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Investments Current commitment of money for a
period of time - to derive future payments,that compensate the investor for1. The time the funds are committed2. The expected rate of inflation
3. The uncertainty of the future payments
Investorcan be individual, a government, a pensionfund or a company
Investments includes investments1. by corporations in plant and equipment2. by individuals in stocks, bonds, commodities
or real estate
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Financial Investments Investment by individuals in stocks and bonds of
corporations Investors enter the securities market and
exchange cash for financial instrumentsCash is exchanged between investors, no new
capital reaches the corporationsNo real investment occurs as result of this
activity
Financial assets are claims to income generatedby real assetsFinancial assets are created and destroyed in
the ordinary course of doing business
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Real InvestmentsOccurs when a corporation takes capital and
invests it in productive assetsReal investment is channeled in real assets
which determines the productive capacity of the
economy
Real assets are land , buildings, machines andknowledge necessary to produce goods
together with the workers and their skills in
operating these resourcesReal assets are income generating assetsReal assets are destroyed by accident or by
wearing out over time
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Clients of the Financial SystemThe Household Sector
Interested in wide array of assetsDifferences in risk tolerance creates demand for
assets with a variety of risk return combinations
Business Sector
Need to raise money to finance their investmentin real assets: plant, equipment & technological
know how
Government Sector
Governments require money to finance theirexpenditure
Restricted to borrowing - raise funds when tax
revenues are not sufficient to cover expenditure
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Stock Market /Capital Market
Rationale for a Stock Market
1. Allows efficient distribution of consumption overtime People save money by postponing consumption Market provides an avenue to set aside the money
and let funds grow over time1. Allows idle resources to be put to work System has surplus units (with lots of income) and
deficit units who need the funds Market allows savings of surplus units to be
converted to investments Enables economic growth and hence creation of jobs Breakdown of this mechanism is disastrous for the
economy
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Rationale (continued)
3. Enables efficient allocation of financial resourcesamong competing users
Price of a Share is a function of future expectedearnings Depends on future investment opportunities and the
ability of the firm to turn them into profit Share price channels funds to companies with
prospects and those without prospects do not receivefunds
3. Stock Market provides Liquidity A mismatch exists between Investors Investment
Horizon and Planning Horizon of Project
Market allows people (financers) to come in and getout without affecting the financing of the project Long Term Projects can be executed STOCK MARKET HAS A LEGITIMATEPURPOSE, OTHER THAN THAT OF MAKING
MONEY
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Types of Capital Markets
Primary Markets
Firms requiring capital to fund their growthsell(float) securities
This new issue of securities to the public is
referred to as Primary Markets Stocks are marketed to the public by
Investment Bankers/Underwriters to the
issue
Secondary Markets Purchase and Sale of already issued
securitieswhich takes place at the Exchange
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Players in the MarketInvestorsMarkets owe their existence to them
Invest in various assets to reduce overall riskSpeculators In the market for Short TermReady to take high risks for high returnsGive Liquidity to the Market
ArbitrageursMake money if securities are mis priced or
when small price differences exist in differentmarkets
Time Period in the market few minutesMARKET REQUIRES ALL OF THEM
EACH HAS A ROLE TO PLAY-SYMBIOSIS!!!!!
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Market RegulatorSecurities & Exchange Board of India (SEBI)
Set up in 1988, to create confidence in investors To create an environment to facilitate the mobilization of
adequate resources through the securities market and
its efficient allocation Done by introducing and implementing Rules &
Regulations regarding transactions in the market Caters to Issuers of Securities, Investors, Market
Intermediaries Prohibits fraudulent and unfair trade practices
Regulates substantial acquisition of shares andtakeover of companiesEg. Prior to SEBI, DCM & ESCORTS-Swaraj Paul
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Capital Market location - Stock ExchangesStock Exchanges in India are governed by
Securities Contract Regulation Act (SCRA)Most popular Stock Exchanges in India
National Stock Exchange (NSE)
Set up by IDBI and other Financial Institutions
No trading floor on this exchange Trading is screen based Brokers are connected
to the exchange by PC terminals
Membership is not a property right, members pay
annual subscription fee Screen based trading with automated order matching
System operates on a "price-time priority''?
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Price Time Priority
A market has price-time priority if it gives a
guarantee that every order will be
matched against the best available price in
the country, and that if two orders areequal in price, the one which came first
will be matched first
Matching of orders is done by computers-transparent,objective fair
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DEPOSITORYDepository holds securities of investor in
electronic form at the request of the investorthrough a registered DepositoryParticipant(DP)
Depository is similar to a Bank
Holds securities in an accountTransfers securities between accounts on
the instruction of the account holderFacilitates transfer of ownership, no physical
handling involvedDepositories registered with SEBINSDL National Securities Depository Ltd.CDSL Central Depository Services Ltd.
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Market Intermediaries
Broker Buy and Sell securities for earning a commission
Market MakersA brokerage or bank that maintains a firm bid and ask
price in a given security by standing ready, willing, andable to buy or sell at publicly quoted prices (calledmarking to market).
These firms display bid and offer prices for specificnumbers of specific securities, and if these prices are
met, they will immediately buy for or sell from their ownaccounts. Market makers are very important for maintaining
liquidity and efficiency for the particular securities thatthey make markets in
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Merchant Banker/Investment BankerPerform role of middleman, help companies
raise(market) new capital/issuesDo all groundwork for new issues and give
Due Diligence certificate to SEBIRegistrar
Collect applications for new issues andcomputerize them
Make allotments in case of over subscriptionUnderwriters
In case new issues are not fully subscribed,they make good the shortfall by their ownsubscriptions. eg. Infosys IPO 1993
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Market Terminology
IndexStatistical Indicator providing a representation ofthe value of the securities which constitute it.
Indices often serve as barometer for a givenmarket or industry
Uses Use Index Values as a benchmark to judge
performance of individual portfolios, ETFs, riskadjusted performance of other alternative asset
classes. Technical Analysis Proxy for Market portfolio of risky assets,
considering the fact that relevant risk for anindividual risky asset is systematic risk
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Factors in constructing an Index
The Sample(important characteristic of desired population)
Size(Large or small), Breadth
(Random orNon random) and Source (in case of
differences in segments of
population)Weighting Sample MembersPrice Weighted Index
Market Value Weighted Index
Unweighted Index
Computational Procedure
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Price Weighted Index Computed by totaling the current prices of selected
stocks and dividing the sum by a divisor which isadjusted to take into account bonus issues, splits andchanges in the sample over time
Example DJIA
Criticism1. High priced stock carries more weight than low priced
stock
change in high priced stock causes greater change in
index1. When Bonus/Split occurs price declines, therefore their
weight in index declines
high growth stocks declaring bonus will continuouslylose weight in Index
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(Market )Value Weighted Index
Use Market Capitalization of all stocks in theIndexMarket value of a company is determined by
multiplying the price of the stock by the numberof shares outstanding
SENSEX represents the total market value of 30component stocks. Base Year for Sensex is1978. Value for Base Year is 100
SENSEX calculated using Free Float MethodNIFTY M-Cap calculated using total number of
outstanding shares till June 2009, now FFMethod
Base Year for Nifty is 1995 (November 3). Valuefor Base Year is 1000
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SENSEX - Scrip selection criteria
Listed HistoryListing history of at least 3 months at BSE.Exception if full market capitalization of a newly
listed company ranks among top 10 in the list of
BSE scrips.merger/demerger/amalgamation, minimum
listing history would not be required
Trading FrequencyThe scrip should have been traded on each and
every trading day in the last three months.
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SENSEX Criteria (continued)
Final Rank
The scrip should figure in the top 100
companies listed by final rank.
75% weightage to the rank on the basis ofthree-month average full market
capitalisation
&25% weightage to the liquidity rank based
on three-month average daily turnover&
three-month average impact cost.
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SENSEX Criteria (continued)Market Capitalization Weight
The weight of each scrip in SENSEXbased on three-month average free-floatmarket capitalisation should be at least0.5% of the Index.
Industry Representation Scrip selection would generally take into
account a balanced representation of thelisted companies on BSE.
Track Record In the opinion of the Committee, the
company should have an acceptable track
record.
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Unweighted (Equal Weighted) Index
All stocks carry equal weight regardless oftheir price or market value
Actual movements in the index are based
on the arithmetic mean of the percentagechanges in price or value for the stocks inthe index
percentage changes imply price level ormarket level has no impact on the index
Some tend to use GM
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From
Indian
Express
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ORDER DESCRIPTION/SPECIFICATION
I. ORDER TYPE
1. Buy2. Sell
3. Short Sell a Stock
Short Sale
Investor borrows shares from broker and sellsthem
Later investor must repurchase the shares inorder to replace the shares that were borrowed.
This is covering of short position Short Seller must not only return the stock But give the lender any dividend paid on shares
during the period of short sale
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Short Sale (continued) Lender of the Shares would have received
the dividends directly from the firm, had theshares not been lent Buyer - Gets possession of stock & receives
dividend
Original Owner- Not legal owner anymore, ownsstock on paper and receives amount equal todividend from short seller
Short Seller gets no dividend, but shells out anamount equal to dividend and pays to original
owner
II.ORDER SIZE
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III. ORDER RESTRICTIONS1. Price Restrictions 2. Time Restrictions
Exercising OrdersBid Price Price at which a dealer is willing to buy a securityAsk Price Price at which dealer will sell a security
Market Orders Instructions to the broker to buy or sell at the bestprice immediately available
Limit Orders (Buy or Sell) Instructs a broker to buy /sell at a stated price or
better Buy-Maximum Price one is willing to pay Sell-Lowest Acceptable price you are willing to
sell for
Specifies maximum /minimum investor is willing toaccept
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Stop Order/Stop Loss Order (Buy or Sell)
After you buy the stock difficult part is when to sell
Used to limit the amount oflosses orprotectcapital gains
can be used to sell securities automatically in
case a major decline occurs in market If stock drops to specified price say Rs.68, stop
loss becomes market order, position is closed outReduce losses - specify Stop Order at Rs.45
(say)so may get more or less STOP ORDER MEANT for WISHY WASHY PEOPLE,
those who lack conviction in their Stock Picking Skills
STOP ORDER & LIMIT ORDER ARE NOT IDENTICAL
Rs.50 Rs.70 (Now)
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STOP ORDER & LIMIT
ORDER LIMIT ORDER TO
SELL AT Rs.50
Lowest acceptable is
Rs.50, you do notmind anything above
Rs.50
STOP ORDER TO
SELL AT Rs. 50
Even if Price falls to
Rs.40 OK, sell
Rs.50TRADE
NO TRADE
NO TRADE
TRADE
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Time Restrictions
Fill or Kill (F.O.K) -Short Time Restrictions
Fill order immediately or kill it
Day Order
Good till Cancelled (GTC)
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Account Types
1. Cash Account
When you buy, you pay full amount. All purchases paid in full.
2. Margin Account
Investors borrow part of the purchase price from brokers
All securities purchased with margin are with broker as
collateral
Margin Accounts magnify your gains or losses
Margin Ratio = Net Worth/Equity Value
Say margin Ration is 0.3 means, 70% purchase price isborrowed
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Magnification of Gains/Losses on Margin A/C Stock Price Rs. 100
No. of Shares Brought =1000
Total Amount = Rs. 100,000Cash A/C You pay Rs. 100,000 + Commission
Margin A/C
Initial Amount required = 0.30*Rs.100,000 = 30,000
Broker lends you the rest = Rs.100,000- Rs.30,000= Rs. 70,000
SCENE 1 Price From Rs. 100 to Rs.120 (20 % increase)
Actual Margin = (Rs.120*1000 Rs.70,000)/Rs.120,000
= 41.67% > 30%
Return = (Rs.50000-Rs.30000) / Rs. 30000
= 66.67% (Magnified Gain)
SCENE 2 Price From Rs. 100 to Rs.80 (20 % decrease)
Actual Margin = (Rs. 80*1000-Rs.70000)/Rs.80,000
= 12.5% < 30 % Margin Call
Return = (Rs.10,000-Rs.30,000)/Rs.30,000
66.67 (Magnified Loss)
Degree of Leverage 3.33