BASIC,S:, OE .

tNVESifvlENJ,-,t"i
" . ' , ..·. .,. . . . ., .. ,.. ' ·.· · . · ... ,

After reading this chapter you will be able to

Understand the concept (& features) of investment
Differentiate,between investment and speculation ·
Know var_ious types of investment
Understand direct and indirect approach of investing
Identify the various components of investment environment
Learn the process of making investment decision
Know the two modes of making investment

Investment is the backbone of any economy. Savings of an economy must be

channelized into productive investment to generate income. An individual
may keep his savings in a bank account or invest in financial and/or real
assets. In India savings bank.account does not provide high interest income.
Therefore the investors, who wish to earn higher returns, have to explore
other avenues for investment such as equity shares, bonds, mutual funds,
gold, property, derivatives, etc. Hence, the need for financial literacy on the
part of individual investors. This chapter provides an overview of the basic
concept of investment, types of investment and approaches of investing.
Investment refers to commitment of funds in expectation of future gains or
benefits. Every investment requires that current consumption isforegone so
that in future some benefits or returns are generated Different investment
products have different level.s of risk and return and hence their estimation
and analysis is an important aspect of investment decision making. An in-
vestor should make his investment decision depending upon his risk-return
preferences and analysis of risk-return features of the investment options.
1
 Para 1.2
Para 1.1 BASICS OF INVESTMENT 2 FEATURES OF INVESTMENT
3
This chapter provides a clear understanding of the v~rious . investrne,
. 1/ An individual investor invests in financial assets (equity shares, bo~d, etc)
avenues available, modes of investment an d processoI ta k mgan mvestnien 1 and commodity assets (e.g. gold, silver etc.). Now-a-days real estate mve~t-
decision. ment has also become an important part of individual investor's portfolio.
Real estate is investment in tangible house/ co~ercial properties_ t~ get
1.1 INVESTMENT income in the form of rent and/ or capital gain due to price apprec1at1on.
The term investment implies employment of current funds to earn corn. The subject matter of this book - "Investing in stock markets" is_f~an-
mensurate return in future. It implies sacrifice of cur~en! consumption cial investment. Financial assets are primarily in the form of secw1.t1es. A
for expected income in future bec~use the amo~nt which is not spent on security as defined under the Securities Contacts (Regulation) Act, 1956
current consumption is saved and mvested. An m~esto~ f?re~oes current includes- ', I
consumption and invests his savings in investments ill a_ntJ.c1patlon of higher (z) shares, scrips, stocks, bonds, debentures, debenture stock or other
future consumption. It is important to note ~ere that mvestment_does not marketable securities of a like nature in 'o r of any incorporated
always guarantee higher future returns: At t~es losses _a re also m~urred. company or other body corporate;
Hence the environment of investment 1s qwte uncertam. We are m fact
facing a VUCA (Volatile, Uncertain, Complex, Ambiguous) environment in ( iz) derivative;
the context of investments. •·i 1, , ., (iii) units or any other instrument issued by any collective investment
"In I986, Microsoft Corporation first offered its stocks to public and ~thin scheme to the investors in such schemes;
JO years, the stock's value had increased over 500096. In the same year, (iv) security recejpt as defined in clause (zg) of section 2 of theSecuriti-
Worlds of Wonder also offered its stock to public but ten years later the sation and Reconstruction of.Financial Assets and Enforcement of
company was defunct." Security Interest Act, 2002 (54 of 2002);
The word 'investment' connotes different meanings to different people. ( v) units or any other such instrument issued to the investors under any
To a layman it may mean purchase of shares, bonds or others financial mutual fund scheme;
instruments. To an economist, it implies purchase of fixed productive
assets (Capital assets) such as plant and machinery. To a businessman as (vz) any certificate or instrument (by whatever name called), issued to an
well investment refers to purchase of fixed assets such as land, building, inve1ltor by any issuer being a special purpose distinct entity which
plant, machinery etc. · possesses any debt or receivable, including mortgage debt, assigned
to such entity, and acknowledging beneficial interest of such investor
Irrespective of its context, the word investment requires commitment of in such debt or receivable including mortgage debt, as the case may
funds in some assets at present so as to be able to generate higher income be;
in future. ·
(viz) Government securities;
1.1.1 Financial Investment vs. Real Investment ( viii) such other instruments as may be declared by the Central Govern-
Depending upon the type of asset, all the investments can be classified as ment to be securities; and
financial or real investment. (ix) rights or interests in securities.
• Financial investment is investment of funds in financial assets. Finan- Thi~ b~ok primarily deals with investment in stocks, mutual funds and
c_ial as~ets are claims over some real/ physical assets. The examples of denvative mstruments.
fmanc1al assets are shares, bonds, mutual fund units etc. The returp.
of financial investment is in the form of interest dividend and/or 1.2 FEATURES (OR FACTORS AFFECTING) OF INVESTMENT
appreciation in value. ' Individual invest~rs make investment keeping in mind certain objectives.
• Real Investment (or Economic Investment) is an investment where After all they forego current consumption in order to avail of higher income
funds are invested in real or tangible assets. Real assets are those long and hence consumption in future. The ultimate objective of investment is
term (or fixed) assets which are used in the production process. The to minimize risk and maximize return. However due to the fact that risk
ext·amples of real assets are plant, machinery, equipments, building and return move hand-in-hand, it is not always possible to get very high
e c. return at very low risk. So risk-return trade-off becomes the primary fac-
 Para 1.2
Para 1.2
BASICS OF INVESTMENT 4 5
FEATURES OF INVESTMENT

. d"vidual Other factors which must b tress sale of property). For being marketable it is important that there is a
tor affectin~ inves~mentakinb_y ax:iy U:t:Oent ~ay be tax benefits; safety an~ ready market for the security, where it can be bought or sold.
kept into mmd while m g mve ·
capital, liquidity, etc. hil . akin . s. Tax Benefits
The following is the list of factors to be considered w em g mvestment: Availing tax advantage is another important objective of inves~ment in ~-
nancial assets in India. Section SOC of Income Tax Act, 1961 proVI~es c~rtam
1. Return . f investment alternatives ( e.g. PPF, NSC, Mutual Funds, ELSS-Eqwty Linked
d t rovide certam rate o return over a period
Every investment i~ exhpe~te mo:generated by investment expressed as a Savings Schemes etc.) which qualify for deduction from taxable income
· future Return 1s t e mco
10 if b upto tl,50,000. Assessment of tax benefits is ir?portant which _undertaking
· f th ost of investment. For example a person uys an eq.
Percentage e di "d d t th investment because it affects the actual effective return from mvestment.
O C
. share at a cost o f"'lOOandgetstl0as
wty , VI en a een o f t h eyear,
d
For example : Rural Electrification Corporation (REC) has come out with
uld be _!Q_x 100 = 1096. Here we assume no change
hi s return on sh are Wo 100 tax-free bonds at a coupon rate of 8.1296 p.a. for 10 years. It implies that
interest income from these bonds will be exempt from tax. If an individ-
in share rice at the end of the year. If the share price also increases to ual is in 3096 tax bracket then the effective pre-tax interest rate would be
p 10+(105-100) _ 1596
nos then his return would be ---'---~xlO0 - ~=11.696
100
1-0.30
Different investment instruments have different returns depending on their
level of risk. For example Treasury bills (T-bills) and govt. securities carry 6. Hedge against Inflation
.
low return as compared to equity shares and derivatives. A good investment should provide hedge against the purchasing power
, risk or inflation. The investor must ensure that the return generated by
.
2.Risk .
his investment is higher than the prevailing inflation rate. Then only he is
Risk is defined as variability in expected return. If return from an invest- benefited by making investment, otherwise he is worse off. For example, if
ment is certain, fixed and 10096 sure then there is no risk attached to it. the prevailing inflation rate is 896, the investor should look for investment
Generally, Government securities are considered to be risk-free. However options which provide more than 896 return otherwise his real worth of
instances of sovereign debt crisis (in which European Countries government investment will go down. Inflation erodes purchasing power of money and
failed to repay the public debt) cast doubt on government securities being hence hedge against inflation is an important consideration in investment.
risk free. Risk can be calculated as standard deviation of the expected re-
turns from an investment. The objective of any investment is to minimize Generally, equity shares are considered to be a good hedge against inflation
risk. Different individuals have different risk taking abilities. For example because of their varying return. It is expected that in times of inflation, equity
young entrepreneurs may take higher risk than old and retired people. shares generate higher return. On the other hand fixed income securities
Therefore investment must be done keeping in mind the risk bearing ability like bonds are not a good hedge against inflation due to the fact that their
of the investors. interest rate are fixed and do not increase in times of rising inflation.
3. Liquidity 7. Safety of Capital
It is the "moneyness" of investment ie. the ease with which investment can Safety of capital should come first. The investor must secure his principal
amount which he invests. That is he should not be impressed by very high
be co_nvert~d ~to cash with no or little risk of loss of capital. Some asse_ts
rate of return on an investment if the amount invested is not safe. For this
are ~1~Y liqwd (e.g. equity shares, mutual fund units etc.) and some are
less liqwd ( e. g. bonds, debentures). It is important to mention here that th<r credit rating agencies play an important role in providing bond-ratings'.
Generally bonds which have lower than AAA ratings are considered to be
develop_me_n~ and efficiency of financial markets depends to a great extent
on the liqwdity of the securities traded in it. not so safe. For example many NBFC come out with fixed deposit schemes
4. Marketability
at an attractive interest rate but safety of investment is less.

: related aspect is marketability ie. the e~se with which an asset can be
ought or sold. An asset may be highly marketable but less liquid (e.g. dis-

L
 Para 1.3 BASICS OF INVESTMENT
7 INVESTMENT ENVIRONMENT Para 1.4
Don'ts of Good investing
1. Don't try to predict market movement Basis of Difference I Investment Speculation
Speculators also borrow
2. Don't expect quick returns 4. I Funds
/ ~wn funds are used for
funds and/ or do margin
mvestment
3. Avoid chasing hot tips trading
II
4. Don't blindly follow the crowd S. I Income Dividend, Interest etc. Change in price of asset
Fundamental factors
5. Over or inadequate diversification
.. Source of Informa- of the company are Subjective analysis, inside
,, 6· I tion information etc.
6. Use of borrowed money to make more money analysed
·i
I 7. Don '. t fall in love with poor investn;zents TABLE I.I: INVESTMENT VS. SPECULATION
_J , '

1.3 SPECULATION 1.3.2 Gambling

Speculation is investment in an asset that o~~rs a potenti~y large return Gambling is a game undertaken for someone's excitement e.g. horse race,
. but is also very risky; a reasonable probability t_hat the rnv_estment Will card games, lotteries. Here although the winner makes big money but
produce a loss. It can be defin_ed as t~e assump_t10n of cons1derabl~ ri~k that cannot be classified as return because it is not consistent or regular.
in obtaining commensurate gam. Considerable nsk means that the nsk is Gambling is a zero sum game - someone's loss is other party's gain. It is
sufficient to affect the decision. Commensurate gain means a higher risk purely by chance that one party wins over the other. Therefore gambling
premium. Speculative assets are high risk-high ret1;1111 assets and hence is highly uncertain and may involve complete loss of funds put in it.

'
should be invested in with caution. Generally large rnvestors hold specu-
lative assets so as to make quick gains. 1.4 INVESTMENT ENVIRONMENT
Stock market is identified with two types of speculators - bulls and bears The investment environment implies various types of securities which are
Bull speculators expect increase in stock prices while bear speculators ex- available for investment and the entire mechanism or process through
pect decline in prices. It must be noted here that speculation, per se, is not which these securities can be bought or sold.
bad. Rather it is essential for smooth funetioning of stock market and to The investment environment comprises of three main aspects- securities
maintain price continuity and liquidity. However excessive speculation is (also referred as financial assets or financial instruments); securities mar-
bad as it takes the prices away from their true fundamental values. There- kets (i.e. financial market) and intermediaries in securities markets. The
fore SEBI keeps a check on excessive speculation in Indian stock market, investment environment now-a-days is characterized as VUCA (Volatile,
through various rules and guidelines under SEBI Act, 1992. · ::. Uncertain, Complex, Ambiguous).
It must be noted here that· the same asset can ,be held by an investor for i. Securities :
investment and by t~e o,t~er for speculation. 'F or example shares of RIL, An investor can invest in a variety of securities such as equity shares,
if held by a small investor for long term amounts to investment but if it bonds, debentures, derivatives, mutual funds, exchange traded funds
is held by an FII for making quick return over short run then it implies etc. One may also invest in commodities and bullions (such as gold
speculation. and other precious metals). Even currency derivatives are also getting
popular as an investment avenue these days._These securities may
1.3.1 Investmen,t vs. Speculation . be transferred from one owner to the other without much difficulty.
Investment and speculation can be distinguished on the following grounds ii. Securities Market:
' --,
Basis of Difference Security market brings together buyer and seller of securities and
Investment Speculation provides operational mechanism to facilitate the exchange of securi-
I. I Time horizon Long generally exceed- Short may be as short , ties. An efficient and developed security market is a prerequisite for
ing one year intra-day increased investment in securities. There are many types in which
2. I Risk Low to Moderate Very high securities market can be classifjed.
3. I Return (expected) Low to moderate and
consistent Very high and inconsistent
 BASICS OF INVESTMENT Para 1.5
Para 1.4 TYPES OF INVESTMENT
9
quately regulated by regulatory bodies such as SEBI (Securities and
Exchange Board of India), RBI (Reserve Bank of India), Department
of Company Affairs, Ministry of Finance etc. The multiplicity of
regulatory agencies sometimes proves detrimental to the growth
On the basis .of iu:ne'of5'\fti and efficient regulation of securities market. Hence the re is a move
secutjti~ c. "s ' i,t ,,
towards reducing the number of regulatory bodies in India. On 28'"
September, 2015, Forwards Markets Commission has been merged
'.:capiti!} ~. with SEBI.
' Maj"k!!t+,r,
·~ 1.5 TYPES OF INVESTMENT (OR SECURITIES)
FIGURE 1.1: TYPES OF SECURITIES MARKET Various types of securities or Investment option can b e classified into the
On the basis of Time, securities market is classified as: following categories on the basis of their peculiar features as well as risk
return relationships:
(a) Capital market is the market for long term ~anci~l investment
and instruments (more than one year). It pnmarily deals With a. Equity shares - "investment in stock markets": Equity share s are also
known as 'Common stocks' in western economies. An e quity share
equity shares, long term bond~ and debentures. In ~dia, it is
further classified into the followmg two segments- Eqwty Market represents an ownership claim in a company. The owner of the equity
share is termed as equity shareholder in the company and e njoys all
and Wholesale Debt Market. voting rights in corporate matters. Equity shareholders get future
( b) Money market deals with short term securities (one year or less). benefits in the form of dividends (i.e. the amount of profit distribute d
It deals with Treasury bills, short term debts such as commercial as dividends) and in the form of price appreciation (or capital gains).
paper, certificates of deposits etc. However it is not obligatory on the part of the company to declare
On the basis of nature of securities, a security market can be further dividends every year and the amount of dividends, if any, may also
classified as: vary from year to year. Hence equity shares are also refe rred to as
'variable income securities' and do not promise fixed return. Due to
(a) Primary market is the market where new securities are issued variability in returns, equity shares are highly risky securities. They
for the first time. IPO is a tool of primary market. may generate a very high return or very high loss during the invest-
( b) Secondary market which provides the platform where existing ment horizon. Worldwide equity shares are expected to generate
(or second hand) securities are bought or sold. Shares issued in higher returns (as they have higher risk) over long term.
!PO are traded in secondary market. Equity shares are offered to general public for the first time through
A well functioning primary market is essential for the growth of a public offer. There are two types of public offer:
investments in an economy. At the same time, a transparent and ef- ( z) IPO (Initial Public Offering): IPO is the process through which
ficient secondary market that ensures speedy transfer of ownership a company goes public. IPO is the sale of equity shares by a
of securities, is a prerequisite for investment in a particular security. company to general public for the first time. It can be a public
For example in India, secondary market for bonds is not properly issue of shares· by a new company trying to raise capital or an
developed and hence growth in bond market in India is lagging be- old private company which wants to be listed on stock exchange
hind as compared to growth in other countries bond markets. and become public company. IPO is a very lucrative opportunity
Every security is characterized by market intermediaries who are for investment as shares bought through IPO, if held for long
positioned between the buyer and seller of securities. Stock exchange, term, have potential to yield huge profits. E.g. Burger King has
its brokers and sub-brokers act as market intermediaries in secondary come. up with anIPO in the month of December 2020.
m arket. An investor can subscribe to an IPO by filling the application
iii. Regulation of securities Market: form and paying the initial application money for the numbe r
of shares he wants to buy. An IPO is open only for a limite d
Th e investment environment and hence securities market is well number of days. Once the IPO closes and the shares are listed
regulated. Securities market is not a laissez-faire market but ade-
r- ...........----

Para 1.5
BASICS OF INVESTMENT ,, TYPES OF INVESTMENT
Para 1.5
11
on the stock exchange for trading, buyers can easily buy or Sej p.a. interest on the amount invested. This interest i_ncome is taxa ~l e
these shares anytime. also except for the tax-saving deposit schemes which provide relief
(ii) FPO (Follow-on Public Offering): FPO it thbe proce:s of issuing up to~ 1,50,000 und er section SOC of Income Tax Act, 1961. Th e pos t
additional or new equity shares to pub c y ai:i a eady listed tax returns on these deposit s are usually not adequate to m~rease
is brought by a company which has alread the value of investment because inflation is high er than th eir post
company. S0 , FPO O · · ii bl Y
crone through the IPO process. An FP 1s ava a e to new as tax returns.
~veil as existing shareholders of the company. [E.g. Faceboo[ e. Government schemes: Government launches various_types of schem~s
announced its FPO in December 2013 to raise money for its from time to time with an objective of mculcatmg savmg ha bit
working capital needs.] amongst citizens and for this purpose various t~x benefit s are also
An investor can either buy equity shares in the p1imarr market attached with these investment schemes. Followmg are th e popula r
through an IPO/FPO or in the sec?ndary market, te., stock government schemes:
exchange where the shares are contmuously traded. (i) National Savings Certi~i~ate ('."SC): NSC is a n _Indi an govern-
b. Bonds and debentures: Bonds and debentures are fixed incorne ment savings bond certificate issued by post offices. Currently,
NSC Vill (8.596, 5 years) and NSC IX (8.896, IO years) a re being
securities. A bond is an IOU (I Owe You) of the borrower. It arises
out of a lending-borrowing contract wherein, the bor:rower (or the offered. These are transferable once in their time horizon. One
issuer of the bond) promises to pay a f1Xed amount of mterest to the certificate costs t 100 but there is no upper limit on amount
]ender (or the bond holder) periodically and repays the loan either of investment. Investment amount qualifies for rebate under
periodically or at maturity. Most of the bonds _and debentures are section BOC of Income Tax Act.
redeemed at maturity only and they carry a fixed coupon rate or ( ii) Public Provident Fund(PPF): The Public Provident Fund Scheme,
fixed rate of interest. Bonds may be corporate bonds or government 1968 is one of the most popular Jong-term, tax-free investment
bonds, short term bonds or long term bonds, secured bonds or un- scheme of Ministry of Finance. It acts as a kind of compulsory
secured bonds, etc. Bonds and debentures may also be convertible , saving and helps in developing saving discipline.It has a minim um
or non-convertible. Since bonds and debentures carry a fixed rate of investment limit of~ 500 and a maximum limit oft 1,50,000
interest, their future benefits are known in advance, therefore they per armum. Investors get an interest rate of a round 796 p.a. on
have relatively lower risk than equity shares. At the same time they a compounding basis. It has a maturity period of 15 years. PPF
generate relatively lower return. Some bonds also offer tax exemption account can be opened throughout the year with bank or post
up to a certain amount of investment depending upon notification by office. PPF is an Exempt, Exempt, Exempt scheme, i.e., periodic
th e government. E.g. NABARD (National Bank for Agricultural and deposits provide tax deduction while no tax is levied on interest
Rural Development), REC (Rural Electrification Corporation) and income and withdrawals on maturity.
NHAI (National Highway Authority of India) bonds, RBI tax relief No withdrawals are allowed till first 6 years. From 7'" year
bonds. onwards, a person can withdraw amount (not more than 5096
c. Treasury Bills: Treasury bills are the securities issued by Central of the balance) every year. PPF also provides a Joan facility
Government in the context of a lending- borrowing contract. An wherein a person can take a loan of up to 2596 of the account
mvestor 111 Treasury bills actually lends money to the Central balance available at the end of first financial year. This facility
Government. This type of security carries minimum (or negligible) is available from third year onwards.
nsk ?f non-payment of the amount as promised. Hence the default (iii) Post office schemes: Indian Post Offices offer tax saving deposit
nsk 111 case of Treasury bills is negligible. These bills are issued at schemes for different maturity periods and investment peri-
discount and redeemed at par and hence the rate of return is known odicity. E.g.: Monthly Deposits, Saving Deposit, Time Deposit,
wi_th certainty in the very beginning of the investment. Because of Recurring Deposit, etc.
this feature, Treasury bills are also referred to and used as "Risk free (iv) Infrastructure bonds: Government allows its undertakings a nd
asset" in research studies. some approved infrastructure companies to issue tax-free bonds
d Deposit related investments: There are various types of deposit options from time to time. Most popular are the infrastructure bonds
avail~ble to mvestors like fixed deposits, recurring deposits, and issued by NABARD, REC, PFC and NHAI. These bonds have a
speczal term deposit schemes in banks. These offer a return of 6-896 lock-in period and if sold by an investor before th e expiry o f

L.___
r Para 1.5 BASICS OF INVESTMENT 12

lock-in period, the tax exemption will not be given. In the uni
I 13
TYPES OF INVESTMENT Para 1.5

(iv) Exchange-traded funds (ETFs) - ETFs are baskets of securities

t~
budget 2016, government had declared that only interest inco on th~t are traded on an_e~change like individual stocks. They track
on these bonds is tax free, the capital gains would be taxed an index and money 1s invested in securities of the index in same
the money invested will not be eligible for tax deduction. n proporti?n as that in the index itself. The first ETF in India, "Nifty
BeEs (Nifty ~enchmark Exchange. Traded Scheme)" based on
/. Alternative investment avenues: Besides above, a number of ne S&P CNX Nifty, was launched in January 2002 by Benchmark
securities have been introduced in securities market over the pa~ Mutual Fund. Unlike index funds, ETFs offer the convenience
two decades. These securities include- mutual funds, exchange traJ- of intra-day purchase and sale on the Exchange. These days
ed funds (ETFs), derivatives ( financial derivatives and commodit we also have Gold ETFs which are referred to as 'paper gold'
derivatives), warrants, mortgaged backed securities, deep discouJ because you invest in gold but not in physical form. Investor
bonds, catastrophe bonds, collective investment schemes, REITs gets gold ETF units which will emulate return on tangible gold.
(Real Estate Investment Trusts), etc. These securities have enriched
the investment environment by providing a variety of choice to the (v) Derivatives - A derivative is a contract between two or more par-
ties, whose value is based on the value of the underlying asset /
investors. assets which may be stocks, bonds, commodities, currencies,
(1) Mutual funds - Mutual funds collect money from investors and interest rates, etc. Futures and options contracts on stocks and
put the pool of money so collected into investment products like indices are very popularly used by traders and speculators. Oflate,
equity shares, bonds, debentures, money market instruments or commodity and currency derivatives have also been picked up
combinations thereof. Most funds are launched with a predeter- by Indian investors. Derivatives are highly leveraged instruments
mined investment nature such as debt funds, equity funds, or and thus too risky as compared to investment in the underlying
balanced funds. Mutual funds are professionally managed and asset. However, the expectations of returns are also equally high.

} provide diversification benefits to retail investors. Systematic

Investment Plan (SIP) - a new development in mutual fund in-
vestment - is a smart mode for investing money in mutual funds.
(vz) Collective investment schemes - Collective investment scheme
(CIS) is a scheme or arrangement made by a company to collect
money from investors in the form of contributions and invest
It provides rupee cost averaging and compounding benefits. the pool of money(~ 100 Crore or 'more) to earn income, profit,
(i1) Equity Linked Savings Scheme (ELSS): ELSS are diversified produce or property for the contributors. However, investors
mutual fund schemes with tax benefits under section 80 C of don't have a close say in day to day operations of a CIS. A CIS
Income Tax Act. ELSS as the name suggests invest in equity prod- has to file an offer document with SEBI and obtain a credit
ucts along with debt investment. These funds invest in equities, ratmg before it can actually raise funds from investors. Units
thus offer long-term growth opportunities. These come with a issued by CIS are compulsorily listed on stock exchanges.
lock-in period of three years; however, the dividend income is Investors need to be highly cautious before giving their hard-
tax free and long term capital gains are also exempt from tax. earned money to these lucrative schemes because a CIS is illegal
So, ELSS is also an EEE (Exempt, Exempt, Exempt) option but if it is not registered with SEBI, the market regulator. Despite
it has the shortest lock in period as compared to PPF and NSC. of numerous such schemes running in our country, ironically,
(iiz) ULIP (Unit Linked Insurance Policy) - ULIP is an insurance India has only one CIS which is registered with SEBL
product which offers a combination of insurance and investment. The sARADHA SCAM of 2013 which offered plot of land or
It provides life cover and investment benefit. Some premium flat or very high rates of interest rates was one sue~ CIS fraud.
portion goes for the life insurance policy and the·rest is investe_d It actually had no business and was totally a Pon~ scheme. In
into an option chosen by investor. The worth of investment 1s a bid to save small investors' money, SEBI has issued more
highly linked or dependent on market performance. Differ~nt stringent norms to govern CIS from January 2014 onwards.
insurance companies offer differerit types of ULIP schemes with
( viz) REITs (Real Estate Investment. Trusts_) - REITs provide an
varying investment portfolio, different fees and premiums. ULIPs
have not been able to make a mark amongst investors because alternative to purchasing properties for_ inve~tment. REITs a:e
companies which invest in real estate -residential and commercial
of not so consistent returns and high market risk involved. ULIP
premium is eligible for SOC deduction.
 BASICS OF INVESTMENT 14
I INVESTMENT DECISION PROCESS
Para 1.7
Para 1.7 15
property, and investors are able to earn real estate like prOf'1 5. Portfolio performance evaluation and management
through relatively smaller investments in REITs as comp ts
to hefty sums of money required to buy property. ared 6. Portfolio revision
These steps are discussed in detail below:
Some of these investments like stocks, mutual funds, derivatives etc I. Setting up the Investment Policy: The first step involves setting up
discussed in detail in later chapters of this book. ' · are the investment policy for the investor. The investment policy is based
on investment goals or objectives, investible funds, tax status and
1.6 OBJECTIVES OF INVESTMENT investment horizons. Different investment objectives of an investor
I. Wealth creation by capital appreciation - It is one of the Prima may be capital appreciation, regular income, tax benefits etc. the
objectives of investment. Investors basically want to grow their mon; investment objectives are framed as per the risk return preferences
and therefore park their funds in various investment instruments/0 of the investors. Every investor has a different risk appetite or risk
accumulate more and more wealth for their future. The accretio profile which is an essential ingredient in investment policy. The
in the value of investment creates wealth for the investors. n investment objective is also related to the period of investment or
2. Steady source of secondary Income - Every rational being is risk investment horizon. Investment policy sets the broad fram ework for
averse and thus wants to secure his or her future from uncertainties investment decision making by an individual investor.
Investment ensures a steady inflow of income in the form of interest· 2. Building up an inventory of securities: This step involves building
dividend, etc. Such recurring inflows act as secondary income fo; up a list of all available securities wherein an investor may make his
the investor apart from the primary income like salary, profits from investment. Depending upon investment objectives and investment
busin·ess/profession, etc. horizon, the securities may be filtered. For example if an investors

,
objective is to receive regular income at low risk, then equity shares
3. Hedge against inflation - Inflation is a usual economic phenome-
which do not pay regular dividends may not be included in the list
non which reduces the purchasing power of money. Therefore, it
is essential that your money grows at a pace faster than the rate of of securities where an investor may invest.
inflation so that inflation doesn't eat up your wealth. So, creating a 3. Performing Security Analysis: Once an inventory or list of available
hedge against inflation is another objective of investment. securities has beeri made, the next step is to analyze these securities
primarily with respect to risk and return characteristics. This is known
4. Financial goals - Investment is also done with the goal of meeting life as security analysis. The main idea in security analysis is to estimate
aims like house, car, marriage, children education, etc ..which require the expected return and risk of individual securities. This may also
large outlay of funds. Investment helps in building the huge corpus ·help investors in detecting undervalued or overvalued securities and
of funds necessary to fulfil these financial goals and also ensures
timing of buy or sell decision.
that the right amounts of funds are available at the right time.
There are various approaches of security valuation- Fundamental
5. Reducing tax liability-Availing tax advantage is another important analysis, Technical analysis and efficient market hypothesis (EMH).
objective of investment in financial assets in India. Section 80-C of As per fundamental analysis, in the long term, the price of a security
Income-tax Act, 1961 provides certain investment alternatives (e.g. is equal to its intrinsic value or true worth. Intrinsic value of a secu-
PPF, NSC, Mutual Funds, which qualify for deduction from taxable rity is the present value of all future cash inflows associated with the
income. security. Hence the investor first calculates the intrinsic value of the
security using some appropriate discount rate and then compares it
1.7 THE INVESTMENT DECISION PROCESS with the prevailing market price to ascertain whether the security is
The process of investment broadly comprises of the following steps : undervalued ( intrinsic value> market price) or overvalued ( intrin-
sic Value< Market price). The investor should choose undervalued
I. Setting up the investment policy securities for investment purposes. Fundamental analysis comprises
2. Building up an inventory of securities of analysis of Economy, Industry and Company level factors in or-
3. Performing security analysis der to ascertain the expected cash inflows from the security. This is
termed as Top Down approach or EIF framework of analysis.
4. Constructing portfolios, analyzing portfolios and selecting the optimal
portfolio
'
BASICS OF INVESTMENT 16 Para 1.8
MODES OF INVESTMENT
Para 1.7 17
.
Technica 1ana 1ysis,
• on the other hand, is .based on the premise th
bh • . at Portfolio performance Evaluation: The last step in the inve.stm ~nt
't If' and hence future pnce e av10uns predictabl 6· process is to evaluate the performance of t?e portfolios. It Implies
'history repeats I se . f . H · e
. f t prices and volume m ormat10n. ence past trend determining periodically whether the portfolio has performed better
on the bas1s o pas f hn' 1· d'
. h t atterns and a number o tee 1ca m 1cators can b than the benchmark portfolio or other similar portfolios or not. Port-
ana Iys1s, c ar p h b . ff t d' e folio performance evaluation may be dome using absolute return .as
use d to pre d I·ct future prices. On t he as1s
. . oh u. ure
h .pre 1ction of
. well as various risk adjusted return measures such as Sharp~ ~a!10,
pnces, an 1·nvestor may decide whet er . 1t 1st .e ng tktime. to. buy 0r
h m mar et t1mmg.
se ll. Hence t echnical analysis helps an mvestor . E"'.
111
Treynor's ratio or Jensen's alpha. Sharpe ratio is calculated by d1v1?mg
cient market hypothesis ( EMH) a~sumes t at current ~ecunty Prices excess return ( i.e. risk premium) by the total risk of the portfolio. It
fully reflect all available informati.on a?out that sec~nty . Hence the is a measure of excess return per unit of risk. The higher this ratio
market price is nothing but the farr pnce or true pn~e of a security. the better is the performance of the portfolio.
Hence anytime is a good time to buy?~ sell as th~re 1s no consistent
overpricing or underpricing in an efficient secunty market. 1.8 MODES OF INVESTMENT- DIRECT INVESTING AND INDIRECT
4. Constructing portfolios, portfolio analysis and po~t.fol~o selection: INVESTING
A portfolio is a combination of two or more secu?tles m which an An investor can invest in securities directly or indirectly.
investor may prefer to hold investments rather th'.111 mall th~ securities Direct investing involves the purchase or sale of securities by the investors
available for investment. Therefore after secunty analysis, the next themselves. In this case the investor has the entire control over the invest-
step is to construct all feasible portfolios or portfo~o opportunity set ment decision i.e. which securities are to be purchased and sold as well as
and selecting optimal portfolio for the concerned mvestor. Portfolio when to purchase or sell. The securities may be securities of capital market
opportunity set is also termed as Investment opportunity Set. It must (such as equity shares, bonds, debentures), or of derivatives markets (such as
be noted that there may be many feasible portfolios by combining futures and options) or of money market ( such as treasury bills, certificates
various securities in different proportions, but all of them may not of deposits, commercial papers etc). The investor is required to perform all
be efficient. An efficient portfolio is one which provides maximum the steps of Investment decision process, as explained above, on his own.
return for a given level of risk or which has minimum risk for a Therefore direct investing requires investing skills and expertise. Moreover
given level of return. Such efficient portfolios may also be large in it is a time consuming process of investing. In case of direct investment,
numbers. Hence in order to select the optimal or best portfolio for the the cost of analysis and monitoring is incurred by the investor directly.
investor, one needs to consider risk return preferences of the investor. Indirect investing involves investing in mutual funds (open ended as well
For example for a young person, who is willing to undertake risk to as closed-ended funds), exchange - traded funds or collective investment
maximize return, we may have an optimal portfolio comprising 7096 schemes including Alternative Investment Funds (such as venture capi-
of equity and 3096 of bonds. On the other hand for a retired old aged tal funds, hedge funds, REITs, SME fund etc ). In this case, the investor
investor the optimal portfolio may be 1096 equity and 90 bonds and does not invest directly in various securities. He has no control over the
debentures or fixed deposits.
composition of the fund's investment; the investor only controls wheth-
5. Portfolio Revision: The fifth step in investment decision process is er to buy or sell the shares or units of the fund. Therefore, the investor
portf~lio rev!sion. It consists of the repetition of the previous four only decides which mutual fund or investment company to invest in. The
steps m the light of changes in investment environment. Moreover ~ltimate investment decision is made by the fund or investment company
the investment objectives of the investor may also change overtime m case of indirect investing. The investor buys or sell the units (or shares)
an~ h~nce there is a need to revise the originally selected portfolio of the Fund, which in turn makes investment if securities and build up
penod1.cally. Due to changes in security prices, the originally built portfolios as per investment objective of the Fund or Scheme. The investor
portfolio may not remain optimal and hence the investor needs to become unit holder in the Fund and has ownership interest in the asset of
revise it or buil? up a n_e ~ portfolio. Changes in security prices may th~ fund or investment company and is entitled to interest, dividends and
also make certam secunties attractive, which were not selected earlier pnce appreciation ( or decline). Thus Indirect investing in a mutual fund
?ue to highe~ prices or may make certain securities already include ETF or investment company or even in alternative investment funds, i~
m the portfolio, unattractive. All this calls for periodic revision of the
portfolio.
 Para 1.9 BASICS OF INVESTMENT
18 TEST YO URSELF
19
an alternative route for investor to inves~. It. is convenient and ideal forni
of investing for investors who are not skilled enough or who do not ha
time to perform security analysis and portfolio m3:'1agement process. ~ SUMMARY
case of investment in mutual funds or any other mvestment cornpan • Investment is employment of c w-re nt fund s to ea rn comm e n s urnt e
the investment costs are incurred by the fund or company but ultirnatef' returns in future.
tJiese costs are passed on to the investors in terms of managernent fe~ Investment may be classified as Real inves tm e nt and Finan c ia l inves t-
or expenses. These expenses or fee reduce the value of the portfolio or
ment.
investment done by the fund or company. • Real investment is investment in tangible assets whic h a 1-e u sed in
production process. e.g. investme nt in plant, mac hine ry, land, building,
1.9 APPROACHES TO INVESTING -ACTIVEINV~STING (INVESTMENT)
AND PASSIVE INVESTING (INVESTMENT) etc.
• Financial investment represents claims ove r real asse ts, e.g. sha r es,
A popular classification of investing is active investing (or Active Investrnent) bonds, debentures, etc.
and passive investing (or Passive Investment). , While taking an investment decision, an investor s hould car e fulJ y
I. Active investing implies making investment in securities after active. analyse it against factors like return, risk, liquidity, marke ta bility, tax
ly and carefully analyzing all the securities and portfolios. Such an benefit, hedge against inflation and safety of capita l.
approach to investing requires that the investor is actively engaged Speculation js taking high risk in expectation of high and quick r e turns.
in the task of security analysis, selection and building up suitable
portfolios. Portfolios are then revised and their performance is as- • The investment environment comprises of - securities, securities mar-
sessed at regular intervals. The choice of securities is made in such ket and intermediaries in the securities marke t.
a manner that the investor gets maximum return ·for a -given level • There are multiple investment options available like equity shares,
of risk. The idea behind active investing is that investment analysis bonds, debentures, T-bills, mutual funds, PPF, ELSS, ULIP, REITs,
can yield superior returns to the investors. Active investing requires financial derivatives and commodity derivatives.
investment skills and is a time consuming and continuous process. There are two modes of investing - direct investing and indire ct
2. Passive Investing implies making investment in Index ·Funds or investing
Exchange traded funds. An index funds is a fund that tracks the Direct investing means buying and seUing of securities by the investor
performance of a broad-based market index. Buy and hold is also himself.
termed as passive investing. In case of passive investing, the investor • Indirect investing means investment in a mutual fund, ETF, or invest-
is content with the market return at market risk. He does not expect
ment company.
to earn returns over and above the one that is given by the market.
The idea behind passive investing is that nobody can earn superior • Investment decisions are affected by taxes and inflation.
returns in an efficient market. He~ce it is better to buy and hold the
market portfolio or market index which is the underlying asset of
the Index Funds or ETFs. Passive investing does not require much
investment skills and is not a time consuming or continuous process.
Once investment is made in Index fund the investor holds it over the TRUE/FALSE
investment horizon. '
(z) Financial investment is done in tangible physical assets.
(iz) Speculation is also a type of investment.
(iiz) PPF (Public Provident Fund) is a totally tax exempt scheme, i. e., neither
the periodic income nor the redemption amount attract tax liability.
(iv) Equity shares are more risky than bonds or debentures.
 ---
BASICS OF INVESTMENT lO Tfl EORY QUESTIONS
21
(v) Direct in vesting means investment in mutual fund or ETFs. 11. An investor's motives to invest arc inherently different from those or a
(vi) Equity shares are considered to be a good hedge against inflation speculator yet both are key to efficient functioning of the market. Expbin.
(B.Co111 (/-//. GGSll'U, 20 17/
(vii) It is mandatory for all Collective Investment Schemes to be register d
with SEB!. e 12. Distinguish between Bond and Equity as investment alt ernati ve.
(B.Com {P), DU. 2019)
(viit) Active in vesting means in vestment in a mutual fund, ETF or investment
company. 13. Can investment be used to save tax? Mention somL' of tht! in ves tment
options which also provide tax shell er to in vestors.
(ir) Gambling is also a type of speculation.
14. Di fferentiate between active inves tin g and passive in ves tin g. Give cx:-irn-
(x) Same asset cannot be held for the purpose of investment and speculation.
ples.
(Ans. (i) F (ii) F (iii) T (iv) T (v) F (vi) T (vii) T (viii) F (ix) F (x) F) JS. Compare the following investmen ts in terms of retu rn, risk. liquidity and
tax shelter:
a. Equity shares
TH EORY QUESTIONS b. Bond i debentures
c. PPF
I. Explain the term 'Investment' and its types.
d. Residential house
2. What is financial in vestment? How is it different from real investment?
3. Explain in brief the nature of investment. What are the differences between
e. Gold
investment and speculation? (B. Com {P), DU, 2018) /. Derivatives
4. Differentiate between investment and speculation. Can the same asset be 16. Explain the various modes of investing. (B.Co,n (HJ DU, 2016)
held for investment by one investor and speculation by other?
(B.Co111 (H), DU. 2017) (B.Com {P), DU, 2019)
5. "Investment is well grounded and carefully planned speculation". In the
light of the above statement, explain and differentiate between in vestment
and speculation. How do they differ from gambling?
(B.Com (H), GGSIPU, 2016)
6. What do you understand by the term Investment? What objectives should
be kept in mind while investing in securities market?
(B.Com (H), DU, 2019)
7. What principles should be kept in mind while selecting an investment
option? (B.Com /P), DU. 2016)
8. What are the main features of equity shares? As an investor what factors
should you consider while investing in equity shares?
(B.Com {H), DU. 2018)
9. Explain the following:
a. ELSS
b. ULIP
c. RE!Ts
d. Collective Investment Schemes
I 0. Explain the different types of investment aven ues available to an investor.