SAPM – Unit 1

• Nature and Scope of Investment Management

• Objectives and Constraints
• Investment Factors
• Gambling – Nature and Scope
• Difference b/w Investment and Gambling
• Role of Capital Markets
 What is Investment?

Investment is defined as a sacrifice made now to obtain a return later.

It can be understood as the application of money for earning more money.

In economics, investment is the utilization of resources in order to increase

income or production output in the future.

An amount deposited into a bank or a purchase of machinery in anticipation

of earning income in the long run are both examples of investment. Here,
former is termed as financial investment while the latter is an example of
physical /real investment.
Real vs Financial Assets

Tangibility
Marketability
Liquidity
Holding Period
Investment Management - Meaning

Investment Management refers to the handling of an investment portfolio or a group of assets.

Nature of Investment Management

Helps in making
investment decisions
Higher the risk, higher
the expected return
Higher the time-period of investment,
lesser the uncertainties of investment
 Scope of Investment Management

Identification of Investors’ Requirements

Formulation of investment policy and strategy

Execution of strategy

Monitoring of portfolio
 Investment Decision Process

2. Analysis and 3. Formation of 5. Measurement

1. Setting of
evaluation of diversified 4. Portfolio and evaluation
investment
investment investment revision of portfolio
policy.
vehicles. portfolio. performance
1. Setting of Investment Policy
•First Step in Investment Management Process: Investment Policy
•The investment policy involves setting investment objectives.
•Objectives include the required investment return and risk tolerance of the investor.
•Key Aspects of Investment Policy
•Example: Target an average return of 15% while avoiding losses exceeding 10%.
•Risk tolerance is crucial as it balances the positive relationship between risk and return.
•Unrealistic objectives, such as "to make a lot of money," should be avoided.
•Setting Investment Objectives
•Based on current and future financial goals of the investor.
•Required rate of return depends on the amount investable today and the financial need at the
investment horizon.
•Higher income goals require assessing and accepting a commensurate level of risk.
•Considerations in Investment Policy
•Include the investor's tax status.
•Define potential financial asset categories for portfolio inclusion.
•Decisions are guided by investment objectives, available funds, investment horizon, and tax
considerations.
2. Analysis and evaluation of
investment vehicles
•Analyzing Investment Types
•Analysis to be conducted after setting the investment policy, defining objectives, and identifying potential
financial asset categories.
•Involves examining various investment vehicles and individual options within these groups.
•Example of Analysis
•If common stock is identified as a relevant investment vehicle, the analysis focuses on common stock
as an investment.
• The purpose of Investment Analysis is to identify investment vehicles that appear to be mispriced.
•Approaches to Investment Analysis
•Technical Analysis: Historical price and volume data are evaluated to predict future trends.
•Fundamental Analysis: Examines financial health, earnings, and intrinsic value of investment vehicles.
3. Formation of a diversified investment portfolio.

•Technical Analysis focuses on analyzing historical market prices to predict future price movements
assuming that the historical price trends and patterns will repeat.
•Fundamental Analysis evaluates the intrinsic value of a financial asset as the present value of future cash
flows.
•Identifies underpriced or overpriced assets by comparing intrinsic value to market value.
•Portfolio Formation
•Involves selecting specific financial assets and determining their proportions in the portfolio.
•Diversification: Reducing risk by spreading investments across various assets.
•Techniques of Diversification
1.Random Diversification: Adding several financial assets to the portfolio at random.
2.Objective Diversification: Selecting financial assets systematically to align with investment objectives.
•Investment Management Theory emphasises objective portfolio diversification and professional investors
follow predefined objectives to construct and manage portfolios.
 4. Portfolio Revision
•Portfolio Revision involves periodic revision of the previous stages in the investment management process.
•Reasons for Portfolio Revision
•Changes in the investor’s objectives.
•Fluctuations in asset prices, making previously attractive assets less desirable.
•The need to replace existing assets with more suitable options.
•Factors Influencing Portfolio Revision
•Transaction costs associated with buying and selling assets.
•Market conditions, tax laws, and security regulations that impact investment goals.
•Frequency of Portfolio Revision
•Institutional investors continuously revise portfolios as part of their activity.
•Individual investors should periodically re-evaluate and revise their portfolios to ensure alignment
with objectives and market conditions.
•Importance of Periodic Re-Evaluation
•Helps adapt to changes in financial markets and external factors that affect investment goals.
•Ensures the portfolio remains optimized for the investor’s current needs.
 5. Measurement and evaluation of
portfolio performance
•Portfolio Performance Evaluation is the final step in the investment management process.
•Evaluates portfolio performance based on both return and risk.

•Measures for Evaluation

•Requires appropriate metrics for return and risk assessment.
•Benchmarks are used for comparison purposes.
•Benchmarks represent the performance of a predefined set of assets.
•Usage of Benchmarks is widely adopted by institutional investors for portfolio performance evaluation.
 Speculation

Speculation refers to the act of engaging in financial transactions,

typically involving high-risk assets, with the hope of making a
profit from price fluctuations over a short period.

Unlike investing, which generally focuses on long-term value and

fundamentals, speculation involves betting on the future price
movements of an asset, often without regard for the asset's
underlying value or long-term prospects.
 Characteristics of Speculation
High Risk: Speculation is inherently riskier than investing because it involves trying to predict short-term
market movements, which can be volatile and unpredictable.

Short-Term Focus: Speculators typically aim for quick profits and are often involved in trading stocks,
commodities, currencies, or other assets over a short time frame (ranging from days to months).
Market Timing: Speculation is largely based on market timing—the ability to buy and sell an asset at the
right time to capitalize on price changes. Speculators try to "buy low and sell high" or "sell high and buy
low" based on anticipated price swings.
Uncertain Outcomes: The potential for significant profits is balanced by the possibility of substantial losses.
Speculators are willing to take on more risk in pursuit of higher returns, but they do so with the
understanding that they may not always succeed.
Leveraged Transactions: Speculators may use leverage (borrowed money) to increase the size of their
trades, which amplifies both potential gains and potential losses. This is a common practice in markets like
forex (foreign exchange) or commodities.
 Examples of Speculation

Stock Market: Buying stocks based on

Commodities: Trading in commodities like oil,
predictions about short-term price
gold, or agricultural products, betting on price
movements, often driven by market
movements caused by factors such as weather,
trends, news events, or earnings reports,
geopolitical events, or shifts in supply and
without regard for the company’s long-
demand.
term fundamentals.

Real Estate: Buying properties with Cryptocurrency: Many cryptocurrency traders

the expectation that their value will engage in speculation, hoping to profit from the
increase in the short term due to volatility of digital currencies like Bitcoin,
market conditions, development in Ethereum, and others.
the area, or other factors.
 Investment v/s Speculation
BASIS FOR COMPARISON INVESTMENT SPECULATION
Meaning The purchase of an asset with the hope of Speculation is an act of conducting a risky
getting returns is called investment. financial transaction, in the hope of
substantial profit.
Basis for decision Fundamental factors, i.e. performance of Hearsay, technical charts and market
the company. psychology.

Time horizon Longer term Short term

Risk involved Moderate risk High risk
Intent to profit Changes in value Changes in prices
Expected rate of return Modest rate of return High rate of return
Funds An investor uses his own funds. A speculator uses borrowed funds.
Income Stable Uncertain and Erratic
Behavior of participants Conservative and Cautious Daring and Careless
 Gambling

Gambling refers to taking financial risks in a manner that

resembles the randomness and chance-based nature of
gambling, rather than relying on careful analysis, strategy, or
fundamentals.
In the context of investing, gambling typically involves making
speculative decisions where the outcome is highly uncertain
and largely dependent on luck or external factors, rather than
informed judgment or market analysis.
 Characteristics of Gambling

• Just like gambling, where the outcome of a bet is uncertain, gambling in investment involves

High Degree of Uncertainty: taking positions with little to no understanding of the underlying factors that might affect the
asset's value. The investment is based more on chance than on a structured, informed
analysis.

• Similar to gambling, which often involves betting on short-term outcomes (e.g., the outcome of a game,

Short-Term Focus:
race, or lottery), gambling in investment tends to be short-term in nature. Investors may be hoping for a
quick windfall rather than seeking long-term growth or stability.

Lack of Fundamental • Investments made with a "gambling" mindset often lack due diligence, such as studying a company's
financials, business model, or market trends. Instead, the focus may be on speculative opportunities,
rumors, or "hot tips," with little regard for the asset's intrinsic value.
Analysis:
• In gambling, bettors often take high risks, such as making large wagers with little chance of winning.

Excessive Risk-Taking: Similarly, in investing, gambling may involve using excessive leverage (borrowing money to invest),
speculating on highly volatile assets, or making risky trades that expose the investor to significant
losses.

• Like games of chance, where outcomes are determined largely by luck (e.g., a roll of dice, the spin of a

Reliance on Luck: roulette wheel), gambling in investment often involves decisions where the investor has little to no
control over the outcome. The outcome is seen as more random than based on analysis or informed
decision-making
 Examples of Gambling

Day Trading:
• Day trading, particularly when done with high frequency and little regard for fundamentals, can resemble gambling. Traders may make
numerous short-term trades based on speculative moves, trying to profit from small fluctuations in stock prices, often without understanding
the long-term prospects of the companies involved.

Options and Futures Speculation:

• While options and futures can be used as legitimate hedging tools, they can also be used in speculative ways that resemble gambling.
Speculators might buy options contracts or futures contracts hoping for large, short-term gains, without truly understanding the underlying
assets or managing the associated risks.

Penny Stocks:
• Investing in extremely low-priced, volatile stocks (often referred to as "penny stocks") based on hype, rumors, or price movements rather than
solid financial analysis can be likened to gambling. These stocks often lack liquidity and stability, making them highly speculative and risky.

Cryptocurrency Speculation:
• Some cryptocurrency investments, particularly in highly speculative coins or tokens, can resemble gambling. Cryptocurrencies are often
volatile, and many traders jump into the market based on speculative news or trends, rather than a long-term investment thesis or
understanding of the technology behind the coin.

Lottery-like Investment Schemes:

• Participating in high-risk, "get-rich-quick" investment schemes or ventures that promise extraordinary returns with little-to-no underlying
rationale can be seen as gambling. This includes situations where investors make decisions based purely on hope or the belief in striking it rich,
such as investing in risky startup ventures without conducting proper due diligence.
 Basis Investing Gambling

Investing involves putting money into assets like stocks, bonds, real
Gambling is wagering money or valuables on an event with
Meaning estate, or mutual funds with the expectation of generating long-term
an uncertain outcome, primarily driven by chance.
growth.

Investing is focused in Growth and income. Investors focus on capital Winning a bet. Focused on the excitement of the bet and
Focus
appreciation (asset price increase) and regular income (dividends). the prospect of winning, regardless of the underlying odds.

A long-term endeavour, focusing on years or even decades. Investors Immediate win-or-lose outcomes, with little focus on long-
Time Horizon
aim for steady growth and compound interest. term gain. Decisions are driven by chance.

Relatively low risk, prioritizing the potential for consistent returns over Extremely high risk, with the odds often stacked against the
Risk Tolerance
time. participant.

Extensive analysis of market fundamentals, company financials like

Research and
Balance sheet, Profit and Loss Statement, and Cash Flow Statement), Little to no research involved, purely a bet on chance
Analysis
and economic trends to identify potential long-term winners.

Decision- It is driven by company performance, long-term economic health, and

Based on random chance with no strategic analysis.
Making asset diversification.

Investing is focused typically in stable assets like stocks, bonds, index

Asset Focus Casino games, lotteries, and sports betting.
funds, and real estate.

Capital gains tax applies, generally more favourable if assets are held for Winnings may be taxable; losses may be deductible only up
Taxation
longer than a year. to the amount of winnings.
Capital Market – Meaning &
Definition
A capital market is an organised market for borrowing and lending
long-term funds.
It is a mechanism for channelling savings into long-term
investments.
It enables the flow of funds from those with surplus funds to those
who require it for long-term investments.
Capital Market consists of primary markets and secondary markets.
According to Gitman and Johlenk, ”Capital market is the market
where transactions are made in the long-term securities such as
stocks and debentures”.
Difference b/w Money Market &
Capital Market
 Functions of Capital Markets
Mobilization of Savings: Converts individual and institutional savings into
investments.

Capital Formation: Aids in wealth and capital creation in the economy.

Facilitates Trading: Provides a platform for buying and selling securities.

Economic Growth: Channels funds to industries, infrastructure, and

development projects.

Liquidity Provision: Ensures investors can easily convert securities into cash.
 Functions of Capital Markets

Price Discovery: Determines the value of securities through market forces.

Wealth Creation: Offers opportunities for capital appreciation and income

generation.
Encourages Foreign Investment: Attracts global investors, enhancing financial
resources.
Risk Diversification: Provides various investment options to spread and minimize
risks.
Regulation and Control: Protects investors and ensures market stability through
strict governance.
 Classification of Indian Capital
Market

1. Gilt-Edged Securities Market: It is a market for trading government and semi-

government securities which are backed by RBI guarantee. Banks and institutional
investors invest in these securities which carry very low risk.

2. Industrial Securities Market: Companies, Govt. and Fis raise funds through the
issue of shares and debentures in the industrial securities market. It consists of
(a) Primary Market
(b) Secondary Market
 Types of Capital Market

Primary Market:
• Also known as the new issue market.
• Companies issue new securities to raise funds.
• Examples: Initial Public Offerings (IPOs), Follow-on Public Offerings (FPOs).

Secondary Market:
• Also called the stock market.
• Previously issued securities are bought and sold.
• Facilitates liquidity and price discovery for securities.
• Examples: Trading of shares on stock exchanges like NSE, BSE.
 Stock Exchange

A stock exchange is a regulated marketplace where individuals and businesses

can buy and sell securities such as stocks, bonds, and derivatives.

An exchange also acts as an intermediary, facilitating transactions between

buyers and sellers, ensuring liquidity and price transparency.

Buyers and sellers can trade securities listed on the stock exchanges through
stockbrokers. Securities not listed are aso traded; in this case, , trading is called
over-the-counter (OTC).
 Trading Mechanism in Indian Stock
Market
The trading mechanism in the Indian stock market primarily operates through
two main exchanges: the National Stock Exchange (NSE) and the Bombay Stock
Exchange (BSE). Here’s a general overview of how the trading process works:

•Market Participants: The key players in the Indian stock market include retail
investors, institutional investors (such as mutual funds, insurance companies,
and banks), foreign institutional investors (FIIs), and market makers.

•Trading Hours: The regular trading hours for both the NSE and BSE are from
9:15 AM to 3:30 PM, Monday through Friday, except on trading holidays.
 Trading Mechanism in Indian Stock
Market
Order Placement: Investors place buy or sell orders through brokers or through
online trading platforms. Orders can be market orders (executed at the prevailing
market price) or limit orders (executed only at a specified price or better).

Order Matching: Orders are matched through a computerized trading system. The
orders are matched based on price and time priority, with the best available bid
matched with the best available ask.

Continuous Trading: During the trading session, there is continuous matching of

buy and sell orders, leading to price discovery and execution of trades.
 Trading Mechanism in Indian Stock
Market
Market Indices: The key market indices in India, such as the Nifty 50 on the NSE
and the Sensex on the BSE, track the performance of a basket of stocks and
provide a gauge of the overall market sentiment and direction.

Market Phases: The trading session is divided into different phases, including
pre-open session, regular trading session, and post-closing session. Each phase
serves a specific purpose in the trading process.

Regulatory Oversight: The Securities and Exchange Board of India (SEBI)

regulates the Indian stock market to ensure fair and transparent trading
practices, protect investor interests, and maintain market integrity.
 Trading Mechanism in Indian Stock
Market
Settlement Process: After the trades are executed, the settlement process begins. In India,
the settlement cycle is typically T+2, which means trades executed on a trading day settle
two business days later. Settlement involves the transfer of securities and funds between
the buyer and seller through the clearing corporation.

Risk Management: Various risk management mechanisms are in place to ensure the
stability and integrity of the market, including margin requirements, circuit breakers, and
surveillance systems.

Overall, the trading mechanism in the Indian stock market is governed by rules and
regulations aimed at facilitating efficient and orderly trading while safeguarding the
interests of investors and maintaining market stability.
Trading Mechanism Process
Trading Mechanism Process
Primary Market v/s Secondary
Market
 Capital Market Instruments
Equity Shares: Represent ownership in a company.
Shareholders have voting rights.
Returns are in the form of dividends and capital gains.
Preference Shareholders receive fixed dividends before equity shareholders.
Shares:
Do not usually carry voting rights.
Debentures: Long-term debt instruments issued by companies.
Offer fixed interest payments to debenture holders.
Secured or unsecured, depending on the terms of issuance.
Bonds: Issued by governments or corporations.
Provide regular interest income to bondholders.
Convertible Instruments like convertible debentures or bonds that can be converted into
Securities: equity shares.

Other Mutual funds, exchange-traded funds (ETFs), and derivatives linked to

Instruments: securities.
 Mutual Funds
A mutual fund is an investment vehicle that pools money from several investors to invest in a
mix of assets like stocks, bonds, government securities, and even gold. Mutual funds allow
investors to achieve portfolio diversification and professional management, with returns and
risks based on the performance of the fund’s investments.

The funds are managed by financial experts called fund managers. These professionals have
the skills to analyze and make investment decisions.

All the mutual funds are registered with SEBI. They function within the provisions of strict
regulation created to protect the interests of the investor.
 Comparison Table

Comparison of Equity shares,

Preference shares and Debentures
Feature Equity Shares Preference Shares Debentures
Nature Ownership Hybrid (equity + debt) Debt instrument
Returns Dividends and capital gains Fixed dividends Fixed interest
Risk High Moderate Low
After debentures, before
Priority in Payment Last First
equity
Voting Rights Yes Limited/None No
Convertible/Non- Convertible/Non-
Convertibility Non-convertible
convertible convertible

Redeemable/Non-
Repayment Perpetual Redeemable/Irredeemable
redeemable