5. Economic Analysis

by with No Comment NISM Series XV- Research Analyst

Basic Principles of Microeconomics

Microeconomics is the study of the behavior of individuals and their decisions on what to buy and consume based on prevalent prices which in turn signals where the economy has to direct its productive activities. The philosophy of Microeconomics is that prices and production levels of goods and services in an economy are driven by consumer demand.

Microeconomics also deals with the “theory of the firm.” Extending the concept of individuals, here it deals with how firms adopt different strategies to increase their profits. It deals with the decision-making process at the level of inputs, outputs, prices, production levels, profits, and losses of individual firms.

Basic Principles of Macroeconomics

1. Macroeconomics is the study of the economy as a whole, including the interaction of households, businesses, and government.

2. Macroeconomic variables such as GDP, unemployment, and inflation rate are used to measure the performance of an economy.

3. The demand and supply of goods and services are the primary determinants of economic activity in an economy.

4. Fiscal policy, such as government spending and taxation, and monetary policy, such as interest rates and money supply, are used to influence economic activity.

5. Macroeconomic models are used to analyze the effect of policy decisions on the overall economy.

6. Macroeconomic risks, such as external shocks, can have a significant effect on the performance of an economy.

Introduction to Various Macroeconomic Variables

The government and central bankers, in any economy, as policymakers strive to promote economic stability and growth. Their continuous attempt is to implement policies, which ensure a low unemployment rate, price stability with a low inflation rate, and steady growth in economic outputs. However, in spite of the best intentions and efforts of policy makers, economies go through cycles of booms and busts.

National income of an economy is defined through a variety of measures such as gross domestic product (GDP) and gross national product (GNP).

Broadly stated, the national income of an economy can be measured through three methods: (i) Product Method (ii) Income Method, and (iii) Expenditure Method.
1. Product Method- The product method of calculating national income is the most commonly used method. This method calculates national income by summing up the total value of all goods and services produced in an economy over a certain period of time. This value is found by multiplying the total quantity of goods and services produced by the price of each individual good or service.

2. The income method of calculating national income is an alternative to the production method. This method measures national income by adding up all the incomes earned by factors of production, such as wages, rent, interest, and profits. This method is useful for understanding the distribution of income among different groups.

3. Expenditure Method The expenditure method of calculating national income is a third alternative. This method involves adding up all the expenditures made by individuals, businesses, and the government during a certain period of time. This includes spending on final goods and services, as well as investments and transfers. This method is useful for understanding the sources of economic growth.

The level of economic welfare and growth of a country is determined by its total national income. A higher national income means that the average person in the economy has more money to spend, which in turn leads to higher levels of economic welfare. A higher national income also indicates that the economy is growing at a faster rate, which can lead to more job opportunities and higher standards of living.

The distribution of income among the constituents of an economy is also an important factor in determining economic welfare and growth. If the income is distributed evenly, it will lead to greater economic welfare and growth. On the other hand, if the income is concentrated among a few individuals, it will lead to lower economic welfare and slower economic growth. For example, the service sector constitutes 60% of India’s GDP at factor cost.

Support to Fiscal and Monetary policies- National income is also an important factor in supporting fiscal and monetary policies. For example, if a country has a higher national income, this can be used by the government to finance public services and investments, which in turn can lead to higher economic welfare and growth. Similarly, higher national income can provide the resources for the central bank to implement monetary policies such as lowering interest rates, which can stimulate economic activity.

Saving and Investments-
Another way in which national income affects economic welfare and growth is through savings and investments. A higher national income can lead to more savings, which can be used to finance investments. This can lead to higher levels of productivity and faster economic growth.

Inflation (Consume/Wholesale Price Indices) and Interest Rate-
Inflation is defined as the general increase in price levels of goods and services in the economy leading to an erosion of purchasing power of money. If Rs. 1000 was put away in a drawer, what would happen to the money after a year? Yes! It would be the same Rs. 1000 bill after a year, but it would buy lesser goods and services than what it would have fetched a year back as all goods and services would have become more expensive after a year.

inflation is measured in two ways – at the wholesale level in terms of the Wholesale Price Index (WPI) and retail level in terms of the Consumer Price Index (CPI). Typically, economists define a basket of products based on general consumption in the economy and compute its prices based on wholesale prices and retail prices defining WPI and CPI respectively. Statistics on WPI and CPI over several years provides trend in inflation numbers and feeds as an important input for policy measures by both government and central banker.

interest and inflation are closely linked parameters. Higher inflation demands higher rates for people to get motivated to save. As they save more and consume less, consumption goes down. On the other hand, higher rates reduce investments (high cost of capital) and may slow down the overall economy. Higher rates affect some sectors such as real estate and auto more intensely as of most the buying here by the middle-class people happens through loans, which become expensive in higher rates scenarios. Higher inflation reduces the discretionary income that people have and impacts their demand for products and services across the board.

Unemployment Rate
The unemployment rate refers to the eligible and willing-to-work unemployed population of the country in percentage terms. During a slowdown in economies, the unemployment rate rises and during an expansion phase, the unemployment rate falls as more jobs are created as production goes up.

Flows from Foreign Direct Investment (FDI) and Foreign Portfolio Investments (FPI)–
FDI is welcomed by all developing economies and has multiple benefits, in addition, to bring in the capital of the country:
Job creation
New technologies
New managerial skills
New products and services
While FDI is long-term in nature and stable money, FPIs money is considered hot money as they can pull out the money at any time which could create systemic risk for the economy.

Fiscal Policies and their Impact on Economy
The fiscal policy contains the measures of the Government which deal with its revenues and expenses. Fiscal measures are important in any economy because when the government changes the measures of its income (primary source being taxation) and expenditure (education, healthcare, police, military forces, interest on borrowing, administrative machinery, welfare benefits, etc.), it influences aggregate demand, supply, savings, investment and the overall economic activity in the country.

Budgeted excess of the Government’s expenditure over its revenues in a specific year is known as fiscal deficit, which is generally defined as a percentage of GDP. The fiscal deficit is bridged by the government through market borrowings, both short-term and long-term. A large fiscal deficit, and consequently a higher borrowing by the government, will push up interest rates in the economy and make it difficult for corporate borrowers to access funds. A high-interest rate environment is detrimental to economic growth.

Expenditure is funded by the Government in multiple ways, mainly through:
P/L measures – Income from operations: Taxation, interest, and dividend income
B/S measures – Borrowing and Sale of assets

While Government tries to balance between its inflows and outflows, based on its actions, fiscal policy is being categorized as:
Neutral fiscal policy – When governments’ income and expenditure are in equilibrium. No major changes are required in the Fiscal policies.
Expansionary fiscal policy – Fiscal measures when the government’s spending exceeds its income. This policy stance is usually undertaken during recessions/slow-moving economies.
Contractionary fiscal policy – Fiscal measures when the government’s spending is lower than its income. The government uses the excess income to repay its debts/obligations or acquire assets.


Monetary Policies and their Impact on Economy
Monetary policy, similar to Fiscal policy, is referred to as either being expansionary or contractionary depending on policy stance. Expansionary monetary policy is used to push the economy up by increasing the money supply steeply and reduction in interest rates. On the other hand, a Contractionary policy is intended to cool down the heated-up economy through a reduction in the money supply or a slow increase in money supply and an increase in the interest rates.

Central banker controls the money supply and interest rates with tools such as the Repo rate (the rate at which the central bank lends money to commercial banks), Reverse repo rate (the rate at which the central bank borrows money from commercial banks), Cash Reserve Ratio (minimum percentage of the total deposits, which commercial banks have to hold as cash reserves with the central bank) and Statutory liquidity ratio (SLR) (minimum percentage of the total deposits, which commercial banks have to hold in cash equivalents such as gold and government of India securities).

International Trade, Exchange Rate, and Trade Deficit-
If imports are more than exports, then the country will have a current account deficit and if exports are more than imports then it will have a current account surplus.

If a country is running a continuous deficit on its current account, it would need a surplus in capital account to support that or deplete its foreign currency reserves. In both these situations, the country runs the risk of losing the confidence of market participants in the country as the currency of the country would lose value very fast.

Currencies get traded in the world markets like commodities. The exchange rate refers to the value of one unit of a currency with respect to other currency/currencies. For example, if Indian Rupee is quoted against the dollar as $/Rs. 65, it means one dollar is priced at Rs. 65. Currencies can become more expensive and/or lose their value vis a vis other currencies based on the relative strength of the country’s economy.

Globalization – Positives and Negatives
Globalization, simply stated, is the ability of individuals and firms to produce anything anywhere and sell anything anywhere across the world. It also means that resources (people and capital) will flow to the places where they produce best and earn best.

Role of economic analysis in fundamental analysis
Economic analysis helps us understand what is happening to the external environment and how
it is likely to affect a particular business.
Studying the GDP growth rate can help us understand what is happening in the overall
economy of the country. Understanding monetary policy and fiscal policy helps us understand
whether policies support further growth of the economy or otherwise. Tracking metrics such as
interest rates, inflation, public expenditure, and fiscal deficit helps us understand the future
direction of monetary and fiscal policies.

Economic trends can be broadly classified into secular, cyclical, and seasonal trends.
Secular trends are long-term, gradual changes in economic activity that occur over a period of several years. Examples of these trends include changes in employment, wages, inflation, and technology.

Cyclical trends are shorter-term, more volatile changes in economic activity that occur over a period of several months or years. Examples of these trends include business cycles, which can be characterized by periods of expansion and contraction in economic activity.

Seasonal trends are short-term, recurring changes in economic activity that occur over a period of several weeks or months. Examples of these trends include holiday shopping, tourism, and changes in agricultural production.

4. Fundamentals of Research

by with No Comment NISM Series XV- Research Analyst

What is Investing?

Investment activity focuses on the potential of an asset’s value to increase over a period. In the context of the securities market, the value of an asset can increase if it can generate higher cash flow without a proportionate increase in risk or if the risk associated with the asset decreases without a proportionate decrease in the cash flow. Investment activity is generally undertaken by investors with the aim of making a return on their investment.

Active Investing

Active investing involves identifying the specific security or set of securities that should be purchased or sold. It involves constant evaluation of every security in the investment portfolio so that investors can sell securities that are priced above their fair value. Similarly, while buying securities, investors look to identify securities that are priced below their fair value.

Passive Investing

Passive investing involves investing in a broad set of securities that fairly represent the asset class the investor needs to invest. Typically, a passive investing strategy follows an indexing strategy where an investor buys all securities that are part of an index. The objective of a passive investor is to earn the rate of return that the select asset class provides.

The role of research in investment activity

The role of a fundamental research analyst comprises of two parts (i) Research and (ii) Analysis.

Research: The fundamental research analyst is responsible for researching the companies and industries they cover. This involves researching the company’s financials, management, industry trends, competitive landscape, and overall company performance. The research analyst uses various sources such as company websites, financial databases, industry reports, and analyst research notes to obtain the necessary information for analysis.

Analysis: The fundamental research analyst then uses the research gathered to analyze the company’s performance and future prospects. This involves making sense of the data and using it to identify trends and draw conclusions. The analyst then uses the results of the analysis to make investment recommendations and provide advice to clients. The analyst may also be asked to provide commentary on market and sector developments.

Insider information is information obtained from people who are directly involved in the business operations of a company, such as employees, managers, and executives. This information is typically not accessible to the general public.

The mosaic analysis is the process of using publicly available information to build a picture of a company or industry. It involves collecting and analyzing various data points, such as financial reports, news stories, and market trends, in order to gain insight into how a company or industry is performing. Unlike insider information, mosaic analysis is available to anyone with access to public data.

Technical Analysis-
Technical analysis is a method of trading in which past price movement and trading volume of security are analyzed to make predictions about future price movements. This type of analysis focuses on chart patterns, indicators, and other technical tools to identify trends and forecast future prices.

Fundamental Analysis
Fundamental analysis is a method of trading in which a company’s financial performance is analyzed to make predictions about future price movements. This type of analysis focuses on financial statements, such as balance sheets, income statements, cash flow statements, and more, to identify trends and forecast future prices.

 

3. Terminology in Equity & Debt Market

by with No Comment NISM Series XV- Research Analyst

Terminology in Equity Market

1. Face Value (FV)– The face value of a share is the original cost of the share stated by the company, which usually does not change over time unless the company decides to split or consolidate its shares. In such cases, the face value of the company’s shares would reduce (in case of the split) or increase (in case of consolidation).
The face value of a share is important for calculating the dividend payable on a share. When a dividend is mentioned as a percentage, that percentage is reckoned with regard to the face value.

2. Book Value of a company is the net worth of the company. To compute book value per share, the net worth of the company is divided by the number of outstanding shares.

3. the market price of a share. The market value of the entire equity of a company is termed market capitalization and is computed as the market price per share multiplied by the total number of outstanding shares. The market value of a share depends upon a host of factors like the expected performance of the company, market sentiments, and liquidity, among others.

4. Replacement Value- This refers to the market value of all the assets of a company at any point in time. If a new company were to set up with all the infrastructure/plants, which an already existing company has, then the cost which it would have to bear today is known as the ‘Replacement Value of the existing firm.

5. Intrinsic Value- The intrinsic value of an asset is the value that it has based on its underlying fundamentals rather than its market price. Intrinsic value is subjective and can be determined by an individual investor’s analysis of a variety of factors, such as the asset’s cash flows, the strength of its balance sheet, its competitive advantages, and other qualitative and quantitative factors. The intrinsic value should not be confused with fair market value, which is the price an asset would fetch in the open market. Warren Buffett defines intrinsic value as “the present value of all expected future cash flows, discounted at an appropriate interest rate.”

6. Market capitalization is a measurement of the market value of a company based on its current share price and the total number of outstanding shares. It is used to determine the size of a company relative to its peers in the industry. It is calculated by multiplying the current stock price by the total number of outstanding shares. Market capitalization is an indication of a company’s financial strength and market power.

Blue-chip stocks usually have higher market capitalization than smaller companies. This is because blue chips often have more stable business models and larger customer bases, making them more attractive to investors. Additionally, larger companies often have access to more capital and resources, which can help them to compete in the market. Market capitalization is an important factor when assessing a company’s potential for growth and financial performance.

Mid-cap stocks are companies with a market capitalization of between $2 billion and $10 billion. These companies are typically established and well-known, but not as large as the blue-chip stocks. They may have an established customer base, but they often lack the resources of larger companies. Mid-cap stocks may be more volatile than blue-chip stocks, but they can also offer more potential for growth.

Small cap stocks are companies with a market capitalization of less than $2 billion. These companies are typically young and less established than larger companies. They are often more risky investments as they lack the resources and customer base of larger companies. They may offer greater potential for growth, but they also come with higher levels of risk.

7. Enterprise value (EV) is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Whereas market capitalization only considers a company’s equity, EV considers both equity and debt.

EV = Value of common equity + value of non-controlling interest + Value of preferred capital + Debt – cash, cash equivalents, and financial investments

8. Earnings can refer to historical, trailing, or forward earnings. Historical earnings refer to the reported or audited earnings of a company in the past. It is typically reported in a company’s financial statements and is used to measure the performance of a company over time. Trailing earnings refer to the most recently reported earnings of a company, usually from the last four quarters. They are typically used to evaluate the current performance of a company and to make predictions about future performance. Forward earnings refer to expected earnings for future quarters and are typically used to make projections about the future performance of a company.

9. Earnings per share (EPS) is a financial ratio that measures the portion of a company’s profit that is allocated to each outstanding share of common stock. It is calculated by taking the company’s reported profits divided by the total number of outstanding shares of common stock. EPS is an indicator of a company’s profitability and is often used to compare companies within the same sector. Investors use EPS to determine how much they should pay for a share of a company’s stock.

10. Dividend is generally declared as a percentage of the face value of the shares. It is the portion of the profit that the company distributes amongst its shareholders. For example, a 40% dividend declared by the company will translate into a dividend of Rs.4 per share with a face value of Rs 10 (10*40% =4). This is known as Dividend Per Share (DPS).

11. The price to earnings ratio (PE Ratio) is a ratio used to measure the value of a stock by comparing its current price to its earnings per share. It is calculated by dividing the current share price of a stock by its earnings per share (EPS). The ratio is used to compare the current market value of a company to its earnings and is seen as an indicator of the company’s profitability and potential future value. PE Ratios can be used to compare the performance of companies within the same industry or to the overall market.

12. Price to Sales ratio is a valuation ratio that measures the price investors are willing to pay for each rupee of sales. It is calculated as:

P/S Ratio = Current Market Price (CMP) / Annual Net Sales per Share
Or
P/S Ratio = Market capitalization / Annual Net Sales

13. The Price-to-Book Value Ratio (P/BV) is a valuation metric used to compare a company’s market value to its book value. It is calculated by dividing the current market price of a company’s stock by its book value per share. The P/BV ratio is a measure of the market’s expectations of a company’s future performance and gives investors an indication of the value of the company relative to its assets. A lower P/BV ratio indicates that the stock is undervalued, while a higher P/BV ratio indicates that the stock is overvalued.

14. Differential Voting Rights (DVR) is a type of corporate governance structure which allows companies to issue two types of shares with different voting rights. This structure is most commonly used in India and is beneficial for companies that want to list on a stock exchange but want to retain control. The structure allows promoters to hold a majority of the voting rights while still granting a certain amount of voting rights to public shareholders. DVRs are designed to give promoters greater control over the company while still allowing public shareholders to have some say in the company’s affairs.

Terminology in Debt Market

Debt capital refers to the capital provided by lenders who are keen to be compensated regularly in the form of a pre-specified fixed rate of interest. They also expect the money they have lent to be returned to them after an agreed period of time. Debt can be created by borrowing from banks and other institutions or by issuing debt securities. For example, if a company wishes to borrow Rs.100 crore, it has two options.

  1. Face Value-which represents how much the loan is represented by that particular debt paper. This is the nominal or par value of the debt paper and interest, throughout the term of the paper, is paid as a percentage of this amount. The face value may be Rs.100 or Rs.1000 or any other denomination.

  2. The coupon rate is the interest rate paid out by a bond issuer to a bondholder, expressed as a percentage of the bond’s face or par value. Coupon rates are fixed and do not change over the life of the bond. The coupon rate is also referred to as the bond yield.
  3. Maturity is the date on which a debt instrument, such as a bond, note, or loan, comes due and must be repaid by the issuer to the holder. Maturity dates vary based on the type of debt instrument, with some having maturities of as little as 30 days and others having maturities of several decades.
  4. The principal is the face value or original amount of money borrowed or lent, on which interest is calculated. In a loan, the principal is the amount of money borrowed and on which interest is paid; in a bond, it is the face value of the bond and on which interest payments are made to the bondholders.

  5. Redemption of a bond is the process by which a bond issuer repays the principal amount of the bond to the bondholder at the maturity date. The bond issuer will typically redeem the bond by paying the bondholder the face value of the bond plus any accrued interest. If a bond is called for early redemption, the bond issuer will typically redeem the bond at a price above the face value.

  6. Holding period returns (HPR) is the rate of return earned on an investment over a specific period of time. This rate of return includes both capital gains and income earned on the investment. HPR is calculated by subtracting the purchase price of the investment from the sale price and dividing it by the purchase price.

  7. The current yield is the annual income from a bond divided by the current market price of the bond. It is a measure of yield that takes into account the price of the bond and is expressed as a percentage. Current yield is often used to compare the yields of different bonds of the same quality. Suppose the 8.24GS2018 is trading at Rs. 104, the current yield would be: Current Yield = (8.24/104) = 0.07923 = 7.92%.

  8. Yield to Maturity (YTM)- Yield to Maturity or YTM is a more comprehensive and widely used measure of return calculation of a debt security than current yield. This method takes into consideration all future cash flows coming from the bond (coupons plus the principal repayment) and equates the present values of these cash flows to the prevailing market price of the bond.

    The YTM can be calculated by trial and error method by plugging in different rates in the equation and arriving at the one that equates the market price of bond to the present value of the expected cash flows from the bond. It can also be calculated using the XIRR function in
    Excel. The calculations are shown below for the HDFC 9.70% 2017 bond issued on 19 July 2007 and maturing on 19 July 2017 with annual payment of interest, assuming the bond is trading at Rs. 103 on Nov 1, 2014:

9. Duration- Duration measures the sensitivity of the price of a bond to changes in interest rates. Bonds with high duration experience greater increases in value when interest rates decline and greater losses in value when rates increase, compared to bonds with lower duration.

Duration is the weighted average maturity of the bond, where the present values of the future cash flows are used as weights. Duration thus incorporates the tenor, coupon and yield in its calculation

10. Types of Bonds– Bonds are securities that represent a loan. For a loan to be completely defined, the loan amount, the time for which the loan is taken, and the rate at which it is taken, must be known. These three are known as Principal, Maturity, and Coupon respectively in bonds.

Zero–Coupon Bond is a type of bond which does not make any coupon payments. It is sold at a deep discount from its face value, and the investor earns a return in the form of the difference between the purchase price and the face value. The face value is paid out at maturity. This type of bond is attractive to investors who don‘t need or want regular income, but are instead happy to receive a lump sum at maturity. 

Floating–rate bonds are bonds which have a coupon rate that changes periodically based on an index or benchmark rate. The coupon rate on these bonds is reset periodically, usually every 6 months. This means that the coupon payments received by the investor are a function of the current interest rate environment. Floating–rate bonds are attractive to investors who want to benefit from a changing interest rate environment.

Convertible bonds are bonds which can be converted into a predetermined number of the issuer‘s common stock. Convertible bonds are attractive to investors who believe that the issuer‘s stock will increase in value. Investors can benefit from the appreciation in the stock price, while still receiving the coupon payments from the bond. 

Principal – Protected Note (PPN) is a relatively complex debt product which aims at providing protection of the principle amount invested by investors, if the investment is held to maturity. Typically, a portion of the amount is invested in debt in such a way that it matures to the principal amount on expiry of the term of the note. The remaining portion of the original investment is invested in equity, derivatives, commodities and other products which have the potential of generating high returns. 

Inflation – Protected Securities (TIPS) TIPS are a type of bond that provides investors with protection from inflation. The principal amount of TIPS is adjusted for inflation or deflation based on the Consumer Price Index (CPI). This ensures that the investor‘s purchasing power is maintained in the long run. TIPS are attractive to investors who are concerned about the potential for inflation to erode their purchasing power in the future. 

Foreign currency bonds are bonds denominated in a currency other than the investor‘s domestic currency. These bonds are attractive to investors looking to diversify their portfolios or hedge against currency risks. Foreign currency bonds also provide investors with the potential for higher returns as the foreign currency may appreciate against the domestic currency. 

External bonds, also referred to as Euro bonds, are bonds issued in a currency that is different from the currency of the country in which it is issued. For example, if a company issues a US dollar–denominated bonds in Kuwait, it would be referred to as a Euro bond as the currency of the bond (USD) is different from the currency of the country in which it is issued (Kuwaiti Dinar). 

Perpetual bonds are bonds with no maturity date. These bonds typically have a coupon rate and make regular payments to the investor, but do not have a fixed maturity date. Perpetual bonds are attractive to investors who are looking for a steady stream of income, as the payments are not dependent on the maturity date.

2. Introduction to Securities Market

by with No Comment NISM Series XV- Research Analyst

Introduction to Securities and Securities Market

Securities are transferrable financial instruments or contracts that show evidence of indebtedness or ownership interest in assets of an incorporated entity. These include equity shares, preference shares, debentures, bonds, and other such instruments. These are issued by companies, financial institutions, or the government. They are purchased by investors who have money to invest. Security ownership allows investors to convert their savings into financial assets which provide a return. On the other hand, security issuance allows borrowers to raise money at a cost. Thus, the objectives of the issuers and the investors are complementary.

 

Product Definitions/Terminology-

  1. Equity share (also known as ordinary share capital or ordinary shares) is the amount of money that shareholders have invested in a company. It is one of the sources of a company’s capital, along with debt and retained earnings. Equity share capital is represented by shares of stock that can be bought and sold in the stock market. Equity shareholders are the owners of a company and have the right to vote on certain matters, such as electing members of the Board of Directors. They also receive dividends, which are payments made out of the profits of the company. (Regulator:- SEBI & Companies Act)
  2. Debentures (also called bonds or notes) are a form of long-term debt, usually issued by companies to raise capital. They are usually secured against the assets of the company and are repaid in periodic installments with interest. Debentures can be traded on the stock market and provide investors with a regular income. However, they do not carry any voting rights, unlike equity shareholders. (Regulator:- RBI, SEBI & Companies Act)

    Fully convertible debentures (FCDs) are a type of debt instrument that can be exchanged for a fixed number of equity shares of the issuing company at a predetermined price. The conversion is usually done at a predetermined date, usually after a certain period of time. FCDs are a form of hybrid security, as they combine the features of both debt and equity.

    Partly convertible debentures (PCDs) are a type of debt instrument that can be partially converted into equity shares of the issuing company at a predetermined price.

    Non-Convertible Debentures (NCDs) are pure debt instruments without a feature of conversion. The NCDs are repayable/redeemable on maturity.
  3. Foreign currency bonds are bonds issued by a company in a currency that is different from the currency of its home country. For example, in February 2020, Delhi International Airport Limited (an SPV of GMR Infrastructure Ltd) issued USD bonds. (Regulator- Regulators in the respective country of issue).
  4. External bonds / Masala bonds– also referred to as Euro bonds, are bonds issued in a currency that is different from the currency of the country in which it is issued. For example, if a company issues a US dollar-denominated bond in Kuwait, it would be referred to as a Euro bond as the currency of the bond (USD) is different from the currency of the country in which it is issued (Kuwaiti Dinar). (Regulator- Regulators in the respective country of issue).
  5. Warrants and Convertible Warrants- are options that entitle an investor to buy equity shares of the issuer company after a specified time period at a pre-determined price. Only a few companies in Indian Securities Market have issued warrants till now.
  6. Indicies– A market index tracks the market movement by using the prices of a small number of shares chosen as a representative sample. we can call the stock market index a benchmark and it presents the economy of the country and specific sector.
    Common Indicies in India- Nifty 50, Nifty 100, Nifty 500, S&P Sensex, BSE Midcap, etc.
  7. Mutual Funds (MFs) are investment vehicles that pool together the money contributed by investors the fund invests in a portfolio of securities that reflect the common investment objectives of the investors. Each investor’s share is represented by the units issued by the fund. The value of the units, called the Net Asset Value (NAV), changes continuously to reflect changes in the value of the portfolio held by the fund. (Regulator- SEBI & RBI)
    An open-ended scheme offers the investors an option to buy units from the fund at any time and sell the units back to the fund at any time.
    The unit capital of closed-ended funds is fixed and they sell a specific number of units.
  8. Exchange Traded Funds (ETFs) are investment vehicle that invests funds pooled by investors to track an index, a commodity, or a basket of assets. It is similar to an index fund in the sense that its portfolio reflects the index it tracks. But, unlike an index fund, the units of the ETF are listed and traded in Demat form on a stock exchange, and their price changes continuously to reflect changes in the index or commodity prices. (Regulator SEBI & RBI)
  9. Preference Shares- as their name indicates, are a special kind of equity shares that have preference over common/ordinary equity shares at the time of dividend and at the time of repayment of capital in the event of winding up of the company. They have some features of equity and some features of debt instruments.
  10. Depository receipts (DRs) are financial instruments that represent shares of a foreign company. These depositary receipts trade in the local market (in which it is issued) and are denominated in local currency.

    American Depositary Receipts (ADRs): These depositary receipts issued and traded in the U.S.A. are issued by a non-US company. Some of the Indian companies that have issued ADR include Infosys, Wipro, ICICI Bank, and HDFC Bank.

    Indian Depositary Receipts (IDR): DR issued and traded in the Indian market by a non-Indian company is referred to as IDR.

    Hong Kong Depositary Receipts (HKDR): HKDRs refer to a depositary receipt issued by a non-Hong Kong company that is traded in the Hong Kong market.

    Global Depositary Receipts (GDRs): GDRs are preferred to be issued in the European Union member states as the commonality of the regulations makes it easy for the issuing companies to comply with regulations across the region.
  11. Foreign Currency Convertible Bonds (FCCBs):- denominated convertible debt papers issued by companies in international markets. These instruments are to be understood the way convertibles are with the only difference being that they are generally optionally convertible and issued offshore in different denominations under guidelines as defined by the Reserve Bank of India (RBI) from time to time. (Regulator- Foreign Exchange Management Act (FEMA) & RBI)
  12. Equity Linked Debentures (ELDs)- are floating rate debt instruments whose interest is based on the returns of the underlying equity asset such as Nifty 50, S&P Sensex, individual stocks, or any customized basket of individual stocks.
  13. Commodity Linked Debentures (CLDs)– CLDs are floating-rate debt instruments whose interest is based on the returns of the underlying commodity asset.
  14. Mortgage Backed Securities (MBS) and Asset-Backed Securities (ABS): are debt instruments issued by institutions against the receivables and cash flows from financial assets such as home loans (MBS), auto loans, rent receivable, credit card receivables, and others.
  15. REITs/InvITs– Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are investment vehicles that pool money from various investors and invest in revenue-generating real estate projects and infrastructure projects, respectively. In the case of REITs, 80% of the asset should be held in the form of real estate assets. Similarly, for InvITs, the regulation stipulates that 90% of the unit capital should be invested in revenue-generating infrastructure projects. These assets can be held directly or through a special-purpose vehicle (SPV)
  16. Commodities– are largely traded goods that are meant for use in the production of goods or for consumption. Since inflation and prices of commodities are directly related, investing in commodities can help protect the real value of the investment.
  17. Precious metals such as gold and silver are viewed as an investment that can help preserve the real value of money.
  18. Commodity ETFs– A commodity ETF is an exchange-traded fund that invests the pooled investment in a range of physical commodities.
  19. Managed futures contract– Futures contract is a contract to buy or sell an asset at a specified future date at a specific price. Since the price of the contract is pre-determined, the buyer of the contract tends to gain if the price of the product increases in the future (the reverse is also true).
  20. Warehouse receipts– is a document that shows proof of ownership of goods that are stored in a warehouse. Most of these warehouse receipts are negotiable. Thus, the title to the underlying goods can be transferred by simply transferring the receipts.
  21. Structure of Securities Market-

    Primary Market: also called the new issue market, is where issuers raise capital by issuing securities to investors. Fresh securities are issued in this market

    Secondary Market: The secondary market facilitates trades in already-issued securities, thereby enabling investors to exit from an investment or new investors to buy the already existing securities.
  22. Public issue- Securities are issued to the members of the public, and anyone eligible to invest can participate in the issue. This is primarily a retail issue of securities.
  23. Initial Public Offer (IPO)– An initial public offer of shares or IPO is the first sale of a corporate’s common shares to investors at large. The main purpose of an IPO is to raise equity capital for further growth of the business. Eligibility criteria for raising capital from public investors are defined by SEBI in its regulations and include minimum requirements for net tangible assets, profitability, and net worth.
    at least 35% of shares should be allocated to retail investors (investors investing less than or equal to Rs.2,00,000 in the issue) while the utmost 50% can be allocated to qualified institutional investors. Other investors can be issued the balance.
  24. Follow-on Public Offer (FPO)– When an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, it is called FPO.
  25. Private Placement- It refers to issuing large quantities of shares to a select set of investors.
    According to the Companies Act 2013, the number of investors to whom shares are issued under
    private placement should not exceed fifty (50).
  26. Qualified Institutional Placements (QIPs)- private placements of shares made by a listed company to certain identified categories of investors known as Qualified Institutional Buyers (QIBs).
  27. Preferential Issue– means an issue of specified securities by a listed issuer to any select person or group of persons on a private placement basis and does not include an offer of specified securities made through a public issue, rights issue, bonus issue, employee stock option scheme, employee stock purchase scheme or qualified institutions placement or an issue of sweat equity shares or depository receipts issued in a country outside India or foreign securities.
  28. Rights and Bonus Issues- Securities are issued to existing shareholders of the company as on a specific cut-off date, enabling them to buy more securities at a specific price (in case of rights) or without any consideration (in case of bonus). Both rights and bonus shares are offered in a particular ratio to the number of securities held by investors as of the record date.
  29. Onshore and Offshore Offerings- If capital is raised from the domestic market, it is called an onshore offering and if capital is raised from investors outside the country, it is termed an offshore offering.
  30. Offer for Sale (OFS)- is a form of share sale where the shares offered in an IPO or FPO are not fresh shares issued by the company, but an offer by existing shareholders to sell shares that have already been allotted to them.
  31. Sweat Equity – Under Sec.54 of the Companies Act, 2013, a company may issue shares to its employees, promoters, technocrats, or others as a reward for their contribution to the company. These shares are referred to as sweat equity.
  32. Employee Stock Option Scheme (ESOPs)– ESOPs are instruments given by a company to its employees that give them the option to buy the shares of the company at a pre-determined price after a period of time (referred to as a vesting period).
  33. Secondary Market- the dealings between investors and the issuers do not come into the picture.
  34. Over-The-Counter Market (OTC Market)– OTC markets are the markets where trades are directly negotiated between two or more counterparties. In this type of market, the securities are traded and settled over the counter among the counterparties directly.
  35. Exchange Traded Markets -trading and settlement are done through the stock exchanges. The trades executed on the exchange are settled through the clearing corporation, which acts as a counterparty and guarantees the settlement of the trades to both buyers and sellers.
  36. Trading– A formal contract to buy/sell securities is termed as trading.
  37. Clearing and Settlement- are post-trading activities that constitute the core part of the equity trade life cycle. Clearing activity is all about ascertaining the net obligations of buyers and sellers for a specific time period. And, settlement is the next step in settling obligations by delivering shares (by the seller) and paying money (by the buyer).
  38. Risk Management– In OTC transactions, counterparties are expected to take care of the credit risk on their own. In the exchange-traded world, the clearing corporation, as defined above, gives a settlement guarantee of trades to the counterparties (all buyers and sellers).
  39. Stock Exchanges– provide a trading platform where buyers and sellers can transact in already issued securities. Stock markets such as NSE, BSE and MSEI are nationwide exchanges. Trading happens on these exchanges through electronic trading terminals which feature anonymous order matching.
  40. Depositories -are institutions that hold securities (like shares, debentures, bonds, government securities, and mutual fund units) of investors in electronic form. two Depositories in India that are registered with SEBI: 1. Central Depository Services Limited (CDSL) & National Securities Depository Limited (NSDL)
  41. Depository Participant- (DP) is an agent of the depository through which it interfaces with the investors and provides depository services. Depository participants enable investors to hold and transact in securities in the dematerialized form.
  42. Trading Members (Broker)– are registered members of a Stock Exchange. They facilitate buy and sell transactions of investors on stock exchanges.
  43. A Sub-Broker is an entity that is not a member of the Stock Exchange but who acts on behalf of a trading member or Stock Broker as an agent for assisting the investors in buying, selling, or dealing in securities through a such trading member or Stock Broker with whom he is associated.
  44. Brokerage- Brokers receive a commission for their services, which is known as brokerage. Maximum brokerage chargeable to customers is fixed by individual stock exchanges.
  45. Authorized Person – An authorized person is any person (individual, partnership firm, LLP, or body corporate), who is appointed by a stock broker or trading member as an agent to reach out to investors scattered across the country.
    SEBI had earlier allowed the spread of sub-brokership as well as Authorised Person’s network to expand the brokers’ network. However, SEBI Board in its meeting held on June 21, 2018, decided that sub-brokers as an intermediary shall cease to exist with effect from April 01, 2019. All existing sub-brokers would migrate to become Authorised Persons (APs) or Trading Members if the sub-brokers meet the eligibility criteria prescribed under Stock Exchange bye-laws and SEBI Regulations and by complying with these Regulations.
  46. Custodians- an entity that is charged with the responsibility of holding funds and securities of its large clients, typically institutions such as banks, insurance companies, and foreign portfolio investors. a custodian also settles transactions in these securities and keeps track of corporate actions on behalf of its clients.
  47. Clearing Corporations – play an important role in safeguarding the interest of investors in the Securities Market. Clearing agencies ensure that members of the Stock Exchange meet their obligations to deliver funds or securities.
  48. Clearing Banks– act as an important intermediary between clearing members and the clearing corporation. Every clearing member needs to maintain an account with the clearing bank.
  49. Merchant Bankers- are entities registered with SEBI and act as issue managers, investment bankers, or lead managers. They help issuer access the security market with the issuance of securities.
    They evaluate the capital needs of issuers, structure an appropriate instrument, get involved in pricing the instrument and manage the entire issue process until the securities are issued and listed on a stock exchange.
  50. Underwriters- are intermediaries in the primary market who undertake to subscribe to any portion of a public offer of securities that may not be bought by investors.
  51. Foreign Portfolio Investors (FPIs)- an entity established or incorporated outside India that proposes to make investments in India. These international investors must register with the regulator – the Securities and Exchange Board of India (SEBI) to participate in the Indian Securities Market.
  52. Participatory Notes (P-Notes or PNs) are instruments issued by SEBI-registered foreign portfolio investors to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator.
  53. Insurance companies’ core business is to ensure assets. Depending on the type of assets that are insured, there are various insurance companies like life insurance and general insurance, etc. These companies have huge corpus and they are one of the most important investors in the Indian economy by investing in equity investments, government securities, and other bonds.
  54. Pension Funds – A fund established to facilitate and organize the investment of the retirement funds contributed by the employees and employers or even only the employees in some cases. The pension fund is a common asset pool meant to generate stable growth over the long term and provides a retirement income for employees.
  55. Venture Capital Funds (VC) -are pools of capital provided by investors to startup companies and small businesses with perceived long-term growth potential. The venture capital funds provide financing to these companies in exchange for equity or an ownership stake in the business. These funds typically focus on high-growth, high-risk investments in exchange for the potential for a high return. Venture capital funds are typically managed by professional investors and are typically structured as limited partnerships.
  56. Private Equity Firms-is a term used to define funding available to companies in the early stages of growth, expansion, or buy-outs. Investee companies may be privately held or publicly traded companies.
  57. Hedge Funds- is an investment vehicle that pools capital from a number of investors and invests that across assets, across products, and across geographies. These fund managers generally have a very wide mandate to generate a return on the invested capital. They hunt for opportunities to make money for their investors wherever possible.
  58. Alternative Investment Funds (AIF)– are funds that invest in non-traditional asset classes such as private equity, venture capital, hedge funds, real estate, commodities, and derivatives. These funds provide investors with more diversified exposure and the potential for higher returns than traditional investments. However, they also come with higher risks and are not suitable for all investors.
  59. Investment advisers work with investors to help them decide on asset allocation and make a choice of investments based on an assessment of their needs, time horizon return expectation, and ability to bear risk. They may also be involved in creating financial plans for investors, where they help investors define their financial goals and propose appropriate saving and investment strategies to meet these goals.
  60. Employee Provident Fund (EPF)- is a scheme that is used to provide retirement benefits in the form of defined benefit schemes to employees of covered organizations. Every employer is obligated to provide 12% of the basic salary as a contribution to the scheme and an equal amount is deducted from the employee’s salary.
  61. National Pension Scheme (NPS)– This is a government-sponsored retirement scheme. Subscribers contribute regularly to the scheme and on maturity, the funds accumulated in the scheme can be used to buy annuity products. Subscribers will also have the option to partially withdraw the funds at maturity.
  62. Family Offices– refers to an organization that handles the wealth of a wealthy family. They typically take care of all aspects of the financial management of the family including investments, estate planning, and tax planning.
  63. Corporate Treasuries– Companies and other business organizations may have surplus funds which they intend to use for potential future opportunities or to meet future obligations. The organizations would gain if these funds are temporarily invested rather than let them be idle in their banks’ current accounts. Large corporates have a separate treasury team that handles such investments of surplus funds.
  64. Retail Participants– include individual investors who buy and sell securities for their personal account, and not for another company or organization. HNIs or High Net-worth Individuals and UHNIs (Ultra High net-worth individuals) are individual investors who invest large sums of money in the market. Reserve Bank of India has also granted general permission to Non-Resident Indians (NRIs), Persons of Indian origin (PIOs), and Qualified Foreign Investors (QFIs) for undertaking direct investments in Indian companies under the Automatic Route.
  65. Proxy Advisory services firms- advise investors in relation to the exercise of their rights in the company including recommendations on public offers or voting recommendations on agenda items. As investors may not be able to track shareholder announcements of all their investee companies or analyze each of the proposals in depth, the service of proxy advisors adds value to them.
  66. Cash trades are the trades where settlement (payment and delivery) occurs on the same trading day (T+0, where 0 defines the time gap in days between trade day and settlement day). we see cash transactions in our normal day-to-day life all the time when we buy groceries, vegetables, and fruits from the market.
  67. Tom trades are the trades where settlement (payment and delivery) occurs on the day next to the trading day (T+1).
  68. Spot trades are the trades where settlement (payment and delivery) occurs on the spot date, which is normally two business days after the trade date (T+2). Equity markets in India offer Spot trades.
  69. Forward contracts are contractual agreements between two parties to buy or sell an underlying asset at a certain future date for a particular price that is decided on the date of the contract. These are Over-the-counter (OTC) contracts.
  70. Futures are standardized exchange-traded forward contracts. They are standardized as to the market lots (traded quantities), quality, and terms of delivery – delivery date, cash settlement or physical delivery, etc. As these contracts are traded and settled on a stock exchange and the clearing corporation provides a settlement guarantee on them.
  71. An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying asset on or before a stated date and at a stated price.

    Call gives the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price on or before a given future date.
    Put gives the buyer the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a given date.
  72. A swap is an agreement between two parties to exchange one type of asset for another. It is typically used for a variety of reasons, such as to hedge risk, increase liquidity, or raise capital. For example, an interest rate swap is an agreement between two parties to exchange a fixed interest rate payment for a variable rate payment. In this case, one party may be looking to hedge against a potential rise in interest rates, while the other is looking to take advantage of the potential for a lower rate. There are a number of different types of swaps, including currency swaps, credit default swaps, and commodity swaps.
  73. Trading or speculating is an act of purchase or sale of an asset in the expectation of a gain from changes in the price of that asset over a short period of time.
  74. Hedging is an act of taking a position in financial transactions to offset potential losses that may be incurred by another position. A hedge can be constructed from many types of financial instruments, including insurance, forward/futures contracts, swaps, options, etc.
  75. Arbitrage is the simultaneous purchase and sale of an asset in an attempt to profit from discrepancies in its prices in two different markets. Buying a stock in the spot market and simultaneously selling that in the futures market to benefit from the price differential is an example of an arbitrage transaction.
  76. Pledge is an act of taking a loan against securities by the investor. The investor is called a ‘pledgor’ and the entity who is giving the loan against the securities is called a ‘pledgee’. Securities held in a depository account can be pledged/ hypothecated to avail of a loan/credit facility.
  77. Dematerialization is the process of converting securities held in physical form into holdings in book entry (electronic) form.
  78. Rematerialization is the reverse of dematerialization and is the process of converting securities held in electronic form into physical form.


1. Introduction to Research Analyst Profession

by with No Comment NISM Series XV- Research Analyst

Primary Role of a Research Analyst

Research Analysts (RAs) do, this to help their clients make investment decisions. There is Research – a collection of information from various sources and then Analysis – the processing of data to make decisions.

Analysis and decision-making process is a combination of understanding qualitative factors that affect operational performance, such as the efficiency of operations, competitiveness, business plans, and work ethics of the management among others, and quantitative factors such as revenues, costs, profitability, and risks to these financials. Therefore, RAs spend a lot of time interacting with companies and others, accumulating data, analyzing it, and arriving at a buy, hold or sell call.

Research Analysts are defined by the nature of the analysis they do, the coverage, and the use of the recommendations they provide. Let us understand some of them:

Sell-side Analysts – They typically publish research reports on the securities of companies or industries with specific recommendations to buy, hold, or sell the subject security. These recommendations include the analyst’s expectations of the earnings of the company and the future price performance of the security (“price target”). These analysts work for firms that provide investment banking, broking, and advisory services for clients

Buy-side Analysts – They generally work for money managers like mutual funds, hedge funds, pension funds, or portfolio managers that purchase and sell securities for their own investment accounts or on behalf of their clients. These analysts generate investment recommendations for their internal consumption viz. use by the fund managers within an organization. Research reports of these analysts are generally circulated among the top management/investment managers of the employer firms as these reports contain recommendations about which securities to buy, hold or sell.

Independent Analysts – They work for research originators or boutique firms separate from full-service investment firms and sell their research to others on a subscription basis. Their clients could be investors, institutions, investment bankers, regulators, stock exchanges, fund managers, etc. They also provide customized research reports on the businesses on specific requests.

Primary Responsibilities of a Research Analyst

Understanding economy – Changes in macroeconomic factors, Fiscal & Monetary Policies, FDI, FPI, Saving and Investing patterns & Global factors that impact the GDP.

Understanding industry – Research Analysts need to understand the industry, business models, competition, operating factors, the sensitivity of demand to price changes, consumers’ behavior, etc.

Understanding Companies– companies are also studied by analysts in two dimensions – Qualitatively and Quantitatively.

Basic Principles of Interaction with Companies/Clients

Pre-meeting Research – While the management is generally open to interviews with Research
Analysts, they must bear in mind that these opportunities do not come very frequently and
therefore must be made full use of whenever they come.

Independence and Neutrality of view- analysts must have an unbiased opinion and should always hold their independence. Also, they must make it clear to the management to not reveal any information which is not available in the public domain.

Network– analysts may use their network to acquire more contacts relevant to the research, who would be able to provide meaningful insights into the company’s performance and plans.

Clarity of questions– As analysts start analyzing a company, there would be certain aspects on which they might need more clarity. Time with management would be effectively used if analysts have a clear and specific set of questions in mind. They must be realistic in suggesting companies to their clients. Research reports should be simple, clear, and concise. They need to mention everything (conflicts, swot, and all details) clearly.

Important Qualities of a Research Analyst

  1. Good with numbers
  2. Good Excel (spreadsheet) and other data analytical tools
  3. The clarity in financial concepts
  4. Ability to read and comprehend financial statements and reports
  5. Ability to ask pertinent questions
  6. Attention to details
  7. Communication Skills – Written and Verbal