Raghunandan Money – Investment Khushiyon Ka.

Equity


Investment

Money earned is partly spent and the rest is saved for meeting future expenses. Instead of keeping the resource(money) idle , it is used to earn a return in the future, this is called investment

Why to invest?

To put forward in simple terms we invest in order to create wealth. While investing is relatively painless, its rewards are plentiful. To understand why investment is necessary, we need to realize what we lose when we just save and do not invest. That is because the value of the rupee decreases every year due to inflation. For example, if you ran a household within a budget of Rs.10000 in 2000, to run the same household today (assuming the same set of expenses) you would probably need Rs 15,000. This means Rs15,000 is added to your budget because of inflation. Thus we need to generate an additional Rs15,000 and that can be possible only by INVESTING your hard-earned money.
To sum up, we need to invest for the following reasons

To create wealth
Earn a return on idle resources
Make a provision for an uncertain future
Generate a specified sum of money for a specific goal in life
Meet the cost of inflation

When to start investing ?

The sooner one starts investing the better. Investing early would allow investments to grow more with time, whereby the concept of compounding increases your income, by accumulating the principal and the interest or dividend earned on it, year after year.

The three rules for all investors are

Invest early
Invest regularly
Invest for long term and not short term

How much money do I need to invest? 

There is no statutory amount that an investor needs to invest inorder to generate adequate returns from his savings. The amount that you invest will eventually depend on factors such as:

Your risk profile
Your Time horizon
Savings made

Options available for investment

Physical assets like real estate, gold, commodities etc.

AND/OR

Financial assets like fixed deposits with banks, small savings instruments with post offices, insurance/provident/pension fund etc. or securities market related instruments like shares, bonds, debentures etc.

Twelve important steps to investing

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

Interest

Interest is an amount charged to the borrower for the privilege of using the lender’s money. Interest is usually calculated as a percentage of the principal balance (the amount of money borrowed). The percentage rate may be fixed for the life of the loan, or it may be variable, depending on the terms of the loan.

Factors which determine the interest rates

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

Short term financial options available for investment

Savings bank account

is often the first banking product people use, which offers low interest (4%-5% p.a.), making them only marginally better than fixed deposits.

Money market or liquid funds 

are a specialized form of mutual funds that invest in extremely short-term fixed income instruments and thereby provide easy liquidity. Money market funds are primarily oriented towards maximizing returns,protecting capital and usually yield better returns than savings accounts, but lower than bank fixed deposits.

Fixed deposits with banks

are also referred to as term deposits and minimum investment period for bank FDs is 30 days. Fixed Deposits with banks are for investors with low risk appetite, and may be considered for 6-12 months investment period as normally interest on less than 6 months bank FDs is likely to be lower than money market fund returns.

Long term financial options available for investment

Post office savings

Post Office Monthly Income Scheme is a low risk saving instrument, which can be availed through any post office. It provides an interest rate of 8% per annum, which is paid monthly. Minimum amount, which can be invested, is Rs. 1,000/- and additional investment in multiples of 1,000/-Maximum amount is Rs. 3,00,000/- (if Single) or Rs. 6,00,000/- (if held Jointly) during a year. It has a maturity period of 6 years. Premature withdrawal is permitted if deposit is more than one year old. A deduction of 5% is levied from the principal amount if withdrawn prematurely.

Public provident fund

A long term savings instrument with a maturity of 15 years and interest payable at 8% per annum compounded annually. A PPF account can be opened through a nationalized bank at anytime during the year and is open all through the year for depositing money. Tax benefits can be availed for the amount invested and interest accrued is tax-free. A withdrawal is permissible every year from the seventh financial year of the date of opening of the account and the amount of withdrawal will be limited to 50% of the balance at credit at the end of the 4th year.

Company fixed deposits

These are short-term (six months) to medium-term (three to five years) borrowings by companies at a fixed rate of interest which is payable monthly, quarterly, semiannually or annually. They can also be cumulative fixed deposits where the entire principal along with the interest is paid at the end of the loan period. The rate of interest varies between 6-9% per annum for company FDs. The interest received is after deduction of taxes.

Bonds

It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell bonds. A bond is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the Maturity Date.

Mutual funds

These are funds operated by an investment company which raises money from the public and invests in a group of assets. It is a substitute for those who are unable to invest directly in equities or debt because of resource, time or knowledge constraints. Mutual fund units are issued and redeemed by the Fund Management Company based on the fund’s net asset value (NAV), which is determined at the end of each trading session. NAV is calculated as the value of all the shares held by the fund, minus expenses, divided by the number of units issued. Mutual Funds are usually long term investment vehicle though there some categories of mutual funds, such as money market mutual funds which are short term instruments.

Need for capital

Companies require capital for the following purposes

Business Start up
Expansion
Investment in projects
Diversification

Sources of finance for companies

Own Capital – It is the money which the promoters or the owners of the company invest . This is internal source of financing the business.
AND/OR
External Sources- It is the money which is borrowed from the external sources like raising from banks or other financial institutions or through issue of financial instruments to the public like shares, debentures etc.

External sources for long term financing

  • Issue of Shares
  • Issue of Debentures
  • Company Fixed Deposits
  • Raising capital from Banks
  • Venture Capital

Equity / Stock

A share or stock is also known as an equity share as well. The equity share basically represents ownership in the company. When a company needs capital or money to operate, it generates the required funds by selling ownership in the company. Total equity capital of a company is divided into equal units of small denominations, each called a share. For example, in a company the total equity capital of Rs 3,00,00,000 is divided into 30,00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then is said to have 30,00,000 equity shares of Rs 10 each. The holders of such shares are members of the company and have voting rights.

Why do companies need to issue shares to public?

Most companies are usually started privately by their promoter(s). Promoters’ capital ,borrowings from banks and financial institutions may not be sufficient for setting up or running the business over a long term. So companies invite the public to contribute towards the equity and issue shares to individual investors. A public issue is an offer to the public to subscribe to the share capital of a company. Once this is done, the company allots shares to the applicants as per the prescribed rules and regulations laid down by SEBI.

Different kinds of issues

Primarily, issues can be classified as a Public, Rights or Preferential issues (also known as private placements).

Initial public offering (IPO) 

When an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer’s securities.

A follow on public offering (further issue)

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

When a listed company which proposes to issue fresh securities to its existing shareholders as on a record date. The rights are normally offered in a particular ratio to the number of securities held prior to the issue. This route is best suited for companies who would like to raise capital without diluting stake of its existing shareholders.

A preferential issue

An issue of shares or of convertible securities by listed companies to a select group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital. The issuer company has to comply with the Companies Act and the requirements contained in the Chapter pertaining to preferential allotment in SEBI guidelines.

Issue price

The price at which a company’s shares are offered initially in the primary market is called as the Issue price. When they begin to be traded, the market price may be above or below the issue price.

Market capitalization

The market value of a quoted company, which is calculated by multiplying its current share price (market price) by the number of shares in issue is called as market capitalization. E.g. Company X has 100 million shares in issue. The current market price is Rs. 100. The market capitalization of company X is Rs. 10000 million.

Types of shares

Equity shares

An equity share, commonly referred to as ordinary share, represents the form of fractional ownership in a business venture.

Rights issue/ rights shares

The issue of new securities to existing shareholders at a ratio to those already held, at a price. For e.g. a 2:4 rights issue at Rs. 100, would entitle a shareholder to receive 2 shares for every 4 shares held at a price of Rs. 100/share.

Bonus shares

Shares issued by the companies to their shareholders free of cost based on the number of shares the shareholder owns.

Preference shares

Owners of these kind of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank below the claims of the company’s creditors, bondholders/debenture holders.

Cumulative preference shares

A type of preference shares on which dividend accumulates if remained unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares.

Cumulative convertible preference shares

A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company.

Equity investment

Why should one invest in equities?

Equities have the potential to increase in value over time. It also provides portfolio with the growth necessary to reach long term investment goals. Research studies have proved that the equities have outperformed most other forms of investments in the long term. Equities are considered the most challenging and the rewarding,when compared to other investment options. Research studies have proved that investments in some shares with a longer tenure of investment have yielded far superior returns than any other investment.

Average return on equities in India

Since 1990 till date, Indian stock market has returned about 17% to investors on an average in terms of increase in share prices or capital appreciation annually. Besides that on average stocks have paid 1.5% dividend annually. Dividend is a percentage of the face value of a share that a company returns to its shareholders from its annual profits. Compared to most other forms of investments, investing in equity shares offers the highest rate of return, if invested over a longer duration.

Factors that influence the price of a stock

Broadly there are two factors

Stock specific
Market specific

The stock-specific factor is related to people’s expectations about the company, its future earnings capacity, financial health and management, level of technology and marketing skills. The market specific factor is influenced by the investor’s sentiment towards the stock market as a whole. This factor depends on the environment rather than the performance of any particular company. Events favorable to an economy, political or regulatory environment like high economic growth, friendly budget, stable government etc. can fuel euphoria in the investors, resulting in a boom in the market. On the other hand, unfavorable events like war, economic crisis, communal riots, minority government etc. depress the market irrespective of certain companies performing well. However, the effect of market-specific factor is generally short-term. Despite ups and downs, price of a stock in the long run gets stabilized based on the stock specific factors.

Growth stock / value stock

Growth stocks

Growth Stocks are companies whose potential for growth in sales and earnings are excellent, are growing faster than other companies in the market or other stocks in the same industry. These companies usually pay little or no dividends and instead prefer to reinvest their profits in their business for further expansions.

Value stocks

Value stock companies are those which may have been beaten down in price because of some bad event, but still has assets to its name like buildings, real estate, inventories, subsidiaries, and so on. Many of these assets still have value, yet that value may not be reflected in the stock’s price. Value investors look to 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. The value investors tend to purchase a company’s stock usually based on relationships between the current market price of the company and certain business fundamentals.

How can one acquire equity shares?

  • a. Primary market- IPO’s /private placements
  • b. Secondary market

Allotment in case of IPO

Allotment of shares is made within 15 days of the closure of the issue.
An investor must see the prospectus of the company that he is applying in which gives the information about the company, the project for which it is raising funds and its future potential.

BID and ASK price

The ‘Bid’ is the buyer’s price. It is this price that needs to be known when the stock has to be sold. Bid is the rate/price at which there is a ready buyer for the stock, which seller intends to sell. The ‘Ask’ is the price that needs to be known when stock has to be bought i.e. it is the rate/ price at which there is seller ready to sell his stock.

Face value of a share

The nominal or stated amount assigned to a security by the issuer is known as the face value of a share.It is the original cost of the share shown on the certificate. It is also known as par value or nominal value.For an equity share, the face value is usually a very small amount (Rs.5 or Rs.10)

Market value of a share

It is the price at which the share is traded in the stock exchange.The face value doesn’t have much bearing on the price

Secondary market

Secondary market provides a platform for buying and selling of securities that have already been issued. Stock markets (national and regional) deal in secondary market. One can invest in shares, government securities,derivative products, units of Mutual Funds through secondary market.

Portfolio

A Portfolio is a combination of different investment assets mixed and matched for the purpose of achieving an investor’s goal(s). Items that are considered a part of portfolio can include any asset owned from shares, debentures, bonds, mutual fund units to items such as gold, art and even real estate etc

Diversification

It is a risk management technique that mixes a wide variety of investments within a portfolio. It is designed to minimize the impact of any one security on overall portfolio performance. Diversification is possibly the best way to reduce the risk in a portfolio

Securities

As per Securities Contract (Regulation) Act (SCRA) 1956, securities are Instruments such as shares, bonds, scrips, stocks or other marketable securities of similar nature in or any company, body corporate, government securities, derivatives of securities, units of collective investment scheme, interest and rights in securities, security receipt or any other instruments so declared by the Central Government. The stock exchange where they are dealt with is called security market.

Security market

Security market is a place where buyers and sellers of securities can enter into transactions to buy and sell shares, bonds, debentures etc. It enables corporates, entrepreneurs to raise resources for their companies and business ventures through public issues. It enables to tansfers resources from those having idle ( investors) to others who have a need for them (corporates) most efficiently. Hence, it links savings to investments through various financial products, called securities

Regulators for security market

 

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

Issue of securities

Securities can be issued at face value, premium or discount in domestic and/or international market

SEBI

It is a regulatory authority which is established under Sec 3 of SEBI Act, 1992.

SEBI has statuary powers for

Protecting the interests of investors in securities
Promoting the development of the securities market
Regulating the securities market

SEBI functions

  • Regulating the business in stock exchanges and any other securities market
  • Registering and regulating the working of stock brokers, sub-brokers etc
  • Promoting and regulating self regulatory organizations
  • Prohibiting fraudulent and unfair trade practices
  • Calling for information from, undertaking inspection, conducting inquiries and audit of stock exchanges, intermediaries, self regulatory organizations, mutual funds and other persons associated with the securities market

ISSUE of securities

It can be done at face value, premium or discount. The securities may be issued in domestic and/or international market

Stock exchange

Formed under Securities Contract (Regulation) Act , 1956. It is a body of individuals constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.

Stock exchanges

National Stock Exchange (NSE)
Bombay Stock Exchange (BSE)
The above are the national stock exchanges where most trading is done. Other than these, there are regional exchanges.

Trading in stock exchanges

The traditional method of trading used to take place through open outcry without use of information technology for immediate recording or matching of trades. This was time consuming and inefficient. This imposed limits on trading volumes and efficiency. In order to provide efficiency, liquidity, and transparency, NSE introduced a nation wide, online fully automated screen based trading system where a member can punch into the computer the quantities of a security and the price at which he would like to transact, and the transaction is executed as soon as a matching order from the counter party is found.

Investor access to IBT

Internet based trading enables an investor to buy/sell securities through internet which can be accessed from a computer at the investor’s residence or anywhere else where the client can access the internet. Investors need to get in touch with the NSE broker providing this service to avail of the internet based trading facility.

Demutualization of exchange

It refers to the legal structure of the exchange where ownership, management and trading rights are segregated from each other. So, it doesn’t lead to conflict of interest in decision making. In India, NSE and OTCEI ( over the counter exchange of India) are demutualised

Demat account

It is mandatory for an investor to have a demat account which is managed by a depository. Hence, an investor needs to choose a SEBI registered intermediary who can give guidance regarding the formalities required to be met with.

Opening a demat account

The investor has to approach a Depository Participant and fill up an account opening form with the support proof of identity and address.

Proof of Identity : Photograph and Signature of investor must be authenticated by investor’s bank or by an existing demat account holder.
Alternatively, one can submit a copy of a valid Passport, Voters Id Card, Driving License or PAN card with photograph.
Proof of Address : A copy of ration card or passport or voter ID or PAN card or driving license or bank passbook as proof of address.

Contract note

Contract note is a confirmation of trades done on a particular day on behalf of the client by the trading member.It is the only proof that a client has with him of the transactions that have taken place. It imposes a legally enforceable relationship between the client and the trading member with respect to purchase/sale and settlement of trades.It also helps to settle disputes/claims between the investor and the trading member.The contract note should be received from the broker within 24 hours of the transaction.

Benefits of trading through a recognized stock exchange

An investor doesn’t get any protection if he trades outside a stock exchange.
Trading at the exchange offers investors the best prices prevailing at the time in the market, lack of any counter party risk which is assumed by the clearing corporation, access to investor grievance, protection up to a prescribed limit from the investor protection fund.

Entities in trading system

Trading members

  • Trading members are members of NSE they can either trade on their behalf or their clients.
  • The exchange assigns a trading member ID to each trading member.
  • Each trading member can have more than one user
  • The number of users is notified by NSE from time to time
  • Each user of the trading member is assigned an ID by the exchange
  • This ID is common for all users of a particular trading member

Clearing members

Clearing members are members of NSCCL
They carry out risk management activities and confirmation / enquiry of trades through the trading system

Professional clearing members

  • professional clearing member is one who is not a trading member
  • Typically banks and custodians become professional clearing members and clear and settle for their trading members

Participants

A participant is a client of a of a trading member like financial institutions
They may trade through multiple trading members but settle through a single clearing member

Order types and condition

The system allows the trading members to enter orders with various conditions attached to them as per their requirements. These conditions are broadly divided into the following categories:

Time condition
Price condition
Other condition

Time condition

  • DAY ORDER: A day order as the name suggests is valid for the day on which it is entered. If the order is not executed during the day the system automatically cancels the order.
  • IMMEDIATE OR CANCEL (IOC): An IOC order allows the user to buy or sell a contract as soon as the order is released into the system failing which the order is canceled from the system.

Price condition

Stop Loss The facility allows the user to release an order into the system, after the market price of the security reaches or crosses a threshold price e.g. if for a stop loss buy order the trigger is Rs. 1027 the limit price is Rs. 1030 and the market price is Rs. 1023 then the order is released into the system once the market price reaches or crosses Rs. 1027

Margins

Types of margins

  • Initial Margin The amount required to be collected in order to open a position.
  • Maintenance MarginThe minimum amount of money to be kept by a broker in order to keep a position open.
  • Premium Margin An addition to the initial margin a premium margin is charged. This is required to be paid by the buyer of an option till the premium settlement is complete.

Margin call

When the margin posted in the margin account is below the minimum margin requirement, the broker or exchange issues a margin call. The investor then closes his position or provides additional margin to keep his position open

Depository

Two main depositories

  • National Securities Depository Ltd (NSDL)
  • Central Depository Services Ltd (CDSL)

NSDL

Estd August, 1996
Largest Depository in India

CDSL

Estd Feb, 1999

Depository participant

A Depository Participant (DP) is described as an agent of the depository. They are the intermediaries between the depository and the investors. The relationship between the DPs and the depository is governed by an agreement made between the two under the Depositories Act, 1996. Legally, a DP is an entity who is registered as such with SEBI under the provisions of the SEBI Act. As per the provisions of the SEBI Act, a DP can offer depository- related services only after obtaining a certificate of registration from SEBI

Capital market intermediaries

Merchant bankers

Mandated by SEBI to overlook Public Issues (as Lead Managers) and open offers in takeovers

Fewer banks are allowed because the 2 activities have major implications on the integrity of the markets

Underwriting of Shares and debentures
Other Services

Organizing and extending finance for investment projects
Assistance in financial management
Raising euro-dollar loans
Issue of foreign currency bonds

Stock broker 

Stock brokers are intermediaries who are allowed to trade in securities of the stock exchange they are members of. They buy and sell on their own behalf as well as on the behalf of their clients and charge a commission while trading on behalf of their clients for every transaction that the customer makes. In addition they offer research tips and advise the client on when to buy and when to sell stocks in the market. They also intimate clients as to when new offers and NFO’s come in the market to enable them to trade better in the market.

Mutual fund  

Mutual funds are financial intermediaries which collect savings from a large no. of small investors and then invest these funds in a diversified portfolio (ie a collection of different stocks) to minimize the risk and maximize returns for their participants.

Profitability ratios 

(i)  Gross Profit Ratio   =
  Gross Profit
  —————-
  Net Sales
(ii)  Net Profit Ratio      =
  Net Profit
  —————-
  Net Sales

Some of the profitability ratios related to investments are:

iii)  Return on Total Assets  =
  Net Income
  ————————–
  Average Total Assets
(iv)  Return on capital Employed  =
  Net Profit
  ———————
  Capital Employed

( Here, Capital Employed = Fixed Assets + Current Assets – Current Liabilities)

Return on Shareholder’s Equity  =
  Net Income After Tax
  ———————————————————–
  Average Total Shareholder’s Equity or Net worth

(Net Worth includes shareholder’s Equity capital plus reserves and surplus)

A common (equity) shareholder has only a residual claim on profits and assets of a firm, i.e. ,only after claims of creditors and preference shareholders are fully met, the equity shareholders receive a distribution of profits or assets on liquidation. A measure of his well being is reflected by return on equity.
There are several other measures to calculate return on shareholder’s equity:
(i) Earnings Per Share (EPS):
EPS measures the profit available to the equity shareholders per share, that is, the amount that they can get on every share held. It is calculated by dividing the profits available the profits available to the shareholders by number of outstanding shares. The profits available to the ordinary shareholders are arrived at by net profits after taxes and preference dividend.
It indicates the value of equity in the market

EPS  =
  Net Profit
  ——————————————————
  Number of Ordinary Shares Outstanding
(ii)  Price-earnings ratios  =  P/E Ratio  =
  Market Price Per Share
  ———————————–
  EPS
(iii) Cash Earnings Per Share (CPS/CEPS):
(iii)  CPS/CEPS  =
  Net Profit – Preference Dividend + Depreciation
  ———————————————————————
  Number of Equity Shares

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