CHAPTER - III

Factors influencing investment decisions, financial positions, tax positions, risk perception and attitude.

Introduction to systematic and non-systematic risks.

FACTORS INFUENCING INVESTMENT DECISIONS

INTERNAL FACTORS Investment objectives Income age Educational background Spending and savings Risk taking capacity Expected return Tax rebate

EXTERNAL FACTORS Government policy –

SEBI,RBI,IRDA,FEMA etc.,

Availability of financial assets

Tax policy of the country Financial intermediaries Financial Market

condition

RISK AND RETURN CONCEPT

Concept of Risk All Investments are risky The degree of risk varies Risk is defined as “deviations from

the expected outcome” Risk is measured through standard

deviation or Beta analysis. Risk arises out of variability. The most useful method of

calculating the variability is the standard deviation.

Risk can be diversified.

Risk

Typically, risk is defined as short-term price volatility or variability.

But on a long-term basis, you can think of risk as the possibility that your accumulated real capital will be insufficient to meet your financial goals.

And if you want to reach your financial goals, you must start with an honest appraisal of your own personal comfort zone with regard to risk.

Individual tolerance for risk varies, creating a distinct "investment personality " for each investor.

If an asset value jumps up and down a lot, it is deemed to be riskier than an asset value that stays put or climbs slowly - even if the asset that jumps around a lot tends to outperform the slower moving assets over time.

Some investors can accept short-term volatility with equanimity, others with near panic.

Types of Risk

Systematic risk Market risk Interest rate risk Purchasing power

risk

Unsystematic risks Business risk Financial risk

Uncontrollable in nature affects all investments in general Can be minimized through diversified

investments

Systematic risk

Systematic riskArises out of external and uncontrollable

factors such as economic, sociological, political and legal factors.

Market risk Interest rate risk Purchasing power risk

Types of Risk Market Risk.

Also known as systematic risk.

Referred as stock variability due to changes in investors attitude and expectations.

At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences.

Investors reaction towards tangible and intangible events is the chief cause for Market risk.

For e.g. investors perception towards Mergers and acquisitions, dividends declaration, Bulk buying and selling by FII, Institutional investors, MFs.rumors, and other economic issues like government policy etc.,

Types of Risk

Interest Rate Risk.

Changing interest rates effect both stocks and bonds in many ways.

Investors are reminded that "predicting" which way rates will go is rarely successful.

A diversified portfolio can offset these changes.

Interest Rate risk This risk arises due interest rate policy in the

economy. Regulated by RBI as per the Inflation and economic

condition of the country Affects the portfolio ROI

Affects Money market Bond Market Commercial paper Certificates of Deposits and indirectly stock market transactions.

Connected with the Maturity of the securities

Inflation Risk. Sometimes referred to as "loss of purchasing power."

Whenever inflation sprints forward faster than the earnings on your investment, you run the risk that you'll actually be able to buy less, not more.

Inflation risk also occurs when prices rise faster than your salary.

Currency Fluctuations.

As the dollar rises in value, the value of overseas investments will decline, and vice versa.

For Eg: the present IT stock prices are affected by the rupee appreciation

Political Turmoil. At home and abroad, events in the political arena can encourage or discourage those who want to invest.

This is also a consideration when investing outside of the United States.

Unsystematic risk

Arises due to the uncertainty surrounding a particular firm or industry.

Factors like labor strike,change in management, change in the production, products etc can cause for these risk

Such risk can be classified as Business risk Financial risk

Unsystematic Risk

Business risk

Financial risk

Business risk

It arises out of the internal and external factors of a company

Internal business risk may be Policy of the management Resources of the concern Suppliers Employees Cost of operation Selling prices

Financial risk

Associated with the financial structure of an organizations

Depends on the capital mix (Debt/equity mix)

Affects the EPS, P/E Ratio, and Dividend pay out ratio.

How to measure risk Beta, Standard Deviation Regression and Correlation techniques variance analysis Look for the ratings of the Instruments.

End of Module - III