Investment planning

Trendlines A trendline is a simple charting technique that adds a line to a chart to represent the trend in the market or a stock. Drawing a trendline is as simple as drawing a straight line that follows a general trend. These lines are used to clearly show the trend and are also used in the identification of trend reversals. Channels A channel, or channel lines, is the addition of two parallel trendlines that act as strong areas of support and resistance. The upper trendline connects a series of highs, while the lower trendline connects a series of lows. A channel can slope upward, downward or sideways but, regardless of the direction, the interpretation remains the same Technical Analysis: Support and Resistance Technical analysts often talk about the ongoing battle between the bulls and the bears, or the struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom moves above (resistance) or below (support). As you can see in Figure 1, support is the price level through which a stock or market seldom falls (illustrated by the blue arrows). Resistance, on the other hand, is the price level that a stock or market seldom surpasses (illustrated by the red arrows). These support and resistance levels are seen as important in terms of market psychology and supply and demand. Support and resistance levels are the levels at which a lot of traders are willing to buy the stock (in the case of a support) or sell it (in the case of resistance). When these trendlines are broken, the supply and demand and the psychology behind the stock's movements is thought to have shifted, in which case new levels of support and resistance will likely be established. Support and resistance analysis is an important part of trends because it can be used to make trading decisions and identify when a trend is reversing. Technical Analysis: The Importance of Volume Volume is simply the number of shares or contracts that trade over a given period of time, usually a day. The higher the volume, the more active the security. To determine the movement of the volume (up or down), chartists look at the volume bars that can usually be found at the bottom of any chart. Volume bars illustrate 41

how many shares have traded per period and show trends in the same way that prices do. Volume is an important aspect of technical analysis because it is used to confirm trends and chart patterns. Any price movement up or down with relatively high volume is seen as a stronger, more relevant move than a similar move with weak volume. Therefore, if you are looking at a large price movement, you should also examine the volume to see whether it tells the same story. Technical Analysis: Charts, Chart Types and Chart Patterns In technical analysis, charts are similar to the charts that you see in any business setting. A chart is simply a graphical representation of a series of prices over a set time frame. For example, a chart may show a stock's price movement over a one-year period, where each point on the graph represents the closing price for each day the stock is traded: Figure 1 Figure 1 provides an example of a basic chart. It is a representation of the price movements of a stock over a 1.5 year period. The bottom of the graph, running horizontally (x-axis), is the date or time scale. On the right hand side, running vertically (y-axis), the price of the security is shown. By looking at the graph we see that in October 2004 (Point 1), the price of this stock was around $245, whereas in June 2005 (Point 2), the stock's price is around $265. This tells us that the stock has risen between October 2004 and June 2005. The time scale refers to the range of dates at the bottom of the chart, which can vary from decades to seconds. The most frequently used time scales are intraday, daily, weekly, monthly, quarterly and annually. The price scale is on the right-hand side of the chart. It shows a stock's current price and compares it to past data points. It can be either linear or logarithmic. There are four main types of charts used by investors and traders: line charts, bar charts, candlestick charts and point and figure charts. A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements. There are two types: reversal and continuation.  A head and shoulders pattern is reversal pattern that signals a security is likely to move against its previous trend. 42

 A cup and handle pattern is a bullish continuation pattern in which the upward trend has paused but will continue in an upward direction once the pattern is confirmed.  Double tops and double bottoms are formed after a sustained trend and signal to chartists that the trend is about to reverse. The pattern is created when a price movement tests support or resistance levels twice and is unable to break through.  A triangle is a technical analysis pattern created by drawing trend lines along a price range that gets narrower over time because of lower tops and higher bottoms. Variations of a triangle include ascending and descending triangles.  Flags and pennants are short-term continuation patterns that are formed when there is a sharp price movement followed by a sideways price movement.  The wedge chart pattern can be either a continuation or reversal pattern. It is similar to a symmetrical triangle except that the wedge pattern slants in an upward or downward direction.  A gap in a chart is an empty space between a trading period and the following trading period. This occurs when there is a large difference in prices between two sequential trading periods.  Triple tops and triple bottoms are reversal patterns that are formed when the price movement tests a level of support or resistance three times and is unable to break through, signaling a trend reversal.  A rounding bottom (or saucer bottom) is a long-term reversal pattern that signals a shift from a downward trend to an upward trend. Technical Analysis: Moving Averages Most chart patterns show a lot of variation in price movement. This can make it difficult for traders to get an idea of a security's overall trend. One simple method traders use to combat this is to apply moving averages. A moving average is the average price of a security over a set amount of time. By plotting a security's average price, the price movement is smoothed out. Once the day-to-day fluctuations are removed, traders are better able to identify the true trend and increase the probability that it will work in their favor. There are a number of different types of moving averages that vary in the way they are calculated, but how each average is interpreted remains the same. The calculations only differ in regards to the weighting that they place on the price data, shifting from equal weighting of each price point to more weight being placed on recent data. The three most common types of moving averages are simple, linear and exponential. Technical Analysis: Indicators and Oscillators Indicators are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum. Indicators are used as a secondary measure to the actual price movements and add additional information to the analysis of securities. Indicators are used in two main ways: to confirm price movement and the quality of chart patterns, and to form buy and sell signals. There are two main types of indicators: leading and lagging. A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement. A leading indicator is thought to be 43

the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods. There are also two types of indicator constructions: those that fall in a bounded range and those that do not. The ones that are bound within a range are called oscillators - these are the most common type of indicators. Oscillator indicators have a range, for example between zero and 100, and signal periods where the security is overbought (near 100) or oversold (near zero). Non-bounded indicators still form buy and sell signals along with displaying strength or weakness, but they vary in the way they do this. The two main ways that indicators are used to form buy and sell signals in technical analysis is through crossovers and divergence. Indicators that are used in technical analysis provide an extremely useful source of additional information. These indicators help identify momentum, trends, volatility and various other aspects in a security to aid in the technical analysis of trends. It is important to note that while some traders use a single indicator solely for buy and sell signals, they are best used in conjunction with price movement, chart patterns and other indicators. 1.3.6. Stocks- Fundamental and Technical Analysis Fundamental Vs Technical Analysis Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we've mentioned, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals. Let's get into the details of how these two approaches differ, the criticisms against technical analysis and how technical and fundamental analysis can be used together to analyze securities. The Differences Charts vs. Financial Statements At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company's value. In financial terms, an analyst attempts to measure a company's intrinsic value. In this approach, investment decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it's a good investment. Technical traders, on the other hand, believe there is no reason to analyze a company's fundamentals because these are all accounted for in the stock's price. Technicians believe that all the information they need about a stock can be found in its charts. Time Horizon Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of 44

weeks, days or even minutes, fundamental analysis often looks at data over a number of years. The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company's value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock's market price rises to its \"correct\" value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This \"long run\" can represent a timeframe of as long as several years, in some cases. Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don't emerge on a daily basis like price and volume information. Also remember that fundamentals are the actual characteristics of a business. New management can't implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts. Trading Versus Investing Not only is technical analysis more short term in nature than fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools. Let’s take a more detailed look at the Fundamental Analysis. Technical analysis has already been discussed in detail in the last topic. Fundamental Analysis Fundamental analysis is about understanding the quantitative and qualitative factors that impact earnings of a company and make an estimate of future earnings based on this analysis. Analysts follow two broad approaches to fundamental analysis – top down and bottom up. If the factors to consider are economic (E), industry (I) and company (C) factors, beginning at company-specific factors and moving up to the macro factors that impact the performance of the company is called the bottom-up approach. Scanning the macro economic scenario and then identifying industries to choose from and zeroing in on companies, is the top-down approach. EIC framework is the commonly used approach to understanding fundamental factors impacting the earnings of a company, scanning both micro and macro data and information. Economic Factors The economic cycle has an impact on the performance of companies. A slowdown in Gross Domestic Product (GDP) growth rates can impact investment and consumption-oriented businesses. Revival in economic indicators is tracked by looking at Index of industrial 45

Production (IIP), lead indicators such as auto sales, movement in consumer durables, capital goods imports, purchasing managers‘ index and consumer confidence index. As the momentum returns, concurrent and lag indicators such as changes in GDP, interest rates and wages are monitored. ₹Economic policy has an impact on the performance of most businesses. Direct and indirect tax rates, tax concessions and tax holidays impact business decisions on location, production and pricing. Fiscal policy impacts government and private spending patterns and market borrowing. Monetary policy impacts expectations for interest rates and inflation. External policy impacts relative competitiveness of exports and imports and the currency rates. Tracking policy stance is a critical part of economic analysis. It is important at this stage to know that understanding macro-economic variables is a crucial part of equity analysis. Industry Factors Factors which are specific to an industry impact revenue, costs, margins and growth plans of companies. Consider the following examples: • Regulation: Banking industry in India is subject to regulation that restricts acquisition of Indian banks by foreign banks to some extent. Inorganic and organic growth of banks is subject to several approvals and regulations. The analysis of growth prospects and expansion has to consider these constraints. • Entry Barriers: Telecom business in India can operate only if spectrum is allotted in a particular circle. There are restrictions on who can bid for spectrum and how much would be allotted. There are limitations to overall spectrum availability as well. Thus industry factor may create entry barriers for new players. • Cost: Production of aluminium requires proximity to bauxite ore deposits and is highly energy-intensive. Aluminium producers have to bear the cost of captive power if located near the mines; or higher transport cost if located in a power-surplus location. Cement industry incurs huge transportation costs from the bulk of its produce and geographical dispersion of its markets. Regional costs per bag can vary depending on where the cement is coming from. Raw material costs similarly hit automobile manufacturers. • Seasonal Factors: Sugarcane crushing is a seasonal activity. The industry works at high capacity in the crushing season, and holds the stocks for the rest of the season. Produce demanded during specific seasons, such as umbrellas, rain coats, woollens, coolers, festival accessories, are all subject to seasonal fluctuations in demand. • Cyclicality: Shipping industry builds tonnage based on demand. But it takes a long time to increase tonnage. It is usual for shipping business to find that the economic cycle has turned before the additional capacity is ready. They are saddled with high tonnage during a slack, tend to sell off at losses and then struggle to meet demand when the cycle turns up. These are some examples of industry factors. There can be various other factors such as supply and demand, price elasticity, market segments, market shares and technology. 46

Analyst reports that speak of industry margins, industry PE and industry growth rates, consider these factors and their impact on companies. Company Factors Analysis of company factors encompasses the following: • Ownership structure • Capital Structure • Capital expenditure • Product segments • Market share and growth rates • Competitive environment • Management strategy and quality • Financial history and prospects • Market price statistics • Risk factors to revenue and earnings • Investment rationale • Estimates for growth, margins and earnings • Valuation of the shares Several commercial databases track information about companies and provide fairly detailed information to subscribers. Company analysis involves both quantitative and qualitative analysis. The objective is to present an investment or divestment recommendation on the stock. Detailed financial analysis of a company involves understanding the following: • Order books and growth in revenue • Cost structure and operating margin • Asset base and utilization • Capacity expansion and funding plans • Mix of debt and equity and costs • Interest, depreciation, tax burden • Cash generated by the business • Pre and post tax margin • Earnings defined variously – earnings before interest and tax (EBIT), earnings before interest, depreciation, tax and amortisation (EBIDTA), Profit after tax (PAT), earnings per share (EPS) and so on. • Comparison of earning estimates with revenue, capital, equity, assets, investments, market price and such variables. Such detailed financial analysis tries to understand the factors impacting the earnings of the company and make a reasonable estimate of the future earning and growth potential. 47

Historical estimates are used in understanding the underlying relationship, but recommendations are made based on what is expected, rather than what happened in the past. Valuation Measures Quantitative models are also used to estimate the current value of a share from the estimated future earnings, using the discounted value of cash flows, or applying more complex valuation models that consider the growth prospects, investments, cash flow and sustainability of earnings growth. A simpler approach is to use financial ratios to estimate the value of a share. I. Price Earning Multiple The price-earnings ratio or the PE multiple is a valuation measure that indicates how much the market values per rupee of earning of a company. It is computed as: Market price per share/Earnings per share PE is represented as a multiple. When one refers to a stock as trading at 12x, it means the stocks is trading at twelve times its earnings. The PEx based on historical earnings is of limit value. The prices change dynamically, while the reported earning is updated every quarter. Therefore prices tend to move even after the historical earning per share is known, in anticipation of the future earnings. If it is expected that earnings of a firm will grow then the market will be willing to pay a higher multiple per rupee of earnings. The focus is therefore on ‗prospective‘ PE or how much the current price is discounting the future earnings. For example, we hear analysts say that shares of XYZ company is trading at 20 times its 2013 earnings, but is still about 15 times the 2014 earnings, given the state of its order book. What they are saying is that the growth in EPS is likely to be high, and therefore the current high PE based on historical numbers may not be the right one to look at. Most publications and reports show the PE using historical earning numbers from the latest quarterly reports. Analyst‘s estimates of future earnings are not widely available and they may vary. Some publications report ‗consensus‘ view of prospective earnings. It is common to look at the PE multiple of the index to gauge if the market is overvalued or undervalued. The PE multiple moves high when prices run ahead of the earnings numbers and the market is willing to pay more and more per rupee of earnings. Many would consider a market PE of 22x or above as an overvalued zone (Please note that this varies from industry to industry). When markets correct and uncertainty about future earnings increases, the PE multiple also drops. A value investor, who would like to pick up stocks when they sell at lower valuations, may be interested to purchase when PE is low. 48

Analysts also compare the PE of one company with another, to check the relative value. The PE multiple of a stable, large and well known company is likely to be higher than the PE multiple the market is willing to pay for another smaller, less known, and risky company in the same sector. II. Price to Book Value (PBV) The PBV ratio compares the market price of the stock with its book value. It is computed as market price per share upon book value per share. The book value is the accounting value per share, in the books of the company. It represents the net worth (capital plus reserves) per share. An important limitation of this number is that most assets on the books of the company are shown at cost less depreciation, and not inflation adjusted. Therefore the realizable value of the assets is not reflected in the book value. However, in a company which has been building reserves from sustained profitability, the book value is an important indicator of value. Since the book value considers the net worth of a company, it is an important number in fundamental analysis. If the market price of the stock were lower than the book value (i.e., the PBV is less than one), the stock is deemed to be undervalued and undiscovered. Analysts would concur that the market prices have fallen more than what is justified by the value of the stock, and would consider the price attractive to buy. In a bullish market when prices move up rapidly, the PBV would go up, indicating rich valuation in the market. However, please note that there may be other reasons for a stock being sold for less than its book value such as the poor investments made by the firm in the past which needs to be written down subsequently. Hence investors should not rely only on PBV for their investment decisions and should understand that not all stocks that trade at a discount on their book values are bargains (under-valued). III. Dividend Yield Value investors, who look for the opportunity to buy a stock at a price lower than its fundamental or intrinsic value, prefer a combination of low PE, low PBV and high dividend yield. Dividend yield compares the dividend per share to market price per share. A higher dividend yield would mean that the income potential of the share is not yet reflected in market prices. A lower dividend yield is associated with a higher valuation for a share. Dividend yields are also used as broad levels with which to measure market cycles. A bull market will be marked by falling dividend yields, as prices move up. A bear market will have a relatively higher and increasing dividend yields as prices tend to fall. Some companies have a history of growing and consistent dividends. They are sought by investors who seek a regular income. Public sector units, especially PSU banks, in India tend to have a higher dividend yield. 49

1.3.7. Portfolio Management Scheme (PMS) PMS is an investment facility offered by financial intermediaries to larger investors. Investors can choose to invest through a Portfolio Management Service (PMS) offered by banks, broking houses, mutual funds and others. Unlike mutual funds, which maintain their investment portfolio at the scheme level, the PMS provider maintains a separate portfolio for each investor. The cost structure for PMS, which is left to the PMS provider, can be quite high. Besides a percentage on the assets under management, the investor may also have to share a part of the gains on the PMS portfolio; the losses are however borne entirely by the investor. PMS have an unconstrained range of investments to choose from. The limits, if any, would be as mentioned in the PMS agreement executed between the provider and the client. Variants of PMS structure exist. In some cases the PMS provider has the discretion to decide on investments. In other cases, approval of the client has to be taken for each investment. Some PMS providers operate on ‗advice only‘ basis. The service can either be a discretionary PMS, here the portfolio manager manages the portfolio in alignment with the investor‘s requirement or a non-discretionary PMS where the portfolio manager will provide advice and information to the investor who will themselves take the decisions on investment choices and timing of the investment. The portfolio manager will execute the decisions taken by the investor. A discretionary PMS provides the benefits of professional management of the portfolio with the decisions being taken by the portfolio manager. This service comes at a cost. The portfolios can be structured to meet specific preferences of the investors such as asset classes to invest in, holding concentrated portfolios to enhance returns, and stocks or sectors to avoid. Transactions in the investor account lead to transaction costs and taxes. Investors have easy access to information on their portfolio, even daily. A non-discretionary PMS puts the onus of decision making on the investor, with the portfolio manager providing support and execution facilities. PMS are regulated by SEBI, under the SEBI (Portfolio Managers) Regulations, 1993. However, since this investment avenue is meant only for the larger investors, the mutual fund type of rigorous standards of disclosure and transparency are not applicable. The protective structures of board of trustees, custodian etc. is also not available. Investors therefore have to take up a major share of the responsibility to protect their interests. 1.3.8. Market Correction - Value Correction and Time Correction A correction is a decline or downward movement of a stock, or a bond, or a commodity or market index. The amount of the decline is at least 10 percent and a true correction exceeds that amount. In short, corrections are price declines that stop an upward trend. When the market is showing a trend of closing lower, a correction may be at hand. A correction in the market as a whole does not necessarily tell us how any one stock is performing, however. A stock may remain strong despite a correction - for example, consumer staples tend to perform steadily in any market. A stock could also perform about 50

the same as the overall market during a correction, or it could plummet even further than the overall market. A correction can be an opportunity for value investors to pick up good companies at bargain prices. Time Correction To understand what the phrase \"time correction\" means, one first has to understand that stocks tend to rise over time. A longish period of time in which stocks return little to nothing, represents a kind of correction after a bull run. This correction is a decrease in the market price of an asset or entire market after extensive price increases. It occurs even when there is no evidence that the increasing price trend should cease. It is often caused when investors temporarily slow down their purchases of securities, which commonly leads to a pullback toward a short-term support level. Time correction is a drop in stock or market prices when there is no fundamental reason for a decrease. After a steady increase in value, investors may become more cautious buyers at the higher prices and look to reevaluate the market, resulting in a decrease in purchases. The drop in purchase volume will stop the upward price trend from continuing while the market re-evaluates the short-term direction. Value Correction In theory, a stock‘s price or the value of a market index is supposed to represent the value of the company or the overall health of the stock market. In reality, it‘s often as much of a measure of investor‘s impressions of the market or a company‘s earnings. If investors have confidence that a company will issue dividends or report earnings that back up an increased stock price, they‘re likely to invest in it. The increased demand for the stock, or all stocks in general, drives prices up. Speculation can only drive a market so far before investors realize that the prices they‘re paying for stocks doesn‘t accurately represent a company‘s earnings, and the stocks, or again, the entire market, are either overvalued or undervalued. Once investors discover the disconnect between market prices and the real value of their stocks, demand for the commodities changes markedly, with buyers either purchasing undervalued stocks or selling overvalued ones. Through this process, the market ―corrects‖ itself, returning to represent a more accurate measure of values. A market correction isn‘t a reversal of a longstanding market trend, but a temporary downturn or upturn that‘s counter to the market‘s long-term performance. Corrections can occur in bull and bear markets, and are usually accompanied by a 10 to 20 percent fluctuation of value. After the market correction is over, the market returns to its prior trend, continuing the bull and bear market. Because corrections are but a reversal of a trend for a limited time, it can be difficult to determine if a change is a correction or the start of a long-term trend. 51

1.3.9. Understanding Earnings Growth Cycle The equity market is driven by earnings. The level and growth of earnings and profits are determined by the long-term secular growth trend of the economy and the progression of the economy. Earnings change with economic cycle. Corporate earnings increase during economic expansion and decline or slow in economic contraction. As corporate earnings rise, common stock prices rise. As corporate earnings fall, common stock prices fall. Every business model is unique and every industry has its own demand cycles. Investors are accustomed to reviewing earnings releases at the end of the four fiscal quarters of a company's fiscal year. As per Market Regulator SEBI, guidelines it is compulsory for every listed company to produce quarterly results. Quarterly reports are the earning reports which include company‘s earnings for every share, net income, net sales, and earnings from continuing operations. Normally companies announce results in Press conference or in Leading financial newspapers like Economic times, Business standard, Financial Standard, The Mint etc. A very good outcome of the results will be positive and the stock price will go up. While a bad quarterly results or results below the expectations will have negative effects on the stock price of that company. Thus, the quarterly earnings of companies is one of the important factor which sets the tone for the stock markets. Earnings growth reflects the business conditions of a corporation. If quarterly and annual revenues and earnings are consistently rising (earnings = revenues - costs) then investors will want to own a part of that company. On the stock market, net purchases will increase and the price of a share will also rise. In contrast, beware the company that faces slowing earnings growth, its share price will be punished as investors flee for more promising corporation 1.3.10. Understanding Capital Cycle The working capital cycle (WCC) is the amount of time it takes to turn the net current assets and current liabilities into cash. The longer the cycle is, the longer a business is tying up capital in its working capital without earning a return on it. Therefore, companies strive to reduce its working capital cycle by collecting receivables quicker or sometimes stretching accounts payable. A positive working capital cycle balances incoming and outgoing payments to minimize net working capital and maximize free cash flow. Growing businesses require cash, and being able to free up cash by shortening the working capital cycle is the most inexpensive way to grow. Sophisticated buyers review closely a target's working capital cycle because it provides them with an idea of the management's effectiveness at managing their balance sheet and generating free cash flow. 52

1.3.11. Understanding Secular Bull and Bear Cycles A market trend is a tendency of financial markets to move in a particular direction over time. These trends are classified as secular for long time frames, primary for medium time frames, and secondary for short time frames. The terms bull market and bear market describe upward and downward market trends, respectively, and can be used to describe either the market as a whole or specific sectors and securities. The names perhaps correspond to the fact that a bull rampages forward, while a bear protects itself and (often) retreats. A secular market trend is a long-term trend that lasts 5 to 25 years and consists of a series of primary trends. A secular bear market consists of smaller bull markets and larger bear markets; a secular bull market consists of larger bull markets and smaller bear markets. In a secular bull market the prevailing trend is \"bullish\" or upward-moving. The United States stock market was described as being in a secular bull market from about 1983 to 2000 (or 2007), with brief upsets including the crash of 1987 and the market collapse of 2000-2002 triggered by the dot-com bubble. In a secular bear market, the prevailing trend is \"bearish\" or downward-moving. An example of a secular bear market occurred in gold between January 1980 to June 1999, culminating with the Brown Bottom. During this period the nominal gold price fell from a high of $850/oz ($30/g) to a low of $253/oz ($9/g),[4] and became part of the Great Commodities Depression. Stock markets are subject to bull and bear cycles. A bull market is a period of generally rising prices. Example: India's Bombay Stock Exchange Index, BSE SENSEX, was in a bull market trend for about five years from April 2003 to January 2008 as it increased from 2,900 points to 21,000 points. A bull market is when buyers are willing to pay higher and higher prices, as the overall optimism for better future performance of stocks is high. This happens when businesses are expanding, growing at an above average rate, face favourable and growing demand for their products and services and are able to price them profitably. The returns to equity investors go up as stock prices appreciate to reflect this optimism. As buyers pay a higher and higher price for a stock, prices may move beyond what can be justified by the underlying intrinsic value. Also businesses tend to overreach themselves, borrowing to fund expansion based on optimistic forecasts. Input costs for raw materials and labour and interest costs for capital may increase as the bull market reaches its peak. Unrealistic increase in prices may tend to correct itself with a crash. The bull market paves way to a bear market when stock prices fall and correct themselves. A downturn in economic cycles can lead to stress for several businesses, when they face lower demand for their products and services, higher input and labour costs, lower ability to raise capital and in many cases risks of survival. When the economic conditions change, several businesses that began profitably may come under stress and begin to fail. Bear markets in equity reflect this pessimism, stocks prices fall. Sellers quit in despair, accepting a lower price and a loss on their stocks. As prices may fall well below intrinsic values, buyers 53

who find the valuation attractive will start coming into stocks that now are priced reasonably or lower. Lower interest rates lead to investment, and slowly the bear cycle gives way to the next bull cycle. Stock prices reflect the underlying economic conditions for the market as a whole, the specific business conditions for sectors and companies and move in long-term cycles. Equity capital gets reallocated from failing businesses whose prices have fallen, to performing businesses whose prices appreciate. The overall effect of these cycles is that while long-term return from equity may be high, such return is subject to high short-term volatility. Investing in equity requires skills in constructing a portfolio such that the risks are well diversified across companies and sectors, and then periodically monitoring it for its composition and performance. 54

SUMMARY  The S&P BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply the SENSEX, is a free-float market-weighted stock market index of 30 well- established and financially sound companies listed on Bombay Stock Exchange.  The CNX Nifty is a well diversified 50 stock index accounting for 23 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.  Investing in equity shares of a company means investing in the future earning capability of the company. The return to an investor in equity is in two forms – dividend that may be periodically paid out and changes in the value of the investment in the secondary market over the period of time.  Blue chips stocks that are unsurpassed in quality and have a long and stable record of earnings and dividends. Blue-chip stocks are issued by large, well established firms that have impeccable financial credentials.  Growth shares that have experienced, and are expected to continue experiencing, consistently high rates of growth in operations and earnings are known as growth stocks. A good growth stock might exhibit a sustained rate of growth in earnings of 15% to 18% per year over a period when common stocks, on average, are experiencing growth rates of only 6% to 8%.  High-Dividend stocks are ideal for those who seek a relatively safe and high level of current income from their investment capital. Holders of high-dividend stocks (unlike bonds and preferred stocks) can expect their dividends they receive to increase regularly over time.  Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we've mentioned, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals.  Portfolio Management Services (PMS) is an investment facility offered by financial intermediaries to larger investors. Investors can choose to invest through a Portfolio Management Service (PMS) offered by banks, broking houses, mutual funds and others. Unlike mutual funds, which maintain their investment portfolio at the scheme level, the PMS provider maintains a separate portfolio for each investor.  A secular market trend is a long-term trend that lasts 5 to 25 years and consists of a series of primary trends. A secular bear market consists of smaller bull markets and larger bear markets; a secular bull market consists of larger bull markets and smaller bear markets. 55

Sub-Section 1.4 Derivatives and Commodities 1.4.1. Essential features of Derivatives Derivative is a contract or a product whose value is derived from value of some other asset known as underlying. Derivatives are based on wide range of underlying assets. These include: • Metals such as Gold, Silver, Aluminium, Copper, Zinc, Nickel, Tin, Lead etc. • Energy resources such as Oil (crude oil, products, cracks), Coal, Electricity, Natural Gas etc. • 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 functions: • 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. For example, hedgers want to give away the risk where as traders are willing to take risk. • Derivatives market helps shift of speculative trades from unorganized market to organized market. Risk management mechanism and surveillance of activities of various participants in organized space provide stability to the financial system. Derivatives are typically used for three purposes: a) Hedging b) Speculation c) Arbitrage a) Hedging When an investor has an open position in the underlying, he can use the derivative markets to protect that position from the risks of future price movements. Example: An investor has saved for the education of his child. The portfolio is made up of an index fund that invests in the CNX S&P Nifty. The investor has been systematically investing in this product over the last 15 years. In the next three months, the child would enter college and the investor is keen to liquidate the investment to fund the education expense. The current value of the investment is ₹10 lakhs. The investor can enter into a contract to sell his portfolio three months from now, at a price to be determined today. b) Speculation A speculative trade in a derivative is not supported by an underlying position in cash, but simply implements a view on the future prices of the underlying, at a lower cost. 56

Example: A speculator believes that the stock price of a particular company will go up from ₹200 to ₹250 in the next three months and wants to act on this belief by taking a long position in that stock. If he buys 100 shares of this company in spot market (delivery), he needs ₹200 x 100 = ₹20,000 to enter into this position. If his prediction comes true and the stock price moves up from ₹200 to ₹250, he will make a profit of ₹50 per share and total profit of ₹50 x 100 shares = ₹5,000 over an investment of ₹20,000 which is a return of 25%. Alternatively, he can take a long position in that stock through futures market as well. Suppose he buys a three months futures contract of that stock (1 lot of 100 shares), he need not pay the full amount today itself and pays only the margin amount today. If the margin required for this stock is 10%, then he needs ₹200 x 100 x 10% = ₹2,000 only to take this long position in futures con tract. If the stock price moves to ₹250 at the end of three months, he makes a profit of ₹50 x 100 = ₹5,000 from this contract. Since his initial investment was only ₹2,000, his returns from the futures position will be 5,000/2,000 = 250%. This difference in returns between the spot position and futures position is due to the leverage provided by the futures contracts. This leverage makes the derivatives the favorite product of speculators. However please note that the same leverage makes the derivatives products highly risky. If the market had moved against his prediction, he would have incurred huge losses compared to the spot market position. c) Arbitrage If the price of the underlying is ₹100 and the futures price is ₹110, anyone can buy in the cash market and sell in the futures market and make the costless profit of ₹10. This is called arbitrage. The ₹10 difference represents the cost of buying at ₹100 today, selling at ₹110 in the future, and repaying the amount borrowed to buy in the cash market with interest. Arbitrageurs are specialist traders who evaluate whether the ₹10 difference in price is higher than the cost of borrowing. If yes, they would exploit the difference by borrowing and buying in the cash market, and selling in the futures market at the same time (simultaneous trades in both markets). If they settle both trades on the expiry date, they will make the gain of ₹10 less the interest cost, irrespective of the settlement price on the contract expiry date, as long as both legs settle at the same price. After necessary approvals from SEBI, derivative contracts in Indian stock exchanges began trading in June 2000, when index futures were introduced by the BSE and NSE. In 2001, index options, stock options and futures on individual stocks were introduced. India is one of the few markets in the world where futures on individual stocks are traded. Equity index futures and options are among the largest traded products in derivative markets world over. In the Indian markets too, volume and trading activity in derivative segments is far higher than volumes in the cash market for equities. Other highly traded derivatives in global markets are for currencies, interest rates and commodities. 57

1.4.2. Futures and Options - Call Option and Put Option Derivative Products are either traded on organized exchanges (called exchange traded derivatives) or agreed directly between the contracting counterparties over the telephone or through electronic media (called Over-the-counter (OTC) derivatives). I. 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 honour 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. II. 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. III. Options An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying on or before a stated date and at a stated price. While buyer of option pays the premium and buys the right, writer/seller of option receives the premium with obligation to sell/ buy the underlying asset, if the buyer exercises his right. 58

Options are derivative contracts, which splice up the rights and obligations in a futures contract. The buyer of an option has the right to buy (in case of ―call‖) or sell (in case of ―put‖) an underling on a specific date, at a specific price, on a future date. The seller of an option has the obligation to sell (in case of ―call‖) or buy (in case of ―put‖) an underlying on a specific date, at a specific price, on a future date. An option is a derivative contract that enables buyers and sellers to pick up just that portion of the right or obligation, on a future date. A buyer of an option has the right to buy (in case of call) or sell (in case of put) the underlying at the agreed price. He is however not under obligation to exercise the option. The seller of a call option has to complete delivery as per the terms agreed. For granting this right to the buyer, the seller collects a small upfront payment, called the option premium, when he sells the option. A call option represents a right to buy a specific underlying on a later date, at a specific price decided today. A put option represents a right to sell a specific underlying on a later date, at a specific price decided today. Option Terminology Arvind buys a call option on the Nifty index from Salim, to buy the Nifty at a value of 5400, three months from today. Arvind pays a premium of ₹100 to Salim. What does this mean? • Arvind is the buyer of the call option. • Salim is the seller or writer of the call option. • The contract is entered into today, but will be completed three months later on the settlement date. • 5400 is the price Arvind is willing to pay for Nifty, three months from today. This is called the strike price or exercise price. • Arvind may or may not exercise the option to buy Nifty at 5400 on the settlement date. But if he exercises the option, Salim is under obligation to sell the Nifty at 5400 to Arvind. • Arvind pays Salim ₹100 as the upfront payment. This is called the option premium. This is also called as the price of the option. • On settlement date, Nifty is at 5700. This means Arvind‘s option is ―in the money.‖ He can buy the Nifty at 5400, by exercising his option. • Salim earned ₹100 as premium, but lost as he has to sell Nifty at 5400 to meet his obligation, while the market price is 5700. • On the other hand, if on the settlement date, the Nifty is at 5200, Arvind‘s option will be ―out of the money.‖ • There is no point paying 5400 to buy the Nifty, when the market price is 5200. Arvind will not exercise the option. Salim will pocket the ₹100 he collected as premium. Buy a Call option: This gives the buyer of the option the right to buy a security on a specified date in future at the specified price, also known as strike price. The buyer of option pays a premium to the seller of option (also known as writer). The buyer 59

exercises the right if on the specified date; the strike price is lower than the market price (spot price) of the security. Buy a Put option: This gives the buyer of the option the right to sell a security on a specified date in future at the specified price (strike price). The buyer of option pays a premium to the seller of option. The buyer exercises the right if on the specified date; the strike price is higher than the market price (spot price) of the security. Sell a Call option: This obligates the seller (writer) of the option to sell a security on a specified date in future at the specified price (strike price), if the buyer of the option exercises the right to transact. The seller of option receives a premium from the buyer of option. The buyer exercises the right if on the specified date; the strike price is lower than the market price (spot price) of the security. Sell a Put option: This obligates the seller (writer) of the option to buy a security on a specified date in future at the specified price (strike price), if the buyer of the option exercises the right to transact. The seller of option receives a premium from the buyer of option. The buyer exercises the right if on the specified date; the strike price is higher than the market price (spot price) of the security. As seen from the above examples, option buyer has limited loss (premium paid) and unlimited profit whereas option seller/writer has unlimited loss and limited profit (premium received). IV. Swaps A swap is an agreement made between two parties to exchange cash flows in the future according to a prearranged formula. Swaps are, broadly speaking, series of forward contracts. Swaps help market participants manage risk associated with volatile interest rates, currency exchange rates and commodity prices. 1.4.3. Commodity Investments – Futures, Physical Stock, ETFs, etc. When investors seek to move beyond the traditional asset classes, they look for asset classes with low correlation. They also seek hedge against inflation, attractive returns and diversification benefits when traditional asset classes under perform. Commodities have emerged as a sought after asset class in this context. Commodities have an inherent return that is generated based on their demand and supply. Investors can earn such returns both by a passive index replication and from active management of a commodity portfolio. Investing in commodities can be done using three routes: • investing in commodity indices or their ETFs • investing in commodity-based stocks, bonds or mutual funds • investing in commodity futures or hedge funds. It must be noted that mutual funds in India are not yet allowed to invest in commodities directly, except gold. Exposure to commodities through mutual funds is possible by investing in commodity-based mutual funds, which invest in stocks and bonds of companies in the commodity sector. For example, a commodity-based fund may take 60

exposure to non-ferrous and ferrous metals by holding shares of Hindalco and SAIL in its portfolio. In 2002, a new set of commodity exchanges (Multi Commodity Exchange of India – MCDEX and National Commodity Exchange of India – NCDEX) began operations in 2003. Both exchanges deal in standardized futures contracts in commodities. New commodity exchanges have also come up viz., Indian Commodity Exchange Limited, National Multi- Commodity Exchange of India Ltd etc. The Forward Markets Commission is the regulatory authority for commodity exchanges. Commodity Futures A popular way to invest in commodities is through commodity futures, which are agreements to buy or sell a specific quantity of a commodity at a specific price at a future date. Commodity exchanges are permitted to trade goods including agricultural produce (such as cotton, pulses), precious metals (such as gold, silver, platinum) and industrial metals (such as zinc, copper, iron ore, aluminium) and fossil fuels, including crude oil. Commodities derivatives are a fine choice for those who want to broaden away from real estate, bonds, shares, etc. One can trade if commodities derivatives through three multi commodities exchanges in the country; MCX, NCDEX, and NMCE. Multi Commodity Exchange of India Ltd. (MCX) is India‘s leading commodity futures exchange and the world‘s one of highest ranking commodity in Natural Gas, Crude Oil, Silver and Gold. Exchange Traded Funds ETFs are just what their name implies: baskets of securities that are traded, like individual stocks, on an exchange. Unlike regular open-end mutual funds, ETFs can be bought and sold throughout the trading day like any stock. Most ETFs charge lower annual expenses than index mutual funds. However, as with stocks, one must pay a brokerage to buy and sell ETF units, which can be a significant drawback for those who trade frequently or invest regular sums of money. ETFs are not futures Even though ETFs and Futures allow investors exposure to an index, they are different in many regards. While Futures is a derivative product and trades in the F&O segment of NSE, ETFs are a cash market product and trade in the Capital Market segment of NSE. The maximum tenure available for futures is 3 months while ETFs can be held for as long as the investor wants. Physical Gold Vs Gold ETF Gold in physical form entails high costs towards storage, security and purity. However, ETF offers a cost efficient way to take exposure to gold A gold exchange-traded fund (or GETF) is an exchange-traded fund (ETF) that aims to track the price of gold. Gold ETFs are units representing physical gold which may be in paper or dematerialised form. These units are traded on the Exchange like a single stock of any company. Gold ETF's are intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that participation through the trading of a security on a stock exchange. 61

1.4.4. e-Gold, e-Silver, etc. NSEL had introduced e-Series products in commodities for retail investors. These are investment products that enable investors to buy and sell commodities in demat form and hold them in their demat account. E-Series products provide opportunity for intra-day trading, coupled with demat delivery in respect of positions outstanding at end of the day. NSEL had launched e-Gold, e-Silver, e- Copper, e-Zinc, e-Lead, e-Nickel and e-Platinum. Systemic investments in e-series products promotes savings in a secured way offering ease of transaction and flexibility of trade timings. This instrument provides ample opportunity to the mass as secured investment in their product basket diversification. What is the electronic form of buying Gold or Silver ‗E-Gold‘ is electronic gold currency operated by Gold & Silver Reserve Inc. under e-gold Ltd., and allows a moment transfer of gold ownership among users. ‗E-Gold‘ units can be bought and sold through the exchange called National Spot Exchange Limited (NSEL) just like shares are bought and sold. ‗E-Gold 'and ‗E-Silver‘ launched by National Spot Exchange Limited (NSEL) is a combination of both the forms - physical and electronic. Benefits NSEL enables one to buy gold, silver and copper in electronic form, and hold it in a de- materialized (Demat) account. It provides a digital, transparent, unionized and centralized trading platform with the facility to approach and enter the market simply from several locations. It facilitates risk free and trouble free purchase and sell of quality and quantity specified commodities to the commodity market. NSEL is recognized by the Ministry of Consumer Affairs, and the Government of India. Procedure Since ‗E-Gold‘ and ‗E-Silver‘ can only be purchased in electronic form, you need to have a demat account. A Demat account is like a case where you can store your shares, assets and bonds electronically. The existing Demat account which you are using for your shares etc. will not work for holding E-Gold units. Therefore, you need to open a separate demat account with one of the depository participants impaneled with the National Spot Exchange Limited (NSEL). The list of options of such depository participants is available on the web site of National Spot Exchange A Safe Transaction Gold and silver are seen as safe investment options. The same is also reflected in the rising prices of these commodities. E-Gold and E-Silver is not affected by any economic crisis. Since gold is an excellent hedge against inflation, it is always best to buy gold as an investment. By buying gold in electronic form, one need not worry about the purity of gold, storage costs and the insurance of gold. Individuals buying E-gold only for investment purpose and not for usage can always sell the E-gold units and encash them. If one wants to 62

take physical delivery of E-gold units then he can take it in multiples of 8 grams, 10 grams, 100 grams and 1 kg. Gold ETF vs. E-Gold Gold Exchange Traded Funds (ETFs) is another method to invest your money in gold. It gives an opportunity to gain multi-fold returns on gold price movement. Gold ETF‘s are designed to benefit investors with high risk appetite. But the biggest advantage of investing in E-Gold over gold ETF‘s is that it involves no management costs or other recurring expenses. So, the product works out to be more effective for people who have a long-term investment horizon. ‗E-Gold‘ and ‗E-Silver‘ investment gives better returns as compared to ETF‘s. National Spot Exchange charges 0.4 % annually while the charge is 2.5 % for ETFs. Transparent pricing, and zero holding costs are some of the advantages of ‗E-Gold‘ and ‗E- Silver‘ trading. The only charge involved in the E-series of purchasing assets is the one-time transaction fee of 2-3 paisa per gram and a brokerage fee of 0.2-0.3%. Both these charges also apply in case of gold ETFs at much higher rates. ‗E-Gold‘ can be converted into physical gold for quantities as small as 8 gm, while gold ETF‘s offers the option of physical delivery but only for an appellation of over a kilogram. Accumulating such a huge amount of gold is not feasible for small investors and is a huge responsibility for a common man with limited capacity. E-Silver E-Silver is a new incarnation of silver, innovated by National Spot Exchange (NSEL), which enables investors to invest their funds into silver in smaller denomination and hold it in demat form. It is available on the pan India electronic trading platform set-up by National Spot Exchange, which can be accessed through members of NSEL or their franchises. It provided an unique opportunity to buy, accumulate, hold and liquidate \"Electronic Silver (E-Silver)\" as well as to convert the same into physical silver coin/ bar in a seamless manner. Contract Specifications of E-Silver (Demat Silver Units) Commodity Details Commodity E-SILVER (Demat Silver units) Contract Symbol E-SILVER Daily contract Daily contract for trading in Demat E-SILVER units Trading Related Parameters Trading period Monday To Friday (except Exchange specified holidays) Trading session 10:00 AM to 11:30 PM Trading unit One lot of 100 demated units of E-Silver, which is equivalent to 100 grams of Silver. Price Quote/Base Value Per 100 gram Silver of 999 purity Tick size (minimum price 10 paise per Trading unit movement) 63

Daily Price Range 5% Maximum order size 50000 units Margin Parameters Initial Margin 5% Delivery Margin 10% Special Margin In case of additional volatility, a special margin of such percentage, as deemed fit, will be imposed immediately on both buy and sale side in respect of all outstanding position, which will remain in force for the same trading day. Demat Parameters ICIN INC200000015 Market description T+2 Settlement cycle T+2 Delivery Related Parameters Delivery unit 1 lot (equivalent to 100 Demated units of E-Silver) Quality Specifications Grade: 999 and Fineness: 999 Only dematerialized units of E-SILVER are eligible for trading and delivery in this contract. Tender and Delivery day T+2 (2 working day from the date of transaction) Delivery Logic Compulsory delivery All open positions (buy and Sell trades) must result into compulsory delivery in demat form on the designated delivery day. Other conditions a) Only such clients/ members shall create sale position in applicable this contract, who are holding demat E-SILVER units in their account. Persons holding Silver bars/coins in physical form must not create any sale position in this contract, as it is compulsory demat settlement contract. b) Before creating any buy position in this contract, the client should open his beneficiary account for NSEL trading. c) Intraday trading and netting is permitted, but short sale is not allowed. In case of short sale, the position will be settled by buying in auction of undelivered position. 64

SUMMARY  Derivative is a contract or a product whose value is derived from value of some other asset known as underlying. Derivatives are based on wide range of underlying assets.  Derivatives are typically used for three purposes – Hedging, Speculation and Arbitrage  Derivative Products are either traded on organized exchanges (called exchange traded derivatives) or agreed directly between the contracting counterparties over the telephone or through electronic media (called Over-the-counter (OTC) derivatives).  Forward 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.  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.  An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying on or before a stated date and at a stated price. While buyer of option pays the premium and buys the right, writer/seller of option receives the premium with obligation to sell/ buy the underlying asset, if the buyer exercises his right.  A call option represents a right to buy a specific underlying on a later date, at a specific price decided today. A put option represents a right to sell a specific underlying on a later date, at a specific price decided today.  A swap is an agreement made between two parties to exchange cash flows in the future according to a prearranged formula.  Commodities derivatives are a fine choice for those who want to broaden away from real estate, bonds, shares, etc. One can trade if commodities derivatives through three multi commodities exchanges in the country; MCX, NCDEX, and NMCE.  Gold in physical form entails high costs towards storage, security and purity. However, ETF offers a cost efficient way to take exposure to gold  ‗E-Gold‘ is electronic gold currency operated by Gold & Silver Reserve Inc. under e-gold Ltd., and allows a moment transfer of gold ownership among users. ‗E-Gold‘ units can be bought and sold through the exchange called National Spot Exchange Limited (NSEL) just like shares are bought and sold. ‗E-Gold 'and ‗E-Silver‘ launched by National Spot Exchange Limited (NSEL) is a combination of both the forms - physical and electronic. 65

Sub-Section 1.5 Foreign Exchange Market 1.5.1. Functions of the Foreign Exchange Market and Participants The origin of the foreign exchange market in India could be traced to the year 1978 when banks in India were permitted to undertake intra-day trade in foreign exchange. However, it was in the 1990s that the Indian foreign exchange market witnessed far reaching changes along with the shifts in the currency regime in India. The exchange rate of the rupee, that was pegged earlier was floated partially in March 1992 and fully in March 1993 following the recommendations of the Report of the High Level Committee on Balance of Payments (Chairman: Dr.C. Rangarajan). The unification of the exchange rate was instrumental in developing a market-determined exchange rate of the rupee and an important step in the progress towards current account convertibility, which was achieved in August 1994. The foreign exchange market is the market to determine the price of different currencies in terms of one another in order to enable trade between countries and to provide a way to transfer currency associated risks arising from economic transactions. The legal framework for the conduct of foreign exchange transactions in India is provided by the Foreign Exchange Management Act, 1999.Foreign exchange transactions in India happens both on an OTC market and an exchange traded market. The Indian foreign exchange market is a decentralised multiple dealership market comprising two segments – the spot and the derivatives market. In the spot market, currencies are traded at the prevailing rates and the settlement or value date is two business days ahead. The two-day period gives adequate time for the parties to send instructions to debit and credit the appropriate bank accounts at home and abroad. The derivative segment of the foreign exchange market is assuming significance and the activity in this segment is gradually rising. The foreign exchange derivative products that are now available in Indian financial markets can be grouped into three broad segments, viz., forwards, options (foreign currency rupee options and cross currency options) and currency swaps (foreign currency rupee swaps and cross currency swaps). Though forward contracts exist for maturities up to one year, majority of forward contracts are for one month, three months, or six months. Forward contracts for longer periods are not as common because of the uncertainties involved and related pricing issues. A swap transaction in the foreign exchange market is a combination of a spot and a forward in the opposite direction. As in the case of other emerging market economies (EMEs), the spot market is the dominant segment of the Indian foreign exchange market. Participants The principal participants in the foreign exchange market are the authorized dealers (AD), foreign exchange brokers and customers. The authorized dealers are the market makers who give buy and sell quotes for different currency pairs. The brokers act as intermediaries who find the best quotes for their clients who may be the end users of the currency. For dealing in foreign exchange market, the intermediaries need to be registered with RBI. Authorized dealers are banks and others who are licensed to deal in the foreign exchange market by the RBI. RBI categorizes ADs into category I, II and III. The eligibility norms and scope of permitted activity differ for each category. The RBI also appoints Full Fledged 66

Money Changers who are authorized to purchase foreign exchange from resident and non- residents visiting India and to sell foreign exchange for specific purposes such as private visits and business visits up to the limit fixed by RBI. Brokers are intermediaries who enable currency trades of their client by making available the bid and ask quotes provided by different dealers. They compare rates and execute trades for their clients. They do this for a commission. The customers are the end users of foreign exchange. They may be the government, banks, public sector units and private companies, FIIs and individuals and others who need foreign exchange for their transactions. Authorized dealers provide quotes for currency pairs such as USDINR, EURINR, GBPINR and so on. The quote defines the price of one unit of the first currency in a pair in terms of the other. This is the global market practice. The first currency is called the base currency and the second one is the quotation currency. For example, a quote of EURINR 76.7652 reads as a price of INR 76.7652 for one unit of Euro. The Euro is the base currency and the rupee is the quotation currency in this example. 1.5.2. Determinants of Exchange Rates The foreign exchange rates constantly respond to a number of economic variables, both domestic and global, which have an impact on the demand and supply of foreign currency in the short-term and long term. Some of the factors that affect the value of a currency in the foreign exchange market include the gross domestic product (GDP) growth rate, balance of payment situation, deficit situation, inflation, interest rate scenario, policies related to inflow and outflow of foreign capital. It is also a function of factors like prices of crude oil, value of against other currency pairs and geopolitical situation. These economic indicators, not only of the Indian economy but also of other countries, determine the exports and imports of the country, its attractiveness as a destination for investment through FDI as well as portfolio flows and the risks that are seen in the economy. The flow of foreign currency in and out of the country as a result of the economic situation will determine the exchange rate. At any point in time some factors may support an appreciation in the currency while other factors may indicate a weakening or depreciation. In the short-term, the dominant factor may decide the direction of the currency movement. In the long-term the market will incorporate all the information that is relevant to the currency and decides the overall impact on the currency. The exact impact would be a function of relative health of other economies, global risk appetite among investors and market expectations. Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no particular order; like many aspects of economics, the relative importance of these factors is subject to much debate. 67

1. Differentials in Inflation As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. This is also usually accompanied by higher interest rates. 2. Differentials in Interest Rates Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates. 3. Current-Account Deficits The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country's exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interests. 4. Public Debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant of its exchange rate. 68

5. Terms of Trade A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved. Increasing terms of trade shows greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate than that of its imports, the currency's value will decrease in relation to its trading partners. 6. Political Stability and Economic Performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries. The exchange rate of the currency in which a portfolio holds the bulk of its investments determines that portfolio's real return. A declining exchange rate obviously decreases the purchasing power of income and capital gains derived from any returns. Moreover, the exchange rate influences other income factors such as interest rates, inflation and even capital gains from domestic securities. While exchange rates are determined by numerous complex factors that often leave even the most experienced economists flummoxed, investors should still have some understanding of how currency values and exchange rates play an important role in the rate of return on their investments. 1.5.3. Speculative and Hedging Instruments - Futures, Options, Interest Rate Swaps, etc. Currency risks could be hedged mainly through forwards, futures, swaps and options. Each of these instruments has its role in managing the currency risk. The main advantage of currency futures over its closest substitute product, viz. forwards which are traded over the counter lies in price transparency, elimination of counterparty credit risk and greater reach in terms of easy accessibility to all. Currency futures are expected to bring about better price discovery and also possibly lower transaction costs. Apart from pure hedgers, currency futures also invite arbitrageurs, speculators and those traders who may take a bet on exchange rate movements without an underlying or an economic exposure as a motivation for trading. Futures and options are the exchange traded derivatives available on recognized stock exchanges permitted to deal in currency derivatives by SEBI and the RBI. Exchange traded currency derivatives can be used to hedge a currency position, speculate on the future direction of the market and to benefit from arbitrage opportunities. 69

Futures A futures contract is a standardized forward contract, traded on an exchange, to buy or sell a certain underlying asset or an instrument at a certain date in the future, at a specified price. Some of the common terms used in the context of currency futures market are given below:  Spot price: The price at which the underlying asset trades in the spot market.  Futures price: The current price of the specified futures contract  Contract cycle: The period over which a contract trades. The currency futures contracts on the SEBI recognized exchanges have one-month, two-month, and three- month up to twelve-month expiry cycles. Hence, these exchanges will have 12 contracts outstanding at any given point in time.  Value Date/Final Settlement Date: The last business day of the month will be termed as the Value date / Final Settlement date of each contract. The last business day would be taken to be the same as that for Inter-bank Settlements in Mumbai. The rules for Interbank Settlements, including those for ‗known holidays‘ and ‗subsequently declared holiday‘ would be those as laid down by Foreign Exchange Dealers‘ Association of India (FEDAI).  Expiry date: Also called Last Trading Day, it is the day on which trading ceases in the contract; and is two working days prior to the final settlement date.  Contract size: The amount of asset that has to be delivered under one contract. Also called as lot size. In the case of USDINR it is USD 1000; EURINR it is EUR 1000; GBPINR it is GBP1000 and in case of JPYINR it is JPY 100,000.  Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.  Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market. Futures contracts provide the same benefits of hedging as a forward contract. Persons who have payment obligations in a foreign currency in the future can buy a currency pair future that will lock in the price today. Depreciation in the rupee will not affect them. They will still need to pay on the price decided at the time of buying the future contract. On the other hand, persons excepting to receive a sum in foreign currency would like to protect the rupee value from the effects of rupee appreciation. They can do this by selling the relevant currency pair future and at maturity receive the price decided at the time of entering the contract, irrespective of the price movement. Options SEBI and RBI permitted introduction of USDINR options on stock exchange from July 30 2010.Eligible stock exchanges are expected to take approval from SEBI for introducing USDINR options. 70

Option is a contract between two parties to buy or sell a given amount of asset at a pre- specified price on or before a given date.  The right to buy the asset is called call option and the right to sell the asset is called put option.  The pre-specified price is called as strike price and the date at which strike price is applicable is called expiration date.  The difference between the date of entering into the contract and the expiration date is called time to maturity.  The party which buys the rights but not obligation and pays premium for buying the right is called as option buyer and the party which sells the right and receives premium for assuming such obligation is called option seller/ writer.  The price which option buyer pays to option seller to acquire the right is called as option price or option premium  The asset which is bought or sold is also called as an underlying or underlying asset. Buying an option is also called as taking a long position in an option contract and selling is also referred to as taking a short position in an option contract. Option gives a right but does not impose an obligation on the buyer to buy or sell depending upon what type of option has been bought. In a futures contract there is an obligation to buy or sell, depending upon the nature of futures bought. The buyer of a call option will be ‗in the money‘ and exercise the call option as long as the spot price of the currency at the time of maturity is higher than the strike price. The position will break even at (strike price +premium paid) and at any level of the spot price after that the position can make unlimited profits. The seller of the option believes that the underlying currency will not depreciate. The profits of the seller will be limited to the premium earned but the losses can be unlimited. The buyer of a put option believes that the underlying currency will appreciate and therefore buys the right to sell at the strike price. The position is in the money if at maturity the spot price is lower than the strike price. Breakeven is achieved at a spot price level of (strike price premium) and unlimited profits are possible at all levels of the spot price below this. The seller or writer of the put option believes that the underlying currency will not appreciate. The seller‘s profits are limited to the premium but the losses can be unlimited. Swaps Swaps are agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:  Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.  Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction 71

SUMMARY  The foreign exchange market is the market to determine the price of different currencies in terms of one another in order to enable trade between countries and to provide a way to transfer currency associated risks arising from economic transactions.  The foreign exchange rates constantly respond to a number of economic variables, both domestic and global, which have an impact on the demand and supply of foreign currency in the short-term and long term.  Currency risks could be hedged mainly through forwards, futures, swaps and options.  A futures contract is a standardized forward contract, traded on an exchange, to buy or sell a certain underlying asset or an instrument at a certain date in the future, at a specified price.  Option is a contract between two parties to buy or sell a given amount of asset at a pre- specified price on or before a given date.  Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction. 72

Sub-Section 1.6 Real Estate and Other Investments 1.6.1. Forms of Real estate- Land, Residential and Commercial In case of real estate investments, categorization as residential and commercial properties is the most common basis for classification. Other categorisations include investment in land versus investment in constructed property and classification based on the stage of investment in a project, such as pre-launch stage, under-construction and completed property. These sub-categories form the basis of diversification in a real estate portfolio since there are variations in the risks and returns from each category. For example, rents from commercial property is more susceptible to economic downturns, see greater volatility in rentals and values and have longer gestation periods, as compared to residential property. For the bulk of investors, the most important asset in their portfolio is a residential house. The real estate can be categorized in the following types: (i) Agricultural land. (ii) Semi urban land. (iii) Residential Property. (iv) Commercial property. Physical Investment in Land The investment may be in agricultural land or non-agricultural (NA) land for residential purposes or land reserved for specific purposes such as industry, school, tourism etc. Agricultural income from agricultural land is not taxable. Further, agricultural land is exempt from wealth tax too. Appreciation in agricultural land value along with regular income makes it an attractive investment vehicle. Residential land in suburban areas is usually available at prices lower than those prevailing in the city. This is usually a converted land in private layouts and has a high potential for capital appreciation as the infrastructure increases and surrounding areas develop. Investment in land suffers from the following limitations:  Land records in various parts of the country are subject to manipulation. Therefore, verification of ownership is cumbersome and fraught with risk.  At times, restrictions on purchase or use of land are known much later. Investors are known to lose money when it is subsequently found that it is forest land or tribal land.  Encroachments on land are common. Once encroached, it becomes difficult to getrid of the encroachers, who are at times backed by local leaders.  Land might get acquired by the government for public purpose. In that case, the investor may not get the full value.  Purchase and sale of land entail stamp duty and registration charges that are high. 73

 Many sellers expect to be paid for their land through unaccounted money. This makes it difficult for honest tax payers to invest in land.  Land valuation can be quite subjective. The market is not transparent.  Land is not so liquid.  Land generally does not offer rental income.  There are limitations on access to bank finance for purchase of land. Physical Investment in Property The appreciation in real estate comes out of the land; buildings depreciate. Therefore, subject to the limitations mentioned above (many of which are also applicable to buildings), investing in land offers a better return on investment (in percentage terms) than investing in land and building. Another aspect to consider is residential versus commercial. Experts believe that growth prospects are better with residential property, while rental prospects are better in the case of commercial. Investment in Residential Property: This investment vehicle provides returns in the form of rent and capital appreciation. Tax rebates are available on interest paid and principal repayment when the investment is through a loan. Further, long term loans at attractive rates make this investment attractive. Investment in Commercial property: For an investor, constructing a commercial complex or buying a shop or office in a commercial complex could offer regular rental income and capital appreciation over a time period. However this investment requires sufficient outlay and time and effort in managing it. The following are the benefits of investing in land and building or such other property:  Financing from banks or other such intermediaries become possible.  Rental income is possible.  Encroachment risk is lower than in the case of investment in land alone.  Property, especially in cities is more liquid.  The role of unaccounted money is lesser Real estate investments require a large investment, and thus needs to be financed. In addition to residential house, the more affluent investors are likely to invest in other types of real estate. 1.6.2. Interplay of Cost of Credit, Rentals and Tax Benefits on Realty Investments A house is probably the most expensive purchase that one makes—be it for self-use or as an investment. Investment in real estate offers additional immediate benefits in the form of rental income or personal use rather than just capital appreciation, making it an attractive asset class. For most households, this asset is the largest and most expensive one they would hold on their portfolio. Fundamentally, property is also a safe investment because it's a tangible asset. 74

Cost of credit: Since real estate investment requires a large investment, it is therefore typically acquired with a combination of savings and loans. Property is one of the few investments where loans are easily available for it. Generally, banks usually limit installments at 40-50 per cent of the borrower's salary. The loan amount is capped at 70-80 per cent value of the property. Some investors take loans to buy their second home to gain from tax deductions on principal and interest payments. Real estate allows one to monetize and own assets simultaneously. Notwithstanding the financial burden imposed by EMIs, the actual asset being created offers the buyer far more flexibility than other alternatives. As compared to other forms of investments (fixed deposits, mutual funds, equities, gold, and others), property, while being immovable, offers both tangible and intangible benefits. Here, it is pertinent to note that while other assets such as gold, FDs and mutual funds have to be monetized to reap the returns, with a house it is not so. The buyer can choose to occupy the property or alternately, lease if out and generate a regular rental income. Rentals Generate Cash Flow: A common approach to investment in real estate is buying an independent house, apartment or commercial space to be rented out. On renting out the property, one can benefit from rental incomes in addition to capital appreciation. Such rental incomes are to an extent inflation-protected, because as operating costs increase, the rental income increases too, compensating the additional expense outgo. The high capital values combined with high cost of loans also implies that most real estate investments have negative cash flows for the investor in the initial period of investment. That is, the cash inflow in the form of rent earned on the property being lower than cash outflow on the property on account of home loan repayments, property taxes and maintenance. Over a period of time, as rents go up and loan repayments cease, the cash flow from the investment turns positive. The periodic returns from real estate in the form of rentals has shown to be sensitive to inflation and tend to increase in such situations while the real returns from debt goes down. Rents usually increase with inflation, while mortgage payments on the property remain stable. This increases cash flow, with more rent income without increased expense for holding the property. When inflation is up, it can also mean more renters, as the affordability of homes can be negatively impacted by inflation. More renters increases demand, so rents can escalate. Rental properties normally appreciate in value with inflation. Increased value can mean sale and reinvestment in higher value properties, or provide an equity line of credit to use for other investments. This is the second, and a historically proven value component of real estate investment return. However, real estate growth is aligned to economic cycles, as real estate growth has a high dependence on money supply and credit availability. The drawback of real estate comes from the low liquidity that it has. If there is an emergency and funds are required immediately, it will be difficult to liquidate the investment fast, though it is possible to get a loan against the property. Tax Benefits 75

A house is the biggest purchase most people make in their lifetime and the government realizes this. To give buyers relief, the government has allowed income tax (I-T) deductions if the property is bought on a loan. Under Section 80C, the borrower can claim deduction of up to ₹1.5 lakh. For a self-occupied property, ₹2 lakh benefit is available under Section 24 (b) of the Income Tax Act for interest on the home loan. If the property is not self-occupied, the entire interest paid to the lender can be deducted from income. 1.6.3. Ways to Gain Long-term Capital Appreciation and Steady Income Steam Real estate investments may be structured as income generating or growth oriented investment. Income generating investments focus on rental income; while growth oriented investments seek to benefit from value appreciation over time. Real estate contributes both growth and income to a portfolio and the total return from the investment comprises of both rental income and capital appreciation. Rental yield is calculated as the annual rent divided by the market value of the property. Given the high capital values of real estate in India, rental yield tends to be low. Income Stream from Investment in Real Estate Rental income from real estate property held provide a source of income that is adjusted for inflation. The income also has the advantages of being periodic and known in advance to plan and use. Investors can take exposure to real estate in the following ways to have steady income stream:  Residential Property: Investment in residential property provides a steady source of income in the form of rental income in addition to providing returns in form of capital appreciations. Rental yield earned depends upon the price at which the property was purchased. If the property that was purchased at a lower price earlier on is now generating good rental income, it adds to the financial security of the individual.  Commercial Property: Constructing a commercial complex or buying a shop or office in a commercial complex could offer regular rental income and capital appreciation over a time period. However, rents from commercial property is more susceptible to economic downturns, see greater volatility in rentals and values and have longer gestation periods, as compared to residential property. Experts believe that growth prospects are better with residential property, while rental prospects are better in the case of commercial. Capital Appreciation from Investment in Real Estate Real estate investments benefit from capital appreciation in periods of low interest rates and rental incomes tend to go up in periods of inflation. The gain in the value of the property constitutes a greater portion of the return on investment from real estate. Investment in real estate can be made in the following ways to benefit from capital appreciation: 76

 Investment in Land: The investment may be in agricultural land or non-agricultural (NA) land for residential purposes or land reserved for specific purposes such as industry, school, tourism etc. The appreciation in real estate comes out of investment in land and not buildings, as buildings depreciate. Investing in land offers a better return on investment (in percentage terms) than investing in residential or commercial property.  Residential and Commercial Property: Investment in residential or commercial property also offers capital appreciation in addition to regular rental income. Real Estate: Source of Income for Retired Individuals Rental Income from Residential or Commercial Property can be a great source of income for retired individuals. Real estate can be one more asset class for generating income in retirement provided the investor has adequate investments in financial assets that are liquid and provide regular income. The self-occupied home can also become a source of income in the extreme situation of the retirement corpus being inadequate to fund a comfortable retirement through the reverse mortgage scheme which is offered by housing finance companies and banks. The important features of Reverse Mortgage are summarized below: 1. In a typical mortgage, you borrow money in lump sum right at the beginning and then pay it back over a period of time using Equated Monthly Installments (EMIs). In reverse mortgage, you pledge a property you already own (with no existing loan outstanding against it). The bank, in turn, gives you a series of cash-flows for a fixed tenure. 2. Eligibility Criteria  Indian citizen of 60 years or more,  Married couples will be eligible as joint borrowers for joint assistance. In such cases, the age criteria for the couple would be at the discretion of the RML lender, subject to atleast one of them being above 60 years of age and the other not below 55 years of age.  Should be the owner of a residential property (house or flat) located in India, with clear title indicating the prospective borrower's ownership of the property.  The residential property should be free from any encumbrances.  The residual life of the property should be at least 20 years. There is no minimum period of ownership of property required.  The prospective borrower(s) should use that residential property as permanent primary residence. 3. The amount of loan available under RML depends on the age of the borrower, appraised value of the house and the prevalent interest rates of the lending institution. 4. A reverse mortgage loan cannot be availed against commercial property. 5. The maximum monthly payments under RML have been capped at ₹50, 000/-. The maximum lump sum payment shall be restricted to 50% of the total eligible amount of 77

loan subject to a cap of ₹15 lakhs, to be used for medical treatment for self, spouse and dependents, if any. The balance loan amount would be eligible for periodic payments. 6. All receipts under RML shall be exempt from income tax under Section 10(43) of the Income-tax Act, 1961. 7. The rate of interest and the nature of interest (fixed or floating) will be decided by the lender. 8. The maximum tenure of an RML will be 20 years. 9. An RML will become due and payable only when the last surviving borrower dies or permanently moves out of the house. An RML will be settled by proceeds obtained from sale of the house property mortgaged. After the final settlement, the remaining amount (if any) will be given to the borrower or his/her heirs/beneficiary. However, the borrower or his/her heirs may repay the loan from other resources without bringing the property to sale. 10. The borrower will remain the owner of the house property and need not service the loan during his/her lifetime as long as the property is used as primary residence. Periodic payments under RML will cease after the conclusion of the loan tenure. Interest will accrue until repayment. 11. The Reverse Mortgage loan can be prepaid at any time during the currency of the loan. On clearance of all the dues, all the title deeds will be returned by the lender. 12. The borrower can opt for the frequency of EMI pay out (a monthly, quarterly, and annual or lump sum payments) at any point, as per his discretion. 1.6.4. Real Estate Investment Trusts (REITs) and Real Estate Mutual Funds (REMFs) Real Estate Investment Trusts (REITs) REITs is an investment trust that owns and manages a pool of commercial properties and mortgages and other real estate assets; shares can be bought and sold in the stock market. In other words, REITs is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs typically offer investors high yields, as well as a highly liquid method of investing in real estate. REITs are essentially a pooling vehicle which allows investors to participate in small amounts into a securitized real estate-linked investment. On the one hand, these securities help to make investing in real estate more accessible, long term and income-oriented. On the other hand, they also help to build an efficient secondary market for developers to exit projects. REITs usually will invest in commercial properties and use rental income to distribute as dividend to unit holders. The advantage of REITs is that it is regulated and managed under a trust umbrella. This means that there is accountability and audit around the use of investor funds. Real estate is often considered as an unorganized sector and there can be ambiguity linked to transaction value. In case of REITs the transactions are monitored and there is a specified method for valuations of properties, hence the ambiguity is reduced. 78

REITs will help investors channelize their investments into India's realty sector through a regulated mechanism. As the investment in REITs is asset-backed, it is helpful for investors to invest in real estate without the hassle of going through the checks on property titles and the plethora of regulatory formalities. Thus, REITs are an investment vehicle for retail investors to invest in real estate and diversify their investment portfolio. Further, REITs provide an exit option to developers and investors in commercial/retail assets and also addresses the liquidity concerns for an illiquid asset. With listing of REITs, disclosures and transparency improve in addition to providing a professional management structure. Further, with 90% of profits to be distributed annually as dividend, regular dividend income with annual appreciation acts as a hedge against rising inflation. Real Estate Mutual Funds (REMFs) REMFs is a close ended mutual fund scheme which invests only in real estate either in the form of physical property or in the form of securities of companies engaged in the real estate business. This means that polled money is used to buy a piece of real estate instead of shares of a company as in the case of regular Mutual Funds. These funds make it possible for small investors to take exposure to real estate as an asset class. SEBI has permitted the launch of real estate mutual fund schemes with the following guidelines:  Existing Mutual Funds are eligible to launch real estate mutual funds if they have adequate number of experienced key personnel / directors.  Sponsors seeking to set up new Mutual Funds, for launching only real estate mutual fund schemes, shall be carrying on business in real estate for a period not less than five years. They shall also fulfill all other eligibility criteria applicable for sponsoring a MF.  Every real estate mutual fund scheme shall be close-ended and its units shall be listed on a recognized stock exchange.  Net asset value (NAV) of the scheme shall be declared daily.  At least 35% of the net assets of the scheme shall be invested directly in real estate assets. Balance may be invested in mortgage backed securities, securities of companies engaged in dealing in real estate assets or in undertaking real estate development projects and other securities. Taken together, investments in real estate assets, real estate related securities (including mortgage backed securities) shall not be less than 75% of the net assets of the scheme.  Each asset shall be valued by two valuers, who are accredited by a credit rating agency, every 90 days from date of purchase. Lower of the two values shall be taken for the computation of NAV.  Caps will be imposed on investments in a single city, single project, securities issued by sponsor/associate companies etc.  No mutual fund shall transfer real estate assets amongst its schemes.  No mutual fund shall invest in any real estate asset which was owned by the sponsor or the asset management company or any of its associates during the period of last five years or in which the sponsor or the asset management company or any of its associates hold tenancy or lease rights. 79

 A real estate mutual fund scheme shall not undertake lending or housing finance activities. 1.6.5. Art and Antiques Art objects, collectibles and antiques are costly and illiquid investments. These investments have illiquid markets, because the markets are characterized by low volumes and high values. Investments in art and antiques are large value investments which cannot be easily converted to cash at a fair price. Moreover, one really has to know the market for these products to be able to buy and sell these products. Investment in art and antiques is being made for reasons which are personal and emotional, generally deriving pleasure. Art and antiques have a very low correlation with other asset classes and hence, have diversification benefits. Fine art and other antiques have a very subjective value. Hence, there may be no exact measure for determination of the same. This asset class comes with very low level of liquidity. The key to investing in these products is to know the upsides and downsides of the antique and art market which are discussed below: Advantages Following are the unique upsides of investing in these products:  Tangible assets: Antiques are not influenced by inflation or interest rate headwinds.  Low-correlation to the stock market: Art and antiques have a very low correlation with other asset classes and hence, have diversification benefits.  Growing rarity: It is all supply and demand. Over time, historic antiques become scarce, as they are lost, damaged, or enter museums and institutions.  Tax differences: Many items that are collectible are considered as \"wasting assets\" and do not factor into inheritance or capital gains tax calculations.  Personal satisfaction: The pursuit of antiques and art can be a much more satisfying experience than investing in the stock market. Art and antiques have an immediate and practical advantage over other types of investments. They can be used to help furnish a home. To some, art and antiques provide an aesthetic element or simple comfort to an interior. For others, art and antiques offer an ancestry look in the home. Unlike other investments, they can imbue an individual with a sense of achievement and pleasure in owning something rare and beautiful.  Wealth Transfer: These investments not only provide financial growth to the current generation, but aesthetic value and financial appreciation that can be passed down within a family. Collecting fine art and antiques thus provide generational wealth transfer opportunities. Disadvantages Following are the drawbacks for investing in these products:  Illiquid Investments: The general cycles in the antiques market tend to be very long, and antiques are very illiquid relative to most stocks, bonds or currencies 80

 Unorganized Markets: There are no formal, publicly-available benchmarks in the antiques market such as the SENSEX in the Indian stock market and relevant market data for specific antiques can be difficult to find, even with the internet as a search tool.  Maintenance: An antique may require restoration, preservation, transaction or insurance costs well beyond the costs for ―paper‖ investments with comparable values.  Wear and tear: Accidents happen. Unfortunately, they can catastrophically affect value. Anything that isn't in pristine condition will often sell for half of the potential value, if not less.  Counterfeits and fraud: High-quality forgeries can fool even experts. Shady dealers will sell something worthless for a small fortune.  Markup: If you go through a dealer, you will pay a hefty markup for the retail price. If you sell to a dealer, you will essentially be selling at a wholesale price.  Low Pace Growth: As a whole, most collectibles appreciate at a slower rate than stocks, bonds, and other investments. One can invest in arts and antiques if one is passionate about and — and dispassionate investors should evaluate the price and market —investors can maintain an alternative store of wealth that can be enjoyed far more than owning shares, bonds, or precious metals. 1.6.6. Venture Capital Fund (VCF) and Private Equity (PE) Investment Venture Capital Fund (VCF) Venture Capital Funds largely invest in unlisted companies. Venture capital funds invest at an earlier stage in the investee companies‘ life than the private equity funds. Thus, they take a higher level of project risk and have a longer investment horizon (3 – 5 years). Start-up companies with a potential to grow need a certain amount of investment. Wealthy investors like to invest their capital in such businesses with a long-term growth perspective. This capital is known as venture capital and the investors are called venture capitalists. Such investments are risky as they are illiquid, but are capable of giving impressive returns if invested in the right venture. The returns to the venture capitalists depend upon the growth of the company. Venture capitalists have the power to influence major decisions of the companies they are investing in as it is their money at stake. Private Equity (PE) Investment Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet. While the company is relatively stable, it requires long term capital to scale up and grow in size. Private equity investment managers screen such companies with significant growth 81

potential and provide them capital. Each private equity investment is backed by a strong investment thesis which plays out over a 3 to 5 year time horizon. Each investment is preceded by extensive business, legal and financial due-diligence and post investment the investment managers exert significant influence on the company through shareholder rights and board positions. The subscription offer for investment into the fund is exclusively opened for a short period to a select group of investors, including HNIs, body corporates, trusts, partnership firms, as the threshold investment amount (ticket size) is typically high. Investment can be done into a venture capital fund (SEBI Approved) or a PE structure. Investments could be made into equity or debentures of unlisted entities. A share of the profits of the fund's investments, called carried interest, is paid to the PE fund's management company as a performance incentive, typically up to 20%. The remaining 80% of the profits are paid to the fund's investors. A minimum rate of return (e.g., 8–12%) is fixed, which must be achieved before the fund manager can receive any carried interest payments. The investment approach is sector agnostic investments in various stages of growth. PE funds may provide capital at various stages of the growth of the company starting with  seed financing which involves development of a new concept and start-up financing  (also known as early financing);  expansion financing (also known as second and third stage financing);  mezzanine financing, which is typically used for companies which are expected to go public and may involve debt or equity. Sometimes, PEs may fund a buyout or a merger/acquisition transaction. PE funds adopt suitable exit mechanisms, in consultation with the promoters of the portfolio companies, including public market exits through IPO, sale to financial / strategic investors or buy back by the company / promoters. 1.6.7. Structured Products Structured Products are pass-through debt or hybrid products outside the mutual fund structure. Structured products or notes are hybrid products with a large component of debt and then some derivatives. The derivative exposure could be linked to any risk asset, such as equity, commodities and currencies. In India, structured notes with debt securities and equity derivative exposure are popular. These are also available in the mutual fund format as hybrid fixed term funds. Essentially, structured products seek to give potential returns that are higher than the underlying derivative-linked asset in times of a rally and limit the downside when markets fall. Many notes come with a capital protection theme, seeking to limit losses and return at least the capital. Structured products come with limited maturity and investors have to stay put for a specified period. In the Indian capital market, most structured products are modeled around equity markets and the maturity ranges from 12-36 months. There are generally two types of structures—conservative and aggressive. The conservative notes 82

come with capital protection as the main attraction and the upside participation in the risk asset returns is lower than for the aggressive products. For example, an 18-month structured product could offer 150% participation in upside returns of equity markets from now till maturity, and if the market falls below the initial index level, you get your capital back. A 150% upside participation means, if the equity market returns for the specified period stands at 10%, you will get 15% return on the portion invested in equity derivatives. Some products have a more aggressive pay off. These offer a higher participation in upside returns but don‘t protect capital. For example, 250% upside participation, but if the market falls in the defined period, by, say, more than 15% (or any other defined threshold), you also face the downside. Hence, there is a chance making a loss, but gains, too, can be much higher. 83

SUMMARY  For the bulk of investors, the most important asset in their portfolio is a residential house. The real estate can be categorized as - Agricultural land, Semi urban land, Residential Property and Commercial property.  Real estate contributes both growth and income to a portfolio and the total return from the investment comprises of both rental income and capital appreciation.  Investment in residential property provides a steady source of income in the form of rental income in addition to providing returns in form of capital appreciations.  Constructing a commercial complex or buying a shop or office in a commercial complex could offer regular rental income and capital appreciation over a time period.  Tax Benefits: To give buyers relief, the government has allowed income tax (I-T) deductions if the property is bought on a loan. Under Section 80C, the borrower can claim deduction of up to ₹1.5 lakh. For a self-occupied property, ₹2 lakh benefit is available under Section 24 (b) of the Income Tax Act for interest on the home loan. If the property is not self-occupied, the entire interest paid to the lender can be deducted from income.  REITs is an investment trust that owns and manages a pool of commercial properties and mortgages and other real estate assets; shares can be bought and sold in the stock market.  REMFs is a close ended mutual fund scheme which invests only in real estate either in the form of physical property or in the form of securities of companies engaged in the real estate business.  Art objects, collectibles and antiques are costly and illiquid investments. These investments have illiquid markets, because the markets are characterized by low volumes and high values.  Venture capital funds invest at an earlier stage in the investee companies‘ life than the private equity funds. Thus, they take a higher level of project risk and have a longer investment horizon (3 – 5 years).  Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity.  Structured Products are pass-through debt or hybrid products outside the mutual fund structure. Structured products or notes are hybrid products with a large component of debt and then some derivatives. The derivative exposure could be linked to any risk asset, such as equity, commodities and currencies. 84

SECTION-1: SELF-ASSESSMENT QUESTIONS 1. Monitoring Volume of trading in a stock is an important aspect of technical analysis because _______. a) it confirms the trend in price movement and the pattern formation b) it indicates the stock‘s potential to c) scale new high it indicates delivery position in the stock d) it indicates value at risk in the stock 2. ______________ are a pooling vehicle which allow investors to participate in small amounts into a securitized real estate-linked investment a) Venture Capital Funds b) Structured Products c) REITs d) PMS 3. Mr. A is attracted by the high dividend yield of the stock. Which of the following is a likely feature of the investment going forward? a) High growth in EPS b) Low dividend payout c) High capital appreciation d) Low earnings growth 4. Blue chip stocks: a) are common stocks of large, financially sound corporations with a good history of dividend payments and consistent earnings growth b) are common stocks of older, more mature firms that pay higher dividends and are not growing rapidly c) are common stocks of medium-size firms having earnings growth in excess of the industry average d) have high growth potential but are very risky 5. The owner of a futures contract: a) has the obligation to buy or sell a specified amount of an asset at a stated price on a particular date b) has the right to sell a specified stock at a fixed price c) agrees to exchange specific assets at future points in time d) can convert the contract into a specified number of stocks e) has the right to buy a specified stock at a fixed price 85

6. Commercial paper is issued by: a) commercial banks b) large corporations c) the US government d) government agencies 7. Which of the following is a way to invest in international securities? a) American Depository Receipts b) International mutual funds c) Eurodollars d) Both a and b e) Both a and c 8. Tarun is looking to invest in equity markets. He is evaluating shares of VKP Ltd. with a PE ratio of 22, PEG ratio of 0.98, dividend yield of 3.5.Which of the following may make VKP Ltd unsuitable Kapil as a conservative investor? a) PEG ratio lower than 1 b) A dividend yield lower than the risk free rate of interest c) PE ratio higher than peer average d) Dividend yield higher than dividend yield of index 9. The PEG ratio of the company classifies it as a) Overvalued b) Undervalued c) Low growth stock d) High growth stock 10. Which of the following statements concerning technical stock market indicators is/are correct? a) The stock market is considered strong when the volume of the market is increasing in a rising market. b) The market‘s direction will change when the percent of odd-lot short sales significantly increases or decreases. c) Price crossing the moving average line would be an indication of the change in the market. a) 1 only b) 1 & 2 only c) 2 & 3 only d) 1,2 & 3 86

11. Bond prices are less sensitive to changes in the interest rates when the bonds have_______. a) small coupons and long maturity b) small coupons and short maturity c) large coupons and long maturity d) large coupons and short maturity 12. Choose the instrument from the following which does not have reinvestment risk: a) Short term bonds b) Corporate Bonds with Call option c) Zero coupon bonds d) Government securities 13. Ex-mark, commonly known as R-Squared in Statistics, in mutual funds is defined as _____. a) the measure of dispersion from the risk free rate of return for the period b) the annual recurring costs as a percentage of the net assets of the scheme c) the extent to which the return of a mutual fund scheme is explained by a particular financial market d) the volatility of return from its chosen benchmark index 14. The system of trading on margin is practiced in futures markets to _____. a) make futures contracts more readily tradable b) reduce the risk of default on contracts c) allow people to make higher profits d) reduce the ticket size for participation 15. The deviation of an ETF‘s value from the value of its underlying asset is known as ____. a) standard error b) Variance c) Standard deviation d) tracking error 87

SECTION 1: SOLUTIONS TO SELF-ASSESSMENT QUESTIONS 1. (A) it confirms the trend in price movement and the pattern formation 2. (C) REITs 3. (D) Low earnings growth 4. (A) are common stocks of large, financially sound corporations with a good history of dividend payments and consistent earnings growth 5. (A) has the obligation to buy or sell a specified amount of an asset at a stated price on a particular date 6. (B) Large Corporations 7. (d) Both a and b 8. (C) PE ratio higher than peer average 9. (B) Undervalued 10. (D) 1,2 & 3 11. (D) large coupons and short maturity 12. (C) Zero Coupon Bonds 13. (C) the extent to which the return of a mutual fund scheme is explained by a particular financial market 14. (B) reduce the risk of default on contracts 15. (D) Tracking Error 88

SECTION–II andRISK PROFILING OF PRODUCTS INVESTORS-ASSET ALLOCATION DETERMINATION SUB-SECTIONS 2.1 Types of Investment Risks 2.2 Product Profiling in terms of inherent Risk and Tenure 2.3 Risk Profiling of Investors 2.4 Asset Allocation- Financial Assets 2.5 Types of Asset Allocation Strategies 89

Learning Outcomes At the end of this section, the students will be able to: • Understand the common types of risk associated with investments and their implications. • Explain the different types of risks and tenure based profiling of investment products. • Explain the method of risk profiling and factors on which risk profiling depends. • Explain the concept of behavioral finance used in understanding investor‘s psychology and behaviour in investment decisions making. • Understand the concept of asset allocation and importance of asset allocation in achieving financial goals and investment objectives. • Explain the different types of asset allocation –strategic asset allocation, tactical asset allocation and life stage based asset allocation. • Understand how to evaluate different products, their suitability and how the recommendation of the same can impact investment risks, returns and strategies in a personal finance environment for investors. 90