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Unit 4: BONDS
Pricing of Bonds, Returns on Bonds, Risks associated with Bonds, Duration and Modified
Duration. Bond Portfolio Construction-Immunization Strategy.
Investment is the employment of funds on assets with the aim of earning income
or capital appreciation Investment has two attributes, namely, time and risk
INVESTMENT OBJECTIVES
(a) Short-term high priority objectives: Some investors have high priority
towards achieving certain objectives in short time. For example: high priority to
buy a house.
(b) Long-term high priority objectives: Some investors look forward and invest
on the basis of objectives of long-term needs. They want to achieve financial
independence in long period. For example, investing for post-retirement period
or education of child, etc.
(c) Low priority objectives: These objectives have low priority in investing. These
objectives are not painful. After investing in high priorities assets, investors can
invest in these low priority assets. For example, provision for tour, domestic
appliance, etc.
(d) Money making objectives: Investors put their surplus money in this kind of
investment. Their objective is to maximize wealth. Usually, the investors invest
in shares of companies which provides capital appreciation apart from regular
income from dividend.
ELEMENTS OF INVESTMENT
(a) Return: Investors buy or sell financial instruments in order to earn return on
them. The return on investment is the reward to the investors. The return includes
both current income and capital gains or losses, which arises by the increase or
decrease of the security price.
(b) Risk: Risk is the chance of loss due to variability of returns on an investment.
In case of every investment, there is chance of loss. It may be loss of interest,
dividend or principal amount of investment. However, risk and return are
inseparable. Return is a precise statistical term and it is measurable. But the risk is
not precise statistical term.
(c) Time: Time is an important factor in investment. It offers several different
courses of action. Time period depends on the attitude of the investors who follows
a ‘buy and hold’ policy. As time moves on analysts believe that conditions may
change and investors may revaluate expected return and risk for each investment.
SPECULATION
Speculation involves trading a financial instrument involving high risk, in
expectation of significant returns. The motive is to take maximum advantage from
fluctuations in the market. Description: Speculators are prevalent in the markets
where price movements of securities are highly frequent and volatile.
GAMBLING
A gamble is a very short-term investment in a game or chance. The time horizon
involved in gambling is shorter than speculation and investment. Rational people
gamble for fun, not for income.Gambling employs artificial risk whereas
commercial risk is present in the other two Risk and return are not found , negative
outcomes are expected in gambling
• Stock analysis is a very detailed study of the stocks of the company with
respect to two broad parameters namely, fundamental analysis and
technical analysis.
• This detailed study helps in understanding the right time to enter and exit
the markets as well as the correct holding period for the stocks.
• This analysis is not limited to the individual stocks but also the economy
and the industry as a whole to determine if it is on an upward trend or an
adverse one.
Stock analysis
FUNDAMENTAL ANALYSIS
Fundamental analysis is primarily concerned with determining the intrinsic
value or the true value of a security. For determining the security’s intrinsic
value, the details of all major factors (GNP, industry sales, firm sales and
expense etc) are collected or an estimates of earnings per share may be
multiplied by a justified or normal prices earnings ratio. After making this
determination, the intrinsic value is compared with the security’s current market
price. fundamental analysis comprises:
1. Economic Analysis
2. Industry Analysis
3. Company Analysis
ECONOMIC ANALYSIS
It is very important to assess the state of the economy of making investment. If a
recession is likely or undergoing the stock market is affected at certain times. On
the other hand the stock market is also affected at certain times. This status of an
economic activity has a major impact on overall stock market. Therefore, it is
very important for the investor to assess the state of the economy and
its impact on the stock market
Factors of Economic Analysis
• Gross Domestic Product
The GDP represents the aggregate monetary value of the goods and services
produced in the economy during a specified period. Although GDP is usually
calculated on an annual basis, quarterly estimates an also available. The common
equation for the calculation of GDP is:
GDP Consumption + Investment + Exports - Imports
The growth rate of GDP points out the prospects for the industrial sector and the
return investors can expect from an investment in shares. A decline in the GDP
indicates a potential economic slowdown. A high GDP growth rate is
advantageous to the stock market
• Savings and Investment
Growth requires investment, which in turn, requires a considerable amount of
domestic savings. Growth in savings naturally leads to more investments. High
capital investment means possibility of more production, more demand and
supply, better prices in the future and consequently, higher business profits and a
positive outlook for the stock market. Savings are distributed over different assets
like equity shares, deposits, mutual fund units, estate, and bullion. The primary
market is a channel through which the savings of investors are made available to
corporate bodies. Over the years, household and private corporate savings have
increased and in turn gross domestic investment has also increased
• Inflation
Inflation refers to a situation where too much money is chasing to few goods.
Inflation indicates a rise in the price of goods and services. Along with the growth
of GDP if the inflation rate also increases, then the real rate of growth would be
very low Inflation and stock markets he a very close relationship. If there is
inflation, the stock market is adversely affected. The price of stock is directly
related to the performance of the company. Inflation typically results in the
following
• High raw material cost
• Non-availability of cheap credit due to rise in interest rates
• Low earnings
These factors have a negative impact on the stock price and market return. If there
is a mild level of inflation, it is good for the stock market but high rates of inflation
are harmful.
• Interest Rates
Interest rates have a direct impact on the economy. The base rate of banks affects
the cost of borrowed funds. The base rate is the minimum rate of interest at which
banks lend to anyone. It is the floor rate below which they will not allow banks
to lend. A decrease in the interest rate implies low cost of finance for firms and
more profitability. An increase in lending rates affects negatively firms which
depend on banks for their working capital and growth requirements
• Budget and Fiscal Deficit
The budget draft provides a detailed account of government revenues and
expenditures. A deficit budget may lead to a high rate of inflation and adversely
affect the cost of production surplus budget may results deflation. A balanced
budget is highly favourable to the stock market. Fiscal deficit is the difference
between the government's total receipts (excluding borrowing) and expenditure.
• Balance of Payments
The balance of payments is the record of a country's money receipts from abroad
and payments to foreign countries. The difference between receipts and payments
may be a surplus or a deficit. Balance of payments is a measure of the strength of
the rupee on the external account. If the deficit increases, the rupee value may
depreciate against other currencies, thereby affecting the cost of imports.
Industries involved in the exports and imports are markedly affected by changes
in the foreign exchange rate. The volatility of the foreign exchange rate affects
the investment of the foreign institutional investors in the Indian stock market. A
favourable balance of payments has a positive effect on the stock market
• Foreign Direct Investment
According to the International Monetary Fund (IMF), the of foreign direct
investment (FDI) includes different elements, namely, equity capital, reinvested
earnings of foreign companies, inter-company debt transactions, short- and long-
term loans, financial leasing, trade credits, investment made by foreign venture
capital investors, and so on. FDIs help in the upgrading of technology, skills, and
managerial capabilities and bring much needed capital into the economy. They
also help in providing employment opportunities. Inflow of capital helps the
economy grow and has a positive impact on the stock market.
• Demographic Factors
Demographic data provide details about the population by age, occupation,
literacy, and geographic location. This is needed to forecast the demand for
consumer goods. The population by age indicates the availability of a skilled
workforce. The cheap labour force in India has encouraged many multinationals
to launch their ventures. Indian labour is cheaper compared to its Western
counterpart. Population, by providing employees and demand for products,
affects industry and the stock market.
• Economic Forecasting
To estimate stock price changes, an analyst must look at the macroeconomic
environment and the factors peculiar to the industry he is concerned with.
Economic activities affect corporate profits, investor attitudes, and share prices.
A fall in the GDP or a slowdown in economic growth may lead to a fall in
corporate
INDUSTRY ANALYSIS
Industry analysis is the study of industries which are on the upswing or growing.
The ideal
investment is the investment in the growing industry. There are certain industries
which are growing
in India. The investor should know the industry classification used in the
economy. It is also necessary to know the characteristics, problems and practices
in different industries. A careful analysis of growth of industries will help to select
few industries for investments. The competitive position of industries is also
affected due to high labour cost, change in social habits, government regulations
and automation
COMPANY ANALYSIS
The industry analysis helps to select few industries for investment in securities.
There are many
companies in an industry. There are thousands of listed companies from computer
software industry.
Therefore, an investor has to select few companies for investment