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Module 1: Stock Market

Why Invest?

Adjust for 8-10% inflation.

So, popular asset classes are:

1. Fixed Income Instruments

   • Bank FD
   • Government Bonds
     Have around 5-6% return
     For corp, 9-10% return

2. Equity

   • Shares of publicly listed companies on BSE & NSE.
   • Upto 12% return (Can be 20%.)

3. Real Estate

   • Very closed & require money upfront
   • Little complex

4. Commodity

   • Gold & Silver
   • 5-8%

   %%mermaid
   graph TD
     Commodity -->|↑ High ↑ Return| CommodityDetails

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Regulators?

Market Participants

• Domestic Retail Participants
  (Me & other people)
• NRI, & OCI
• Domestic Institutions
  (Corporate entities)
• Domestic Asset Management Companies
  (MF companies like SBI MF, ICICI Prudential)
• Foreign Institutional Investors
  (Non-Indian corporate entities)

SEBI

SEBI (Securities & Exchange Board of India) is regulator for market. It has rules for each entity:

• Credit Rating Agency (e.g. Corp (co. govt. loan))
• CRISIL
• Debenture Trustees (Companies loan)
  They issue Deb. Trustee
  Banks

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• Depositories
  (Digital vault for shares)
  Stored in Depository Account or Demat Account
  NSDL & CDSL

• Repository Participant (DP)
  DP opens & maintains your account
  Banks & Stockbrokers

• Foreign Institutional Investors
  Foreign entities with interest in investing in India
  Foreign corp, Individuals, Funds

• Merchant Bankers
  Help companies with IPO process
  Karvy, Axis Bank, etc.

• Asset Management Companies
  Offer MF schemes & invest money in markets
  HDFC AMC, SBI Capital

• Portfolio Managers
  Similar to MF but min investment is 50 lakh
  Capital Mind Wealth PMS, Motilal PMS

• Stock Brokers
  Gateway to Stock Market, giving electronic access to stock markets
  Zerodha, ICICI Direct

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Market Intermediaries

%%mermaid
flowchart TD
    BankAccount(Bank Account)
    TradingAct(Trading Act / ML)
    StockBroker(StockBroker)
    WebPlatform(Web Platform / Call API)
    StockExchange(Stock Exchange)
    Clearing(NSCCL / ICCL)
    DepositoryAccount(Depository Account)
    DepositoryParticipant(Depository Participant)
    NSDL(NSDL)
    CDSL(CSDL)
    Dematerialization(DEMAT)
    
    BankAccount --> TradingAct
    TradingAct --> StockBroker
    StockBroker --> WebPlatform
    WebPlatform --> StockExchange
    StockExchange --> Clearing
    Clearing --> BankAccount
    StockBroker --> DepositoryParticipant
    DepositoryParticipant --> DepositoryAccount
    DepositoryAccount --> NSDL
    DepositoryAccount --> CDSL
    NSDL & CDSL --> Dematerialization
    DepositoryAccount -->|Provide Share Certificate| Dematerialization
    Clearing -->|Identify buyer & seller, ensure no defaults| BankAccount

• DEMATERIALIZATION of shares

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IPO?

Company (Small Team)

Shares are issued by %

• Angel Investors / Seed Round or Fund
  Dilution of shares by promoter
  More fund required by company

• Venture Capitalist (VC) / Series X
  Dilution → More fund for improving business, called CAPEX

• Funding through Profits (called internal accruals)

• Series B Funding
  Approach bank for loan (Debt)
  More fund

• Series C through VC (Not practical as VC have less money)

• Debt (Finance charges/Interest Rate)

• Private equity (PE)
  Invests in later stage of startups, big professional team
  They sit on board, help to make decisions

• All above → IPO - general public (Initial Public Offer)

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Why go for IPO? (Primary Market)

• Raise funds for CAPEX requirement
• Avoid the need to raise Debt
• Larger investors other than PE
• Early exit for early investors
• Reward employees
• Improve visibility

IPO Process

Company
  |
  v
Merchant Banker (Apply with registration statement)
  |
  v
SEBI (Nods)
  |
  v
DRHP preparation
  |
  v
Market (fix price band, range 100-120)
  |
  v
Book building (effective price discovery)
  |
  v
Close → Listing day

• Merchant Banker:

  • Conduct due diligence on company
  • Prepare DRHP
  • Underwriting shares
  • Help in marketing
  • Help in getting price band

• Size of IPO, estimated no. of shares offered, fund utilization, business description, financial statements, risks involved in business, management details & background

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After shares are listed, it is in secondary market and people can buy/sell shares.

• Undersubscription: During book building, 1 lakh were offered but bids received only on 90K
• Oversubscription
• Green Shoe option: In case of oversubscription, some extra shares they can list.
• Fixed Price IPO
• Price Bands & Cut-off price: Range at which stock gets listed, cut-off price is the list price.

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Stock Markets?

Electronic marketplace to express one's POV in trade. It facilitates the transaction between market participants.

Market moves on sentiment:

• If a buyer wants to buy, seller can decide what price they want to sell it to buyer.
• If a seller wants to sell, buyer can decide what price they want to buy from.
• If both buyer & seller agree, least → new trade price is set.
• It moves on news & events, no major news or events no movement, except supply & demand.

Once when a decision is made, an order is placed. Let's say 20 shares at 3000.

The stock exchange will look for sellers & try to ensure the shares are available to you.

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To buy, you need to provide:

• Details of trading account
• Price at which you intend to buy
• No. of shares you intend to buy

You can own these shares for as long as you want and now you are part of the company. (Bonus, dividends, rights)

Returns is what the annual yield is:

i) Absolute Return

$$\left( \frac{\text{Ending Period Value}}{\text{Starting Period Value}} - 1 \right) \times 100$$

ii) Compounded Annual Growth Rate

$$\left( \frac{\text{Ending Value}}{\text{Starting Value}} \right)^{\frac{1}{\# \text{ of years}}} - 1$$

Trader

• Exiting the trade at earliest given opportunity

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Types of Traders

i) Day Trader

• Initiates & closes the position during the day

ii) Scalper

• Very less time & large share dealer
• High risk

iii) Swing Trader

• Holds trade for slightly long

Investor

• Buys stock expecting significant appreciation in the stock

  i) Growth Investor
  Identify companies that grow

  ii) Value Investor
  Identify companies that have been god → good
  beaten down

• Index allows you to get sentiment of the market. Stock Market Index

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• Nifty 50 → NSE index
• Sensex → BSE index
• Nifty Bank Index → Banking Sector Index

It gives us the sentiment & practically:

i) Information
Trend & state of the economy

ii) Benchmarking
To compare whether your return compared with market

iii) Trading
Check if index improves & trade accordingly

iv) Portfolio Hedging

India follows free-float market capitalization method to construct the index.

Buy → Broker → NSE → Seller (Hold funds)
Trade completed at T+1 day

80% back in trade acct
20% sell → Broker → NSE → Buyer T day
(Blocked in DEMAT → Not in broker acct)
Trade completed at T+1 day

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Two Types of Brokerage

• Intraday
  Same day, doesn't require DEMAT

• Equity Delivery
  T+1 day (as of Jan'23), require DEMAT

Earmarking allows to put a temporary hold on the securities towards an upcoming settlement for the sale transaction.
Instead of broker's pool account.

In Harshad Mehta, the securities could be put in broker's account for as long as 30 days.

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Corporate Actions

Financial initiatives taken by company that results in a change to its stock price.

1. Dividends

   • Can choose to pay dividends (portions of profits made by company)
   • Not mandatory but can be paid from cash reserve if there is loss.

   Dividend Declaration Date → Ex-Date → Record Date → Dividend Payout Date
   (AGM decides)

   After dividend of ₹15 is paid, stock drops by 15 ₹. Can be paid at any time.

2. Bonus Issue

   • Instead of cash in dividend, shares are paid out here (from company's reserves)
   • Done in 1:2, 1:1, 1:3, etc. ratio
   • Stock price declines

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Done to encourage retail participants if price is very high.

3. Stock Split

   • No. of shares held increase
   • Value of shares remains same (Total investment)
   • Encourages more retail participation

4. Rights Issue

   • Raise fresh capital before doing IPO or after IPO
   • Select a right ratio 1:4
     Shareholders for every 4 share can buy 1 more share at a discount
     Helps to raise capital (dilute the share)

5. Buyback of Shares

   • Company invests in itself & buys back
   • Improve profitability on per-share basis
   • To consolidate their stake in company
   • Prevent take-over
   • Support share price from declining & show confidence

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6. OFS (Offer for Sale)

   • Offer secondary issue of shares to whole market from their reserves (promoter's)

7. FPO (Follow on Public Offer)

   • Shares can be diluted & fresh shares can be created & offered in FPO
   • Requires Merchant Bankers

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Key Events & Impact on Markets

Events outside impact market

i) Monetary Policy

Money supply controlled by RBI in market, by setting interest rates

• ↑ Interest Rate → ↓ growth → ↓ economy
• ↓ Interest Rate → ↑ spending → ↑ price (inflation)

So, growth & inflation needs to be managed by RBI rates

a) Repo Rate
Rate at which RBI lends money → lends money to banks.

• ↑ Repo Rate → ↑ borrowing cost → ↓ economy

b) Reverse Repo Rate
Rate at which RBI borrows money.

• ↑ Reverse Repo → ↓ money in market → ↓ economy

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Economic Indicators and Market Analysis

c) Cash Reserve Ratio (CRR)

• Banks must maintain funds with RBI.
• $\uparrow \text{CRR} \rightarrow \downarrow \text{money in market} \rightarrow \downarrow \text{economy}$

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ii) Inflation

Measured by Index:

• a) WPI (Wholesale Price Index)
  Movement of prices at wholesale level.
• b) CPI (Consumer Price Index)
  Movement of prices at retail level.
  Complex & different for rural, urban.

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iii) Index of Industrial Production (IIP)

• Production of industries.
• $\uparrow \text{IIP} \rightarrow \uparrow \text{economy}$
• If IIP is low, RBI might be force to reduce intrest rate → forced to reduce interest rate.

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iv) Purchasing Managers Index (PMI)

• Business activity across manufacturing & service sectors.
• $\uparrow \text{PMI} \rightarrow \uparrow \text{economy}$ (50 is base)

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v) Budget

• Policy announcements & economic reforms.
• Released end of Feb week.

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vi) Corporate Earnings Announcement

• Companies declare earnings every quarter:

  • Revenue growth
  • Expense trend
  • Finance charges
  • Profitability trends
  • Project updates

• $\uparrow \text{earnings} \rightarrow \uparrow \text{stock price}$

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vii) Non-financial events

• Covid → $\downarrow$ Supply Chain → $\downarrow$ Economy / $\uparrow$ Inflation
• Ukraine/Russia → $\downarrow$ Supply Oil → $\uparrow$ Energy Costs / $\uparrow$ Inflation

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Getting Started: Building a Market POV

• To get a POV (Point of View):
  • Fundamental Analysis
    Company earnings & financial statements.
  • Technical Analysis
    Study of price & volume, can be used on all assets.
  • Quantitative Analysis
    Study of quantified data; objective way of tools.

---

Diagram: Market Analysis POV

flowchart TD
    FA(Fundamental Analysis) --> POV
    TA(Technical Analysis) --> POV
    QA(Quantitative Analysis) --> POV
    Outside(Outside View) --> POV
    POV --> Trading[Trading Terminal]
    Trading --> Spot[Spot Market Transactions]
    Trading --> Derivative[Derivative Market Transactions]
    Derivative --> Futures
    Derivative --> Options
    Options --> Call(CALL Option)
    Options --> Put(PUT Option)

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Module 7: Markets & Taxation

Trader or Investor or Both?

• Individual can decide on their own to either show stock investments as capital gain or as business income (trading).
• Once decided, same will be continued for subsequent years.

How to classify income:

i) Long Term Capital Gain (LTCG)

• After 365 days:
  • LTCG (Equity & equity MF)
  • Equity-oriented MF: First 1 lakh is tax-free, other is 10%
  • Non-equity with benefit of indexation: For unlisted stocks, tax is 20%.

ii) Short Term Capital Gain (STCG)

• Stocks or equity MF under 12 months & more than 1 day.
• Tax is flat 15% of gain.

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iii) Speculative Business Income

• Intraday stocks or non-delivery is under SBI.
• Currency trading.
• Taxed like business income (slab %).

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iv) Non-Speculative Business Income

• Trading futures & options on recognized exchange.
• Taxed like business income.

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Pros on Trading Income

• Low tax if less than 5L.
• Claim expenses: Brokerage charges, STT, taxes are considered as expenses.
• Offset the loss with gains: loss - total income.
• Carry forward the F&O loss: If net loss is there, it can be carried for next 8 years.

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• Carry forward the intraday equity loss.

Cons on Trading Income

• Potentially high taxes.
• ITR forms: ITR 3 or 4 required.
• Audit: Need to maintain book of accounts if turnover is over 5 crore OR profit is less than 6% of turnover.

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What to decide then?

• For intraday trading & F&O trading, ITR3 and come under trading income.
• For equity delivery, if more than a year holding, show as investments and claim an exception.
• If buying & selling is frequent for shorter terms, declare as non-speculative business income instead of STCG.

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• If investing/trading is only source of income, declare as business income instead of capital gains.
• You can be both trader & investor.

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What is STT?

• STT is Securities Transaction Tax payable to GOI when trades are executed on recognized stock exchanges.

• STT is 0.1% of trade value for equity delivery-based trades & usually is less tax if off-market is compared.

• Brokerage + other charges = Cost of share (not STT).

• Advance tax is required for STCG; salary on 15th June, Sept, Dec & March.

  • 15%, 45%, 75%, 100%.

• Equity MF: $\geq 65\%$ money invested in domestic companies.

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Turnover, Balance Sheet & P&L

• Turnover is business turnover.

  • For delivery-based transactions:
    Sales value = Total turnover.
  • For speculative transactions:
    Turnover = $| \text{Buy} - \text{Sell} |$
  • For non-speculative transactions:
    Turnover = Total of favourable & unfavourable differences.

• Why we need turnover calculation: only when treating trading as business income.

• Audit requirement is determined from turnover:

  • i) Rs 5 crore mark turnover
    Section 44AD: If turnover is less than 5 crore & profit is less than 6% of total income, it is taxable.

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• If audit is required, following are required to be maintained (ITR3 requires them):

i) Balance Sheet

• Overall snapshot of wealth.

• Summary of assets, your liabilities & net worth (assets - liabilities).

  • Requires:
    • Bank statement
    • Loan statement
    • House loan statement
    • Personal loan statement
    • Principal balance of any outstanding loans
    • Demat holding statement

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ii) Profit & Loss Statement

• Summary of revenue streams & expenses of the FY.

  • Revenue:
    • Sale value from stock holdings
    • Income from F&O, intraday or commodity trades

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• Salary is not revenue.

  • Expenses:
    • Salaries of trading help
    • Rent for office/room
    • Brokerage charges, taxes
    • Advisory fees, consultancy, depreciation

• $\text{Profit} = \text{Revenue} - \text{Expenses}$

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iii) Book of Accounts / Book-keeping

• Bank book
• Trading book (can be done from broker)

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ITR Forms

To fill taxes, ITR forms are needed. If sources of income are different, ITR forms are different.

---

i) ITR 1

• Salary + Interest Income + Rental Income

ii) ITR 2

• Income from Capital Gains + ITR 1 (Investors)

iii) ITR 3

• Income from business/profession + ITR 2 (Trading + Investors)

iv) ITR 4

• If turnover is low, declare presumptive income & get away from audit requirement.

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Foreign Stock and Taxation

• Limit of 2 crore annually under LRS (Liberalised Remittance Scheme).
• TCS = 20% if investments exceed 7 lakh per year.
• Investments sold should be brought back to India within 180 days unless invested back.

For investments in stock, there are 2 incomes:

• i) Dividends
• ii) Capital Gains

For foreign company, if holding is more than 24 months, gains are LTCG & taxed at 20% with benefit of indexation.
Otherwise, STCG and tax is according to slab.

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• For dividends, it is income from other sources.
• Conversion of currency = Exchange rate of last day of month prior to month you received dividend.
• And taxed at slab rate.

Above all was India tax, there is foreign tax also:

• For capital gains, US or foreign → don't charge tax (other countries might) for non-residents.

• For dividends, between US and India:

  • They are taxed only in India, but US does a 25% withholding tax.
  • And then India again does tax.
  • Form 67 needs to be used to claim the credit for withholding tax paid in US.

• This can be different for each country.

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• Going to foreign assets,
  Banks & depository accounts.

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Module 11: PF - Mutual Funds

PF Math

• Simple Interest:
  $\text{Simple Interest} = P \times T \times R$

• Compound Interest:
  $\text{Compound Interest} = P \times (1+R)^T$

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• Present Value of Money

  • Opportunity Cost = What else can be done with funds available that is risk-free.

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• $\text{Risk-free rate} + \text{Risk premium}$
  (measure of excess return to compensate if there is high risk in investment)

• Government bonds over 15 years is usually 7.5%.
  Premium can be 1.5-2%.

• Total opportunity cost = 9% (called as discount rate if discounting)

• $\text{Present Value} = \frac{\text{Future Value}}{(1 + \text{discount rate})^{\text{time}}}$

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• Future Value of Money

  • $\text{Future Value} = P \times (1 + \text{Opportunity Cost})^T$

  • Also, consider inflation in future value if retirement is a concern.

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Intro to MF

AMC (Asset Management Company) is a company where a fund manager works and manages your money.

• Large scale fund managers, registered with SEBI & easily available all over India.

Structure of AMC and Related Entities

flowchart TD
    SEBI -->|Regulates| FundSponsor["Fund Sponsor"]
    FundSponsor -- Main Promoter (usually a corporate body) --> AMC
    FundSponsor --> Trustee
    Trustee -- Unassociated with Sponsor, works in interest of clients of AMC --> AMC
    AMC --> Custodian
    AMC --> OPS["Operations: Fund Mgmt, Operations, Sales"]
    AMC --> RTA["Registrar & Transfer Agent: Investor Services"]

• Custodian holds shares & assets of AMC.
• AMC is the investment manager, appointed with fund sponsor & trustee.
• Custodian & RTA are service providers for AMC company.

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Investment Process in Mutual Funds

• When a fund manager invests in MF, they are issued shares/unit at notional value.
• Fund is formed when different people pool in their money.
• Investment objective is same, notional value is assigned at start of fund formation which fluctuates based on the daily investment value.
• It is called Net Asset Value (NAV).

$$\text{NAV} = \frac{\text{Value of all assets} - \text{expenses}}{\# \text{ of shares/unit}}$$

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Fund Fact Sheet

Document that puts all the information related to fund/scheme.

• Before discussing fund's fact sheet, some numbers:

  • No. of fund houses = 45 (AMC)
    • Kotak, Axis, ICICI Pru AMC, etc.
  • No. of schemes = 1510
  • Money managed by AMCs = 35L crore
  • No. of unique investors = 2.4 crore

• Going back to fund fact sheet: all schemes need to have SEBI approval.

  1. Investment Objective

     • Where will stock be invested?
     • How will it generate revenue?

  2. Benchmark

     • Benchmarked against an index suitable.

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3. **Type of Scheme**
    - Open-ended: If fund will run forever or will close after a fixed period.
        - *Deal with open-ended fund*
    - Equity: Asset class where MF invests (Debt or Equity).
    - Growth: Whether dividends is the main way of money or capital appreciation (capital appreciation is growth).

4. **Fund Manager**
    - Who is managing fund?

5. **Allotment Date**
    - How old the fund is.

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6. **Plans & Options**
    - Regular Plan: MF distributor is between AMC & investor who earns commission.
    - Direct Plan: Buy MF directly from AMC.
    - Dividends Payout Option: Dividends if issued are paid & can be withdrawn.
    - Dividends Reinvestment Option: Dividends are reinvested in same fund.
    - Growth Option: Capital appreciation.

7. **SIP Details** (Systematic Investment Plan)
    - Fixed amount of money in same fund for many years.

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8. **Load Structure**
    - Entry Load
    - Exit Load: Amount of money you will have to pay at time of withdrawal.

• Riskometer
  AMC is supposed to self-assess & let customers know about risk.

  • Low, Low to Moderate, Moderate, Moderately High, High, Very High

Categories of Mutual Funds are different & for each category there are multiple sub-categories which tells what that MF invests in.

• Large Cap Stock: 1 to 100 company
• Mid-cap: 101 to 250
• Low/Small-cap: 251st onwards (in terms of full market capitalization)

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MF Categories

5 different categories of MF and each category has more categories:

• Equity

  • Large-Cap, Mid-Cap, Small-Cap, Multi-Cap
  • Focused, Dividend Yield, Value or Contra, Sector, ELSS, Flexi-Cap

• Debt

  • Money-Mkt, Short Duration, Overnight, Liquid, Long Duration
  • Medium Duration, Short Term, Ultra Short Term, Medium to Long Duration, Dynamic Bond
  • Corporate Risk, Credit Risk, Banking & PSU, GILT, Floater

• Hybrid

  • Conservative Hybrid, Balanced/Aggressive Hybrid, Dynamic Asset Allocation/Balanced Fund
  • Multi Asset, Arbitrage, Equity Savings

• Solution Oriented

  • Children's Fund, Retirement Fund

• Others

  • Index Fund/ETF, Fund of Fund

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An AMC is supposed to run only one scheme per category:

• 1 large cap
• 1 mid cap, etc. But sectoral funds can be multiple.

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I. Equity Schemes

Different categories differ with timeline of wealth generation & risk/reward ratio.

Some considerations:

• Requires time
• Don't switch
• Don't do headline investing

a) Large-Cap Fund - Top 100 companies, more than 80% investment in large-cap companies. - Portfolio is always disclosed.

b) Mid-cap/small cap/large & midcap funds - Volatility high ↑, Risk ↑

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c) Multi-cap Fund - Requirement: 65% in equity & related instruments. - Risk ↑, Return ↑ - Good for beginners to learn.

d) Focused Fund - No. of stocks in other funds: 60 to 70 - No. of stocks in this fund: 30 (max.), 11 in JM's - High Risk ↑, High Return ↑ - More volatile, so should take when person is matured in investment journey.

e) Dividend-Yield Fund - Invests in stocks of companies that pay high dividends regularly. (You don't get the dividend as investor, depends.) - Dividend yield:

$$
\text{Dividend yield} = \frac{\text{Dividend paid during year}}{\text{Stock Price}}
$$

- At least 65% in dividend-yielding stock.

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f) ELSS Fund (Equity Linked Savings Scheme) - Special category of MF that enjoy tax exemption on investments under 80C. - Mandatory lock-in of 3 years. - 80% investment in equity & related instruments by fund manager. - Kinda like multi-cap fund, no restriction on where to invest.

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II. Debt Schemes

What is debt? Taking money on loan.
There are risks with debt:

i) Cashflow Risk
- Irregular payment

ii) Default Risk
- Bankrupt

iii) Interest Rate Risk
- IR may reduce

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iv) Credit Rating Risk - Credit score may degrade

v) Asset Risk - The asset/collateral property loses its value

If corporates take loan from bank, it is called 'loan agreement'.

If corporates raise money from multiple investors, it is called 'bond'.

• Interest + Principal will be returned.

For bonds, there is: i) Credit risk ii) IR risk iii) Price risk iv) Liquidity risk (No money to take out)

a) Liquid Fund

• Makes investment in debt products with maximum maturity of up to 91 days.

  • When corp borrows, it issues commercial paper.
  • When govt. borrows, it issues T-Bills.

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Just like humans, corporates have credit score which tells the credit rating.

Why invest in liquid fund?

• To park cash which is going to be used soon. The purpose is to protect the capital & use it in its entirety for the purpose planned.
• Liquid fund offers a slightly higher return compared to bank's saving account (6% to 3-5%).
• Risk is more as companies can default, government not so much.

b) Overnight Fund

• Investment in securities which have 1-day debt obligation.
• Credit rating risk is low; default risk exists but small.
• The investment is done in Tri Party Repo or TREPS, which is RBI regulated money market.
• All 100% investment is done in TREPS, so overnight fund A & B are same for investors except the expense ratio.
• So if park cash which is needed within 90 days, overnight fund is an option. Return is around 4-5%.

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c) Ultra Short Duration Fund

Macaulay's Duration of Bond: Estimated time to recover the principal amount invested in a bond.

• Bond issues interest rate so invested principal will be back before maturity as part of coupon/timely payments.

So, ultra short duration fund is when the Macaulay duration of the portfolio is between 3–6 months.

• Good if parking money for 1–2 years, return is close to bank's FD.

$$\text{Price of bond} \propto \frac{1}{\text{Yield of bond}}$$ $$\text{Interest Rates} \propto \frac{1}{\text{Bond Price}}$$

(Simple supply & demand)

Modified Duration (of bond): Sensitivity of the bond's price to the change in interest rate.

In context of MF, we use NAV.

• ↑ Interest rates → ↓ NAV

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d) Low Duration & Money Market

Macaulay duration of the low duration fund at the aggregate portfolio level varies between 6 to 12 months.

Rating of a corp bond:

• AAA, AA (+-), BB (+-)

  • High rating, low credit risk.

• Good if parking money for short duration.

Money market fund can invest only in money market instruments having maturity upto 1 year: - Commercial papers - Certificate of deposits - T-Bills

e) Short Duration & Medium Duration Fund

• Macaulay duration is 1–3 years at portfolio level (Short)
• 3–4 years (Medium)

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f) Banking & PSU Debt Fund

• 80% debt investment to be done in Banks, Public Sector Undertakings, Public Financial Institutions & Municipal Bonds.
• 20% in any paper.
• Credit risk is low.
• Good if parking cash for 3–5 years.

g) Credit Risk Funds

• Minimum investment in corporate bonds of AA- or below rated company = 65%.
• 35% anywhere.
• High credit risk.
• Not really worth it for retail investors.

h) GILT Funds

• Minimum investment in government securities = 80%.
• 0 credit risk, but high interest rate risk.

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Recap So Far

• Direct Equities (Kite: Stocks, IPO)
• Equity Mutual Fund (Coin)
• Direct Bonds (CPs, T-Bills, Coin)
• Debt Mutual Fund (Coin)
• Sovereign Gold Bonds (Coin)
• Fixed Deposits from Bank

With these assets, we can build portfolios with different asset allocation patterns to achieve any portfolio goal.

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Index Funds

Management of one fund from another is what distinguishes each fund. The management can decide what strategy to deploy:

• Active: Beat a benchmark or deliver alpha
• Passive: Simply tracks the performance of a benchmark as closely as possible

Examples: Nifty 50, Nifty 100, ...

Return of passive/index fund:

$$\text{Return of passive/index fund} = \text{Benchmark Return} - \text{Cost/Expense Ratio}$$

An index fund is one that tracks a broad cap-weighted index like Nifty 50, S&P 500.

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Arbitrage Funds

Simultaneous buying & selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.

• Example 1: Price

  • Maruti at NSE: 5714
  • Maruti at BSE: 5735
  • $21 =$ profit

• Example 2: Spot-Future

  • Rollover, transaction costs, execution risk

It is risky because of debt component (35% can be invested anywhere).

Proxy for low/short duration funds.

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Measuring Returns of Mutual Funds

• XIRR: Extended Internal Rate of Return

Point-to-Point Returns / Rolling Returns:

• Return between date A & B
• Returns between A & B for rolling period of time

$$\text{Final Return} = \frac{\text{Ending NAV} + \text{No. of Units}}{\text{Old NAV}}$$

• Max, Min, Average for the period
• Equity funds should be taken for 5 years rolling

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MF Expense Ratio, Direct & Regular Plans

• Fee charged by MF's AMC is ‘Total Expense Ratio’ or TER.
• NAV that is declared is after deducting the TER.

Example:

• Investment Amount = 1000

• NAV = 10

• Number of units = 100 (This NAV includes the expense charged)

• Money is collected from investments & deducted daily.

• SEBI has directed maximum TER over an equity & debt fund.

• Expense ratio is different for direct & regular plans (Only TER is different.)

I. Direct Plan

Buying a MF directly from AMC.

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Investor has to deal with MF:

• Market understanding & track
• MF performance
• Rebalancing

II. Regular Plan

MF distributors come in between & they charge money.

Because expense ratio ↑, NAV ↓

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MF Benchmarking

Measure the performance of a fund by comparison on a set against a TRI.

Example:

• Benchmark = 10.5% by Nifty 50
• Equity fund = 12% CAGR

Alpha = 1.5% (12 - 10.5) on a risk-adjusted basis.

TRI (Total Return Index) includes & factors in dividends.

• Indexes only check appreciation.

The returns of the "index" largely depend on the weights assigned to each of the index constituents.

Upto investor to look at benchmark.

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MF Risk Measures

I. Beta

Measure of relative risk vis-à-vis its benchmark:

• $\leq 1$: Less risky (depends on market)
• $= 1$: Market index
• $> 1$: Market performer

Does not give actual risk of MF but relative risk compared to benchmark.

II. Alpha

Risk-free return is the maximum return you can generate without taking any risk (FD return & savings acct. return is risk-free).

Alpha is excess return of the MF over the benchmark return, on a "risk-adjusted basis".

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$$\text{Alpha} = \frac{\text{MF Return} - \text{Riskfree Return}}{\text{Benchmark Return} - \text{Riskfree Return}} \quad \text{(Beta)}$$

Fund is rewarded if returns are generated by keeping a low-risk profile & penalized for being volatile.

III. Standard Deviation

Riskiness of stock or MF.
Volatility is % of standard deviation.

• ↑ SD → ↑ Volatility → ↑ Risk

IV. Sharpe Ratio

Bundles the concept of risk, reward & return, risk-free rate.

$$\text{Sharpe Ratio} = \frac{\text{Fund Return} - \text{Risk-Free Return}}{\text{Standard Deviation of Fund}}$$

Only works for equities as it considers price-based volatility.

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V. Sortino Ratio

Standard deviation considers +ve & -ve returns (returns variation/risk).

If we don't penalize (+ve returns) as we did in Sharpe ratio, we can use:

$$\text{Sortino Ratio} = \frac{\text{Fund Return} - \text{Risk-Free Return}}{\text{Downside Risk}}$$

VI. Capture Ratio

Tells to what extent did the fund capture from (+ve) returns of its benchmark & to what extent it captured the (-ve) returns from the benchmark.

"Morningstar India" lists capture ratios.

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Analyzing Mutual Funds

I. Equity Fund

Before this, a recap:

• Investment and personal finance
• Assets required to finance goal
• MF as primary financial instrument
• Learn about MF, their categories & types
• Index fund & Arbitrage fund
• Risk & performance of MF

Now, we want to build a portfolio and it requires:

• Identify a financial goal and translate in terms of time and corpus
• Identification of funds to help achieve the goal
• Periodic review & maintenance of portfolio

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Step 1: Basic Hygiene Check

• Type of fund: Multi, Mid, Small, Large
• Index benchmark
• Fund inception date
• Fund manager history
• AUM of the fund
• Expense ratio

Check on 3rd party for other metrics:

• Standard deviation
• SD, Beta, Alpha
• Capture Ratio
• Comparison to each category from different AMCs

Step 2: Rolling Returns Check

• Comparison with peers

Step 3: Risk-Return Matrix Check (Morningstar)

Step 4: Capture Ratios

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II. Debt Fund

• Centered on risk & portfolio of fund.
• Minimum amt. to be invested in debt fund = average maturity of the fund.

Step 1: Portfolio Allocation (for corporate bonds)

• Diversification of fund
• Exposure to companies
• Credit rating check on the papers held by fund

(For govt. bonds)
We assume risk free in credit but interest risk.

Step 2: Now, check industry average (Value Research)

• How much securities compared to other bond funds.

Quality of papers: AAA, AA+ (compare to industry average)

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Step 3: Modified Duration

• Average Maturity
• Yield to Maturity

Total returns expected based on assumption that bond is held to maturity & cash flow is reinvested into bond.

Best to avoid debt funds with large and small AUMs.

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Building Mutual Fund Portfolio

Before building portfolio, we need to cover for risk:

I. Cover for the risk

• Term Insurance
• Life Insurance

II. Cover for emergency

• 6 month of corpus

Now, portfolio building is all about financial goal:

• I. Time
• II. Investment Amount
• III. Risk availability (Age)
• IV. Target Amount

Refer to MF cheat-sheet to choose.

MF portfolio for a single financial goal can be done with 2-3 MFs at max.

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• Reduce overlap to minimum.
• If want AMC diversification, use different types of fund (equity large from one, debt/liquid from other, etc.)

Method of elimination can be used as per goal.

Examples:

• 10 years, 1.5 cr (young): For 10 years, debt is not required, so equity (large cap, mid cap, value fund) are options. Don't stack in lumpy flow.
• 25 lakh in 8 years (old): Not 100% equity, so a mix (arbitrage, short duration, corp bond).

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Example 3: Retirement with ₹50 Lakh from Sale of Asset (20+ years)

• May be 20-25% → 20–25% can go into large-cal → large-cap.
• Invest lumpsum in fund which offers capital protection.
• Withdraw chunks of it every month & invest into designated fund for retirement.
• Continue doing so till exhaustion of capital.

Options:

• Index funds
• Mid-cap funds are options.

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Asset Allocation

• Asset: Anything you own
• Liability: Anything you owe

Assets

flowchart LR
    A[Assets] --> B[Precious Metals]
    A --> C[Real Estate]
    A --> D[Collectibles]
    A --> E[Financial]
    B --> F[Gold, Silver]
    C --> G[Land]
    C --> H[Rental]
    C --> I[Commercial]
    D --> J[Art]
    D --> K[Stamps]
    D --> L[Coins]
    D --> M[Bitcoin]
    E --> N[Stock]
    E --> O[Equities]
    E --> P[Bonds]
    E --> Q[Commodities]

Allocation

• Splitting one’s savings between different types of assets.

Liabilities

flowchart TD
    A[Liability] --> B[Housing Loan]
    A --> C[Loan Balances]

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Macro-Economics

I. GDP

• Total value of the economic output of the family, which includes goods sold, products manufactured and sold, and service offered.

• GDP is usually measured in % age (growth rate) → (growth rate).

  • Absolute:
    • Nominal growth rate
    • Real GDP growth rate
    • $\text{Nominal} - \text{Inflation}$

• Market Cap = Price of stock & stock action clng → (unclear term, possible error: "closing"? – flag for manual review)

• Family = Government & people of India

• Government Revenue = Tax + Non-tax (PSU, LIC)

  • Revenue Expenditure (Subsidies, salary)
  • Capital Expenditure

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Personal Finance Review

I. Don’t be scared

• You fail, you learn

II. Reflect on where you are

III. Know where your finances are

• Assets
• Liabilities

IV. Review goals

• Well defined

• Cost of goal

• Adjust for inflation

• Figure out right asset allocation

• Have reasonable return assumptions

• Risk Tolerance: Ability to withstand market volatlity → volatility

• Risk Capacity: How much risk you can take at goal level → take at goal level

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V. Have emergency fund

VI. Clear debt

• Avalanche
• Snowball

VII. Diversification & Asset Allocation

• Diversity of investing in different asset classes.

• Equity: Domestic & Intl. equities

• Debt: Within, between various durations & risk levels.

• Don’t diversify:

  • See where investment is (don’t invest in same stock through different mutual funds).

VIII. Check performance against benchmarks

• Rolling return – check consistency
• Sharpe ratio, Sortino ratio, capture ratio
• Fees

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IX. Rebalancing

• 65%, 30%, 5%
• If equity goes up to 70%, sell 5% and invest somewhere else.
• 65%, 30%, 10%

X. Savings Rate Matters

• Rate of saving $>$ Rate of return (as return is unpredictable)
• Human capital is important

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Insurance

1. Get one good insurance.
2. Fill everything correctly:
   • Age
   • History of medical conditions
3. Choose insurance cover smartly
   • 20 lakh is good enough → good enough
   • Health insurance premiums increase:
     • 4–6% to counter inflation
     • If age bands are crossed, they can increase premium out of blue.
4. Co-payment is a scam.
   • They make sense unless they are mandatory or buying a policy for someone old with pre-existing disease.

• Check room renting in insurance clause.

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5. Dunning-Kruger Effect

   • People overestimate their ability even when they may have little to no expertise on the subject matter.
     • Declare everything if hiding kills
     • Tell surgeries & genetic condition
     • You can’t fool/outwit insurers.

6. Insurance company have waiting periods for certain illnesses.

   • Permanent exclusions: Sometimes even no payment.
   • Also, they can have limit on certain illness.
   • Hospitals overcharge, so insurance add them in exclusion list.

7. Check who are covered under policy.

   • Buy personal insurance even if employer gives one.

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8. How to choose which insurance?

   • Check network hospitals & work on ensuring pre-auth of claim (Not gimmick)
   • Alternative medicine cover (like homeo, allo) (Slightly gimmick)
   • Restoration Benefit
     • Under group policy, if one is hospitalized, a top-up can be done for other family to cover.
     • Check how will they cover (Not gimmick, but can be)
   • Pre & Post Hospitalization expenses cover for 30 days to 6 months (Not gimmick, but kinda available in all)

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• Day care treatment (won’t cover treatments if hospitalized for less than 24 hours) (Not gimmick)
• No claim bonus
  • If no claim done in last year, cover increases (Not gimmick, but good feature)
• Domiciliary cover
  • Condition that prevents you from moving to actual medical facility
  • Medical practitioner must confirm that hospitalization is necessary
  • All costs must be deemed just and reasonable. Hospital can give needless provision (Slightly gimmicky)

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• Consumables: Glove, TV monitors, mask, PPE kit are covered or not (Not a gimmick)
• Critical illness
  • If well-defined it's good.
  • Top-up if it is critical illness (Slightly gimmicky)
• Top-up plans (to increase cover)
  • It offers a sizeable extended cover after the customer pays the deductible during a hospitalization.
  • Deductible could be from another insurance or from pocket.
  • But the catch is deductible needs to be low as you will exhaust the base insurance anyway if you go to hospital once (Highly gimmicky)

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• Super Top-up Plans

  • Remove the recurring deductible feature.
  • Exhaust base insurance & then only you can use super top up.
  • Provided that base insurance is exhausted, so better to have same date for base insurance & top-up.
  • (Not gimmick, actually good to have)

• Claim Settlement Ratio

  • Not very useful to us as we don’t have context on claims settled.
  • If we see IRDAI’s annual report, we get good idea.
    • How many claims?
    • (ICR) How much is insurer in profit?
    • Formula for calculating claim settlement ratio?
  • (Not gimmick, but requires research)

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• Porting
  • If insurance is no good today, ditch it and buy a new plan or port it.
  • Check if carryover of benefits can be done like:
    • Waiting periods
    • How much cover is waived off for waiting period
  • (Not a gimmick)