Security Analysis

A pre-requisite for making investments

Investment
Parting with ones fund, to be used by another party, for productive activity. Conversion of cash into a monetary asset or a claim on future money for a return.

Investment Activity
Investor

Physical Assets

Financial Assets

Marketable Assets

Investment Alternatives
SAVER Investor (by acquiring assets)

I Physical Assets

II Financial Assets
(Non-Marketable)

III Marketable Assets

Shares (categories) Bonds Govt. Securities MF Schemes UTI etc. Derivatives Money market instruments

House, Land, Buildings Gold, Silver, Etc Consumer durables

Banks, deposits PF, LIC, Pension Schemes PO Certificates NSS, NSC, etc

SECURITY
Investments in capital market in various financial instruments (shares, scrips, bonds, debentures) which are all claims of money. Is an instrument of promissory note.

Security analysis
Superior returns are possible by proper security analysis thro
Better forecasting ability Superior expertise in security analysis Insider information

PORTFOLIO
Combination of various assets & / or instruments of investments. An analysis of risk & return characteristics of individual securities in the portfolio.

Objectives of Investment
1.Safety of Principal___ .& Diversification 2. Stability of Income 3. Capital Appreciation 4. Liquidity & Collateral Value 5. Minimise risk & Maximise returns 6. Protection against inflation 7. Tax-saving

Year

2003 2004 2005 2006 2007

Inflation rate (consumer prices ) 5.40 % 3.80 % 4.20 % 4.20 % 5.30 %

Financial Markets
 Securities market  National  Capital market International
(eg. Euromarket)

Forex market

Money Market

 Equity market

Debt Market

 Primary market

Secondary market Spot market Derivative

market

Domestic capital market (RBI & SEBI)

Capital Market Total listed Market Capitalisation($ bn) companies 7524 1904 2561 1022 9922 704 1086

Advanced markets USA 15104 UK 2577 Japan 3157 Germany 1207 Emerging markets 166 India 172 Korea China 581

Modes:
I ) Security Forms (Marketable)  Corporate Bonds  Public sector bonds  Preference  Equity II ) Non Security Forms (Non Marketable / contractual forms of investment ) NSS NSC PF LIC UTI PO savings Company & Bank FDs

Non-security forms (Non-marketable)

Deposits * Types * Safety * Interest rate * premature encashment * loans * Interest between 10th and last date of the month

Post-office Time deposits

Multiples of Rs 50 Interest rate Calculated 1/2yearly & paid annually Withdrawal after 1 year Penal deduction of 2% Pledged Tax exemption 80C

Monthly Income scheme

Tenure 6 years Min amount Rs1000 Max Rs 300,000 Interest 8% Bonus 10% on maturity Premature withdrawal with 5% before 3 years

KVP
Min Rs.1000 Max No limit Investment doubles in 8 years & 7 months CI - 8.4% Withdrawal after 21/2years

NSC
Denominations Rs100; Rs.500; Rs.1000; Rs.5000 & Rs.10,000 6 years CI 8.16% Sec 80 C No withdrawal

Company deposits
 CLB and RBI  Term 1 to 3 years (non-banking 25mths to 5 years)  25% of its NW from public & addl amount of 10% of its NW from shareholders  Interest  Unsec. Loans & so credit rated  No tax benefit (except more than Rs.5000)  Premature withdrawal allowed

Portfolio Management Process

Specification of Investment objectives & constraints Choice of Asset Mix Formulation of Portfolio Strategy Selection of securities Portfolio execution Portfolio Revision Performance Evaluation

CHARACTERISTICS
1. 2. 3. 4. 5. 6. 7. Risk Return Safety Liquidity Marketability Hedge against Inflation Tax Shelter

 Characteristics  Risk:
 Credit worthiness of the borrower  Nature of instrument  Risk of variability of returns Business risk & Financial risk  Nature of tax liability (NSS, NSC, UTI)

 Return:
 Yield + Capital appreciation

 Safety
 Certainty of return on capital without loss of time or money involved  Government bonds vs. private securities.

 Liquidity
 Bank deposit vs. equity  Higher Liquidity Lesser return

 Marketability
 easily transferable low cost- price change (listed companies, public ltd., companies & non listed & Pvt Ltd companies. )  Depth Breadth Resilience

Risk Return Relationship

Y

Venture funds
Equity shares

R E W A R D

Corporate deposits Convertible debentures Non-convertible debentures UTI & Mutual funds Post office certificates Bank Deposits & Insurance Schemes

Risk Taken by Investor

Return =
Annual Income +(Ending price beginning price) X 100 Beginning price

ie., Capital Appreciation + dividend X 100 Purchase Price

Speculation
Short term objective Maximizes return thru buying & selling Delivery of securities nil Stakes of risk is higher & returns also higher.


1. Risk

Investment
: Low / Moderate return Own funds

vs.

Speculation
Higher Risk Higher Return Borrowed funds (supplement his Personal resources). No intention to own Trades frequently holding period too short (few days to months) Achieve profits through price changes ( i.e capital gains) Speculates on experience Market behaviour, price movement & inside information

Assumes moderate / low risk

2. Returns: 3. Use of funds :

4. Ownership :

Owns the instruments

5. Holding period: Commitment of funds for a Longer term (1 year to few years) 6. Motives: direct income + capital gains

7. Diligence: 8. Factors considered:

high in selecting securities real worth of the security

Any four differences between speculation and Gambling?!

Classification of financial markets

Nature of claim Maturity of claim Seasoning of claim Timing of delivery Organisational structure a) Debt market b) Equity market a) Money market b) Capital market a) Primary market b) secondary market a) spot market b) Forward/Futures a) ET market b) OTC market

Financing Decision
 Raising of funds Debt Equity  Best / Optimum mix ( proportion)  E.g. Infosys purely non debt  RCL purely non debt

How are funds raised?

Through Financial Markets Financial market establishes a bridge between the savers and investors of money to accelerate the growth of economic development.

How to raise funds?

PRIMARY MARKET SECONDARY MARKET

    

Public issues Rights issues Bonus issue Private placement ADRs & GDRs

Deals with previously issued / existing securities through a brokerage firm authorized to trade in the market ( Eg: BSE, NSE)

Debenture Types
1. 2. 3. 4. 5. Secured and non-secured Fully convertible debenture Partly convertible debenture Non- convertible debenture Secured or unsecured

Bonds
 At par / discount  Fixed interest rate (coupon rate)  Redemption value at par or premium Types: 1. Secured / unsecured 2. Perpetual and redeemable 3. Fixed or floating interest 4. Zero-coupon (sell at discount and repaid at face value) 5. Deep Discount bonds (IDBI (1992) & ICICI (1997)

6. Capital Indexed bonds - principal amount is adjusted for inflation for every year - to avail benefit of inflated principal the investor need to hold the instrument for entire 5 year period - can be sold in the secondary market , value of principal repayment adjusted by Index Rate (IR)

Blue chip shares

Heavy weight shares High Market Cap. Large volume traded High Performers

Growth Shares
Higher rate of growth than industrial growth rate Eg In 1999 major gainers were software stocks HCL & Infosys rised sharply

Income shares
Stable operations Limited growth opportunities Eg: Banks, FMCG (HLL , Nestle,etc.)

Defensive Shares:
- unaffected by market movements - Eg. Pharma, Oil, telecom etc

Cyclical Shares
Business prospects affected by business cycles Low to moderate yield Capital gain is highly variable Eg. Automobile, durable goods etc.

Speculative shares
Small and Midcap companies Short term gains Only speculative purpose And day trading

Fixed Income securities

Preference Debentures Bonds IVPs and KVPs (PO savings certificates) Govt. securities Money Market Securities ( Treasury Bills, CPs, COD)

Money Market Instruments

Treasury Bills - 91 days , 364 days maturity - low interest - sold at discount & redeemed at par CPs - fixed maturity period (3 to 6 months) - unsecured Pro-note - 1993 extended to one year - sold at discount and redeemed at face value - mostly for companies & IIs - min. period reduced to 30 days

Certificate of Deposits - marketable receipt of funds deposited in a bank. - Fixed period & fixed interest - bearer documents & negotiable - For IIs and companies - Min. size is Rs. 10 lakh and additional amount in multiples of Rs. 5 Lakh - issuers banks & FIs - investors banks, corporates,FIs, MFs

Ready Forward Contracts (REPO)

Transaction where two parties agree to sell and repurchase the same security. ( at a mutually agreed future date & price)  Buyer purchases , to sell the same to the seller at an agreed date & predetermined price Rate of interest agreed repo rate. Approved by RBI ( T bills & Government securities)

Primary & Secondary Market

Parties Involved in the New Issue: Managers to the issue (Eg. SBI Capital
Markets Ltd., ICICI Securities & Finance Co.; DSP Financial Consultants; etc)

Registrars to the issue Underwriters (insurance against

subscription)

inadequate

Bankers to the issue Advertising Agents Financial Institutions

Regulatory Bodies
SEBI Registrar of Companies RBI Stock Exchanges Industrial Licensing Authorities Pollution Control Authorities

Placement of Issues: Initial Issues are floated through:Prospectus offer Bought out deals (offer for sale - sponsors) Private Placement (FIs, Corporates, HNI) Eg. UTI, MFs, Insurance Cos., Merchant Banks etc. ) Rights Issue Book Building

Secondary Market
Types of Orders  Limit Orders Eg. Buy RPL at Rs60  Best Rate order (lowest for buying & highest for selling)  Discretionery order Eg. Buy TCS 100 shares around Rs.800 Stop Loss order Eg. Sell SBI at Rs.990, stop loss at 897

Functions of SE
Maintains Active Trading Fixation Of prices Ensures safe and fair dealing Helps Financing Industry Dissemination Of Information Performance Indicator Self-regulating organisation

Executions of Trade
Settlement Cycle Rolling settlement Price filters / circuit filters Intraday Price bands

Stock Exchanges
23 SEs 20 regional 3 NSEs (NSE, OTCEI, ISE) Provides an organized market for transactions in shares & securities BSE & NSE ( primary exchanges) account for nearly 72% of all capital market activity in India

BSE:
1887: Native Share & Stock Broker Association in Dalal Street 1899 inaugurated as BSE Governed by a Board chaired by a non executive chairman supported by elected directors, SEBI nominee & public representatives.

NSE:
Promoted by leading Financial Institutions June 1994 commenced its operation in the wholesale debt market segment. November 1994 equity market June 2000 derivative segment.

Secondary Market
 An organized market place where securities are traded.  An association of members brokers for the purpose of facilitating and regulating the trading in securities.  According to Securities Contract Regulation Act (1956), securities trading regulated by central government conducted in stock exchanges ( 23 in Numbers)  Normal trading hours 10 AM to 3.30 PM

Types of delivery
    Spot Delivery ( Same day / next day) Hand Delivery ( 7 to 14 days) Through clearing ( 2 months) Special Delivery ( longer period) > 14 days

 < 2 months  No carried forward ( D & P)

Listing:
making a quotation available for a companys share to be traded. Trading on a SE Public Ltd. Companies with minimum paid up capital of Rs. 5 Crores Trading on BSE / NSE - Minimum paid up capital of Rs. 10 Crores

Types of Orders
Limit orders Buy RPL at Rs. 61 Best rate order execute at best possible rate discretionary order range of price , Buy SBI 100sh. Around Rs.952 Stop loss order sell RPL at Rs. 65, stop loss @ Rs.62 to limit the loss on sale.

SEBI April 1988

 Need  To regulate & develop the Stock & Capital Market in India  To curb the malpractices in case of companies, merchant bankers & brokers.
 Manipulation of market prices before new issues  Delay in allotment letters / refund orders / dispatch of share certificates.  Lack of transparency in the trading operations.  Delay / not passing contract notes.  Delay in making payments / giving delivery of shares to clients.  Insider training.

 Investor protection for steady flow of savings.  Promote efficient services by brokers & intermediaries.  Fair disclosures of the companies in the new issue market.

New guidelines from June 1992 Free pricing companies having 3 years of track record of consistent profitability out of last 5 years. Not less than 20 % of equity offered to the public. September 1999 IT companied subject to a min. public offer of only 10 % of the issued capital instead of 25% for other companies. ( offer at least Rs. 50 crores / at least give out 20 lakh shares)

Certificates of Deposit Market ( CDs)

Issued by banks & FIs Is a negotiable promissory note, secure & short term ( one year) Issued at a discount to face value - to corporates trusts, high net worth individuals & others.

Commercial Paper (CP)

 Unsecured promissory note  Issued by highly rated corporate borrowers & financial institutions ( on limit fixed by RBI)  Corporate borrower & having tangible NW greater than 4 crore.  Issuers need to obtain credit rating from recognized rating agencies.  Maturity minimum 15 days & maximum of one year  Issued at a discount to face value & redeemed at face value  Held in dematerialized form thru registered depositories.

Call Market
Amount borrowed / lent on demand ( for a short period) Period of one day to 14 days notice money otherwise called call money Adjustments for cash reserve requirement Players banks, financial institution, MFs Entirely an Inter Bank market Borrowers & lenders maintain a current account with RBI

T Bill Market

    

Short term upto one year ( borrowing instruments of the Govt) RBI issues T Bills on a predetermined day. Auctioned at regular intervals Issued at a discount to face value & prepaid at face value on maturity. 4 types - 14 days , 91 days, 182 days & 364 days

 Auction every Friday Alternate Wednesday  of every week  Amount for 14 days , 91 days 7 82 days Rs 100 Crores & 364 days T Bill auction is Rs 500 Crores  Investors - banks( T Bills form part of SLR) Insurance companies & financial institutions  Issued as entries in the subsidiary General ledger maintained by RBI