Security analysis

Explanation:
Unit 1 Investment is elucidated and defined
as an addition to the stockpile of 
Investment : physical capital such as:

Machinery
An investment is an asset or item accrued with the goal of
generating income or recognition.  Buildings
Roads etc.,
Investment in terms of economic i.e. anything that sums up to the
In an economic outlook, an investment is the purchase of goods future productive ability of the
economy and changes in the
that are not consumed today but are used in the future to catalogue (or the stock of finished
generate wealth.  commodities) of a manufacturer.
Note that ‘investment
Investment in terms of financial commodities’ (such as machines)
In finance, an investment is a financial asset bought with the are also part of the final commodities
– they are not intermediate
idea that the asset will provide income further or will later be commodities like raw materials.
sold at a higher cost price for a profit. Machines manufactured in an
economy in a given year are not
‘used up’ to produce other
commodities but yield their services
Characterises of investment
over a number of years.
1. Return
Risk Factor
∑ All investments are characterized by the expectation of a Risk is an inherent characteristic of
return. In fact, investments are made every investment. Risk refers to loss
of principal amount, delay or non-
with the primary objective of deriving a return. payment of capital or interest,
variability of return etc. Every
∑ The return may be received in the form of yield plus capital investment differs in terms of risk
appreciation. associated with them. However, less
risky investments are the most
∑ The difference between the sale price and the purchase price preferred ones by investors.
is capital appreciation. Return
Return refers to the income expected
∑ The dividend or interest received from the investment is from investment done. It is the key
theyield. objective for doing investment by
investors. Investment provides
∑ The return from an investment depends upon the nature of benefits to peoples either in the form
the investment, the maturity period of regular yields or through capital
appreciation.It refers to the surety of
and a host of other factors. return or protection of principal
amount without any loss. Safety is an
Return = Capital Gain + Yield (interest, dividend etc.)
important feature of every
2. Risk investment tool that is analyzed
before allocating any fund in it. 
Risk refers to the loss of principal amount of an investment. It
is one of the major characteristics of
an investment.
 Safe
The risk depends on the following factors:
∑ The investment maturity period is longer; in this case, Income Stability
Income stability refers to the
investor will take larger risk.
regularity of income without any
∑ Government or Semi Government bodies are issuing fluctuations. Every investor wants to
invest in such assets which provide
securities which have less risk.
return consistently. 
∑ In the case of the debt instrument or fixed deposit, the risk of
above investment is less due to Liquidity
Liquidity refers to how quickly an
their secured and fixed interest payable on them. For instance investment can be sold or converted
debentures. into cash. It simply means easiness
with which investment can be sold in
∑ In the case of ownership instrument like equity or preference the market
shares, the risk is more due to
their unsecured nature and variability of their return and
ownership character.
The risk of degree of variability of returns is more in the case
of ownership capital compare to
debt capital.
The tax provisions would influence the return of risk.
3.Safety:
Safety refers to the protection of investor principal amount and
expected rate of return.
Safety is also one of the essential and crucial elements of
investment. Investor prefers safety
about his capital. Capital is the certainty of return without loss
of money or it will take time to
retain it. If investor prefers less risk securities, he chooses
Government bonds. In the case,
investor prefers high rate of return investor will choose private
Securities and Safety of these
securities is low.
4.Liquidity:
Liquidity refers to an investment ready to convert into cash
position. In other words, it is available
immediately in cash form. Liquidity means that investment is
easily realizable, saleable or
marketable. When the liquidity is high, then the return may be
low. For example, UTI units. An
investor generally prefers liquidity for his investments, safety Investment objectives are related to
what the client wants to achieve with
of funds through a minimum risk and the investments portfolios. Generally,
the objectives are concerned with
maximization of return from an investment. risk and return, which are
interdependent, as the risk that you
Objectives of investment are willing to take, will determine your
returns.
There are four types of investment objectives:
For example, if an elderly widow with
little income, wants to invest her life’s
savings. She will primarily be
1. Safety of Capital concerned with safety and income.
Whereas, a young single lawyer, with
While there is no such thing as an absolutely safe and secure a healthy income and relatively few
investment or one that is completely risk free. If your primary financial obligations will be more
objective is safety, you will look for investments that have a interested in pursuing growth through
her investments.
minimal risk level. But then, the safest investments tend to have
the lowest rates of return and may not even keep up with
inflation. Safe investments include government issued
securities, money market instruments and securities guaranteed
by banks.

2. Income
If your primary objective is income, you will have to sacrifice a
degree of safety in order to increase your returns. Even the most
conservative investors like to have some level of income in
their portfolios just to keep up with the rate of inflation. Eg:
investing in stock markets earns a higher return but with higher
risk.
3. Growth
If you are growth oriented, you would normally be less
concerned with safety, and do not totally depend on income
from investment funds. These types of investments in growth
instruments are more likely to fluctuate in value and might have
a greater risk of loss.
Higher risk investments may have greater long term rewards,
but in the meantime you will probably see some ups and downs.
It is important to be prepared and be aware of this in advance.
Eg: Investments in shares of publicly traded companies are
usually associated with growth and are generally considered
high risk investments.
4. Tax Savings
Income generated by common shareholders is considered
capital gains and is taxed differently. Taxes on capital gains are
significantly lower than taxes on interest income or ordinary
income like salary. If your primary objective is tax-saving,
registered plans such as national pension schemes and tax free
savings accounts are the best bet. However, there are also
effective ways to earn good returns along with saving taxes like
investing in tax saving mutual funds or life insurance policy

An alternative investment is a financial asset that

does not fall into one of the conventional
investment categories. Conventional categories
include stocks, bonds, and cash. Alternative
investments can include private equity or venture
capital, hedge funds, managed futures, art and
antiques, commodities, and derivatives contracts.
Real estate is also often classified as an
alternative investment.
Concept of Risk:
A person making an investment expects to get some returns
from the investment in the future. However, as future is
uncertain, the future expected returns too are uncertain. It is the
uncertainty associated with the returns from an investment that
introduces a risk into a project. The expected return is the
uncertain future return that a firm expects to get from its
project. The realized return, on the contrary, is the certain return
that a firm has actually earned.

The realized return from the project may not correspond to the
expected return. This possibility of variation of the actual return
from the expected return is termed as risk. Risk is the
variability in the expected return from a project. In other words,
it is the degree of deviation from expected return. Risk is
associated with the possibility that realized returns will be less
than the returns that were expected. So, when realizations
correspond to expectations exactly, there would be no risk.

i. Elements of Risk:
Various components cause the variability in expected returns,
which are known as elements of risk. There are broadly two
groups of elements classified as systematic risk and
unsystematic risk.

Systematic Risk:
Business organizations are part of society that is dynamic.
Various changes occur in a society like economic, political and
social systems that have influence on the performance of
companies and thereby on their expected returns. These
changes affect all organizations to varying degrees. Hence the
impact of these changes is system-wide and the portion of total
variability in returns caused by such across the board factors is
referred to as systematic risk. These risks are further subdivided
into interest rate risk, market risk, and purchasing power risk.

Unsystematic Risk:
The returns of a company may vary due to certain factors that
affect only that company. Examples of such factors are raw
material scarcity, labour strike, management inefficiency, etc.
When the variability in returns occurs due to such firm-specific
factors it is known as unsystematic risk. This risk is unique or
peculiar to a specific organization and affects it in addition to
the systematic risk. These risks are subdivided into business
risk and financial risk.

ii. Measurement of Risk:

Two approaches are followed in measurement of risk:
(i) Mean-variance approach, and

(ii) Correlation or regression approach.

Mean-variance approach is used to measure the total risk, i.e.

sum of systematic and unsystematic risks. Under this approach
the variance and standard deviation measure the extent of
variability of possible returns from the expected return and is
calculated as:

Where, Xi = Possible return,

P = Probability of return, and

n = Number of possible returns.

Correlation or regression method is used to measure the
systematic risk. Systematic risk is expressed by β and is
calculated by the following formula:

Where, rim = Correlation coefficient between the returns of

stock
i and the return of the market index,
σm = Standard deviation of returns of the market index, and
σi = Standard deviation of returns of stock i.
Using regression method we may measure the systematic risk.

Concept of Return:
Return can be defined as the actual income from a project as
well as appreciation in the value of capital. Thus there are two
components in return—the basic component or the periodic
cash flows from the investment, either in the form of interest or
dividends; and the change in the price of the asset, commonly
called as the capital gain or loss.

The term yield is often used in connection to return, which

refers to the income component in relation to some price for the
asset. The total return of an asset for the holding period relates
to all the cash flows received by an investor during any
designated time period to the amount of money invested in the
asset.

It is measured as:
Total Return = Cash payments received + Price change in assets
over the period /Purchase price of the asset. In connection with
return we use two terms—realized return and expected or
predicted return. Realized return is the return that was earned
by the firm, so it is historic. Expected or predicted return is the
return the firm anticipates to earn from an asset over some
future period.

In the financial markets, there is a flow of funds from one

group of parties (funds-surplus units) known as investors
to another group (funds-deficit units) which require funds.
However, often these groups do not have direct link. The
link is provided by market intermediaries such as brokers,
mutual funds, leasing and finance companies, etc. In all,
there is a very large number of players and participants in the financial market. These
can be grouped as follows :

 The individuals: These are net savers and purchase the securities issued by
corporates. Individuals provide funds by subscribing to these security or by making
other investments.
 The Firms or corporates: The corporates are net borrowers. They require funds for
different projects from time to time. They offer different types of securities to suit the
risk preferences of investors’ Sometimes, the corporates invest excess funds, as
individuals do. The funds raised by issue of securities are invested in real assets like
plant and machinery. The income generated by these real assets is distributed as
interest or dividends to the investors who own the securities.
 Government: Government may borrow funds to take care of the budget deficit or as
a measure of controlling the liquidity, etc. Government may require funds for long
terms (which are raised by issue of Government loans) or for short-terms (for
maintaining liquidity) in the money market. Government makes initial investments in
public sector enterprises by subscribing to the shares, however, these investments
(shares) may be sold to public through the process of disinvestments.
 Regulators: Financial system is regulated by different government agencies. The
relationships among other participants, the trading mechanism and the overall flow
of funds are managed, supervised and controlled by these statutory agencies. In
India, two basic agencies regulating the financial market are the   Reserve Bank of
India (RBI ) and Securities and Exchange Board of India (SEBI). Reserve Bank of India,
being the Central Bank, has the primary responsibility of maintaining liquidity in the
money market. It undertakes the sale and purchase of T-Bills on behalf of the
Government of India. SEBI has a primary responsibility of regulating and supervising
the capital market. It has issued a number of Guidelines and Rules for the control and
supervision of capital market and investors’ protection. Besides, there is an array of
legislation’s and government departments also to regulate the operations in the
financial system.
 Market Intermediaries: There are a number of market intermediaries known as
financial intermediaries or merchant bankers, operating in financial system. These are
also known as investment managers or investment bankers. The objective of these
intermediaries is to smoothen the process of investment and to establish a link
between the investors and the users of funds. Corporations and Governments do not
market their securities directly to the investors. Instead, they hire the services of the
market intermediaries to represent them to the investors. Investors, particularly small
investors, find it difficult to make direct investment. A small investor desiring to invest
may not find a willing and desirable borrower. He may not be able to diversify across
borrowers to reduce risk. He may not be equipped to assess and monitor the credit
risk of borrowers. Market intermediaries help investors to select investments by
providing investment consultancy, market analysis and credit rating of investment
instruments. In order to operate in secondary market, the investors have to transact
through share brokers. Mutual funds and investment companies pool the
funds(savings) of investors and invest the corpus in different investment alternatives.
Some of the market intermediaries are:
 Lead Managers
  Bankers to the Issue
 Registrar and Share Transfer Agents
 Depositories
 Clearing Corporations
 Share brokers
 Credit Rating Agencies
 Underwriters
 Custodians
 Portfolio Managers
 Mutual Funds
 Investment Companies

These market intermediaries provide different types of financial services to the

investors. They provide expertise to the securities issuers. They are constantly
operating in the financial market. Small investors in particular and other investors
too, rely on them. It is in their (market intermediaries) own interest to behave
rationally, maintain integrity and to protect and maintain reputation, otherwise the
investors would not be trusting them next time. In principle, these intermediaries
bring efficiency to corporate fund raising by developing expertise in pricing new
issues and marketing them to the investors.

The following are the various methods through which floating of new issues can be done.
(i) Offer through Prospectus
The most commonly used method for raising funds in primary market is offer through
prospectus. It involves inviting the subscriptions from public by issue of prospectus. A
prospectus is published as advertisements in newspapers, magazines, etc. It provides such
information as the purpose for which the fund is being raised, company’s background and
future prospects, its past financial performance, etc. Such information helps the public and
the investors to know about the company as well as the potential risk and the earnings
involved. Such issues need to be listed on one of the stock exchanges and should be in
accordance with the guidelines and rules listed under the Companies Act and SEBI
disclosure.
(ii) Offer through Sale
As against offer through prospectus, under the offer through sale method, the company does
not issue securities directly to the public rather they are issued through intermediaries such as
brokers, issuing houses, etc. That is, under offer through sale, securities are issued in two
steps, first the company sells its securities to the intermediaries at the face value and later the
intermediaries resell the securities to the investing public at a higher price than the face value
to earn profit.
(iii) Private Placement
Under this method, the securities are sold only to some selected individuals and big
institutional investors rather than to the public. The companies either allot the securities
themselves or they sell the securities to intermediaries who in turn sell them to selected
clients. This method saves the company from various mandatory or non-mandatory expenses
such as cost of manager fees, commission, underwriter fees, etc. Thus, the companies which
cannot afford the huge expenses related to public issue often go for private placement.
(iv) Rights Issue
Under the Companies Act 1956, it is the right of the existing share holders of a company to
subscribe to the new shares issued by it. The existing share holders are offered subscription of
new shares of the company in proportion to the number of shares possessed by them.
(v) e-IPOs
It is system of issuing securities through online system. If a company decides to offer its
securities through an online system it is required to gets into an agreement with the stock
exchange. This is called Initial Public Offer (IPO). Company appoints brokers for accepting
applications and placing orders. A company can apply to get listed in any stock market except
from the one through which it has already offered securities. Herein, the lead manager looks
upon the various activities and coordinates them.