Security analysis& investment management

By-Jaya MishraSecurity analysis& investment management

InvestmentInvestment may be defined as an activity that commits fund in any financial/ physical form in the present with an expectation of receiving additional return in the future.In its broadest sense an investment is a sacrifice of current money or other resources for future benefits.Investment is an activity that is undertaken by those who have savings.

securityA security is a document or certificate as evidence of loan (as in the case of bond or deposit) or supply of capital in some other form(as in the case of shares).It is also known as claim, financial asset, or financial instrument

Market of securities/financial marketsFinancial markets are the centers or arrangements that provide facilities for buying & selling of financial claims & services.The corporations, financial institutions, individuals & government trade in financial products on these markets either directly or through brokers & dealers on organized exchanges or off exchanges.

Functions of financial marketsIt facilitates price discovery.It provides liquidity to financial assets.It considerably reduces the cost of transacting.

Classification of financial marketsOn the basis of : Nature of claim debt market equity market derivative marketMaturity of claim money market capital market Seasoning of claim primary market secondary marketOrganizational structure exchange traded market over the counter market

Derivative marketA derivative is an instrument whose value depends on the value of some underlying assets.From the point of view of investors &portfolio managers future & options are the two most important financial derivatives.Derivatives are used for hedging against inflation & for speculation.

The need for a derivative marketThey help in transferring risks from risk averse people to risk oriented people,They help in discovering of future as well as current prices,They catalyze entrepreneurial activity,They increase the volume traded in markets ,They increase savings & investment in the long run.

Future contractsA future contract is an agreement between two parties to exchange an asset for cash at a predetermined future date for a price that is specified today.The party which agrees to purchase the asset is said to have a long position & the party which agrees to sell the asset is said to have a short position.

Option contractsAn option gives its owner the right to buy or sell an underlying asset on or before a given date at a predetermined price.Types : call option put optionHere option holder enjoys the right but has no obligations to do something.

Factors driving growth of financial derivativesIncreased volatility in asset prices in financial markets.Increased integration of national financial markets with the international markets.Market improvement in communication facilities & sharp decline in their costs.Development of more sophisticated risk management tools.Innovations in the derivative markets which optimally combine the risks & returns over a large no. of financial assets leading to higher returns, reduce risk as well as transactions costs as compared to individual financial assets.

Derivative markets in India

SEBI permitted the derivative segments of two stock exchanges NSE,BSE& their clearing house/corporations to commence trading & settlement in approved derivatives contracts.The trading on BSE in options on individual securities commenced in July 2001. future contracts on individual stocks were launched in nov 2001.The derivatives trading on NSE in options on individual securities commenced on July 2,2001.Single stock futures were launched on nov9,2001.

Money marketDebt instruments which have a maturity of less than one year at the time of issue are called money market instruments.These instruments are highly liquid & have negligible risk.This market is dominated by the government, financial institutions, banks & corporate.Individual investors scarcely participate in the money market directly.

The major money market instruments

1.Treasury billsRepresent the obligations of the govt. of India.Have a primary tenor like 91 days & 364 days.Sold on auction basis every week in certain minimum denominations by RBI.Sold at a discount & redeemed at par.They dont carry coupan rate.

2.Certificate of deposits

Represent short term deposits which are transferable from one party to another.Major issuers-Banks & FIs Principal investors-banks, FIs, corporate & MFs.Generally have a maturity of 3 months to 1 year.Carry a certain interest rate.Are issued in either bearer or registered form.

3.Commercial paper

Short term, unsecured promissory note issued by firms that are generally considered to be financially strong.Usually has a maturity period of 90 to 180 days.Sold at discount & redeemed at par.

4.ReposThe term Repo is used as an abbreviation for Repurchase Agreement or Ready Forward.A Repo involves a simultaneous sale & repurchase agreementReverse Repos are a safe & convenient form of short-term investment.

Primary market/new issue marketThe primary market deals in new financial claims or new securities.The primary market mobilise savings & they supply fresh or additional capital to business units.

Primary market for equity sharesThere are 4 ways in which a company may raise equity capital in the primary market:1. Public issue:Sale of securities to the public at large.Public issues in India are governed by the Provisions of the Companies Act 1956, SEBI Guidelines on investor protection & listing agreement between issuing company & stock exchanges.Company making public issue informs the public about it through statutory announcements.

2.Right issueInvolves selling of securities by issuing rights to the existing shareholders.

3.Private placementIt involves sale of securities to a limited no. of sophisticated investors such as financial institutions, MFs, venture capital fund ,banks & so on.

4.Preferential allotmentIt involves an issue of equity by a listed company to selected investors at a price which may or may not be related to the prevailing market price.

Primary market for debt securities1)Government securities marketThe issue of G-Sec is regulated by the RBI.G-sec are issued through an auction mechanism.RBI(serves as the merchant banker to the central & state government) announces the auction of G-sec through a press notification & invites bids from prospective investors like banks, insurance companies, MFs & so on.Two systems of auction are widely used all over the world A)French auction b) Dutch auction

Corporate debt marketThe issuance of corporate debt securities is regulated by SEBI.Debentures are offered to the public or issued on a right basis or privately placed.Debt securities are generally secured against the assets of the issuing company.A debt issue cant be made unless credit rating from a credit rating agency is obtained & disclosed in the offer document.It is mandatory to create a debenture redemption reserve for every issue of debenture.

Secondary marketThe securities that are already outstanding & owned by investors are usually bought & sold through the secondary market.Presently there are 23 stock exchanges in India. A large volume of transactions on the secondary market are put through the BSE & NSE.There are 4 imp. Elements of securities markets:1)investors 2)issuers 3)intermediaries 4)regulators

2 broad segment of secondary market the organized stock exchanges

the over-the-counter market

Reasons for transactions on secondary markets

Information motivated reasonsliquidity motivated reasons

Functions of stock exchanges1.they provide a market place for exchange of securities.2.They provide a linkage between the savings of household sector & investment in corporate economy.3.They ensures interest of investors through regulatory bodies.4.They are beneficial for the whole community.5.They provide ready liquidity & constant evaluation of assets.

Contd.(Functions of stock exchanges)The overall trend of prices & volume of business on the stock exchanges serve as an economic indicator.

Limitations of stock exchangesRampant speculationInsider tradingOligopolisticLimited forward tradingOutdated share trading systemLack of a single marketInadequacy of investor service.

Trading1) trading of equity shares

Open outcry system screen based systemOpen outcry system:Traders shout & resort to signals on the trading floor of the exchange.Exchange consists of several notional trading posts for different securities.

Screen based systemWith the establishment of NSE in 1994 India entered in the era of screen-based trading.Trading ring is placed by the computer screen.This system enhances the informational efficiency of the market.This system permits the market participants to get a full view of the market.In this system distant participants can trade with each other.

Screen based system(contd.)The kind of screen based trading system adopted in India is referred to as the open electronic limit order book(ELOB) market system.Buyers & seller place their order on computer; these orders may be limit order or market order.The computer constantly tries to match mutually compatible orders on price-time priority.The limit order book i.e. the list of unmatched limit orders is displayed on the screen.

SettlementTrades in India were settled by physical delivery.To mitigate the costs & risks associated with physical delivery security transactions in developed markets are settled mainly through electronic delivery facilitated by depositories.A depository is an institution which dematerializes physical certificates & effects transfer of ownership by electronic book entries.SEBI has made dematerialised trading compulsory for all the stock exchanges in country.

Shift to rolling settlementTill recently share transactions in India were settled on the basis of a weekly account period.Presently the settlement of all trades is on a T+2 basis.

Secondary market for government securitiesAs soon as they are issued, G-sec are deemed to be listed & eligible for trading.NSE has a wholesale debt market(WDM)segment which is fully automated screen based trading system.Retail investors can buy G-sec from a primary dealer.

Secondary market for corporate debt securitiesWhile the equity market in India has witnessed reasonably high trading volumes & liquidity, the secondary market for corporate debt instruments historically has been very dull for several reasons.Debt instruments do not appeal to the speculative trader who has dominated the secondary market.Debt has been subscribed to by individual investors who have typically pursued a buy & hold strategy.

Comparison between primary & secondary marketDifferences1)Types of security dealt: Primary market deals with new securities that is, securities which were not previously available & therefore, offered to the investing public for the first time. secondary market is a market for old securities(securities which have been issued already & granted stock exchange quotation).Here concerned company is not involved in trading procedure.

Contd.2) Nature of financing Primary market provides additional funds to the issuing companies either for starting a new enterprise or for the expansion or diversification of the existing one & therefore its contribution to the company financing is direct. secondary markets can in no circumstances supply additional funds since the company is not involved in the transaction. Stock markets role regarding the supply of capital is indirect.

Contd. The existence of secondary markets which provide institutional facilities for the continuous purchase & sale of securities & to that extent lend liquidity & marketability, play an important part in the process.3) Organizational differences The stock exchanges have organizationally speaking, physical existence & are located in a particular geographical area.

Contd.

The new issue market is not rooted in any particular spot & has no geographical existence.

Contd.Similarities1)Stock exchange listing Securities issued in the NIM are invariably listed on a recognized stock exchange for dealing in them.2)Control In terms of regulatory framework related to dealings in securities, the new issues of securities which seek stock quotation/listing have to comply with statutory rules as well as regulation framed by the stock exchanges with the objective of ensuring fair dealing in them.

Contd.This requirement obviously enables the stock exchange to exercise considerable control over the NIM & is indicative of close relationship between the two.3) Economic Interdependence The markets for new & old securities are, economically an integral part of a single market-the industrial securities market. The behavior of the stock exchanges has a significant bearing on the level of activity in the NIM.

Contd.New issues increases when share values are rising & vice versa. This is because the stock exchanges are usually the first to feel a change in the economic outlook & the effect is quickly transmitted to the new issue section of the market.

Listing of securitiesListing means admission of the security to dealing on a recognized stock exchange.The security may be of any public limited company, central or state government, quasi government & other financial institutions.The exchange has a separate listing department to grant approval for listing of securities.A company intending to have its securities listed on the exchange has to comply with the listing requirements prescribed by the exchange.

The objectives of listingProvide liquidity to securities;Mobilize savings for economic development;Protect interest of investors by ensuring full disclosures.It helps the company to gain national importance & widespread recognition.

Minimum listing requirement for a new company The following eligibility criteria have been prescribed effective August1, 2006 for listing of companies on BSE:In respect of large cap companiesThe min. post issue paid up capital of the applicant company shall be Rs.3 crore;The min. issue size shall be Rs. 10 crore;The min. market capitalization shall be Rs.25 crore.

Contd.In respect of small cap companiesThe min. post issue paid up capital of the company shall be Rs.3 crore;The min. issue size shall be Rs.3 crore;The min. market capitalization shall be Rs.5 crore;The min. turnover/income shall be Rs.3 crore in each of the preceding three 12-months period;The min. number of public shareholders after vthe issue shall be 1000.

Listing requirements for all companiesPayment of excess application moneyListing on multiple exchangesThe no. of shareholdersAppointment of market makerArticle of associationAdvertisementApplying modePublic offer size

SEBI & investor protection To ensure the healthy growth of market the investing public should be protected. The principal ingredients of investor protection are: a)provision of all the relevant information; b)provision of accurate information; c)transparent allotment procedures without any bias.To provide above factors several steps have been taken.

Steps taken for investor protectionProject appraisalDisclosures in the prospectsClearance by the stock exchangeSigning by Board of DirectorsRedressal of investors grievancesAllotment committeeInformation through news papersAdditional information