Investments

Current commitment of money for a period of time - to derive future payments, that compensate the investor for
1. The time the funds are committed 2. The expected rate of inflation 3. The uncertainty of the future payments
fund or a company

Investor can be individual, a government, a pension Investments includes investments

1. by corporations in plant and equipment 2. by individuals in stocks, bonds, commodities or real estate

Financial Investments Investment by individuals in stocks and bonds of corporations Investors enter the securities market and exchange cash for financial instruments Cash is exchanged between investors, no new capital reaches the corporations No real investment occurs as result of this activity Financial assets are claims to income generated by real assets Financial assets are created and destroyed in the ordinary course of doing business

Real Investments Occurs when a corporation takes capital and invests it in productive assets Real investment is channeled in real assets which determines the productive capacity of the economy Real assets are land , buildings, machines and knowledge necessary to produce goods together with the workers and their skills in operating these resources Real assets are income generating assets Real assets are destroyed by accident or by wearing out over time

Clients of the Financial System

The Household Sector Interested in wide array of assets Differences in risk tolerance creates demand for assets with a variety of risk return combinations Business Sector Need to raise money to finance their investment in real assets: plant, equipment & technological know how Government Sector Governments require money to finance their expenditure Restricted to borrowing - raise funds when tax revenues are not sufficient to cover expenditure

Stock Market /Capital Market

Rationale for a Stock Market 1. Allows efficient distribution of consumption over time
People save money by postponing consumption Market provides an avenue to set aside the money and let funds grow over time

1. Allows idle resources to be put to work

System has surplus units (with lots of income) and deficit units who need the funds Market allows savings of surplus units to be converted to investments Enables economic growth and hence creation of jobs Breakdown of this mechanism is disastrous for the economy

Rationale (continued)

3. Enables efficient allocation of financial resources among competing users

Price of a Share is a function of future expected earnings Depends on future investment opportunities and the ability of the firm to turn them into profit Share price channels funds to companies with prospects and those without prospects do not receive funds A mismatch exists between Investors Investment Horizon and Planning Horizon of Project Market allows people (financers) to come in and get out without affecting the financing of the project Long Term Projects can be executed

3. Stock Market provides Liquidity

STOCK MARKET HAS A LEGITIMATE PURPOSE, OTHER THAN THAT OF MAKING MONEY

Types of Capital Markets Primary Markets

Firms requiring capital to fund their growth sell(float) securities This new issue of securities to the public is referred to as Primary Markets Stocks are marketed to the public by Investment Bankers/Underwriters to the issue

Secondary Markets
Purchase and Sale of already issued securities which takes place at the Exchange

Players in the Market

Investors Markets owe their existence to them Invest in various assets to reduce overall risk Speculators In the market for Short Term Ready to take high risks for high returns Give Liquidity to the Market Arbitrageurs Make money if securities are mis priced or when small price differences exist in different markets Time Period in the market few minutes MARKET REQUIRES ALL OF THEM EACH HAS A ROLE TO PLAYSYMBIOSIS!!!!!

Market Regulator
Securities & Exchange Board of India (SEBI) Set up in 1988, to create confidence in investors To create an environment to facilitate the mobilization of adequate resources through the securities market and its efficient allocation Done by introducing and implementing Rules & Regulations regarding transactions in the market Caters to Issuers of Securities, Investors, Market Intermediaries Prohibits fraudulent and unfair trade practices Regulates substantial acquisition of shares and takeover of companies Eg. Prior to SEBI, DCM & ESCORTS-Swaraj Paul

Capital Market location - Stock Exchanges

Stock Exchanges in India are governed by Securities Contract Regulation Act (SCRA) Most popular Stock Exchanges in India National Stock Exchange (NSE) Set up by IDBI and other Financial Institutions No trading floor on this exchange Trading is screen based Brokers are connected to the exchange by PC terminals Membership is not a property right, members pay annual subscription fee Screen based trading with automated order matching System operates on a "price-time priority''?

Price Time Priority

A market has price-time priority if it gives a guarantee that every order will be matched against the best available price in the country, and that if two orders are equal in price, the one which came first will be matched first
Matching of orders is done by computers-transparent, objective fair

DEPOSITORY

Depository holds securities of investor in electronic form at the request of the investor through a registered Depository Participant(DP) Depository is similar to a Bank Holds securities in an account Transfers securities between accounts on the instruction of the account holder Facilitates transfer of ownership, no physical handling involved Depositories registered with SEBI NSDL National Securities Depository Ltd. CDSL Central Depository Services Ltd.

Market Intermediaries
Broker
Buy and Sell securities for earning a commission

Market Makers

A brokerage or bank that maintains a firm bid and ask price in a given security by standing ready, willing, and able to buy or sell at publicly quoted prices (called marking to market). These firms display bid and offer prices for specific numbers of specific securities, and if these prices are met, they will immediately buy for or sell from their own accounts. Market makers are very important for maintaining liquidity and efficiency for the particular securities that they make markets in

Merchant Banker/Investment Banker Perform role of middleman, help companies raise(market) new capital/issues Do all groundwork for new issues and give Due Diligence certificate to SEBI Registrar Collect applications for new issues and computerize them Make allotments in case of over subscription Underwriters In case new issues are not fully subscribed, they make good the shortfall by their own subscriptions. eg. Infosys IPO 1993

Market Terminology Index Statistical Indicator providing a representation of the value of the securities which constitute it. Indices often serve as barometer for a given market or industry Uses Use Index Values as a benchmark to judge performance of individual portfolios, ETFs, risk adjusted performance of other alternative asset classes. Technical Analysis Proxy for Market portfolio of risky assets, considering the fact that relevant risk for an individual risky asset is systematic risk

Factors in constructing an Index

The Sample
(important characteristic of desired population)

Size(Large or small), Breadth (Random or Non random) and Source (in case of differences in segments of population)
Weighting Sample Members Price Weighted Index Market Value Weighted Index Unweighted Index Computational Procedure

Price Weighted Index

Computed by totaling the current prices of selected stocks and dividing the sum by a divisor which is adjusted to take into account bonus issues, splits and changes in the sample over time Example DJIA High priced stock carries more weight than low priced stock change in high priced stock causes greater change in index When Bonus/Split occurs price declines, therefore their weight in index declines high growth stocks declaring bonus will continuously lose weight in Index

1.

Criticism

1.

(Market )Value Weighted Index

Use Market Capitalization of all stocks in the Index Market value of a company is determined by multiplying the price of the stock by the number of shares outstanding SENSEX represents the total market value of 30 component stocks. Base Year for Sensex is 1978. Value for Base Year is 100 SENSEX calculated using Free Float Method NIFTY M-Cap calculated using total number of outstanding shares till June 2009, now FF Method Base Year for Nifty is 1995 (November 3). Value for Base Year is 1000

SENSEX - Scrip selection criteria

Listed History
Listing history of at least 3 months at BSE. Exception if full market capitalization of a newly listed company ranks among top 10 in the list of BSE scrips. merger/demerger/amalgamation, minimum listing history would not be required

Trading Frequency
The scrip should have been traded on each and every trading day in the last three months.

SENSEX Criteria (continued)

Final Rank The scrip should figure in the top 100 companies listed by final rank. 75% weightage to the rank on the basis of three-month average full market capitalisation & 25% weightage to the liquidity rank based on three-month average daily turnover & three-month average impact cost.

Market Capitalization Weight The weight of each scrip in SENSEX based on three-month average free-float market capitalisation should be at least 0.5% of the Index. Industry Representation Scrip selection would generally take into account a balanced representation of the listed companies on BSE. Track Record In the opinion of the Committee, the company should have an acceptable track record.

SENSEX Criteria (continued)

Unweighted (Equal Weighted) Index

All stocks carry equal weight regardless of their price or market value Actual movements in the index are based on the arithmetic mean of the percentage changes in price or value for the stocks in the index percentage changes imply price level or market level has no impact on the index Some tend to use GM

From Indian Express

ORDER DESCRIPTION/SPECIFICATION I. ORDER TYPE

1. Buy 2. Sell 3. Short Sell a Stock

Short Sale Investor borrows shares from broker and sells them Later investor must repurchase the shares in order to replace the shares that were borrowed. This is covering of short position Short Seller must not only return the stock But give the lender any dividend paid on shares during the period of short sale

Short Sale (continued)

Lender of the Shares would have received the dividends directly from the firm, had the shares not been lent
Buyer - Gets possession of stock & receives dividend Original Owner- Not legal owner anymore, owns stock on paper and receives amount equal to dividend from short seller Short Seller gets no dividend, but shells out an amount equal to dividend and pays to original owner

II. ORDER SIZE

III. ORDER RESTRICTIONS 1. Price Restrictions 2. Time Restrictions Exercising Orders Bid Price Price at which a dealer is willing to buy a security Ask Price Price at which dealer will sell a security Market Orders Instructions to the broker to buy or sell at the best price immediately available Limit Orders (Buy or Sell) Instructs a broker to buy /sell at a stated price or better Buy-Maximum Price one is willing to pay Sell-Lowest Acceptable price you are willing to sell for Specifies maximum /minimum investor is willing to accept

Stop Order/Stop Loss Order (Buy or Sell)

Rs.50 Rs.70 (Now)

After you buy the stock difficult part is when to sell

Used to limit the amount of losses or protect capital gains can be used to sell securities automatically in case a major decline occurs in market If stock drops to specified price say Rs.68, stop loss becomes market order, position is closed out Reduce losses - specify Stop Order at Rs.45 (say) so may get more or less
STOP ORDER MEANT for WISHY WASHY PEOPLE, those who lack conviction in their Stock Picking Skills STOP ORDER & LIMIT ORDER ARE NOT IDENTICAL

STOP ORDER & LIMIT ORDER

LIMIT ORDER TO SELL AT Rs.50 Lowest acceptable is Rs.50, you do not mind anything above Rs.50
TRADE Rs.50 NO TRADE TRADE

STOP ORDER TO SELL AT Rs. 50 Even if Price falls to Rs.40 OK, sell

NO TRADE

Time Restrictions Fill or Kill (F.O.K) -Short Time Restrictions

Fill order immediately or kill it

Day Order Good till Cancelled (GTC)

Account Types
1. 2. Cash Account Margin Account Investors borrow part of the purchase price from brokers All securities purchased with margin are with broker as collateral Margin Accounts magnify your gains or losses Margin Ratio = Net Worth/Equity Value Say margin Ration is 0.3 means, 70% purchase price is borrowed
When you buy, you pay full amount. All purchases paid in full.

Magnification of Gains/Losses on Margin A/C

Stock Price Rs. 100 No. of Shares Brought =1000 Total Amount = Rs. 100,000 Cash A/C You pay Rs. 100,000 + Commission Margin A/C Initial Amount required = 0.30*Rs.100,000 = 30,000 Broker lends you the rest = Rs.100,000- Rs.30,000= Rs. 70,000 SCENE 1 Price From Rs. 100 to Rs.120 (20 % increase) Actual Margin = (Rs.120*1000 Rs.70,000)/Rs.120,000 = 41.67% > 30% Return = (Rs.50000-Rs.30000) / Rs. 30000 = 66.67% (Magnified Gain) SCENE 2 Price From Rs. 100 to Rs.80 (20 % decrease) Actual Margin = (Rs. 80*1000-Rs.70000)/Rs.80,000 = 12.5% < 30 % Margin Call Return = (Rs.10,000-Rs.30,000)/Rs.30,000 66.67 (Magnified Loss)

Degree of Leverage 3.33