What is a security?

Security is an investment instrument, other than an insurance policy or fixed annuity, issued by a corporation, government, or other organization which offers evidence of debt or equity. A security is a fungible, negotiable instrument representing financial value. Securities are broadly categorized into debt securities (such as banknotes, bonds and debentures) and equity securities, e.g., common stocks; and derivative contracts, such as forwards, futures, options and swaps. The company or other entity issuing the security is called the issuer. What is Investment? Investment means sacrificing some money value in the present with the expectation of making gains in the future. The two important features of an investment are current sacrifice and future benefit. When we postpone consumption, sacrifice takes place in the present and is certain whereas the benefits occur in future and are certain. Therefore, risk and expected return from the investments are the two key determinants of investment process. Forms of investment: 1) R buys 200 shares of X ltd @ Rs.150 per share 2) K buys a piece of land with the aiming of selling it in future. 3) T buys a plant for 20 lacs for its factory. 4) S buys ticket of Play wind with the aim of winning it. 5) L deposits 10000 in post office time deposit a/c. An act of investment has the following dimensions Element of sacrifice Element of futurity Risk Expectation of gain
1) Element of sacrifice: as soon as commitment of some money value

is made either in buying shares, land, plant etc, it entails an

element of sacrifice current consumption of money value. By investing the money in present, utility of money is being postpone, which otherwise have been derived through current consumption. This sacrifice is one of the basis of expectations in investment.
2) Element of Futurity: Every investment is made with the aim of

holding it for a certain time period. Few investors hold it for a few days, whereas others hold it for a certain months or years. The holding period is generally classified into three types- short term, medium term and long term. Expected returns are always higher for a long duration investment as compared to short duration ones. This can be attributed to the uncertainty of future.
3) Risk: since every investment activity has an element of futurity

and the future is always uncertain, it induces the risk factor. Risk means the chances of having adverse or low returns in contrast to the expected high returns by the investor. Some risks arise due to system wide factors, which cannot be avoided, whereas others arise due to specific performance of the investment avenue that can be minimized through diversification.
4) Expectations of gains: The element of sacrifice of current utility of

money value, futurity and the risk of monetary loss put together makes the basis for expecting gains from the invested money. The gains expected by the investors are nothing but the compensation for: a) waiting b) loss in purchasing power c) risk premium

Investment Process: The investment process comprises of 5 steps which are as under1) Determining investment objectives and policy: the investor should evolve a policy considering the amount of wealth at his disposal. The investors objectives should be defined in terms of risk and return. At this point it is important to determine the category of financial assets that an investor is interested in. This in turn would depend upon the objectives, amount of wealth and the tax structure of the investor. 2) Security analysis: this step would include examining the risk return characteristics of individual securities. The aim is to ascertain the worth of a security before acquiring it for portfolio. This depends upon the extent to which a security is MISPRICED. There are two approaches to identify the mispriced status of a securityi) Technical Analysis: in this the past movements of price of a security are studied, to determine the trends and patterns that repeat themselves. Then recent trends are studied to identify emerging trends. Then the two are integrated to predict if a given trend will repeat in future. The current market price is compared with the predicted price to calculate the level of mispricing.
ii)

Fundamental analysis: in it the intrinsic value of a security is determined and it is compared with the current market price. The intrinsic value is the present value of all future cash flows expected during and at the end of the holding period. This entails first forecasting the cash flows, for which a forecast of earnings of the company and its payout ratios is required. Forecast of the price of the security at the end of the holding period is also needed. These are then discounted at an appropriate rate which corresponds with the investors required ROR. The intrinsic value is compared with the current market price. If the current price is more then
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the intrinsic value, the shares are overvalued and vice versa. It is noted that cases of mispricing are eventually corrected by the market, which implies that the prices of undervalued shares will increase and those of overvalued shares will decline.

3) Portfolio Construction: this includes the specific securities in which to invest and the proportion of wealth to be invested in each. The issue of selectivity will have to be based upon micro level forecast of expected cash flows from the shares and debentures of different companies. Timing of investment will have to be determined by observing forecasted price movement of shares relative to debentures at macro level. Efforts will be made to minimize risk for a given expected level of average returns. This would happen when the returns of shares and debentures that comprise a portfolio are not positively co related. The resultant portfolio will be a DIVERSIFIED PORTFOLIO.
4) Portfolio Revision: securities once included in the portfolio are

never attractive for ever. New securities with different risk return considerations emerge. Therefore it becomes necessary to review the portfolio. Unattractive securities should be liquidated and funds so acquired should be invested in new securities. While doing so transaction cost incurred in buying and selling activities should be considered. 5) Portfolio performance evaluation: portfolio should be examined constantly for average return and risk.

Investment vs Speculation vs Gambling: Pure Investment: financial investments are exchange of financial claims i.e. buying of shares, debentures, investing money in post office or banks etc. While investing the money, an investor has certain objectives in mind, which forms the basis of his investment decisions. Generally, pure investment is Carefully thought of Well planned Based on the study of fundamental factors about investment avenues Meant for a reasonable time horizon Expected returns commensurate with risk assumed Low risk Something in which investors do not tend to borrow money for investment Investments are made with a future end date in mind. A financial asset purchased with a very short holding period in mind probably in not an investment- it is a gamble or speculation. Speculation: It starts where investment ends. It is an act of investing money on the basis of market wide information about the investment avenue. Such information may include trends of share prices or traded volume of shares. While speculating, the investor tends to take more risk as compared to pure investment activity and accordingly, the returns expected are also comparatively higher. It is for a relatively short duration based on market related information

 an act in which the investor has an attitude to assume risk rather than to avoid it the tendency of a speculator to sometimes borrow money for investment, with the expectation of gaining more than the cost of borrowing a positive attitude towards losses, in case of adverse happenings ready to book losses The way brokers/ investors Speculate: speculation on the stock market can be done by adopting any of the following mechanism Jobbing: it is an activity in which a broker tries to square up his position by the end of the settlement or the same trading day. The main purpose of jobbing is to gain profit from the price difference between the bid and ask price, as specified by the jobber. A broker who regularly does the jobbing is identified as the jobber- he always gives two way quotations for scrip. Lower quotation is the bid rate and higher quotation is the ask rate. A jobber is ready to buy or sell any quantity at the bid and ask price quoted by him. The aim of a jobber is to derive benefits from the spread of bid and ask price. Usually, jobber specializes in one or two scrips. Speculation using Jobbing: At 10.10 am A purchases 500 shares of wipro @ Rs.230 and he expects the price to rise within the same day and plans to sell it by the end of the same trading session.

 During the day, he hears from his broker that shares of TISCO will decline from the level of Rs.190 and he sells 200 shares of TISCO @ Rs.190 with the hope of buying it back by the end of the days trading. At 12.10 pm, price of Wipro increases to Rs.246 and he sells 500 shares and books the profit. At 3.20 pm price of TISCO has become Rs.200 in contrast to his expectations and he covers (buys) 200 shares of TISCO at Rs.200 and books a loss. Badla/ carry forward: when one buys or sells securities, the transaction is to be settled i.e. the buyers need to pay for it and the seller needs to deliver the securities sold as per the settlement program of the exchange. When a buyer does not have money to pay for the transaction and is hopeful about the future scenario and hence is not willing to square up his position, then the next alternate is badla (to forward the transaction for the next settlement). Badla is the postponement of the settlement of a transaction from one settlement to another. Similarly, when a seller is not willing to settle a transaction, he can carry forward his sales position to the next settlement. Badla of a transaction can be done in every settlement for a maximum of 90 days. As soon as badla is done, the following charges are paid by the client Badla charges Badla margin A badla transaction has the following features-

Badla charges: it is charge t be paid by the client who carries forward his transaction. This is like interest compensation for the delayed period and is to be paid over and above the price of the transaction. This can be of two types: (a) contango and (b) backwardation charges. When a purchaser pays badla charges for carrying forward his purchase, it is called contango/sidha badla. On the contrary, when a seller pays badla charges for carrying forward his sales transaction, it is called backwardation/undha badla. Badla margin: it is to be deposited by the party doing badla. This margin money is either refunded or adjusted when transaction is either squared up or settled. Under the traditional system of badla, there was a fixed percentage of margin, but under the new system it is calculated on a progressive basis- margin percentage increases for a transaction, which is in carry forward for a longer duration. Eligible scrips: this facility is available for scrips in A category, which are called specified shares. Shares are categorized in A category on the basis of certain factors like profitability, traded volume, frequency of trades, number of trades etc. Badla Financer: When an original party does not agree to carry forward, it is the badla financer who bails out the party willing to enter into badla. A badla financer is a broker, who specializes in providing scrips for the carry forward of the sales transaction and money to carry forward the purchase transaction. These are provided by the financer with the understanding that these will be returned to him at the end of the settlement. He asks badla charges for it.
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Regulated by the stock exchange: all badla transactions are regulated by the stock exchange. The exchange specifies eligible scrips, margin and other related aspects. A tool to speculate: It is a tool to speculate because it provides ways in which an investor can avail the opportunity to gain form price fluctuations. He can keep his position open till it becomes favorable for him. With the help of Badla transactions artificial demand and supply is created for the scrips. For entering into a badla transaction, a speculator only pays margin and hence he can enter into transactions of higher value by paying only margin. This leads to the creation of artificial demand and supply, depending upon the type of Badla. A tool to hedge the risk: Hedging means counterbalancing or minimizing risk. With the help of Badla, losses arising due to adverse price movement can be set off.

Gambling: It is like betting for an uncertain outcome. In it, the investor is always ready to take high degree of risk. Gambler expects higher gains in a very short time horizon due to high level of risk assumed. Gambling is entirely based upon rumors, hunches and tips. Therefore, it can be said that every speculation is an investment but every investment is not speculation. Speculation starts where investment ends and gambling starts where speculation ends.

Difference Between Investment and Speculation:

Basis Investor An investor has a long time horizon. His holding period is usually at least a year. Investors do not like to assume more risk. Investors seek moderate rate of return which is commensurate with the limited risk assumed by him. Investor attaches higher significance to fundamental factors Uses his own funds and avoids and borrowed funds Speculator A speculator has a short planning horizon. His holding period may be a few days or months. Speculators are ready to assume higher risk. Speculators assume higher rate of returns as they assume more risk. Speculator relies on technical charts and market psychology Normally restores to borrowings

Planning Horizon Risk

Return Expected Basis for decisions Leverage

Investment Objectives:

Safety: This means protection against losses. Investor would always ensure full safety of his investment. This can be done by investing in an avenue where risk- default risk, market risk, interest rate risk, inflation risk, political risk etc. is minimum and return is maximum.
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Regularity of Income: Few investors invest their savings with the objective of generating regular income. Eg. Monthly income scheme of post office. Capital gain: Investors now-a-days put a large part of their savings in stock markets because they expect capital appreciation. High capital appreciation is achieved in stock prices however, with high risk. Tax Saving: in India, most of the salaried people buy insurance policies to avail tax benefit associated with them. Premium paid on these policies qualifies for tax rebate u/s 88 of income tax rule. Now, such premium does not attract any tax rebate instead it is deducted from the gross income up to 1.1 lac in a financial year. Investors also plan tax to enjoy tax free income. This can be done by investing in tax free bonds of central government or MF. Liquidity: liquidity is if an investment is converted into cash without these reasons: (a) difficulty (b) delay and (c) loss in the original value of investment. Instrument is liquid only if there are large number of buyers and sellers, who are ready to deal in it every time. Speculation: some investors invest their money in highly risky securities which leads to speculation. These kinds of investors are known as risk assumers. Hedging: it is the act of counterbalancing or minimizing risk. Hedging is a technique by which all possible adversities to an investment can be over ruled and stability can be ensured.

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Arbitrage: it means buying in a market where prices are low and selling in the market where prices are high. Investors also at times invest to take advantage of differences in same share prices across different stock exchanges.

Investment Attributes: For evaluation of investment avenues, the following attributes are relevant: 1) Returns 2) Capital Appreciation Conservative Aggressive Growth Speculation

Form of return Periodic cash receipts Capital Gain Safety and security of funds Risk Liquidity Tax Consideration Conceal ability Adequate Liquidity and Collateral Value Stability of Income

Types of Investors:
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 Contrarians- They buy when rest of the world sells. Trend Followers- They are conservative and tend to invest in products such as bank deposits. Hedgers and Holders- They are small investors who want high return and low risk.
Measured Investor- They start investing early, enjoys investing

and is happy with his current financial situation. He regularly rebalances portfolio and avoids concentration in a single investment. Reluctant Investor- They do not enjoy investing and spends a little investment on investments. They are assured of a comfortable retirement. They do not invest regularly and neither rebalances their portfolio.
Competitive Investor- They invest regularly and remain

optimistic about the future.

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