Chapter-1 Introduction

COMPANY PROFILE

Kotak Securities Limited

Kotak Securities Ltd., a subsidiary of Kotak Mahindra Bank Limited, is one of Indias largest private brokerage and distribution house, set up in 1994, by Mr. Uday Kotak; it has equity participation from Goldman Sachs L. I. P. (25%).

Kotak Securities is a corporate member of both the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Its operations include stock broking, distribution of various Investment products including private and secondary placement of debt and equity, mutual funds, fixed deposits and the like. Currently Kotak Securities is one of the largest broking houses in India with offices in more than fifteen cities. In India as well as a presence in US, Europe and the Middle East (through our associate companies Kotak Mahindra U.K. Limited and Kotak Mahindra International Limited, Kotak Mahindra Inc).

Our core strengths are our expertise in equity research and a wide retail distribution network. We have an outstanding research division involved in macro economic studies, industry and company specific equity research, with analyst specializing in particular economic sectors and large cap stocks. In August 2000, Kotak Securities launched Kotakstreet.com, its e broking service for retail investors on the net and currently has over 20,000 registered users.

Kotak Securities Limited is one of the larger players in distribution of IPOs - it was ranked number One in 2003-04 as Book Running Lead Manager in public equity offerings by PRIME Database. It has also won the Best Equity House Award from Finance Asia - April 2004.

The Company has a full-fledged Research division involved in macro economic studies, sectoral research and Company specific equity research combined with a strong and well networked sales force which helps deliver current and up-to-date market information and news.

Kotak Securities Limited is also a depository participant with National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) providing dual benefit services wherein the investors can use the brokerage services of the Company for executing the transactions and the depository services for settling them.

The Company has 113 branches servicing around 1,00,000 customers, through our own offices and a large franchisee network. Its has an Online presence through Kotakstreet.com where we offer Internet Broking services and also online IPO and Mutual Fund Investments. Kotak Securities Limited manages assets over Rs. 1700 crores through its Portfolio Management Services (PMS) servicing high net worth clients with a large investible surplus through its preferred client services in the mass affluent and wealth management segments.

Chapter-2 Literature Review

PORTFOLIO Meaning of portfolio:Portfolio

A combination of securities with different risk & return characteristics will constitute the portfolio of the investor. Thus, a portfolio is the combination of various assets and/or instruments of investments. The combination may have different features of risk & return, separate from those of the components. The portfolio is also built up out of the wealth or income of the investor over a period of time, with a view to suit his risk and return preference to that of the portfolio that he holds. The portfolio analysis of the risk and return characteristics of individual securities in the portfolio and changes that may take place in combination with other securities due to interaction among themselves and impact of each one of them on others.

An investor considering investments in securities is faced with the problem of choosing from among a large number of securities. His choice depends upon the risk and return characteristics of individual securities. He would attempt to choose the most desirable securities and like to allocate is funds over this group of securities. Again he is faced with the problem of deciding which securities to hold and how much to invest in each. The investor faces an infinite number of possible portfolios or groups of securities. The risk and return characteristics of portfolio differ from those of individual securities combining to form a portfolio. The investor tries to choose the optimal portfolio taking in to consideration the risk return characteristics of all possible portfolios.

As the economy and the financial environment keep changing the risk return characteristics of individual securities as well as portfolios also change. This calls for periodical review and revision of investment portfolios of investors. An investor invests his funds in a portfolio expecting to get a good return consistent with the risk that he has to bear. The return realized from the portfolio has to be measured and the performance of the portfolio has to be evaluated.

PORTFOLIO DESIGN

Before designing a portfolio one will have to know the intention of the investor or the returns that the investor is expecting from his investment. This will help in adjusting the amount of risk. This becomes an important point from the point of view of the portfolio designer because if the investor will be ready to take more risk at the same time he will also get more returns. This can be more appropriately understood from the figure drawn below.

R1

Expected Returns

R2

Risk less Investment M1 Risk M2

From the above figure we can see that when the investor is ready to take risk of M 1, he is likely to get expected return of R1, and if the investor is taking the risk of M2, he will be getting more returns i.e. R2. So we can conclude that risk and returns are directly related with each other. As one increases the other will also increase in same of different proportion and same if one decreases the other will also decrease.

From the above discussion we can conclude that the investors can be of the following three types:

1. Investors willing to take minimum risk and at the same time are also expecting minimum returns.

2. Investors willing to take moderate risk and at the same time are also expecting moderate returns.

3. Investors willing to take maximum risk and at the same time are also expecting maximum returns.

PORTFOLIO AGE RELATIONSHIP

Your age will help you determine what a good mix is / portfolio is Age below 30 Portfolio 80% in stocks or mutual funds 10% in cash 10% in fixed income 70% in stocks or mutual funds 10% in cash 20% in fixed income 60% in stocks or mutual funds 10% in cash 30% in fixed income 50% in stocks or mutual funds 10% in cash 40% in fixed income 40% in stocks or mutual funds 10% in cash 50% in fixed income

30 t0 40

40 to 50

50 to 60

above 60

These aren't hard and fast allocations, just guidelines to get you thinking about how your portfolio should look. Your risk profile will give you more equities or more fixed income depending on your aggressive or conservative bias. However, it's important to always have some equities in your portfolio (or equity funds) no matter what your age. If inflation roars back, this will be the portion of your investments that protects you from the damage, not your fixed income. Also, the fixed income of your portfolio should be diversified. If you buy bonds and debentures directly or if you invest in FDs, then make sure you have at least five different maturities to spread out the interest rate risk. Diversifying in equities and bonds means more than buying a number of positions. Each position needs to be scrutinized as to how it fits into the stocks or bonds that already are in your portfolio, and how they might be affected by the same event such as higher interest rates, lower fuel prices, etc. Put your portfolio together like a puzzle, adding a piece at a time, each one a little different from the other but achieving a uniform whole once the portfolio is complete. 9

Types of portfolio for study:

In portfolio Design, we are considering only two types of portfolio. They are as follow: 1. Random Portfolio 2. Sector Portfolio

Random portfolio
Random portfolio consists of the scripts that are randomly selected by the investor by its own knowledge and preference of the stocks. Here there is no analysis is done of the script, they are selected on the tips and buts received by the investors from the external sources.

Features of random portfolio

There is no method used for selection of the script in the portfolio. Selection is based on the individual criteria for the scripts. The investment is made for higher return in short term. Generally in India most of the portfolio are selected according to this random methods as no investor himself in that much analysis of the script.

Advantages of random portfolio

Easier to keep a track on the market as not much time wasted in the analysis. This portfolio seems to have perform better in short term as script are generally which are performing better at that time. Tips are available every where for the investor to pouch. It is the experience of the individual that can fetch him good return.

Disadvantages of random portfolio

There is every chance that you may select a script that has a very bad background in the market. Not every time the tips pay off for you. You need to have strong reason to select that script. Such portfolios are not able to sustain when there is a crisis in the market. 10

There is a very high risk and return involve in such portfolio.

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2. Sector specific portfolio

Sector specific portfolio includes securities of those companies which are in the same business. Sector portfolios are very useful when there is a particular sector which is doing very good and has a bright future a head. Sector portfolio has the securities of those companies that engage in same kind of business. e.g. In late 1990s sector that was providing the highest return was information technology. Investors who have invested their money in these securities had earned very high return.

Features of sector portfolio

Script form the same group of companies that are in to the similar type of business. Maximum exposure to the industry/sector. So any news or event has the direct effect on the portfolio. Risk regarding the portfolio increases as it is expose to sector specific ups and downs. Useful investment tools for speculator and short-sellers. It is better suited for the sectors which have been providing good revenue in the near past.

Advantages of sector portfolio

It is better suited to investors who are willing to take risk. It provides better short term return then other portfolios. It is easy to keep a watch on one sector rather than many. You can have a good command over the things happening. Limited exposure to other sectors keeps the portfolio safe from the performance of other sectors in the economy.

Disadvantages of sector portfolio

It is a highly risky portfolio as risk associated with the sector directly affects the performance of the portfolio. These types of portfolios are not suited for long-term investor as risk taken for the return can be too high. There is always the possibly many scripts in the sector may not be giving that much good attractive return as others. They may eat the profits from other scripts. 12

RANDOM PORTFOLIO
Random portfolio consists of the scripts that are randomly selected by the investor by its own knowledge and preference of the stocks. Here there is no analysis is done of the script, they are selected on the tips and buts received by the investors from the external sources. We are considering BETA factor to design our Random Portfolio.

Beta Factor Beta indicates the proportion of the yield of a portfolio to the yield of the entire
market (as indicated by some index). If there is an increase in the yield of the market, the yield of the individual portfolio may also go up. If the index goes up by 1.5% and the yield of your portfolio goes up by 0.9%, the beta is 0.9/1.5 i.e 0.6. in other words, beta indicates that for every 1 % increase in the market yield, the yield of the portfolio goes up by 0.6%. High beta shares do move higher than the market when the market rises and the yield of the fund declines more than the yield of the market when the market falls. In the Indian context a beta of 1.2% is considered very bullish. You can be indifferent to market swings if you know your stocks well. Or you can put your portfolio into neutral or bias for the upside if you're bullish or a little for the downside if you're bearish. One way to do that is to have a mix of stocks that have certain betas in your portfolio. When investors are bullish on the market, they like to have high beta stocks in their portfolios because if they're right, then their stocks go up faster than the market in general, and their performance is better than the market. If investors are bearish on the market, then they use the low beta or negative beta stocks because their portfolios will go down less than the market and their performance will be better than the general market. And if they want to be neutral, they can then make sure that they have stocks with a beta of 1 or develop a portfolio that has stocks with betas greater than 1 and less than 1 so that they have the whole portfolio with an average beta of 1. A beta for a stock is derived from historical data. This means it has no predictive value for the future, but it does show that if the stock continues to have the same price patterns relative to the market in general as it has in the past, you've got a way of knowing how your portfolio will perform in relation to the market. And with a portfolio 13

with an average beta of 1, you can create your own index fund since you'll move more or less in tandem with the market.

Interpretation of Beta
When B = 1 means that the scrip has same volatility as compared to Index. Suitable for moderate investor. When B>1 means that scrip is more volatile as compared to market suitable for aggressive investors. When B<1 then scrip is less volatile as compared to market and suitable for defensive investors. Beta of scrips plays vital role in scrip selection in Portfolio management. Portfolio can be created in many ways as sector wise, diversified in various sector, beta wise scrip portfolio. SO BASED ON THIS BETA NOW WE WILL PREPARE THREE PORTFOLIO TO MATCH THE RISK TAKING CAPACITY OF AN INVESTOR THAT IS, PORTFOLIO

AGGRESSIVE

MODERATE

DEFENSIVE

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Interpretation of Random Portfolio

As in the theoretical way we have scene that the Beta shows the movement or change in the price of script vis--vis index. And a Beta >1 is more riskier and hence should give more return as compared to the script having Beta < 1. as the person is taking more risk then he should get more return. But in our case we have scene that Moderate portfolio having Beta < 1 has given more return as compared to Aggressive Portfolio.

So we can easily say that the investment in equity market is subject to market risk and
any one having long-term investment horizon should only enter into equity market. This analysis that has been carried out was only for a period of two month there are chances that in the long run aggressive portfolio would outperform the other portfolio

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DERIVATIVES
Derivatives is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex or commodity or any other asset. For example, wheat farmer may wish to sell their harvest at a future date to eliminate the risk of a change in prices by the date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the underlying.

In the Indian context the Securities Contracts (Regulation) Act. 1956 (SC(R)A) defines derivative to include

1. A security derived from a debts instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.

2. A contract, which derives its value from the prices, or index of price, of underlying securities.

The derivatives are securities under the (SC(R)A) and hence the trading of derivatives is governed by the regulatory framework under the (SC(R)A).

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TYPES OF DERIVATIVES
The most commonly used types of derivatives are as follows: o Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at todays pre -agreed price.

o Futures: A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are special types of forward contract in the sense that the former are standardized exchange-traded contracts.

o Options: Options are of two types call and put. Calls give the buyer the right but not the obligation to buy a gives quantity of the underlying asset, at a given price on or before a given future date. Plus give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

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INTRODUCTION TO FUTURE

Future markets were designed to solve the problems that exist in forward markets. A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the future contracts are standardized and exchange traded. To facilitate liquidity in the future contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purpose in settlement) and a standard time of such settlement. A future contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of future transactions ate offset this way.

The standardized items in a future contract are: Quantity of the underlying. Quality of the underlying. The date and the month of delivery. The units of price quotation and minimum price change. Location of settlement.

FEATURES OF A FUTURE CONTRACT Future contracts are organized / standardized contracts, which are traded on the exchanges. These contracts, being standardized and traded on the exchanges are very liquid in nature. In futures market, clearing corporation/ house provides the settlement guarantee.

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DISTINCTION BETWEEN FUTURE AND FORWARD CONTRACTS:

Future contracts are often confused with future contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity.

Features

Forward Contract

Future Contract
Operational Mechanism Not traded on exchange Traded on exchange

Contract Specifications

Differs from trade to trade.

Contracts contracts.

are

standardized

Counterparty Risk

Exists

Exists, but assumed by Clearing Corporation/ house.

Liquidation Profile

Poor Liquidity as contracts are Very high Liquidity as contracts tailor maid contracts. are standardized contracts.

Price Discovery

Poor;

as

markets

are Better; as fragmented markets are brought to the common platform.

fragmented.

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FUTURE TERMINOLOGY
Spot Price: The price at which an asset trades in the spot market.

Future Price: The price at which the future contracts trades in the market.

Contract Cycle: The period over which a contract trades. The index futures contracts on the NSE have one-month, two-months and three-months expiry cycle, which expire on the last Thursday of the month. Thus a January expiration contract would expire on the last Thursday of January and a February expiration contract would cease trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry would be introduced for trading.

Expiry Date: It is the date specified in the future contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.

Contract Size: The amount of asset that has to be delivered under one contract. For instance, the contract size on NSEs futures market is 200 Nifties.

Basis: Basis is usually defined as the spot price minus the future price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be negative. This reflects that futures prices normally exceed spot prices.

Cost of Carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

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Initial Margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

Marking-to-Market: In the future market, at the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the futures closing price. This is called marking-to-market

Maintenance Margin: This is somewhat lower than the initial margin.

This is set to

ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, investor receives a margin call and is expected to top up the margin account to the initial level before trading commences on the next day.

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DIFFERENCE BETWEEN FUTURES AND OPTIONS

At a practical level, the option buyer faces an interesting situation. He pays for the option in full at the time it is purchased. After this, he only has an upside. There is no possibility of the options position generating any further losses to him (other than the funds already paid for option). This is different from futures, which is free to enter into, but can generate very large losses. This characteristic makes options attractive to many occasional market participants, who cannot put in the time to closely monitor their future options.

Buying put option means that you are buying insurance. To buy a put option on Nifty is to buy insurance which reimburses the full extent to which Nifty drops below the strike price of the put option. This is attractive to many people, and to mutual funds creating guaranteed return products. The Nifty index fund industry will find it very useful to make a bu ndle of a Nifty index fund and a Nifty put option to create a new kind of a Nifty index fund, which gives the investor protection against extreme drops in Nifty.

Selling put option is selling insurance, so anyone who feels like earning revenues by selling insurance can set himself up to do so on the index option market. More generally, option offer nonlinear payoffs whereas futures only have linear payoffs. By combining futures and options, a wide variety of innovative and useful payoff structures can be created.

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PAYOFF FOR DERIVATIVES CONTRACT

Payoff is likely profit/loss that would accrue to a market participant with change in the price of the underlying asset. This is generally depicted in the form of payoff diagrams, which show the price of the underlying asset on the X-axis and the profit/losses on the Y-axis. Payoff for Futures: Future contracts have linear payoffs. It means that the losses as well as profits for the buyer and the seller of a future contract are unlimited. These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs.

Payoff for buyer for futures: Long Futures

The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. He has a potentially unlimited upside as well as a potentially unlimited downside. Take the case of a speculator who buys a two-month Nifty index futures contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves down it starts making losses. Profit

1220 0 Nifty Loss

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Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contracts is similar to the payoff for a person who shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited downside. Take the case of a speculator who sells a two-month Nifty index futures contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves down, the short future position starts making profits, and when the index moves up, it starts making losses.

Profit

1220 0 Nifty

Loss

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USING INDEX FUTURES

There is always risk involved when we trade in a stock market. The risk cannot be eradicated fully but can be minimized up to some extent. Following are the types of risks that can be minimized through futures: Basic objective of introduction of futures is to manage the price risk. Index futures are used to manage the systemic risk, vested in the investment in securities. Basically there are eight basic modes of trading on the index futures market;

Hedging
H1 Long stock, short Nifty futures H2 Short stock, long nifty futures H3 Have portfolio, short Nifty futures H4 Have funds, long Nifty futures

Hedge Terminology:
Long hedge- When you hedge by going long in futures market. Short hedge - When you hedge by going short in futures market. Cross hedge - When a futures contract is not available on an asset, you hedge your position in cash market on this asset by going long or short on the futures for another asset whose prices are closely associated with that of your underlying. Hedge Contract Month- Maturity month of the contract through which hedge is accomplished. Hedge Ratio - Number of future contracts required to hedge the position.

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Speculation
Speculation is all about taking position in the futures market without having the underlying. Speculators operate in the market with motive to make money. They take: Naked positions - Position in any future contract. Spread positions - Opposite positions in two future contracts. This is a conservative speculative strategy. Speculators bring liquidity to the system, provide insurance to the hedgers and facilitate the price discovery in the market. S1 Bullish index, long Nifty futures S2 Bearish index, short Nifty futures

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HEDGING

H1: long stock, short Nifty futures

A person who feels that the stocks will be intrinsically under evaluated or the profits and the quality of the company will make it more worth as compared to the market will always like to take a long position on the cash market. While doing so he will have to face the following kinds of risks:

1. His understanding can be wrong, and the company is really not worth more than the market prices. 2. The entire market moves against him and generate losses even though the underlying idea was correct.

The second outcome happens all time. A person may buy Reliance at Rs.190 thinking hat it would announce good results and the stock price would rise. A few days later, Nifty drops, so he makes losses, even if his understanding of Reliance was correct.

There is a peculiar problem here. Every buy position on a stock is simultaneously a buy position on Nifty. This is because a, LONG RELIANCE position generally gains if Nifty rises and generally losses if Nifty drops. In this sense, a LONG RELIANCE position is not a focused play on the valuation of Reliance. It carries a LONG NIFTY position along with it, as incidental baggage. The stock picker may be thinking that he wants to be LONG RELIANCE but a long position on Reliance effectively forces him to be LONG RELIANCE + LONG NIFTY. If we think that WIPRO is under evaluated, the position LONG WIPRO is not purely about WIPRO; it is also partly about Nifty. Every trader who has a LONG WIPRO position is forced to be an index speculator, even though he may not have no interest in the index. Those who are bullish about the index should just buy Nifty futures; the need not trade individual stocks. Those who are bullish about WIPRO do wrong by carrying along a long position on Nifty as well. 27

There is a simple way out. Every time we adopt a long position on a stock, we should sell some amount of Nifty futures. This will help in offsetting the hidden Nifty exposure that is every longstock position. Once this is done, we will have a position which will be purely about the performance of the stock. The position LONG WIPRO + SHORT NIFTY is a pure play on the value of WIPRO, without any risk from fluctuation of the market index. When this will be done the stockpicker has hedged away his index exposure. The basic point o f this hedging strategy is that the stockpicker proceeds with his core skill, i.e. picking stocks, at the cost of lower risk.

NOTE: hedging does not remove losses. The best that can be achieved by using hedging is
the removal of unwanted exposure, i.e. unnecessary risk. The hedged position will make less profit than the un-hedged position, half the time. One should not enter into a hedging strategy hoping profit for sure; all that can come out of hedging is reduced risk.

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H2: Short stock, long Nifty futures

If a person feels that the stock is over evaluated or the profits and the quality of the company made it worth a lot less as compared to what the market thinks, he can take a short position on the cash market. This will give rise to two types of risks:

1. His understanding can be wrong, and the company is really worth more than the market price. 2. The entire market moves against him and generates losses even though the underlying idea was correct.

The second outcome happens all time. A person may sell Reliance at Rs.190 thinking that Reliance would announce poor result and the stock price would fall. And if after few days if the Nifty rises, he will incur loss, even if the intrinsic understanding of Reliance was correct.

There is a peculiar problem here. Every sell position on a stock is simultaneously a sell position on Nifty. This is because a SHORT RELIANCE position generally gains if Nifty falls and generally loses if Nifty rises. In this sense, a SHORT RELIANCE position is not a focused play on the valuation of Reliance. It carries a SHORT NIFTY position along with it, as incidental baggage. The stockpicker may be thinking he wants to be SHORT RELIANCE, but a short position on Reliance on the market effectively forces him to be SHORT RELIANCE + SHORT NIFTY.

Even if we think that WIPRO is overvalued, the position SHORT WIPRO is not purely about WIPRO; it is also about the Nifty. Every trader who has a SHORT WIPRO position is forced to be an index speculator, even though he may not have any interest in the index. Those who are bearish about the index should just sell Nifty futures; the need not trade individual stocks. Those who are bearish about WIPRO do wrong by carrying along a short position on Nifty as well. 29

There is a simple way out. Every time we adopt a short position on a stock, we should buy some amount of Nifty futures. This will help in offsetting the hidden Nifty exposure that is every shortstock position. Once this is done, we will have a position, which will be purely about the performance of the stock. The position SHORT WIPRO + LONG NIFTY is a pure play on the value of WIPRO, without any risk from fluctuation of the market index. When this will be done the stockpicker has hedged away his index exposure. The basic point of this hedging strategy is that the stockpicker proceeds with his core skill, i.e. picking stocks, at the cost of lower risk.

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H3: Have Portfolio, short Nifty futures

Some of us might have experienced the feeling of owing an equity portfolio, and then one day, we become uncomfortable about the overall stock market. Sometimes we have a view that the stock prices will fall in the near future. At other times, we may see that the market is in for a few days or weeks of massive volatility, and we do not have an appetite for this kind of volatility. The best example of this volatility is the union budget. Market positions become volatile for one week before and two weeks after the budget. Many investors want to eradicate this three weeks volatility.

This becomes a peculiar problem if we are thinking of selling the shares in the near future, for example, in order to finance a purchase a house. This planning can go wrong if by the time we sell shares, Nifty has dropped sharply. There are two main alternatives, when one faces this type of problem: 1. Sell shares immediately. This sentiment generates panic selling which is rarely optimal for the investor. 2. Do nothing, i.e. suffer the pain of volatility. This leads to political pressure for government to do something when stock prices fall.

Here in this case, with the index futures market, a third and a remarkable alternative becomes available:

3. Remove your exposure to index fluctuations temporarily using index futures. This will allow rapid response to market conditions, without panic selling of shares. It will allow an investor to be in control of his risk, instead of doing nothing and suffering the risk.

The idea here is that every portfolio contains a hidden index exposure. This statement is true for all portfolios, whether a portfolio is composed of index stock or not. In the case of portfolios, most of the portfolio risk is accounted for by index fluctuations. Hence a position LONG PORTFOLIO + SHORT NIFTY can often become one-tenth as risky as the LONG PORTFOLIO position.

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Is suppose we have a portfolio of Rs.1 billion, which is having a beta of 1.25. Then a complete hedge is obtained by selling Rs.1.25 million of Nifty futures.

H4: Have funds, buy Nifty futures

A person may be in a situation where he is having funds, which needed to be invested in equity, or he may be expecting to get funds in future to be invested in equity. The following can be the occurrences in the above conditions: A closed-end fund, which just finished its initial public offering, has cash, which is not yet invested. If a person is planning to sell some of his shares. The land deal is slow and will take time to complete. It takes several weeks from the date that it becomes sure that the funds will come to the date that the funds are actually are in hands. An open-ended fund has just sold fresh units and has received funds.

To get oneself invested in equity sounds quite easy but it involves the following problems:

1. A person may need time to research stocks, and carefully pick stocks that are expected to do well. This process of research takes time. For that time the investor is partly invested in cash and partly invested in stocks. During this time, he is exposed to the risk of missing out if the overall market index goes up. 2. A person may have made up his mind on what portfolio he seeks to buy, but going to the market and placing the market order would generate large impact cost. The execution would be improved substantially if he could instead place a limit orders and gradually accumulate the portfolio at favorable prices. This takes time, and during this time, he is exposed to the risk of missing out if the Nifty goes up. 3. In some cases, such as land sale above, the person may not simply have cash to immediately buy the shares, hence he is forces to wait even if he feels that Nifty is unusually cheap. He is exposed to the risk of missing out if Nifty rises.

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The three alternatives that are available with an investor are as follows: The investor would obtain the desired equity exposure by buying index futures, immediately. A person who expects to obtain Rs.5 million by selling land would immediately enter into a position LONG NIFTY worth Rs.5 million. Similarly a closeend fund, which has just finished its initial public offering and has cash, which is not yet invested, can immediately enter into a LONG NIFTY to the extent it wants to be invested into equity. The index futures market is likely to be more liquid than individual stocks so it is possible to take extremely large position at a low impact cost. Later, the investor / close-end fund can gradually acquire stocks. As and when shares are obtained, one would scale down the LONG NIFTY position correspondingly. No matter how slowly the stocks are purchased, this strategy would fully capture a rise in Nifty, so there is no risk of missing out on a broad rise in the stock market while this process is taking place. Hence, this strategy allows the investor to take more care and spend more time in choosing stocks and placing aggressive limit orders.

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SPECULATION

S1: Bullish index, long Nifty futures

We may sometimes think that the market index is going to rise and we can make profits by adopting a position on the index. After a good budget, or good corporate results, or the onset of the stable government, many people may feel that the index would go up. Now a days people have the following two strategies to get benefit from an upward movement in the index:

1. Buy selected liquid securities, which move with the index, and sell them at a later date. 2. Buy the entire index portfolio and then sell it at a later date.

The first alternative is widely used. A lot of the trading volume on the liquid stock is based on using these liquid stocks as an index proxy. However, these positions run the risk of making losses owing to company. The second alternative is cumbersome and expensive in terms of the transaction cost involved in it.

Taking a position on the index is effortless using the index futures market. By using the index futures an investor can buy or sell the entire index by trading on one singe security. Once a person is LONG NIFTY using the futures market, he gains if the index rises and losses if the index falls.

34

S2: Bearish index, short Nifty futures

We may sometimes think that the market is going to fall and we can make profit by adopting a position on the index. After a bad budget, or bad corporate results, or the onset of a coalition government, many people feel that the index would go down. So to get the benefit from the downward movement in the index we are having the following two choices:

1. Sell selected liquid securities, which move with the index, and buy them at a later date. 2. Sell the entire index portfolio and then buy it at a later date.

The first alternative is widely used. A lot of the trading volume on liquid stock is based on using these positions run the risk of making losses owing to company. The second alternative is hard to implement. This strategy is cumbersome and also expensive in terms of the transaction cost involved.

Taking a position on the index is effortless using the index futures market. By using the index futures an investor can buy or sell the entire index by trading on one singe security. Once a person is SHORT NIFTY using the futures market, he gains if the index falls and losses if the index rises.

Now after learning about the futures what we can do is that as we are having our three portfolios we would see how we could hedge our position using the futures contract. As we know that Hedging does not always make money. The best way that can be achieved using hedging is the removal of unwanted exposure, i.e. unnecessary risk. The hedged position will make less profit than the unhedged position. One should not enter into a hedging strategy hoping to make excess profits for sure; all that can come out of hedging is reduced risk. So one should go for hedging only if the movement of market makes him uncomfortable.

Here we are having a portfolio of script so to hedge our position we would have to know what is the portfolio BETA.

35

The Portfolio BETA = Wi * Beta

Where, Wi = the weightage of scrip in the portfolio

Beta =

% Change in Scrip Return

% Change in Market Return

The BETA of a scrip can be easily found out from the website of National Stock Exchange and also from the website of Bombay stock exchange.

Here for the purpose of hedging we will have to short nifty futures as we are having the portfolio and the future contracts may not be available for all the scrip. But as we have seen earlier that all scrip have hidden exposure to nifty. So we will short the nifty future contract for the purpose of hedging our portfolio. The current nifty lot size is 200. Now for the purpose of hedging the portfolio we will have to decide about the number of lots of Nifty that the investor will have to sell in order to hedge his position. To find out that figure we will have to do the following calculations: -

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SECTOR PORTFOLIO
Sector specific portfolio includes securities of those companies which are in the same business. Sector portfolios are very useful when there is a particular sector which is doing very good and has a bright future a head. Sector portfolio has the securities of those companies that engage in same kind of business. e.g. In late 1990s sector that was providing the highest return was information technology. Investors who have invested their money in these securities had earned very high return.

We are considering Telecom Sector as our Sector Portfolio.

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ANALYSIS OF INVESTMENT

WHAT IS INVESTMENT?
Investment is the activity, which is made with the objective of earning some sort of positive returns in the future. It is the commitment of the funds to earn future returns and it involves sacrificing the present investment for the future return. Every person makes the investment so that the funds he has increases as keeping cash with himself is not going to help as it will not generate any returns and also with the passage of time the time value of the money will come down. As the inflation will rise the purchasing power of the money will come down and this will result that the investor who does not invest will become more poor as he will not have any funds whose value have been increased. Thus every person whether he is a businessman or a common man will make the investment with the objective of getting future returns.

38

TYPES OF INVESTMENT:There are basically three types of investments from which the investors can choose. The three kinds of investment have their own risk and return profile and investor will decide to invest taking into account his own risk appetite. The main types of investments are: -

Economic investments:These investments refer to the net addition to the capital stock of the society. The capital stock of the society refers to the investments made in plant, building, land and machinery which are used for the further production of the goods. This type of investments are very important for the development of the economy because if the investment are not made in the plant and machinery the industrial production will come down and which will bring down the overall growth of the economy.

Financial Investments:This type of investments refers to the investments made in the marketable securities which are of tradable nature. It includes the shares, debentures, bonds and units of the mutual funds and any other securities which is covered under the ambit of the Securities Contract Regulations Act definition of the word security. The investments made in the capital market instruments are of vital important for the country economic growth as the stock market index is called as the barometer of the economy.

General Investments:-

39

These investments refer to the investments made by the common investor in his own small assets like the television, car, house, motor cycle. These types of investments are termed as the household investments. Such types of investment are important for the domestic economy of the country. When the demand in the domestic economy boost the over all productions and the manufacturing in the industrial sectors also goes up and this causes rise in the employment activity and thus boost up the GDP growth rate of the country. The organizations like the Central Statistical Organization (CSO) regularly takes the study of the investments made in the household sector which shows that the level of consumptions in the domestic markets.

CHARACTERISICS OF INVESTMENT
Certain features characterize all investments. The following are the main characteristics features if investments: -

1.Return: All investments are characterized by the expectation of a return. In fact, investments are made with the primary objective of deriving a return. The return may be received in the form of yield plus capital appreciation. The difference between the sale price & the purchase price is capital appreciation. The dividend or interest received from the investment is the yield. Different types of investments promise different rates of return. The return from an investment depends upon the nature of investment, the maturity period & a host of other factors.

2.Risk: Risk is inherent in any investment. The risk may relate to loss of capital, delay in repayment of capital, nonpayment of interest, or variability of returns. While some investments like government securities & bank deposits are almost risk less, others are more risky. The risk of an investment depends on the following factors. The longer the maturity period, the longer is the risk. The lower the credit worthiness of the borrower, the higher is the risk. The risk varies with the nature of investment. Investments in ownership securities like equity share carry higher risk compared to investments in debt instrument like debentures & bonds.

3. Safety: 40

The safety of an investment implies the certainty of return of capital without loss of money or time. Safety is another features which an investors desire for his investments. Every investor expects to get back his capital on maturity without loss & without delay.

4. Liquidity: An investment, which is easily saleable, or marketable without loss of money & without loss of time is said to possess liquidity. Some investments like company deposits, bank deposits, P.O. deposits, NSC, NSS etc. are not marketable. Some investment instrument like preference shares & debentures are marketable, but there are no buyers in many cases & hence their liquidity is negligible. Equity shares of companies listed on stock exchanges are easily marketable through the stock exchanges.

IMPORTANCE
In the current situation, investment is becomes necessary for everyone & it is important & useful in the following ways:

1. Retirement planning: Investment decision has become significant as people retire between the ages of 55 & 60. Also, the trend shows longer life expectancy. The earning from employment should, therefore, be calculated in such a manner that a portion should be put away as a savings. Savings by themselves do not increase wealth; these must be invested in such a way that the principal & income will be adequate for a greater number of retirement years. Increase in working population, proper planning for life span & longevity have ensured the need for balanced investments.

2. Increasing rates of taxation: Taxation is one of the crucial factors in any country, which introduce an element of compulsion, in a persons saving. In the form investments, there are various forms of saving outlets in our country, which help in bringing down the tax level by offering deductions in personal income. For examples: Unit linked insurance plan, Life insurance, National saving certificates, 41

Development bonds, Post office cumulative deposit schemes etc.

3. Rates of interest: It is also an important aspect for sound investment plan. It varies between investment & another. This may vary between risky & safe investment, they may also differ due different benefits schemes offered by the investments. These aspects must be considered before actually investing. The investor has to include in his portfolio several kinds of investments stability of interest is as important as receiving high rate of interest.

4. Inflation: Since the last decade, now a days inflation becomes a continuous problem. In these years of rising prices, several problems are associated coupled with a falling standard of living. Before funds are invested, erosion of the resource will have to be carefully considered in order to make the right choice of investments. The investor will try & search outlets, which gives him a high rate of return in form of interest to cover any decrease due to inflation. He will also have to judge whether the interest or return will be continuous or there is a likelihood of irregularity. Coupled with high rate of interest, he will have to find an outlet, which will ensure safety of principal. Beside high rate of interest & safety of principal an investor also has to always bear in mind the taxation angle, the interest earned through investment should not unduly increase his taxation burden otherwise; the benefit derived from interest will be compensated by an increase in taxation.

5. Income: For increasing in employment opportunities in India., investment decisions have assumed importance. After independence with the stage of development in the country a number of organization & services came into being. For example: The Indian administrative services, Banking recruitment services, 42

Expansion in private corporate sector, Public sector enterprises, Establishing of financial institutions, tourism, hotels, and education.

6. Investment channels: The growth & development of country leading to greater economic activity has led to the introduction of a vast array of investment outlays. Apart from putting aside saving in savings banks where interest is low, investor have the choice of a variety of instruments. The question to reason out is which is the most suitable channel? The investor in his choice of investment will give a balanced growth & stability of return? The investor in his choice of investment will have try & achieve a proper mix between high rates of return to reap the benefits of both . For example: Fixed deposit in corporate sector Unit trust schemes.

43

INVESTMENTS AVENUES:There are various investments avenues provided by a country to its people depending upon the development of the country itself. The developed countries like the USA and the Japan provide variety of investments as compared to our country. In India before the post liberalization era there were limited investments avenues available to the people in which they could invest. With the opening up of the economy the number of investments avenues have also increased and the quality of the investments have also improved due to the use of the professional activity of the players involved in this segment. Today investment is no longer a process of trial and error and it has become a systematized process, which involves the use of the professional investment solution provider to play a greater role in the investment process.

Earlier the investments were made without any analysis as the complexity involved the investment process were not there and also there was no availability of variety of instruments. But today as the number of investment options have increased and with the variety of investments options available the investor has to take decision according to his own risk and return analysis.

An investor has a wide array of Investment Avenue. They are as under:

44

Investment
Avenues

Equity

Fixed Income

Shares

securities Deposits

Mutual Fund

Schemes
Tax Sheltered Life Insurance

Schemes
Real Estate Precious

Objects

Financial Derivatives

45

EQUITY SHARES: -

Types of Equity Instruments: Ordinary Shares

Ordinary shareholders are the owners of a company, and each share entitles the holder to ownership privileges such as dividends declared by the company and voting rights at meetings. Losses as well as profits are shared by the equity shareholders. Without any guaranteed income or security, equity shares are a risk investment, bringing with them the potential for capital appreciation in return for the additional risk that the investor undertakes in comparison to debt instruments with guaranteed income.

Preference Shares
Unlike equity shares, preference shares entitle the holder to dividends at fixed rates subject to availability of profits after tax. If preference shares are cumulative, unpaid dividends for years of inadequate profits are paid in subsequent years. Preference shares do not entitle the holder to ownership privileges such as voting rights at meetings.

Equity Warrants
These are long term rights that offer holders the right to purchase equity shares in a company at a fixed price (usually higher than the current market price) within a specified period. Warrants are in the nature of options on stocks.

46

Classification in terms of Market Capitalisation

Market capitalisation is equivalent to the current value of a company i.e. current market price per share times the number of outstanding shares. There are Large Capitalisation companies, Mid-Cap companies and Small-Cap companies. Different schemes of a fund may define their fund objective as a preference for Large or Mid or Small-Cap companies' shares. Large Cap shares are more liquid and hence easily tradable. Mid or Small Cap shares may be thought of as having greater growth potential. The stock markets generally have different indices available to track these different classes of shares.

Classification in terms of Anticipated Earnings

In terms of the anticipated earnings of the companies, shares are generally classified on the basis of their market price in relation to one of the following measures:

* Price/Earnings Ratio is the price of a share divided by the earnings per share, and indicates what the investors are willing to pay for the company's earning potential. Young and/or fast growing companies usually have high P/E ratios. Established companies in mature industries may have lower P/E ratios. The P/E analysis is sometimes supplemented with ratios such as Market Price to Book Value and Market Price to Cash Flow per share.

Dividend Yield for a stock is the ratio of dividend paid per share to current market price. Low P/E stocks usually have high dividend yields. In India, at least in the past, investors have indicated a preference for the high dividend paying shares. What matters to fund managers is the potential dividend yields based on earnings prospects.

Based on companies' anticipated earnings and in the light of the investment management experience the world over, stocks are classified in the following groups: Cyclical Stocks are shares of companies whose earnings are correlated with the state of the economy. Their earnings (and therefore, their share prices) tend to go up during upward 47

economic cycles and vice versa. Cement or Aluminium producers fall into this category, just as an example. These companies may command relatively lower P/E ratios, and have higher dividend pay-outs. Growth Stocks are shares of companies whose earnings are expected to increase at rates that exceed normal market levels. They tend to reinvest earnings and usually have high P/E ratios and low dividend yields. Software or information technology company shares are an example of this type. Fund managers try to identify the sectors or companies that have a high growth potential. Value Stocks are shares of companies in mature industries and are expected to yield low growth in earnings. These companies may, however, have assets whose values have not been recognised by investors in general. Fund managers try to identify such currently under-valued stocks that in their opinion can yield superior returns later. A cement company with a lot of real estate and a company with good brand names are examples of potential value shares.

48

FIXED INCOME SECURITIES

Many instruments give regular income. Debt instruments may be secured by the assets of the borrowers as generally in case of Corporate Debentures, or be unsecured as is the case with Indian Financial Institution Bonds. A debt security is issued by a borrower and is often known by the issuer category, thus giving us Government Securities and Corporate Securities or FI bonds. Debt instruments are also distinguished by their maturity profile. Thus, instruments issued with short-term maturities, typically under one year, are classified as Money Market Securities. Instruments carrying longer than oneyear maturities are generally called Debt Securities. Most debt securities are interest-bearing. However, there are securities that are discounted securities or zero-coupon bonds that do not pay regular interest at intervals but are bought at a discount to their face value. A large part of the interest-bearing securities are generally Fixed Income-paying, while there are also securities that pay interest on a Floating Rate basis.

49

A Review of the Indian Debt Market

The Wholesale Debt Market segment deals in fixed income securities and is fast gaining ground in an environment that has largely focused on equities. The Wholesale Debt Market (WDM) segment of the Exchange commenced operations on June 30, 1994. This provided the first formal screen-based trading facility for the debt market in the country.

This segment provides trading facilities for a variety of debt instruments including Government Securities, Treasury Bills and Bonds issued by Public Sector Undertakings/ Corporates/ Banks like Floating Rate Bonds, Zero Coupon Bonds, Commercial Papers, Certificate of Deposits, Corporate Debentures, State Government loans, SLR and Non-SLR Bonds issued by Financial Institutions, Units of Mutual Funds and Securitized debt by banks, financial institutions, corporate bodies, trusts and others.

Large investors and a high average trade value characterize this segment. Till recently, the market was purely an informal market with most of the trades directly negotiated and struck between various participants. The commencement of this segment by NSE has brought about transparency and efficiency to the debt market, along with effective monitoring and surveillance to the market.

50

Business Growth in WDM Segment

Instruments in the Indian Debt Market

Certificate of Deposit Certificates of Deposit (CD) are issued by scheduled commercial banks excluding regional rural banks. These are unsecured negotiable promissory notes. Bank CDs have a maturity period of 91 days to one year, while those issued by FIs have maturities between one and three years. Commercial Paper Commercial paper (CP) is a short term, unsecured instrument issued by corporate bodies (public & private) to meet short-term working capital requirements. Maturity varies between 3 months and 1 year. This instrument can be issued to individuals, banks, companies and other corporate bodies registered or incorporated in India. CPs can be issued to NRIs on nonrepatriable and non-transferable basis. Corporate Debentures The debentures are usually issued by manufacturing companies with physical assets, as secured instruments, in the form of certificates They are assigned a credit rating by rating agencies. Trading in debentures is generally based on the current yield and market values are based on yield-tomaturity. All publicly issued debentures are listed on exchanges. Floating Rate Bonds (FRB) These are short to medium term interest bearing instruments issued by financial intermediaries and corporates. The typical maturity of these bonds is 3 to 5 years. FRBs issued by financial institutions are generally unsecured while those from private corporates are secured. The FRBs are pegged to different reference rates such as T-bills or bank deposit rates. The FRBs issued by the Government of India are in the form of Stock Certificates or issued by credit to SGL accounts maintained by the RBI.

51

 Government Securities These are medium to long term interest-bearing obligations issued through the RBI by the Government of India and state governments. The RBI decides the cut-off coupon on the basis of bids received during auctions. There are issues where the rate is pre-specified and the investor only bids for the quantity. In most cases the coupon is paid semi-annually with bullet redemption features. Treasury Bills T-bills are short-term obligations issued through the RBI by the Government of India at a discount. The RBI issues T-bills for different tenures: now 91 -days and 364-days. These treasury bills are issued through an auction procedure. The yield is determined on the basis of bids tendered and accepted. Bank/FI Bonds Most of the institutional bonds are in the form of promissory notes transferable by endorsement and delivery. These are negotiable certificates, issued by the Financial Institutions such as the IDBI/ICICI/ IFCI or by commercial banks. These instruments have been issued both as regular income bonds and as discounted long-term instruments (deep discount bonds). Public Sector Undertakings (PSU) Bonds PSU Bonds are medium and long term obligations issued by public sector companies in which the government share holding is generally greater than 51%. Some PSU bonds carry tax exemptions. The minimum maturity is 5 years for taxable bonds and 7 years for tax-free bonds. PSU bonds are generally not guaranteed by the government and are in the form of promissory notes transferable by endorsement and delivery. PSU bonds in electronic form (demat) are eligible for repo transactions.

52

MUTUAL FUND SCHEMES

An investor can participant in various schemes floated by mutual fund instead of buying equity shares. In mutual funds invest in equity shares & fixed income securities. There are three broad types of mutual fund schemes. Growth schemes Income schemes Balanced schemes

53

DEPOSITS

It is just like fixed income securities earn a fixed return. However, unlike fixed income securities, deposits are negotiable or transferable. The important types of deposits in India are: Bank deposits Company deposits Postal deposits.

TAX-SHELTERED SAVING SCHEMES

It provides benefits to those who participate in them. The most important tax sheltered saving schemes in India is: Employee provident fund scheme Public provident fund schemes National saving certificate

LIFE INSURANCE
In a broad sense, life insurance may be viewed as an investment. Insurance premiums represent the sacrifice & the assured sum the benefit. In India, the important types of insurance polices are: Endowment assurance policy Money back policy Whole life policy Premium back term assurance policy

54

REAL ESTATE
For the bilk of the investors the most important asset in their portfolio is a residential house. In addition to a residential house, the more affluent investors are likely to be interested in the following types of real estate: Agricultural land Semi-urban land

PRECIOUS OBJECTS PRECIOUS OBJECTS: It is highly valuable in monetary terms but generally they are small in size. The important precious objects are: Gold & silver Precious stones Art objects

FINANCIAL DERIVATIVES: -

FINANCIAL DERIVATIVES

A financial derivative is an instrument whose value is derived from the value of underlying asset. It may be viewed as a side bet on the asset. The most import financial derivatives from the point of view of investors are: Options Futures.

55

RISK RETURN OF VARIOUS INVESTMENT AVENUES

Every investment is characterized by return & risk. Investors intuitively understand the concept of risk. A person making an investment expects to get some return from the investment in the future. But, as future is uncertain, so is the future expected return. It is this uncertainty associated with the returns from an investment that introduces risk into an investment. Risk arises where there is a possibility of variation between expectation and realization with regard to an investment.

Meaning of Risk
Risk & uncertainty are an integrate part of an investment decision. Technica lly risk can be define as situation where the possible consequences of the decision that is to be taken are known. Uncertainty is generally defined to apply to situations where the probabilities cannot be estimated. However, risk & uncertainty are used interchangeably.

56

Types of risks
1. Systematic risk: Systematic risk is non diversifiable & is associated with the securities market as well as the economic, sociological, political, & legal considerations of prices of all securities in the economy. The affect of these factors is to put pressure on all securities in such a way that the prices of all stocks will more in the same direction. Example: During a boom period prices of all securities will rise & indicate that the economy is moving towards prosperity. Market risk, interest rate risk & purchasing power risk are grouped under systematic risk.

RISKS

SYSTEMATIC Market Risk Interest Rate Risk Purchasing power Risk

UNSYSTEMATIC Business Risk Financial Risk

57

1. Systematic Risk

(A) Market risk Market risk is referred to as stock variability due to changes in investors attitudes & expectations. The investor reaction towards tangible and intangible events is the chief cause affecting market risk.

(B) Interest rate risk

There are four types of movements in prices of stocks in the markets. These may termed as (1) long term, (2) cyclical (bull and bear markets), (3) intermediate or within the cycle, and (4) short term. The prices of all securities rise or fall depending on the change in interest rates. The longer the maturity period of a security the higher the yield on an investment & lower the fluctuations in prices.

(C) Purchasing Power risk

Purchasing power risk is also known as inflation risk. This risk arises out of change in the prices of goods & services and technically it covers both inflation and deflation periods. During the last two decades it has been seen that inflationary pressures have been continuously affecting the Indian economy. Therefore, in India purchasing power risk is associated with inflation and rising prices in the economy.

58

2. Unsystematic Risk: -

The importance of unsystematic risk arises out of the uncertainty surrounding of particular firm or industry due to factors like labour strike, consumer preferences and management policies. These uncertainties directly affect the financing and operating enviourment of the firm. Unsystematic risks can owing to these considerations be said to complement the systematic risk forces.

(A) Business risk

Every corporate organization has its own objectives and goals and aims at a particular gross profit & operating income & also accepts to provide a certain level of dividend income to its shareholders. It also hopes to plough back some profits. Once it identifies its operating level of earnings, the degree of variation from this operating level would measure business risk.

Example:If operating income is expected to be 15% in a year, business risk will be low if the operating income varies between 14% and 16%. If the operating income were as low as 10% or as high as 18% it would be said that the business risk is high.

(B) Financial Risk: -

Financial risk in a company is associated with the method through which it plans its financial structure. If the capital structure of a company tends to make earning unstable, the company may fail financially. How a company raises funds to finance its needs and growth will have an impact on its future earnings and consequently on the stability of earnings. Debt financing provides a low cost source of funds to a company, at the same time providing financial leverage for the common stock holders. As long as the earnings of the company are higher than the cost of borrowed funds, the earning per share of common stock is increased. Unfortunately, a large amount of debt financing also increases the variability of the returns of the common stock holder & thus increases their risk. It is found that variation in returns for shareholders in levered firms (borrowed funds company) is higher than in unlevered firms. The variance in returns is the financial risk. 59

Risk Return Of Various Investment Alternatives

Market Investment Risk Purchasing Power Risk L L L L L H H H H H H M-H H H

Management Decision Required H H M M L L L L L O O O O O

Business Risk H H M M M L L L L L L L L L

Interest Risk L L L L L H H L L L L L L L

Growth stock Speculative stock Blue chips Convertible referred stock Convertible debentures Corporate bonds Government bonds Short-term bonds Money market funds Life insurance Commercial banks Unit trusts Saving a/c Cash common

H H M M M L L L L L L L L L

So, there are so many investment options & the different option have different benefits & limitations in the sense risk associated with it. So it is difficult for them to chose option, which give maximum return at minimum risk.

60

Chapter-3 Research Methodology

61

OBJECTIVE OF THE STUDY

To provide knowledge to investor about various type of risk associated with various investment instruments. To provide investor knowledge about P\E, P\BV and Beta that would help them in selection of script and creation of portfolio. To help investor in learning about derivative instrument future for the purpose of speculation and hedging.

62

METHODOLOGY OF THE PROJECT

Research problem: To identified the Stock Market Investment Avenue. Methods to help investor in selection of script to create portfolio. The measures of hedging the portfolio with the use of derivative instrument future.

Data collection:

Primary data : - Primary data are collected by my regularly tracking the stock price of various script selected. Research area : Agra No. of respondents: 100 Sampling Method: Convenience Sampling Sampling Research Design: Exploratory Research Data Collected: Through self designed questionnaire.

Secondary data :- Secondary data are collected from various journals , websites and financial news paper.

63

Chapter-4 Data Analysis & Interpretation

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1. What amount of money you are invested normally? (i) Upto 5, 00,000 (ii) 10,00,000 to 15,00,000 (iii) 15,00,000 to 20,00,000 (iv) Above 20,00,000

Chart Title
Above 20,00,000 10%

Upto 5,00,000 25% 15,00,00020,00,000 35%

10,00,00015,00,000 30%

INTERPRETATION According to the survey, we find that 25% people says that we are investing the money upto 5,00,000 and 30% people says that we are investing the money 10,00,000-15,00,000 and 35% to 10% people says that we are investing the money from 15,00,000-20,00,000 to above 20,00,000.

65

2. Over what period are you prepared to invest? (i) Very short (<1 year) (ii )Short (1-5 years) (iii) Medium (5-10 years) (iv) Long (10+years)

Chart Title

long 25%

very short 25%

medium 20%

short 30%

INTERPRETATION According to the survey, we find that 25% people says that we are investing the money for very short period and 30% people says that we are investing the money for short period and 20% to 25% people says that we are investing the money for medium and long period.

66

3. How would you describe your investment knowledge & experience? (i) No experience (ii) In experience (iii) Moderate experience (Iv) Highly experience

Chart Title
No experience 10%

Highly experience 25%

In experience 30%

Moderate experience 35%

INTERPRETATION According to the survey, we find that 10% people says that we are no experience and 30% people says that we are inexperience and 35% to 25% people says that we are moderate experience and highly experience.

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4. How many times in the past have you invested or traded in Shares, Bonds, Fixed interest &Funds? (i) Never (ii) Infrequently (iii) Regularly (iv) Active investor

Chart Title
Never 15% Active Investor 30% Infrequently 30% Regularly 25%

INTERPRETATION According to the survey, we find that 15% people says that we are never invested and 30% people says that we are infrequently invested and 25% to 30% people says that we are regularly and active investor.

68

5. Yours preferences in respect of the assumed risk? (i) Low risk (ii) Medium risk (iii) High risk (iv) No risk

Chart Title

No risk 30%

Low risk 35%

High risk 15%

Medium risk 20%

INTERPRETATION According to the survey, we find that 35% people says that we are low risk and 20% people says that we are medium risk and 15% to 30% people says that we are high risk.

69

6. What are your financial objective for this portfolio? (i) Savings for future retirement (ii) Retirement income being drawn (iii) Lump sum for capital growth (iv) Inheritance

Chart Title

Inheritance 20%

Saving for future retirement 30%

Lumpsum for capital growth Retirement 25% income being drawn 25%

INTERPRETATION According to the survey we find that 20 %people says that its financial ojective is Inheritance, 30 % people says that saving for future retirement, 25% people says That lumpsum for capital growh and rest 25 % people says that retirement income Being drawn.

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7. If you have more than one main goal for your investment. Do you wish for Investment Policy Statement & recommendation to be divided into separate portfolio? (i) Yes (ii) No (iii) May be (iv) Not applicable

Chart Title
Not applicable 10%

May be 20%

Yes 40%

No 30%

INTERPRETATION According to this survey 10% people says that it is not applicable 20 % people Says that may be think on that 30 % people says that no, and rest of 40% people Says that its yes.

71

8. Indicate the % of equity market capitalization as of the most recent quarter end? (i) Micro cap (ii) Small cap (iii) Mid cap (iv) Large cap

Chart Title
Micro cap 10% Large cap 15%

Mid cap 35%

Small cap 40%

INTERPRETATION According to this survey, 10% people says that micro cap for equity market Capitalization as of the most recent quarter end 15% people says that for the Large cap 35% for the mid cap, and rest of the 40% people like for small cap.

72

9. If a couple, do you wish to have your portfolio work done separately? (i) Yes (ii) No (iii) May be (iv) Not applicable

Chart Title
Yes 20% Not applicable 25%

May be 25%

No 30%

INTERPRETATION According to his survey, 25% people says that its not applicable, 25% People says that may be, 30% people says that no idea and rest 20% People says yes.

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10. Periodically,it is appropriate that you and the advisor review the relationship & the policy being implemented. How often will this IPS (initial public share) review & updated? (i) Annually (ii) Every 2 years (iii) Every 3years (iv) Every 4years

Chart Title

Every 4 years 35%

Anually 30%

Every 2 years 20% Every 3 years 15%

INTERPRETATION According to this survey, 35% people says that every 4 years, 30% people Says that its anually,15% people says that its for 3 years, and rest 20% People says that fooor 2 years.

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11. What % of assests available for investment would the portfolio represent? (i) 25% (ii) 50% (iii) 75% (iv) 100%

Chart Title
1 10% 4 40% 2 20%

3 30%

INTERPRETATION According to this survey,40% people says that the assets available for Investment portfolio represent,10% people says that the assests available for Investment portfolio represent, 20% to 30% people says that the assests available for Investment portfolio represent. 12. Have you ever being investment in financial products? (i) Equities (ii) Bonds (iii)ETFs/ETCs
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(iv) Foreign currencies

Chart Title
Foreign curriences 20% ETFs/ETCs 20% Bonds 25%

Equities 35%

INTERPRETATION According to this survey, 20% people says that to invest his money on the Foreign currencies, 35% people says that for equities, 20% people says that For ETFs/ETCs and rest 25% people says that to invest his money on bonds.

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Chapter-5 Findings & Conclusion

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FINDING OF THE REPORT

Findings of the report gives the fruit of the all the analysis done on the research of measuring and comparing performance of the portfolio with the market portfolio.

Random portfolio

After understanding the various concepts about what are the investments option and what are the risks associated with the various investment avenues. And also about how one can use Derivative to be specific Future for the purpose of Hedging and Speculation.

But it is advisable to use the direct equity investment only if the investors have adequate knowledge about selection of stocks. There task does not ends with the selection of script but they are also required to pay close attention to the various happening in the economy that have direct or indirect effect on stock market as we have learn that the price of the script is affected by two factor, one is company specific news and the other is economy specific news so any investor investing in the equity directly has to keep the close track of the economy as well as the company in which they invest to look out for any new development that take place

As in the theoretical way we have scene that the Beta shows the movement or change in the price of script vis--vis index. And a Beta >1 is more riskier and hence should give more return as compared to the script having Beta < 1. as the person is taking more risk then he should get more return. But in our case we have scene that Moderate portfolio having Beta < 1 has given more return as compared to Aggressive Portfolio.

So we can easily say that the investment in equity market is subject to market risk and any one having long-term investment horizon should only enter into equity market. This analysis that has been carried out was only for a period of two month there are chances that in the long run aggressive portfolio would outperform the other portfolio. 78

And we have also scene the Derivative- Future how one can use it for the purpose of speculation and hedging. But hedging is only for the removal of unnecessary risk or exposure one should not go for hedging for earning excess return.

So if one does not have enough knowledge, expertise & analytical capabilities then one should avoid going for direct equity investment as the chances of loss increases. And the other very important aspect is the regular monitoring of the portfolio and reviewing is also an important aspect that one needs to pay close attention to.

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Sector portfolio Sector portfolio has given negative return in the month of the study as there is systemic risk as very high in the sector portfolio because of non diversification. This portfolio has given -3.62% returns on the one month performance so it is advisable for the investor not to go for such a high risky investment options. All the individual scripts and the portfolio showing very steady chart, there is very little movement in the performance chart. There is a very high Beta of majority of the scripts in the portfolio edging more than 2 in most of the script. Only one script having a Beta under 1 but it is too low to give a good return on the investment. Because of that the overall portfolio Beta is also sizing more than 2. In the sector portfolio the volatility of the majority of script is under 10. Thats shows less risk with the portfolio and also less fluctuation means less chance of return.

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Chapter-6 Suggestions/Recommendations

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RECOMMENDATION
From the above given findings and the conclusions of the study done by me, here are the list of recommendations that comes out of the study.

Form the study it is also proven that even in short run sector portfolio is highly risky option for investment. Here in the study it is providing negative return. That shows that investors who want to have safe return must think twice before selecting sector portfolio for a long term investment.

Though random portfolio is having scripts with highest return and volatility, but for a long term prospect is becomes hard to fetch good return out of it as it is hard to take use of high volatility.

There is a requirement for frequent portfolio checking to maintain the higher return and to make use of high volatility.

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Chapter-7 Limitation

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LIMITATIONS OF THE PROJECT

The time duration given to complete the report was not sufficient. The report is basically is made between the horizon of two months and the situation of market is very dynamic so the conclusion or the return might not reflect the true picture.

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Bibliography

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Bibliography Books:
1. Derivatives Module of NSE ( NCFM ) 2. Securities analysis and Portfolio Management -B.K. Bhalla

Magazine & Journals/Newspaper

1. Magazines Business World

2. News Papers Economic Times of India Times of India

Internet :

1. www.kotaksecurities.com 2. www.nseindia.com 3. www.bseindia.com 4. www.derivativesindia.com 5. www.moneycontrol.com

6. www.icicidirect.com

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Questionnaire

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Dear respondent, I am student of MBA. I am working on the project of Portfolio Management Services. You are requested to fill the questionnaire to enable, to undertake the study on the said Project. Name. Occupation Address Phone no... 1. What amount of money you are invested normally? (i) Upto 5, 00,000 (ii) 10,00,000 to 15,00,000 (iii) 15,00,000 to 20,00,000 (iv) Above 20,00,000

2. Over what period are you prepared to invest? (i) Very short (<1 year) (ii )Short (1-5 years) (iii) Medium (5-10 years) (iv) Long (10+years)

3. How would you describe your investment knowledge & experience? (i) No experience (ii) In experience (iii) Moderate experience (Iv) Highly experience 88

4. How many times in the past have you invested or traded in Shares, Bonds, Fixed interest &Funds? (i) Never (ii) Infrequently (iii) Regularly (iv) Active investor 5. Yours preferences in respect of the assumed risk? (i) Low risk (ii) Medium risk (iii) High risk (iv) No risk

6. What are your financial objective for this portfolio? (i) Savings for future retirement (ii) Retirement income being drawn (iii) Lump sum for capital growth (iv) Inheritance

7. If you have more than one main goal for your investment. Do you wish for Investment Policy Statement & recommendation to be divided into separate portfolio? (i) Yes (ii) No (iii) May be (iv) Not applicable

8. Indicate the % of equity market capitalization as of the most recent quarter end? (i) Micro cap (ii) Small cap (iii) Mid cap (iv) Large cap

9. If a couple, do you wish to have your portfolio work done separately? (i) Yes (ii) No (iii) May be (iv) Not applicable

10. Periodically,it is appropriate that you and the advisor review the relationship & the policy being implemented. How often will this IPS (initial public share) review & updated? (i) Annually (ii) Every 2 years (iii) Every 3years (iv) Every 4years 89

11. What % of assests available for investment would the portfolio represent? (i) 25% (ii) 50% (iii) 75% (iv) 100%

12. Have you ever being investment in financial products? (i) Equities (ii) Bonds (iii)ETFs/ETCs (iv) Foreign currencies

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