CFP- Level-1-IP and Asset Management (Global) Chapter 1-6

Valuation of Real Estate (Gross Income Multiplier (GIM) • Example: Property A is an apartment building that has 10 one- bedroom units renting for Rs7500 per month, 20 two-bedroom units renting for Rs.10,000 per month, and 10 three-bedroom units renting for Rs.12,500 per month. The annual gross income and sales prices of three recently sold, similar apartment buildings in the area are: • Property B: Sale price= 35,27,500, Gross Income= 4,25,000 • Property C: Sale price= 41,31,000, Gross Income= 5,10,000 • Property D: Sale price= 41,32,500, Gross Income= 4,75,000 • What is the value of Property A based on the gross income multiplier approach? Friday, 15 July 2022 Investment Planning & Asset Management

Valuation of Real Estate (Gross Income Multiplier (GIM) • First, we must convert the monthly rental income to annual figures: • 1-bedroom units: 7500 x 12 months x 10 units = 900,000 • 2-bedroom units: 10,000 x 12 months x 20 units = 24,00,000 • 3-bedroom units 12,500 x 12 months x 10 units = 15,00,000 • Total gross annual rents: Rs.48, 00,000 Friday, 15 July 2022

Valuation of Real Estate (Gross Income Multiplier (GIM) • Next, we need to calculate the gross income multiplier (GIM) for each of the other comparable properties: • Property B: 3,527,500/425,000 = 8.3 (Sale price/Gross Income) • Property C: 4,131,000/510,000 = 8.1 • Property D: 4,132,500/475,000 = 8.7 • The average gross income multiplier for these three properties is 8.37: • (8.3 + 8.1 + 8.7)/3 = 8.3666 • The last step is to multiply the gross rents of Property A by this average GIM to arrive at the estimated value of the property: • 48,00,000 x 8.37 = 4,017,6000 Friday, 15 July 2022 Investment Planning & Asset Management

Valuation with discounted cash flow method • Valuing real estate follows the same logic as valuing shares and dividends • The value of a property is the present value of all Cash flows to be received from owning that property • Cash Flow would be net rentals and cash flow from the eventual sale of property • PV= PMT/(1+I)+PMT/(1+I)^2+----------------FV/(1+I)^n • Same formula as computing the PV of Bonds Friday, 15 July 2022

Valuation with discounted cash flow method • A wishes to purchase property and expects to receive Rs.2,50,000 in rentals every year and sell the property after 5 years and get sale proceeds of Rs.50,00,000. What is the PV of property if expected rate of return is 15% • FV= 50,00,000, N=5, I= 15%, PMT= 250000 • Solve PV= -3323922 Friday, 15 July 2022

Segments of Secondary Market Secondary Market BSE/NSE/Other exchanges Cash Market Futures and Wholesale & RDM Options Debt Market Friday, 15 July 2022

Derivatives • Derivative is a contract or a product whose value is derived from value of some other asset known as underlying. • Underlying Assets can be: Metals, Energy resources such as Oil, Agri commodities such as wheat, Sugar, Coffee, Cotton, Pulses etc., and Financial assets such as Shares, Bonds and Foreign Exchange. • Like other segments of Financial Market, Derivatives Market serves following specific purposes  Derivatives market helps in improving price discovery based on actual valuations and expectations. Derivatives market helps in transfer of various risks from those who are exposed to risk but have low risk appetite to participants with high risk appetite. Friday, 15 July 2022 Investment Planning & Asset Management

Derivatives • For example: Hedgers want to give away the risk where as traders are willing to take risk. • Derivatives are typically used for three purposes: • a) Hedging • b) Speculation • c) Arbitrage Friday, 15 July 2022 Investment Planning & Asset Management

Futures and Options - Call Option and Put Option Forwards • It is a contractual agreement between two parties to buy/sell an underlying asset at a certain future date for a particular price that is pre-decided on the date of contract. • Both the contracting parties are committed and are obliged to honor the transaction irrespective of price of the underlying asset at the time of delivery. • Since forwards are negotiated between two parties, the terms and conditions of contracts are customized. These are Over-the-counter (OTC) contracts. Friday, 15 July 2022 Investment Planning & Asset Management

Futures and Options - Call Option and Put Option Futures • A futures contract is similar to a forward, except that the deal is made through an organized and regulated exchange rather than being negotiated directly between two parties. Indeed, we may say futures are exchange traded forward contracts. • A futures contract refers to the purchase of an underlying for delivery on a future date. • For example, if one buys a share of Reliance Industries paying today‘s price and agrees to deliver shares for settlement, such a transaction is a spot transaction. However, if one buys Reliance on December 9, for delivery on December 28, one is a buyer of the share on the future date. • The buyer may agree to a price at which he would buy on the future date, and that is the futures price of Reliance Industries Ltd. A futures contract enables a buyer or a seller to buy or sell a stock, commodity or interest rate, for delivery on a future date. It is possible using a futures contract to implement a view about an underlying asset, for a future date. • For example, a producer of food grains might like to sell his produce before the grains are due to be harvested. He is then able to sell his future produce at a price he is able to negotiate today. • An important feature of an exchange-traded futures contract is the clearing-house. The counterparty for each transaction is the clearing-house. Buyers and sellers are required to maintain margins with the clearing- house, to ensure that they honor their side of the transaction. The counterparty risks - are eliminated using the clearing-house mechanism. Friday, 15 July 2022 Investment Planning & Asset Management

Futures and Options - Call Option and Put Option Options An option is a contract between a buyer and a seller (also known as a writer). Rather than own the actual stock (or other security), the buyer uses an option to buy or sell an underlying investment at a given price for a specified period. Option buyers have the right but not the obligation to fulfill the terms of the contract they’ve bought. Option writers have the obligation to fulfill the terms of the contract they’ve sold. Buying options is less risky than selling or writing options. Friday, 15 July 2022 Investment Planning & Asset Management

CALL and PUT Options Buying a call option gives the buyer the right to purchase 100 shares of the underlying stock at the stated strike price, until the option expires. The seller (writer) must deliver the 100 shares upon receiving notice that the buyer is exercising the option. (Notice the significant difference—the buyer may exercise the option, but the seller must deliver if the option is exercised.) People buy calls if they think the underlying security will rise in price. Buying a put option gives the buyer the right to sell 100 shares of underlying stock at a strike price, until expiration. As with a call, a put writer has the obligation to buy the shares if the holder exercises the option. People buy puts if they think the underlying security will drop in price. Investors who want to short sell (or short) a stock borrow the stock and then sell it. If the market rises rather than falls, shorting results in a loss—sometimes substantial. Friday, 15 July 2022 Investment Planning & Asset Management

Payoff of CALL and PUT Options and Futures • Futures have Linear pay off, means the profit and loss for the buyers and sellers will be unlimited • Options have Non Linear pay off • Profits are unlimited for the buyer of call option, loss is limited to Premium paid • Profits are limited to premium received for seller/writer of call option, losses are unlimited • Profits are limited to the price of share-premium paid for buyer of put option, losses are limited to premium paid • Profits are limited to premium received for seller/writer of put option, losses are limited to price of stock- premium received Friday, 15 July 2022

ITM, ATM and OTM options CALL Option Premium 17700 PUT Option Premium (PUT) (CALL) 17655 OTM 130 17620 ITM 145 OTM 130 17600 ITM 135 OTM 135 17550 ITM 125 ATM 140 17525 ATM 120 ITM 145 17500 OTM 115 ITM 150 17470 OTM 110 ITM 154 OTM 105 ITM 160 OTM 100 Friday, 15 July 2022

Factors affecting CALL and PUT Options • Option’s Strike Price • Price of the underlying • Risk Free interest rate • Time remaining until expiration • Volatility of the underlying Friday, 15 July 2022

Factors affecting CALL and PUT Options premium CALL Prices (Option price) PUT Prices (Option price) Underlying Stock price Increases Decreases increases Decreases Increases Underlying Stock price decreases Decreases /Increases Increases/Decreases Strike price Increases/Decreases Increases/Decreases increases/Decreases Higher/Lower Higher/ Lower Volatility Increases/Decreases Decreases/increases Increases/Decreases Remaining time is Increase/Decrease Decrease/Increase longer/Shorter Dividends increase/decrease Interest rates Finridcarye, 1a5sJeul/yd20e2c2rease

Greeks • Option pricing models can provide values that reflect price sensitivity to various factors. The sensitivities are commonly called “Greeks,” labeled with letters of the Greek alphabet (plus Vega, which is not a Greek letter). The Greeks identify the expected change in option price with • Delta: Delta is the most important of the “Greeks“ in options. This measures the sentivity of the option value to a given small change in the price of the underlying asset. It may also be seen as the speed with whih an option moves with respect to the price of the underlying asset. Delta= change in option premium/Unit change in price of the underlying asset • Gamma: It measures change in delta with respect to change in underlying stock price. It is called a second derivative option. Gamma= Change in the option delta/Unit change in the price of the underlying asset • Theta: It ia a measure of an option’ sensitivity to time decay. Theta is the change in option price given a one day decrease in time to expiration. • Theta = Change in an option premium/Change in time to expiry • Vega: This is a measure of the sensitivity of an option price to changes in the market volatility. Vega= Change in an option premium/ Change in Volatility Friday, 15 July 2022 Investment Planning & Asset Management

What Is a Protective Put? • A protective put is a risk-management strategy using options contracts that investors employ to guard against the loss of owning a stock or asset. The hedging strategy involves an investor buying a put option for a fee, called a premium. • Puts by themselves are a bearish strategy where the trader believes the price of the asset will decline in the future. However, a protective put is typically used when an investor is still bullish on a stock but wishes to hedge against potential losses and uncertainty. • Protective puts may be placed on stocks, currencies, commodities, and indexes and give some protection to the downside. A protective put acts as an insurance policy by providing downside protection in the event the price of the asset declines • A protective put is a risk-management strategy using options contracts that investors employ to guard against a loss in a stock or other asset. • For the cost of the premium, protective puts act as an insurance policy by providing downside protection from an asset's price declines. • Protective puts offer unlimited potential for gains since the put buyer also owns shares of the underlying asset. • When a protective put covers the entire long position of the underlying, it is called a married put. Friday, 15 July 2022

Example • Let's say an investor purchased 100 shares of Company stock for Rs.10 per share. The price of the stock then increased to Rs.20, giving the investor Rs.10 per share in unrealized gains—unrealized because it has not been sold yet. • The investor does not want to sell their holdings, because the stock might appreciate further. They also do not want to lose the Rs.10 in unrealized gains. The investor can purchase a put option for the stock to protect a portion of the gains for as long as the option contract is in force. • The investor buys a put option with a strike price of Rs.15 for 0.75 which creates a worst-case scenario of selling the stock for Rs.15 per share. The put option expires in three months. If the stock falls back to Rs.10 or below, the investor gains on the put option from Rs.15 and below on In short, anywhere below Rs.15, the investor is hedged until the option expires. • The option premium cost is Rs.75 (0.75 x 100 shares). As a result, the investor has locked in a minimum profit equal to Rs.425 (15 strike price - 10 purchase price =5 -0.75 premium = 4.25 x 100 shares = 425). • To put it another way, if the stock declined back to the 10 price point, unwinding the position would yield a profit of 4.25 per share, because the investor earned 5 in profit—the 15 strike less 10 initial purchase price—minus the 0.75 cents premium. • If the investor didn't buy the put option, and the stock fell back to 10, there would be no profit. On the other hand, if the investor bought the put and the stock rose to 30 per share, there would be a 20 gain on the trade. The 20 per share gain would pay the investor 2,000 (30 - 10 initial purchase x 100 shares = 2000). The investor Fridmay,u1s5 tJutlhy 2e0n22deduct the 75 premium paid for the option and would walk away with a net profit of 1925.

Covered call • Under such a situation, what do you do? You can book a short-term profit and protect yourself from minor downsides in the price of the stock by using the call option contract of the stock. • And so, you sell a call option contract of the stock at a strike price that is higher than the purchase price of the stock. The buyer of the call option would in turn give you a premium • Let’s take an example. Suppose you own 7,000 shares of ‘XYZ’ company, which you bought at Rs 130 per share . And looking at the future potential of the stock, you wish to hold it. • But at some point, the stock slips into a consolidation mode and repeatedly faces a stiff hurdle around the Rs 135 mark. So you enter the derivatives market and write Call options of the near-month series at Rs 135 per share for the 7,000 shares you hold, at say Rs 4 per share . So, you earn Rs 28,000 (Rs 4 X 7,000). Friday, 15 July 2022

What is covered call • The covered call strategy essentially involves an investor selling a call option contract of the stock that he currently owns. • By selling a call option, the investor essentially locks in the price of the asset, thereby enabling him to enjoy a short-term profit. Apart from this, the investor also gets a slight protection from any future declines in stock prices. • When should you use the covered call option strategy? • The covered call is ideal for neutral and moderately bullish situations, where the future upside potential of the stock that you own is limited. This strategy is ideal when the outlook for the stock that you own is not very bright and when booking short-term profits would be a better idea than to keep holding the stock. • For utilizing a covered call option strategy, you’re required to first own the stock of a company. So, let’s assume that you already hold the stock of a company i.e. going long. Your view when you bought the stock was bullish, but as time passed, you’re now unsure of the future upside potential for the stock and so you don’t expect the price to rise much. Friday, 15 July 2022

Covered call strategy • This strategy can be used to hedge a portfolio. • For example, one buys shares of XYZ at Rs 50 per share with the hope that the stock will move up to Rs 60. • To create a Covered Call, he then writes a Call option at strike price Rs 55 and receives Rs 6 as premium. • Now, the stock falls to Rs 40. Instead of an outright Rs 10 loss, his/her loss will get reduced to just Rs 4, because of the Covered Call strategy. Friday, 15 July 2022

Put Call Parity • Individuals trading options should familiarize themselves with a common options principle, known as put-call parity. • Put-call parity defines the relationship between calls, puts and the underlying futures contract. • This principle requires that the puts and calls are the same strike, same expiration and have the same underlying futures contract. The put call relationship is highly correlated, so if put call parity is violated, an arbitrage opportunity exists. • The formula for put call parity is c + k = f +p, meaning the call price plus the strike price of both options is equal to the futures price plus the put price. Friday, 15 July 2022 Investment Planning & Asset Management

Put Call Parity –Interpretation Friday, 15 July 2022 Investment Planning & Asset Management

Put Call Parity • Using algebraic manipulation, this formula can be rewritten as futures price minus call price plus put price minus strike price is equal to zero f - c + p – k = 0. If this is not the case, an arbitrage opportunity exists. • For example, if the futures price is 100 minus the call price of 5, plus the put price of 10 minus the 105 strike equals zero. • Say the futures increase to 103 and the call goes up to 6. The put price must go down to 8. • Now say the future increases to 105 and the call price increases to 7. The put price must go down to 7. • As we originally said, if futures are at 100, the call price is 5 and the put price is 10. If the futures fall to 97.5, the call price is 3.5, the put price goes to 11. • If a put or call does not adjust in accordance with the other variables in the put-call parity formula, an arbitrage opportunity exists. Consider a 105 call priced at 2, the underlying future is at 100 so the put price should be 7. Friday, 15 July 2022 Investment Planning & Asset Management

Put Call Parity Interpretation Friday, 15 July 2022 Investment Planning & Asset Management

Why is the Put-Call Parity Important? • If you could sell the put at 8 and simultaneously buy the call for 2, along with selling the futures contract at 100, you could benefit from the lack of parity between the put, call and future. • Market Outcomes • Look at different market outcomes demonstrating that this position allows individuals to profit by arbitrage regardless of where the underlying market finishes. • The futures price finished below 105 at expiration. Our short 105 put is now in-the-money and will be exercised, which means we are obligated to buy a futures contract at 105 from the put owner. • When this trade was executed, we shorted a futures contract at 100, therefore our futures loss is $5, given the fact that we bought at 105 and sold at 100. This loss is mitigated by the $8 we received upon the sale of the put. The put owner forfeited the $8 when he exercised his option. • Our long 105 call expires worthless, so we forfeit the $2 call premium. This brings our net profit to $1 with the loss of $5 from the futures and loss of $2 from the call and the gain of $8 from the put. Friday, 15 July 2022 Investment Planning & Asset Management

Why is the Put-Call Parity Important? Friday, 15 July 2022 Investment Planning & Asset Management

Why is the Put-Call Parity Important? • Another scenario, the futures price finished above 105 at expiration. Our long 105 call is now in-the-money allowing us to exercise the call and buy a futures contract at 105. Because we exercised the option, our Rs.2 premium is forfeited. • When this trade was executed, we shorted a future at 100, therefore our futures loss is 5. The 8 we received from the sale of the put is now profit because it expired worthless. If you add up the 8 gain from the put, less the 5 loss from the futures and 2 loss from the call you would net a profit of 1. • If the futures end exactly at 105, both options expire worthless. We lose 5 on the futures and make net 6 in options premium, therefore, we net 1. • We stated earlier that put-call parity would require the put to be priced at 7. We have now seen that a put price of 8 created an arbitrage opportunity that generated a profit of 1 regardless of the market outcome. • Put-call parity keeps the prices of calls, puts and futures consistent with one another. Thus, improving market efficiency for trading participants. Friday, 15 July 2022 Investment Planning & Asset Management

Few questions to practice • An index option is a __________________. • (a) Debt instrument • (b) Derivative product • (c) Cash market product • (d) Money market instrument Friday, 15 July 2022

Few questions to practice • b) • The purchase of a share in one market and the simultaneous sale in a different market to benefit from price differentials is known as ____________. • (a) Mortgage • (b) Arbitrage • (c) Hedging • (d) Speculation Friday, 15 July 2022

Few questions to practice • B) Arbitrage • Financial derivatives provide the facility for __________. • (a) Trading • (b) Hedging • (c) Arbitraging • (d) All of the above Friday, 15 July 2022

Few questions to practice • D) All of the above • You sold one XYZ Stock Futures contract at Rs. 278 and the lot size is 1,200. What is your profit (+) or loss (-), if you purchase the contract back at Rs. 265? • (a) 16,600 • (b) 15,600 • (c) -15,600 • (d) -16,600 Friday, 15 July 2022

Few questions to practice • B) Profit of Rs.15600 • You sold a Put option on a share. The strike price of the put was Rs245 and you received a premium of Rs 49 from the option buyer. Theoretically, what can be the maximum loss on this position? • (a) 196 • (b) 206 • (c) 0 • (d) 49 Friday, 15 July 2022

Few questions to practice • A) 196 (-245+49) • Current Price of XYZ Stock is Rs 286. Rs. 260 strike call is quoted at Rs 45. What is the Intrinsic Value? • (a) 19 • (b) 26 • (c) 45 • (d) 0 Friday, 15 July 2022

Few questions to practice • B) Rs.26 • A Speculator with a bearish view on a security can a) Buy index futures b) Buy stock futures c) Sell stock futures d) Sell index futures Friday, 15 July 2022

Few questions to practice • C) • An Index Call option at a strike price of Rs.17500 is selling at a premium of Rs.200. At what index level will it break even for the buyer and seller of the option ? • A)17700 • B) 17300 • C)17500 • D) None of the above Friday, 15 July 2022

Few questions to practice • A) • A stock PUT option at a strike of Rs.1176 is selling at a premium of Rs.36. At what price level (SP) will it break even for the buyer of the option? a) Rs.1870 b) Rs.1140 c) Rs.1212 Friday, 15 July 2022

Few questions to practice • B) • Premium on a CALL option @ strike of Rs.1500 is Rs.130. If the Spot price is Rs. 1600, compute Intrinsic Value and Time Value • Premium (Option Price)= Intrinsic Value (IV)+Time Value • Intrinsic Value= 1600-1500 (Change in market price) • Time Value= 130-100= 30 • ATM and OTM options have no Intrinsic Value • Only ITM option Friday, 15 July 2022

Structured Products/Market-Linked Securities In general terms, structured products are investment vehicles whose value is derived from, or based on, a reference asset, market measure or investment strategy. Reference assets and market measures may include single equity or debt securities, indexes, commodities, interest rates and/or foreign currencies, as well as baskets of these reference assets or market measures. Market-Linked Notes: Market-linked notes offer a return of principal if held to maturity, subject to the issuer’s ability to repay. In other words, the promise to return principal at maturity is only as good as the financial strength of the company that makes the promise. In the event the issuer goes bankrupt, investors who hold these notes are generally considered unsecured creditors and might recover little, if anything, of their original investment. Friday, 15 July 2022 Investment Planning & Asset Management

Alternative Investments • Alternative investments are those assets and asset classes that fall outside of the scope of traditional stocks, bonds, Real estate and cash. • It include private equity, hedge funds, art, antiques, managed futures • Real estate is also classified as alternative investment in few countries Friday, 15 July 2022 Investment Planning & Asset Management

Asset Classes and Securities Venture Capital & Private Equity Real Estate Commodities

Asset Classes and Securities Private Equity Many individuals use the terms “venture capital” and “private equity” interchangeably, which is incorrect. Venture capital is a type of private equity transaction that targets new, smaller start-up companies. When people say “private equity,” they are usually referring to the other primary type of private equity transaction, which is called a private equity buyout. Private equity buyouts typically involve larger, more established companies that are not performing well for a variety of reasons. The primary objective of many private equity buyouts is to acquire a struggling company, get it back on its feet and performing well, and then sell the company. Friday, 15 July 2022 Investment Planning & Asset Management

Asset Classes and Securities Venture Capital Typically used by start-up companies that do not have the capacity to raise capital through a public stock offering, venture capital involves the exchange of a percentage ownership in the new company in exchange for the start-up capital from a venture capital firm. Companies receiving venture capital money tend to be innovative in nature, and are expected to produce new breakthrough products or services, and as a result experience very rapid growth. Friday, 15 July 2022 Investment Planning & Asset Management

Asset Classes and Securities Hedge Funds Hedge funds are a form of pooled investment structure, but are subject to much less regulation and oversight, and can employ many different strategies. Unlike traditional pooled funds like mutual funds or exchange-traded funds that only take a buy-and-hold approach, hedge funds can establish long and short positions within their holdings, as well as employing the use of options, margin, or other derivative securities. Many diverse hedge fund strategies: Long-short equity Event driven Relative value Global Macro Managed futures Friday, 15 July 2022 Investment Planning & Asset Management

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Chapter-2 Chapter 2: Pooled Investment Products Friday, 15 July 2022 Investment Planning & Asset Management

What is Mutual Fund • Vehicles to mobilize money from investors • Under various schemes • With Different objectives agreed upon between investors and Mutual Fund Mutual Funds vs. Direct Stocks • You have these 3 things, you can invest directly in stocks Money Time Knowledge about Fundamental and Technical Analysis OR It is better to invest through Mutual Fund route Friday, 15 July 2022 Investment Planning & Asset Management

Role of Mutual Funds • Assisting investors in building wealth • Tap a large corpus and participates in opportunities available in various securities • The money mobilized benefits governments, companies invest in various projects • The investee companies provide employment and economic development • As a large investor, MFs check on operations of the investee company, corporate Governance and ethical standards • MF Industry offers employment to large number of Employees, Distributors, Registrars and various other service providers • Also act as market stabilizer in countering large inflows or outflows from foreign investors. • MFs are key participants in Capital market of any economy Friday, 15 July 2022 Investment Planning & Asset Management

How Mutual Fund Schemes work? • NFO (Open ended or Closed ended) • Face value of unit is Rs.10 • Existing schemes have higher value (NAV) • Assets under Management increase with launch of new schemes and increase in value of existing schemes Friday, 15 July 2022 Investment Planning & Asset Management