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Investment classes
Equity Real estate Precious Objects Commodities
Fixed Incomesecurities
Derivatives andstructured products
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Investors can keep their money in the formof fixed deposits with banks. These fixed ortime deposits offer a fixed rate of interest
for the entire period. This is the safestinstrument for someone looking for a modestrate of growth.
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Fixed-Income Securities are financial claimsissued by governments, governmentagencies, state governments, corporations,
municipalities, banks, and other financialintermediaries. These securities offer apredictable stream of payments by way ofinterest and repayment of principal at the
maturity of the instrument.
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Debt funds are mutual funds that invest indebt instruments. This is another way oftaking exposure in the debt markets.
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These schemes are meant to promote savingsamong masses. Such schemes are usuallyfloated by government or government
agencies. The rate of interest is less, butthen there are tax exemptions on interestearned.
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1. Investors benefit by investing in debt as theyreserve and increase their invested capital andensure the receipt of regular interest income.
2. Investors can even neutralize the default risk
on their investments by investing ingovernment securities. If the risk tolerancelevel of the investor is low, debt instrumentsmay suit the investment needs better.
3. The prices of debt securities display a loweraverage volatility as compared to the prices ofother financial securities and ensure greatersafety of accompanying investments.
4. Debt securities enable wide-based andefficient portfolio diversification and thusassist in portfolio risk mitigation.
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Interest rate risk
Reinvestment risk
Default risk
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This is the most risky asset class as equitycapital is permanent/non-redeemable capitaland the payment of dividends is also
discretionary. The return comes in the form of dividends
and through appreciation in the price of theshares.
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A. Dividends
B. Cash Dividends stock dividends and sharerepurchase
C. Capital GainsD. Right to subscribe to new shares
E. Right to vote
F.
Right to information
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A. Residual capital
B. Capital Losses
C. Liquidity Risk
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Stock Market classification of Equity Shares
Blue chip shares Shares of large, well established, as well as financially
strong companies with an impressive record of earningsand dividends
Income shares Such shares have stable operations, high dividend
payments, and relatively limited growth opportunities
Growth shares Shares of companies that have a fairly entrenched
position in a growing market. Such shares enjoy anabove average rate of growth as well as profitability.
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Cyclical shares
Shares of such companies that have apronounced cyclicality in their operations.
Speculative shares Shares that tend to fluctuate widely because
there is a lot of speculative trading in them.
Defensive shares
Shares of such companies are relativelyunaffected by the ups and downs in generalbusiness conditions.
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The investment decision-making process iscarried out while investing in the stocks inthree major ways:
Fundamental Analysis (what to buy) Technical Analysis (when to buy)
Quantitative Analysis (tools to be used)
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Top down approach studies the economicfactors like consumer demand, percentagechange in business investments, percentage
change in government expenditure, changesin net exports, change in inventories,inflation, unemployment, fiscal andmonetary policies.
Starting with the actual and potential outputgrowth in the economy, the factors thatdetermine the growth in a good portfolio areas below:
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Top-Down Approach:
Depending on the state of the economy, there can befour phases like:
A) Overheat (high growth, high inflation)
B) Soft landing (low growth, low inflation) C) Hard landing (low growth, high inflation) D) Recovery (high growth, low inflation)
For example, during soft landing, the stock market
outlook would be: Positives low interest rate, rising earnings Negatives uncertainty high Positive/subdued outlook for stock market cash
position is low
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Style:
Growth/large best during periods of fallingrates and sluggish economy
Current outlook positive for chosenlarge/growth style
Sector:
Defensive/growth best (cyclical/value worst)during periods of economic sluggishness(recovery)
Moving towards underweight consumer stocks
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Bottom-up approach:
This approach determines what stocks tobuy in each sector buy fear and sell greed.
The goal of stock analysis is to find theoutliers. Buy/sell stocks that will rise/fallmore than the industry and sector.
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Bottom-up Approach: Business factors include: A) Competition B) Product and markets C) Production and distribution D) Government regulation E) Labor F) Quality
G) Assets H) R&D i) Business Plan J) Management
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Financial Factors Include:
A) Growth rate B) Payout C) Financial leverage
D) Asset Utilization E) Margins F) Life Cycle Valuation factors include:
A) Time horizon B) Patience of investors C) Consensus expectations D) Trading E) Value Added F) Previous performance of stock
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As per the IAS, a derivative has the followingfeatures:
1) Its value changes in response to the
change in a specified interest rate, financialinstrument price, commodity price, foreignexchange rate, and such others.
It requires no initial net investment or an
initial net investment that is smaller thanwould be required for other types ofcontracts.
It is settled at a future date.
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Exchange Traded futures and options Future contracts are organized/standardized
contracts, which are traded on the exchanges.The terms like quantity, quality, standard time
delivery, place etc. are standardized by theexchange. Futures may be financial futures orcommodity futures.
Options are instruments whereby the right isgiven by the option seller to the option buyer tobuy or sell a specific asset at a specific price on
or before a specific date. Option Terminology Option buyer, Option seller,
Call Option, Put Option, American option,European option, Strike price/exercise price,Option premium.
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Factors Affecting Option prices
a) Spot Prices
b) Strike Price
c) Time to expiration
d) Volatility
e) Risk free rate of interest
f) Dividends
OTC or structured derivatives - FRAs
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Structured products are synthetic investmentinstruments. They are created to meet specificneeds that cannot be met from the standardizedfinancial instruments available in the market.
Structured products typically result in a financialproduct that is often non-standard andstructured to meet the specific financialobjectives of a customer.
There are usually two components for anystructured product: An at risk element which is called an alpha
generator, provides the high performancepotential. This alpha generator can be a stock, anindex, currencies, or commodities.
An element of capital protection, usually a bondproduct.
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The bond element sets the time horizon andthe level of capital protection offered by theproduct. The alpha generator provides the
enhanced performance potential. A lower risk, defensive structured product
will allocate the majority of the investorscapital to the bond element. A higher risk
aggressive product will use derivatives toincrease the extent of alpha exposure.
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Residential House
The total return (rental savings plus capitalappreciation) from a residential house is
satisfactory.Ownership of a residential property provides
psychological satisfaction.
Loans are available from various banks and
financial institutions for buying orconstruction of a residential property.
Interest on loans taken is tax deductiblewithin certain limits.
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Commercial Property
The more affluent class of investors may beinterested in investing in commercial
property. This investment fetches both agood rental value and enjoys capitalappreciation.
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Agricultural Property
Merits:
Agricultural income is not taxable.
Loans are available for agriculturaloperations at a concessional rate.
Agricultural land is exempted from wealthtax.
Capital gains arising from the sale ofagricultural land are not regarded as capitalassets or may be taxed at a concessionalrate.
There is a charm in living in a farmhouse.
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Demerits
In many states, land ceiling laws are quiterestrictive. In addition, law of some states
precludes non-agriculturist from acquiringagricultural land.
Farm houses in general are not safe.
Many states have laws that confer ownership
to the cultivating agent. Agricultural activity is often uneconomical or
not that profitable, particularly if done on apart time basis.
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Suburban Land
Land within city limits is often veryexpensive. Investors can buy residential land
(converted land) in private layouts insuburban areas at affordable prices. Suchinvestments enjoy high capital appreciation.
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Real Estate Investment Trust (REIT)
This class of investments not in existence inIndia. AMFI and SEBI have agreed to launch
Real Estate Mutual Fund Schemes as an initialstep.
REIT is common in the USA with over 190publicly traded REITs approved by SEC. REITs
offer a source of capital to realty firms. In UK, real estate investments are done
through pooled management vehicles (PMVs).
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Mutual fund is a mechanism for poolingresources by issuing units to investors andinvesting funds in securities,
Diversification reduces risk. Investors inproportion to their investments share theprofits or losses.
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Diversification
Professional Management
Liquidity
Convenience
Economies of scale
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Dilution
Fluctuating returns
Evaluating funds
Costs
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On the basis of maturity period
On the basis of investment objective
Growth/Equity-oriented scheme
Income/debt-oriented scheme
Balanced fund
Money market or liquid fund
Gilt funds Index funds
Equity-linked savings schemes
Load fund Vs. no-load fund
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The hedge fund industry has grown at anextraordinary pace in the last decade, from 300 fundsin 1990 to more than 9000 today. These funds havebecome highly visible in the markets and manage thecapital of around US$ 1.3 trillion.
Hedge fund is a private investment vehicle thataggregates the investments of several participants.
Hedge funds have very limited public transparency,high minimum investment, investors accreditationstandards, and incentive fees for the investmentmanager. The attraction of hedge funds is theirpotential to earn attractive returns irrespective ofthe direction of general market movements. Thus,hedge funds are also called absolute return funds.
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Role of Hedge Funds in portfolio construction
Since hedge funds are expected to provide a combination ofconsistently positive return stream and a low correlation to therest of the portfolio, the addition of this asset class to a standardequity-dominated risky portfolio should result in reducedvolatility with little or no diminution of expected return.
Investment strategies of Hedge Funds1. Long/short equity
2. Market-neutral
3. Event-driven
4. Convertible arbitrage
5. Short selling
6. Fixed-income arbitrage7. Managed futures
8. Global macro9. Equity trading
Market benefits of Hedge Funds
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The various types of commodities can becategorised as below:
a. Energy the commodities under this
category can be classified broadly intothree categories
i. Primary energy sources like coal, crude oil,natural gas and nuclear fuel.
ii. Secondary energy sources like electricity,refined oil products, diesel, petrol, LPG
iii. Half products such as petrochemicals,ethylene, and naptha which may be includedas commodities in a broader sense.
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b. Mineral ores ferrous metals like iron, castiron, steel, and steel products; non-ferrousmetals like aluminum, copper, lead, nickel,tin, zinc; precious metals like gold, silver,
platinum.c. Agricultural food products most commonly
agricultural products are cereals, wheat,and corn, beverages like tea, coffee and
cocoa; fruits like apple, dates, grapes,bananas, oranges; cotton, jute, wool;rubber and timber; seafood products likefish, shrimps, and crab meat
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Not an efficient Market
Traded products are differentiated. Artmarkets are often very thin with very few
works of art of a specific artist traded eachyear
Market transparency is low
Large differences in expertise between
buyers and sellers Low liquidity
Transaction costs are high.
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Indian is an emerging story in the global art market
Recognition across geographies: good in quality aswell as aesthetic appeal.
Highly undervalued: both in comparison with
emerging markets and developed economies Nearly 3000 art investors in India investing above 2
million in a year.
Indian art market is growing at 30-40% today asagainst the world art market that is growing at 3-4%.
Expected to become Rs.1,000 crore industry in thenext 5 years.
A close ended art fund called Yatra launched byEdelweiss capital.
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Very subjective in terms of quality andvaluation
No regulation, no recourse
Not very liquidHigh transaction costs
Authenticity of art works
Long term investment horizon
High maintenance costs Sustenance of artists
No intrinsic value
No accounting standardisation