The document provides an overview of capital markets and securities analysis. It discusses the key participants in securities markets like regulators, stock exchanges, brokers, and depositors. It also outlines the different components of capital markets like equity markets, debt markets, and derivatives markets. The document then examines the primary and secondary markets, describing how new securities are issued in the primary market and then traded in the secondary market. It also discusses various valuation techniques for equities like balance sheet methods, discounted cash flow models, and relative valuation approaches. Overall, the document serves as an introduction to capital markets and securities analysis.

1. SECURITIES ANALYSIS
&
INVESTMENT MANAGEMENT
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2. Capital Market – An Overview
Securities
Market
Equity Debt Derivatives
Market Market Market
Govt. Corporate Options Futures
Money
Securities Debt Market Market
Market
Market Market
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3. Capital Market – An Overview
 Participants In Securities Market
Regulators – Agencies having direct or indirect
influence over the securities market.
• Company Law Board
• Reserve Bank of India
• Securities & Exchange Board of India
• Department of Economic Affairs
• Department of Company Affairs
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4. Capital Market – An Overview
 Participants In Securities Market
Stock Exchanges – A place where old
securities are bought & sold.
Listed Securities – Securities registered with
stock exchanges for trading.
Depositories - An institution where physical
certificates are dematerialised and ownership
is transferred by Electronic Book Entries.
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5. Capital Market – An Overview
 Participants In Securities Market
Brokers – Registered members of stock
exchanges through whom investors transact.
E. g., Sharekhan, Indiabulls.
Foreign Institutional Investors – Institutions
from abroad registered with SEBI to invest in
Indian capital market.
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6. Capital Market – An Overview
 Participants In Securities Market
Registrars – Agencies responsible to handle
investor-related services, e.g. Karvy, Cams.
Underwriter – A person or agency that
guarantees for public subscription to a given
no. of shares.
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7. Capital Market – An Overview
Primary Equity Market
o Working in India since late nineteenth century.
o Remained dull & inactive till 1991.
o Control of Capital Issues Act abolished & SEBI
formed as governing body to regulate the
primary market.
o Companies now free to fix price of their shares &
interest on debt securities.
o Disclosure of Investor Protection Guidelines made
compulsory.
o New shares to be issued only in dematerialised
form.
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8. Nature of
Primary Market
1) Market for New Equity Capital – Deals only with securities
sold for the first time. Also called the New Issues Market.
2) Direct Issuance of Securities – The securities are issued
directly to the investors in a Primary Market.
3) Used by Companies – Helps companies to raise funds to set
up new business or expanding & modernising the existing
business.
4) Capital Formation – Facilitates the flow of idle money in the
market for economic growth & development.
5) Private going Public – Used to raise funds by converting
private capital into public capital.
6) Sale of Securities – Securities can only be sold by original
investors.
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9. Nature of
Secondary Market
1) Transfer of Securities – Securities can be sold
& transferred from one person to another.
2) Liquidity – Availability of fixed place &
presence of large no. of investors makes the
securities easily sellable.
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10. Trading
• Only listed & permitted securities traded on
Stock Exchange.
• Investors need to place their orders with the
members / brokers of the exchange.
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11. Ways of Trading
Open Outcry System
• There are several trading posts for different
securities.
• Traders or their representative shout and
respond to signals on these posts.
• Sellers quote their rates and buyers make
their bids.
• Bargains are closed at a mutually agreed
prices.
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12. Ways of Trading
Screen-based System
• Used widely around the globe.
• Trading floor is replaced by the computer
screen.
• Trading carried on at a very fast speed.
• Traders sitting at distant places can buy or sell
securities through network of computers.
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13. REGULATORY
MECHANISM
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14. SEBI
• Came into existence in 1989 by the Ministry
Of Finance.
• Prime objective is to control & regulate the
Primary & Secondary Markets to protect the
interests of the investors.
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15. SEBI’ s Guidelines
1. Regulating the Securities Markets.
2. Register & regulate the market intermediaries, like
Brokers, Investment Bankers, etc.
3. Register & regulate working of Mutual Funds.
4. Promote & regulate self-regulatory organisations.
5. Prohibit unfair trade practices in securities market.
6. Promote investor education.
7. Training of intermediaries.
8. Prohibit insider trading.
9. Regulate acquisitions & take-overs.
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16. UNIT – 2
RISK & RETURN
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17. • Some people invest in a business to acquire
control and enjoy the prestige associated with
it.
• Desire to earn return leads to bearing some
risk.
• Risk and Return are center points of
investment decisions.
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18. The Concept
• Risk refers to the possibility that the actual outcome of
an investment will differ from its expected outcome.
• A mix of danger and opportunity.
• The wider the range of possible outcomes, the greater
the risk.
• Biggest risk – Not investing at all.
• Also known as reward for understanding towards
investments.
• Risk – averse means willing to sacrifice some return to
reduce risk.
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19. The Concept
The three types of Risk:
1) Business Risk
2) Interest Rate Risk
3) Market Risk
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20. Business Risk
• Associated with poor business performance.
• May be due to high competition, new
technology, substitute products, change in
consumers’ preferences, change in govt.
policies, etc.
• Affects the interests of equity shareholders who
have claim on income and wealth of the
company.
• May also affect the interests of debentureholders
sometimes.
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21. Interest Rate Risk
• Affects the welfare of investors.
• Market price of existing fixed income
securities fall, when the interest rate goes up.
• When the prevailing interest rate is lower than
fixed rate, buyer would not buy it at its face
value.
• Also affects the equity shares’ price indirectly.
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22. Market Risk
• Associated greatly with the sentiments of the
investors.
• When the investors are bullish &
optimistic, share prices tend to rise high.
• Similarly, when the investors are bearish &
pessimistic, share prices tend to decline.
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23. COMPONENTS OF RISK
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24. Systematic Risk
• Associated with firm-specific factors
like, emergence of new products, labour
strike, etc.
• Affects a specific firm and not the sector
generally.
• Can be washed away by diversifying portfolio
(combining with other stocks).
• A favourable development in one firm may
offset an adverse happening in another.
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25. Unsystematic Risk
• Associated with national economic factors like
GDP growth rate, level of govt.
spending, interest rates, inflation, etc.
• Cannot be avoided, as these factors affect all
the firms.
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26. Measuring Historical Return
Cash payment received Price change over
during the period + the period
Total Return =
Price of Investment at the beginning
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27. OR
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28. Measuring Historical Return
C + (PE – PB)
R=
PB
where,
R is the total return over the period,
C is the cash payment received during the period,
PE is the price of investment at the end of period, &
PB is the price of investment at the beginning of period.
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29. Measuring Expected Return
• Investment in a stock can take various possible
values and the chances of these possible
values can vary.
• If we say there is 3 to 1 chance that the price
of a stock will rise in a certain period say, one
month, it means that there is a 75% chance of
price rise & 25% chance of price decline.
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30. OR
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31. Measuring Expected Return
• If we say -
• Stock A may provide return of 6%, 11% or 16%
with certain probabilities based on state of
economy, &
• Stock B may provide return of -20%, 10% or
40% with same probabilities based on state of
economy….………
• Their probability distribution of returns shall
be as -
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32. Measuring Expected Return
State of Economy Probability of Rate of Return (%)
Occurrence Stock A Stock B
Boom 0.30 16 40
Normal 0.50 11 10
Recession 0.20 6 -20
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33. Measuring Expected Return
• Expected Rate of Return is weighted average of all
possible returns multiplied by their respective
probabilities.
• The formula –
n
E(R) = ∑ Ri Pi
i=1
Where E(R) is the expected return,
Ri is the return under state i,
Pi is the probability that state i occurs, &
n is the no. of possible states of the economy.
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34. State of Economy Probability of Rate of Return (%)
Occurrence Stock A Stock B
Boom 0.30 16 40
Normal 0.50 11 10
Recession 0.20 6 -20
Expected return of Stock A shall be
E(R) = (0.30)(16)+(0.50)(11)+(0.20)(6) = 11.5%
Expected return of Stock B shall be
E(R) = (0.30)(40)+(0.50)(10)+(0.20)(-20) = 13.0%
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35. Measuring Expected Return
σ² = ∑ pi (Ri – E(R))²
Where
σ² is the variance
Ri is the return for the ith possible outcome
Pi is the probability with the ith possible
outcome, &
E (R) is the expected return
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36. Measuring Expected Return
Hence,
Standard Deviation σ = (σ²)½
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37. Calculation of Standard Deviation
Stock A
i. State of pi Ri piRi Ri – E(R) (Ri – E(R))² Pi(Ri-
Economy E(R))²
1. Boom 0.30 16 4.8 4.5 20.25 6.075
2. Normal 0.50 11 5.5 -0.5 0.25 0.125
3. 0.20 6 1.2 -5.5 30.25 6.050
Recession
E(R) = ∑piRi = 11.5 σ² = ∑pi(Ri – E(R))² = 12.25
σ = *∑pi(Ri-E(R))²]½ = (12.25)½ = 3.5%
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38. Valuation of Equity
• Fixed income securities have limited life &
fixed returns.
• Equity shares have unlimited life & uncertain
returns.
• The valuation of equity is complex due to
growth & risk factors.
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39. Valuation of Equity
Two approaches to Equity Valuation are -
1. Fundamental Analysis
2. Technical Analysis
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40. Valuation of Equity
1) Fundamental Analysis: Examines the assets,
earning prospects, cash flow projections &
dividend potential to assess fair market value
of equity shares.
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41. Valuation of Equity
2) Technical Analysis: Focuses on price
trends, volume trends & other market
indicators to assess fair market value of equity
shares.
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42. Valuation of Equity
Balance Sheet Technique
•Book Value
•Liquidation Value
•Replacement Cost
Discounted Cash Flow Technique
Fundamental Equity
Valuation •Dividend Discount Model
•Free Cash Flow Model
Relative Valuation Techniques
•Price – Earnings Ratio
•Price – Book Value Ratio
•Price – Sales Ratio
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43. Balance Sheet Technique
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44. Balance Sheet Valuation
1) Book Value: Net worth of a company divided
by the no. of outstanding equity shares.
Net worth = Paid-up Equity Shares + Reserves
& Surplus
Book Value = Net Worth / No. of Equity Shares
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45. Balance Sheet Valuation
2) Liquidation Value: It is the value realised after
liquidating all the assets of the firm & amount
paid to creditors and shareholders divided by the
no. of outstanding equity shares.
Value realised from Amt. to be paid to creditors
LV= all assets of firm - & Preference Shareholders
No. of Outstanding Equity Shares
Although liquidation value appears more realistic, it
is very difficult to estimate the amounts to be
realised after liquidation of assets. Also, it does
not reflect the earning capacity.
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46. Balance Sheet Valuation
3) Replacement Cost: It is the cost of replacement
of assets less liabilities. It is assumed here that
market value of a firm cannot deviate much from
its replacement cost. The ratio of market price to
replacement cost is called Tobin q.
Limitation of Replacement Cost is that
organisational capital is not shown in the balance
sheet. Organisation capital is the group of people
associated with the firm, directly or
indirectly, such as
employees, customers, suppliers, etc in a
mutually beneficial and productive relationship.
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47. Discounted Cash Flow Techniques
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48. Discounted Cash Flow Techniques
1) Dividend Discount Model: According to this
model, the value of a share is equal to the
present value of dividends expected plus the
present value of share expected when it is
sold. It is assumed here that dividends are
paid annually and the first dividend is received
after one year of buying the share.
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49. Discounted Cash Flow Techniques
1) Dividend Discount Model:
a. Single Period Valuation: It is the case where
the investor is expected to hold the share for
one year.
D1 P1
P0 = +
(1 + r) (1+r)
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50. Discounted Cash Flow Techniques
1) Dividend Discount Model:
b. Multi-Period Valuation: It is the case where
the investor is expected to hold the shares for
more than one year.
D1 D2 D∞
P0 = + +-----+
(1+r) (1+r)² (1+r)∞
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51. Discounted Cash Flow Techniques
1) Dividend Discount Model:
c. Zero Growth Model: It is the case where
dividend per share remains constant year
after year.
P0 = D
r
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52. Discounted Cash Flow Techniques
1) Dividend Discount Model:
d. Constant Growth Model: It is the case where
the dividend grows at a constant rate (g).
D1
P0 =
r-g
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53. Discounted Cash Flow Techniques
2) Free Cash Flow Model: This model involves the following
procedure:
a) Dividing the future into Explicit Forecast Period &
Balance Period: This is the period during which the firm is
expected to grow & reach a steady state.
b) Forecasting the Free Cash Flow (cash available for
distribution to shareholders & debtholders after
providing for investment in fixed assets & net working
capital required) during the Explicit Forecast Period:
FCF = NOPAT – Net Investment
NOPAT = Net Operating Profit after adjusting for taxes
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54. Discounted Cash Flow Techniques
c) Calculating the weighted average cost of capital:
WACC = Were + Wprp + Wdrd (1-t)
Where ‘w’ is the weight associated with
equity, preference & debt;
r is the cost associated with equity, preference & debt.
d) Establishing the Horizon Value of the firm: It is the
value placed on the firm at the end of explicit forecast
period (H).
FCF (1+g)
VH =
WACC - g
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55. Discounted Cash Flow Techniques
e) Estimating the Enterprise Value:
FCF1 + FCF2 + ...... + FCFH VH
EV = (1+WACC) (1+WACC) 2 +
(1+WACC)H (1+WACC)H
f) Deriving the Equity Value:
Equity Value = Enterprise Value – Preference Value – Debt
Value
g) Computing the value per share: It is the equity value
divided by the no. of outstanding equity shares.
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56. Relative Valuation Technique
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57. Relative Valuation Technique
1) Price – Earning Ratio: It is the value after
dividing dividend per share by the share price
or earning per share divided by the share
price.
D1 E1
P0 = OR
r r
Where r is the Expected Return.
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58. Relative Valuation Technique
2) Price to Book Value Ratio: Book value is the
net worth of the company divided by the no.
of equity shares.
Market Price Per Share at time t
PBV Ratio=
Book Value Per Share at time t
OR
P0
PBV Ratio=
BV0
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59. Relative Valuation Technique
3) Price to Sales Ratio: It is calculated by
dividing current market value of equity capital
by annual sales of the firm.
P S Ratio = P0
S0
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60. Valuation of Debentures / Bonds
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61. Meaning & Characteristics of Bonds
A Bond is a security issued that obligates the
issuer to make specified
payments, i.e., interest & principal, to the
bondholder.
It may be characterised in terms of par
value, coupon rate & maturity date.
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62. Meaning & Characteristics of Bonds
• Par Value is the value that is stated on the face
of the bond and represents the amount the
issuer promises to pay at the time of maturity.
• Coupon Rate is the rate at which the interest
is payable to the bondholder.
• Maturity Date is the date at which the
principal amount is payable to the
bondholder.
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63. Valuation
Value of a Bond is equal to the present value of
the cash flows expected from it. Determining
the value of a bond requires -
An estimate of expected cash flows
An estimate of the required return
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64. Valuation
Bond with Annual Interest
Assuming that
o The coupon rate is fixed for the entire term,
o The coupon payments are made every year, &
o The bond will be redeemed at par on maturity.
Value of a bond shall be;
C M
P=∑ t
+
(1+r) (1+R)n
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65. Valuation
Where,
P is the value;
n is the number of years to maturity;
C is the annual coupon payment;
r is the periodic required return;
M is the maturity value; &
t is the time period when the payment is
received.
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66. Valuation
OR
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67. Valuation
P = C X PVIFA r,n + M X PVIF r,n
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68. Valuation
Bond with Semi-Annual Interest
Value of Bond shall be
C/2 M
P=∑ +
(1+r/2)t (1+r/2)2n
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69. Valuation
OR
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70. Valuation
P = C/2 (PVIFA r/2,2n) + M(PVIF r/2,2n)
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