A Mutual fund is a trust that attracts savings which are then invested in capital markets. A Mutual fund is an investment vehicle for investors who pool their savings for investing in diversified portfolio securities with the aim of attractive yields and appreciation in their value.

According to SEBI, a mutual fund defined as a fund, established in the form of a trust to raise money through the sale units of the public under one or more schemes for investing in securities, including money and market instruments.

Advantages of Mutual Fund

• Mutual funds promote savings among the lower and middle-income groups of investors because mutual funds units are available with a single unit of ₹ 10 and multiplies of the same value
• Mutual funds reduce the risks as they diversify the investment into shares, debentures, bonds, etc.
• Mutual funds can be recapitalized at any time i.e. one can sell their mutual fund units at any time
• Investors get an attractive return because mutual funds are linked with the stock market
• Mutual funds are convenient and easy to invest
• Mutual funds are flexible which means it can be transferred from one scheme to another easily
• Mutual funds contribute to the economy

Types of Mutual fund

Following are the types of mutual funds:

1. Public sector Mutual funds – State bank of India, Canara Bank, Punjab national bank, general insurance, corporation are some of the public sector mutual funds.
2. Private sector Mutual funds – Kothari pioneer fund, twentieth-century fund, ICCI fund, Morgan Stanly fund, Taurus fund and CRB fund are examples of the private sector of mutual funds.
3. Open-ended mutual funds – When the mutual fund units are sold and redeemed at any time on the basis of the price determined by the fund’s net asset value, it is called an open-ended mutual fund. There is no maturity period in these mutual funds and investors can sell the units back whenever they wish.
4. Closed-ended Mutual funds – These types of mutual funds have a fixed maturity period from 2-15 years. The units of these funds can’t be redeemed.
5. Growth generated Mutual funds – These types of mutual funds are reinvested in highly growth-oriented equity shares. It consists of securities that offer high returns and growth potential.
6. Income generated mutual funds – When the investors need regular income for their investment then they can select income generated mutual funds. These funds offer a regular dividend to its investors.
7. Balanced Mutual funds – The balanced mutual funds are characterized by investment in a combination of various securities as well as government bonds. It consists of both equity and debt instruments.
8.  Domestic Mutual funds – When the mutual funds mobilize savings from a particular country or region it is called domestic mutual funds.
9. Global Mutual funds – When the mutual fund investment stocks are traded in the market throughout the world, it is called global mutual funds.
10. Regional mutual funds – When the mutual funds consist of investment from a particular region of a country then it is called a regional mutual fund.
11. Sector mutual funds- Sector mutual funds are specialized in a particular industry which consists of aggressive funds from a particular sector/industry.

Mutual funds in India

There are various mutual funds companies in India that invest in equity or stocks and manage the fund to achieve a range of goals.

Many equity mutual funds are structured to generate long term capital gains through growth or value investing strategies like Birla SL Frontline Equity fund, while others focus on generating income for its shareholders. Indian mutual funds may also invest in bonds and other securities with the goal of generating regular interest income. Funds can also take a balanced approach i.e. invest in both equity and debt instruments to create diverse portfolios that offer stability and also offer the potential for huge gains in the stock market.

Mutual funds in India are regulated by the securities and exchange board of India (SEBI). The SEBI regulations include a minimum of ₹ 500 million for open-ended debt funds and ₹ 200 million for closed-ended funds. Indian mutual funds are only allowed to borrow up to 20% of their value for a term not to exceed six months to meet short term requirements.

Mutual Fund Sponsor

The mutual fund sponsor can be either an individual, a group of individuals, or a corporate body. The Sponsor is responsible for registration with SEBI. Once approved, the sponsor must form a trust to hold the assets of the fund, appoint a board of trustees, and choose an asset management company.

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Speculation – It involves taking calculated business risks for the purpose of earning short-term profits. It involves buying and selling of assets with expectations of getting profits from price fluctuations.

Gambling – It involves taking artificially created risk in a game of chance.

Investment Objectives

• Return – Income from investment
• Risk – Risk of an investment refers to the variability of returns from different investment alternatives
• Liquidity – It depends upon marketability and trading facilities associated with an investment. It refers to the ease of converting as an asset into liquid cash
• Hedge against Inflation – Returns from investments provide protection against inflationary tendencies present in the economy
• Safety – Investment alternatives are subjected to a sound legal and regulatory framework

Investment Alternatives: Negotiable and Non-negotiable Securities

Investment Process

• Framing of Investment policy – Funds, Objectives, Knowledge
• Investment Analysis – Economic Analysis, Market Analysis, Industry Analysis, Company Analysis
• Valuation – Industrial value and Future Value
• Portfolio construction – Diversification, Selection and allocation of funds to an optimum mix of various debt and equity instruments.
• Portfolio Evaluation – Appraisal and Revision

(1) Framing of investment policy – Before making any investment one must formulate an investment policy for systematic functioning. The main components of an investment policy include –

• Investible Funds – Availability of funds, Source of funds i.e. Savings or borrowing (if funds are borrowed then the rate of return on investment must be higher than the rate of borrowing)
• Objectives – Required rate of return, Need for regular income, risk perception, need for liquidity, capital appreciation or safety of principle
• Knowledge – One should be aware of different investment alternatives, various stock markets, and financial structure of the country and must have sufficient knowledge regarding functions of brokers, mode of operations, related taxes and charges etc.

(2) Investment Analysis – After a suitable investment policy has been formulated, the next step is to conduct market, industry as well as company analysis to scrutinize the securities one plans to buy.

• Market Analysis – A market analysis helps an investor to understand the general economic scenario. Economic variables like Gross domestic product (GDP), inflation, Recession etc. help an investor to depict stock prices and stock trends and fluctuations. One can set entry and exit points through technical analysis.
• Industry Analysis – An industry analysis helps analyze the economic significance and growth potential of an industry. Factors like growth rate, growth potential and contribution of an industry in an economy helps an investor to make an informed decision.
• Company Analysis – Knowledge regarding a company`s earnings, profitability, operating efficiency, capital structure, top management, market share etc. is essential for an investor, as these factors have a direct impact on the stock prices of the company and the return to investors. Companies with high market share are capable of creating wealth in form of capital appreciation for an investor.

(3) Valuation – The next step is to determine the expected risks and returns from an investment. The intrinsic value of a share is measured through the book value and price-earnings ratio of a share. The intrinsic value of a share is then compared with its market value to make an investment decision. An effort is made to determine the future value of the investment.

Intrinsic value = Book Value + P/E Ratio compared with the market price

(4) Portfolio Construction – A portfolio is a combination of different securities. A portfolio must be constructed in such a way that it meets the investor`s needs and objectives with the aim to deliver maximum returns with minimum risk. The goal is to create an optimum mix of debt and equity instruments. The reduce the risk and ensure the safety of principal a portfolio is diversified by creating a portfolio with an optimum mix of debt and equity instruments, securities from different companies and industries are chosen on the basis of expected returns. In the end, funds are allocated to the selected securities. 

(5) Evaluation – Portfolio performance is periodically evaluated to measure and compare the variability of returns from different securities. Portfolio appraisal involves evaluating the portfolio with respect to two key dimension – Risk and Return. On the basis of appraisal results, revisions are made to the portfolio. Low yielding securities with high risk are replaced with low risk and high yielding securities. This process is done periodically to keep stable returns.

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A portfolio is a combination of various securities such as stocks, bonds and money market instruments. Diversification of investments helps in spreading risk over many assets; hence one must diversify securities in the portfolio to create an optimum portfolio and ensure good returns on portfolio.

There are two approaches to portfolio construction:

(A) Traditional Approach of Portfolio Construction

(B) Modern Approach of Portfolio Construction

Traditional Approach of Portfolio Construction

Under traditional approach, the financial plan of an individual is evaluated with regard to an individual`s needs in terms of income and capital appreciation and appropriate securities are selected to meet those needs. It consists of five steps which are:

(1) Analysis of constraints: It involves analysis of constraints of the investor within which the objectives will be formulated. The constraints may be decided on the basis of:

• Income needs – Investors need for current income (to meet living expenses) and constant income (to offset the effect of inflation)
• Liquidity needs – Investors preference for liquid assets
• Safety of Principal – Safety of principal value at the time of liquidation
• Time Horizon – Life cycle stage and investment planning period of the investor
• Tax Consideration – Tax benefits of investing in a particular asset
• Temperament – Risk bearing capacity of the investor

(2) Determination of objectives: It involves formulation of objectives within the given framework of constraints. Constraints reflect the risk bearing capacity and income requirements of the investor. Some common objectives of investors are:

• Current Income
• Growth in Income
• Capital Appreciation
• Preservation of Capital

All objectives cannot be achieved simultaneously, hence if an investor`s objective is capital appreciation, he must be ready to invest it securities that have high risk in order to get high returns.

(3) Selection of Portfolio: The optimum asset mix for an investor depends upon his investment objectives.

(4) Risk & Return Analysis: It involves analysis of risk and returns involved in following a particular course of action. Major risk categories that an investor can tolerate are determined and efforts are made to minimize these risks to get expected returns.

(5) Diversification: It involves assigning relative portfolio weights to different securities on the basis of which the portfolio is diversified.  Diversification is done on the basis of investor`s need of income and his risk bearing capacity. Industries that correspond to specific goals of the investor are selected, out of which few companies from each industry are chosen on the basis of its growth, profits, dividend, R&D, expected earnings, goodwill etc. Finally, the number of different stocks required to give adequate portfolio diversification are selected and the number of shares of each stock to be purchased are determined depending upon the size of portfolio.

Modern Approach of Portfolio Construction

The modern approach of portfolio construction also known as Markowitz Approach emphasizes on selection of securities on the basis of risk and return analysis. The financial plan of an individual is audited in terms of risks and returns and efforts are made to maximize expected returns for a given level of risk.

Unlike traditional approach which considers an investors need for income or capital appreciation as basis for selection of stocks, the modern approach takes into account the investors needs in from of market return or dividend and his tolerance for risks as basis for selection of stocks. Returns are usually measured in terms of market return and dividend and form the basis of selection of stocks.

Ten to Fifteen stocks are selected after thorough analysis and expected risk and return is computed for each stock.  Stocks with good return prospects are selected and funds are appropriately allocated among different stocks according to the portfolio requirements (risk & return) of the investor.

An investor may adopt an active or passive approach to manage his portfolio. Under passive approach, the investor holds the securities for a previously established holding period while an active approach involves continuous assessment of risk and return of securities and replacing low performing securities with high performing securities over time.

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Hence, the amount paid for a stock or security and the return when discounted based on the amount of risk it involves will give a Net Present Value equal to Zero (NPV = 0), i.e. there is no way to beat an effective market consistently. This is because all current and relevant information is already reflected in the share price.

Concepts of Efficient Market Theory

• Market Efficiency – An efficient market is a market that provides fair return to its investors. This is possible only when the market is able to quickly and accurately reflect the expectations of investors in share prices, this is known as market efficiency.

It can be of two types: Operational Efficiency and Informational Efficiency.

While Operational efficiency of a market is determined on the basis of time taken to execute an order and number of bad deliveries, Informational Efficiency in a market is determined on the basis of swiftness and accuracy of the market to adjust itself in reaction to new information (economic reports, company analysis, political agendas, government policies etc.).

• Liquidity Traders – Traders who do not buy or sell shares on the basis of research and analysis but on the basis of their individual fortune and liquidity needs are liquidity traders.

• Informational Traders – Traders who buy or sell shares on the basis on thorough research and analysis of the market are informational traders. They usually invest of the basis of differences in intrinsic value and market value of a security.

Assumptions of Efficient Market Theory:

• There are large number of buyers and sellers for a security
• All investors act rationally with the motive of making profit
• New information arises randomly and is available to all market participants for free
• Prices of securities respond quickly to newly available information and reflect all available information

The Random-Walk Theory

This Random Walk theory was propounded by Professor Eugene Fama.  It stated that an efficient market fully reflects the available information in share prices. Hence, if the markets are efficient, security prices will reflect normal returns for level of risk associated with the security. Fama suggested three forms of market on the basis of market efficiency and type of information considered in the market.

Forms of Efficient Market (Strong, Semi Strong, Weak)

• A Weak Form of EMH makes use of only historical information and states that all historical information found in past prices and volume of trade is reflected in current prices. It suggests that all new public and private information may not be available to all investors, while all historical information is available with all investors; hence all information is not translated in current prices. Therefore future prices cannot be predicted by analysing historical prices. In such a market, liquidity traders cause price fluctuations as they sell their shares without considering its intrinsic values; while the buying and selling activities of informational traders result in alignment of market prices with intrinsic values.

• A Semi-Strong Form of EMH makes use of historical data as well as publically available information and states that all historical and public information is available with all investors and is translated into current prices. Hence whenever new information arrives in the market, it is quickly reflected in security prices. In such a market informational traders can earn huge profits in a short run while liquidity traders with naïve buy and hold policy will incur losses.

• A Strong From of EMH takes into account all public, private and historical information and states that all information is fully reflected in current prices even though private information may not be available with all investors, but only with few insiders(CEO`s of the company, Board of directors etc.).

Hence all information historical, public or private is useless in predicting the future values and there is no way to consistently beat the market.

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Derivative

A derivative is a financial contract, the value of which, is derived from an underlying asset (share, commodity, currency, security etc.). If the value of underlying asset declines the value of the derivative also decreases and vice versa.

Options

An option is a right, but not an obligation; to buy or sell something on a specified date and at a specified price. In the securities market, It is a contract between two parties, an option buyer and an option seller or writer in which the seller gives the buyer an option to buy or sell a specified number of shares in the future at an agreed price.  

An option contract contains:

• The name of the company whose shares are to be bought or sold
• The number of shares to be bought or sold
• The purchase price or striking price at which shares bought, the selling price or the striking price at which shares are sold
• The expiration date of the option/contract

Parties involved in option trading:

• Option Seller or Writer – The one who provides the option to buy or sell something in return for a premium on its price.
• Option Buyer – The one who pays the price for an option.
• Broker/Agent – The one links options buyers with option sellers in return for a fee or commission.

Types of Options:

• Call Option – A contract that gives the owner the right to buy an asset or security.
• Put Option – A contract that gives the owner the right to sell an asset or security.

Futures

A future is a financial contract which derives its value from the underlying assets. They may be Commodity Futures or Financial Futures. While the former involves commodities like sugarcane or wheat the latter involves foreign currencies, interest rate and market index futures. Market index futures are directly related to the stock market.

Future markets aim to solve the problems of trading, liquidity and counter party risk which are achieved through standardised contracts, centralized trading and settlement through clearing houses. A forward market lacks these three features.

Forwards

In a Forward contract, two parties mutually agree to buy or sell a specific quantity of an underlying asset on a future date at a specified price. No monetary transactions are involved at the time of signing of contract. A forward contract safeguards and eliminates the risk of fall in prices in the future. Such a contact is not tradable, there is no centralization of trade and no third party guarantee is involved in the contract. Hence, if a party to contract declares bankruptcy, the other party suffers the loss.

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Various economic, industrial and company specific factors can have a direct bearing on prices of securities. A fundamental analysis helps an investor to understand the general behaviour of the market, industry or a company and prepare a buying and selling strategy. 

Also Read: Technical Analysis – Dow Theory

Various factors studied under Fundamental Analysis

Also Read: Technical Analysis – Dow Theory

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Technical Analysis is the process of identifying trend reversals at an earliest stage to formulate the buying and selling strategy with the help of several indicators. It seeks to identify and exploit price patterns and market trends in the financial markets.

Assumptions of Technical Analysis:

• The market value of the script is decided by the market forces of demand and supply
• Market discounts everything
• The market always follows a trend except minor deviations
• History repeats itself

DOW Theory 

Technical Analysis is based on the doctrine given by Charles H Dow in the year 1884 in wall street journal. He developed the Dow Theory to explain the movement of indices of ‘Dow Jones Averages’ on the basis of the following assumptions:

• No single individual can influence the major trends in the market
• Market discounts everything
• Theory is not infallible

According to Dow Theory, the market trend can be divided into three trends namely:

• Primary trend (1-2 years) which is interrupted by
• Intermediate trend (3 weeks to 3 months) (these are corrective movements)
• Tertiary (Short Term) trend (day to day price fluctuations)

• Primary Trend: The security price trend may be either increasing or decreasing. When the market exhibits increasing trend, it is a bull market that shows three clear peaks. Each peak is higher than previous peak and each bottom is also higher than the previous bottom. The trend following the peak halts for some time, reaches the bottom and then rises again.

The three peaks form three unique phases which signifies:

• Phase I – Revival of corporate confidence/market confidence
• Phase II – Good Corporate Earnings
• Phase III – Price increase due to Inflation and Speculation

The reverse of the bull market is bear market. It is the period when the prices of shares are falling. In a bear market the three downward sloping peaks and bottoms signify:

• Phase I – Loss of hope – People lose confidence and start selling shares
• Phase II – Recession in business, Low dividends, Low profits
• Phase III – Distress selling

• Intermediate trend/Secondary Trend – It moves against the primary trend and the deviation is usually corrected automatically. In the bull market an intermediate trend can result in a downward trend of 33% to 66%, while in a bear market it would result in an upward trend of 33% to 66%.

• Short Term Trend – These are random wriggles or minor trends that correct the movement of the secondary trend. They represent the day to day price fluctuations in the market.

https://en.wikipedia.org/wiki/Support_and_resistance

• Support and Resistance level – When price of a share is moving in an upward trend it will peak again and again at a certain price level and will not rise above that level known as the resistance level due to excess supply of scrip over demand. Support level is the opposite. It is the level beyond which the share price will not fall as the demand for scrip is greater than its supply.

Technical Indicators of the market

Technical Indicators give a holistic view of the market and help to determine the behaviour and direction of the market. 

• Volume of Trade – Usually the, volume of trade expands in the bull market and contracts in the bear market. However, a large rise or fall in prices leads to a sudden increase in volume of trade. An investor must worry if the volume falls with rise in prices or vice versa as such a trend may not prevail for a long time. A large volume with rise in prices signifies a bull market while large volume with fall in prices indicates the bear market.

• Breadth of the Market – It is used to study the advances and declines in the stock market. Advances refer to a price increase in shares from its previous trading day while declines indicate a fall in prices of shares from its previous trading day. The net difference between the advances and declines in a particular period is the breadth of the market.

• Short Sales – It is selling of shares that are not owned. Short sellers sell shares now and hope to purchase it at a lower price in the future to make profits.

• Odd Lot – Shares sold in a lot that is less than 100 are called an odd lot. An increase in odd lot trading leads to an increase in the index.

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Causes of Risk

• Wrong decision or Wrong timing
• Term of Investment – Long term investments are more risky than short-term investments as future is uncertain.
• Level of Investment – Higher the quantum of investment the higher is the risk.
• Nature of Industry – Risk is higher in speculative and cyclical industries while less in defensive and growth industries.
• Political and Legal factors – Risk may arise due to changes in government policy and legislative regulations in a country.

Types of Risk

Systematic Risk

It refers to the risk caused by factors external to a business which affects the entire industry and not any specific business. They are uncontrollable and unavoidable by a business and are associated with economic, social, legal and political aspects of all securities in an economy.

• Market Risk – It is the risk caused by the alternating forces of demand and supply (bear and bull market) i.e. the value of investment increases or decreases due to the movements in the market factors. These factors may be tangible or intangible. In Bull Market, when the economy is booming the Security Index takes an upward swing and increases for a significant period of time while the opposite happens in a Bear Market.
• Interest Risk – It is the risk that adversely affects the investment due to unexpected changes in market interest rates. A change in monetary policy by the central bank will directly affect the debt instruments like bonds and debentures due to changes in interest rates.
• Purchasing Power Risk – It refers to the risk of reduction in purchasing power of expected returns due to high rate of inflation.

Unsystematic Risk

It refers to risk caused by the factors internal to a business and unlike systematic risk it is specific to a business and hence can be controlled by the business. It arises due to lack of operating efficiency in a business or due to its inability to grow or maintain competitive edge or achieve stable profits.

• Business Risk – It arises due to: Internal risk – It is associated with the operational efficiency of the business, and External risk – It is associated with the economic, social, political and legal factors external to the business which can affect it adversely.
• Financial Risk – It is the risk related to the capital structure of a business. An inefficient capital structure results in financial instability and leads to unstable earnings. Hence there must be an optimum mix of debt and equity to ensure financial stability and reduce financial risk. Types  of Financial Risk – Credit risk, Currency risk, Country risk, Liquidity risk

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The Stock Market Indices give a broad outline of the market movement and also represent the market. As it is not possible to track the price of each stock listed on the exchange several stock market indices like BSE-SENSEX, BS@-200, DOLLEX, NSE-50, CRISIL-500 etc. are used to estimate the trends in the stock market.

SENSEX is the Index for Top 30 companies in the Bombay Stock Exchange (BSE) 

NIFTY is the Index of Top 50 companies in the National Stock Exchange (NSE) 

A stock market Index may be a Price Index or a Wealth Index. A price index is simply the average of all share prices with a base year, while in a wealth index the prices are weighted by market capitalization and the base period values are adjusted for subsequent rights and bonus offers. While the price index reflects the general price movement of stocks in the market, the wealth index helps to estimate the real wealth created for shareholders over a period of time.

Usefulness of Stock Market Indices / Index

• It helps to recognize the broad trends in the market
• It can be used as a benchmark for evaluating an investor`s portfolio
• It serves as a status report of the general economy
• It helps investors to allocate funds rationally among various stocks
• Index Funds and futures can be formulated with the help of indices
• It helps stock analysts to estimate the future movements in the stock market.

Differences between Stock Market Indices

• The number of stocks – It influences the behaviour of the index. The larger the no. of stock the more representative is the sample. SENSEX has 30 scrips, NIFTY has 50 scrips
• The composition of the stocks – It reflects the market movement as well as some macro-economic changes. Scrips that have lost their value are dropped and replaced with another performing scrip. This makes the stock market indices more representative and efficient.
• The weights – The weight assigned to each company`s scrips  which have a significant influence on market movements. The indices are weighted with price or value. Hence the stocks with high price or value influence the index more than stocks with low value.
• The Base Year – The closer the base year is to the current year the more effective is the index in reflecting changes in market movements .SENSEX – 1978-79, NIFTY – 1995

SENSEX

It is also called BSE Sensitivity Index. Base Year – 1978-79 and at that time of its inception it contained only private companies geared towards commodity production, but with time more and more private and public companies came into the market and representation was given to various industrial sectors such as services, telecom, consumer goods, FMGC, automobile etc. Only the top 30 scrips are used to compute the SENSEX.

The criteria adopted for selection of 30 shares are:

Qualitative Criteria:

• Industry representation – The index must capture a macro-industrial situation through price movements of individual scrips. Therefore the company`s scrip must reflect the present state of the industry.
• Previous track record – the company must have an acceptable track record of good performance in terms of corporate governance and dividend payment. It must also have a listing history of at least 1 year on BSE.

Quantitative Criteria

• Market Capitalization – Market capitalization indicates the true value of the stock. It equals no. of outstanding shares x price of share. The outstanding shares depend upon equity base. The scrip should be in the top 100 listed companies according to full market capitalization.
• Liquidity – It is based on trading frequency. The scrip should have been traded on each and every trading day for last 1 year except for extreme reasons and must have a good trading frequency, average daily trades and average daily turnover.

Initially full market capitalization methodology was used, but since September 2003 Free Float Methodology is used. Under this only the free float market capitalization of the company is considered. Free float market capitalization of the company refers to the proportion of the total shares that are readily available for trading in the market. For this purpose the following holdings are excluded:

• Holding of founders/directors/acquires which have control element
• Holdings of persons/bodies with a controlling interest
• Holdings as promoters
• Holding through FDI
• Strategic stakes by private corporate bodies/individuals
• Equity held by employee welfare trust etc.

The free float factor is calculated for each company and multiplied by its market capitalization. A Free float factor of 50% means that only 50% of the market capitalization of the company is considered for the calculation of SENSEX.

The policy framework for SENSEX is set by the Index committee. It is monitored and revised by the Index cell of exchange.

NIFTY

It is also known as NSE-50 Index. The base year for NIFTY Index is 1995 and the base value of index is set at 1000. This Index was built by IIS (India Index Service Ltd) and CRISIL (Credit Rating Information Services of India) along with strategic Alliance of SOP ( Standard Poor Rating Service). It was formed with the following objectives:

• To reflect market movements more accurately
• To provide a tool for measuring portfolio returns in comparison to market returns for fund managers
• To provide a basis for introducing index based derivatives

Features of NIFTY Index

• The selection criteria for the nifty index are market capitalization and liquidity.
• The NIFTY Index represents 45% of the total market capitalization.
• The impact cost of NIFTY portfolios is less compared to other portfolios.
• It provides best protection against inflation.
• It is selected for derivative trading

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The chart below attempts to show a basic investment strategy of an investor. Percentage of total income to be spent on various investment alternatives are:

Different Investment Alternatives

(1) Negotiable Instruments / Securities – 

These investment alternatives can be traded in the market. 

(i) Variable Income Securities

• Equity Shares: Shares which do not carry any preferential rights in repayment of capital and dividend payments are equity shares. The rate of dividend is not fixed and varies depending upon the profitability, financial position and business objectives of a company. The owners of equity shares are the owners of the company and have voting rights in the management of the company.

Classification on the basis of nature of shares:

• Growth Shares: These stocks have a higher growth rate than the industry growth rate on the basis of profitability. E.g. HCL
• Income Shares: These stocks have a relatively stable operations and limited growth opportunities. E.g. Banks, FMGC, Cadbury, nestle, Hindustan lever
• Defensive Shares: These shares are normally not affected by the movements in the market. E.g. Pharma Stocks
• Cyclical Shares: These stocks are affected by the business cycles. The upward and downward movements of business cycles affect the profitability of the company and also the share price of a company. E.g. Automobile stocks
• Speculative Shares: These shares have a lot of speculative trading. They attract the investors in bull and bear phases of the market.

(ii) Fixed Income Securities

• Preference Shares – Shares which carry preferential rights in respect of dividend payment and repayment of capital are preference shares. These shares carry a fixed rate of divided and preference over equity shareholders in dividend payment and payment of capital at the time of liquidation. They do not carry any voting rights.

• Debentures – These are capital market instruments used to raise medium and long term capital funds from the public. It comprises of Periodic interest payments over the life of the instrument and principle payment at time of its redemption. These are for investors who wish to sacrifice liquidity for high returns.

• Bonds – They are similar to debentures but are issued by public sector companies. Its value in the market depends upon the interest rate and maturity of the bond. The coupon rate is the nominal interest rate offered on the bond which cannot be changed till its maturity. E.g. Education benefit bond, retirement benefit bond.

• IVP`s and KVP`s – These are savings certificates issues by the post office with the name Indra Vikas Patra and Kisan Vikas Patra. IVPs have a face value of 500,1000, 5000 and KVPs have a face value of 1000, 5000, 10000. The capital is doubled in 5.5 years with 13.47% rate of return. They do not carry any tax benefits but are transferable just like bearer bonds.

• Government Securities – These are secured securities issues by the central and state government. The rate of interest on these securities is relatively low but they are highly liquid and safe.

• Money Market Securities – These securities have very short term maturity usually less than a year. E.g. Treasury bills, Commercial paper, Certificate of Deposit

(2) Non Negotiable Instruments / Securities – These investment alternatives cannot be traded in the market. 

• Deposits:  Deposits earn a fixed rate of return.

• Bank Deposits – Banks usually offer three traditional facilities, they are; current account facility (no interest is paid), savings account (4-5% interest is paid) and fixed account (7-8% interest is paid).
• Post Office Deposits – Fixed deposit and Income schemes at Post offices provide around 13% to 15% interest rate.
• NBFC Deposits – NBFC`s having bet owned funds over 25 lakh can accept deposits with maturity ranging from 3-5 years and provide interest rate higher than commercial banks.

• Tax Sheltered Savings Scheme – These are beneficial for tax-paying Investors. They offer tax relief to its participants according to the taxation laws. E.g. Public Provident Fund Scheme, National savings scheme, National Saving Certificate, Public Provident Fund Scheme, National Savings Scheme, National Savings Certificate

• Life Insurance – It is a contract for payment of a sum of money to the person assured or entitled on happening of an insured event or at maturity. It also provides tax benefits to the person buying the insurance scheme. E.g. Basic Life Insurance: Whole Life Assurance Plan, Endowment Assurance Plan, Term Assurance Plans, Plans for Children, Pension Plans

(3) Mutual Funds

A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.

An investor can buy mutual fund ‘units’ which represent his/her share in a particular scheme. These units can be purchased or redeemed as needed at the fund’s current net asset value (NAV). These NAVs keep fluctuating, according to the fund’s holdings. All the mutual funds are registered with SEBI.

• Open Ended Mutual Fund Schemes – These offer its units on continuous basis and accept funds from investors continuously. There are no restrictions on buying or selling funds. These schemes do not have a maturity period and are not listed on the stock exchange. These provide liquidity to investors since repurchase facility is available.

• Closed Ended Mutual Fund Schemes – These have a fixed maturity period and are kept open for a limited period. Once closed the units are listed on the stock exchange. The demand and supply factors influence the price of the units.

Types of Mutual Fund Schemes

• Growth Schemes – These funds invest money in equities and offer high returns.
• Income Schemes – These funds invest money in fixed securities and provide a regular return to its holders.
• Balanced Schemes – These funds provide a steady return as well as a reasonable growth. The money is generally invested in equity and debt instruments.
• Money Market Schemes – These funds invest money in money market instruments like TB, CP.
• Tax Savings Schemes – These offer tax rebate to its investors. Equity linked saving schemes and pension schemes provide exemption from capital gains on specific investment.
• Index Schemes – These funds invest on equities of the index. The returns are approx. equal to the return of the Index.

(4) Non-Financial Instruments or Real Assets

These Investment alternatives usually form the major part of the investor`s portfolio. They include:

• Gold and Silver – They provide best protection against inflationary tendencies in an economy.
• Real Estate – They provide high returns to investors but require high investment and long term commitment. This investment alternative includes investment on land, buildings, any personal and property.
• Antiques – They usually guarantee safety of investment. A price rise is generally due to increased interest of collectors or increased social importance.

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