Friday, October 16, 2009

MUTUAL FUND

A Mutual Fund is a body corporate that pools the savings of a number of investors and invests the same in a variety of different financial instruments, or securities. Mutual funds can thus be considered as financial intermediaries in the investment business who collect funds from the public and invest on behalf of the investors. The Investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual Fund scheme. The investment objectives specify the class of securities a Mutual Fund can invest in. Mutual Funds invest in various asset classes like equity, bonds, debentures, commercial paper and government securities.
An Asset Management Company (AMC) is a highly regulated organization that pools money from investors and invests the same in a portfolio.
NAV or Net Asset Value of the fund is the cumulative market value of the assets of the fund net of its liabilities. NAV per unit is simply the net value of assets divided by the number of units outstanding. Buying and selling into funds is done on the basis of NAV-related prices. NAV is calculated as follows:

NAV= Market value of the fund's investments + Receivables + Accrued Income - Liabilities - Accrued Expenses __________________________________________________________________________________
Number of Outstanding units
NAVs are helpful in keeping an eye on your mutual fund's price movement, but NAVs are not the best way to keep track of performance. The reason for this is mutual fund distributions. Mutual funds are forced by law to distribute at least 90% of its' realized capital gains and dividend income each year. When a fund pays out this distribution, the NAV drops by the amount paid. This is important because an investor may become frightened when they see their fund's NAV drop by Rs.3 even though they haven't lost any money (the Rs.3 was paid out to the shareholder).
The percentage of total fund assets that is used to cover expenses associated with the operation of a mutual fund. This amount is taken out of the fund's assets and lowers the return that fund holders achieve. These expenses include management fees and operating expenses. The management fee is the fee that is charged to the fund by the portfolio manager, and it is often a fixed percentage. The operating expenses are the expenses that the fund incurs through operation and this can include brokerage fees, taxes, investor services and interest expenses.
  • Professional Management - Qualified and experienced professionals manage Mutual Funds. Generally, investors, by themselves, may have reasonable capability, but to assess a financial instrument a professional analytical approach is required in addition to access to research and information and time and methodology to make sound investment decisions and keep monitoring them.

  • Diversification - Since Mutual Funds make investments in a number of stocks, the resultant diversification reduces risk. They provide the small investors with an opportunity to invest in a larger basket of securities.

  • Regulated- Mutual Funds are registered with SEBI. SEBI monitors the activities of Mutual Funds.

  • Liquidity- In case of open-ended funds, the investment is very liquid as it can be redeemed at any time with the fund unlike direct investment in stocks/bonds.

Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures and deposits. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and companies may default in payment of interest/principal on their debentures/bonds/deposits. Besides this, the government may come up with new regulation which may affect a particular industry or class of industries. All these factors influence the performance of Mutual Funds.
(a) On the basis of Objective
Equity Funds/ Growth Funds - Funds that invest in equity shares are called equity funds. They carry the principal objective of capital appreciation of the investment over the medium to long-term. The returns in such funds are volatile since they are directly linked to the stock markets. They are best suited for investors who are seeking capital appreciation. There are different types of equity funds such as Diversified funds, Sector specific funds and Index based funds.
Diversified funds - These funds invest in companies spread across sectors. These funds are generally meant for risk-taking investors who are not bullish about any particular sector.
Sector funds - These funds invest primarily in equity shares of companies in a particular business sector or industry. These funds are targeted at investors who are extremely bullish about a particular sector.
Index funds - These funds invest in the same pattern as popular market indices like S&P 500 and BSE Index. The value of the index fund varies in proportion to the benchmark index.
Tax Saving Funds - These funds offer tax benefits to investors under the Income Tax Act. Opportunities provided under this scheme are in the form of tax rebates U/s 88 as well saving in Capital Gains U/s 54EA and 54EB. They are best suited for investors seeking tax concessions.
Debt / Income Funds - These Funds invest predominantly in high-rated fixed-income-bearing instruments like bonds, debentures, government securities, commercial paper and other money market instruments. They are best suited for the medium to long-term investors who are averse to risk and seek capital preservation. They provide regular income and safety to the investor.
Liquid Funds / Money Market Funds - These funds invest in highly liquid money market instruments. The period of investment could be as short as a day. They provide easy liquidity. They have emerged as an alternative for savings and short-term fixed deposit accounts with comparatively higher returns. These funds are ideal for Corporate, institutional investors and business houses who invest their funds for very short periods.
Gilt Funds - These funds invest in Central and State Government securities. Since they are Government backed bonds they give a secured return and also ensure safety of the principal amount. They are best suited for the medium to long-term investors who are averse to risk.
Balanced Funds - These funds invest both in equity shares and fixed-income-bearing instruments (debt) in some proportion. They provide a steady return and reduce the volatility of the fund while providing some upside for capital appreciation. They are ideal for medium- to long-term investors willing to take moderate risks.
Hedge Funds - These funds adopt highly speculative trading strategies. They hedge risks in order to increase the value of the portfolio.
(b) On the basis of Flexibility
Open-ended Funds - These funds do not have a fixed date of redemption. Generally they are open for subscription and redemption throughout the year. Their prices are linked to the daily net asset value (NAV). From the investors' perspective, they are much more liquid than closed-ended funds. Investors are permitted to join or withdraw from the fund after an initial lock-in period.
Close-ended Funds - These funds are open initially for entry during the Initial Public Offering (IPO) and thereafter closed for entry as well as exit. These funds have a fixed date of redemption. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but the discount narrows as maturity nears. These funds are open for subscription only once and can be redeemed only on the fixed date of redemption. The units of these funds are listed (with certain exceptions), are tradable and the subscribers to the fund would be able to exit from the fund at any time through the secondary market.
Interval funds - These funds combine the features of both open-ended and close-ended funds wherein the fund is close-ended for the first couple of years and open-ended thereafter. Some funds allow fresh subscriptions and redemption at fixed times every year (say every six months) in order to reduce the administrative aspects of daily entry or exit, yet providing reasonable liquidity.
(c) On the basis of geographic location
Domestic funds - These funds mobilize the savings of nationals within the country.
Offshore Funds - These funds facilitate cross border fund flow. They invest in securities of foreign companies. They attract foreign capital for investment.
Growth Plan and Dividend Plan - A growth plan is a plan under a scheme wherein the returns from investments are reinvested and very few income distributions, if any, are made. The investor thus only realizes capital appreciation on the investment. This plan appeals to investors in the high income bracket. Under the dividend plan, income is distributed from time to time. This plan is ideal to those investors requiring regular income.
Dividend Reinvestment Plan - Dividend plans of schemes carry an additional option for reinvestment of income distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a fund are reinvested on behalf of the investor, thus increasing the number of units held by the investors.
A Load is a charge, which the AMC may collect on entry and/or exit from a fund. A load is levied to cover the up-front cost incurred by the AMC for selling the fund. It also covers one time processing costs. Some funds do not charge any entry or exit load. These funds are referred to as 'No Load Fund'. Funds usually charge an entry load ranging between 1.00% and 2.00%. Exit loads vary between 0.25% and 2.00%.
For e.g. Let us assume an investor invests Rs. 10,000/- and the current NAV is Rs.13/-. If the entry load levied is 1.00%, the price at which the investor invests is Rs.13.13 per unit. The investor receives 10000/13.13 = 761.6146 units. (Note that units are allotted to an investor based on the amount invested and not on the basis of no. of units purchased).
Let us now assume that the same investor decides to redeem his 761.6146 units. Let us also assume that the NAV is Rs 15/- and the exit load is 0.50%. Therefore the redemption price per unit works out to Rs. 14.925. The investor therefore receives 761.6146 x 14.925 = Rs.11367.10
Sales/Purchase price is the price paid to purchase a unit of the fund. If the fund has no entry load, then the sales price is the same as the NAV. If the fund levies an entry load, then the sales price would be higher than the NAV to the extent of the entry load levied.
Redemption price is the price received on selling units of open-ended scheme. If the fund does not levy an exit load, the redemption price will be same as the NAV. The redemption price will be lower than the NAV in case the fund levies an exit load.
Repurchase price is the price at which a close-ended scheme repurchases its units. Repurchase can either be at NAV or can have an exit load.
Some Mutual Funds provide the investor with an option to shift his investment from one scheme to another within that fund. For this option the fund may levy a switching fee. Switching allows the Investor to alter the allocation of their investment among the schemes in order to meet their changed investment needs, risk profiles or changing circumstances during their lifetime.
There is no lock-in period in the case of open-ended funds. However in the case of tax saving funds a minimum lock-in period is applicable. The lock-in period in case of Tax Savings Schemes (ELSS) is 3Yrs.
The performances of Mutual funds are influenced by the performance of the stock market as well as the economy as a whole. Equity Funds are influenced to a large extent by the stock market. The stock market in turn is influenced by the performance of the companies as well as the economy as a whole. The performance of the sector funds depends to a large extent on the companies within that sector. Bond-funds are influenced by interest rates and credit quality. As interest rates rise, bond prices fall, and vice versa. Similarly, bond funds with higher credit ratings are less influenced by changes in the economy.
Choice of any scheme would depend to a large extent on the investor preferences. For an investor willing to undertake risks, equity funds would be the most suitable as they offer the maximum returns. Debt funds are suited for those investors who prefer regular income and safety. Gilt funds are best suited for the medium to long-term investors who are averse to risk. Balanced funds are ideal for medium- to long-term investors willing to take moderate risks. Liquid funds are ideal for Corporates, institutional investors and business houses who invest their funds for very short periods. Tax Saving Funds are ideal for those investors who want to avail tax benefits. An important aspect while selecting a particular scheme is the duration of the investment. Depending on your time horizon you can select a particular scheme. Besides all this, factors like promoter's image, objective of the fund and returns given by the funds on different schemes should also be taken into account while selecting a particular scheme.
Tax Benefit for Mutual Fund Investments: ELSS (Equity Linked Saving Schemes) is eligible for Tax Deduction u/s 80C of Income Tax Act. Up to a maximum of Rs.100000/-
Long Term Capital Gain: If the investment tenure in equity fund is more that 1Yr i.e. at least 366 days then it is treated as Long Term Capital Gain. As per the current Income Tax Laws, it is Tax free in the hands of investors.
Short Term Capital Gain: If the investment tenure in equity fund is less than 365 days, then it is treated as Short Term Capital Gain. As per the current Tax Laws, it is taxed @10%.
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Saturday, October 10, 2009

Stock Exchange

Stock Exchange
A stock exchange is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts, derivatives, pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for record keeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks to investors is by definition done in the primary market by means of a initial public offer and subsequent trading is done in the secondary market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks.

Ownership
Stock exchanges originated as mutual organizations, owned by its member stock brokers. There has been a recent trend for demutualization of stock exchanges, where the members sell their shares in an initial public offering. In this way the mutual organization becomes a corporation, with shares that are listed on a stock exchange. Examples are Australian Securities Exchange (1998), Euronext (merged with New York Stock Exchange), NASDAQ (2002), the New York Stock Exchange (2005).
Listing requirements
Listing requirements are the set of conditions imposed by a given stock exchange upon companies that want to be listed on that exchange. Such conditions sometimes include minimum number of shares outstanding, minimum market capitalization, and minimum annual income. For example to list in National Stock Exchange (NSE), paid up equity capital of the company should not be less than Rs. 10 crores and the capitalization of the equity of company should not be less than Rs. 25 crores.
Role of Stock Exchanges
Stock exchanges have multiple roles in the economy as given below:
Raising Capital for Businesses
The Stock Exchange provides companies with the facility to raise capital for expansion through selling shares to the investing public.
Mobilizing savings for investments
When people draw their savings and invest in shares, it leads to a more rational allocation of resources because funds, which could have been consumed, or kept in idle deposits with banks, are mobilized and redirected to promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and higher productivity levels and firms.
Facilitating company growth
Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion.
Profit Sharing
Both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses. Corporate governance: By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately-held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors).
Creating Investment opportunities for small investors
As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.
Government capital raising
Governments at various levels may decide to borrow money in order to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. The issuance of such bonds can obviate the need to directly tax the citizens in order to finance development, although by securing such bonds with the full faith and credit of the government instead of with collateral, the result is that the government must tax the citizens or otherwise raise additional funds to make any regular coupon payments and refund the principal when the bonds mature.
Barometer of the Economy
At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy.
 
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Wednesday, October 7, 2009

SHORT SELL

Short Selling

Introduction
Traditionally the premise of investing is that you buy an asset and hold it until it rises enough to make a sizable profit, it doesn't get much easier than that. What about the times you come across a stock that you wouldn't invest a penny in, you know that stock is doomed, a sure loser. If you knew that the stock was going to decline wouldn't be nice to be able to profit from its decline. Well you can profit from the decline of a stock and although it sounds easy, there are substantial risks and pitfalls that you need to watch out for. The mechanics of a short sale are somewhat complicated and the investor's risks are high so it is important that you understand the transaction before getting into it.
What does it mean to sell short?
If you sell a stock you don't own, you are selling short.


A short seller sells a stock that he believes will fall in value. A short seller does not own the stock before he sells it. Instead, he borrows it from someone who already owns it. Later, the short seller buys back the stock he shorted and returns the stock to close out the loan. If the stock has fallen in price since he sold short, he can buy the stock back for less than he received for selling it. The difference is his profit.


Short selling allows investors to profit from falling stock prices. "Buy low, sell high" is the goal of both short selling and purchasing shares ("going long"). A short sale reverses the order of a typical stock purchase: the stock is sold first and bought later.


For example, in March 2002, Anil thinks HLL is overvalued. He sells short 100 shares of HLL at Rs. 250 per share. The stock market crashes in April and HLL's share price falls to Rs. 210 per share. Anil buys back 100 shares of HLL and closes out the short sale. Anil gains the difference between the sales proceeds and the purchase costs and pockets Rs. 4,000 from the short sale, excluding transaction costs.
Where Does The Broker Get The Stock?
The short answer is from other customers or the Stock Holding Corp. of India. Short selling is a marginable transaction. In plain English, that means you must open a margin account to sell short. This is the same account you would use if you want to use your stocks as collateral margin to trade in the markets. When you open a margin account, you must sign an agreement with your broker. This agreement says you will maintain a cash margin or pledge your stocks as margin.
How Does Short Sell works?
Unlike a stock purchase transaction, which involves two parties (the buyer and the seller), short selling involves three parties: the original owner, the short seller, and the new buyer. The short seller borrows shares from the original owner, and immediately sells them on the open market to any willing buyer. To finalize ("close out") the short sale transaction, the short seller must then go out into the stock market and buy the same amount of shares as he sold so that the broker can return them to the original owner.


To sell short you first must set up a margin account with your broker. A margin account allows you borrow from your brokerage company using the value of your portfolio as collateral. The general rule is that the value of your portfolio must equal at least 50% of the size of the short sale transaction. In other words, If you have Rs. 100,000 worth of stock/cash in your margin account, you can borrow Rs. 200,000 of stock to sell short.


To sell a stock short, you must borrow stock. To initiate a short sale, you simply call up your broker and ask to sell short a specific number of shares of your selected stock. Your broker then checks with the Margin Department to see whether the shares are available or can be borrowed. If they are available, the brokerage borrows the shares, sells them in the open market, and puts the proceeds into your margin account. To close out your short sale, you tell your broker that you want to buy the same number of shares that you shorted. The broker will purchase the shares for you using the money in your margin account, return the shares and close out the short sale transaction.


While your short sale is outstanding, your account will be charged interest against the value of the short position. If the stock you shorted goes up in price, or the value of the stock you are using as collateral goes down in price, so that your collateral is less than the "maintenance" requirement you will be required to add money to your margin account or buy back the stock that you sold short. You must also pay any dividends issued by the company whose stock you sold short.
Why Sell Short?
The two primary reasons for selling short are opportunism and portfolio protection. Occasionally investors see a stock that they believe has been hyped to a ridiculously high level. They believe that the stock price will fall when reality replaces the hype. A short sale provides the opportunity to profit from the overpriced stock. Short sales are also used to protect an investor's portfolio against a market downturn. By shorting stocks that the investor believes will fall sharply when the market as a whole falls, investors can help insulate the value of their portfolios against sudden market drops.


Short selling is also used to protect portfolios against erosion due to a broad market decline. Short sellers make money when stock prices fall. An investor can diversify a long portfolio by adding some short positions. The portfolio will then have positions that make money both when prices rise and when they fall. This reduces the volatility in the portfolio's returns and helps protect the value of the portfolio when prices are falling.


By shorting carefully selected stocks that are priced near their peak but that will fall sharply if the market falls, an investor can use the profits from the short sales to help offset losses in his long position to protect the value of his portfolio.


Short selling just like long buying is essential for proper functioning of the stock market. It provides essential liquidity which in turn leads to proper price discovery.
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Initial Pubic Offer (I.P.O)

Initial Pubic Offer (I.P.O)
Introduction


An initial public offering, or IPO, is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it's known as an IPO.


Companies fall into two broad categories: Private and Public.


A privately held company has fewer shareholders and its owners don't have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held.


It usually difficult to buy shares in a private company. One can go to the owners for investing, but they're not obligated to sell anyone anything. Public company, on the other hand, have sold at least a portion of itself to the public and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."


Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In the India, public companies report to the Securities and Exchange Board of India (SEBI). An investor can trade the stocks of a public compnay in the open market, like any other commodity. If one has the cash, he can invest.
Why Go Public?


Going public heps raising cash. Being publicly traded also opens many financial doors:


1. Because of the increased scrutiny, public companies can usually get better rates when they issue debt.


2. As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.


3. Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.


4. Being on a major stock exchange carries a lot of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn't easy to get listed.
The Underwriting Process


When a company wants to go public, the first thing it does is hire an investment bank. A company could theoretically sell its shares on its own, but realistically, an investment bank is required. Underwriting is the process of raising money by either debt or equity. You can think of underwriters as middlemen between companies and the investing public.


The company and the investment bank will discuss the amount of money a company will raise, the type of securities to be issued and all the details in the underwriting agreement. The deal can be structured in a variety of ways. For example, in a firm commitment, the underwriter guarantees that a certain amount will be raised by buying the entire offer and then reselling to the public. In a best efforts agreement, however, the underwriter sells securities for the company but doesn't guarantee the amount raised. Also, investment banks are hesitant to shoulder all the risk of an offering. Instead, they form a syndicate of underwriters. One underwriter leads the syndicate and the others sell a part of the issue.


Once all sides agree to a deal, the investment bank puts together a registration statement to be filed with the SEBI. This document contains information about the offering as well as company info such as financial statements, management background, any legal problems, where the money is to be used and insider holdings. The SEBI then requires a cooling off period, in which they investigate and make sure all material information has been disclosed. Once the SEBI approves the offering, a date (the effective date) is set when the stock will be offered to the public.


During the cooling off period the underwriter puts together what is known as the red herring. This is an initial prospectus containing all the information about the company except for the offer price and the effective date, which aren't known at that time. With the red herring in hand, the underwriter and company attempt to hype and build up interest for the issue. They go on a road show where the big institutional investors are courted.


As the effective date approaches, the underwriter and company sit down and decide on the price. It depends on the company, the success of the road show and, most importantly, current market conditions. Of course, it's in both parties' interest to get as much as possible.


Finally, the securities are sold on the stock market and the money is collected from investors.
No History


It's hard enough to analyze the stock of an established company. An IPO company is even trickier to analyze since there won't be a lot of historical information. The main source of data is the red herring, one must examine this document carefully. Look for the usual information, but also pay special attention to the management team and how they plan to use the funds generated from the IPO.
The Lock-Up Period


If one look at the charts following many IPOs, you'll notice that after a few months the stock takes a steep downturn. This is often because of the lock-up period.


When a company goes public, the underwriters make company officials and employees sign a lock-up agreement. Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The period can range anywhere from three to 24 months. Ninety days is the minimum period but the lock-up specified by the underwriters can last much longer. The problem is, when lockups expire all the insiders are permitted to sell their stock. The result is a rush of people trying to sell their stock to realize their profit. This excess supply can put severe downward pressure on the stock price.
Flipping


Flipping is reselling a hot IPO stock in the first few days to earn a quick profit. This isn't easy to do, and you'll be strongly discouraged by your brokerage. The reason behind this is that companies want long-term investors who hold their stock, not traders.


Of course, institutional investors flip stocks all the time and make big money
. The double standard exists and there is nothing we can do about it because they have the buying power. Because of flipping, it's a good rule not to buy shares of an IPO if you don't get in on the initial offering. Many IPOs that have big gains on the first day will come back to earth as the institutions take their profits.
Avoid the Hype


It's important to understand that underwriters are salesmen. The whole underwriting process is intentionally hyped up to get as much attention as possible. Since IPOs only happen once for each company, they are often presented as "once in a lifetime" opportunities. Of course, some IPOs soar high and keep soaring. But many end up selling below their offering prices within the year. Don't buy a stock only because it's an IPO - do it because it's a good investment.
Conclusion


1. An initial public offering (IPO) is the first sale of stock by a company to the public.


2. Broadly speaking, companies are either private or public. Going public means a company is switching from private ownership to public ownership.


3. Going public raises cash and provides many benefits for a company.


4. The process of underwriting involves raising money from investors by issuing new securities.


5. Companies hire investment banks to underwrite an IPO.


6. The road to an IPO consists mainly of putting together the formal documents for the SEBI and selling the issue to institutional clients.


7. An IPO company is difficult to analyze because there isn't a lot of historical info.


8. Lock-up periods prevent insiders from selling their shares for a certain period of time. The end of the lockup period can put strong downward pressure on a stock.


9. Road shows and red herrings are marketing events meant to get as much attention as possible. Don't get sucked in by the hype.
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Tuesday, October 6, 2009

INVESTMENT

The money one earns is partly spent and partly saved to meet the future needs. Rather than keeping the savings idle one can use them to earn more returns than he can generate by keeping them with him. This is called as investment.
One needs to invest to:


  • generate a specified sum of money for a specific goal in life


  • make a provision for an uncertain future

The most important reason for a person to invest is to beat inflation. Inflation is the rate at which the cost of living increases. The cost of living is what it costs to buy the goods and services you need to live. Inflation causes money to lose value because it will not buy the same amount of a good or a service in the future as it does now or did in the past. For example, if there was a 7% inflation rate for the next 10 years, a Rs. 100 purchase today would cost Rs. 197 in 10 years. Remember to look at an investment's 'real' rate of return, which is the return after inflation. The aim of investments should be to provide a return above the inflation rate to ensure that the investment does not decrease in value. For example, if the annual inflation rate is 7%, then the investment will need to earn more than 7% to ensure it increases in value.
The sooner one starts investing the better. By investing early you allow your investments more time to grow, whereby the concept of compounding (as we shall see later) increases your income, by accumulating the principal and the interest or dividend earned on it, year after year. The three rules for all investors should be:

  • Invest early


  • Invest regularly


  • Invest for long term and not short term

There are four main things you need to think about before you can decide how to invest your money:

  • Liquidity needs


  • Goals and Objectives


  • Time Horizon


  • Risk Profile


  • Before making any investment, one must ensure to:


  • Obtain written documents explaining the investment


  • Read and understand such documents


  • Verify the legitimacy of the investment


  • Find out the costs and benefits associated with the investment


  • Assess the risk-return profile of the investment


  • Know the liquidity and safety aspects of the investment


  • Ascertain if it is appropriate for your specific goals


  • Compare these details with other investment opportunities available


  • Deal only through an authorized intermediary


  • Seek all clarifications about the intermediary and the investment


  • Explore the options available to you if something were to go wrong, and then, if satisfied, make the investment.
One may invest in:

  • Physical assets like real estate, gold/jewellery, commodities etc. and/or


  • Financial assets such as fixed deposits with banks, small saving instruments with post offices, insurance/provident/pension fund etc. or securities market related instruments like shares, bonds, debentures etc.

Broadly speaking, savings bank account, money market/liquid funds and fixed deposits with banks may be considered as short-term financial investment options:
Savings Bank Account is often the first banking product people use, which offers low interest (3%-4% p.a.), making them only marginally better than fixed deposits.
Money Market or Liquid Funds are a specialized form of mutual funds that invest in extremely short-term fixed income instruments and thereby provide easy liquidity. Money market funds usually yield better returns than savings accounts, but lower than bank fixed deposits.
Fixed Deposits with Banks are also referred to as term deposits and minimum investment period for bank FDs is 30 days. Fixed Deposits with banks are for investors with low risk appetite, and may be considered for 6-12 months investment period as normally interest on less than 6 months bank FDs is likely to be lower than money market fund returns.
What are various Long-term financial options available for investment?
Post Office Savings Schemes, Public Provident Fund, Company Fixed Deposits, Bonds and Debentures, Mutual Funds etc.
Post Office Savings: Post Office Monthly Income Scheme is a low risk saving instrument, which can be availed through any post office. It provides an interest rate of 8% per annum, which is paid monthly. Minimum amount, which can be invested, is Rs. 1,000/- and additional investment in multiples of 1,000/-Maximum amount is Rs. 3, 00,000/- (if Single) or Rs. 6, 00,000/- (if held jointly) during a year. It has a maturity period of 6 years. A bonus of 10% is paid at the time of maturity. Premature withdrawal is permitted if deposit is more than one year old. A deduction of 5% is levied from the principal amount if withdrawn prematurely; the 10% bonus is also denied.
Public Provident Fund: A long term savings instrument with a maturity of 15 years and interest payable at 8% per annum compounded annually. Tax benefits can be availed for the amount invested and interest accrued is tax-free. A withdrawal is permissible every year from the seventh financial year of the date of opening of the account and the amount of withdrawal will be limited to 50% of the balance at credit at the end of the 4th year immediately preceding the year in which the amount is withdrawn or at the end of the preceding year whichever is lower the amount of loan if any.
Company Fixed Deposits: These are short-term (six months) to medium-term (three to five years) borrowings by companies at a fixed rate of interest which is payable monthly, quarterly, semi10 annually or annually. They can also be cumulative fixed deposits where the entire principal along with the interest is paid at the end of the loan period. The rate of interest varies between 6-9% per annum for company FDs. The interest received is after deduction of taxes.
Bonds: It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell bonds. A bond is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the Maturity Date.
Mutual Funds: These are funds operated by an investment company which raises money from the public and invests in a group of assets (shares, debentures etc.), in accordance with a stated set of objectives


Growth Investing- The approach to investing which aims to invest in fast-growing companies which are rapidly increasing their turnover and profits, and where the expectation is to make money from a rising share price (rather than income).
Value Investing- The strategy of selecting stocks that trade for less than their intrinsic value is called as Value Investing. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, causing stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated
Bull- An investor who expects the market, sector or security to rise in price.
Bear- An investor who is pessimistic about the prospects for a market, a sector or a particular security
Bid- The highest price at which a buyer is willing to buy a particular security. The buyer may be a market maker or an ordinary investor
Bull Market- A financial market of a certain group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used in respect to the stock market, but really can be applied to anything that is traded, such as bonds, currencies, commodities, etc.
Bear Market- A financial market of a certain group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used in respect to the stock market, but really can be applied to anything that is traded, such as bonds, currencies, commodities, etc.
Blue Chip- A blue chip is a large and well established company, or its shares. The key criterion is that these are large companies, primarily in terms of market capitalisation. The term also implies financial strength and stability.
Broker- A broker is a party that mediates between a buyer and a seller.
Spread- The amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it.
Market Capitalization- It is measure of a company's total value. It is estimated by determining the cost of buying an entire business in its current state. Often referred to as "market cap", it is the total value of all outstanding shares. It is calculated by multiplying the number of shares outstanding by the current market price of one share.
Dividends- Distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
BY
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