NIE FIRST GRADE COLLEGE

INVESTMENT MANAGEMENT
Module No. 2: Fundamental Analysis

FUNDAMENTAL ANALYSIS:
Fundamental analysis is the examination of the underlying forces that affect the wellbeing of the
economy, industry groups and companies. As with most analysis, the goal is to develop a
forecast of future price movement and profit from it. At the company level, fundamental analysis
may involve examination of financial data, management, business concept and competition. At
the industry level, there might be an examination of supply and demand forces of the products.
For the national economy, fundamental analysis might focus on economic data to assess the
present and future growth of the economy.

To forecast future stock prices, fundamental analysis combines economic, industry, and
company analysis to derive a stock’s fair value called intrinsic value. If fair value is not equal to
the current stock price, fundamental analysts believe that the stock is either over or under
valued. As the current market price will ultimately gravitate towards fair value, the fair value
should be estimated to decide whether to buy the security or not. By believing that prices do not
accurately reflect all available information, fundamental analysts look to capitalize on perceived
price discrepancies. Fundamental Analysis is a method of evaluating a security by attempting to
measure its intrinsic value by examining related economic, financial and other qualitative and
quantitative factors. Fundamental analysts attempt to study everything that can affect the
security’s value, including macroeconomic factors (like the overall economy and industry
conditions) and individual specific factors (like the financial condition and management of
companies).

OBJECTIVES OF FUNDAMENTAL ANALYSIS:

1. To predict the direction of national economy because economic activity affects the
corporate profit, investor attitudes and expectation and ultimately security prices.
2. To estimate the stock price changes by studying the forces operating in the overall
economy, as well as influences peculiar to industries and companies.
3. To select the right time and right securities for the investment.

THREE PHASES OF FUNDAMENTAL ANALYSIS: ( EIC Framework )

1) Understanding of the macro-economic environment and developments (Economic Analysis)
2) Analyzing the prospects of the industry to which the firm belongs (Industry Analysis)
3) Assessing the projected performance of the company (Company Analysis)

The three-phase examination of fundamental analysis is also called as an EIC (Economy-

Industry-Company analysis) framework or a top - down approach - Here the financial
analyst first makes forecasts for the economy, then for industries and finally for companies. The
industry forecasts are based on the forecasts for the economy and in turn, the company forecasts
are based on the forecasts for both the industry and the economy. Also in this approach, industry
groups are compared against other industry groups and companies against other companies.
Usually, companies are compared with others in the same group.
Fundamental analysis is primarily concerned with determining the intrinsic value or the true
value of a security. For determining the security’s intrinsic value, the details of all major factors
(GNP, industry sales, firm sales and expense etc.) is collected or an estimates of earnings per
share may be multiplied by a justified or normal prices earnings ratio. After making this
determination, the intrinsic value is compared with the security’s current market price. If the
market price is substantially greater than the intrinsic value the security is said to be overpriced.
If the market price is substantially less than the intrinsic value, the security is said to be
underpriced. However, fundamental analysis comprises:
Global economy: Global economy can be defined as the sum of activities that take place both
within a country and between different countries. Each country is a separate unit, with its own
industrial production, labor market, financial market, resources and environment.
Global economics provides comprehensive and consistent economic forecasts and analysis to
help our clients identify business growth opportunities, measure industry performance, and
quantify market risk
Domestic economy: The domestic economy refers to the full array of provisioning activities
carried out by the co-resident household or family unit for its social and biological maintenance.
Without question, households are the most important economic and social units in human
society.
Economic Analysis:
Every common stock is susceptible to the market risk. This feature of almost all types of
common stock indicates their combined movement with the fluctuations in the
economic conditions towards the improvement or deterioration.
Stock prices react favorably to the low inflation, earnings growth, a better balance of trade,
increasing gross national product and other positive macroeconomic news. Indications that
unemployment is rising, inflation is picking up or earnings estimates are being revised
downward will negatively affect the stock prices. This relationship is reasonably reliable that the
US economy is better represented by the Standard & Poor 500 stock index, which is famous
market indicator. The stock market will forecast an economic boom or recession properly from
the signs in front of average citizen. The Federal bank of New York has conducted research that
describes that the slope of the yield curve is the perfect indicator of the economic growth more
than three months out. Recession is indicated by negative slope while positive slope is
considered as good one.
The implications of market risk should be clear to the investor. When there is recession in the
economy, the prices of stocks move downward. All the companies suffer the effects of recession
despite of the fact that these are high performing companies or low performing ones. Similarly,
the stock prices are positively affected by the boom period of the economy.

MACRO ECONOMIC FACTORS:

The macro economy is the study of all the firms operates in economic environment. The key
variables to describe the state of economy are explained as below:
1. Growth rate of Gross Domestic Product (GDP): GDP is a measure of the total
production of final goods and services in the economy during a year. It is indicator of
economic growth. It consists of personal consumption expenditure, gross private
domestic investment, government expenditure on goods and services and net export of
goods and services. The growth rate of economy points out the prospects for the
 industrial sector and the returns investors can expect from investment in shares. The
higher the growth rate of GDP, other things being equal, the more favorable it is for stock
market.

2. Price level and Inflation: If the inflation rate increases, then the growth rate would be
very little. The increasingly inflation rate significantly affect the demand of consumer
product industry. The industry which has a weak market and come under the purview of
price control policy of the government may lose the market, like sugar industry. On the
other hand, the industry which enjoy a strong market for their product and which do not
come under purview of price control may benefit from inflation. If there is a mild level of
inflation, it is good to the stock market but high rate of inflation is harmful to the stock
market.

3. Savings and investment: Growth of an economy requires proper amount of investments

which in turn is dependent upon amount of domestic savings. The amount of savings is
favorably related to investment in a country. The level of investment in the economy and
the proportion of investment in capital market is major area of concern for investment
analysts. The level of investment in the economy is equal to: Domestic savings + inflow
of foreign capital - investment made abroad. Stock market is an important channel to
mobilize savings, from the individuals who have excess of it, to the individual or
corporate, who have deficit of it. Savings are distributed over various assets like equity
shares, bonds, small savings schemes, bank deposits, mutual fund units, real estates,
bullion etc. The demand for corporate securities has an important bearing on stock
prices movements. Greater the allocation of equity in investment, favorable impact it has
on stock prices.

4. Industry Growth rate: The GDP growth rate represents the average of the growth rate
of agricultural sector, industrial sector and the service sector. Publicly listed company
play a major role in the industrial sector. The stock market analysts focus on the overall
growth of different industries contributing in economic development. The higher the
growth rate of the industrial sector, other things being equal, the more favorable it is for
the stock market.

5. Agriculture and monsoons: Agriculture is directly and indirectly linked with the
industries. Hence increase or decrease in agricultural production has a significant impact
on the industrial production and corporate performance. Companies using agricultural
raw materials as inputs or supplying inputs to agriculture are directly affected by change
in agriculture production. For example- Sugar, Cotton, Textile and Food processing
industries depend upon agriculture for raw material. Fertilizer and insecticides
industries are supplying inputs to agriculture. A good monsoon leads to higher demand
for inputs and results in bumper crops. This would lead to buoyancy in stock market. If
the monsoon is bad, agriculture production suffers and cast a shadow on the share
market.
6. Interest Rate: Interest rates vary with maturity, default risk, inflation rate, productivity
of capital etc. The interest rate on money market instruments like Treasury Bills are low,
long dated government securities carry slightly higher interest rate and interest rate on
corporate debenture is still higher. With the deregulation interest rates are softened,
which were quite high in regulated environment. Interest rate affects the cost of
financing to the firms. A decrease in interest rate implies lower cost of finance for firms
and more profitability and it finally leads to decline in discount rate applied by the equity
investors, both of which have a favorable impact on stock prices. At lower interest rates,
more money at cheap cost is available to the persons who do business with borrowed
money, this leads to speculation and rise in price of share.

7. Government budget and deficit: Government plays an important role in the growth of
any economy. The government prepares a central budget which provides complete
information on revenue, expenditure and deficit of the government for a given period.
Government revenue come from various direct and indirect taxes and government made
expenditure on various developmental activities. The excess of expenditure over
revenue leads to budget deficit. For financing the deficit, the government goes for
external and internal borrowings. Thus, the deficit budget may lead to high rate of
inflation and adversely affects the cost of production and surplus budget may results in
deflation.

8. The tax structure: The business community eagerly awaits the government
announcements regarding the tax policy in March every year. The type of tax exemption
has impact on the profitability of the industries. Concession and incentives given to
certain industry encourages investment in that industry and have favorable impact on
stock market.

9. Balance of payment, forex reserves and exchange rate: Balance of payment is the
record of all the receipts and payment of a country with the rest of the world. This
difference in receipt and payment may be surplus or deficit. Balance of payment is a
measure of strength of rupee on external account. The surplus balance of payment
augments forex reserves of the country and has a favorable impact on the exchange
rates; on the other hand if deficit increases, the forex reserve depletes and has an adverse
impact on the exchange rates. The industries involved in export and import are
considerably affected by changes in foreign exchange rates. The volatility in foreign
exchange rates affects the investment of foreign institutional investors in Indian Stock
Market. Thus, favorable balance of payment renders favorable impact on stock market.

10. Infrastructural facilities and arrangements: Infrastructure facilities and arrangements

play an important role in growth of industry and agriculture sector. A wide network of
communication system, regular supply or power, a well-developed transportation system
(railways, transportation, road network, inland waterways, port facilities, air links and
telecommunication system) boost the industrial production and improves the growth of
the economy. Banking and financial sector should be sound enough to provide adequate
support to industry and agriculture. The government has liberalized its policy regarding
 the communication, transport and power sector for foreign investment. Thus, good
infrastructure facilities affect the stock market favorable.

11. Demographic factors: The demographic data details about the population by age,
occupation, literacy and geographic location. These factors are studied to forecast the
demand for the consumer goods. The data related to population indicates the availability
of work force. The cheap labor force in India has encouraged many multinationals to start
their ventures. Population, by providing labor and demand for products, affects the
industry and stock market.

12. Sentiments: The sentiments of consumers and business can have an important bearing
on economic performance. Higher consumer confidence leads to higher expenditure and
higher business confidence leads to greater business investments. All this ultimately leads
to economic growth. Thus, sentiments influence consumption and investment decisions
and have a bearing on the aggregate demand for goods and services.

ECONOMIC FORECASTING TECHNIQUES

Forecasting for an individual firm obviously begins with a forecast for the industry or
industries in which it is involved. Beyond this, the analyst must determine the degree to
which the company’s share of each market may vary during the forecast period. Such
variations can result from the introduction of a new product, the improvement of an
existing product, the opening, closing, or expansion of plants, the activities of domestic
or foreign competitors, a change in sales effort, or a variety of other factors. Information
required to make such assessments may come in part from the company’s own
investment and marketing plans. Information on the activity and sales prospects of
competitors is frequently collected from the firm’s own salesmen. An increasing number
of companies now employ sophisticated market research techniques to determine the
probable reaction of their customers to new products.

1. Anticipatory Surveys: Some elements of the future are known with reasonable
accuracy. Government spending is reflected in existing budgets. These budgets
indicate how much will be spent and how much money will be extracted from the
stream of private spending by taxation. Similar information is available on some parts
of the private economy. Periodic surveys conducted both by government and by
private organizations measure business plans to invest in new plants and equipment.
Increasingly, attempts are made to probe the mood and intentions of consumers
concerning the possible purchase of automobiles, houses, appliances, and other
durable goods. Regular surveys are also made to determine the general mood of the
public—whether people are optimistic or pessimistic about their own economic future
and thus whether their spending is apt to be relatively strong or relatively weak. In
 general, such information obtained from the various surveys of investment plans,
spending plans, and attitudes has been highly useful to economic forecasters. Such
information helps to limit the range of possibility. But plans and attitudes change,
sometimes quite abruptly, and although the surveys are useful tools they are not clear
and reliable guides to the future.

2. Barometric or Indicator approach: Some elements of the future are known with
reasonable accuracy. Government spending is reflected in existing budgets. These
budgets indicate how much will be spent and how much money will be extracted
from the stream of private spending by taxation. Similar information is available on
some parts of the private economy. Periodic surveys conducted both by government
and by private organizations measure business plans to invest in new plants and
equipment. Increasingly, attempts are made to probe the mood and intentions of
consumers concerning the possible purchase of automobiles, houses, appliances, and
other durable goods. Regular surveys are also made to determine the general mood of
the public—whether people are optimistic or pessimistic about their own economic
future and thus whether their spending is apt to be relatively strong or relatively
weak. In general, such information obtained from the various surveys of investment
plans, spending plans, and attitudes has been highly useful to economic forecasters.
Such information helps to limit the range of possibility. But plans and attitudes
change, sometimes quite abruptly, and although the surveys are useful tools, they are
not clear and reliable guides to the future.

3. Diffusion Indexes: Some economists also use sets of statistics called diffusion
indexes to calculate economic turning points. A diffusion index is a method of
summarizing the common tendency of a group of statistical series. If a greater number
of the series are rising than are declining, the index will be above 50; if fewer are
rising than declining, it will be below 50. In effect, a diffusion index measures the
degree to which either strength or weakness pervades the economy. If, for example,
most of a group of industries are increasing their production rates, the economy as a
whole is probably expanding; if the proportion of industries that are growing begins
to decline and falls significantly below 50 percent for a period of time, the economy
is probably in a recession, or at least moving in that direction.

4. Money and Stock Prices: Monetary theory in its simplest form states that
fluctuations in the rate of growth of money supply are of utmost importance in
determining GNP, corporate profits, interest rates, stock prices etc. Monetarists
contend that changes in growth rate of money supply set off a complicated series of
events that ultimately affects share prices. In addition, these monetary changes lead
stock price changes. Thus, while making forecasts, changes in growth rate of money
supply should be given due importance. Some thinker’s states that stock market leads
 changes in money supply. However, sound monetary policy is a necessary ingredient
for steady growth and stable prices.

5. Econometric Model Building: Economists frequently use mathematical equations to

express the normal relations between various economic factors. As a simple example,
a given increase in consumer income will ordinarily produce a certain increase in
sales, saving, and tax revenue, and these developments can be expressed
mathematically. With a sufficient number of equations, all the important interactions
within the economy can be simulated in a mathematical model. With the advent of
computers able to make millions of calculations in a few moments, economists began
to construct more and more complex sets of equations, called econometric models.
These models, some of which include hundreds of equations, can be used to forecast
overall economic activity (macroeconomic forecasting) or developments in particular
parts of the economy (microeconomic forecasting). The success of econometric
forecasting has so far been limited because the exact nature of economic relations is
not fully known, and also because of the inadequacies of existing statistics.
Nevertheless, the improvement of these techniques represents the greatest hope for
more accurate economic forecasting in the future

6. Opportunistic Model Building: Opportunistic model building or GNP model

building or sectoral analysis is widely used forecasting method. Initially, the
forecaster must hypothesize total demand and thus total income during the forecast
period. Obviously, this will necessitate assuming certain environmental decisions,
such as war or peace, political relationships among the level of interest rates. After,
this work has been done, the forecaster begins building a forecast of the GNP figure
by estimating the levels of the various component of GNP like the number of
consumption expenditures, gross private domestic investment, government purchases
of goods and services and net exports. After adding the four major categories the
forecaster comes up with a GNP forecast. Now he tests this total for consistency
with an independently arrived at a priori forecast of GNP.

INDUSTRY ANALYSIS:
The mediocre firm in the growth industry usually out performs the best stocks in a stagnant
industry. Therefore, it is worthwhile for a security analyst to pinpoint growth industry, which
has good investment prospects. The past performance of an industry is not a good predictor of
the future- if one look very far into the future. Therefore, it is important to study industry
analysis.
For an industry analyst- industry life cycle analysis, characteristics and classification of industry
is important. All these aspects are enlightened in following sections:
INDUSTRY LIFE CYCLE ANALYSIS: Many industrial economists believe that the
development of almost every industry may be analyzed in terms of following stages:

1. Pioneering stage: During this stage, the technology and product is relatively new. The
prospective demand for the product is promising in this industry. The demand for the
product attracts many producers to produce the particular product. This lead to severe
competition and only fittest companies survive in this stage. The producers try to develop
brand name, differentiate the product and create a product image. This would lead to non-
price competition too. The severe competition often leads to change of position of the
firms in terms of market share and profit.

2. Rapid growth stage: This stage starts with the appearance of surviving firms from the
pioneering stage. The companies that beat the competition grow strongly in sales,
market share and financial performance. The improved technology of production leads
to low cost and good quality of products. Companies with rapid growth in this stage,
declare dividends during this stage. It is always advisable to invest in these companies.

3. Maturity and stabilization stage: After enjoying above-average growth, the industry
now enters in maturity and stabilization stage. The symptoms of technology obsolescence
may appear. To keep going, technological innovation in the production process should be
introduced. A close monitoring at industries events are necessary at this stage.

4. Decline stage: The industry enters the growth stage with satiation of demand,
encroachment of new products, and change in consumer preferences. At this stage the
earnings of the industry are started declining. In this stage the growth of industry is low
even in boom period and decline at a higher rate during recession. It is always
advisable not to invest in the share of low growth industry.
 CLASSIFICATION OF INDUSTRY

Industry means a group of productive or profit-making enterprises organizations that have a

similar technically substitute goods, services or source of income. Besides Standard Industry
Classification (SIC), industries can be classified on the basis of products and business cycle i.e.
classified according to their reactions to the different phases of the business cycle. These are
classified as follows:

1. Growth Industries: A sector of the economy experiencing a higher-than-average growth

rate. Growth industries are often associated with new or pioneer industries that did not
exist in the past and their growth is related to consumer demand for the new products or
services offered by the firms within the industry. If companies across and industry
exhibit solid earnings and revenue figures, that industry may be showing signs that it is in
its growth stage. Growth industries tend to be composed of relatively volatile and risky
stocks. Often investors must be willing to accept increased risk in order to take part in the
potentially large gains offered by stocks within a particular growth industry.

2. Cyclical Industries: A type of an industry that is sensitive to the business cycle, such
that revenues are generally higher in periods of economic prosperity and expansion, and
lower in periods of economic downturn and contraction. Companies in cyclical
industries can deal with this type of volatility by implementing cuts to compensations
and layoffs during bad times, and paying bonuses and hiring en masse in good times.
Cyclical industries include those that produce durable goods such as raw materials and
heavy equipment For example, the airline industry is a fairly cyclical industry; in good
economic times, people have more disposable income and, therefore, they are more
willing to take vacations and make use of air travel. Conversely, during bad economic
times, people are much more cautious about spending. As a result, they tend to take more
conservative vacations closer to home (if they go at all) and avoid expensive air travel.

3. Defensive Industries: Defensive industries are those, such as the food processing
industry, which hurt least in the period of economic downswing. For example- the
industries selling necessities of consumers withstands recession and depression. The
stock of defensive industries can be held by the investor for income earning
purpose. Consumer nondurable and services, which in large part are the items
necessary for existence, such as food and shelter, are products of defensive industry.

4. Cyclical-growth Industries: These possess characteristics of both a cyclical industry

and a growth industry. For example, the automobile industry experiences period of
stagnation, decline but they grow tremendously. The change in technology and
introduction of new models help the automobile industry to resume their growing path.
 CHARACTERISTICS OF AN INDUSTRY ANALYSIS

In an industry analysis, the following key characteristics should be considered by the analyst.
These are explained as below:

1. Post sales and Earnings performance: The historical performance of sales and earnings
should be given due consideration, to know how the industry have reacted in the past.
With the knowledge and understanding of the reasons of the past behavior, the investor
can assess the relative magnitude of performance in future. The cost structure of an
industry is also an important factor to look into. The higher the cost component, the
higher the sales volume necessary to achieve the firm’s break-even point, and vice-versa.

2. Nature of Competition: The top firms in the industry must be analyzed. The demand of
particular product, its profitability and price of concerned company scrip’s also
determine the nature of competition. The investor should analyze the scrip and should
compare it with other companies. If too many firms are present in the industry, this will
lead to a decline in price of the product.

3. Raw Material and Inputs: We need to have a look on industries which are dependent
on raw material. An industry which has limited supply of raw material will have a less
growth. Labor in also an input and problems with labor will also lead to growth
difficulties.

4. Attitude of Government towards Industry: The government policy with regard to

granting of clearance, installed capacity and reservation of the products for small industry
etc. are also factors to be considered for industry analysis.

5. Management: An industry with many problems may be well managed, if the

promoters and the management are efficient. The management has to be assessed in
terms of their capabilities, popularity, honesty and integrity. A good management also
ensures that the future expansion plans are put on sound basis.

6. Labor Conditions and Other Industrial Problems: The industries which depend on
labor, the possibility of strike looms as an important factor to be reckoned with.
Certain industries with problems of marketing like high storage costs, high transport
costs etc. leads to poor growth potential and investors have to careful in investing in
such companies.

7. Nature of Product Line: The position of industry in the different stages of the life
cycle is to be noted. And the importance attached by planning commission on these
industries assessment is to be studied.

8. Capacity Installed and Utilized: If the demand is rising as expected and market is good
for the products, the utilization of capacity will be higher, leading to bright prospects and
higher profitability. If the quality of the product is poor, competition is high and there
are
 other constraints to the availability of inputs and there are labor problems, then the
capacity utilization will be low and profitability will be poor.

9. Industry Share Price Relative to Industry Earnings: While making investment the
current price of securities in the industry, their risk and returns they promise is
considered. If the price is very high relative to future earnings growth, the investment in
these securities is not wise. Conversely, if future prospects are dim but prices are low
relative to fairly level future patterns of earnings, the stocks in this industry might be an
attractive investment.

10. Research and Development: The proper research and development activities help in
increasing economy of an industry and so while investing in an industry, the expenditure
should also be considered.

11. Pollution Standards: These are very high and restricted in the industrial sector.
These differ from industry to industry, for example, in leather, chemical and
pharmaceutical industries the industrial effluents are more.

PROFIT POTENTIAL OF INDUSTRIES: PORTER MODEL

Michael Porter (Harvard Business School Management Researcher) designed various vital
frameworks for developing an organization’s strategy. One of the most renowned among
managers making strategic decisions is the five competitive forces model that determines
industry structure. According to Porter, the nature of competition in any industry is personified
in the following five forces:
• Threat of new potential entrants
• Threat of substitute product/services
• Bargaining power of suppliers
• Bargaining power of buyers
• Rivalry among current competitors

The five forces mentioned above are very significant from point of view of strategy formulation.
The potential of these forces differs from industry to industry. These forces jointly determine
the profitability of industry because they shape the prices which can be charged, the costs which
can be borne, and the investment required to compete in the industry. Before making strategic
decisions, the managers should use the five forces framework to determine the competitive
structure of industry.
 Forces driving industry competition

Let’s discuss the five factors of Porter’s model in detail:

1. Risk of entry by potential competitors: Potential competitors refer to the firms which are not
currently competing in the industry but have the potential to do so if given a choice. Entry of
new players increases the industry capacity, begins a competition for market share and lowers
the current costs. The threat of entry by potential competitors is partially a function of extent of
barriers to entry. The various barriers to entry are-
• Economies of scale
• Brand loyalty
• Government Regulation
• Customer Switching Costs
• Absolute Cost Advantage
• Ease in distribution
• Strong Capital base

2. Rivalry among current competitors: Rivalry refers to the competitive struggle for market
share between firms in an industry. Extreme rivalry among established firms poses a strong
threat to profitability. The strength of rivalry among established firms within an industry is a
function of following factors:
• Extent of exit barriers
• Amount of fixed cost
• Competitive structure of industry
• Presence of global customers
• Absence of switching costs
• Growth Rate of industry
• Demand conditions

3. Bargaining Power of Buyers: Buyers refer to the customers who finally consume the
product or the firms who distribute the industry’s product to the final consumers. Bargaining
power of buyers refer to the potential of buyers to bargain down the prices charged by the firms
in the industry or to increase the firms cost in the industry by demanding better quality and
service of product. Strong buyers can extract profits out of an industry by lowering the prices
and increasing the costs. They purchase in large quantities. They have full information about the
product and the market. They emphasize upon quality products. They pose credible threat of
backward integration. In this way, they are regarded as a threat.
4. Bargaining Power of Suppliers: Suppliers refer to the firms that provide inputs to the
industry. Bargaining power of the suppliers refer to the potential of the suppliers to increase the
prices of inputs (labor, raw materials, services, etc.) or the costs of industry in other ways. Strong
suppliers can extract profits out of an industry by increasing costs of firms in the industry.
Supplier’s products have a few substitutes. Strong suppliers’ products are unique. They have
high switching cost. Their product is an important input to buyer’s product. They pose credible
threat of forward integration. Buyers are not significant to strong suppliers. In this way, they are
regarded as a threat
5. Threat of Substitute products: Substitute products refer to the products having ability of
satisfying customer’s needs effectively. Substitutes pose a ceiling (upper limit) on the potential
returns of an industry by putting a setting a limit on the price that firms can charge for their
product in an industry. Lesser the number of close substitutes a product has, greater is the
opportunity for the firms in industry to raise their product prices and earn greater profits (other
things being equal). The power of Porter’s five forces varies from industry to industry.
Whatever be the industry, these five forces influence the profitability as they affect the prices,
the costs, and the capital investment essential for survival and competition in industry. This five
forces model also help in making strategic decisions as it is used by the managers to determine
industry’s competitive structure.
 Company Analysis:
In company analysis different companies are considered and evaluated from the selected industry
so that most attractive company can be identified. Company analysis is also referred to as
security analysis in which stock picking activity is done. Different analysts have different
approaches of conducting company analysis like
• Value Approach to Investing
• Growth Approach to Investing
Additionally in company analysis, the financial ratios of the companies are analyzed in order to
ascertain the category of stock as value stock or growth stock. These ratios include price to book
ratio and price-earnings ratio. Other ratios like return on equity etc. can also be analyzed to
ascertain the potential company for making investment.
A. Competitive Edge: Many industries in India are composed of hundreds of individuals
companies. The large companies are successful in meeting the competition and some
companies rise to the position of eminence and dominance. The companies who have
obtain the leadership position; have proven his ability to withstand competition and to
have a sizable share in the market. The competitiveness of the company can be
studied with the help of:

a) Market share: The market share of the company helps to determine a company’s
relative position within the industry. If the market share is high, the company would be
able to meet the competition successfully. The size of the company should also be
considered while analyzing the market share, because the smaller companies may find it
difficult to survive in the future.

b) Growth of annual sales: Investor generally prefers to study the growth in sales because
the larger size companies may be able to withstand the business cycle rather than the
company of smaller size. The rapid growth keeps the investor in better position as growth
in sales is followed by growth in profit. The growth in sales of the company is analyzed
both in rupee terms and in physical terms.

c) Stability of annual sales: If a firm has stable sales revenue, other things being remaining
constant, will have more stable earnings. Wide variation in sales leads to variation in
capacity utilization, financial planning and dividends. This affects the company’s position
and investor’s decision to invest.

B. Earnings: The earning of the company should also be analyzed along with the sales level.
The income of the company is generated through the operating (in service industry like banks-
interest on loans and investment) and non-operating income (ant company, rentals from lease,
dividends from securities). The investor should analyze the sources of income properly. The
investor should be well aware with the fact that the earnings of the company may vary due to
following reasons: Change in sales, change in costs, Depreciation method adopted, Inventory
accounting method, Wages, salaries and fringe benefits, Income tax and other taxes.

C. Capital Structure: Capital structure is combination of owned capital and debt capital which
enables to maximize the value of the firm. Under this, we determine the proportion in which the
capital should be raised from the different securities. The capital structure decisions are related
with the mutual proportion of the long-term sources of capital. The owned capital includes
share capital.

a) Preference shares: Preference shares are those shares which have preferential rights
regarding the payment of dividend and repayment of capital over the equity
shareholders. At present many companies resort to preference shares. The preference
shares induct some degree of leverage in finance. The leverage effect of the preference
shares is comparatively lesser than that the debt because the preference shares dividend
is not tax deductible. If the portion of preference share in the capital is large, it tends to
create instability in the earnings of equity shares when the earnings of the company
fluctuate.

b) Debt: It is an important source of finance as it has the specific benefit of low cost of
capital because interest is tax deductible. The leverage effect of debt is highly
advantageous to the equity shareholders. The limits of debt depend upon the firm’s
earning capacity and its fixed assets.

D. Management: The basic objective of the company is to attain the stated objectives of the
company for the good of the equity holders, the public and employees. If the objectives of
the company are achieved, investor will have a profit. Good management results in high
profit to investors. Management is responsible for planning, organizing, actuating and
controlling the activities of the company. The good management depends upon the qualities
of the manager.

E. Operating Efficiency: The operating efficiency of the company directly affects the earnings
capacity of a company. An expanding company that maintains high operating efficiency with a
low breakeven point earns more than the company with high breakeven point. If a firm has stable
operating ratio, the revenues also would be stable. Efficient use of fixed assets with raw
materials, labor and management would lead to more income from sales. This leads to internal
fund generation for the expansion of the firm.

F. Financial Performance:
a) Balance Sheet: The level, trends, and stability of earnings are powerful forces in the
determination of security prices. Balance sheet shows the assets, liabilities and owner’s equity in
a company. It is the analyst’s primary source of information on the financial strength of a
company. Accounting principles dictate the basis for assigning values to assets. Liability values
are set by contracts. When assets are reduced by liabilities, the book value of shareholder’s
equity can be ascertained. The book value differs from current value in the market place, since
market value is dependent upon the earnings power of assets and not their cost of values in the
accounts.

b) Profit and Loss account: It is also called as income statement. It expresses the results of
financial operations during an accounting year i.e. with the help of this statement we can find
out how much profit or loss has taken place from the operation of the business during a period of
time. It also helps to ascertain how the changes in the owner’s interest in a given period have
taken place due to business operations.

COMPANY ANALYSIS: THE STUDY OF FINANCIALS STATEMENTS:

Financial statement means a statement or document which explains necessary financial
information. Financial statements express the financial position of a business at the end of
accounting period (Balance Sheet) and result of its operations performed during the year (Profit
and Loss Account). In order to determine whether the financial or operational performance of
company is satisfactory or not, the financial data are analyzed. Different methods are used for
this purpose. The main techniques of financial analysis are:

1) Comparative Financial Statements: In comparative financial statement, the financial

statements of two periods are kept by side so that they can be compared. By preparing
comparative statement the nature and quantum of change in different items can be
calculated and it also helps in future estimates. By comparing with the data of the
previous years it can be ascertained what type of changes in the different items of
current year have taken place and future trends of business can be estimated.

2) Trend Analysis: In order to compare the financial statements of various years trend
percentages are significant. Trend analysis helps in future forecast of various items on
the basis of the data of previous years. Under this method one year is taken as base year
and on its basis the ratios in percentage for other years are calculated. From the study of
these ratios the changes in that item are examined and trend is estimated. Sometimes
sales may be increasing continuously and the inventories may also be rising. This would
indicate the loss of market share of a particular company’s product. Likewise, sales may
have an increasing trend but profit may remain the same. Here the investor has to look
into the cost and management efficiency of the company.

3) Common Size Statement: Common size financial statements are such statements in which
items of the financial statements are converted in percentage on the basis of common base. In
common size Income Statement, net sales may be considered as 100 percent. Other items are
converted as its proportion. Similarly, for the Balance sheet items total assets or total liabilities
may be taken as 100 percent and proportion of other items to this total can be calculated in
percentage.
4) Fund Flow Statement: Income Statement or Profit or Loss Account helps in ascertainment
of profit or loss for a fixed period. Balance Sheet shows the financial position of business on a
particular date at the close of year. Income statement does not fully explain funds from
operations of business because various non-fund items are shown in Profit or Loss Account.
Balance Sheet shows only static financial position of business and financial changes occurred
during a year can’t be known from the financial statement of a particular date. Thus, Fund Flow
Statement is prepared to find out financial changes between two dates. It is a technique of
analyzing financial statements.

5) Cash Flow Statement: The investor is interested in knowing the cash inflow and outflow of
the enterprise. The cash flow statement expresses the reasons of change in cash balances of
company between two dates. It provides a summary of stocks of cash and uses of cash in the
organization. It shows the cash inflows and outflows. Inflows (sources) of cash result from cash
profit earned by the organization, issue of shares and debentures for cash, borrowings, sale of
assets or investments, etc. The outflows (uses) of cash results from purchase of assets,
investment redemption of debentures or preferences shares, repayment of loans, payment of tax,
dividend, interest etc. With the help of cash flow statement, the investor can review the cash
movement over an operating cycle. The factors responsible for the reduction of cash balances in
spite of increase in profits or vice versa can be found out.

6) Ratio Analysis: Ratio is a relationship between two figures expressed mathematically. It is

quantitative relationship between two items for the purpose of comparison. Ratio analysis is a
technique of analyzing financial statements. It helps in estimating financial soundness or
weakness. Ratios present the relationships between items presented in profit and loss account
and balance sheet. The ratios are divided in the following group:
a) Liquidity Ratios: Liquidity rations means ability of the company to pay the short term
debts in time. These ratios are calculated to analyze the short term financial position and
short term financial solvency of firm. Commercial banks and short term creditors are
interested in such analysis.
b) Turnover Ratios: These ratios show how well the assets are used and the extent of
excess inventory.
c) Profit Margin Ratios: Earning of more and more profit with the optimum use of
available resources of business is called profitability. The investor is very particular in
knowing net profit to sales, net profit to total assets and net profit to equity. The
profitability ratio measures the overall efficiency and control of firm.
FORECASTING EARNINGS: There is strong evidence that earnings have a direct and
powerful effect upon dividends and share prices. So, the importance of forecasting
earnings cannot be overstated. These ratios are generally known as ‘Return on Investment
Ratios’. These ratios help in evaluating whether the business is earning adequate return
on the capital invested or not. With the help of the following ratios the performance of
the business can be measured.
 Valuation of Securities

Definition of 'Bond'
A debt investment in which an investor loans money to an entity (corporate or governmental)
that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by
companies, municipalities, states and U.S. and foreign governments to finance a variety of
projects and activities. Bonds are commonly referred to as fixed-income securities and are one
of the three main asset classes, along with stocks and cash equivalents.

Bonds are a popular form of investment because they offer regular income, capital
preservation, and diversification benefits. It is a loan agreement between a borrower and a
lender. When an entity or an individual buys a bond, they lend money to the issuer for a
specific period.

The issuer promises to repay the amount at the end of the term with an agreed-upon interest rate.
This article discusses different types of bonds in India, their features, advantages, limitations,
and things to consider before investing.
Types of Bonds
1. Treasury Bonds: The central government issues treasury bonds. Hence, it is the safest type
of bond because there is no credit risk. These bonds have a maturity period of ten to thirty years
and pay a fixed interest rate, which is a factor in the prevailing market conditions.
2. Municipal Bonds: Local and state governments use these to gather funds for development
projects such as schools, highways, and hospitals. Municipal Bonds are exempted from tax. They
are available in both short-term and long-term maturities.
3. Corporate Bonds: Companies or business conglomerates issue corporate bonds to raise
capital for their business operations. They are riskier than treasury bonds because the
creditworthiness of the issuing company backs them. Corporate bonds can have varying
maturities and interest rates, depending on the issuer's creditworthiness and market conditions.
4. High-yield Bonds: Companies issue high-yield bonds with lower credit ratings and are
riskier than investment-grade bonds. They offer a higher yield to compensate for the higher
risk. High-yield bonds are also known as junk bonds.
5. Mortgage-Backed Securities: Real estate companies create mortgage-backed securities by
pooling many mortgages and issuing bonds against the underlying mortgage pool. The cash
flow from the mortgages backs these securities, so they are safer than corporate bonds because
they carry less credit risk.
6. Floating Rate Bonds: Floating rate bonds have an interest rate adjusted periodically
based on a reference rate, such as the Reserve Bank of India's repo rate. It protects investors
from interest rate risk because the rates move with prevailing market rates. The interest rate of
these bonds is subject to market fluctuations and macroeconomic parameters.
7. Zero-Coupon Bonds: Zero-coupon bonds are issued at a discount to their face value and
do not pay periodic interest. Instead, they offer a fixed return at maturity, i.e., the difference
between the issue price and face value. They are ideal for investors who want to lock in a fixed
return for a specific period.
8. Callable Bonds: The issuer can redeem callable bonds before maturity, usually at a
premium price. They offer the issuer flexibility in managing their debt obligations but
carry reinvestment risk for the investor.
9. Convertible Bonds: The issuing company can convert these bonds into shares of the issuing
company's stock at a pre-determined conversion ratio. They offer the investor the potential for
capital appreciation and fixed income.
10. Inflation-Protected Bonds: The government issues inflation-protected bonds intending to
protect investors from inflation. They pay a fixed interest rate, which is adjusted periodically to
reflect changes in the Consumer Price Index.
Features of Bonds
Bonds come with several features that distinguish them from other forms of investment.
A. Interest Rate: The interest rate is the coupon the bond issuer pays the bondholder.
Typically, it is a fixed percentage of the face value of the bond and is paid out periodically over
the bond’s life.
B. Maturity date: The maturity date refers to the redemption date, and the bond issuer must
repay the bond's principal amount to the bondholder. It is the date on which the bond "matures."
C. Face value: The face value is the amount the bond issuer will pay the bondholder
at maturity. It is also known as the par value of the bond.
D. Yield: The yield is the rate of return on a bond. It is a percentage of the bond's
current market price. It considers both the coupon rate and the bond's current market price.
E. Credit rating: Credit rating agencies assign a bond rating based on the issuer's
creditworthiness. This rating reflects the likelihood that the issuer will default on its bond
payments.
F. Liquidity: Bonds can be bought and sold in the secondary market so that investors can
sell their bonds before maturity. The liquidity of a bond refers to the ease with which it can be
bought or sold in the secondary market.

Advantages of Bonds
There are various types of bonds to invest in, each with pros and cons. Bonds are a stable
investment option for risk-averse investors due to the dependability of interest and principal
returns. Some of these advantages include the following.
1. Steady income: Bonds typically provide a fixed income source through periodic interest
payments. This feature makes bonds an attractive option for investors seeking regular
income.
2. Diversification: Bonds offer an opportunity to diversify an investor's portfolio. They tend
to have a low correlation with other asset classes, such as equities and can help reduce overall
portfolio risk.
3. Lower risk: They are less risky than equities since they have a higher priority of payment if
the issuer defaults. Bondholders are also typically paid back before equity holders are in
liquidation.
4. Predictability: Bonds have a fixed term and interest rate, making them predictable
investments. This predictability can be especially attractive for investors seeking a stable, low-
risk investment.
5. Issuer flexibility: They can be issued in various forms and terms, allowing issuers
flexibility in raising capital. Bonds are customisable and meet the specific needs of the issuer,
such as funding long-term projects or managing short-term cash needs.

Limitations of Bonds
Despite their many advantages, bonds also have some limitations.
1. Interest rate risk: Generally, bond prices tend to fall when the interest rate increases. It
means that if an investor needs to sell their bond before maturity, they may have to sell at a
loss. This risk is particularly relevant in a rising interest rate environment.
2. Inflation risk: While bonds provide a steady income stream, inflation can erode the value of
that income over time. It means that investors may end up with less purchasing power.
3. Credit risk: Bonds are only as good as the issuer’s creditworthiness. If the issuer defaults,
bondholders may not receive their entire principal and interest payments. One can mitigate the
risk by investing in bonds with higher credit ratings, but this generally comes at the cost of lower
yields.
4. Liquidity risk: Some bonds may be difficult to sell quickly, especially if they do not
trade frequently. It can be a problem for investors who must sell their bonds before maturity.
5. Limited potential for capital appreciation: While some bonds may experience capital
appreciation, the potential for price gains is generally limited. Investors looking for
significant capital appreciation may need to consider other investments.
Debentures
There are various kinds of instruments depending on the characteristics and terms of borrowing.
Debentures come under the category of medium- or long-term debt instruments which a firm
gives in return for some money borrowed and provides the person with a fixed amount of
interest.
Debentures are a profitable option for a firm as when the company grows and thrives, debentures
attract only a fixed sum out of the profit, but equity becomes part of the profit. Hence, from a
firm’s point of view, selling debentures is better than diluting equity. It is a far better way to
raise funds when compared to shares and can be easily reddened. It is a slightly better option for
people who don’t want to take the risk of investing in equity as equity provides ownership, but
one has to bear losses as well. On the other hand, debentures always get a fixed interest if the
company has enough funds to do so. They are always preferred over shareholders.

Types of Debentures
Debentures are a debt to a firm, but they are preferred because there is no equity dilution. It is
just a form of loan which is used for a company’s long term profit and growth. There are
various types of debentures in the market and one should always know about these before
choosing the one to be purchased.
1. Convertible Debentures- One of the various types of debentures is convertible debentures.
The most significant feature of differentiation of a convertible debenture is that it can be
converted into shares or stocks at a certain point in time or when the firm notifies of the same.
Although these debentures have a lower interest rate when compared to stock, they are extremely
useful.
2. Partially Convertible Debentures- The debentures which can be converted into shares but to
a certain limit or a certain percentage are known as partially convertible debentures. It is hybrid
as after its partial conversion, some portion remains debenture while some become part of the
company’s share.
3. Non- Convertible Debentures- These are normal or basic kinds of debentures which
can never be converted into stocks after they have been issued and till the time they exist.
4. Registered Debentures- The kind of debentures which are transferred providing a pepper
proof of records and documents needed for it. These are one of the safest kinds of debentures as
there is less chance of fraud compared to bearer debentures discussed below.
5. Bearer Debentures- The type of debentures that are unregistered and can be delivered after
purchase without any compulsory need for evidence or record are known as bearer debentures.
There is no tertiary involvement in the transaction for a bearer debenture and it a
comparatively more prone to tax evasion and fraud.
6. Secured Debenture- These are the kind of debentures that are like an alternative to a loan
where the collateral is needed to make money and when the firm starts paying off the debts at
the time of its closure due to any reason, then the secured debenture holders are paid first.
7. Unsecured Debentures- The type of debentures which don’t need any kind of collateral are
unsecured debentures and are preferred less at the time of payment compared to secured
debentures.
8. Redeemable Debentures- The debentures which are purchases for a pre-specified period
and are paid by the end of this time are known as redeemable debentures.
9. Irredeemable Debentures- Also known as perpetual debentures, irredeemable debentures
don’t have a fixed time for the redemption of the invested amount.
Preference shares:
Preference shares commonly known as preferred stocks; are those shares that enable
shareholders to receive dividends announced by the company before receiving to the equity
shareholders.
If the company has decided to pay out its dividends to investors, preference shareholders are the
first to receive payouts from the company.
Preference shares are released to raise capital for the company, which is known as preference
share capital. If the company is going through a loss and winding up, the last payments will be
made to preference shareholders before paying to equity shareholders.
Preference shares that can be easily converted into equity shares are known as convertible
preference shares. Some preference shares also receive arrears of dividends, which are called
cumulative preference shares.
In India, preference shares should be redeemed within 20 years of issuance, and these types of
preference shares are called redeemable preference shares.
As per the Companies Act 2013, companies do not have any right to issue irredeemable
preference shares in India.
 Types of Preference Shares
There are nine different types of preference shares given below:
1. Redeemable Preference Shares: Redeemable preference shares are those shares that
can be repurchased or redeemed by the issuing company at a fixed rate and date.
These types of shares help the company by providing a cushion during times of
inflation.
2. Non-Redeemable Preference Shares: Non-redeemable preference shares are those
shares that cannot be redeemed or repurchased by the issuing company at a fixed date.
Non-redeemable preference shares help companies by acting as a lifesaver during
times of inflation.
3. Participating Preference Shares: Participating preference shares help shareholders
demand a part in the company’s surplus profit at the time of the company’s liquidation
after the dividends have been paid to other shareholders. However, these shareholders
receive fixed dividends and get part of the surplus profit of the company along with
equity shareholders.
4. Non-Participating Preference Shares: These shares do not benefit the shareholders
the additional option of earning dividends from the surplus profits earned by the
company, but they receive fixed dividends offered by the company.
5. Cumulative Preference Shares: Cumulative preference shares are those type of shares
that gives shareholders the right to enjoy cumulative dividend payout by the company
even if they are not making any profit. These dividends will be counted as arrears in
years when the company is not earning profit and will be paid on a cumulative basis the
next year when the business generates profits.
6. Non - Cumulative Preference Shares: Non - Cumulative Preference Shares do not
collect dividends in the form of arrears. In the case of these types of shares, the
dividend payout takes place from the profits made by the company in the current year.
So, if a company does not make any profit in a single year, then the shareholders will
not receive any dividends for that year. Also, they cannot claim dividends in any
future profit or year.
7. Adjustable Preference Shares: In the case of adjustable preference shares, the
dividend rate is not fixed and is influenced by current market rates.
Features of preference shares:
1. They can be converted into common stock
2. Dividend payouts
3. Dividend preference
4. voting rights
5.preference in
assets
 Equity shares:
An equity share, normally known as ordinary share is a part ownership where each member is a
fractional owner and initiates the maximum entrepreneurial liability related to a trading concern.
Difference between Bonds, Preference shares and equity shares
 Bond Duration
DEFINITION of 'Duration' -A measure of the sensitivity of the price (the value of principal) of
a fixed-income investment to a change in interest rates. Duration is expressed as a number of
years. Rising interest rates mean falling bond prices, while declining interest rates mean rising
bond prices.
First, it's important to understand how interest rates and bond prices are related. The key point to
remember is that rates and prices move in opposite directions. When interest rates rise, the prices
of traditional bonds fall, and vice versa. So, if you own a bond that is paying a 3% interest rate
(in other words, yielding 3%) and rates rise, that 3% yield doesn't look as attractive. It's lost
some appeal (and value) in the marketplace.
Duration is a way of measuring how much bond prices are likely to change if and when interest
rates move. In more technical terms, duration is measurement of interest rate risk.
Duration is measured in years. Generally, the higher the duration of a bond or a bond fund
(meaning the longer you need to wait for the payment of coupons and return of principal), the
more its price will drop as interest rates rise.

Elements of Duration
The concept of duration is straightforward: It measures how quickly a bond will repay its true
cost. The longer it takes, the greater exposure the bond has to changes in the interest rate
environment.
Here are some of factors that affect a bond's duration:
 Time to maturity: Consider two bonds that each cost $1,000 and yield 5%. A bond that
matures in one year would more quickly repay its true cost than a bond that matures in 10
years. As a result, the shorter-maturity bond would have a lower duration and less price risk.
The longer the maturity, the higher the duration.
 Coupon rate:A bond's payment is a key factor in calculating duration. If two otherwise
identical bonds pay different coupons, the bond with the higher coupon will pay back
its original cost quicker than the lower-yielding bond. The higher the coupon, the lower
the duration.

Types of Duration There are four main types of duration calculations, each of which differ in
the way they account for factors such as interest rate changes and the bond's embedded options
or redemption features. The four types of durations are
Macaulay duration
modified duration
effective duration
and Key-rate
duration.

Macaulay Duration The formula usually used to calculate a bond\'s basic duration is the
Macaulay duration, which was created by Frederick Macaulay in 1938, although it was not
commonly used until the 1970s. Macaulay duration is calculated by adding the results of
multiplying the present value of each cash flow by the time it is received and dividing by the
total price of the security. The formula for Macaulay duration is as follows:
n = number of cash flows
t = time to maturity
C = cash flow
i = required yield
M = maturity (par) value
P = bond price

Remember that bond price equals:

So the following is an expanded version of Macaulay duration:

Modified Duration Modified duration is a modified version of the Macaulay model that accounts
for changing interest rates. Because they affect yield, fluctuating interest rates will affect
duration, so this modified formula shows how much the duration changes for each percentage
change in yield. For bonds without any embedded features, bond price and interest rate move in
opposite directions, so there is an inverse relationship between modified duration and an
approximate 1% change in yield. Because the modified duration formula shows how a bond's
duration changes in relation to interest rate movements, the formula is appropriate for investors
wishing to measure the volatility of a particular bond. Modified duration is calculated as the
following:

OR
Effective Duration The modified duration formula discussed above assumes that the expected
cash flows will remain constant, even if prevailing interest rates change; this is also the case for
option-free fixed-income securities. On the other hand, cash flows from securities with
embedded options or redemption features will change when interest rates change. For calculating
the duration of these types of bonds, effective duration is the most appropriate. Effective duration
requires the use of binomial trees to calculate the option-adjusted spread (OAS). There are entire
courses built around just those two topics, so the calculations involved for effective duration are
beyond the scope of this tutorial. There are, however, many programs available to investors
wishing to calculate effective duration

Key-Rate Duration The final duration calculation to learn is key-rate duration, which calculates
the spot durations of each of the 11 "key" maturities along a spot rate curve. These 11 key
maturities are at the three-month and one, two, three, five, seven, 10, 15, 20, 25, and 30-year
portions of the curve.

In essence, key-rate duration, while holding the yield for all other maturities constant, allows the
duration of a portfolio to be calculated for a one-basis-point change in interest rates. The key-
rate method is most often used for portfolios such as the bond ladder, which consists of fixed-
income securities with differing maturities. Here is the formula for key-rate duration:

The sum of the key-rate durations along the curve is equal to the effective duration.

Bond Return
There are several ways of describing a rate of return on bond. Some of them are:
 Holding period return
 The current yield
 Yield to maturity
 Holding Period Return
It is a return in which an investor buys a bond and liquidates it in the market after holding it for
a definite period of time.

The formula for calculating holding period of return is as follows:

 Price gain + Coupon payment

Purchase price

 It can be calculated on a daily, monthly or annual basis.

The Current Yield

 It is a measure through which the investors can easily figure out the rate of cash flow
on the investments made by them every year.

 It is calculated as: Annual Coupon Payment

Purchase Price

Yield to Maturity
 It is the single discount factor that makes the present value of future cash flowsfrom a
bond equivalent to the current price of the bond.

 The following assumptions are used to calculate yield to maturity:

 There should not be any default.

 The interest payments are reinvested at yield to maturity.

 The investor has to hold the bond till its maturity.

 It is calculated as:
Present value = coupon1 + coupon2 +………. + coupon n + Face

value (1+y)1 (1+y)2 (1+y)n