and 18%.
In a practical application of Markowitz Portfolio Theory, let's assume there are two
portfolios of assets both with an average return of 10%, Portfolio A has a risk or
standard deviation of 8% and Portfolio B has a risk of 12%. As both portfolios
have the same expected return, any investor will choose to invest in portfolio A
as it has the same expected earnings as portfolio B but with less risk.
It is important to understand risk; it is a necessary concept, as there would be no
expected reward without it. Investors are compensated for bearing risk and, in
theory, the higher the Risk, the higher the Return.

Going back to our example above it may be tempting to presume that Portfolio B
is more attractive than Portfolio A. As portfolio B has a higher risk at 12%, it may
obtain a return of 22%, which is possible but it may also witness a return of -2%.
All things being equal it is still preferable to hold the portfolio that has an
expected range of returns between +2% and +18%, as it is more likely to help
you reach your goals.

Ans part.IV
Market segmentation theory

Market segmentation theory posits that the behavior of short-term and long-term
interest rates is mutually exclusive.

How it works (Example)

Market segmentation theory suggests that the behavior of short-term interest

rates is wholly unrelated to the behavior of long-term interest rates. In other
words, a change in one is in no way indicative of an immediate change in the
other. Both must be analyzed independently. Accordingly, the yield curve reflects
the market supply and demand for Treasury bonds of a certain maturity only.

Why it Matters:

Market segmentation theory suggests that it is impossible to predict future

interest rate outcomes based on short-term interest rates. Moreover, long-term
interest rates (for example, the rate of the 30-year Treasury bond) only express
market expectations and do not indicate that a definite outcome will occur A
modern theory pertaining to interest rates stipulating that there is no necessary
relationship between long and short-term interest rates. Furthermore, short and
long-term markets fall into two different categories. Therefore, the yield curve is

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shaped according to the supply and demand of securities within each maturity
length.

Also called the "Segmented Markets Theory", this idea states that most investors
have set preferences regarding the length of maturities that they will invest in.
Market segmentation theory maintains that the buyers and sellers in each of the
different maturity lengths cannot be easily substituted for each other. An offshoot
to this theory is that if an investor chooses to invest outside their term of
preference, they must be compensated for taking on that additional risk. This is
known as the Preferred Habitat Theory.

References
 Hahn, Thomas K. (Spring 1993). "Commercial Paper" (PDF). Economic
Quarterly. Federal Reserve Bank of Richmond, VA. Retrieved June
1, 2017. History of origin, and special regulations governing the issuing of
commercial paper
 Davidson, Adam; Blumberg, Alex (September 26, 2008). "The Week
America's Economy Almost Died". All Things Considered. National Public
Radio. Retrieved June 1, 2017
 Veale, Stuart R. (2001). "Stocks, Bonds, Options, Futures", New York
Institute Of Finance
 Gregoriou, Greg (2006). Initial Public Offerings (IPOs). Butterworth-
Heineman, an imprint of Elsevier.
 Kieso, Donald E.; Weygandt, Jerry J. & Warfield, Terry D.
(2007), Intermediate Accounting (12th ed.), New York: John Wiley & Sons,
p. 738
 Amenc, N.; Goltz, F.; Le Sourd, V. (2006). Assessing the Quality of Stock
Market Indices. EDHEC Publication

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