St.

Joseph’s College Hassan Sub: Investment management

ST. JOSEPH COLLGE HASSAN

(B. KATIHALLI NEAR DAIRY CIRCLE)

DEPARTMENT OF COMMERCE & MNAGEMNET

PROGRAMME: B.COM

COURSE: INVESTMENT MANAGEMENT

COURSE CODE: COM FM2

SEM: IV SEMESTER

PREPARED BY: ANIL BK

Assistant Profesor SJC HASSAN

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 1
St. Joseph’s College Hassan Sub: Investment management

MODULE 1 : INTRODUCTION OF INVESTMENT

In today's world everybody is running for money and it is considered as a root of happiness. For
secure life and for bright future people start investing. Every time investors are confused with investment
avenues and their risk return profile. In fact, investing in various assets is an interesting activity that attracts
people from all walks of life, irrespective of their occupation, economic status, education and family
background.
Financial market have the basic function of mobilizing the Investment needed by corporate entities.
Investment is an economic activity in which every person is engaged in one form or another. Even though
the basic objective of making investment is earning profits, not everybody who makes investment benefits
from it.
The art of investment is to see that the return is maximized with the minimum degree of risk.

Meaning: The investment is the process of sacrificing something now for the prospect of gain something
later. A commitment of funds made in the expectation of some positive rate of return”

Definition: According to Sharp / Alexander, “Sacrificing of certain present value for some uncertain future
value” .

"Purchase of a financial asset that produces a yield that is proportional to the risk assumed over some future
investment period" – F. AMLING

Economic V/s financial investment

• Economic investment is the purchase of capital goods, which are not consumed but instead used in
future production. It means the net additions to the economy’s capital stock which consists of goods
and services that are used in the production of other goods.

• Example: construction of factory or bridge or money spent on job- training.

• Financial investment refers to purchasing securities from capital and money market with high
market liquidity for example gold, silver real properties, stocks bonds, mutual funds & etc

Financial investment can be further classified as:

i. Investment in terms of personal finance
Personal finance theories, an investment is the implementation of money for buying shares or mutual funds
or purchasing an asset with the involvement of the factor of capital risk.
ii. Investment in terms of real estate
According to real estate theories, investment is referred to money utilized for buying property for the
purpose of ownership or leasing. Also in the case, the factor of capital risk is involved.
iii. Investment in terms of commercial real estate
It involves real estate investment in properties for commercial purposes such as renting or using for business
purpose
iv. Investment in terms of residential real estate
This is the most basic type of real estate investment, which involves buying of houses as real properties.

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 2
St. Joseph’s College Hassan Sub: Investment management

Investment Vs Speculation

Sl. Basis INVESTMENT Speculation

No.

1 Meaning The investment is the process of Speculation is like

sacrificing something now for the gambling. It involves a lot
prospect of gain something later. of risk and investor can lose
his money.

2 Nature Investment is long term nature Speculation is short term in

nature.

3 Aims Its aims at income and normal long term Its aims only at short term
capital growth, trade – gains through
buying and selling
i.e. capital appreciation.

4 Risky Its less risky Its more risky

5 Base Investment is made on fundamentals of Speculation is made on

the company. purely trading.

6 Types of contract Investor is a creditor of the investment Speculator is an owner of

the speculation.

7 Changes of values / Investment is based on changes of value. Speculation is based on

price changes of price.

8. Based on Investment is based on fundamentals. Speculation is based on

fundamentals/sentiments sentiment.

9. Strategy The strategy of investing is The strategy of speculation

countercyclical. is cyclical.

10. Returns Can result in consistent or regular returns It’s expected to deliver
quick returns.

11. Complexity Simple Complex (to make it works)

12 System Growing ( like a living organic creature ) Zero –sum or less remain
over time constant or shrinking over
time

13 Wasted Less ( buys and holds ) More (buy and sell and
repeat)

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 3
St. Joseph’s College Hassan Sub: Investment management

Factors to be considered in investment decision or Investment attributes/ Objectives or

Characteristics of Investment/ good features of investment

1. Return: Investments are made with the primary objectives of deriving a return. The return may be received in
form of yield plus capital appreciation. All investments are characterized by the expectation of a return. In
fact, investments are made with the primary objective of deriving a return. The return may be received in
the form of yield plus capital appreciation. The difference between the sale price & the purchase price is
capital appreciation. The dividend or interest received from the investment is the yield. Different types
of investments promise different rates of return. The return from an investment depends upon the nature
of investment, the maturity period & a host of other factors. The purpose for which the investment is put
to use influences, to a large extent, the expectation of return of the investors. Investment in high growth
potential sectors would certainly increase such expectations. The longer the maturity period, the longer
is the duration for which the investor parts with the value of the investment. Hence, the investor would
expect a higher return from such investments.
2. Risk: Risk is inherent in any investment. The risk may relate to loss of capital, delay in repayment of
capital, non-payment of interest, or variability of returns. While some investments like government
securities ties & bank deposits are almost risk less, others are riskier. The risk of investment depends on
the following factors:-
a. The longer the maturity period, the longer is the risk.
b. The lower the credit worthiness of the borrower, the higher is the risk.
c. The risk varies with the nature of investment. Investments in ownership securities like equity
shares carry higher risk
3. Safety: The safety of an investment implies the certainty of return of capital without loss of money or time.
Safety is another feature which an investors desire for his investments. Every investor expects to get back
his capital on maturity without loss & without delay. Investment safety is gauged through the reputation
established by the borrower of funds. A highly reputed and successful corporate entity assures the
investors of their initial capital. For example, investment is considered safe especially when it is made in
securities issued by the government of a developed nation.
4. Tax Benefit/ Concessions: Tax planning is very important function in investment management. An
investor wants to protect present income from taxes. This is a valid consideration no matter what his income
level is.
5. Stability of Income: An investor must consider stability of return. If the stability of return is stressed,
capital growth and diversification will be restricted.
6. Growth of Capital: Capital growth is an important element in the investment management. Investor
constantly seeks 'growth stock'. The ideal 'growth stock' is the right issue in the right industry bought at
the right time.
7. Legality: All investments should be approved by law. Law relating to minors, estates, trusts, shares and
insurance should be studied. Illegal securities will bring out many problems from the investor. One way
of being free from care is to invest in securities like unit trust of India or Life Insurance Corporation.
8. Tangibility: Intangible securities have many times lost their value, due to price level inflation,
confiscatory laws or social collapse. Some investors prefer to keep a part of their wealth invested in
tangible properties like building, machinery and land. It is, however, be considered that tangible property
does not yield an income apart from the direct satisfaction of possession or property.
9. Liquidity: An investment, which is easily saleable, or marketable without loss of money & without loss

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 4
St. Joseph’s College Hassan Sub: Investment management

of time is said to possess liquidity. Some investments like company deposits, bank deposits, P.O.
deposits, NSC, NSS etc. are not marketable. Some investment instrument like preference shares &
debentures are marketable, but there are no buyers in many cases & hence their liquidity is negligible
10. Purchasing Power Stability: Since an investment nearly always involves the commitment of
current funds with the objective of receiving greater amounts of future funds, the purchasing power of
the future fund should be considered by the investor. For maintaining purchasing power stability,
investors should carefully study:
(1) the degree of price level inflation they expect,
(2) the possibilities of gain and loss in the investment available to them,
(3) The limitations imposed by personal and family considerations.

Investment process
Setting
investme
nt policy

Measurement Analysis and

and evaluation Evaluation of
of portfolio investment
performance vehicles

Formation of
Portfolio Diversified
Investment
Revision portfolio

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 5
 St. Joseph’s College Hassan Sub: Investment management

1. Setting of Investment Policy

It is the first and very important step in investment management process. Investment policy
includes setting of investment objectives. The investment policy should have the specific
objectives regarding the investment return requirement and risk tolerance of the investor. For
example, the investment policy may define that the target of the investment average return
should be 15% and should avoid more than 10% losses.

• Its includes setting of investment objectives.

• The specific objectives regarding the investment return requirement and risk tolerance
of the investors.
• The formulation of investment policy require
• Determination of investible wealth
• Determination of portfolio objectives
• Identification of potential investment assets
• Consideration of attributes of investment assets
• Allocation of wealth to asset categories
2. Analysis and Evaluation of Investment Vehicles:

When the investment policy is set up, investor's objectives defined, and the potential
categories of financial assets for inclusion in the
investment portfolio identified, the available investment types can be analysed. This step
involves examining several relevant types of investment vehicles and the individual vehicles
inside these groups. For example, if the common stock was identified as investment vehicle
relevant for investor, the analysis will be concentrated to the common stock as an investment.
The one purpose of such analysis and evaluation is to identify those investment vehicles that
currently appear to be mispriced. There are many different approaches how to make such
analysis. Most frequently two forms of analysis are used:

(a) Technical analysis.

(b) Fundamental analysis.
Technical analysis involves the analysis of market prices in an attempt to predict future price
movements for the particular financial asset traded on the market. This analysis examines the
trends of historical prices and is based on the assumption that these trends or patterns repeat
themselves in the future.
Fundamental analysis in its simplest form is focused on the evaluation of intrinsic value of
the financial asset. This valuation is based on the assumption that intrinsic value is the present
value of future flows from particular investment.
3. Formation of Diversified Investment Portfolio:

This is the next step in investment management process. Investment portfolio is the set of
investment vehicles, formed by the investor seeking to realize its defined investment
objectives. In the stage of portfolio formation, the issues of selectivity, timing and
diversification need to be addressed by the investor.
Selectivity refers to micro forecasting and focuses on forecasting price movements of
individual assets.

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 6
St. Joseph’s College Hassan Sub: Investment management

Timing involves macro forecasting of price movements of particular type of financial asset
relative to fixed income securities in general.
4. Portfolio Revision.
• This step of the investment management process concerns the periodic revision of
three previous stages.
• This is necessary, because over time investor with long term investment horizon
may change his / her investment objectives and this, in term means that currently held
investor's portfolio may no longer be optimal and even contradict with the new settled
investment objectives.
• Investor should form the new portfolio by selling some assets in his portfolio and
buying the others that are not currently held.

5. Measurement and Evaluation of Portfolio Performance

This the last step in investment management process involves determining periodically how
the portfolio performed, in terms of not only the return earned, but also the risk of the
portfolio. For evaluation of portfolio performance appropriate measures of return and risk
and benchmarks are needed. A benchmark is the performance of predetermined set of
assets, obtained for comparison purposes. The benchmark may be a popular index of
appropriate assets-stock index, bond index.

The benchmarks are widely used by institutional investors evaluating the performance of their
portfolios.

It is important to point out that investment management process is continuing process

influenced by changes in investment environment and changes in investor's attitudes as well.

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 7
St. Joseph’s College Hassan Sub: Investment management

Financial instruments
Financial instruments are broadly classified into two types

 Capital market
 Money market
Meaning of Capital Market

Capital market is a place where the medium- term financial needs of business and other undertakings are
met by financial institutions which supply medium and long – term resources to borrowers.
Instruments used in capital market

1. Debt instruments
A debt instrument is used by either companies or governments to generate funds for capital –
intensive projects. It can be obtained either through the primary or secondary market. The relationship
in this form of instrument ownership is that of a borrower creditor and thus, does not necessarily imply
ownership in the business of the borrower. The contract is for a specific duration and interest is paid
at specified periods as started in the trust deed. The principal sum invested, is therefore repaid at the
expiration of the contract period with interest either paid quarterly, semi – annually or annually. The
interest stated in the trust deed may be either fixed or flexible. The tenure of this category ranges from
3 to 25 years. Investment in this instrument is, most times, risk – free and therefore yields lower
returns when compared to other instruments traded in capital market. Investors in this category get top
priority in the event of liquidation of a company.

I. The Federal Government, it is called a Sovereign Bond.

II. A State Government it is called a State Bond.
III. A local Government, it is called a municipal Bond.
IV. A Corporate Body it is called a Debentures, Industrial Loan or Corporate Bond.
2. Equities (also called Common Stock)
This instrument is issued by companies only and can also be obtained either in the primary market or
secondary market. Investment in the form of business translates to ownership of the business as the
contract stands in perpetuity unless sold to another investor in the secondary market. The investor
therefore possesses certain rights and privileges in the company. Whereas the investor in debts may be
entitled to interest which must be paid, the equity holder receives dividends which may or may not be
declared.
The risk factor in this instrument is high and thus yields a higher return. Holders of this instrument
however rank bottom on the scale of preference in the event of liquidation of a company as they are
considered as owners of the company.

3. Preference shares
The instruments are issued by corporate bodies and the investors rank second on the scale of
preference when a company goes under liquidation. The instrument possesses the characteristics of
equity in the sense that when the authorized share capital and paid-up capital are being calculated,
they are added to equity capital to arrive at the total. Preference shares can also be treated as a debt
instrument as they do not confer voting rights on its holders and have a dividend payment that is
Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 8
St. Joseph’s College Hassan Sub: Investment management

structured like paid for bonds issues.

Preference shares may be,

a. Irredeemable, convertible: in this case, upon maturity of the instrument, the principal sum
being returned to the investor is converted to equities even though dividends had earlier been
paid.
b. Irredeemable, non – convertible: Here, the holder can only sell his holding in the secondary
market as the contract will always be rolled over upon maturity. The instrument will also not
be converted to equities.
c. Redeemable: Here, the principal sum is repaid at the end of a specified period. In this case it is
treated strictly as a debt instrument.
4. Derivatives
These are instruments that derive from other securities, which are referred to as underlying assets. The
price, riskiness and function of the derivative depend on the underlying assets since whatever affects the
underlying assets must affects the derivatives. The derivative might be asset, index or even situation.
Some examples of derivatives are: futures, options, swaps.

5. Mutual funds
Mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors
for the purpose of investing in securities such as stocks, bonds, money instruments and similar assets.
Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce
capital gains and income for the fund’s investors. A mutual fund’s portfolio is structured and
maintained to match the investment objectives stated in its prospectus.

Meaning and definitions of Money Market Meaning

Money market refers to the market where money and highly liquid marketable securities are bought
and sold having a maturity period of one or less than one year. The money market constitutes a very
important segment of the Indian financial system.
Definitions

According to Geoffrey, “Money market is the collective name given to the various firms and
institutions that deal in the various grades of near money”.
According to the Reserve Bank of India, “ money market is the center for dealing, mainly of short-
term character, in money assets; it meets the short-term requirements of borrowings and provides
liquidity or cash to the lenders. It is the place where short requirements of borrowings and provides
liquidity or cash to the lenders. It is the place where short term surplus investible funds at the disposal
of financial and other institutions and individuals are bid borrowers’ agents comprising institutions
and individuals and also the government itself’’.
Instruments of money market

1. Treasury Bills
Treasury bills are short term instruments issued by Reserve Bank on behalf of the government to tide
over short term liquidity shortfalls, this instrument is used by the government to raise short term funds
to bridge a seasonal or temporary gaps between its receipts and expenditure. They form the most
important segment of the money market and not only in India but all over the world as well. In other
Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 9
St. Joseph’s College Hassan Sub: Investment management

words, T-bills are short-term borrowing instrument of the Government of India which enables the
investor to pack their short- term surplus fund while reducing their market risk.
2. Commercial Papers
Commercial Paper is an unsecured short-term instrument issued by the large banks and corporation in
the form of promissory note, negotiable and transferable by endorsement and delivery with the fixed
maturity period to meet the short-term financial requirement. There are four basic kinds of
commercial paper. Promissory Note, drafts, cheques and certificate of deposit.
3. Certificate of Deposit.
Certificate of Deposits are unsecured negotiable short-term instruments in a bearer form issued by
commercial bank and developed financial institutions. The scheme of Certificate of Deposit was
introduced by RBI as a setup towards deregulation of interest rate or deposit. Under this scheme, any
scheduled commercial bank, cooperative bank, excluding Land Development Bank, can issue
certificate of deposit for a period of not less than three months and up to a period of not more than one
year.
4. Repurchase agreement
Repo a money market instrument which enables the collateralized short-term borrowings and lending
through sale or purchase operation in debt instruments. Under a repo transaction, a holder of securities
sells them to an investor with an agreement to repurchase at a predetermined date and rate. It is a
temporary sale of debt involving full transfer of ownership of the securities, that is the assignment of
voting and financial rights.
Repo is also referred to as a ready for a transaction as it is a means of funding by selling a security held
on a spot basis and repurchasing the same on forward basis. Though there is no restriction on
maximum period for which repos can be undertaken, generally repo is done for a period not exceeding
14 days. Different instruments can be considered as collateral security for undertaking the ready
forward deals and they include government dated securities, treasury bills.
5. Reserve repos
A reserve repo a mirror image of repo. For, in a reserve repo, securities are acquired with the
simultaneous commitment to resell. Hence whether a transaction is repo or reverse repo is determined
only in terms of who initiated the first leg of the transaction. The reverse repurchase transaction
mature, the counterparty returns a security with the entity consult and receive its cash along with the
profit spread. One factor which encourages an organization to enter into a reverse repo is that it earned
some extra income on it otherwise idle cash.
6. Inter corporate deposits.
An inter corporate deposit is an unsecured borrowing by corporate and FIs from other corporate
entities registered under the Companies Act 1956. The corporate having surplus fund would lend to
another corporate in need of funds. This lending will be an uncollateralized basis and hence a higher
rate of interest would be demanded by a lender. The short-term credit rating of the corporate would
determine the rate at which the corporate will be able to borrow funds.

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 10
St. Joseph’s College Hassan Sub: Investment management

Derivatives
Meaning

Derivate are financial instruments whose value depends on the value of some underlying assets. Such
assets could be tangible such as wheat, cotton, real estate or financial instruments like equity, or it could be
intangible such as interest rates or index, etc. The returns on derivate are derived from those of the assets.
In a way, the performance of derivate depends on how the underlying assets perform. A derivate does not
have any physical existence but emerges out of a contract between two parties. It does not have any value
of its own but its value, in turn, depends on the value of other physical assets which are called the
underlying assets. These underlying assets may be shares, debentures, tangible commodities, currencies
or short-term or long- term financial securities, etc. The value of derivative may depend upon any of these
underlying assets. The parties to the contract of derivatives are the parties other than the issuer or dealer in
the underlying asset.
Derivatives include forward contracts, futures contracts, options and swaps. Derivatives have a valuable
purpose in providing a means of managing financial risk. By using derivatives companies and investors
can transfer any undesired risk, for a price, to other parties who either want to assume that risk or have
risks that offset that risk.
DEFINITION
Securities contracts (Regulations) Act, 1956 defines a derivative as
(a) Security derived from a debt investment, share, loan, risk investment,
or contract for difference, and
(b) Contract which derive its value from the prices or index of prices of underlying securities.
Features of financial derivatives

1. It is a contract: Derivative is defined as the future contract between two parties. It means there
must be a contract-binding on the underlying parties and the same to be fulfilled in future. The
future period may be short or long depending upon the nature of contract, for example, short term
interest rate futures and long- term interest rate futures contract.
2. Derives value from underlying asset: Normally, the derivative instruments have the value which
is derived from the values of other underlying assets, such as agricultural commodities, metals,
financial assets, intangible assets, etc
3. Specified obligation: In general, the counter parties have specified obligation under the derivative
contract. Obviously, the nature of the obligation would be different as per the type of the
instrument of a derivative. For example, the obligation of the counter parties, under the different
derivatives, such as forward contract, future contract, option contract and swap contract would be
different.
4. Direct or exchange traded: The derivatives contracts can be undertaken directly between the two
parties or through the particular exchange like financial futures contracts.
5. Delivery of underlying asset not involved. Usually, in derivatives trading, the making of delivery
of underlying assets is not involved; rather underlying transactions are mostly settled by taking
offsetting positions in the derivatives themselves.
6. Secondary market instruments: Derivatives are mostly secondary market instruments and have
little usefulness in mobilizing fresh capital by the corporate world.

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 11
St. Joseph’s College Hassan Sub: Investment management

7. Exposure to risk: Although the market, standardized, general and exchange -traded derivatives
are being increasingly evolved, however, still there are so many privately negotiated customized,
over the counter traded derivatives are in existence.

Types of derivatives

1. Forwards 2. Futures 3. Options 4. Swaps

1. Forwards
 It is a tailored agreement between two parties to buy or sell an asset, a product, or a commodity at
a defined price at a future date.

 Forwards are not traded on any central exchanges but rather over-the-counter, and they are not
standardized to be controlled. As a result, even if it does not guarantee any gains, it is largely
effective for hedging and reducing risk.

 Over-the-counter Forwards are also subject to counterparty risk. Counterparty risk is a type of
credit risk in which the buyer or seller may be unable to fulfil his or her obligations.

 If a buyer or seller goes bankrupt and is unable to fulfil his or her obligations, the other party may
be without remedy to salvage his or her position.

2. Futures:
• A futures contract is an agreement between two parties to buy or sell asset at a certain time in the
future at a certain price. Futures contracts are special types of forward contracts in the sense that
the former are standardized exchange traded contracts. Futures are financial contracts that are
basically identical to forwards, with the main distinction being that features can be exchanged on
exchanges, resulting in standardization and regulation.

• They're frequently utilized in commodity speculation.

3. Options
• Options are financial contracts in which the buyer or seller has the option to buy or sell a
security or financial asset but not the obligation to do so.
• Options are quite similar to futures.
• It is a contract or agreement between two parties to buy or sell any form of security at a
certain price in the future.
• The parties, on the other hand, are under no legal responsibility to keep their end of the
contract, which means they can sell or buy the security at any time.
• It is simply an option provided to lessen risk in the future if the market is volatile.
4. Swaps
Swaps are private agreements between two parties to exchange cash flows in the future according to a
prearranged formula. They can be regarded as portfolio of forward contract. The commonly used swaps
are:
 Interest rate Swaps : this entail swapping only the interest related cash flows between the parties
in the same currency.
 Currency Swaps: these entails swapping both principal and interest on different currency than in
the opposite direction.

Prepared by : ANIL B K
Assistant Professor SJC Hassam Page 12