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Investment Basics

What is Investment?
Investment is using savings in order to get a return on it in the future instead of keeping the savings
idle.

Why Invest?
To earn return on idle resources
To generate a specified sum of money for a specific goal
To make a provision for an uncertain future
To meet the cost of inflation

Inflation
The rate at which the cost of living increases.

Inflation causes money to lose value, as it won't buy the same amount of goods or services in the future. It's
important to consider inflation in any long-term investment strategy.

Aim for a return above the inflation rate.

Look at an investment's real rate of return, which is the return after inflation.
If the after-tax return is less than the inflation rate, assets have actually decreased in value.
Example: With a 6% inflation rate over 20 years, a Rs. 100 purchase today would cost Rs. 321 in 20
years.

When to Start Investing?

The sooner, the better. Investing early allows more time for investments to grow, utilizing compounding.

Three Golden Rules for Investors:

1. Invest early
2. Invest regularly
3. Invest for the long term

What Care Should One Take While Investing?

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Step Action

1 Obtain written documents explaining the investment.

2 Read and understand such documents.
3 Verify the legitimacy of the investment.
4 Find out the costs and benefits associated with the investment.
5 Assess the risk-return profile of the investment.
6 Know the liquidity and safety aspects of the investment.
7 Ascertain if it is appropriate for specific goals.
8 Compare details with other investment opportunities.
9 Examine if it fits in with other investments you are considering or have already made.
10 Deal only through an authorized intermediary.
11 Seek all clarifications about the intermediary and the investment.
Explore the options available if something were to go wrong, and then, if satisfied, make the
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investment.

What is Interest?
An amount charged to the borrower for the privilege of using the lender's money.

It is usually calculated as a percentage of the principal balance. The percentage rate may be fixed or variable.

Factors Determining Interest Rates

Interest rates are governed by economy-related factors, also known as macroeconomic factors.

Demand for money

Level of Government borrowings
Supply of money
Inflation rate
The Reserve Bank of India and the Government policies

Investment Options
One may invest in:

Physical assets
Real estate
Gold/jewellery
Commodities
Financial assets
Fixed deposits with banks
Small saving instruments with post offices
Insurance/provident/pension fund
Securities market related instruments
Shares
Bonds
Debentures

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Short-Term Financial Options

Savings bank account
Money market/liquid funds
Fixed deposits with banks
Mutual Funds

Funds operated by an investment company which raises money from the public and invests in
a group of assets (shares, debentures etc.), in accordance with a stated set of objectives.

Financial Investment Options

Short-Term Financial Options

Savings Bank Account: Often the first banking product people use, offering low interest (4%-5% p.a.),
only marginally better than fixed deposits.
Money Market or Liquid Funds: Specialized mutual funds investing in extremely short-term fixed income
instruments for easy liquidity. They prioritize capital protection and offer better returns than savings
accounts, but lower than bank fixed deposits.
Fixed Deposits with Banks: Also known as term deposits, with a minimum investment period of 30 days.
Suitable for investors with low risk appetite, and may be considered for 6-12 months investment period.
Interest on less than 6 months bank FDs is likely to be lower than money market fund returns.

Long-Term Financial Options

Post Office Savings Schemes
Public Provident Fund
Company Fixed Deposits
Bonds and Debentures
Mutual Funds

Post Office Savings Schemes

Post Office Monthly Income Scheme

Description: A low-risk saving instrument available through any post office.
Interest Rate: 8% per annum, paid monthly.
Investment Amounts:
Minimum: Rs. 1,000/-
Additional investments in multiples of Rs. 1,000/-
Maximum: Rs. 3,00,000/- (Single), Rs. 6,00,000/- (Joint) per year.
Maturity Period: 6 years.
Bonus: 10% paid at maturity.
Premature Withdrawal: Allowed after one year, with a 5% deduction from the principal and denial of the
10% bonus.

Public Provident Fund (PPF)

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Description: A long-term savings instrument.

Maturity: 15 years.
Interest: 8% per annum, compounded annually.
Account Opening: Can be opened through a nationalized bank anytime during the year.
Tax Benefits: Available on invested amount; interest accrued is tax-free.
Withdrawal Rule: A withdrawal is permissible every year from the seventh financial year of the date of
opening of the account. The amount of withdrawal will be limited to 50% of the balance at credit at the
end of the 4th year immediately preceding the year in which the amount is withdrawn or at the end of the
preceding year whichever is lower the amount of loan if any.

Company Fixed Deposits

Description: Short-term (6 months) to medium-term (3-5 years) borrowings by companies.
Interest Rate: Varies between 6-9% per annum.
Payment of Interest: Monthly, quarterly, semi-annually, or annually.
Cumulative Fixed Deposits: Principal along with interest paid at the end of the loan period.
Taxation: Interest received is after deduction of taxes.

Bonds
Definition:

A fixed income (debt) instrument issued for a period of more than one year to raise capital.

Issuers: Central or state governments, corporations, and similar institutions.

Features: Promise to repay the principal along with a fixed rate of interest on a specified date, called the
Maturity Date.

Mutual Funds

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Definition:

Funds operated by an investment company that raises money from the public and invests in a
group of assets (shares, debentures, etc.) according to stated objectives.

Function: A substitute for those unable to invest directly in equities or debt due to resource, time, or
knowledge constraints.

Benefits:

Professional money management

Buying in small amounts
Diversification

Net Asset Value (NAV): Mutual fund units are issued and redeemed by the Fund Management Company
based on the funds net asset value (NAV), which is determined at the end of each trading session.

Value of shares - Expenses

N AV =
Number of units issued

Investment Objectives: Outlined in the fund's prospectus and binding on the scheme, specifying the class
of securities a Mutual Fund can invest in.

Asset Classes: Equity, bonds, debentures, commercial paper, and government securities.

Schemes: Vary from fund to fund, including pure equity schemes and mixes of equity and bonds.

Options for Investors: Dividends (declared periodically) or participation in the capital appreciation of the
scheme.

Equity/Share
Definition: Total equity capital of a company divided into equal units of small denominations.
Example: A company with total equity capital of Rs 300,00,000 divided into 20,00,000 units of Rs 10
each has 20,00,000 equity shares of Rs 10 each.
Rights of Shareholders: Holders of shares are members of the company and have voting rights.

Debt Instrument
Definition:

A contract where one party lends money to another on pre-determined terms regarding
interest rate, periodicity of interest, and repayment of principal.

Bonds vs. Debentures (Indian context):

Bonds: Used for debt instruments issued by Central and State governments and public sector
organizations.
Debentures: Used for instruments issued by the private corporate sector.

Derivative

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Definition:

A product whose value is derived from one or more basic variables, called the underlying.

Underlying Assets: Equity, index, foreign exchange (forex), commodity, or any other asset.

Historical Context:

Initially used as hedging devices against commodity price fluctuations.

Financial derivatives gained prominence post-1970 due to financial market instability.
By the 1990s, they accounted for about two-thirds of total transactions in derivative products.

Stock Exchange
Definition (as per the Securities Contract (Regulation) Act, 1956 [SCRA]):

Any body of individuals, whether incorporated or not, constituted for the purpose of assisting,
regulating, or controlling the business of buying, selling, or dealing in securities.

Types:

Regional Stock Exchange: Area of operation/jurisdiction specified at the time of recognition.

National Exchanges: Permitted nationwide trading from inception (e.g., NSE).

Securities Market

Function
A place where buyers and sellers transact to purchase/sell shares, bonds, debentures, etc.
Enables corporates/entrepreneurs to raise resources via public issues.
Reallocates savings from those with idle resources (investors) to those who need them (corporates).
Provides channels for reallocation of savings to investments and entrepreneurship via securities.

Participants
Issuers of securities
Investors in securities
Intermediaries (merchant bankers, brokers, etc.)
Corporates and governments raise resources; households invest savings.

Securities for Investment

Shares
Government Securities
Derivative products
Units of Mutual Funds

Importance of Intermediaries

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Advisable to transact through an intermediary (e.g., trading member of a stock exchange).

Necessary for buying/selling on stock exchanges, holding securities in demat form, subscribing to public
issues.
Guidance is provided.
Choose a SEBI-registered intermediary for accountability.

Segments of Securities Market

Primary Market (New Issues): Channel for sale of new securities.
Secondary Market: Deals in previously issued securities.

Need for Regulators in the Securities Market

Absence of perfect competition necessitates regulation.
Ensures market participants behave appropriately.
Maintains securities market as a major finance source for corporates/government.
Protects investor interests.

Regulatory Bodies in India

Department of Economic Affairs (DEA)
Department of Company Affairs (DCA)
Reserve Bank of India (RBI)
Securities and Exchange Board of India (SEBI)

Securities and Exchange Board of India (SEBI)

Establishment: Established under Section 3 of SEBI Act, 1992.
Powers and Functions:
Protecting investor interests in securities.
Promoting the development of the securities market.
Regulating the securities market.
Jurisdiction: Extends over corporates issuing capital and transferring securities, plus intermediaries and
individuals associated with the securities market.
Specific Powers:
Regulating stock exchanges and other securities markets.
Registering and regulating stock brokers, sub-brokers, etc.
Promoting and regulating self-regulatory organizations.
Prohibiting fraudulent and unfair trade practices.
Requesting information, conducting inspections, inquiries, and audits of exchanges, intermediaries,
self-regulatory organizations, mutual funds, and others associated with the securities market.

Definition of Securities (SCRA, 1956)

Includes instruments like shares, bonds, scrips, stocks, or other marketable securities of similar nature in
or of any incorporate company or body corporate
Government securities
Derivatives of securities
Units of collective investment scheme
Interest and rights in securities
Security receipt or any other instruments declared by the Central Government

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Index
Definition: Shows how a specified portfolio of share prices are moving to indicate market trends.
Function: A basket of securities where the average price movement indicates the index movement
(upwards or downwards).

Depository
Definition:

Like a bank, but for securities (shares, debentures, bonds, government securities, units, etc.) in
electronic form.

Dematerialization
Definition:

The process of converting physical certificates into an equivalent number of securities in

electronic form, credited to the investor's account with their Depository Participant (DP).

Primary Market (New Issue Market)

Role: Provides the channel for the sale of new securities.
Offers opportunities to issuers of securities.

Primary Market
Raising Capital in the Primary Market
The primary market serves as a platform for governments and corporations to secure funds for investments or
to fulfill obligations. This is achieved through the issuance of securities, which can take various forms, including:

Equity
Debt These securities can be offered in both domestic and international markets.

Face Value, Premium, and Discount

Face Value
The face value of a share or debenture is the nominal or stated amount assigned to it by the issuer.
For shares, it's the original cost shown on the certificate. For bonds, it's the amount paid to the
holder at maturity, also known as par value.

For equity shares, the face value is typically small (e.g., Rs. 5, Rs. 10) and doesn't significantly affect the
share's market price.
For debt securities like government securities and corporate bonds, the face value is often Rs. 100.

Premium and Discount

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Premium: When a security is sold above its face value.

Discount: When a security is sold below its face value.

Why Companies Issue Shares to the Public

Companies, often started privately, may find initial capital and borrowings insufficient for long-term
operations.
To raise additional funds, they invite the public to contribute equity by issuing shares, known as a Public
Issue, which is an offer to the public to subscribe to the company's share capital.
The company then allots shares to applicants according to rules and regulations set by the SEBI
(Securities and Exchange Board of India).

Types of Issues
Issues are classified into:

Public Issues
Rights Issues
Preferential Issues (Private Placements)
Issue Type Procedure Complexity

Public Issues Detailed

Rights Issues Detailed
Private Placements Simpler

Initial Public Offering (IPO)

An Initial Public Offering (IPO) occurs when an unlisted company offers new securities or sells
existing ones to the public for the first time, paving the way for the securities to be listed and traded
on the stock exchange.

Follow-on Public Offering

A follow-on public offering (Further Issue) is when an already listed company makes either a fresh
issue of securities to the public or an offer for sale to the public, through an offer document.

Rights Issue
A Rights Issue involves a listed company offering fresh securities to its existing shareholders on a
record date, usually in proportion to their holdings. It's beneficial for companies seeking capital
without diluting existing shareholders' stakes.

Preferential Issue
A Preferential Issue is when listed companies issue shares or convertible securities to a select
group of individuals under Section 81 of the Companies Act, 1956, which is neither a rights issue
nor a public issue. This method allows companies to raise equity capital more quickly.

Public vs. Private Placement

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Characteristic Public Issue Private Placement

Open to the general public and any investor at

Offering Made to a select set of people
large
Regulations Follows detailed procedures Relatively simpler
An issue becomes public if allotment is made to An issue can be privately placed if allotment is
Threshold
50+ persons <50 persons

Determining the Price of an Issue

Since 1992, the Indian primary market has adopted free pricing, allowing the issuer, in consultation with a
Merchant Banker, to decide the price.
SEBI does not dictate a price formula but requires full disclosure of the parameters considered during
price determination.
Two methods for fixing the price:
Fixed Price: Company and Merchant Banker set a price.
Book Building: Company and Lead Manager set a floor price or price band, allowing market forces
to determine the final price.

Book Building Process

Book Building is an IPO mechanism for efficient price discovery. Bids are collected from investors at
various prices above or equal to a floor price during the IPO period, and the offer price is determined
after the bid closing date.

Book Building vs. Normal Public Issue

Feature Book Building Normal Public Issue

Not known in advance; determined after the bid

Price Known in advance to the investor
closing date
Bidding Investors bid at or above the floor price N/A
Demand Demand is known at the close of the
Demand is known daily as the book is being built
Information issue

Issue Price
The Issue Price is the price at which a company's shares are initially offered in the primary market.
The market price may fluctuate above or below this initial price once trading begins.

Cut-Off Price
The Cut-Off Price is the actual issue price determined in a book-building issue, which can be any
price within the price band or above the floor price. It is decided by the issuer and lead manager
based on investor demand.

Market Capitalization

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Market Capitalization is the total market value of a company's outstanding shares, calculated by
multiplying the current share price by the number of shares in issue. * Formula:

M arket Capitalization = Current Share P rice × N umber of Shares in I ssue

* Example: * Company A has 120 million shares in issue. * The current market price is Rs. 100. *
Market capitalization = Rs. 120 * 100 = Rs. 12000 million.

Floor Price and Price Band

Floor Price: The minimum price at which bids can be made in a book building issue.
Price Band: A range within which investors can bid. The spread between the floor and cap should not
exceed 20% (cap ≤ 120% of the floor price).
The price band can be revised, with changes disseminated via stock exchanges, press releases, and
websites. The bidding period is extended by three days if the price band is revised, up to a maximum of
ten days.

The company, in consultation with Merchant Bankers, determines the price or price band.

Prospectus
A Prospectus is a document disclosing information to the public, including reasons for raising
money, how it will be spent, expected returns, issue size, company status, equity capital,
performance, promoters, project details, costs, and financing.

Issue Timeline and Allotment

The Basis of Allotment should be completed within 8 days from the issue close date.
Details of credit to demat accounts/allotment advice and dispatch of refund orders need to be completed
within 2 working days after finalizing the basis of allotment.
Investors should know whether shares are allotted within about 11 days from the closure of the issue.
It takes 12 working days after the closure of the book-built issue to get the shares listed.

Draft Offer Document

A Draft Offer Document is the offer document in draft stage, filed with SEBI at least 30 days before
registering the red herring prospectus or prospectus with the Registrar of Companies (ROC). SEBI
may suggest changes, and the document is available on the SEBI website for public comments for
21 days.

Abridged Prospectus
An Abridged Prospectus is a shorter version of the Prospectus, containing all salient features. It
accompanies the application form of public issues.

Role of the Registrar

The Registrar:

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Finalizes the list of eligible allottees, removing invalid applications.

Ensures corporate action for crediting shares to demat accounts.
Dispatches refund orders.
The Lead Manager coordinates with the Registrar to oversee the application flow, processing, and
dispatch of security certificates.

NSE's IPO Facility

The NSE (National Stock Exchange) provides an electronic trading network for online IPOs via the Book
Building process.
The NEAT IPO system allows trading members to enter bids directly from their offices.

Advantages of Book Building through NSE

Nationwide bidding facility
Fair, efficient, and transparent method for collecting bids
Lower costs compared to normal IPOs
Reduced time for completion of the issue process

The IPO market timings are from 10:00 a.m. to 5:00 p.m.

Secondary Market
Introduction to the Secondary Market
The secondary market is where securities are traded after their initial offering to the public in the primary
market or after being listed on a stock exchange.
The majority of trading occurs in the secondary market, which includes equity and debt markets.

Role of the Secondary Market

For Investors:
Offers an efficient platform for trading securities.
For Company Management:
Acts as a monitoring and control conduit, enhancing value.
Enables incentive-based management contracts.
Aggregates information (via price discovery) to guide management decisions.

Primary vs. Secondary Market

Feature Primary Market Secondary Market

Purpose Raising capital or funds. Trading existing securities among investors.

Securities Newly issued securities. Pre-issued securities.
Market Type N/A Auction or dealer market.
Examples Initial Public Offering (IPO). Stock exchange, Over-the-Counter (OTC).

Stock Exchanges

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Role of Stock Exchanges

Stock exchanges in India, overseen by SEBI, provide a trading platform for buyers and sellers to transact
in securities.
The trading platform provided by NSE is electronic, eliminating the need for physical meetings.

Demutualization of Stock Exchanges

Demutualization refers to the legal structure of an exchange where ownership, management, and
trading rights are separated.

Demutualized vs. Mutual Exchange

Feature Mutual Exchange Demutualized Exchange

Ownership, management, and trading are Ownership, management, and trading are
Functions
combined. separate.
Potential Conflicts of
High Low
Interest

Stock Trading

Screen Based Trading (SBTS)

Traditional trading in India involved open outcry, which was time-consuming and inefficient.
To improve efficiency, liquidity, and transparency, the NSE introduced a nationwide, online, fully-
automated Screen Based Trading System (SBTS).
SBTS allows members to enter the quantity and price of a security into the computer, executing the
transaction upon finding a matching order.

National Exchange for Automated Trading (NEAT)

NSE was the first exchange to use satellite communication technology for trading.
NEAT is NSE's state-of-the-art client-server-based application.
All trading information is stored in an in-memory database for quick response times and high system
availability.
NEAT boasts an uptime record of 99.7% and a uniform response time of less than one second for all
trades.

Placing Orders with a Broker

Orders can be placed:
In person at the broker's office
Via phone
Via the internet
As defined in the Model Agreement with the broker

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Internet Based Trading

Many NSE brokers offer internet-based trading, allowing investors to buy/sell securities online from
anywhere with internet access.
Investors must contact an NSE broker providing this service to use internet-based trading.

Contract Note
A contract note is a confirmation of trades executed on a specific day on behalf of a client by a
trading member.

Establishes a legally enforceable relationship between the client and the trading member.
Aids in resolving trade disputes/claims.
Required for filing complaints or arbitration against the trading member.

Contract Note Requirements

Must be in the prescribed form.
Include trade details.
Be stamped with the required value.
Be signed by an authorized signatory.
Kept in duplicate, with one copy for the trading member and one for the client.

Financial Products and Investment Strategies

Demutualized vs. Mutual Exchanges
A mutual exchange concentrates ownership, management, and trading within a single group, often leading to
conflicts of interest.

A demutualized exchange, however, segregates these functions:

Ownership
Management
Trading

Contract Notes Issued by Stock Brokers

A broker must issue a contract note for all transactions, containing:

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Name, address, and SEBI Registration number of the Member broker.

Name of Partner/Proprietor/Authorized Signatory.
Dealing Office Address/Tel. No./Fax no., Code number of the member given by the Exchange.
Contract number, date of issue, settlement number, and time period for settlement.
Constituent (Client) name/Code Number.
Order number and order time.
Trade number and Trade time.
Quantity and kind of security bought/sold.
Brokerage and Purchase/Sale rate.
Service tax rates, Securities Transaction Tax, and other charges.
Confirmation of stamp duty payment.
Signature of the Stock Broker/Authorized Signatory.

The client keeps one copy and returns the second copy to the trading member, duly acknowledged.

Investor Dos and Don'ts

Ensure the intermediary has a valid SEBI registration.
Enter into a clear agreement with your broker/sub-broker.
Provide all details in the Know Your Client form.
Read and understand the Risk Disclosure Document.
Insist on a contract note for each day's trades within 24 hours.
Verify the broker's details, trade time, transaction price, brokerage, etc., on the contract note.
Cross-check transactions on the NSE website.
Issue account payee cheques/demand drafts to the broker only.
Ensure delivery instructions are to the broker's designated account.
Insist on periodic statements of accounts.
Reconcile accounts promptly.
Receive payments/deliveries within one working day of the payout date.
Study company fundamentals before investing.
Use your own Demat account for delivery instructions.
Sign blank delivery instruction slips.
Accept deposit assurances of fixed returns from intermediaries.
Part with funds to unauthorized persons for Portfolio Management.
Leave signed blank delivery instruction slips with anyone.
Accept trades executed under another client code.

Accept unsigned/duplicate contract note.

Accept a contract note signed by any unauthorized person.

Delay payment/deliveries of securities to the broker.
Undertake deals on behalf of others or issue cheques from family/friends accounts.
Accept unsigned/duplicate contract note.
Accept contract note signed by any unauthorised person.
Delay payment/deliveries of securities to broker.
Be misled by market rumors or hot tips.
Trade on your own name and then issue cheques from a family members/ friends bank accounts.

Brokerage Limits
The maximum brokerage a broker can charge is 2.5% of the value mentioned in the purchase or sale note.

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Trading on Recognized Stock Exchanges

Trading outside a stock exchange offers no investor protection. Trading at the exchange provides:

Best market prices

No counter-party risk (assumed by the clearing corporation)
Access to investor grievance redressal
Protection up to a prescribed limit from the Investor Protection Fund

Verifying Broker Registration

Confirm registration by checking the SEBI-issued certificate. Broker registration numbers start with INB, and
sub-broker numbers start with INS.

Precautions Before Investing

Ensure broker registration with SEBI and exchanges.
Receive contract notes within one working day.
Understand investment risks and match them to your risk tolerance.
Avoid market rumors and hot tips.
Study company fundamentals.
Be cautious about stocks with sudden price surges.
Any advise or tip that claims that there are huge returns expected, especially for acting quickly, may be
risky and may to lead to losing some, most, or all of your money.
If your financial advisor or broker advises you to invest in a company you have never heard of, be cautious.
Do not be attracted by announcements of fantastic results/news reports, about a company.
Do not be attracted to stocks based on what an internet website promotes, unless you have done
adequate study of the company.
Investing in very low priced stocks or what are known as penny stocks does not guarantee high returns.

Handling Disputes
Notify the broker immediately in writing for any discrepancies/disputes. For sub-broker disputes, inform the
main broker. If unresolved, contact the Investor Services Cell of the NSE. When lodging a complaint with the
Investor Grievances Cell of the NSE, it is very important that you submit copies of all relevant documents like
contract notes, proof of payments/delivery of shares etc. alongwith the complaint. Remember, in the absence of
sufficient documents, resolution of complaints becomes difficult.

Rules and Regulations

Familiarize yourself with stock exchange/SEBI rules, regulations, and circulars before transacting.

Secondary Market Products

Shares

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Equity Shares: Represents fractional ownership in a business venture.

Rights Issue/Rights Shares: New securities offered to existing shareholders at a ratio to their holdings, at
a set price.
Example: A 2:3 rights issue at Rs. 125 entitles a shareholder to receive 2 shares for every 3 held, at
Rs. 125 per share.
Bonus Shares: Shares issued free of cost to shareholders based on their holdings.
Preference Shares: Entitles owners to a fixed dividend rate, paid before equity share dividends. Priority
over equity shareholders in surplus payment but rank below creditors and bondholders in liquidation.
Cumulative Preference Shares: Unpaid dividends accumulate and must be paid before equity dividends.
Cumulative Convertible Preference Shares: Dividends accumulate if unpaid, and shares convert into
equity capital after a specified date.

Bonds
A negotiable certificate evidencing indebtedness, typically unsecured, issued by companies,
municipalities, or government agencies.

Zero Coupon Bond: Issued at a discount and repaid at face value. No periodic interest is paid.
Convertible Bond: Gives the investor the option to convert the bond into equity at a fixed conversion
price.
Treasury Bills: Short-term (up to one year) bearer discount security issued by the government.

Equity Investment

Why Invest in Equities?

Potential for value increase over time.
Historically outperformed other investments in the long term.
Average annual return of the Indian stock market (Nifty index) has been around 16% over the last fifteen
years.
Average dividend paid is about 1.5% annually

Note: Equities are high-risk investments.

Acquiring Equity Shares

Primary Market: Subscribe to fresh public issues (IPOs) or private placements.
Secondary Market: Purchase shares through a SEBI-registered broker.

Factors Influencing Stock Prices

1. Stock-Specific Factors: Company's future earnings, financial health, management quality, technology, and
marketing skills.

2. Market-Specific Factors: Investor sentiment influenced by economic, political, or regulatory events.

Favorable events: high economic growth, stable government.

Unfavorable events: war, economic crisis.

Bid and Ask Prices

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Bid: The buyer's price, relevant when selling a stock.

Ask (Offer): The seller's price, relevant when buying a stock.

Example:

Bid (Buy side) Ask (Sell side)

Qty. Price (Rs.) Qty. Price (Rs.)

(Example Data) (Example Data) (Example Data) (Example Data)

Value Stocks
Value Stocks: Stocks that may have been overlooked by investors and have a hidden value. Value investors buy
stocks that are undervalued, and then hold those stocks until the rest of the market realizes the real value of
the company's assets.

Stock Analysis and Investment Strategies

Factors Influencing Stock Prices

Stock-specific factors: Related to expectations about the company's future earnings, financial health,
management, technology, and marketing skills.
Market-specific factors: Influenced by investor sentiment towards the stock market, depending on the
economic, political, and regulatory environment.
Favorable events (economic growth, friendly budget, stable government) can cause a market boom.
Unfavorable events (war, economic crisis, political instability) can depress the market.

It is important to note that the impact of market-specific factors is generally short-term while stock-specific
factors have a longer-term impact, stabilizing stock prices over time. It is always wise to analyze and invest
rather than speculate.

Growth Stocks
Companies with excellent potential for growth in sales and earnings.
Growing faster than other companies in the market or industry.
Usually reinvest profits for further expansion rather than paying dividends.

Value Stocks
Stocks that have been overlooked by investors but may have hidden value.
Often beaten down in price due to a bad event or unfavored industry.
Investors look for stocks that are undervalued based on:
Low P/E ratio
High dividend yields
Favorable total sales relative to market capitalization

Equity Investments

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Equities: Considered most rewarding when held over a long duration.

Over the past fifteen years, the average annual return of the Indian stock market (Nifty index) has been
around 16%.
Equities are high-risk investments: higher risk, higher potential returns. Investors may lose some or all of
their investment if prices move unfavorably.

Acquiring Equity Shares

Primary Market: Subscribe to issues made by corporates through Initial Public Offerings (IPOs) or private
placements.
Secondary Market: Purchase shares from a SEBI registered broker.

Returns on Equities in India

Indian stock market has returned about 16% annually (Nifty index, past fifteen years).
Stocks have paid an average dividend of 1.5% annually.
Equities offer the highest rate of return if invested over a longer duration.

Understanding Bid and Ask Prices

Bid: The buyer's price; the price at which you can sell a stock.
Ask (Offer): The seller's price; the price at which you can buy a stock.

Example of a stock quote for XYZ Ltd:

Bid (Buy side) Ask (Sell side)

Qty. Price (Rs.) Qty. Price (Rs.)

1000 50.25 2000 50.35
500 50.10 1000 50.40
550 50.05 1500 50.50
2500 50.00 3000 50.55
1300 49.85 1450 50.65
Total 5850 Total 8950
The best Buy (Bid) order is the highest price (e.g., 1000 shares @ Rs. 50.25).
The best Sell (Ask) order is the lowest sell price (e.g., 2000 shares @ Rs. 50.35).
The difference between the best bid and ask prices is the Bid-Ask spread, indicating liquidity. A narrower
spread indicates a more liquid stock.

Portfolio Management
A portfolio is a combination of different investment assets mixed and matched for the purpose of
achieving an investor's goals.

Items that are considered a part of your portfolio can include any asset you own-from shares, debentures,
bonds, mutual fund units to items such as gold, art and even real estate etc. For most investors a portfolio has
come to signify an investment in financial instruments like shares, debentures, fixed deposits, mutual fund units.

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Diversification
Diversification is a risk management technique that mixes a wide variety of investments within a
portfolio to minimize the impact of any one security on overall portfolio performance.

It is one of the best ways to reduce risk in a portfolio. A good investment portfolio includes a mix of a wide
range of asset classes to ensure that the entire portfolio does not suffer from the decline of any single security.

Debt Investment
A Debt instrument represents a contract whereby one party lends money to another on pre-
determined terms with regards to rate and periodicity of interest, repayment of principal amount by
the borrower to the lender.

Bonds vs. Debentures

Bond: Used for debt instruments issued by the Central and State Governments and public sector
organizations.
Debenture: Used for instruments issued by private corporate sector.

Features of Debt Instruments

Maturity: The date on which the principal is repaid.
Term-to-Maturity: The number of years remaining until the bond matures.
Coupon: Periodic interest payments made by the borrower to the lender.
Coupon rate: The rate at which interest is paid, represented as a percentage of the par value of a
bond.
Principal: The amount borrowed, also called the par value or face value of the bond.
Coupon Formula:

Coupon = P rincipal ⋅ Coupon Rate

Example bond: GS CG2008 11.40% refers to a Central Government bond maturing in 2008 with a coupon of
11.40%. With a face value of Rs. 100, it pays Rs. 5.70 semi-annually until maturity.

Interest on Debentures/Bonds
Interest is paid by the borrower to the lender for borrowing the amount for a specific period.
Paid annually, semi-annually, quarterly, or monthly.
Usually paid on the face value of the bond.

Segments in the Debt Market in India

1. Government Securities: Centre, State, and State-sponsored securities.
2. Public Sector Units (PSU) Bonds: Some are tax-free.
3. Corporate Securities: Commercial paper and bonds with tailor-made features for interest payments and
redemption.

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Participants in the Debt Market

Predominantly a wholesale market with institutional investor participation.
Main investors: banks, financial institutions, mutual funds, provident funds, insurance companies, and
corporates.

Bond Credit Ratings

Most bonds/debentures are rated by credit rating agencies such as CRISIL, CARE, ICRA, and Fitch.
Yield varies inversely with credit rating: safer instruments offer lower interest rates.

Acquiring Securities in the Debt Market

Subscribe to issues made by the government/corporates in the primary market.
Purchase from the secondary market through stock exchanges.

Derivatives
Derivatives: Instruments that derive their value from an underlying asset.

Types of Derivatives
Forwards: Customized contracts between two entities with settlement at a pre-agreed price on a specific
future date.
Futures: Agreements to buy or sell an asset at a certain future time and price. Standardized, exchange-
traded contracts (e.g., Nifty index futures).
Options: Contracts that give the right, but not the obligation, to buy or sell an underlying asset at a stated
date and price.

Options: Calls and Puts

Calls: Give the buyer the right, but not the obligation, to buy an asset at a given price on or before a given
future date.
Puts: Give the buyer the right, but not the obligation, to sell an asset at a given price on or before a given
future date.

Options vs. Futures

Feature Options Futures

Obligation Right, but not an obligation Obligation to buy or sell

Premium Buyer pays premium No upfront premium
Buyer's risk is limited to the premium; seller's risk is Both buyer and seller have potentially
Risk/Reward
potentially unlimited unlimited risk
Gives the buyer the right, but not an obligation, to buy or Agreement between two parties to buy
Contract
sell the underlying asset at a stated date and price or sell an asset at a future date

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Warrants
Longer-dated options, generally traded over-the-counter.
Options typically have lives up to one year, with most exchange-traded options having a maximum
maturity of nine months.

Option Premium
The price paid by the option buyer to the option seller for acquiring the right to buy or sell.
Paid upfront.

Commodity Exchange
Commodity Exchange: An association or company organizing futures trading in commodities.

It is any organized marketplace where trade is routed through one mechanism, allowing effective competition
among buyers and sellers.

Commodity
Defined by the Forward Contracts (Regulation) Act, 1952 as every kind of movable property other than
actionable claims, money, and securities.
Futures trading is organized in goods/commodities permitted by the Central Government.
Includes agricultural (including plantation), mineral, and fossil origin products.

Commodity Derivatives Market

Trades contracts where the underlying asset is a commodity (e.g., wheat, gold, silver).

Commodity vs. Financial Derivatives

Feature Commodity Derivatives Financial Derivatives

Underlying Commodity (e.g., agricultural products, precious Financial asset (e.g., stocks, bonds,
Asset metals) currencies)
Settlement Can be physical or cash-settled Mostly cash-settled
Physical Requires special facilities for storage, Financial assets are not bulky and do not
Settlement transportation, and handling need special facility

Financial Markets
Commodity Derivatives Market

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Commodity derivatives market trade contracts for which the underlying asset is a commodity.
The underlying asset can be:
An agricultural commodity (wheat, soybeans, rapeseed, cotton)
Precious metals (gold, silver)
The basic concept of a derivative contract is the same whether the underlying asset is a commodity or a
financial asset.
Commodity derivatives markets have some unique features:
In financial derivatives, most contracts are cash settled, while physical settlement in commodity
derivatives requires warehousing due to the bulky nature of the underlying assets.
The quality of the asset underlying a commodity contract can vary, which is not typically a concern
with financial underlyings.
Under the FCRA, futures trading is allowed for goods and products of agricultural, mineral, and fossil
origin.

Depository System
A depository provides services to investors through agents called depository participants (DPs).

DPs are appointed by the depository with SEBI approval.

Entities that can become DPs:

Banks
Financial Institutions
SEBI registered trading members

A depository is similar to a bank:

BANK DEPOSITORY

Holds funds in an account Holds securities in an account

Transfers funds between accounts on instruction Transfers securities between accounts on instruction
Facilitates transfers without handling money Facilitates transfers without handling securities
Facilitates safekeeping of money Facilitates safekeeping of shares

There is no prescribed minimum balance required in a depository account.

ISIN
ISIN (International Securities Identification Number) is a unique identification number for a
security.

Custodian
A custodian is an organization that helps register and safeguard the securities of its clients.

Responsibilities of a custodian:
Maintaining clients' securities accounts
Collecting benefits accruing to the client
Informing the client of actions taken by the issuer

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Depositories in India
National Securities Depository Limited (NSDL)
Central Depository Services (India) Limited (CDSL)

Benefits of Participation in a Depository

Immediate transfer of securities
No stamp duty on transfer of securities
Elimination of risks associated with physical certificates:
Bad delivery
Fake securities
Reduction in paperwork and transaction costs
Ease of nomination facility
Change of address with DP gets registered electronically with all companies
Transmission of securities is done directly by the DP
Convenient method of consolidation of folios/accounts
Holding investments in equity, debt instruments, and government securities in a single account
Automatic credit of shares arising out of split/consolidation/merger

Dematerialization and Rematerialization

Dematerialization: Converting physical holdings into electronic form.
Fill out a Demat Request Form (DRF) and submit it with physical certificates.
A separate DRF is required for each ISIN number.
Odd lot shares can be dematerialized.
Dematerialized shares do not have distinctive numbers and are fungible (identical and
interchangeable).
Rematerialization: Converting electronic holdings back into physical certificates.
Fill out a Remat Request Form (RRF) and request the DP to rematerialize the balances.
Debt instruments, mutual fund units, and government securities can be dematerialized and held in a
single demat account.

Mutual Funds

Basics of Mutual Funds

Mutual funds allow investments across a spectrum of companies with small investments.
Professionals manage the money collected.
Mutual funds spread risk by investing in a number of stocks or bonds.
Provide investors with information on the value of their investments.
Registered with SEBI and operate within regulations.
The regulatory body for mutual funds is the Securities Exchange Board of India (SEBI).

NAV (Net Asset Value)

NAV is the cumulative market value of the assets of the fund net of its liabilities.

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NAV per unit = (Net value of assets) / (Number of units outstanding)

Buying and selling is done on the basis of NAV-related prices.
NAV must be published in newspapers.
Open end schemes: NAV disclosed daily.
Close end schemes: NAV disclosed weekly.

Benefits of Investing in Mutual Funds

Small investments: Benefit from returns across companies with small investments.
Professional Fund Management: Experts manage the pool of money.
Spreading Risk: Diversify risk by investing in multiple stocks or bonds.
Transparency: Regular information on investment values and portfolio disclosure.
Choice: Wide variety of funds based on risk/return profile.
Regulations: Registered with SEBI and function within strict regulations.

Risks Involved in Investing in Mutual Funds

Mutual Funds do not provide assured returns.
Returns are linked to their performance.
Investments involve an element of risk.
Unit value can vary.

Types of Risks
Market risk: Overall market decline impacts fund performance.
Non-market risk: News about a company can negatively affect fund holdings.
Interest rate risk: Bond prices and interest rates move inversely.
Credit risk: Risk of corporate bonds defaulting on payments.

Types of Mutual Funds

Based on Objective:

Equity Funds/ Growth Funds: Invest in equity shares for capital appreciation.
Diversified Funds: Invest across sectors for risk-averse investors.
Sector Funds: Invest in specific sectors for investors who are bullish on a particular sector.
Index Funds: Invest in the same pattern as market indices (e.g., Nifty 50).
Tax Saving Funds: Offer tax benefits under the Income Tax Act.
Debt/Income Funds: Invest in fixed-income instruments for capital preservation.
Liquid Funds/Money Market Funds: Invest in liquid money market instruments for short-term
investments.
Gilt Funds: Invest in government securities for secured returns.
Balanced Funds: Invest in both equity and debt for steady returns and capital appreciation.

Based on Flexibility:

Open-ended Funds: Open for subscription and redemption throughout the year with prices linked to NAV.
Close-ended Funds: Open for entry during IPO and have a fixed date of redemption and are traded at a
discount to NAV.

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When choosing a fund, it is important to consider:

Investment objectives
Risk factors and special considerations# Mutual Funds and Corporate Actions

Investment Plans Offered by Mutual Funds

Investment plans are services mutual funds provide, offering different ways to invest or reinvest. They
influence the flexibility available to the investor. Here are some common plans in India:

Growth Plan: Returns are reinvested, with very few or no income distributions. Investors realize capital
appreciation on their investment.
Dividend Plan: Income is distributed regularly, ideal for investors needing regular income.
Dividend Reinvestment Plan: Dividends are reinvested in the scheme, increasing the number of units
held.

Active vs. Passive Fund Management

Active Fund Management

Investment decisions are made at the discretion of a fund manager, who chooses companies and
instruments based on research, analysis, and market news.

The fund actively buys and sells securities.

Managers use Growth Investing and Value Investing styles.
Growth Investing: Aims for above-average earnings growth.
Value Investing: Seeks undervalued companies expected to be recognized by the market eventually.

Passive Fund Management

Index funds aim to match the returns of a market index.
They invest in a portfolio reflecting an index like the Nifty index.
Advantage: Offer diversified portfolio with low management costs

Rights of a Mutual Fund Holder in India

According to SEBI Regulations on Mutual Funds, investors are entitled to:

1. Receive unit certificates or account statements within 6 weeks.

2. Access information about investment policies, objectives, and financial status.
3. Receive dividends within 30 days of declaration and redemption/repurchase proceeds within 10 days.
4. Receive essential disclosures from trustees about information that may affect their investments.
5. Terminate the AMC of the fund with 75% unit holder approval and SEBI's approval.
6. Pass a resolution to wind up the scheme with 75% unit holder approval.
7. Send complaints to SEBI for resolution with the concerned Mutual Funds.

Fund Offer Document

A document providing all necessary information about a scheme and the fund launching it, including
risks involved.

It must comply with SEBI guidelines and disclose details about:

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Investment objectives
Risk factors
Expenses
Constitution of the fund
Investment guidelines
Organization and capital structure
Tax provisions
Financial information

Exchange Traded Funds (ETFs)

An exchange-traded fund is like a mutual fund that trades like a stock.

Represents a basket of stocks reflecting an index (e.g., Nifty).

Trades on a stock exchange; its price changes throughout the day.
Offers diversification like an index fund with the flexibility of a stock.
Can be short sold, bought on margin, and purchased in small quantities.
Expense ratios are generally lower than average mutual funds.

Corporate Actions

Definition
Corporate actions are events initiated by a company that bring actual change to its securities.

These actions affect the security's price and reflect the company's financial affairs. Examples include:

Dividends
Stock splits
Rights issues
Bonus issues

Dividends
Dividends are distributions of a company's earnings to shareholders.

Typically paid twice a year.

Expressed on a per-share basis.
Reflect how much of the company's profits are paid out versus retained.

Dividend Yield
Dividend yield is the relationship between a stock's current price and the dividend paid over the last
12 months.

Calculated by dividing the past years dividend by the current stock price.
Can be an indicator of whether a stock is underpriced or overpriced.

Formula:
Annual Dividend
Dividend Yield =
Share Price

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Example:

Share Price: Rs. 360

Annual Dividend: Rs. 10
Dividend Yield: 10

360
= 2.77

Stock Splits
A stock split divides existing shares into smaller denominations, increasing the number of shares but
keeping the market capitalization the same.

Example: A company with 1,00,00,000 shares at Rs. 10 face value and Rs. 100 market price does a 2-for-1
stock split:

Face value reduces to Rs. 5.

Outstanding shares increase to 2,00,00,000.
Share price halves to Rs. 50.

Analogy: Stock splits are like exchanging a Rs. 100 note for two Rs. 50 notes, the value remains the same.

Impact on Shareholders

Pre-Split Post-Split

Number of Shares (2-for-1) 100 million 200 million

Share Price Rs. 40 Rs. 20
Market Capitalization Rs. 4000 mill. Rs. 4000 mill.
Previous Stock Price
New Stock Price =
Split Ratio

For a stock split of 3-for-2: 40

(3/2)
=
40

1.5
= Rs. 26.60

Pre-Split Post-Split

Number of Shares (4-for-1) 100 million 400 million

Share Price Rs. 40 Rs. 10
Market Capitalization Rs. 4000 mill. Rs. 4000 mill.

Reasons for Stock Splits

Attractiveness to Investors: Lowering the share price can make it more accessible to a broader range of
investors.

Stock Splits and Dividends

Stock Splits
A stock split increases the number of shares in a company by issuing more shares to existing shareholders.
This lowers the price of each individual share, but the overall market capitalization of the company remains the
same.

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Examples of Stock Splits

3-for-2 Split: If a stock is trading at Rs. 40 and splits 3-for-2, the new price would be:

40/(3/2) = 40/1.5 = Rs. 26.60

2-for-1 Split:

Pre-Split Post-Split

No. of Shares 100 million 200 million

Share Price Rs. 40 Rs. 20
Market Cap. Rs. 4000 Rs. 4000

4-for-1 Split:

Pre-Split Post-Split

No. of Shares 100 million 400 million

Share Price Rs. 40 Rs. 10
Market Cap. Rs. 4000 Rs. 4000

Motivations for Stock Splits

Attractiveness to Investors: A lower share price may attract more investors, especially small investors
who find a high share price unaffordable.
Increased Liquidity: More affordable shares can lead to increased trading activity and liquidity in the
stock.

Dividends
A dividend is a payment made by a company to its shareholders, typically from its profits.

Directors decide the dividend amount or whether to pay one at all.

If a company with a share price of Rs. 40 pays out Rs. 3 per share as a dividend, it's passing half of its
profits to shareholders while retaining the other half.

Dividend Yield
Dividend Yield: The relationship between the current stock price and the dividend paid by the
issuing company over the last 12 months.

It is calculated as:

Annual Dividend
Dividend Yield =
Current Stock Price

Example:
ABC Co.

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Share price: Rs. 360

Annual dividend: Rs. 10

10
Dividend Yield = = 2.77
360

Interpretation of Dividend Yield

Historically, a higher dividend yield was seen as desirable.
A high dividend yield might suggest a stock is underpriced.
A low dividend yield might suggest a stock is overpriced.

Caution
Some companies with high dividend yields have gone bankrupt.

Buyback of Shares
A buyback, also known as a share repurchase, is when a company buys its own outstanding shares from the
market.

Purpose of Buybacks
To improve liquidity in its shares.
To enhance shareholder wealth.
Reduces the number of outstanding shares in the market

Regulations
Under the SEBI (Buy Back of Securities) Regulation, 1998, a company can buy back shares from:

Existing shareholders on a proportionate basis through the offer document.

Open market through stock exchanges using book building process.
Shareholders holding odd lot shares.

Requirements
The company must disclose pre- and post-buyback holdings of the promoters.
Offers for buyback through stock exchanges shouldn't be open for more than 30 days.
Verification of shares received in buyback must be completed within 15 days of the offer's closure.
Payments for accepted securities must be made within 7 days of verification completion.
Bought back shares have to be extinguished within 7 days of the date of the payment.

Important Dates and Periods

Book-Closure/Record Date
Book closure and record date help a company determine its shareholders on a specific date.

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Book closure refers to closing the register of investor names in the company's records.
Benefits like dividends, bonus issues, and rights issues are given to investors listed on the company's
records on the record date.
The company declares the record date in advance.
Depositories handle records of investor holdings electronically.

No-Delivery Period
No-delivery period: The exchange sets up a no-delivery period for a security when a company
announces a book closure or record date.

Only trading is permitted during this period.

Trades are settled after the no-delivery period to determine entitlement for corporate benefits clearly.

Ex-Dividend Date
The ex-dividend date is the date on or after which a security begins trading without the dividend
included in the price.

Buyers of shares on or after this date won't receive the recently declared dividend.

Ex-Date
The ex-date is the first day of the no-delivery period.

Buyers of shares on or after the ex-date won't be eligible for corporate benefits like rights, bonus, or
dividends.

Clearing and Settlement

Clearing Corporation
A Clearing Corporation clears and settles transactions, provides financial guarantees, and manages
risk.

Functions:

Clears and settles transactions.

Provides financial guarantee for all transactions executed on the exchange.

Provides risk management functions.

The National Securities Clearing Corporation Limited (NSCCL), a subsidiary of NSE, acts as a clearing
corporation for NSE transactions.

Rolling Settlement
Under rolling settlement, all open positions at the end of the day mandatorily result in
payment/delivery n days later.

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Trades are currently settled on a T+2 basis (trade day plus two working days).

Pay-In and Pay-Out

Pay-in day: Securities sold are delivered to the exchange by sellers, and funds for purchased securities
are made available by buyers.

Pay-out day: Purchased securities are delivered to buyers, and funds for sold securities are given to
sellers by the exchange.

Pay-in and pay-out currently happen on the second working day after the trade is executed on the stock
exchange.

Auction
If securities aren't delivered by the trading member on the pay-in day, the securities are put up for auction
by the Exchange.
The Exchange buys the required quantity in the auction market and gives them to the buying trading
member.

NIFTY Index
CNX Nifty (Nifty) is a 50 stock index that reflects the Indian markets' movement.

Comprises of some of the largest and most liquid stocks traded on the NSE.
Maintained by India Index Services & Products Ltd. (IISL), a group company of NSE.
Nifty is the barometer of the Indian markets.

Investor Grievances and Protection

Investor Grievances Cell (IGC)

You can lodge complaints with the IGC of the Exchange against brokers on certain trade disputes or non-
receipt of payment/securities.
IGC takes up complaints related to trades executed on the NSE through NSE trading members or SEBI
registered sub-brokers and trades related to companies traded on the NSE.

Arbitration
Arbitration: An alternative dispute resolution mechanism provided by a stock exchange for
resolving disputes between trading members and their clients.

If no settlement is reached through the exchange's grievance redressal mechanism, you can apply for
arbitration.

Investor Protection Fund (IPF)

Investor Protection Fund (IPF): Maintained by NSE to compensate investor claims arising from non-
settlement of obligations by a trading member declared as a defaulter.

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The IPF settles claims of investors dealing through a trading member declared a defaulter.
Payments from the IPF may cover non-payment/non-receipt of securities.
The maximum claim payable from the IPF to the investor is Rs. 10 lakh.

Time Value of Money

Simple Interest
Simple Interest: Interest paid only on the principal amount borrowed.

No interest is paid on accrued interest during the loan term.

I = P rt

Where:

I = interest
P = principal
r = interest rate (per year)
t = time (in years or fraction of a year)

Example: Mr. X borrowed Rs. 10,000 at 10% per annum for 8 months:

I = Rs. 10, 000 ∗ 0.10 ∗ (8/12) = Rs. 667

Compound Interest
Compound Interest: Interest calculated on the principal amount and the accumulated interest of
previous periods.

The interest accrued on a principal amount is added back to the principal sum, and the whole amount is
then treated as new principal for the calculation of the interest for the next period.
n
C = P (1 + i)

Where:

C = amount
P = principal
i = Interest rate per conversion period
n = total number of conversion periods

Example: Mr. X invested Rs. 10,000 for five years at 7.5% compounded quarterly:

P = Rs. 10,000
i = 0.075/4 = 0.01875
n = 4 * 5 = 20
20
C = Rs. 10, 000 ∗ (1 + 0.01875) = Rs. 14, 499.48

Conversion Period
The conversion period refers to how often the interest is calculated over the term of the loan or investment.

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Example:

Semiannually compounded interest rate means the number of conversion periods per year would be two.
If the loan or deposit was for five years, then the number of conversion periods would be ten.

Important Note: Unless simple interest is explicitly stated, assume interest is compounded.

Time Value of Money

Time Value Definition

The idea that a rupee today is worth more than a rupee in the future due to its potential to earn
interest and grow through compounding. The relationship between the value of a rupee today and
its future value is known as the Time Value of Money.

Why Money Now is Better

Money received now can be invested to earn interest.
An amount invested today has more value than the same amount invested later because of the power of
compounding.

Compounding Explained
Compounding is when interest is earned on both the principal amount and the accumulated interest from
previous periods.

Example:

Suppose Rs. 5,000 is invested with a 10% interest rate.

At the end of the first year, the interest is Rs. 500 (Rs. 5, 000 ∗ 0.10).
In the second year, the 10% interest rate applies to Rs. 5,500 (the initial Rs. 5,000 plus the Rs. 500
interest). Thus, the interest for the second year is Rs. 550 (0.10 ∗ Rs. 5, 500).

Compounding involves reinvesting income at the same rate of return to grow the principal amount consistently
over time. Higher rates of return lead to more income being added back to the principal, generating higher rates
of return year after year.

Time Value of Money Example

Scenario:

Option A: Receive Rs. 10,000 now.

Option B: Receive Rs. 10,000 after three years.

Analysis:

You would choose to receive Rs. 10,000 now because you can invest it and earn interest over the three
years.

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Future Value Illustration

Present Value Future Value

Option A: Rs. 10,000 Rs. 10,000 + Interest

Option B: Rs. 10,000 Rs. 10,000

Simple Interest Example

If you invest Rs. 10,000 at a simple annual interest rate of 5%:

Future value at the end of the first year:

((Rs. 10, 000X(5/100)) + Rs. 10, 000) = (Rs. 10, 000X0.050) + Rs. 10, 000 = Rs. 10, 500

Modified Formula:

Rs. 10, 000x[(1x0.050) + 1] = Rs. 10, 500

Final Equation:

Rs. 10, 000x(0.050 + 1) = Rs. 10, 500

Simple Interest vs. Compound Interest

Using simple interest, you would earn Rs. 3,750. With compound interest, you would earn Rs. 4,499.48, which
is nearly 20% more.

Impact of Compounding with Different Rates of Return

At end of Year 5% 10% 15% 20%

1 Rs 10500 Rs 11000 Rs 11500 Rs 12000

5 Rs 12800 Rs 16100 Rs 20100 Rs 24900
10 Rs 16300 Rs 25900 Rs 40500 Rs 61900
15 Rs 20800 Rs 41800 Rs 81400 Rs 154100
25 Rs 33900 Rs 1,08300 Rs 3,29200 Rs 9,54,000

How to Compute Time Value of Money

The time value of money can be computed by looking at:

1. Future value of a single cash flow

2. Future value of an annuity
3. Present Value of a Single Cash Flow
4. Present value of an annuity

Future Value of a Single Cash Flow

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For a given present value (PV) of money, the future value of money (FV) after a period M: for which
compounding is done at an interest rate of V, is given by the equation

Discrete Discounting: F V = P V (1 + r)
t

Continuous Discounting: F V = PV ∗ e
rt

e is the exponential function ≈ 2.7183

Example 1 (Discrete):

Calculate the value of a deposit of Rs. 2,000 made today, 3 years hence if the interest rate is 10%.
3 3
F V = 2, 000 ∗ (1 + 0.10) = 2, 000 ∗ (1.1) = 2, 000 ∗ 1.331 = Rs. 2, 662

Example 1 (Continuous): Calculate the value of a deposit of Rs. 2,000 made today, 3 years hence if the interest
rate is 10%.
(0.10∗3)
F V = 2, 000 ∗ e = 2, 000 ∗ 1.349862 = Rs.2699.72

Future Value of an Annuity

An annuity is a stream of equal annual cash flows.

The future value (FVA) of a uniform cash flow (CF) made at the end of each period until the time of maturity t
for which continuous compounding is done at the rate V is calculated as follows:
t−1 t−2 t
F V A = CF ∗ (1 + r) + CF ∗ (1 + r) +. . . +CF ∗ (1 + r) + CF = CF ∗ [(1 + r) − 1]/r

The term is the Future Value Interest Factor for an Annuity (FVIFA).
(1+r) −1

Example 1:

Suppose you deposit Rs. 3,000 annually in a bank for 5 years, and your deposits earn a compound interest rate
of 10 percent. What will be the value of this series of deposits (an annuity) at the end of 5 years? Assume each
deposit occurs at the end of the year.
4 3 2
F uture value = Rs. 3000 ∗ (1.10) + Rs. 3000 ∗ (1.10) + Rs. 3000 ∗ (1.10) + Rs. 3000 ∗ (1.10) + Rs. 3000

= Rs. 3000 ∗ (1.4641) + Rs. 3000 ∗ (1.3310) + Rs. 3000 ∗ (1.2100) + Rs. 3000 ∗ (1.10) + Rs. 3000 = Rs. 18315.30

Present Value of a Single Cash Flow

Present value (PV) of the future sum (FV) to be received after a period T for which discounting is done at an
interest rate of V is given by:

Discrete Discounting: P V = F V /(1 + r)

t

Continuous Discounting: P V = FV ∗ e
−rt

Example 1 (Discrete): What is the present value of Rs. 5,000 payable 3 years hence, if the interest rate is 10 %
p.a.?
3
P V = 5000/(1.10) = Rs. 3756.57

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Example 2 (Continuous): What is the present value of Rs. 10,000 receivable after 2 years at a discount rate of
10% under continuous discounting?
(
P resent V alue = 10, 000/(exp 0.1 ∗ 2)) = Rs. 8187.297

Present Value of an Annuity

The present value of an annuity is the sum of the present values of all the cash inflows of this annuity.

Discrete Discounting: P V A = F V ∗ [1 − (1 + r)
−t
]/r

The term [1 − (1 + r)−t

]/r is the Present Value Interest Factor for an Annuity (PVIFA).

Continuous Discounting: P V = F V ∗ (1 − e
−rt
)/r

Example 1: What is the present value of Rs. 2000 received at the end of each year for 3 years?

$= 2000*[1/1.10]+2000*[1/1.10] ^2+2000*[1/1.10] ^3 = 20000.9091+20000.8264+2000*0.7513 =

1818.181818+1652.892562+1502.629602 = Rs. 4973.704$

Effective Annual Return

Effective Annual Return vs. Stated Annual Return:

Effective annual return accounts for intra-year compounding.

Stated annual return does not.

Example:

Consider a savings account with a stated annual interest rate of 10% and an initial deposit of Rs 1,000.

Without Compounding: After one year, the money grows to Rs 1,100.

With Quarterly Compounding:

After the first quarter, the savings grow to Rs 1,025.

The interest earned in each quarter increases the interest earned in subsequent quarters.
By the end of the year, the total is Rs 1,103.80.
The effective rate of return is 10.38% due to quarterly compounding.

Even though the stated annual interest rate is 10%, the effective rate of return is 10.38% because of quarterly
compounding.

Annual Report Analysis

What is an Annual Report?

A formal financial statement issued yearly by a corporate. It shows assets, liabilities, revenues,
expenses, and earnings, reflecting the company's financial status at the year's end.

Key Features to Read Carefully

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1. Directors Report and Chairman's statement: Insights into current and future operational performance.
2. Auditors Report (including Annexure): Provides an audit of the company's financial statements.
3. Profit and Loss Account: Details revenues, expenses, and profits/losses.
4. Balance Sheet: Shows assets, liabilities, and equity at a specific point in time.
5. Notes to accounts: Additional information and explanations related to the financial statements.

Balance Sheet vs. Profit and Loss Account

Balance Sheet: Shows the financial position of the company at a specific point in time.
Profit and Loss Account: Shows the financial performance of the company over a period.

Balance Sheet Layout There are two balance sheet layouts:

1. Account Form
2. Report Form

The account form displays liabilities on one side and assets on the other. The report form has "Sources of
Funds" and "Application of Funds".

Systematic Analysis of a Company

1. Industry Analysis:
Understand the industry the company belongs to.
Consider the effect of government policies and future demand.
2. Corporate Analysis:
Examine the company's current operations, managerial capabilities, and growth plans.
Assess its past performance relative to competitors.
3. Financial Analysis:
Evaluate financial performance and key parameters.
Consider Earnings Per Share (EPS), P/E ratio, and equity size.
Understand financial statements from the Annual Report, including the Balance Sheet and Profit
and Loss Account.

Financial Statement Analysis

Industry and Corporate Analysis
To make informed investment decisions, it's crucial to analyze various factors:

Point of time: When analyzing a company's financials, consider the specific date of the balance sheet.
Industry Analysis: Evaluate the industry/sector to which the company belongs. Consider factors like:
Government policies
Future demand for products
Effect of changes in the business environment. For example, the devaluation of rupee may brighten
prospects of all export-oriented companies.
Corporate Analysis: Investigate the company's:
Current operations
Managerial capabilities
Growth plans
Past performance compared to competitors

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Financial Analysis
Assess whether the share is a good investment at its current price by looking at:
Earnings Per Share (EPS)
P/E ratio
Current size of equity
Estimate the future price of the share.
Understand the company's financial statements, including the Balance Sheet and Profit and Loss
Account (Income Statement) in the Annual Report.

Balance Sheet Structure

The balance sheet is structured according to the Companies Act, 1956, and can be presented in two forms:

Account Form
Report Form

Balance Sheet: Account Form

Liabilities Assets

Share Capital Fixed Assets

Reserves and Surplus Investments
Secured loans Current Assets, loans and advances
Unsecured loans Miscellaneous expenditure
Current liabilities and provisions

Balance Sheet: Report Form

Sources of Funds

I. Shareholders Funds
(a) Share Capital
(b) Reserves & surplus
2. Loan Funds
(a) Secured loans
(b) Unsecured loans
II. Application of Funds
(a) Fixed Assets
(b) Investments
(c) Current Assets loans and advances
Less: Current liabilities and provisions
Net current assets
(d) Miscellaneous expenditure and losses

Profit and Loss Account (Income Statement)

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Shows the financial performance of a company over a period of time (accounting period/year, April-
March).
Indicates revenues and expenses during that period.
Summarizes revenue items, expense items, and the difference between them (net income).

Interpreting Balance Sheet and Profit and Loss Account

Balance Sheet Overview

A balance sheet is a record showing sources of funds and their application for creating/building assets on
a specific date (e.g., 31st March).
Due to daily fund inflow and outflow, balance sheets are drawn on a specific date.

Sources of Funds
Shareholders Fund (Net Worth): Funds from the owners of the company.
Share Capital: Funds contributed by owners (shareholders) when the company starts. Divided into
equity capital and preference capital.
Reserves and Surplus: Retained profits accumulated over the years, belonging to shareholders.
Loan Fund: Funds borrowed from outsiders.

Share Capital Types

Type Description

Equity Capital Does not have a fixed rate of dividend.

Preference Capital Represents contribution of preference shareholders and has a fixed rate of dividend.

Equity vs. Preference Shareholders

Feature Equity Shareholders Preference Shareholders

Preferential right to payment of dividend at a fixed

Dividend Right to get dividend as declared.
rate.
Voting Right to vote in the Annual General
Do not have voting rights.
Rights Meeting.
Trading Can be traded Cannot be traded
Redemption N/A Redeemed after a pre-decided period.

Capital Terminology

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Term Definition

Authorized
> The maximum capital that a company is authorized to raise.
Capital
> The part of the authorized capital which is offered by the company for subscription by the
Issued Capital
public.
Subscribed
> The part of the issued capital which is accepted by the public.
Capital
Called up
> A part of subscribed capital which has been called up by the company for payment.
Capital
Paid up > The part of the called up capital which has been actually paid by the shareholders. Calls in
Capital arrears (defaulted amount) are deducted from called up capital to get paid up capital.

Loan Funds: Secured vs. Unsecured

Feature Secured Loans Unsecured Loans

Borrowings against security (mortgaging immovable

Short-term borrowings without a
Security property or hypothecating/pledging movable property). This
specific security.
creates a charge to safeguard creditors.
Fixed deposits, loans and advances from
Debentures, loans from financial institutions and
Examples promoters, inter-corporate borrowings,
commercial banks.
and unsecured loans from banks.

Application of Funds
Funds from owners and outsiders are used to create assets:

Fixed Assets: Assets acquired for long-term use in business operations, not for resale.
Examples: Land and buildings, plant, machinery, patents, and copyrights.
Investments: Financial securities created by investing surplus funds into non-business avenues for
income.
Current Assets, Loans, and Advances: Resources that can be converted into cash during business
operations.
Held for a short-term period to meet daily operational expenditure.
Examples: Raw materials, finished goods, cash, debtors, inventories, loans and advances, and pre-
paid expenses.
Miscellaneous Expenditures and Losses: Outlays such as preliminary expenses and pre-operative
expenses not written off.

Fixed Assets Sub-headings

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Term Definition

Gross Block > The total value of acquiring all fixed assets (at different points of time).
> Reduction in the value of an asset due to usage, calculated as per the Companies Act
Depreciation
1956 using methods like Straight Line or Written Down Value.
> The worth of the fixed assets after providing for depreciation.
Net Block
N etBlock = GrossBlock − Depreciation

Capital Work in > Funds used for a new plant under erection, a machine yet to be commissioned, etc. These
Progress will be converted into gross block soon.

Current Liabilities and Provisions

Current Liabilities: Amounts due to suppliers for goods and services brought on credit, advances from
customers, etc., where payment is deferred.
Provisions: Amounts set aside for expenses not required to be paid immediately, like dividend to
shareholders or payment of tax.
Net Current Assets (Net Working Capital):
Funds equal to the current assets less the current liabilities.
N etCurrentAssets = CurrentAssets − CurrentLiabilitiesandP rovisions

Balance Sheet Summary

A balance sheet matches sources of funds with the application of funds.
T otalCapitalEmployed = N etAssets

Profit and Loss Account Statement

Shows the profit or loss incurred by a company from its income after accounting for all expenditures
within a financial year.
Indicates how the profit available for appropriation is derived using profit after tax and reserves.
Shows the profit appropriation towards dividends, general reserve, and balance carried to the balance
sheet.

Profit and Loss Account Statement

A Profit and Loss Account shows the profit or loss incurred by a company from its income after accounting for
all its expenditures within a financial year. It also shows how the profit available for appropriation is arrived at
using profit after tax and a portion of reserves. Additionally, it displays the profit appropriation towards
dividends, general reserve, and the balance carried to the balance sheet.

Components of a Profit and Loss Account

The Profit and Loss Account typically includes the following items:

1. Income: Represents the total revenue generated by the company.

2. Expenditure Items: Includes various costs incurred by the company, such as raw material consumption,
manpower costs, manufacturing expenses, and administrative and selling expenses.
3. Profits Available for Appropriation: Shows the profits that can be distributed or reinvested.
4. Appropriation of Profits: Indicates how the profits are allocated towards dividends, general reserve, and
the balance carried to the balance sheet.

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Key Considerations for Evaluating a Profit and Loss Account

When reviewing a company's Profit and Loss Account, consider the following:

Overall Improvement: Check for overall improvement in sales and profits (operating, gross, and net)
compared to the same period in the previous year.

Other Income: Scrutinize the other income carefully.

If it stems from dividends on investments or interest from loans and advances, it is generally a
positive sign, indicating a steady income stream. However, if it is derived from selling assets or
land, it may not be a recurring source of income, and caution is advised.

Expenditure Items: Analyze the increase in all expenditure items, such as raw material consumption,
manpower cost, and manufacturing, administrative, and selling expenses.

Determine whether the increases in these costs are proportionate to the increase in sales. If costs
are increasing faster than sales, it may indicate unfavorable operating conditions.
Evaluate whether the ratio of these costs to sales has been contained compared to the previous
year, which would indicate efficient operations.

Profit from Operations: Assess whether the company can generate profit from its core operations alone.
To determine this, calculate the profits of the company, excluding all other income except sales.

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