Module 1

Introduction to
Investment and Securities

Prof. Rahul Mailcontractor,

KLS’s Institute of Management Education and Research,
Hindwadi, Belgaum
 Investment
• Investment is the employment of funds on assets to earn income or capital
appreciation. Investment has two attributes time and risk.
• Investment is sacrifice of current consumption of resources for future
benefit.
• The individual who makes an investment is known as the investor.
• In economic terms, investment is defined as the net addition made to the
capital stock of the country.
• In financial terms, investment is defined as allocating money to assets with
a view to gain profit over a period of time.
• Investments in economic and financial terms are inter-related where an
individual's savings flow into the capital market as financial investment,
which are further used as economic investment.
 Speculation
• Speculation means taking business risks with the
anticipation of acquiring short term gain.
• It also involves the practice of buying and selling
activities in order to profit from the price fluctuations.
• The time factor involved in speculation is different
from an investor and his investments are for short
term.
• Speculator is interested in market action and price
movements.
• Speculator invests based on technical analysis and
price movements and not on fundamental factors.
 Difference between
Investor and Speculator
Base Investor Speculator
Time horizon Has a relatively longer planning Has a very short planning
horizon. His holding period is horizon. His holding period
usually of one or more than one may be few days to months.
year.
Risk Assumes moderate risk Assumes or willing to take
high risk
Returns Seeks moderate return Seeks high returns for
associated with lower risk assuming high risk
Decision Attaches greater significance to Attaches greater significance
fundamental factors and to hearsay, market
carefully evaluates the behaviour, technical charts
performance of the company. and inside information.
Funds Uses his own funds. Uses borrowed funds along
with his personal funds.
 Gambling
• Gambling is investing for a very short term in
a game of chance where the out is not known.
• Time horizons in gambling is shorter than
investment or speculation.
• The results are determined by outcome of
uncertain events like roll of dice or turn of
cards and are known immediately.
• Gambling involves artificial risk and does not
involve real risk resulting in economic return.
 Investment Objectives
• Rate of Return : The total return, the investor receives during
his holding period includes current income and capital
appreciation.
End period value  Purchase period value
+ Dividends
Return =  100
Purchase period value

• Risk: Variability in the return. Investments whose returns vary

widely are considered as risky. The measures of risk are
variance, standard deviation, beta etc.
• Liquidity/Marketability: The ease, time and cost involved in
converting investment into cash determines its liquidity.
Investments are highly liquid if,
1. They can be transacted quickly
2. The transaction cost is low
3. The price change between successive transactions is negligible.
• Safety: Investments are affected by different types of risks.
Safety refers to the legal and regulatory protection to the
investment. If approved by law the safety also differs from
one mode of investment to another.
• Hedge against inflation: The returns should be higher than
the rate of inflation to ensure cover against inflation and rise
in prices or fall in purchasing value of money.
• Tax Shelter: Different investments attract different tax
rates. The investor tries to minimize tax outflow and
maximize returns. Tax benefits are of following three types
1. Initial tax benefit- relief at the time of investing Ex.PPF,
EPF etc
2. Continuing tax benefit- Tax shield associated with periodic
returns Ex. Dividends
3. Terminal benefits- Relief when the investment is liquidated
Ex. Long term investment in equity
 The Investment Process
The process of investment includes five stages:
1. Framing of Investment Policy: The policy is formulated on
the basis of investible funds, objectives and knowledge about
investment sources.
a. Investible funds: Availability of investible funds generated
from savings or borrowing. The returns on invested funds
should be higher than cost of investments (interest)
b. Objectives and constraints: Objectives are current ( regular)
income, capital appreciation and safety of principal. Required
rate of return, risk perception and need for liquidity are other
objectives.
The constraints arise from liquidity, time
horizon, tax and special circumstances.
c. Knowledge: Knowledge of investment alternatives and market
is very important to frame a policy. Alternatives range from
securities to real estate. Risk and returns associated with each
alternative should be know.
2. Security Analyses: In security analysis, economic
(market) analysis, industry and company analysis
are carried out for the purchase of securities.
a. Economic analysis: Factors like GDP, inflation,
interest rates, BOP, Savings and investment, Fiscal
and monetary policy etc are analyzed
b. Industry: Factors like type of industry, industry life
cycle, nature of competition are analyzed
c. Company: Factors like business model, financial
statements, operating efficiency, management are
analyzed.
3. Valuation: Intrinsic value of the share is measured
using various discounting models like dividend
discount model, Free cash flow model etc. Various
earnings multiple like P/B multiple and P/E ratio are
used to find value of the share.
4. Portfolio Construction: Portfolio is constructed in
order to meet the investors goals and objectives.
Portfolio is diversified to maximize return and
minimize risk.
5. Choice of Asset mix: This is concerned with the
proportion of various financial instruments like
stocks, bonds and other assets in the portfolio. This
depends on risk tolerance and investment horizon of
the investor.
6. Portfolio Evaluation: The performance of the
portfolio is appraised and revised. The portfolio
should be evaluated periodically. The variability in
returns of securities is measured and compared. Low
yielding securities with high risk are replaced with
high yielding securities with low risk.
 Participants in securities market
• Issuer: Corporate entities issue equity shares and
debentures while financial institutions and public
sector enterprises issue equity shares and bonds. RBI
issues government securities, treasury bills and
bonds.
• Buyer: The buyers consists of domestic institutional
investor( DIIs), corporate entities, banks, pension
funds, mutual funds, Foreign Institutional
investors(FIIs) and retail investors.
• Market Intermediaries: Merchant Bankers, Clearing
and Settlement houses, Depositories, Credit Rating
Agencies, Debenture trustees, Bankers, Brokers etc
• Regulators: Ministry of Finance, RBI, SEBI etc.
 Investment Alternatives
• Investment alternatives are broadly classified into Financial
Assets and Real Assets.
• Financial assets are in the form of paper(or electronic) assets
which are claims on some issuer such as the government or
corporate body.
Ex. Equity shares, corporate debentures, government
securities, deposits with bank, mutual funds units, insurance
policies and derivatives.
Financial Assets can be further classified as marketable
Financial assets and non marketable financial assets
• Real assets are represented by tangible assets like residential
house, commercial property, agricultural farm, gold, precious
stones and art
Marketable (Negotiable) Securities
• Equity Shares
• Bonds/ Debentures
• Government securities
• Money market instruments
• Derivatives
• Mutual funds
 Equity Shares
• Common stock or ordinary shares are most
commonly known as equity shares. It represents
ownership of the company. Equity share holders
bear the risk and rewards of ownership.
• Stock is a set of shares put together in a bundle.
• A share is a portion of the share capital of a company
divided into small units of equal value.
• The advantages of equity shares are:
– Capital appreciation
– Limited liability
– Hedge against inflation
• Authorized share capital: The amount of capital that a
company can issue as per its MOA represents authorized share
capital
• Issued capital: The amount offered by the company to
investors is called issued capital.
• Subscribed capital: the part of issued capital that has been
subscribed to by the investors is subscribed capital.
• Paid up capital: The actual amount paid is called paid up
capital.
Usually the issued, subscribed and the paid up capital
are same.
The par value or face value is stated in the MOA. It is
generally Rs.10. It can be Rs. 5, 50,100 or any value decided
by the BOD. The issue price is the price at which the equity
share is issued. If the issue price is greater than the face value
it is issued at premium and if it is less than the face value it is
issued at a discount.
 Stock market classification of equity Shares
• Blue chip shares: Shares of large, well established and financially strong
companies with sound track record of earnings and dividends. Ex.
Infosys, ICICI, Reliance Ind, SBI, TCS, M&M, HUL etc
• Growth shares: Shares of companies that have been growing and which
enjoy an above average rate of growth and profitability. Ex. IT sector
• Income shares: Share of companies that have fairly stable operations,
relatively limited growth opportunities and high dividend payouts. Ex.
• Cyclical shares: The shares which are affected by the upward and
downward movement of the business cycle are cyclical shares. Ex. Auto
companies
• Defensive shares: Shares of companies that are relatively unaffected by
the ups and downs in general business conditions. Ex. Pharma and
FMCG companies
• Speculative shares: Shares that tend to fluctuate widely because there is
a lot of speculative trading in them. Ex. Small and Mid cap stocks.
 Preference Stock
• The characters of the preferred stock are hybrid in nature.
Preference shares are those shares which carry preferential
rights as the payment of dividend at a fixed rate and as to
repayment of capital in case of winding up of the company.
Thus, both the preferential rights viz. (a) preference in
payment of dividend and (b) preference in repayment of
capital in case of winding up of the company, must attach to
preference shares. The rate of dividend on these shares is fixed
and the dividend on these shares must be paid before any
dividend is paid to ordinary shares
• Preference stockholders do not have any voting rights.
• Like the equity, it is a perpetual liability of the corporate.
• Preference stockholders do not have any share in case the
company has surplus profits.
 Types of Preference Stocks
• Cumulative preference shares: The cumulative total of all
unpaid preferred dividends must be paid to the shares holders
before dividends are paid to common equity shareholders. The
arrears accrue only for a limited period.
•Non-cumulative preference shares: Here the unpaid dividends
do not accrue. If the company does not earn adequate profit the
dividends will not be paid.
•Convertible preference shares: These preference shares can be
converted to equity shares at end of specific period and are quasi
equity shares.
•Redeemable preference shares : A preference share which
must be bought back by the company at an agreed date and for
an agreed price or after giving a proper notice of redemption to
preference shareholders. If the provision of AOA to issue these
shares is available they can be issued.
•Irredeemable preference shares: Irredeemable preference
shares are those shares which cannot be redeemed during the
lifetime of the company.
•Cumulative convertible preference shares: Cumulative
Convertible Preference Share are a type of preference shares
where the dividend payable on the same accumulates, if not
paid. After a specified date, these shares will be converted into
equity capital of the company.
 Bonus Shares
• A company builds up its reserves by retaining part of
its profit over the years. These reserves and surplus is
converted into capital and divided among members in
proportion to their rights as fully paid bonus shares.
Bonus issue is also known as capitalization issue.
• Distribution of shares, in addition to the cash
dividends, to the existing shareholders are known as
bonus shares.
• These are issued without any payment of cash.
• Bonus shares are distributed in a fixed ratio to the
shareholders
• These are issued by capitalizing the reserves of the
company.
 Non-voting Shares
• The shares that carry no voting rights are
known as non-voting shares.
• They provide additional dividends in the place
of voting rights.
• They can be listed and traded on the stock
exchanges.
 Sweat Equity
• It is a new equity instrument introduced in the Companies
(Amendment) Ordinance, 1998.
• It forms a part of the equity share capital as its provisions,
limitations and restrictions are same as that of equity shares.

Sweat Equity is for:

 The directors or employees involved in the process of
designing strategic alliances.
 The directors or employees who have helped the company
to achieve a significant market share.
 Debenture
• It is a debt instrument issued by a company, which carries a
fixed rate of interest.
• It is generally issued by private sector companies as a long
term promissory note for raising loan.
• The company promises to pay interest and principal as
stipulated.
• Debentures are generally freely transferable by the debenture
holder.
• It generally specifies the date of redemption, repayment of
principal and interest on specified dates.
• It may or may not create a charge on the assets of the
company.
 Types of debentures
• Secured debentures: Secured debentures are debentures secured
by a charge on the fixed assets of the issuer company. For
instance, mortgage debentures secured on land of the company.
When the issuer company fails on payment of either the principal
or interest amount, the assets of the company can be sold to
repay the liability to the investors.
• Unsecured debenture: Unsecured debentures are debentures
that are not supported by a collateral security. No specific assets
will be set aside against unsecured debentures. It is basically a
loan with out any protection. They are backed only by the
general credit worthiness of the issuer.
• Convertible debenture: Convertible debentures are debentures
issued with the privilege of converting them into other forms of
securities, usually the common stock of the issuing corporation.
Such debentures gives choice to the lender to take stock or shares
in the company, as an alternative to taking the repayment of a
loan. Companies may use convertible debentures as a financing
tool which allows them to raise capital without selling stock.
• Partly convertible debenture: Partly convertible
debentures are convertible debentures that are
converted into equity shares in the future at notice of
the issuer. Part of such debentures will be redeemed
by the issuing company after a specified period of
time and part of it will be convertible into equity or
preference shares at the end of the specified period.
The issuer decides the ratio for conversion, usually at
the time of subscription.
• Non-convertible debenture: Non-convertible
debentures, which are simply regular debentures,
cannot be converted into equity shares of the liable
company. They are debentures without the
convertibility feature attached to them. As a result,
they usually carry higher interest rates than their
convertible counterparts.
 Bond
• A bond is a long term debt security issued by the
government, quasi- government, public sector
enterprises and financial institutions that promises to
pay a fixed rate of interest called coupon rate for a
specified period of time.
• Bonds have a face value or par value. The bonds may
be issued at par or at premium or a discount.
• The interest is paid annually or semi-annually and is
specified on the bond certificate
• The maturity date is specified at the time of issue
except for perpetual bonds
• The redemption value is also stated on the bond. The
bond may be redeemed at premium or at par.
 Types of bonds
• Secured bonds: A type of bond that is secured by the
issuer's pledge of a specific asset, which is a form of
collateral on the loan. In the event of a default, the bond
issuer passes title of the asset or the money that has been
set aside onto the bondholders.
• Unsecured bonds: They are also called “debentures,”
are not secured by a specific asset, but rather the full
faith and credit of the issuer. In other words, the investor
has only the issuer’s promise to repay but no claim on
specific collateral
• Perpetual bonds: It is a bond with no maturity date.
Issuers pay coupons on perpetual bonds forever, and
they do not have to redeem the principal. Perpetual bond
cash flows are, therefore, those of a perpetuity.
• Redeemable bonds/Callable bond: It is a bond that can be
redeemed by the issuer prior to its maturity. Usually a
premium is paid to the bond owner when the bond is called.
The main cause of a call is a decline in interest rates. If
interest rates have declined since a company first issued the
bonds, it will likely want to refinance this debt at a lower rate
of interest.
• Fixed interest rate bonds :Fixed rate bonds have a coupon
that remains constant throughout the life of the bond
• Floating interest rate bonds : Floating rate bond or note
(FRNs, floaters) have a variable coupon that is linked to a
reference rate of interest, such as LIBOR or MIBOR. Bond
whose interest amount fluctuates in step with the market
interest rates, or some other external measure.
• Zero coupon bonds: It is a bond bought at a price lower than
its face value, with the face value repaid at the time of
maturity. The bondholder receives the full principal amount on
the redemption date. It does not make periodic interest
payments, hence the term zero-coupon bond.
• Deep discount bond: It is a bond that sells at a significant
discount from par value. A bond that is selling at a discount
from par value and has a coupon rate significantly less than
the prevailing rates of fixed-income securities with a similar
risk profile. Typically, a deep-discount bond will have a
market price of 20% or more below its face value. They have a
maturity period of 3 to 25 years. Deep discount bonds allow
investors to lock in a better rate of return for a longer period of
time but investors must be prepared since these bonds are
typically higher risk..
• Capital indexed bonds/Inflation-indexed bonds:
They are also known as inflation-linked bonds and
are bonds where the principal is indexed/adjusted to
inflation or deflation for every year in terms of the
official yearly CPI /WPI. It earns the investor a semi-
annual interest income for 5 years. The principal
amount is adjusted for inflation for each year.
Inflation-indexed bonds pay a periodic coupon that is
equal to the product of the inflation index and the
nominal coupon rate of the bond.
 Government securities
• A Government security is a tradable instrument issued by the
Central Government or the State Governments. Such securities
are short term (usually called treasury bills, with original
maturities of less than one year) or long term (usually called
Government bonds or dated securities with original maturity
of one year or more).
• In India, the Central Government issues both, treasury bills
and bonds or dated securities while the State Governments
issue only bonds or dated securities, which are called the State
Development Loans (SDLs). Government securities carry
practically no risk of default and, hence, are called risk-free
gilt-edged instruments. As a government guaranteed security
is a claim on the government, it is secure financial instrument
which guarantees the income and principal payment and hence
the rate of return is relatively lower and it has high liquidity.
 Money market securities
• The money market provides investment avenues of short term
tenor. Money market transactions are generally used for
funding the transactions in other markets including
Government securities market and meeting short term liquidity
mismatches. By definition, money market is for a maximum
tenor of up to one year. Within the one year, depending upon
the tenors, money market is classified into:
• i)Overnight market - The tenor of transactions is one working
day.
ii) Notice money market – The tenor of the transactions is
from 2 days to 14 days.
iii) Term money market – The tenor of the transactions is from
15 days to one year.
• Money market instruments include call money, repos,
Treasury bills, Commercial Paper, Certificate of Deposit
 Treasury Bills
• Treasury Bills are the instruments of short term borrowing by the
Central. They are promissory notes issued at discount and for a fixed
period. These are issued to raise funds for meeting expenditure
needs and also provide outlet for parking temporary surplus funds
by investors. Thus they are useful in managing short-term liquidity
These are highly liquid and safe investment giving attractive yield.
• At present, the Government of India issues three types of treasury
bills through auctions, namely, 91-day, 182-day and 364-day.
• Treasury bills are available for a minimum amount of Rs.25,000 and
in multiples of Rs. 25,000. Treasury bills are issued at a discount
and are redeemed at par
• While 91-day T-bills are auctioned every week on Wednesdays,
182-day and 364-day T-bills are auctioned every alternate week on
Wednesdays
• Commercial banks, scheduled urban co-operative banks, Primary
Dealers insurance companies and provident funds
 Commercial Paper (CP)
• Commercial Paper (CP) : It is an unsecured money market
instrument issued in the form of a promissory note.
• Corporate issue CPs directly or through merchant banks , primary
dealers (PDs) and the all-India financial institutions (FIs) that
have been permitted to raise short-term resources under the
umbrella limit fixed by the Reserve Bank of India are eligible to
issue CP.
• CP can be issued for maturities between a minimum of 7 days and
a maximum up to one year from the date of issue.
• The CPs are sold at a discount and redeemed at their face value.
• CPs can be issued with denominations of 5 lakhs and multiple
there of.
• All eligible participants must obtain the credit rating for issuance
of Commercial Paper .
 Certificate of Deposit (CD)
• Certificate of Deposit (CD) is a negotiable money market
instrument and issued in dematerialized form or as a Usance
Promissory Note, for funds deposited at a bank or other eligible
financial institution for a specified time period.
• Banks can issue CDs for maturities from 7 days to one a year where
as eligible FIs can issue for maturities 1 year to 3 years.
• It is a marketable receipt of funds deposited in a bank for a fixed
period at a specified rate of interest. It is a bearer document and
readily negotiable.
• The denominations of CDs and the interest rate on them are high.
Minimum amount of CD should be Rs. 1 lakh or multiple there of.
• It is preferred by institutional investors and corporates.
 Repos
• Repo is an abbreviation for Repurchase agreement, which
involves a simultaneous "sale and purchase" agreement. When
banks have any shortage of funds, they can borrow it from
Reserve Bank of India or from other banks.
• Repo or ready forward contact is an instrument for borrowing
funds by selling securities with an agreement to repurchase the
said securities on a mutually agreed future date at an agreed
price which includes interest for the funds borrowed.
• Predominantly, repos are undertaken on overnight basis, i.e.,
for one day period. Settlement of repo transactions happens
along with the outright trades in government securities.
 Mutual funds
• A trust that pools the savings of investors who share a common
financial goal is known as mutual fund. The money collected is
then invested in financial instruments such as shares,
debentures and other securities the income and capital
appreciation realized are shared by its unit holders in proportion
to the number of units owned by them.
• Investment in securities are spread over a wide cross section of
industries and sectors reducing the risk of the portfolio.
• Mutual funds are mobilizers of saving of the small investors in
instruments like stock and money market instruments.
• Mutual funds are corporation that accept money from investors
and use this money to buy stocks, long term bonds, short term
debt instruments issued by businesses or Govt.
 Products and Schemes
• Investors have the option of choosing from a wide variety of
schemes in a mutual fund depending upon their requirements.
MF’s are classified as follows:
– Operational classification:
• Open ended scheme: when a fund is accepted and
liquidated on a continuous basis by a MF manager, it is
called as open ended scheme. The fund manager buys
and sells units constantly as demanded by the investors.
The capitalization of the funds changes constantly as it is
always open for the investors to buy or sell their units.
The scheme provides excellent liquidity facility to the
investors. The buying and selling of units takes place at a
declared NAV(Net Asset Value)
• Close ended scheme: when a units of a scheme liquidated only
after the expiry of a specified period it is known as close ended
fund. Such funds have fixed capitalization and remain with the
mutual fund manager, units of close ended schemes are traded
on stock exchange in the secondary market. The price is
determined on the basis of supply and demand. There are 2
prices for such funds, one that is market determined and the
other is NAV based the market price may be above or below
NAV. Managing a close ended scheme is comparatively easy for
the fund Manager. The fund can be liquidated after a specified
period.
• Interval scheme: it is kind of close ended scheme with a feature
that it remains open during a particular part of the year for the
benefit of investors, to either off load or to undertake purchase
of units at a NAV.
 Return based classification
• Income fund scheme: this scheme is customised to suit the
needs of investors who are particular about regular returns.
The scheme offers maximum current income where by the
income earned by the units is distributed periodically there are
2 types of such schemes, one that earns a target constant
income at relatively low risk while the other offers maximum
possible income.
• Growth scheme: it is a MF scheme that offers the advantage
of capital appreciation of the underlying investment such
funds invest in growth oriented securities that are capable of
appreciating in the long run. The risk attached with such funds
is relatively higher.
• Conservative fund Scheme: a scheme that aims at providing a
reasonable rate of return, protecting the value of investment and
achieving capital appreciation is called a conservative fund
scheme. It is also known as middle of road funds as it offers a
blend of the above features. Such funds divide their portfolio in
stocks and bonds in such a way that it achieves the desired
objective.
 Investment based classification
• Equity fund: such fund invest in equity shares they carry a
high degree of risk such fund do well in favorable market
conditions. Investments are made in equity shares in diverse
industries and sectors.
• Debt funds: Such fund invest in debt instruments like bonds
and debentures. These funds carry the advantage of secure and
steady income there is little chance of capital appreciation.
Such funds carry no risk. A variant of this type of fund is
called liquid fund which specializes in investing in short term
money market instruments.
• Balanced funds: such scheme have a mix of debt and equity in
their portfolio of investments. The portfolio is often shifted
between debt and equity depending upon the prevailing market
conditions.
• Sectoral fund: Such fund invest in specific sectors of the
economy. The specialized sectors may include real estate
infrastructure, oil and gas etc, offshore investments,
commodities like gold and silver.
• Fund of Funds: such funds invest in units of other mutual
funds there are a number of funds that direct investments into
specified sectors of economy. This makes diversified and
intensive investments possible.
• Leverage funds: the funds that are created out of investments
with not only the amount mobilized from investors but also
from borrowed money from the capital markets are known as
leveraged funds. Fund managers pass on the benefit of leverage
to the mutual fund investors. Additional provisions must be
made for such funds to operate. Leveraged funds use short sale
to take advantage of declining markets in order to realize gains.
Derivative instruments like options are used by such funds.
• Gilt fund : These funds seek to generate returns through
investment in govt. securities. Such funds invest only in central and
state govt. securities and REPO/ reverse REPO securities. A
portion of the corpus may be invested in call money markets to
meet liquidity requirements. Such funds carry very less risk. Their
prices are influenced only by moment in interest rates.
• Indexed funds: these funds are linked to specific index. Funds
mobilized under such schemes are invested in securities of
companies included in the index of any exchange. The fund
performance is linked to the growth in concerned index.
• Tax saving schemes: certain MF schemes offer tax rebate on
investments made in equity shares under section 88 of income tax
act. Income may be periodically distributed depending on surplus.
Subscriptions made Upto Rs.10000 are eligible for tax rebate under
section 88 for such scheme. The investment of the scheme includes
investment in equity, preference shares and convertible debentures
and bonds to the extent 80-100% and rest in money market
instruments.
 Warrants
• A warrant is a detachable instrument, which gives the right to
purchase or sell equity shares at a specified price and period.
• It is traded in the securities market where the investor can sell
it separately.
• Two types of warrants are:
 Detachable warrants: When the warrants are issued along with host
securities and detachable, then they are known as detachable warrants.
 Puttable warrants: Represent a certain amount of equity shares that
can be sold back to the issuer at a specified price, before a stated date.
• Some of the advantages of warrants are:
 They have limited risk.
 They offer potential for unlimited profits.
 They can be traded in the securities market.
 Investment Information
 An investor must have adequate knowledge about the
investment alternatives and markets before making
any kind of investment.
 The various sources from which an investor can
gather the investment information are:
 Newspapers, Investment dailies
 Magazines and Journals
 Industry Reports
 RBI Bulletin
 Websites of the SEBI, RBI and other private agencies
 Stock market information