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Term Paper on Investment Decisions

Term Paper Contents:

  1. Term Paper on the Introduction to Investment Decisions
  2. Term Paper on the Criteria for Investment Decisions
  3. Term Paper on the Analysis of Investment Decisions
  4. Term Paper on the Objectives of Investment Decisions
  5. Term Paper on the Environmental Considerations of Investment Decisions
  6. Term Paper on Tax Planning in Management of Investment Decisions  
  7. Term Paper on the Execution of Investment Decisions

Term Paper # 1. Introduction to Investment Decisions:

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Any investment is risky and as such investment decision is difficult to make. Investment decision is based on availability of money and information on the economy, industry and company and the share prices ruling and expectations of the market and of the companies in question.

In the Stock Market parlance, investment decision refers to making a decision regarding the buy and sell orders. These decisions are influenced by availability of money and flow of information. What to buy and sell will also depend on the fair value of a share and the extent of over valuation and undervaluation and more important expectation regarding them. For making such a decision the common investors may have to depend more upon a study of fundamentals rather than technical, although technical are also important.

If investment is for short-term and for speculation, technical are more important. Besides, even genuine investors have to guard themselves against wrong timing regarding both buy and sell decisions. Otherwise they will burn their fingers as happened in 1992 following the Harshada Mehta Scam. For this purpose, a study of company’s performance, past record and expected future performance are to be looked into.

It is necessary for a common investor to study the Balance Sheet and Annual Report of the company or analyse the quarterly and half-yearly results of the company and decide on whether to buy that company’s shares or not. This is called fundamental analysis. The decision of what to buy is easier, and if investors are tuned to making fundamental analysis, then decision-making becomes scientific and rational. The likelihood of high risk scenario will come down to a low risk scenario and long-term investors will not lose.

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Term Paper # 2. Criteria for Investment Decisions:

Firstly, investment decision depends on the mood of the market. As per the empirical studies, share prices depend on the fundamentals of the company only to the extent of 50% and the rest is decided by the mood of the market and the expectations of the company’s performance and its share price. These expectations depend on the analyst’s ability to foresee and forecast the future performance of the company. For, price paid for a share at present depends on the flow of returns in future, expected from the company.

Secondly and following from the above, decision to invest will be based on the past performance, present working and the future expectations of the company’s performance, both operationally and financially. These in turn will influence the share prices.

Thirdly, investment decision depends on the investor’s perception on whether the present share price is fair, overvalued or undervalued. If the share price is fair he will hold it (Hold Decision), if it is overvalued, he will sell it (Sell Decision) and if it is undervalued, he will buy it (Buy Decision). These are general rules, but exceptions may be there.

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Thus even when prices are rising, some investors may buy as their expectations of further rise may outweigh their conception of overvalua­tion. That means, the concepts of overvaluation or under valuation are relative to time, space and man. What may be overvalued a little while ago has become undervalued following later developments; information or sentiment and mood may change the whole market scenario and of the valuation of shares. There are two more decisions, namely, Average Up and Average Down of prices.

The investment decision may also depend on the investor’s preferences, moods, or fancies. Thus an investor may go on a spending spree and invest in cats and dogs of companies, if he has taken a fancy or he is flooded with money from lottery or prizes. A rational investor would however make investment decisions on scientific study of the fundamentals of the company and in a planned manner.

At present, investors mostly depend on hearsay and advice of friends, rela­tives, sub-brokers, etc. for the investment decision, but not on any scientific study of the company’s fundamentals. In view of the increasing mushroom growth of companies and lack of any track record of many promoters, investment decision­-making became more difficult now. Even otherwise, risk will increase in case of all investments made on hunches, hearsay etc.

Risk and Investment:

Stock Market investment is risky and there are different types of investments, namely, equity, fixed deposits, debentures etc. Company specific risk also called unsystematic risk can be reduced by diversifying investments into 10 to 15 companies. But the systematic risk relating to the market cannot be reduced but can be managed by choosing companies with that much risk (high or low) that the investor can bear.

For example, some investors can take high risk and they may invest in new ventures, turnaround companies, even when they are incurring losses, and some speculative companies like Reliance and G.E. Shipping etc. But risk-averse investors will choose only Blue Chip Companies with a good track record like Colgate, ITC, ICICI, Telco, Hindustan Lever etc.

It is therefore necessary for investors to be selective and discrete and analyse the risk along with return for each investment. Companies are Blue Chips, some are emerging Blue Chips etc. and some are risky ventures. Their evaluation can be done through fundamental analysis of companies, quoted on the Exchanges.

Term Paper # 3. Analysis of Investment Decisions:

i. Fundamental Analysis:

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This relates to an examination of the intrinsic worth of the company, to find out whether the current market price is fair, overpriced or underpriced. This is done by studying the various aspects of the company (Company Analysis) in the background of the performance of industry to which the company belongs and the general economic and socio-political scenario of the country.

Thus, the fundamen­tal analysis of the share price involves three major steps:

(a) Economic Factors and their Analysis.

(b) Industry Analysis.

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(c) Company Analysis.

The logic of this three tier analysis is that the company performance depends not only on its own efforts and working but on the general industry and economic factors, which influence its performance. No company can work in vacuum. It is a part of the industry and the economy and its performance depends on these forces which are external to the company.

Studies have shown that a company’s share price depends on the intrinsic or internal factors only to the extent of about one-half of the total forces and the rest is contributed by the external forces, namely, psychological and expectational factors regarding the company, relative to others in the industry and the sentiment in the market, which depends on the socio-economic and political forces operating on the market. This reflects the dictum that Stock Market is window of the economy and the totality of forces operating on the economy would influence the Stock market.

In the economy, some industries are expanding while others are stagnant and some contracting, depending on the demand and market conditions. The investor has to choose the growth industry and in that industry, choose the scrips under­valued as judged by his study and analysis.

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ii. Cost-Benefit Analysis:

In making investments of the last category, namely, in financial assets of deposits, bonds, debentures, shares, etc., investment management involves a cost- benefit analysis. The major costs are the risk involved and major benefits are the returns involved.

Risk is measured by the variability of the returns. But the risk is of various types — non-payment of dividend/interest, delay or non-payment of principal, variability of return or market value of investments.

These risks may be classified as:

(a) Company Risk

(b) Market Risk

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(c) Business Risk

(d) Commodity/Product Risk

(e) Financial Risk

(f) Economy Risk of the Nation

(g) International Factors.

Among examples of International factors imports and exports and interna­tional prices of inputs of domestic goods, etc., can be cited. Among economy risk, Govt. Policy, Inflation, Monetary and fiscal policies etc. can be given as examples.

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The other risks particularly the risk of Business is relative to trade/ business of the Company, Product, and Inputs/Outputs etc. Interest Rate, Labour Problems, Inflation effect may lead to financial and Market risks. Company risk is unique to the company, about its own management and operations.

There are many other risks such as socio-economic factors, political and commercial problems etc. The costs are the expenses to be incurred in acquiring the, assets, say registration, brokerage charges etc. In addition there will be uncertainties and risks, involved due to possible non-payment of interest or dividends or capital losses etc.

There are corresponding benefits to be assessed in terms of regular incomes (interest and dividends) — regularity and certainty of them — capital appreciation, safety and security of funds, marketability and liquidity of investments and a host of other goals. The investor has to assess the costs and benefits of each investment, in the process of investment decisions.

Term Paper # 4. Objectives of Investment Decisions:

The first basic objective of investment is the return on it or yields. The yields are higher, the higher is the risk taken by investors. The riskless return is the bank deposit rate of 8.5% at present or Bank rate of 8% (Oct., 1999) Here the risk is least as funds are safe and returns are certain.

Secondly, each investor has his own asset preferences and choice of invest­ments. Thus some risk averse operators put their funds in bank or post office deposits or deposits/certificates with cooperatives and PSUs. Some invest in real estate, land and buildings while others invest mostly in gold, silver and other precious stones, diamonds etc.

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Thirdly, every investor aims at providing for minimum comforts of a house furniture, vehicles, consumer durables and other household requirements. After satisfying these minimum needs, he plans for his income, saving in insurance (LIC and GIC etc.), pension and provident funds etc. In the choice of these, the return is subordinated to the needs of the investor, and his goals.

Lastly, after satisfying all the needs and requirements, the rest of the savings would be invested in financial assets which will give him future incomes and capital appreciation, so as to improve his future standard of living. These may be in stock/ capital market investments. In stock and capital markets, there are a number of scrips and these are selected as per his goals and objectives. Tax Saving is another objective kept before the investor. He programmes his investments as per these goal priorities.

Term Paper # 5. Environmental Considerations of Investment Decisions:

Many times, investor has to take into account the environmental factors in investment management. His past background, family requirements, the assets of neighbours or of colleagues and other external factors may influence his investment decisions.

People in rural and semi-urban areas are influenced by their immediate environment and access to avenues. The agriculturists invest in ploughs, tractors and other requirements, needed for his occupation and environment. Beyond these, he invests in gold and silver or real estate due to the influence of environ­ment as people are assessed in those places by the amount of gold and real estate, they hold and possess.

On the other hand, the environment in urban and metropolitan centres is different. The alternatives available to them are more varied. The funds are invested in vehicles, consumer durables, mutual funds, corporate securities and various other instruments. In many semi-urban and urban areas, housing finance companies, finance and investment companies and chit funds attract the public funds with attractive returns and incentives.

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Chit Funds and Nidhis:

Among the categories of investments popular with semi-urban and urban areas, there are various types of deposits kept with non-bank finance companies like hire-purchase, investment and finance companies, housing finance companies, mutual benefit funds, chit funds and nidhis. Nidhis, chits, etc. are mostly governed by State Acts and partly controlled by the RBI in respect of their deposit raising activities.

Chit funds are of various categories, prize chits, normal and conventional chits, lottery chits, etc. They collect regularly the savings of investors on a monthly basis and lend, if necessary to members and give a lump sum money once in a year depending on the results of lottery or any other mechanism.

Mutual benefit funds and nidhis are also saving mobilisation agencies, for the benefit of members, who are saving households. These are normally registered as trusts or friendly societies and operate in mobilisation of savings and lending for the benefit of members. So long as the promoters are honest and dependable, the funds are safe and members benefit from these activities. But there are many reports, about unscrupulous elements among these promoters, fly-by-night opera­tors who collect the funds and misuse them for trading and speculation or disappear from the scene after working for sometime. Although there are laws and rules to regulate them, the subject being a state subject, the regulation and control on them is lax and hence funds may not always be safe.

Investors have to weigh the pros and cons of making investments in such agencies. Similarly all deposits with companies private limited or public limited are unsecured debt and hence the investors should be careful in taking this risk of investment in deposits in the chits, nidhis and even finance companies.

Term Paper # 6. Tax Planning in Management of Investment Decisions:

As Investment management aims at the highest return possible, reduction in tax liability can increase returns. Tax planning is done to reduce tax liability by proper investment strategy.

The elements of tax planning are as follows:

i. Income Tax:

Interest income and dividend income upto Rs. 2,500 is not subject to tax deduction at sources. Income from dividends and Mutual funds schemes, bank deposits etc. is exempt from tax upto Rs. 15,000 P.A., under Section 88 of Income Tax Act which was widened to encompass the contributions to N.S.S., P.F. etc. to be eligible for tax exemption. From 1998-99, all dividends from companies are exempt from tax in the hands of investors.

ii. Wealth Tax:

Investment in shares and debentures are totally exempt from wealth tax without limit. The other investments in real estate, gold, housing, cars etc. are subject to wealth tax beyond Rs. 15 lakhs with some exceptions for specific purposes.

iii. Corporate Taxation:

From 1995-96, there is a single rate of corporate tax of 30% for all whether widely held or closely held companies. There is also a surcharge of 10% for both companies and individuals. Foreign companies will pay at a tax rate of 48% as against earlier rate of 65% with effect from 1995-96.

iv. TDS:

The current rate of tax deduction at source is 10% for interest income and 20% for dividend income. Mutual funds and banks were exempt from making tax deduction at source for such income payments, but since July 1995, TDS is enforced on them also.

Investments in approved Securities or P.O. certificates, are exempt from income tax, if it is upto Rs. 60,000 and the rebate is upto 20% of investment. In approved mutual fund equity linked schemes, investment upto Rs. 10,000, enjoy a rebate upto Rs. 2,000 in income tax payable for the year. This exemption or rebate for investment upto Rs. 10,000 is within the above limit of Rs. 60,000 under Section 88 of IT Act. Another rebate of Rs. 10,000 is for investment in infrastructure bonds as approved by the Govt.

v. Capital Gains Tax:

Long-term capital gains are taxable at 20% for individuals and 30% for corporate Units. Short-term capital gains are taxable at the same rates as applicable to individual income tax payers and corporate tax payers. Long-term capital gains are those realised after 12 months in the case of shares, UTI and Mutual Fund schemes. But they should be held for more the 36 months to be considered long-term capital gains in the case of other assets like real estate etc.

vi. Gift Tax:

Gifts made by NRIs to resident relatives and friends are completely exempt from gift tax. Gifts made by residents to other residents are exempt up to a limit of Rs. 30,000 P.A. Exemption limits of gifts on marriage of dependent relatives are raised from Rs. 30,000 to Rs. one lakh in the Budget for 1994-95. Gift tax was abolished from 1998 and gift is considered as income in the hands of dones to be taxed.

Term Paper # 7. Execution of Investment Decisions:

If investment is made in corporate securities and having chosen the scrips, to buy or sell, investor gives his orders to the broker. As per the Rules and Byelaws of the exchange, the stock broker and if sub-broker is dealing with clients, the sub- broker should accept orders in the form of entries in their inward Registers. These orders can be oral, written or by Telex or Telephone etc.

The broker has to pass the contract note to the client on the same day or next day after the order is executed. If the order is executed by buying or selling on his own account vis-a-vis the client, then the consent of the client is necessary and the deal should be put through at the market rate, as if it is done in the Trading Ring.

The sub-broker cannot pass contract notes; but based on the contract note of broker to sub-broker, he can pass the confirmation notes to the client. The client has to check the price noted in the contract note or confirmation note with that as reported in the papers. But some variations are permissible as the broker purchases or sells at one price while market price fluctuates within a range from minute to minute.

If the Stock Exchange gives the daily highs and lows and the price charged by the broker falls within that range with some margin for the broker’s and sub- broker’s commissions then the deal should be considered to be fair. Otherwise complaint can be made with the Exchange.

As per the latest directives of the SEBI, the contract note should show separately the price of the scrip and the brokerage charged and service tax payable to brokers on their brokerages income which they pay to Govt. This ensures transparency and the client should insist on this.

At present, SEBI registered sub- brokers can also pass contract notes to the clients and investors should deal with them only and insist on contract notes to be passed. The brokers charge from the clients the surcharge and brokerage income at 5% of that income.

The client has to pay on or before the pay-in-day if he is a buyer and receive the Certificates on the payout day. If the client is a seller, he should deliver the shares before the pay in or settlement date and receive the money on or after the payout day. These pay-in and pay-out dates are fixed well in advance and the brokers know these dates and the clients should insist on this information, from the brokers and sub-brokers. Every Stock Exchange has a Trading Cycle of 5 days to 15 days for each settlement.

The SEBI directed all the Stock Exchanges to have uniform period of 5 days for all. Some Exchanges follow Trading Cycle of 5 days if they have only cash scrips or ‘B’ group shares and pay-in-day comes after about 10 to 15 days from the first day of trading. After a couple of days from the pay- in-day, the pay-out-day is fixed. Thus the client has to wait for about 15 to 20 days from the date of transaction to realise the proceeds of his sale or get delivery of shares. Some banks lend against shares if investors need funds.

The client has to make a note of these days and insist from the sub-broker or broker for cheques or shares, as the case may be, on the due dates. The awareness of these dates and the amounts due to them will help the clients in their transac­tions with brokers. Similarly knowledge of the Rules of the Stock Exchange and practices of brokers will help them to protect their interests.

In the event of non­payment of cheque or non-delivery of shares on due dates, clients have to promptly take up with brokers and if they do not respond, complaints have to be made to the Stock Exchange, in which they are members.