sapm syllabus & notes class-test -i

8/16/2019 SAPM Syllabus & Notes Class-Test -I

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Syllabus:

SAPM

1. Classifcation Capital Markets & Security Analysis

2. Dividend & Dividend Yields !u"erical#. C$aracteristics o% lue C$ip Co"panies

'. (ro)t$ Stocks* Dividend Yield Stocks

+. ,ar-et Price Calculation !u"erical

/. 0nterpretation o% P 3atios

4. Dividend Discount Model !u"erical only

5!ot in t$e so%t copy conducted in class roo"6


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• ASSET CLASSES

Asset class is a sort of investment, which includes bonds, stocks, real estate, or cash. Asset class

can alternatively be defined as the collection of securities demonstrating similar behaviors based on

same policies and regulations. The three primary asset classes are bonds (or fixed income), equities(or stocks) and cash equivalents(or money market instruments). Some other asset class includes

natural resources, foreign currency, stocks, treasured metals, luxury items, automobiles etc.

• Bank Fixed Deposits

ank !ixed "eposits are also known as Term "eposits. #n a !ixed "eposit Account, a certain sum of

money is deposited in the bank for a specified time period with a fixed rate of interest. The rate of

interest for ank !ixed "eposits depends on the maturity period. #t is higher in case of longer maturity

period. There is great flexibility in maturity period and it ranges from $days to %& years. The interest is

compounded annually and is added to the principal amount.

• Postal Services

#ndia possesses the largest postal network in the world with %'',&&& post offices spread all over thecountry as on arch %, *&&%. +ost ffice -ecurring "eposit Account, +ost ffice Time "eposit Account. +ost office time deposit account is ust like the bank fixed deposit account. These timedeposits are meant for those investors who want to deposit a lump sum for a fixed period. The amountcan be deposited for %year, *year, year, and 'years

• ational Savin!s Certi"icate

/ational Savings 0ertificate, popularly known as /S0, is a time1tested tax saving instrument that

combines ade2uate returns with high safety. +eriod of maturity of a certificate is six years. #nterest

accrued on the certificates every year is liable to income tax but deemed to have been reinvested.

• Public Provident Fund

+ublic +rovident !und, popularly known as ++!, is a savings cum tax saving instrument. #t also serves

as a retirement planning tool for many of those who do not have any structured pension plan covering

them. The account matures for closure after %' years. +remature withdrawal is permissible every year

after completion of ' years from the end of the year of opening the account.

#nterest at the rate notified by the 0entral 3overnment from time to time, is calculated and credited to

the accounts at the end of each financial year. +resently, the rate of interest is 45 per annum.

#ncome Tax rebate is available 6on the deposits made6, under Section 44 of #ncome Tax Act, as

amended from time to time. #nterest credited every year is tax1free


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• #overn$ent Bonds %#&Sec'

These are issued by central governments across the world to raise money for public spending.

asically you lend money to a government and it aims to pay you back on a set maturity date.

3overnment bond prices move up and down with market conditions and are often seen as a less

risky investment option when markets are volatile, although this isn7t true all of the time. 31Sec has

maturity period1',%& 8 & yrs. #t is also considered as a way of deficit finance. #t is considered as

enchmark security for setting up of basic interest rates in the country.

• Corporate Bonds

These are issued by large companies to raise money for different purposes. 0ompared with

government bonds, they usually carry a higher rate of interest as they are more susceptible than the

government to the economy. And like government bonds, prices move up and down with market

conditions. 0orporate bonds are normally considered to be riskier than government bonds. This is

because companies can only stay in business as long as they7re profitable, while governments have

a ready source of funds through taxes. #f a company cannot pay back the loan, you could lose all

your money.

• Shares

Shares are also known as e2uities. wning shares in a company means you own a part of it. #t also

means you can receive a share of the company7s profits through dividends. 9ou also have a share in

the value of the company7s assets, through its share price.

• (utual Funds

utual !und is an instrument of investing money. A mutual fund is a group of investors operating

through a fund manager to purchase a diverse portfolio of stocks or bonds. Therefore, keeping large

amounts of money in bank is not a wise option, as in real terms the value of money decreases over a

period of time.

• Propert)

As an investment asset class, property usually means investing in commercial property such as:

offices; retail developments; and leisure and industrial developments.

A maor attraction of property investment is that the success of the venture depends on professionalproperty management. Successful maintenance, refurbishment, repairs and tenancy arrangements

can all add value. oth the rental income and capital value of a property can be enhanced in this

way.


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CLASS*F*CAT*+ +F CAP*TAL (A-ET

CAP*TAL (A-ET

DEBT (A-ET ST+C- (A-ET

DEBET.ES P*(A/ (-T

0/= "==/T?-=S #+ (#/#T#A> +? !!=-)

// 0/= "==/T?-=S 0A>> /=9 @T

B+DS

3


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SEC.*T/ AAL/S*S 0 FEAT.ES

• #overn$ent Bonds %#&Sec'

These are issued by central governments across the world to raise money for public spending.

asically you lend money to a government and it aims to pay you back on a set maturity date.

3overnment bond prices move up and down with market conditions and are often seen as a less

risky investment option when markets are volatile, although this isn7t true all of the time. 31Sec has

maturity period1',%& 8 & yrs. #t is also considered as a way of deficit finance. #t is considered as

enchmark security for setting up of basic interest rates in the country.

• Corporate Bonds

These are issued by large companies to raise money for different purposes. 0ompared with

government bonds, they usually carry a higher rate of interest as they are more susceptible than the

government to the economy. And like government bonds, prices move up and down with market

conditions. 0orporate bonds are normally considered to be riskier than government bonds. This isbecause companies can only stay in business as long as they7re profitable, while governments have

a ready source of funds through taxes. #f a company cannot pay back the loan, you could lose all

your money.

• Shares

Shares are also known as e2uities. wning shares in a company means you own a part of it. #t also

means you can receive a share of the company7s profits through dividends. 9ou also have a share in

the value of the company7s assets, through its share price.

• Call 1 otice (one) (arket 0 Short Ter$ Deposits 1 Ter$ (one) (arket

23 This component of the money market in #ndia deals with % borro4ed 0 lent ' overni!ht 1 one

da) % Call (one) ' 0 otice (one) "or period up to 25 da)s3

63 #t is a market for short term funds repayable on demand 8 with maturity period varying

between one day to a fortnight.

73 8hen $one) is borro4ed 1 lent "or a da), it is kno4n as Call % +verni!ht ' (one)3

53 8hen $one) is borro4ed 1 lent "or $ore than a da) 0 up to 25 da)s, it is kno4n as

otice (one)3 /o collateral security is re2uired to cover these transactions. #t is basically an


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:3 As per -# stipulations for the maintenance of 0-- by anks, to enable anks to choose an

optimum strategy of holding 0-- depending on their intra1period cash flows, banks are

allowed to maintain 0-- on the basis of the last !riday of the second preceding fortnight.

;3 -eduction in the minimum 0-- re2uirement is for smooth adustment of li2uidity 8 better cash

management to avoid sudden increase in overnight call rates.

Call ates<

%. The interest rate paid on call loans is known as the call rate. The call rate varies from day to

day 8 often from hour to hour. #t is very sensitive to changes in demand for the supply of call

loans.

*. The call rates during %F4F were frees from administrative ceiling 8 freely determined by

market forces.

73 Call ates are in"luenced b) nu$ber o" "actors<

a' Eas) 1 ti!ht liquidit) in the $arket a""ect call rate3

b' De$and side o" liquidit) position is dependent on tax = out"lo4s, #ovt3 +" *ndia

borro4in! pro!ra$s3

c' eserves require$ent "or $aintenance o" C a""ect call rate3

d' As)$$etrical nature o" participants = "e4 lenders 0 lar!e borro4ers3

e' >olatile "orex $arket conditions a""ect call rates3

1 Banks "und "orei!n currenc) positions b) 4ithdra4in! "ro$ call $arket

lead to hike in call rate3

1

• TEAS./ B*LLS % T = B*LLS ' (A-ET

23 #t is basically an instrument of short term borrowing by 3ovt. f #ndia. #t is a particular finance

( i.e. a bill which does not arise from any genuine transaction in goods ) or a promissory note

issued by -# on behalf of 3overnment.

63 T1ills are used to raise short term funds to bridge temporary gaps between receipts 8

expenditure of 3ovt. f #ndia.


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73 The main features of T1ills are:

a) They are negotiable securities

b) They are issued at discount 8 are paid at par on maturity .

The difference between the price at which they are sold 8 their redemption value is

the effective return on T1ills

c) igh li2uidity on account of short tenure ( F% day 8 GH days )

d) Absence of default risk due to 3ovt. 3uarantee.

e) Assured yield

f) >ow transaction cost.

53 The development of T1ill market is at the heart of growth of money market. T1bills play a vital

role in the cash management of the 3ovt.

93 eing a risk free instrument, their yields at various maturities serve as a benchmark.

?2 Da) T& Bills<

%. -# issued F% day T1ills on the basis of weekly auctions.

*. A scheme for the issue of F% day T1bill was introduced in %FF*1F on the basis of auction

system with predetermined amount.

. The maor holders of auctioned F% day T1bills are the -#, State 3ovt., State run pension

funds 8 eligible provident funds.

2@6 Da) T& Bills<

%. %4* day T1bills are introduced in %F4G. The F% day T1bill has failed to smoothen the short term

li2uidity re2uirement mainly because of poor yields.

*. Apart from being a useful fiscal instrument, it was also a handy instrument for money

management in anks as much as it could be effectively deployed meeting S>- 8 0--

re2uirements.


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7:5 Da) T& Bills<

%. GH day T1bill became extremely popular due to their higher yield with li2uidity 8 safety and we

are being used as a benchmark by #"# 8 other !inancial #ntermediaries for determining the

rate of interest on floating bonds.

*. They have widened the money market8 provided innovative outlet for surplus funds.

25 Da) *nter$ediate T = Bills

%. #t is introduced in %FFG1F$

*. The investors were limited to the State 3ovts., !oreign 0entral anks and specified bodies.

There were non1transferable and were issued only in book entry forms to be redeemed at par.

. They have been discounted now due to lack of public response.

• C+((EC*AL PAPES % CPs ' (A-ET

23 #t is a short term unsecured negotiable instrument consisting of promissory notes with a fixed

maturity.

63 #t is generally issued by companies as a means of raising short term debt 8 by a process of

securitiIation, intermediation of bank is eliminated.

73 #t is issued on a discount to face value basis but it can also be issued in interest bearing form.

53 The issuer promises the buyer a fixed amount at a future date but ledges no assets. is

li2uidity power is the only guarantee.

93 A 0+ can be issued by a company directly to investor or through bank J merchant banker.

:3 8hen CP is directl) issued to investor 4ithout inter$ediar), then it is called as Direct

Paper3

;3 8hen CPs are issued securit) dealer, the) are called as Dealer Paper3


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Advanta!es<

%. #t is s simple instrument as it hardly involves any documentation between issuer 8 the

investor.

*. #t is additionally flexible in terms of maturities of the underlying promissory note, which can be

tailored to match the cash flows of the issuer.

. 0+ provides investors with returns higher than what they obtain from the banking system.

H. There are no limitations on the end1use of the funds raised through 0+s 8 instruments are

highly li2uid.

'. The issue of 0+ is governed by guidelines issued by -#.

G. All eligible participants should obtain the credit rating for issuance of 0+ from 0-#S#>, #0-A,

0A-=, !#T0.

$. 0+ can be issued for maturities between a minimum of $ days 8 maximum up to % year from

the date of issue.

4. 0+ can be issued in denominations of -s.' >acs or multiples thereof. The amount invested by

a single investor should not be less than -s.' >acs ( face value ).

• CET*F*CATE +F DEP+S*TS % CDs '

23 A 0" is a document of title to a time deposit and can be distinguished from a conventional

time deposit in respect of its free negotiability 8 hence marketability.

63 They are bearer documents and are readily negotiable.

73 #t is a money market instrument, issued in a de1mat form or as a promissory note for funds

deposited at a bank J other !inancial #nstitutions for a specific time period.

53 0"s can be issued by:

a) 0ommercial anks ( excluding --s ( -egional -ural anks ) J >ocal Area anks )

b) All #ndia !inancial #nstitutions permitted by -#

-aise short term resources within limit fixed by it.


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93 Financial *nstitutions $a) issue to!ether 4ith other instru$ents na$el) = Ter$ (one),

Ter$ Deposits, CPs 0 *nter&Corporate Deposits should not exceed 2 o" its net

o4ned "unds3

:3 The minimum amount should be -s.% >akh. 0"s can be subscribed by #ndividuals J

0orporations J 0ompanies J Trusts J !unds etc.

;3 The maturity period of a 0" issued by anks should be between $ days 8 % year C maximum

@3 The issuer is free to determine the discount rate. The interest rate on floating rate 0"s should

be set periodically.

?3 There is no locking period for 0"s. 0"s should be issued in "e1mat form and can be

transferred.

•

"ebentures:

%. A debt security issued by companies, having a certain maturity and bearing a stated 0oupon

rate.

*. "ebentures may be unsecured or secured by assets such as land 8 buildings of the issuing

company.

. "ebenture holders have a prior claim on the earnings and assets in the event of li2uidation as

compared to +reference 8 =2uity Shareholders.

H. "ebentures are either fully convertible or partially convertible.

'. /on convertible debentures are also available.


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INDICES

(arket Capitaliation

The value of e2uity shares outstanding at prevailing market prices.

(arket Capitaliation < o3 o" shares x (arket price o" each share3

Free Float (arket Cap< %o3 o" shares traded in the $arket =+ther than Pro$oters Stake' x (arket

price3

ational *ndex


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SESE & The Baro$eter o" *ndian Capital (arkets

!or the premier stock exchange that pioneered the securities transaction business in #ndia, over a century of

experience is a proud achievement. A lot has changed since %4$' when %4 persons by paying a then princely

amount of -e. %, became members of what today is called ombay Stock =xchange >imited (S=).

ver the decades, the stock market in the country has passed through good and bad periods. The ourney in

the *&th century has not been an easy one. Till the decade of eighties, there was no measure or scale that

could precisely measure the various ups and downs in the #ndian stock market. S=, in %F4G, came out with a

Stock #ndex1S=/S=K1 that subse2uently became the barometer of the #ndian stock market.

The launch of S=/S=K in %F4G was later followed up in Manuary %F4F by introduction of S= /ational #ndex

(ase: %F414H N %&&). #t comprised %&& stocks listed at five maor stock exchanges in #ndia 1 umbai,

0alcutta, "elhi, Ahmedabad and adras. The S= /ational #ndex was renamed S=1%&& #ndex from ctober

%H, %FFG and since then, it is being calculated taking into consideration only the prices of stocks listed at S=.

*ntroduction

S=/S=K, first compiled in %F4G, was calculated on a 6arket 0apitaliIation1Beighted6 methodology of &

component stocks representing large, well1established and financially sound companies across key sectors.

The base year of S=/S=K was taken as %F$41$F. S=/S=K today is widely reported in both domestic and

international markets through print as well as electronic media. #t is scientifically designed and is based on

globally accepted construction and review methodology. Since September %, *&&, S=/S=K is being

calculated on a free1float market capitaliIation methodology. The 6free1float market capitaliIation1weighted6

methodology is a widely followed index construction methodology on which maority of global e2uity indices

are based; all maor index providers like S0#, !TS=, STKK, S8+ and "ow Mones use the free1float

methodology.

The growth of the e2uity market in #ndia has been phenomenal in the present decade. -ight from early

nineties, the stock market witnessed heightened activity in terms of various bull and bear runs. #n the late

nineties, the #ndian market witnessed a huge frenIy in the 7TT7 sectors. ore recently, real estate caught the

fancy of the investors. S=/S=K has captured all these happenings in the most udicious manner. ne can

identify the booms and busts of the #ndian e2uity market through S=/S=K. As the oldest index in the country,

it provides the time series data over a fairly long period of time (from %F$F onwards). Small wonder, the

S=/S=K has become one of the most prominent brands in the country.


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*ndex Speci"ication<

Base /ear %F$41$F

Base *ndex >alue %&&

Date o" Launch &%1&%1%F4G

(ethod o"

calculation

>aunched on full market capitaliIation method and effective September &%, *&&, calcula

method shifted to free1float market capitaliIation.u$ber o"scrips

&

SESE Calculation (ethodolo!)

S=/S=K is calculated using the 6!ree1float arket 0apitaliIation6 methodology, wherein, the level of index at

any point of time reflects the free1float market value of & component stocks relative to a base period. The

market capitaliIation of a company is determined by multiplying the price of its stock by the number of shares

issued by the company. This market capitaliIation is further multiplied by the free1float factor to determine the

free1float market capitaliIation.

The base period of S=/S=K is %F$41$F and the base value is %&& index points. This is often indicated by the

notation %F$41$FN%&&. The calculation of S=/S=K involves dividing the free1float market capitaliIation of &

companies in the #ndex by a number called the #ndex "ivisor. The "ivisor is the only link to the original base

period value of the S=/S=K. #t keeps the #ndex comparable over time and is the adustment point for all #ndex

adustments arising out of corporate actions, replacement of scrips etc. "uring market hours, prices of the

index scrips, at which latest trades are executed, are used by the trading system to calculate S=/S=K on a

continuous basis.

.nderstandin! Free&"loat (ethodolo!)

Concept

!ree1float methodology refers to an index construction methodology that takes into consideration only the free1

float market capitaliIation of a company for the purpose of index calculation and assigning weight to stocks in

the index. !ree1float market capitaliIation takes into consideration only those shares issued by the company

that are readily available for trading in the market. #t generally excludes promoters7 holding, government

holding, strategic holding and other locked1in shares that will not come to the market for trading in the normal

course. #n other words, the market capitaliIation of each company in a free1float index is reduced to the extent

of its readily available shares in the market.

Subse2uently all S= indices with the exception of S=1+S? index have adopted the free1float methodology.

(aGor advanta!es o" Free&"loat (ethodolo!)

http://www.bseindia.com/about/abindices/FreeFloat.asphttp://www.bseindia.com/about/abindices/FreeFloat.asphttp://www.bseindia.com/about/abindices/FreeFloat.asp


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• A !ree1float index reflects the market trends more rationally as it takes into consideration only those

shares that are available for trading in the market.

• !ree1float ethodology makes the index more broad1based by reducing the concentration of top few

companies in #ndex.

• A !ree1float index aids both active and passive investing styles. #t aids active managers by enabling

them to benchmark their fund returns vis1O 1vis an investible index. This enables an apple1to1apple

comparison thereby facilitating better evaluation of performance of active managers. eing a

perfectly replicable portfolio of stocks, a !ree1float adusted index is best suited for the passive

managers as it enables them to track the index with the least tracking error.

•

!ree1float ethodology improves index flexibility in terms of including any stock from the universe oflisted stocks. This improves market coverage and sector coverage of the index. !or example, under

a !ull1market capitaliIation methodology, companies with large market capitaliIation and low free1

float cannot generally be included in the #ndex because they tend to distort the index by having an

undue influence on the index movement. owever, under the !ree1float ethodology, since only the

free1float market capitaliIation of each company is considered for index calculation, it becomes

possible to include such closely1held companies in the index while at the same time preventing their

undue influence on the index movement.

• 3lobally, the !ree1float ethodology of index construction is considered to be an industry best practice

and all maor index providers like S0#, !TS=, S8+ and STKK have adopted the same. S0#, a

leading global index provider, shifted all its indices to the !ree1float ethodology in *&&*. The S0#

#ndia Standard #ndex, which is followed by !oreign #nstitutional #nvestors (!##s) to track #ndian

e2uities, is also based on the !ree1float ethodology. /AS"AP1%&&, the underlying index to the

famous =xchange Traded !und (=T!) 1 PPP is based on the !ree1float ethodology.

De"inition o" Free&"loat

Shareholding of investors that would not, in the normal course come into the open market for trading are

treated as 70ontrollingJ Strategic oldings7 and hence not included in free1float. Specifically, the following

categories of holding are generally excluded from the definition of !ree1float:

• Shares held by foundersJdirectorsJ ac2uirers which has control element

• Shares held by personsJ bodies with 60ontrolling #nterest6


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• Shares held by 3overnment as promoterJac2uirer

• oldings through the !"# -oute

• Strategic stakes by private corporate bodiesJ individuals

• =2uity held by associateJgroup companies (cross1holdings)

• =2uity held by =mployee Belfare Trusts

• >ocked1in shares and shares which would not be sold in the open market in normal course.

The remaining shareholders fall under the Free-float category.

S & P CNX NIFTY

S8+ 0/K /ifty is a well diversified '& stock index accounting for *% sectors of the economy. #t is used for a

variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.

S8+ 0/K /ifty is owned and managed by #ndia #ndex Services and +roducts >td. (##S>), which is a oint

venture between /S= and 0-#S#>. ##S> is #ndia7s first specialised company focused upon the index as a core

product. ##S> has a arketing and licensing agreement with Standard 8 +oor7s (S8+), who are world leaders in

index services.

• The total traded value for the last six months of all /ifty stocks is approximately G'.G45 of the traded

value of all stocks on the /S=

• /ifty stocks represent about G'.H5 of the total market capitaliIation as on ar %, *&&F.

• *ndia *ndex Services 0 Products Ltd3 %**SL' • #ndia #ndex Services 8 +roducts >td. (##S>) is a oint venture between the /ational Stock =xchange of

#ndia >td. (/S=) and 0-#S#> >td. (formerly the 0redit -ating #nformation Services of #ndia >imited).

##S> has been formed with the obective of providing a variety of indices and index related services andproducts for the capital markets.

##S> has a licensing and marketing agreement with Standard and +oor7s (S8+), the world7s leading

provider of investible e2uity indices, for co1branding ##S>7s e2uity indices.

http://nseindia.com/content/indices/ind_niftylist.csvhttp://nseindia.com/content/indices/ind_niftylist.csv


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• Products 0 Services • ##S> offers a wide range of products and services which are key support tools for the e2uity markets.

Be provide reliable, accurate and valuable data on indices and index related services to cater to the

needs of various segments of users. ur speciality is indices based on #ndian e2uity markets, whichmay be used for benchmarking, trading or research.

• Financial products on **SL *ndices

##S> maintains, develops, compiles and disseminates entire gamut of e2uity indices. >icensing is

mandatory for tracking the performance of an ##S> #ndex. Licensin! is also required "or use o" the

na$e o" **SL or S0P C or C or an) **SL *ndex3 !ees for licensing would vary according to the

type of the product and the period.

0/K ensures common branding of indices, to reflect the identities of both the promoters, i.e. /S= and

0-#S#>. Thus, 707 stands for 0-#S#>, 7/7 stands for /S= . The S8+ prefix belongs to the ?S1basedStandard 8 +oor7s !inancial #nformation Services.

0/K indices are useful for fund managers, corporates, brokers and all such enterprises connected

with investments in the e2uity markets. These indices can be used for tracking the markets,

understanding the performance of a company vis1a1vis the market, determining how an investors

portfolio is performing as compared to the market, trading derivative products and most importantly for

development of index based funds by mutual funds.

Custo$ied *ndices

##S> undertakes development 8 maintenance of customiIed indices for clients for tracking the

performance of the client portfolio of stocks vis1Q1vis obectively defined benchmarks, or for

benchmarking /A< performance to customiIed indices. The customiIed indices can be sub1sets of

existing indices or a completely new index viI. Sector #ndices, #ndividual usiness 3roup #ndices,

#ndustry #ndices etc. 0harges for this service vary depending on the activity performed by ##S>.

Consultin!

##S> provides consulting services in areas of #ndex !unds, =xchange1traded1fund, derivatives, #ndex

options, alerting for rebalancing for index funds etc. This is a paid service.

8hat is the basic idea in an indexH

=very stock price moves for two possible reasons: news about the company (e.g. a product launch, or

the closure of a factory, etc.) or news about the country (e.g. nuclear bombs, or a budget


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announcement, etc.). The ob of an index is to purely capture the second part, the movements of the

stock market as a whole (i.e. news about the country). This is achieved by averaging. =ach stock

contains a mixture of these two elements 1 stock news and index news. Bhen we take an average of

returns on many stocks, the individual stock news tends to cancel out. n any one day, there would be

good stock1specific news for a few companies and bad stock1specific news for others. #n a good index,

these will cancel out, and the only thing left will be news that is common to all stocks. The news that is

common to all stocks is news about #ndia. That is what the index will capture.

• 8hat is the port"olio interpretation o" index $ove$entsH

#t is easy to create a portfolio, which will reliably get the same returns as the index. i.e. if the index

goes up by H5, this portfolio will also go up by H5. Suppose an index is made of two stocks, one with

a market cap of -s.%&&& crore and another with a market cap of -s.&&& crore. Then the index

portfolio will assign a weight of *'5 to the first and $'5 weight to the second. #f we form a portfolio of

the two stocks, with a weight of *'5 on the first and $'5 on the second, then the portfolio returns will

e2ual the index returns. So if you want to buy -s.% lakh of this two1stock index, you would buy-s.*',&&& of the first and -s.$',&&& of the second; this portfolio would exactly mimic the two1stock

index. A stock market index is hence ust like other price indices in showing what is happening on the

overall indices 11 the wholesale price index is a comparable example. #n addition, the stock market

index is attainable as a portfolio.

• 8h) are indices i$portantH

Traditionally, indices have been used as information sources. y looking at an index we know how the

market is faring. This information aspect also figures in myriad applications of stock market indices in

economic research. This is particularly valuable when an index reflects highly up to date information (a

central issue which is discussed in detail ahead) and the portfolio of an investor contains illi2uid

securities 1 in this case, the index is a lead indicator of how the overall portfolio will fare.

#n recent years, indices have come to the fore owing to direct applications in finance, in the form of

index funds and index derivatives. #ndex funds are funds which passively Rinvest in the index7. #ndex

derivatives allow people to cheaply alter their risk exposure to an index (this is called hedging) and to

implement forecasts about index movements (this is called speculation). edging using index

derivatives has become a central part of risk management in the modern economy. These applications

are now a multi1trillion dollar industry worldwide, and they are critically linked up to market indices.

!inally, indices serve as a benchmark for measuring the performance of fund managers. An all1e2uity

fund should obtain returns like the overall stock market index. A '&:'& debt:e2uity fund should obtain

returns close to those obtained by an investment of '&5 in the index and '&5 in fixed income. A well1

specified relationship between an investor and a fund manager should explicitly define the benchmark

against which the fund manager will be compared, and in what fashion.


18/30

• Io4 does the S0P C i"t) 4orkH

S8+ 0/K /ifty is based upon solid economic research. A trillion calculations were expended to evolve

the rules inside the S8+ 0/K /ifty index. The results of this work are remarkably simple: (a) the

correct siIe to use is '&, (b) stocks considered for the S8+ 0/K /ifty must be li2uid by the Rimpact

cost7 criterion, (c) the largest '& stocks that meet the criterion go into the index. S8+ 0/K /ifty is a

contrast to the adhoc methods that have gone into index construction in the preceding years, where

indices were made out of intuition and lacked a scientific basis. The research that led up to S8+ 0/K

/ifty is well1respected internationally as a pioneering effort in better understanding how to make a

stock market index.• Io4 did the S0P C i"t) co$e aboutH

=2uities trading at /S= began in /ovember %FFH. y late %FF', /S= became #ndia7s largest e2uity

market and was looking for a market index to utiliIe this uni2ue information source. /S= also wanted

to have a vehicle for the futures and options market. /S= approached the economists "r. Aay Shah

and "r. Susan Thomas, ( then at 0entre for onitoring #ndian =conomy +vt. >td.1 0#=

(www.cmie.com) and now at #ndira 3andhi #nstitute of "evelopment -esearch (#3#"- 1

www.igidr.ac.in), to conduct research on methods in index construction. This work was funded by the

?SA#" !#-= proect (www.usaid.gov) and led to the S8+ 0/K /ifty. Some of their research is visible

over the #nternet at www.igidr.ac.inJaayshah

• 8here does **SL co$e inH

#n %FF4, /S= and 0-#S#> launched a oint venture named ##S> to focus on index management. This

pools the index development efforts of 0-#S#> and /S= into a coordinated whole, #ndia7s first

specialised company focussed upon the index as a core product. Today, the S8+ 0/K /ifty is owned

and operated by ##S>. #t is a global phenomenon where an independent company calculates andmaintains the index.

• 8ho is Standard 0 PoorJs, and 4h) does their na$e appear 4ith the S0P C i"t)H

S8+ owns the most important index in the world, the S8+ '&& index, which is the foundation of the

largest index funds and most li2uid index futures markets in the world.

Bhen S8+ came to #ndia to look at market indices, they focused upon the S8+ 0/K /ifty as opposed

to alternative indices. They now stand behind the S8+ 0/K /ifty, as is evidenced by the name 6S8+

0/K /ifty6 This is a uni2ue occasion; S8+ has never endorsed a market index before.

•

8hat does JCJ in S0P C i"t) stand "orH0/K stands for 0-#S#> /S= #ndices. 0/K ensures common branding of indices, to reflect the

identities of both the promoters, i.e. /S= and 0-#S#>. Thus, 707 stands for 0-#S#>, 7/7 stands for /S=

and K stands for =xchange or #ndex. The S8+ prefix belongs to the ?S1based Standard 8 +oor7s

!inancial #nformation Services.

• 8hatJs S0P C De"t)H

S8+ 0/K "efty is S8+ 0/K /ifty, measured in dollars. #f the S8+ 0/K /ifty rises by *5 it means that

http://www.igidr.ac.in/~ajayshahhttp://nseindia.com/content/indices/ind_iisl.htmhttp://www.vanguard.com/http://www.cme.com/http://www.igidr.ac.in/~ajayshahhttp://nseindia.com/content/indices/ind_iisl.htmhttp://www.vanguard.com/http://www.cme.com/


19/30

the #ndian stock market rose by *5, measured in rupees. #f the S8+ 0/K "efty rises by *5, it means

that the #ndian stock market rose by *5, measured in dollars.

• 8hatJs S0P C 9 H

The S8+ 0/K '&& is #ndias first broad based benchmark of the #ndian capital market. The S8+ 0/K

'&& represents about 4G5 of total market capitaliIation and about $45 of the total turnover on the

/S=. The S8+ 0/K '&& companies are disaggregated into $* industries, each of which has an index

C The S8+ 0/K #ndustry #ndex. #ndustry weightages in the index dynamically reflect the industry

weightages in the market. So for e.g. if the banking sector has a '5 weightage among the universe of

stocks on the /S=, banking stocks in the index would have an approx. representation of '5 in the

index. The S8+ 0/K '&& is a market capitaliIation weighted index. The base date for the index is the

calendar year %FFH with the base index value being %&&&. 0ompanies in the index are selected based

on their market capitalisation, industry representation, trading interest and financial performance. The

index is calculated and disseminated real1time.

• 8hatJs C i"t) KuniorH

S8+ 0/K /ifty is the first rung of the largest, highly li2uid stocks in #ndia. 0/K /ifty Munior is an index

built out of the next '& large, li2uid stocks in #ndia. #t is not as li2uid as the S8+ 0/K /ifty, which

implies that the information in the S8+ 0/K /ifty Munior is not as noise1free as that of the S8+ 0/K

/ifty. #t may be useful to think of the S8+ 0/K /ifty and the 0/K /ifty Munior as making up the %&&

most li2uid stocks in #ndia. S8+ 0/K /ifty is the front line blue1chips, large and highly li2uid stocks.

The 0/K /ifty Munior is the second rung of growth stocks, which are not as established as those in the

S8+ 0/K /ifty. A stock like Satyam 0omputers, which recently graduated into the S8+ 0/K /ifty, was

in the 0/K /ifty Munior for a long time prior to this. 0/K /ifty Munior can be viewed as an incubatorwhere young growth stocks are found. As with the S8+ 0/K /ifty, stocks in the 0/K /ifty Munior are

filtered for li2uidity, so they are the most li2uid of the stocks excluded from the S8+ 0/K /ifty. uying

and selling the entire 0/K /ifty Munior as a portfolio is feasible. The maintenance of the S8+ 0/K

/ifty and the 0/K /ifty Munior are synchronised so that the two indices will always be disoint sets; i.e.

a stock will never appear in both indices at the same time. ence it is always meaningful to pool the

S8+ 0/K /ifty and the 0/K /ifty Munior into a composite %&& stock index or portfolio.

• 8hat is the C (idCapH

The medium capitalised segment of the stock market is being increasingly perceived as an attractive

investment segment with high growth potential. The primary obective of the 0/K id0ap #ndex is to

capture the movement and be a benchmark of the midcap segment of the market. The 0/K id0ap

#ndex is a market capitalisation weighted index with its base period of the index being the calendar

year *&& and base value as %&&&.The distribution of industries in the 0/K id0ap #ndex represents

the industry distribution in the id0ap segment of the market. All companies are evaluated for trading

interest and financial performance


20/30

CHARACTERISTICS OF BLUE CHIP COMPANY

%. A nationally recogniIed, well1established and financially sound company.

*. lue1chip companies are known to weather downturns and operate profitably in the face of adverse

economic conditions, which helps to contribute to their long record of stable and reliable growth.

. The phrase (>?= 0#+ ) refers to a blue poker chip, which is the highest and most valuable piece. A

blue chip stock is classified as the stock of a large company that is an industry leader and provides

consistent, steady investment returns.

H. A blue chip stock is one that is well1established, financially sound, and historically secure, and have a

history of posting earnings and paying dividends, all while continuing to increase profits. Bhile there

will always be some fluctuation in markets

'. lue chip companies are known for their strong executive management teams that make intelligent

growth decisions, and for their high12uality products and services.

G. The return on blue chip stocks is close to a sure thing, the stocks tend to be very expensive and have

a low dividend yield.

$. #t is easy for investors to track these companies and evaluate their advertising and marketing

strategies for themselves. !inally, they are a great tool for teaching kids about the stock market by

using brand names they recogniIe.

4. =ven blue chips can take a nosedive, as every company makes a mistake at some point in its history.

F. lue chip stocks are traditionally thought to be a safe investment since the prices do not tend to varywildly.

%&. To compensate for slower growth, blue chip stocks pay investors dividends at regular intervals. ften,

the amount paid out in dividends increases over time.

%%. lue chip companies are industry leaders, the company is likely to have a long standing record of

successful business.

%*. ost industry leaders have low debts and healthy balance sheets, which leads to consistent and

increased dividends for shareholders.

The state of the economy, industry news, and company mergers 8 ac2uisitions can all cause the price of a

stock to fall, regardless of how well established the company behind it is.

EQUITY ANALYSIS

http://www.answers.com/topic/nosedivehttp://www.answers.com/topic/nosedivehttp://www.answers.com/topic/nosedive


21/30

______________________________________________________

_

a$e o" the co$pan)

Address< % e!d3 +"" 0 Factor) or Plant '

Sector = % T)pe o" Business '

Share Ioldin! Pattern Financial Data %Latest Financial /ear Co$pleted '

+romoters 5 =2uity (+aid ?+) 111111111111111111111111

#nstitutional #nvestors 5 Sales 111111111111111111111111

ther #nvestors 5 /et +rofit 111111111111111111111111

3eneral +ublic 5 "ividend 111111111111111111111111

Share +rice 111111111111111111111111

!ace


22/30

Financial Data

Pro"it 0 Loss A1c % /ear = 8ise = Latest 5 )ears '

(ar @ (ar ; (ar : (ar 9

Sales or %+peratin! *nco$e'

+ther *nco$e

EB*DTA

PBT

PAT

Debt < Equit) atio

Conclusions<

%. #s there any growth in Top1>ine ( Sales ) 9119V

*. #s there any growth in ottom C>ine (+AT) 9119V. Type of growth C rganic or #norganicV

H.

Case = *

• 3rowth in Sales 8 3rowth in /et +rofit

Case = **

• 3rowth in Sales 8 /o 3rowth in /et +rofit

Case = ***

• /o 3rowth in Sales 8 3rowth in /et +rofit


23/30

Case = *>

• /o 3rowth in Sales 8 /o 3rowth in /et +rofit

Pro"it 0 Loss A1c %uarterl) = Latest 5 uarters'

Co$parison

Mune &F Mune &4 ar &4 "ec&4 Sep &4

Sales or %+peratin! *nco$e'

+ther *nco$e

EB*DTA

PBT

PAT

Conclusions

%. #s there any growth in Top1>ine ( Sales ) P11PV

*. #s there any growth in ottom C>ine (+AT) P11PV

. Type of growth C rganic or #norganicV

Case = *

• 3rowth in Sales 8 3rowth in /et +rofit

Case = **

• 3rowth in Sales 8 /o 3rowth in /et +rofit

Case = ***

• /o 3rowth in Sales 8 3rowth in /et +rofit

Case = *>

• /o 3rowth in Sales 8 /o 3rowth in /et +rofit

>aluation o" the Share Price

%. 0urrent valuation of share price on the basis of +J=x

*. Sector +J=x


24/30

. 0omparison of share price +J= with Sector +J=

H. !ind the stock C ?ndervalued - vervalued - !airly +riced

'. Abnormal +J=x: Too high - Too >ow

G. Bhat are the !orward =arningsV

$. Stock 0ategory C 3rowth Stock J Trading Stock J "ividend 9ield Stock

P/E Ratio

The most commonly used valuation metric by investors is the price to earnings ratio or commonly referred to

as the +J= -atio. Though commonly used, it is also misunderstood for various reasons. ere is an attempt to

simplify this valuation metric.

Io4 is P1E CalculatedH

#t is calculated by dividing market price of stock by =+S ( =arnings +er Share ). =+S in turn is calculated by

dividing the net profit of the company by the number of shares outstanding.

et Pro"it

EPS M &&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&

u$ber o" Shares +utstandin!

(arket Price

P1E atio M &&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&

EPS

>ets assume a stock is trading at -s.%&& and its =+S is -s.*&. The +J= multiple is ' ( %&& upon *& )

arket +rice N +J= multiple by =+S. Stock prices reflect future earnings potential and not past performance.

"iscounting the current price with historical =+S is not right way to analyIe companies.

Take hypothetical case. #f Tata Steels =+S for the next year is expected at -S.'& and the growth in =+S is

around %'5, the market price is calculated by multiplying -s.'& with %' times i.e. -s.$'&. Bhen determining

the stock price, one does not discount earnings but multiply earnings.

Bhat is the D-ightE +J= multiple for a stockV


25/30

The answer to this 2uestion is not easy. #n the previous example, we have assigned multiple of %' times

because =+S is expected to grow by %'5 in the immediate year. #s this right wayV /ot necessarily. ere, it is

important to understand characteristics of the company.

!or a commodity stock like Tata Steel, =+S tends to grow at a faster rate when steel prices recovering or are

at the peak and the =+S is likely to decline at a faster rate during downturns. To 2ualify this statement, if welook at =+S growth of Tata Steel from %FFH to *&&H, the compounded growth in earnings is %$5. owever, the

0A3- growth in the last three years was %F5. So, if one believes that steel demand is likely to trace long

term economic growth and that %'5 growth is sustainable, the +J= multiple should be ideally much lower than

%' times. Similarly, the long term growth prospects for software companies could be much higher than

commodities.

Deter$inin! the P1E $ultiple "or a stock 1 sector also depends on<

%. istorical performance C Bhy does #nfosys trade at a higher +J= multiple compared to SatyamV

y historical performance, we mean, focus of the management (without unrelated diversification)

ability to outperform competitors in down J upturns and promise vs performance. This can be gauged if

one looks at the last three to five years annual reports of a company.

*. The sector characteristics C argin profile, whether it is asset intensive and intensity of competition.

>ess asset intensive sectors ( say !03 ) are considered defensive and therefore, could be trade a

premium to the overall market.

. And more importantly, expectations. Take the case of Textile stocks. =xpectations of significant growth

opportunities post the *&&' 2uote regime phase out has resulted in up1gradation of +J= multiple of thetextile sector.

8hen P1E is not use"ulH

%. =conomic cycle: #n !9&*, Tata Steel was trading at +J= multiple of *&.' times its !9&* earnings. Bas

it expensiveV ased on !9&' expected earnings, Tata Steel is trading at a +J= multiple of ' times its

earnings ( at -s.'& ). #s it cheapV #f one ignored Tata Steel in !9&* on the basis that it was expensive

stock, the opportunity loss is as much as '&5. usiness operate in cycles. "uring downturn, =+S will

be low but +J= will be inflated and vise versa. At the same time, during expansionary phase, corporate

invest in capacities. #n this case, high depreciation costs suppress earnings. +J= in this context, may

mislead investors.

*. /ot actively tracked: There are number of companies in the #ndian Stock arket that are not actively

tracked by the investors, analysts and institutions.


26/30

. =xpectations: n the downside, some stocks may be trading at a significant premium because

earnings are higher. igh +J= also does not means a good stock to buy. Bhat if the expectations are

unrealisticV

H. eans little a standalone number C +J=, as a standalone number, means little. esides +J=, it is also

important to look at margins, return on net worth, cash generating ability and consistency inperformance over the years to assign a value to a stock.

'. arket sentiment: "uring bear phase or when interest in stock is low, valuations could be depressed.

Since e2uities are considered, less attractive during these periods, valuations are likely to be below

historical average or below earnings growth prospects.

G. To conclude valuations of stocks involves subectively. A person K may assign a higher +J= to the

stock as compared to person 9 depending on the risk profile and growth expectations. #n the end, it all

boils down to how the company is likely to perform.

P1E atio Across the sectors<

+rice =arnings -atio can vary widely across the sectors and what comprises a low += -atio in one sector can

be high += in another.

Bhat are the reasons for the vast divergence in += -atio across the sectorsV

The sectors with the lowest +J= offer not only lowest expected growth, but also have low returns on e2uity

(-=).

The sectors with the highest +J= offer higher expected growth 8 higher returns on e2uity, with more risk.

9ou have three measures of the +J= -atio for each company. The +J= based earnings in the most recent

financial year (0urrent +J=), the +J= based on earnings in the most recent four 2uarters ( Trailing +J= ) and the

+J= based expected earnings in the next financial year ( forward +J= ). =ach measure has its adherents 8

there is information in each.

Lo4 #ro4th 0 P1E atios

ne reason for >ow +J= -atio for a stock would be low expected growth. ay >ow +J= companies are

immature business for which the potential for growth is minimal. #f you invest in stocks with >ow +J= -atios,you run the risk of holding stocks with anemic or even negative growth rates. Therefore, you have to consider

whether the trade off of a >ower +J= -atio for lower growth works in your favor.

P1E atio elationship

Co$pan) Share Price Current P1E Sector P1E

A0 #ndustries %&& %& %'


27/30

Exa$ple<

!ormula

Sector P1E atio & Current P1E atio

&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&& 2

Current P1E atio

Therefore, Apply to A0 #ndustries

%' C %& %&& K '&5 N '&

1111111111 K %&& N '&5 %&& W '& N %'&

%& Target +rice can be %'&

*nterpretation o" P1E atios

23 I*#I P1E

63 L+8 P1E

73 AB+(AL P1E

53 + P1E

I*#I P1E

N Co$pan) is sho4in! hi!h !ro4th in the business

N *nvestors are read) to pa) hi!h "or the earnin!s o" the co$pan)3


28/30

L+8 P1E

N Co$pan) is sho4in! lo4 !ro4th in the business

N *nvestors are not read) to bu) the stocks as the "uture earnin!s are

expected to be lo43

Scrip Share Price P/E Ratio

Allahabad Bank 113 4.8

Chambal Fertili. 56 8.5

Asian Electronics 46 6.1

GSFC 168 3.6

AB+(AL P1E

N #enerall) a"ter listin! the share Pro"it re$ains the sa$e 0 nu$ber

o" shares increase so, EPS !oes do4n drasticall)3

N The earnin!s are ver) lo4 "or the )ear or a particular quarter3



L ! 1656 "#.$

B%EL ""1$ 31.3

%&FC BA'( 1833 3#.)

*'F+S,S "446 ""."


29/30

Bharat Forge 269 102

GMR INFRA 72 157

JINA! "#$E% 102 66

JA&B'ARA$ $E! (9) *97

+ P1E

N There are no earnin!s to the co$pan) as on date

N For a speci"ic quarter co$pan) has declared loss


!ata Steel 56# --

Adita Birla '/0o 85# --

Chennai etro ""5 --

2et Airas 563 --

Dividend /ield

• 9ield is the returns calculated on annualiIed basis.

• "ividend 9ield is the returns from dividend calculated on annualiIed basis.

For$ula

Dividend

&&&&&&&&&&&& 2 M Dividend /ield

Share Price

Exa$ple< "!0 +ays dividend *&&5 for !ace


30/30

That means -s. *& per share dividend

"!0 Share +rice is -s.&&&

Therefore,

*&

1111111 K %&& N 3:: % Dividend /ield '

&&&

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