Financial Market Know How

Financial Market Know how

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This session will help you understand • The component and Structure of financial market. • The working of the equity as an asset class. • The working of the Fixed Income Securities. • The working of mutual fund products. • Economic Environment and indicators. • How to recommend a investment portfolio. 2

Financial Markets

Organizations that facilitate the trade in financial products. i.e. Stock exchanges facilitate the trade in stocks, bonds and warrants

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Types of financial markets The financial markets can be divided into different categories: – Capital Market • Stock markets, which provide financing through the issuance of shares and enable the subsequent trading. • Bond markets, which provide financing through the issuance of Bonds, and enable the subsequent trading. – Money markets, which provide short term debt financing and investment. – Derivatives markets, which provide instruments for the management of financial risk. – Foreign exchange markets, which facilitate the trading of foreign exchange. – Commodity markets, which facilitate the trading of commodities.

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Capital Market • The capital market is the market for securities, where companies and governments can raise long-term funds. • The capital market includes the stock market and the bond market. • Financial regulators oversee the capital markets to ensure that investors are protected against fraud. • The capital markets consist of primary markets and secondary markets. – Primary markets: Newly formed (issued) securities are bought or sold. – Secondary markets allow investors to sell securities that they hold or buy existing securities. 5

Primary Market • It deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. • In the case of a new stock issue, this sale is an initial public offering (IPO). • Features Of Primary Market are: – Market for new long term capital. – Securities are sold for the first time. – Issued by the company directly to investors • Methods of issuing securities in the Primary Market – Initial Public Offer; – Rights Issue (For existing Companies); and – Preferential Issue. 6

Secondary Market • It is the market for trading of securities that have already been issued in an initial offering • Once a newly issued stock is listed on a stock exchange, investors and speculators can easily trade on the exchange • A stock exchange is an organization which provides facilities for stock brokers and traders, to trade 7

Equity

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Understanding Equity

Equity is the form of shares of common stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in company decisions

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Ordinary shares - Equities • Part Owners of Company – Voting – receive annual report and accounts – entitlement to residual assets in case of winding up

• No Actual Ownership of Company Assets

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Preference shares • Fixed Dividend • Priority for dividend • Priority on liquidation of company

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Terminology

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EPS: Earning per Share •Earning per share: PAT/ No of equity share •PAT: Profit after tax of the company It denote the how much the company has earned on per share.

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P/E Ratio • Market price / number of shares outstanding • P/E could be either trailing or forward, depending on the type of earnings used in the denominator.

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Dividend Yield • Dividend is declared on the face value of the share. • The market price and face value of the share differs • Divided yield: Dividend/ price • In case of a dividend paying company, there is a cut off day – till the cut off day the price

High D/Y paying Company

Low D/Y paying 15 Company

Market capitalization • It gives the idea as how big the company. Price x No. of share

Where, Price: Market price No of share: No of fully diluted share

Large Cap

Small

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Index • A broad-base index represents the performance of a whole stock market — and by proxy, reflects investor sentiment on the state of the economy. – Meaning – represents the value of a set of stocks; relative in value – Importance • Barometer for market behavior • Benchmark portfolio performance • Underlying in derivative instruments like index futures • Passive fund management (index funds) 17

Index: Sensex • Short form of the BSE-Sensitive Index • Is a "Market Capitalization-Weighted" index of 30 stocks representing a sample of large, well-established and financially sound companies. • Base period of SENSEX is 1978-79. Actual total market value of the stocks in the Index during the base period is equal to an indexed value of 100. Calculation: • Divide the total market capitalization of 30 companies in the Index by the Index Divisor. 18

Types of equity research • Fundamental analysis – Future earnings and risk profile considered ( whether to buy or not) • Technical analysis – Study of historic data on the company’s share price movements and volume (To find timing) 19

Valuations • Valuation - process of determining the fair value of a financial asset. • Also referred to as ‘valuing’ or ‘pricing’. • The fundamental principle of valuation - value is equal to present value of expected cash flows. • Valuations of financial assets involve the following three steps: Step 1: Estimate the expected cash flows

Step 2: Determine the appropriate interest rate that should be used to discount the cash flows. Step 3: Calculate the present value of expected cash flows found in Step 1, using the interest rate or interest rate determined in Step 2.

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Equity Valuation • The valuation of equity share is more difficult. • The difficulties arise because of two factors first the rate of dividend on equity share is not known also the payment of equity dividend is discretionary.

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Valuation Process • There are two general approaches to the valuation process – Top- Down (three step) Approach – Bottom Up/ Stock Picking Approach

• Three step approach believe that the economy/ market and the industry effect have a significant impact on the total returns for the individual stock. • The stock picking contend that it is possible to find stocks that are undervalued relative to their market price and these will provide superior returns regardless of the market 22 and industry outlook.

The Bulls A bull market is when everything in the economy is great, people are finding jobs, gross domestic product (GDP) is growing, and stocks are rising. Picking stocks during a bull market is easier because everything is going up. Bull markets cannot last forever though, and sometimes they can lead to dangerous situations if stocks become overvalued. If a person is optimistic and believes that stocks will go up, he or she is called a "bull" and is said to have a "bullish outlook".

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The Bears A bear market is when the economy is bad, recession is looming and stock prices are falling. Bear markets make it tough for investors to pick profitable stocks. One solution to this is to make money when stocks are falling using a technique called short selling. Another strategy is to wait on the sidelines until you feel that the bear market is nearing its end, only starting to buy in anticipation of a bull market. If a person is pessimistic, believing that stocks are going to drop, he or she is called a "bear" and said to have a "bearish 24

Risk consideration Investment Risk: It is the total risk of the investment in stock which is measured by Standard deviation. It can be separated into systematic risk (non diversifiable risk) Plus Unsystematic Risk (Diversifiable Risk) A) Systematic Risk: It includes risks that affect the entire

market e.g. market risk, interest rate risk. Systematic risk cannot be eliminated through diversification because it affects the entire market. Beta is a measure by which systematic risk is determined.

B) Unsystematic risk:

It is unique to a single business or industry, such as operations and methods of financing. Unlike systematic risk, unsystematic risk can be eliminated through 25

Beta • Beta is a measure of the systematic risk of a security that cannot be avoided through diversification. • Beta is a relative measure of risk-the risk of an individual stock relative to the market portfolio of all stocks. • If the stock has a beta of 1, the implication is that the stock moves exactly with the market. • A beta of 1.2 is 20 percent riskier than the market and 0.8 is 20 percent less 26

Return Computation • Total return or Holding period return: The period during which the investment is held by the investor is known as holding period and the return generated on that investment is called as holding period return during that period.

• Compounded Annual Growth Rate (CAGR): The year-over-year growth rate of an investment over a specified period of time.

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CAGR Computation • Suppose you invested Rs. 10,000 in a portfolio on Jan 1, 2005. Let's say by Jan 1, 2006, your portfolio had grown to Rs. 13,000, then Rs. 14,000 by 2007, and finally ended up at Rs. 19,500 by 2008. Your CAGR would be the ratio of your ending value to beginning value (Rs. 19,500 / Rs. 10,000 = 1.95) raised to the power of 1/3 (since 1/# of years = 1/3), then subtracting 1 from the resulting number: 1.95 raised to 1/3 power = 1.2493. (This could be written as 1.95^0.3333).  1.2493 - 1 = 0.2493

• Another way of writing 0.2493 is 24.93%. Thus, your CAGR for your three-year investment is equal to 28

Risk Adjusted Return • A higher return by itself is not necessarily indicative of superior performance. • Alternately, a lower return is not indicative of inferior performance. • There are composite equity portfolio measures that combine risk and return to give quantifiable risk-adjusted numbers. • The most important and widely used measures of performance are: – The Sharpe Measure 29

The Treynor Measure • Relative measure of the risk adjusted performance of a portfolio based on the market risk (i.e. the systematic risk). • Treynor Index (Ti) = (Ri - Rf)/Bi. • Where, Rp represents return on portfolio, Rf is risk free rate of return and Bi is beta of the portfolio. 30

The Sharpe Measure • Relative measure of risk adjusted performance of a portfolio based on total risk (systematic risk + nonsystematic risk). • Standard deviation is used as the measure for the total risk. In comparing, bigger is better Sharpe Index (SI) = (Rp - Rf)/SD • Where, SD is standard deviation of the fund, Rp is the portfolio rate of return and Rf is the risk free rate of return. 31

Long Term Investors Get Rewarded PERFORMANCE OF BSE SENSITIVITY INDEX

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YEAR END

SENSEX

Rolling 1 Yr Growth

Rolling 3 Rolling 5 Rolling 7 Yr Growth Yr Growth Yr Growth

High Risk 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

Mar-79 100 Mar-80 128.57 Mar-81 173.44 Mar-82 217.71 Mar-83 211.51 Mar-84 245.33 Mar-85 353.86 Mar-86 574.11 Mar-87 510.36 Mar-88 398.37 Mar-89 713.6 Mar-90 781.05 Mar-91 1167.97 Mar-92 4285 Mar-93 2280.52 Mar-94 3778.99 Mar-95 3260.96 Mar-96 3366.61 Mar-97 3360.89 Mar-98 3892.75 Mar-99 3739.96 Mar-00 5001.28 1-Mar 3604.38 2-Mar 3469 3-Mar 3049 4-Mar 5528 5-Mar 6492.82 6-Mar 11279.96 7-Mar 13072.1 8-Mar 15644.44 Probability of Loss Investment Success

28.57% 34.90% 25.52% -2.85% 15.99% 44.24% 62.24% -11.10% -21.94% 79.13% 9.45% 49.54% 266.88% -46.78% 65.71% -13.71% 3.24% -0.17% 15.82% -3.92% 33.73% -27.93% -3.76% -12.11% 81.31% 85.14% 57.17% 15.89% 19.68% 29-Oct 66%

29.58% 18.05% 12.24% 17.56% 39.45% 27.66% 4.02% 7.51% 15.22% 43.12% 81.66% 42.88% 47.85% -8.70% 13.85% -3.83% 6.08% 3.57% 14.15% -2.53% -2.48% -15.21% 15.32% 23.24% 54.66% 33.23% 34.06% 27-May 81%

Rolling 10 Yr Growth

Rolling 15 Yr Growth

Medium Risk

19.64% 22.43% 27.03% 18.57% 13.48% 23.79% 17.15% 15.25% 52.97% 41.73% 39.54% 33.07% 23.55% -4.74% 11.28% -0.21% 8.92% 1.37% 0.64% -4.77% 8.13% 5.36% 25.63% 30.39% 38.69% 25-Mar 88%

28.33% 21.76% 12.60% 18.47% 20.50% 24.96% 42.76% 21.76% 33.08% 35.02% 24.79% 23.16% 18.75% -1.92% 11.86% -0.67% 0.89% -1.41% 7.37% 10.34% 17.08% 14.71% 23.33% 23-Mar 87%

Rolling 20 Yr Growth

Safe

21.70% 19.76% 21.00% 34.68% 26.82% 31.43% 24.85% 19.33% 20.72% 25.59% 18.01% 20.39% 11.92% -2.09% 2.95% 3.88% 2.64% 12.09% 14.19% 17.77% 20-Jan 95%

27.37% 24.04% 21.84% 20.00% 21.41% 19.90% 19.30% 13.02% 13.63% 14.53% 14.62% 15.16% 16.32% 7.72% 13.70% 0/15 100%

19.85% 20.09% 16.38% 14.85% 14.27% 16.85% 15.66% 16.06% 17.60% 20.14% 0/10 100%

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Fixed Income Securities

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Introduction to Bonds

A financial obligation to pay a specified sum of money at specified future date- Fixed Income Investment

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Basic Features • Term to Maturity: The number of years the debt is outstanding. • Par Value: The agreed repayment amount to the bondholder at or by maturity date. • Coupon Rate (Nominal Rate): The interest rate that the issuer agrees to pay each year. • Zero Coupon Bond: Bonds that are not contracted to make periodic coupon payment.

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Floating Rate Securities • Coupon rate need not be fixed over the bond’s life. • Floating rate securities - coupon payments reset periodically according to some reference rate. • Calculated as – Coupon rate = reference rate x Quoted margin • Quoted margin: additional amount that the issuer agrees to pay above the reference rate.

Coupon rate = 1 month MIBOR +Quoted Basis point

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Classification of Bonds

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Risk associated with Fixed Income Securities • Interest rate risk: Inverse Relationship between Interest or Yield and bond price. • Following relationship will hold: – Price of a bond = par if coupon rate = yield. – Price of a bond can be < par (sell at discount) or > par (sell at a premium) if the coupon rate is different from yield. • Maturity Effect: All other factors constant, the longer maturity, greater the price sensitivity to interest rates changes.

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Risk associated with Fixed Income Securities • Reinvestment risk: Risk of reinvestment of interest income or principal repayments at lower rates in a declining rate environment. • Credit risk: An investor who lends funds by purchasing a bond issue is exposed to credit risk. • There are two types of credit risk: – Default Risk: Risk that the issuer will not meet the obligation of timely payment of interest & principle. – Downgrade Risk: Risk that one or more of the rating agencies will reduce the credit rating of an issue or issuer. 39

What is a credit rating ? • Rating organizations evaluate credit worthiness of an issuer . • Evaluation on ability to pay back debt. • The rating is an alphanumeric code representing creditworthiness. • The highest credit rating - AAA & lowest - D (for default). • Short-term instruments* rating symbol - "P" (varies depending on the rating agency). • In India, we have 4 rating agencies: CRISIL

ICRA

CARE

Fitch

*of less than one year

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Credit Rating An important tool used to gauge the default risk of an issue credit ratings by rating companies. •

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Risk associated with Fixed Income Securities • Inflation Risk/Purchasing power risk: Risk of decline in the real value of the security due to inflation. • Liquidity Risk: Liquidity risk is the risk that the investor will have to sell a bond below its expected value.

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Relationship between parameters • The relationship between coupon rate, yield, price and par value are as follows: – Coupon rate = Yield required by market, therefore price = par value – Coupon rate < Yield required by market, therefore price < par value (discount) – Coupon rate > Yield required by market, therefore price > par value (premium)

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Yield Measures • Investor should value bonds in terms of Yields and in not rupee terms. • For fixed income instruments, returns can be from : • Coupon interest payment • Capital gain on sale or maturity • Reinvestment of interim cash flow. • Current Yield: relates coupon interest to bond’s market price. • Same as dividend yield to stocks. • Computed as follows • Current yield= Annual coupon / market price

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Yield to Maturity • The Yield to maturity is interest rate that will make the present value of the cash flow equal to price plus accrued interest. It is also known as IRR of bond. • It takes in to account all three sources of return. • The most widely used bond yield figure as it indicates the fully compounded rate of return promised to an investor who buys the bond at prevailing prices, if two assumptions hold true. • The first assumption is that the investor holds the bond to maturity. • Investors reinvest all the interim cash flows at the computed YTM rate. 45

Debt Markets • Capital Markets comprise of : – Equities Market & – Debt Markets. • The Debt Market - where fixed income securities of various types and features are issued and traded. • Fixed income securities can be issued by: – Central and State Governments, – Public Bodies, – Statutory corporations and corporate bodies.

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Indian Debt Markets • Indian Debt Markets - one of the largest in Asia today. • Government Securities (G-Secs) market - the oldest & largest component of Indian Debt Market in terms of capitalization, outstanding securities & trading volumes. • G-Secs- Benchmark for determining level of interest rates in the country are the yields on government securities , referred to as the risk-free rate of return. • The Indian Debt Market structure was a wholesale market with participation largely restricted to the Banks, Institutions and the Primary Dealers. • The Retail Debt Market in India has been created recently. 47

Segments in the secondary debt market • The segments in the secondary debt market based on the characteristics of the investors and the structure of the market are: – Wholesale Debt Market - investors are mostly Banks, Financial Institutions, the RBI, Primary Dealers, Insurance companies, MFs, Corporates and FIIs. – Retail Debt Market involving participation by individual investors, provident funds, pension funds, private trusts, NBFCs and other legal entities in addition to the wholesale investor classes

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Money Market Instruments • Money markets - markets for debt instruments with maturity up to one year. • Money markets allow banks to manage their liquidity as well as provide central bank a means to implement monetary policy. • The most active part of the money market - call money market (i.e. market for overnight and term money between banks and institutions) and the market for repo transactions. • The former is in the form of loans and the latter are sale and buyback agreements - both are obviously not traded. • The main traded instruments are Commercial Papers (CPs), 49

Commercial Paper • A Commercial Paper is a short term unsecured promissory note issued by the raiser of debt to the investor. • In India; corporate & Financial Institutions (FIs) can issue these notes. • Generally companies with very good ratings are active in the CP market, though RBI permits a minimum credit rating of Crisil-P2. • Tenure of CPs - anything between 15 days to one year, the most popular duration being 90 days. • Companies use CPs to save interest costs.

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Certificates of Deposit • Issued by banks in denominations of Rs.5 lakhs & have maturity ranging from 30 days to 3 years. • Banks are allowed to issue CDs with a maturity of less than one year • Financial institutions are allowed to issue CDs with a maturity of at least one year.

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Treasury Bills (T-Bills) • T- Bills: instruments issued by RBI at a discount to face value • Form an integral part of the money market. • In India treasury bills are issued in four different maturities —14 days, 90 days, 182 days and 364 days. • Apart from these, certain other short-term instruments are also popular with investors. • These include short-term corporate debentures, bills of exchange and promissory notes. 52

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Introduction • It is a pool of money, collected from investors, and is invested according to certain investment objectives • The ownership of the fund is thus joint or mutual, the fund belongs to all investors. • A mutual funds business is to invest the funds thus collected, according to the wishes of the investors who created the pool • e.g. money market mutual fund seeks investors to invest predominantly in Money Market 54

Important characteristics • The ownership is in the hands of the investors who have pooled in their funds. • It is managed by a team of investment professionals and other service providers. • The pool of funds is invested in a portfolio of marketable investments. • The investors share is denominated by ‘units’ whose value is called as Net Asset Value (NAV) which changes everyday. 55

Advantages & Disadvantages Advantage: • Portfolio diversification • Professional Management • Reduction in Risk • Reduction in Transaction costs • Liquidity • Convenience and Flexibility • Safety – Well regulated by SEBI Disadvantage: • No control over the costs. Regulators limit the expenses of Mutual Funds. Fees are paid as percentage of the value of investment. • No tailor made portfolios. • Managing a portfolio of funds. (Investor has to hold a portfolio for funds for different objectives) 56

Type of mutual Fund: By Structure Open Ended Fund: Investors can buy and sell units of the fund, at NAV related prices, at any time, directly from the fund. Open ended scheme are offered for sale at a pre- specified price, say Rs. 10, in the initial offer period. After a pre-specified period say 30 days, the fund is declared open for further sales and repurchases Investors receive account statements of their holdings, The number of outstanding units goes up and down The unit capital is not fixed but variable. 57

Type of mutual Fund: By Structure Closed Ended fund: • A closed -end fund is open for sale to investors for a specified period, after which further sales are closed. • Any further transactions happen in the secondary market where closed-end funds are listed. • The price at which the units are sold or redeemed depends on the market prices, 58

Types of Funds - By Investment Objective Equity

Debt

Equity Funds Index Funds Sector Funds

Fixed Income Funds GILT Funds

Money Market

Money Market Mutual Funds

Balanced Funds

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Gilt Funds • Invests only in securities that are issued by the Government and therefore do not carry any credit risk. • Government papers are called as dated securities also. • It invests in both long-term and short-term paper. • Ideal for institutional investors who have to invest in Govt. Securities. • Enables retail Participation

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ELSS (Equity Linked Saving Scheme) • 3 year lock in period • Minimum investment of 90% in equity markets at all times • So ELSS investment automatically leads to investment in equity shares. • Open or closed ended. • Eligible under Section 80 C • Dividends are tax free. • Benefit of Long term Capital gain taxation.

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Fixed Term Plan Series • FTPs are closed ended in nature. • AMC issues a fixed number of units for each series only once and closes the issue after an initial offering period. • Fixed Term plan are usually for shorter term – less than a year. • They are not listed on a stock exchange. • FTP series are likely to be an Income scheme. • Good alternate of Bank deposits/ 62

Money Market Mutual Fund • Money funds provide investors with current income and are managed to maintain a stable share price. • Because of their stability, money funds are often used for cash reserves or money that might be needed right away. • Money funds typically invest in short-term, high-quality, fixed-income securities, such as T-Bills, CDs and CPs • Income from money funds is generally determined by shortterm interest rates.

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How does a Mutual Fund work?

Saving s Unit s

Unit holders

AMC Investmen ts

Trus t Return s Registrar

SEBI

Trust Custodian

AMC

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Loads • Load is charged to investor when the investor buys or redeems units. It is primarily used to meet the expenses related to sale and distribution of units • Load charged on sale of units is entry load. It increases the price above the NAV for new investor. • Load charged on redemption is exit load. It reduces price. • Maximum Entry load or Exit load is 7%.( For Open ended Funds) • Max. Entry or Exit load for closed ended funds is 5% • CDSC is an exit load that varies with holding period. • Load is an amount which is recovered from the investor. 65

Net Assets Value • The net assets represent the market value of assets which belong to the investors, on a given date. • Net assets are calculated as: Market value of investments Plus(+) current assets and other assets Plus(+) accrued income Less(-) current liabilities and other liabilities Less(-) accrued expenses 66

NAV Computation • Unit capital of a MF scheme is Rs.20 million. The market value of investments is Rs. 55 million. The number of units is 1 million. The NAV is – Rs. 20 – Rs. 75 – Rs.55 – Not possible to say 67

Fund Management

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Active fund management Fund manager tends to look at specific attributes in selecting stocks. Active fund manager believes, that his ability to buy right stock at the right time, can translate into superior performance for his portfolio. What are the basic active equity fund management style? Growth Investment style – Objective is capital appreciation, look for companies that are expected to give above average earnings growth, The shares are more risky and thus expected to offer higher returns over a long investment horizons. Relatively higher P/E ratio and have lower dividend yield Value Investment Style – Look for companies that are currently undervalued but whose worth will be recognized eventually.

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Passive fund management • Fund manager believes, that holding a well diversified portfolio is the cost efficient way ,to better returns, he would tend to mimic the market index. • It requires limited research and monitoring costs and is therefore cheaper. • Fund manager may choose to mimic a index, or a subset of the index or choose a basket of shares from multiple indices. • A passive fund manager has to rebalance his portfolio every time changes are made in the index. 70

Performance Measurement • Returns comes form dividend or capital gains. • Rate of Return =(Income Earned/Amount invested)x100 • Simple total return= {NAV(end) – NAV ( begin)}+ Dividend paid x100 NAV at beginning • Rule of 72 is a thumb rule used in finding doubling period. If Rate = 12%, then money will double in 72/12 = 6 years. • CAGR • While comparing funds performance with peer group funds, size and composition of the 71

Investment Plans • Broadly 2 options- Growth option and Dividend Option • Automatic Reinvestment Plans– Benefit of Power of Compounding. • Systematic Investment Plans – For regular investment • Systematic Withdrawal Plan – For regular income ( it is not similar to MIP) • Systematic Transfer Plan 72

Wealth cycle for investors

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Financial Planning Strategies •

Power of Compounding

•

Buy and hold

•

Rupee cost averaging: – A fixed amount is invested at regular intervals – More units are bought when prices are low and fewer units are bought when prices are high. Over a period of time, the average purchase price of investor is lower than average NAV. – Its disadvantage : Does not indicate when to sell or switch.74

Economic Environment and Indicators

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Importance of Economic and Business Environment • Significant implications on the investment recommendation. • Recommendations depend on a number of assumptions about the future performance of the economy. • Financial advisors should always keep a track of economic environment to make reasonable assumptions. • A thorough understanding of economic environment helps in reviewing the existing financial situation. 76

Gross Domestic Product • There are three ways to derive GDP: – The sum of all expenditures, – The sum of all incomes, and – The sum of all value added by business

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ECONOMIC FACTORS: GNP & GDP

This is the value of output of goods and services produced by Indian companies, regardless of whether the production is inside or outside the India

Gross National Product (GNP)

The value of output of goods and services produced in the country, regardless of whether businesses are owned and operated by Indians or foreigners.

Gross Domestic Product (GDP)

Gross National Product (GNP)

=

Gross Domestic Product (GDP)

-

profits on foreign owned businesses

+

profits on Indian owned businesses outside India

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GDP GDP is the measure of total value of final goods and services produced in the domestic economy each year. The following is often used GDP= C+I+G+ (X- M) C = personal consumption spending on goods and services I = Private sector fixed capital expenditure G = Government expenditure (X-M)= Net of export receipts (X) and import payments (M) The relationship highlights actual rupee expenditure for goods and services produced in the economy for measuring GDP. This equation includes all key players involved in the economy – consumers / households, business (private sector) and government. For living standards to rise in India, GDP must grow at a faster rate than the 79 population. This way, there is greater quantity of goods and services per person.

Example The following information is available for an economy. Consumption (C) = Rs 3000 Private Investment (I) = Rs 500 Government Expenditure (G) = Rs 2000 Exports (E) = Rs 1000 Imports = Rs 1500 Calculate the GDP for the economy? Answer: GDP = 3000 + 500 + 2000 + (10001500) 80

Inflation •

A situation of rising prices. Inflation refers to a persistent rise in prices. Simply put, it is a situation of too much money and too few goods.

•

The most popular measure of inflation in India is change in the Whole Price Index (WPI) over a period of time.

•

The WPI is an index measure of the wholesale prices of a selected basket of goods and services in the economy. The WPI is expressed as a percentage with reference to some base year, according to a formula

•

WPI= (aggregate price for current year/aggregate price for the base year)* 100

•

An alternative measure is consumer price Index, which is concerned with the consumer market for goods and services.

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Monetary Policy • Monetary policy is the process by which the central bank of a country controls the supply of money, cost of money or rate of interest. • The Reserve Bank of India (RBI) controls and influences the economy by means of monetary and credit policy. 82

Some Monetary Policy terms •

Bank Rate – Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. – Usually, an increase in bank rate results in commercial banks increasing their lending rates. Changes in bank rate affect credit creation by banks through altering the cost of credit. – Bank Rate is at 6.0 per cent.

•

Cash Reserve Ratio – All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio. – It is cash as a percentage of demand and time liabilities that bank maimtain with RBI – Cash reserve ratio (CRR) of scheduled banks increased to 8.25 per cent with effect from the fortnight beginning May 24, 2008. 83

Some Monetary Policy terms • Open Market Operations – An important instrument of credit control, the Reserve Bank of India purchases and sells securities in open market operations. – In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of money, RBI purchases securities. • Statutory Liquidity Ratio – Banks in India are required to maintain 25 per cent of their deposits in government securities and certain approved securities. – These are collectively known as SLR securities. 84

RakeshChandrayan

THANK YOU By Rakesh Chandrayan PGDF Batch-(2008-09)