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studying the stock picking as per risk profile of investor

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Vikash project report

  1. 1. 1 INTRODUCTION Before we begin, first let‘s understand the origin of word ―finance.‖If we trace the origin of finance, there is evidence to prove that it is as old as human life on earth. The word finance was originally a French word. In the 18th century, it was adapted by English speaking communities to mean ―the management of money.‖ Since then, it has found a permanent place in the English dictionary. Today, finance is not merely a word else has emerged into an academic discipline of greater significance. Finance is now organized as a branch of economics. Furthermore, the one word which can easily replace finance is ―exchange." Finance is nothing but an exchange of available resources. Finance is not restricted only to the exchange and/or management of money. A barter trading system is also a type of finance. Thus, we can say, Finance is an art of managing various available resources like money, assets, investments, securities, etc. At present, we cannot imagine a world without finance. In other words, finance is the soul of our economic activities. To perform any economic activity, we need certain resources, which are to be pooled in terms of money (i.e. in the form of currency notes, other valuables, etc.). Finance is a prerequisite for obtaining physical resources, which are needed to perform productive activities and carrying business operations such as sales, pay compensations, reserve for contingencies (unascertained liabilities) and so on. Hence, Finance has now become an organic function and inseparable part of our day-to- day lives. Today, it has become a word which we often encounter on our daily basis. Definition of Finance Finance is defined in numerous ways by different groups of people. Though it is difficult to give a perfect definition of finance following selected statements will help you deduce its broad meaning.
  2. 2. 2 1. In General sense, "Finance is the management of money and other valuables, which can be easily converted into cash. 2. According to Entrepreneurs, "Finance is concerned with cash. It is so, since, every business transaction involves cash directly or indirectly." 3. According to Experts, "Finance is a simple task of providing the necessary funds (money) required by the business of entities like companies, firms, individuals and others on the terms that are most favourable to achieve their economic objectives." 4. According to Academicians, "Finance is the procurement (to get, obtain) of funds and effective (properly planned) utilization of funds. It also deals with profits that adequately compensate for the cost and risks borne by the business. Features of Finance The main characteristics or features of finance are below.
  3. 3. 3 1. Investment Opportunities In Finance, investment can be explained as a utilization of money for profit or returns. Investment can be done by creating physical assets with the money (such as development of land, acquiring commercial assets, etc.), carrying on business activities (like manufacturing, trading, etc.), and acquiring financial securities (such as shares, bonds, units of mutual funds, etc.).Investment opportunities are commitments of monetary resources at different times with an expectation of economic returns in the future. 2. Profitable Opportunities In Finance, Profitable opportunities are considered as an important aspiration (goal). Profitable opportunities signify that the firm must utilize its available resources most efficiently under the conditions of cut-throat competitive markets. Profitable opportunities shall be a vision. It shall not result in short-term profits at the expense of long-term gains. For example, business carried on with non-compliance of law, unethical ways of acquiring the business, etc., usually may result in huge short-term profits but may also hinder the smooth possibility of long-term gains and survival of business in the future. 3. Optical Mix of Funds Finance is concerned with the best optimal mix of funds in order to obtain the desired and determined results respectively. Primarily; funds are of two types, namely, Owned funds (Promoter Contribution, Equity shares, etc.), Borrowed afunds (Bank Loan, Bank overdraft, Debentures, etc).The composition of funds should be such that it shall not result in loss of profits to the Entrepreneurs (Promoters) and must recover the cost of business units effectively and efficiently. 4. System of Internal Controls Finance is concerned with internal controls maintained in the organization or workplace. Internal controls are set of rules and regulations framed at the inception stage of the
  4. 4. 4 organization, and they are altered as per the requirement of its business. However, these rules and regulations are monitored at various intervals to accomplish the same which have been consistently followed. 5. Future Decision Making Finance is concerned with the future decision of the organization, respectively. A "Good Finance” is an indicator of growth and good returns. This is possible only with the good analytical decision of the organization. However, the decision shall be framed by giving more emphasis on the present and future perspective (economics of country). Conclusion on Finance Finance to be more precise is concerned with the management of- 1-Own funds (promoter contribution). 2-Raised funds (through equity share, preference share, etc.). 3-Borrow funds (loans, debentures, overdrafts, etc.). Finance is a field that studies topics such as borrowing money to receive a greater return on the funds. Finance is important in business because debt payments often require paying a lower rate of return than investors expect with other instruments such as common and preferred stock. Finance allows a company to receive the money necessary to pay bills such as workers' wages, rent and utilities without giving up ownership rights through the sale of stocks. 1-Personal Finance There are many benefits of course to having a sibling, a like-aged companion is always around and you can talk about mom and dad with someone who knows them just as well as you do. But when you are constantly around another kid, there are going to be some difficulties that arise much or sufficient. Being in debt can be a very troubling state to live in, as you find yourself almost losing your freedom to whomever your debt is owed to. Every penny you make can feel like the belonging of the debit, as life itself turns into an uphill battle for financial liberty. There are many ways by which we can collect debt.
  5. 5. 5 2- Financial Planning Finance is a field that studies topics such as borrowing money to receive a greater return on the funds. Finance is important in business because debt payments often require paying a lower rate of return than investors expect with other instruments such as common and preferred stock. Finance allows a company to receive the money necessary to pay bills such as workers' wages, rent and utilities without giving up ownership rights through the sale of stocks. We all buy things we don‘t need or particularly even want, but it‘s that quick impulse buy that often drains our already stretched bank account. How do you stop unnecessary spending, and how can you avoid the annoyance of cluttering your home with items you simply had to have at the time? It‘s simply follow as under. 3-Loans There are many situations that cause people to get in to debt. With prices high and salaries low at the moment, many more people are getting in to debt as well. However, there are certain circumstances that can make debts more common. Debts it may seem odd to state that debts cause debts but it should be small and easily can be pay. Insurance When you take out your insurance for a property that you let out, do double check that it includes liability insurance for your tenants. This covers you if an inhabitant of your property should hurt themselves within your house and it is proved to be due to your negligence. There are a lot of ways by that we make secure our property. Return Expectations Finance includes the study of return expectations. When a company decides to borrow money, it includes risk in the calculations of the return it will receive. A company that borrows a million dollars may predict that it has a 50 percent chance of earning two million dollars with its investment and a 50 percent chance of earning five hundred
  6. 6. 6 dollars. The company averages the two numbers and expects that it will receive a return of a million and a half dollars. Risk Adverse Investors Risk includes the study of variance. If a company can receive a million dollars half the time, and the other half of the time receives nothing, or it can receive a guarantee that it will receive five hundred thousand dollars, its financial analysts will usually recommend that it pursue the option with a guarantee to receive five thousand dollars. According to New York University, most investors are risk averse, so they will require additional returns before they accept a decision that includes larger amounts of potential risk. The Necessity of Finance Finance is necessary for many small businesses. Stock exchanges often require a minimum share value and company size before a company's shares may trade on the exchange. Since the small business owner cannot sell shares of a company to the public, the owner must borrow money from banks and other sources to finance the expenditures of the small business. Cash Flow Finance includes the study of cash flow. A company must pay its bills as they become due. This may include temporarily borrowing money at a higher return than the company is earning on its sales if it is necessary for the company to continue operating. Financial professionals make sure that the company's incoming revenues match its bill payments, by matching current assets such as cash with current liabilities such as the amount of bond interest due during the current year. Cost of Capital The cost of capital is an important area of finance. Businesses can often borrow funds from several sources, such as credit cards at high interest rates and bank loans at lower
  7. 7. 7 rates. Financial calculations provide the rate of return from investing additional funds into company operations, determining whether it is worthwhile to borrow money. Investor profile An investor profile or style defines an individual's preferences in investment decisions, for example: 1-Short term trading (active management) or long term holding (buy and hold). 2-Risk averse or risk tolerant / seeker. 3-All classes of assets or just one (stocks for example). 4-Value stock, growth stocks, quality stocks, defensive or cyclical stocks. 5-Big cap or small cap (Market capitalization) stocks, 6-Use or not use of derivative, 7-Home turf or international diversification. 8-Hands on, or via investment funds. What determines an investor profile? The style / profile is determined by Objective personal or social traits such as age, gender, income, wealth, family, tax situation etc.subjective attitudes, linked to the temper (emotions) and the beliefs (cognition) of the investor. Generally, the investor's financial return / risk objectives, assuming they are precisely set and fully rational. Determining Risk And Risk Pyramid You might be familiar with the risk-reward concept, which states that the higher the risk of a particular investment, the higher the possible return. But, many investors do not understand how to determine the level of risk their individual portfolios should bear. This article provides a general framework that any investor can use to assess his or her personal level of risk and how this level relates to different investments
  8. 8. 8 Risk-Reward Concept This is a general concept underlying anything by which a return can be expected. Anytime you invest money into something there is a risk, whether large or small, that you might not get your money back. In turn, you expect a return, which compensates you for bearing this risk. In theory the higher the risk, the more you should receive for holding the investment, and the lower the risk, the less you should receive. For investment securities, we can create a chart with the different types of securities and their associated risk/reward profile. Risk V/s Return Returns more often than not differ across their risk profiles, Generally rising with the expected risk, i.e., higher the returns, higher the risk. Risk Return Generally rising with the expected risk, i.e., higher the returns, Higher the risk. Although this chart is by no means scientific, it provides a guideline that investors can use when picking different investments. Located on the upper portion of this chart are investments that offer investors a higher potential for above-average returns, but this potential comes with a higher risk of below-average returns. On the lower portion are much safer investments, but these investments having a lower potential for high returns. Determining Your Risk Preference, with so many different types of investments to choose from, how does an investor determine how much risk he or she can handle? Every individual is different, and it‘s hard to create a steadfast model applicable to everyone, but here are two important things you should considers when I deciding how much risk to take.
  9. 9. 9  Time Horizon Before you make any investment, you should always determine the amount of time you have to keep your money invested. If you have $20,000 to invest today but need it in one year for a down payment on a new house, investing the money in higher-risk stocks is not the best strategy. The riskier an investment is, the greater its volatility or price fluctuations, so if your time horizon is relatively short, and you may be forced to sell your securities at a significant a loss. With a longer time horizon, investors have more time to recoup any possible losses and are therefore theoretically be more tolerant of higher risks. For example, if that $20,000 is meant for a lakeside cottage that you are planning to buy in ten years, you can invest the money into higher-risk stocks because there is be more time available to recover any losses and less likelihood of being forced to sell out of the position too early.  Bankroll-determining the amount of money you can stand to lose is another important factor of figuring out your risk tolerance. This might not be the most optimistic method of investing; however, it is the most realistic. By investing only money that you can afford to lose or afford to have tied up for some period of time, you won‘t be pressured to sell off any investments because of panic or liquidity issues. The more money you have, the more risk you are able to take and vice versa. Compare, for instance, a person who has a net worth of $50,000 to another person who has a net worth of $5,000,000. If both invest $25,000 of their net worth into securities, the person with the lower net worth will be more affected by a decline than the person with the higher net worth. Furthermore, if the investors face a liquidity issue and require cash immediately, the first investor will have to sell off the investment while the second investor can use his or her other funds Investment Risk Pyramid - After deciding on how much risk is acceptable in your portfolio by acknowledging your time horizon and bankroll, you can use the risk pyramid approach for balancing your assets. This pyramid can be thought of as an asset allocation tool that investors can use to diversify their portfolio investments according to the risk profile of each security. The pyramid, represented the investor‘s portfolio, has three distinct tiers.  Base of the Pyramid– The foundation of the pyramid represents the strongest portion, which supports everything above it. This area should be comprised of investments that
  10. 10. 10 are low in risk and have foreseeable returns. It is the largest area and composes the bulk of your assets.  Middle Portion– This area should be made up of medium-risk investments that offer a stable return while still allowing for capital appreciation. Although more risky than the assets creating the base, these investments should still be relatively safe.  Summit– Reserved specifically for high-risk investments, this is the smallest area of the pyramid (portfolio) and should be made up of money you can lose without any serious repercussions. Furthermore, money in the summit should be fairly disposable so that you don‘t have to sell prematurely in instances where there are capital losses. Personalizing the Pyramid Not all investors are created equally. While others prefer less risk, some investors prefer even more risk than others who have a larger net worth. This diversity leads to the beauty of the investment pyramid. Those who want more risk in their portfolios can increase the size of the summit by decreasing the other two sections, and those wanting less risk can increase the size of the base. The pyramid representing your portfolio should be customized to your risk preference. It is important for investors to understand the idea of risk and how it applies to them. Making informed investment decisions entails not only researching individual securities but also understanding your own finances and risk profile. To get an estimate of the securities suitable for certain levels of risk tolerance and to maximize returns, investors should have an idea of how much time and money they have to invest and the returns they are looking for. Stock Market A stock market or equity market is a public entity (a loose network of economic transactions, not a physical facility or discrete entity) for the trading of company stock (shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.
  11. 11. 11 Definition of 'Stock Pick A situation in which an analyst or investor uses a systematic form of analysis to conclude that a particular stock will make a good investment and, therefore, should be added to his or her portfolio. The position can be either long or short and will depend on the analyst or investor's outlook for the particular stock's price. Stock picking can be a very difficult process because there is never a foolproof way to determine what a stock's price will do in the future. However, by examining numerous factors, an investor may be able to get a better sense of future stock prices than by relying on guesswork. Because forecasting is not an exact science, an investor or analyst who uses any forecasting technique should include a margin of error in the calculations. The size of the world stock market was estimated at about $36.6 trillion at the beginning of October 2008. The total world derivatives market has been estimated at about $791 trillion face or nominal value, 11 times the size of the entire world economy. The value of the derivatives market, because it is stated in terms of notional values, cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. Moreover, the vast majority of derivatives 'cancel' each other out (i.e., a derivative 'bet' on an event occurring is offset by a comparable derivative 'bet' on the event not occurring). Many such relatively illiquid securities are valued as marked to model, rather than an actual market price. The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organization specialized in the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together. The largest stock market in the United States, by market capitalization, is the New York Stock Exchange (NYSE). In Canada, the largest stock market is the Toronto Stock Exchange. Major European examples of stock exchanges include the Amsterdam Stock Exchange, London Stock Exchange, Paris Bourse, and the Deutsche Burse (Frankfurt Stock Exchange). In Africa, examples include Nigerian Stock Exchange, JSE Limited, etc. Asian examples include the Philippine Stock Exchange, the Singapore Exchange, the Tokyo Stock Exchange, the Hong Kong Stock Exchange, the Shanghai Stock Exchange, and the Bombay Stock Exchange. In Latin America, there are such exchanges as the BM&F Bovespa and the
  12. 12. 12 BMV. Australia has a national stock exchange, the Australian Securities Exchange, due to the size of its population. Market participants include individual retail investors, institutional investors such as mutual funds, banks, insurance companies and hedge funds, and also publicly traded corporations trading in their own shares. Some studies have suggested that institutional investors and corporations trading in their own shares generally receive higher risk- adjusted returns than retail investors. Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere in the world. Their orders usually end up with a professional at a stock exchange, who executes the order of buying or selling. Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere in the world. Their orders usually end up with a professional at a stock exchange, who executes the order of buying or selling. This method known as open outcry. This type of auction is used in stock exchanges and commodity some exchanges are physical locations where transactions are carried out on a trading floor, by exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of stock exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders. Actual trades are based on an auction market model where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place, on a first-come-first- served basis if there are multiple bidders or askers at a given price. The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace (virtual or real). The exchanges provide real- time trading information on the listed securities, facilitating price discovery.
  13. 13. 13 Market participants Market participants include individual retail investors, institutional investors such as mutual funds, banks, insurance companies and hedge funds, and also publicly traded corporations trading in their own shares. Some studies have suggested that institutional investors and corporations trading in their own shares generally receive higher risk- adjusted returns than retail investors. A few decades ago, worldwide, buyers and sellers were individual investors, such as wealthy businessmen, usually with long family histories to particular corporations. Over time, markets have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance companies, mutual funds, index funds, exchange-traded funds, hedge funds, investor groups, banks and various other financial institutions). The rise of the institutional investor has brought with it some improvements in market operations. There has been a gradual tendency for "fixed" (and exorbitant) fees being reduced for all investors, partly from falling administration costs but also assisted by large institutions challenging brokers' oligopolistic approach to setting standardized fees. History In 12th Established in 1875, the Bombay is Asia's first stock exchange Century France the courretiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. A common misbelieve is that in
  14. 14. 14 late 13th century Bruges commodity traders gathered inside the house of a man called Van der Beurze, and in 1409 they became the "Bruges Bourse", institutionalizing what had been, until then, an informal meeting, but actually, the family Van der Burse had a building in Antwerp where those gatherings occurred; the Van der Beurze had Antwerp, as most of the merchants of that period, as their primary place for trading. The idea quickly spread around Flanders and neighboring counties and "Bautzen" soon opened in Ghent and Rotterdam. There are now stock markets in virtually every developed and most developing economies, with the world's largest markets being in the United States, United Kingdom, Japan, India, China, Canada, Germany (Frankfurt Stock Exchange), France, South Korea and the Netherlands. Importance of stock market The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional financial capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange affords the investors gives them the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments. Some companies actively increase liquidity by trading in their own shares. History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. An economy where the stock market is on the rise is considered to be an up-and-coming economy. In fact, the stock market is often considered the primary indicator of a country's economic strength and development. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial functions. Financial stability is the raison d'être of central banks. Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the Sseller of a security. This eliminates
  15. 15. 15 the risk to an individual buyer or seller that the counterparty could default on the transaction. The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as possibly employment. In this way the financial system is assumed to contribute to increased prosperity. Relation of the stock market to the modern financial system The financial system in most western countries has undergone a remarkable transformation. One feature of this development is disintermediation. A portion of the funds involved in saving and financing, flows directly to the financial markets instead of being routed via the traditional bank lending and deposit operations. The general public interest in investing in the stock market, either directly or through mutual funds, has been an important component of this process. Statistics show that in recent decades shares have made up an increasingly large proportion of households' financial assets in many countries. In the 1970s, in Sweden, deposit accounts and other very liquid assets with little risk made up almost 60 percent of households' financial wealth, compared to less than 20 percent in the 2000s. The major part of this adjustment is that financial portfolios have gone directly to shares but a good deal now takes the form of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards forms of saving with a higher risk has been accentuated by new rules for most funds and insurance, permitting a higher proportion of shares to bonds. Similar tendencies are to be found in other industrialized countries. In all developed economic systems, such as the European Union, the United States, Japan and other developed nations, the trend has been the same: saving has moved away from traditional (government insured) bank deposits to more risky securities of one sort or another. From experience it is known that investors may 'temporarily' move financial prices away from their long term aggregate price 'trends'. (Positive or up trends are referred to as bull markets; negative or down trends are referred to as bear markets). Over-reactions may occur—so that excessive optimism (euphoria) may drive prices unduly high or excessive
  16. 16. 16 pessimism may drive prices unduly low. Economists continue to debate whether financial markets are 'generally' efficient. According to one interpretation of the efficient-market hypothesis (EMH), only changes in fundamental factors, such as the outlook for margins, profits or dividends, ought to affect share prices beyond the short term, where random 'noise' in the system may prevail. (But this largely theoretic academic viewpoint—known as 'hard' EMH—also predicts that little or no trading should take place, contrary to fact, since prices are already at or near equilibrium, having priced in all public knowledge.) The 'hard' efficient-market hypothesis is sorely tested and does not explain the cause of events such as the crash in 1987, when the Dow Jones Industrial Average plummeted 22.6 percent—the largest-ever one-day fall in the United States This event demonstrated that share prices can fall dramatically even though, to this day, it is impossible to fix a generally agreed upon definite cause: a thorough search failed to detect any 'reasonable' development that might have accounted for the crash. (But note that such events are predicted to occur strictly by chance, although very rarely.) It seems also to be the case more generally that many price movements (beyond that which are predicted to occur 'randomly') are not occasioned by new information; a study of the fifty largest one-day share price movements in the United States in the post-war period seems to confirm this. A 'soft' EMH has emerged which does not require that prices remain at or near equilibrium, but only that market participants not be able to systematically profit from any momentary market 'inefficiencies'. Moreover, while EMH predicts that all price movement (in the absence of change in fundamental information) is random (i.e., non- trending), many studies have shown a marked tendency for the stock market to trend over time periods of weeks or longer. Various explanations for such large and apparently non- random price movements have been promulgated. For instance, some research has shown that changes in estimated risk, and the use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could cause financial markets to overreact. But the best explanation seems to be that the distribution of stock market prices is non- Gaussian (in which case EMH, in any of its current forms, would not be strictly applicable).
  17. 17. 17 Other research has shown psychological factors may result in exaggerated (statistically anomalous) stock price movements (contrary to EMH which assumes such behaviors 'cancel out'). Psychological research has demonstrated that people are predisposed to 'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes includes or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investor's self-confidence, reducing his (psychological) risk threshold. Another phenomenon also from psychology that works against an objective assessment is group thinking. As social animals, it is not easy to stick to an opinion that differs markedly from that of a majority of the group. An example with which one may be familiar is the reluctance to enter a restaurant that is empty; people generally prefer to have their opinion validated by those of others in the group. In one paper the authors draw an analogy with gambling. In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically. The stock market, as with any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. In the period running up to the 1987 crash, less than 1 percent of the analyst's recommendations had been to sell (and even during the 2000–2002 bear market, the average did not rise above 5%). In the run up to 2000, the media amplified the general euphoria, with reports of rapidly rising share prices and the notion that large sums of money could be quickly earned in the so called new economy stock market. (Before it was in form of paper and Later amplified the gloom which descended during the 2000–2002 bear market, so that by summer of 2002, predictions of a DOW average below 5000 were quite common.
  18. 18. 18 Irrational behavior Sometimes, the market seems to react irrationally to economic or financial news, even if that news is likely to have no real effect on the fundamental value of securities itself. But, this may be more apparent than real, since often such news has been anticipated, and a counteraction may occur if the news is better (or worse) than expected. Therefore, the stock market may be swayed in either direction by press releases, rumors, euphoria and mass panic; but generally only briefly, as more experienced investors (especially the hedge funds) quickly rally to take advantage of even the slightest, momentary hysteria. Over the short-term, stocks and other securities can be battered or buoyed by any number of fast market-changing events, making the stock market behavior difficult to predict. Emotions can drive prices up and down, people are generally not as rational as they think, and the reasons for buying and selling are generally obscure. Behaviorists argue that investors often behave 'irrationally' when making investment decisions thereby incorrectly pricing securities, which causes market inefficiencies, which, in turn, are opportunities to make money. However, the whole notion of EMH is that these non- rational reactions to information cancel out, leaving the prices of stocks rationally determined. The Dow Jones Industrial Average biggest gain in one day was 936.42 points or 11 percent, this occurred on October 13, 2008. Crashes Further information: List of stock market crashes
  19. 19. 19 Shailer‘s plot of the S&P Composite Real Price Index, Earnings, Dividends, and Interest Rates, from Irrational Exuberance, 2d ed. In the preface to this edition, Shriller warns, "The stock market has not come down to historical levels: the price-earnings ratio as I define it in this book is still, at this writing 2005, in the mid-20s, far higher than the historical average... People still place too much confidence in the markets and have too strong a belief that paying attention to the gyrations in their investments will someday make them rich, and so they do not make conservative preparations for possible bad outcomes." Price-Earnings ratios as a predictor of twenty-year returns based upon the plot by Robert Sheller (Figure 10.1The horizontal axis shows the Indexes computed in Irrational Exuberance (inflation adjusted price divided by the prior ten-year mean of inflation- adjusted earnings). The vertical axis shows the geometric average real annual return on investing in the S&P Composite Stock Price Index, reinvesting dividends, and selling twenty years later. Data from different twenty-year periods is color-coded as shown in the key. See also ten-year returns. Shriller states that this plot "confirms that long-term investors—investors who commit their money to an investment for ten full years—did do well when prices were low relative to earnings at the beginning of the ten years. Long- term investors would be well advised, individually, to lower their exposure to the stock market when it is high, as it has been recently, and get into the market when it is low."
  20. 20. 20 A stock market crash is often defined as a sharp dip in share prices of equities listed on the stock exchanges. In parallel with various economic factors, a reason for stock market crashes is also due to panic and investing public's loss of confidence. Often, stock market crashes end speculative economic bubbles. There have been famous stock market crashes that have ended in the loss of billions of dollars and wealth destruction on a massive scale. An increasing number of people are involved in the stock market, especially since the social security and retirement are being increasingly privatized and linked to stocks and bonds and other elements of the market. There have been a number of famous stock market crashes like the Wall Street Crash of 1929, the stock market crash of 1973–4, the Black Monday of 1987, the Dot-com bubble of 2000, and the Stock Market Crash of 2008. One of the most famous stock market crashes started October 24, 1929 on Black Thursday. The Dow Jones Industrial Average lost 50% during this stock market crash. It was the beginning of the Great Depression. Another famous crash took place on October 19, 1987 – Black Monday. The crash began in Hong Kong and quickly spread around the world. By the end of October, stock markets in Hong Kong had fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United States 22.68%, and Canada 22.5%. Black Monday itself was the largest one-day percentage decline in stock market history – the Dow Jones fell by 22.6% in a day. The names "Black Monday" and "Black Tuesday" are also used for October 28–29, 1929, which followed Terrible Thursday—the starting day of the stock market crash in 1929. The crash in 1987 raised some puzzles – main news and events did not predict the catastrophe and visible reasons for the collapse were not identified. This event raised questions about many important assumptions of modern economics, namely, the theory of rational human conduct, the theory of market equilibrium and the efficient-market hypothesis. For some time after the crash, trading in stock exchanges worldwide was halted, since the exchange computers did not perform well owing to enormous quantity of trades being received at one time. This halt in trading allowed the Federal Reserve System and central banks of other countries to take measures to control the spreading of worldwide financial crisis. In the United States the SEC introduced several new measures
  21. 21. 21 of control into the stock market in an attempt to prevent a re-occurrence of the events of Black Monday. Since the early 1990s, many of the largest exchanges have adopted electronic 'matching engines' to bring together buyers and sellers, replacing the open outcry system. Electronic trading now accounts for the majority of trading in many developed countries. Computer systems were upgraded in the stock exchanges to handle larger trading volumes in a more accurate and controlled manner. The SEC modified the margin requirements in an attempt to lower the volatility of common stocks, stock options and the futures market. The New York Stock Exchange and the Chicago Mercantile Exchange introduced the concept of a circuit breaker. The circuit breaker halts trading if the Dow declines a prescribed number of points for a prescribed amount of time. In February 2012, the Investment Industry Regulatory Organization of Canada (IIROC) introduced single-stock circuit breakers. Stock market index The movements of the prices in a market or section of a market are captured in price indices called stock market indices, of which there are many, e.g., the S&P, the FTSE and the Euronextindices. Such indices are usually market capitalization weighted, with the weights reflecting the contribution of the stock to the index. The constituents of the index are reviewed frequently to include/exclude stocks in order to reflect the changing business environment. Derivative instruments Financial innovation has brought many new financial instruments whose pay-offs or values depend on the prices of stocks. Some examples are exchange-traded funds (ETFs), stock index and stock options, equity swaps, single-stock futures, Main article: Derivative (finance) and stock index futures. These last two may be traded on futures exchanges (which are distinct from stock exchanges—their history traces back to commodities futures exchanges), or traded over-the-counter As all of these products are only derived from
  22. 22. 22 stocks, they are sometimes considered to be traded in a (hypothetical) derivatives market, rather than the (hypothetical) stock market. Leveraged strategies Stock that a trader does not actually own may be traded using short selling; margin buying may be used to purchase stock with borrowed funds; or, derivatives may be used to control large blocks of stocks for a much smaller amount of money than would be required by outright purchase or sales. Short selling In short selling, the trader borrows stock (usually from his brokerage which holds its clients' shares or its own shares on account to lend to short sellers) then sells it on the market, betting that the price will fall. The trader eventually buys back the stock, making money if the price fell in the meantime and losing money if it rose. Exiting a short position by buying back the stock is called "covering." This strategy may also be used by unscrupulous traders in illiquid or thinly traded markets to artificially lower the price of a stock. Hence most markets either prevent short selling or place restrictions on when and how a short sale can occur. The practice of naked shorting is illegal in most (but not all) stock markets. Margin buying In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value. In the United States, the margin requirements have been 50% for many years (that is, if you want to make a $1000 investment, you need to put up $500, and there is often a maintenance margin below the $500).
  23. 23. 23 A margin call is made if the total value of the investor's account cannot support the loss of the trade. (Upon a decline in the value of the margined securities additional funds may be required to maintain the account's equity, and with or without notice the margined security or any others within the account may be sold by the brokerage to protect its loan position. The investor is responsible for any shortfall following such forced sales.) Regulation of margin requirements (by the Federal Reserve) was implemented after the Crash of 1929. Before that, speculators typically only needed to put up as little as 10 percent (or even less) of the total investment represented by the stocks purchased. Other rules may include the prohibition of free-riding: putting in an order to buy stocks without paying initially (there is normally a three-day grace period for delivery of the stock), but then selling them (before the three-days are up) and using part of the proceeds to make the original payment (assuming that the value of the stocks has not declined in the interim). New issuance Global issuance of equity and equity-related instruments totaled $505 billion in 2004, a 29.8% increase over the $389 billion raised in 2003. Initial public offerings (IPOs) by US issuers increased 221% with 233 offerings that raised $45 billion, and IPOs in Europe, Middle East and Africa (EMEA) increased by 333%, from $9 billion to $39 billion. Investment strategies One of the many things people always want to know about the stock market is, "How do I make money investing?" There are many different approaches; two basic methods are classified by either fundamental analysis or technical analysis. Fundamental analysis refers to analyzing companies by their financial statements found in SEC Filings, business trends, general economic conditions, etc. Technical analysis studies price actions in markets through the use of charts and quantitative techniques to attempt to forecast price trends regardless of the company's financial prospects. One example of a technical strategy is the Trend following method, used by John W. Henry and Ed Seiko,
  24. 24. 24 which uses price patterns, utilizes strict money management and is also rooted in risk control and diversification. Additionally, many choose to invest via the index method. In this method, one holds a weighted or un weighted portfolio consisting of the entire stock market or some segment of the stock market (such as the S&P 500 or Wilshire 5000). The principal aim of this strategy is to maximize diversification, minimize taxes from too frequent trading, and ride the general trend of the stock market (which, in the U.S., has averaged nearly 10% per year, compounded annually, since World War II). Taxation Capital gains tax According to much national or state legislation, a large array of fiscal obligations is taxed for capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on the stock market, in particular in the stock exchanges. However, these fiscal obligations may vary from jurisdictions to jurisdictions because, among other reasons, it could be assumed that taxation is already incorporated into the stock price through the different taxes companies pay to the state, or that tax free stock market operations are useful to boost economic growth. Major stock exchanges (top 21 by market capitalization), as at 31 December 2012 (Monthly reports, World Federation of Exchanges) Rank Stock Exchange ECONOMY HEAD QUARTER MARKET CAPITAL OPEN- CLOSE 1 NYSE UNITED STATES NEW YORK CITY 14085 9.30-16 P.M 2 NASDAQ UNITED STATES NEW YORK 4582 9.30-16 PM 3 Tokyo Stock JAPAN TOKYO 3478 9-15 PM
  25. 25. 25 Rank Stock Exchange ECONOMY HEAD QUARTER MARKET CAPITAL OPEN- CLOSE Exchange 4 London Stock Exchange UNITED KINGDOM LONDON 3396 8-16.30 P.M 5 Euronext France Netherlands Belgium Portugal FRANCE NETHERLAND BELGIUM PORTUGAL AMESTERDOM 2930 9-17.5 P.M 6 Hong Kong Stock Exchange HONGKONG HONGKONG 2831 9.10- 16P.M 7 Shanghai Stock Exchange CHINA SHANGHAI 2547 9.3-15 P.M 8 Toronto Stock Exchange CANADA TORONTO 2058 9.3-16 P.M 9 Frankfurt Stock Exchange GERMANEY FRANKFURT 1486 8-22 P.M 10 Australian Securities Exchange AUSTRALIA SYDNEY 1386 9.50-16.10 P.M 11 Bombay Stock Exchange INDIA MUMBAI 1263 9.15-15.30 12 National Stock Exchange of India INDIA MUMBAI 1234 9.15-15.30 13 SIX Swiss SWITZERLAND ZURICH 1233 9-17.30
  26. 26. 26 Rank Stock Exchange ECONOMY HEAD QUARTER MARKET CAPITAL OPEN- CLOSE Exchange P.M 14 BM&F Bovespa BRAZIL SAOPAULO 1227 10- 17.30PM 15 Korea Exchange SOUH KOREA SEOUL 1179 9-15 P.M 16 Shenzhen Stock Exchange CHINA SHENZHEN 1150 9.3-15 P.M 17 BME Spanish Exchanges SPAIN MADRID 995 9-17.3 P.M 18 JSE Limited SOUTH AFRIKA JOHN NESBURG 903 9-17 P.M 19 Moscow Exchange RUSSIA SASCOW 625 10-18.40 20 Singapore Exchange SINGAPORE SINGAPORE 765 9-17 21 Taiwan Stock Exchange TIWAN TAIPEI 735 9-13.30 There are two stock Exchanges in INDIA 1-Bombay Stock Exchange (BSE) - Sensex 2-National Stock Exchange of India (NSE) - Nifty BSE SENSEX
  27. 27. 27 1-Bombay Stock Exchange (BSE) - Sensex The Bombay Stock Exchange building located on Dalal Street, Mumbai The S&P BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply the SENSEX, is a free-float market capitalization-weighted stock market index of 30 well-established and financially sound companies listed on BSE Ltd. The 30 component companies which are some of the largest and most actively traded stocks, are representative of various industrial sectors of the Indian economy. Published since 1 January 1986, the S&P BSE SENSEX is regarded as the pulse of the domestic stock markets in India. The base value of the S&P BSE SENSEX is taken as 100 on 1 April 1979, and its base year as 1978–79. On 25 July 2001 BSE launched DOLLEX-30, a dollar-linked version of S&P BSE SENSEX. As of 21 April 2011, the market capitalization of S&P BSE SENSEX was about 29733 billion (US$473 billion) (47.68% of market capitalization of BSE), while its free-float market capitalization was 15690 billion (US$249 billion).
  28. 28. 28 Components The BSE Sensex currently consists of the following 30 major Indian companies as of 17 February 2012. Company Industry Scrip 1 Housing Development Finance Corporation Consumer finance 500010 2 Cipla Pharmaceuticals 500087 3 Bharat Heavy Electricals Electrical equipment 500103 4 State Bank Of India Banking 500112 5 HDFC Bank Banking 500180 6 Hero Motocorp Automotive 500182 7 Infosys Information Technology 500209 8 Oil and Natural Gas Corporation Oil and gas 500312 9 Reliance Industries Oil and gas 500325 10 Tata Power Power 500400 11 Hindalco Industries Metals and Mining 500440 12 Tata Steel Steel 500470 13 Larsen & Toubro Conglomerate 500510 14 Mahindra & Mahindra Automotive 500520 15 Tata Motors Automotive 500570 16 Hindustan Unilever Consumer goods 500696 17 ITC Conglomerate 500875 18 Sterlite Industries Metals and Mining 500900 19 Wipro Information 507685
  29. 29. 29 Company Industry Scrip Technology 20 Sun Pharmaceutical Pharmaceuticals 524715 21 GAIL Oil and gas 532155 22 ICICI Bank Banking 532174 23 Jindal Steel & Power Steel and power 532286 24 Bharti Airtel Telecommunication 532454 25 Marti Suzuki Automotive 532500 26 Tata Consultancy Services Information Technology 532540 27 NTPC Power 532555 28 DLF Real estate 532868 29 Bajaj Auto Automotive 532977 30 Coal India Metals and Mining 533278 Calculation The BSE constantly reviews and modifies its composition to be sure it reflects current market conditions. The index is calculated based on a free float capitalization method, a variation of the market capitalization method. Instead of using a company's outstanding shares it uses its float, or shares that are readily available for trading. As per free float capitalization methodology, the level of index at any point of time reflects the free float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by of corporate actions, replacement of scripts, etc. The index has increased by over ten times from June 1990 to the present. Using information from April 1979 onwards, the long-run rate of return on the S&P BSE SENSEX works out to be 18.6% per annum, which translates to roughly 9% per annum.
  30. 30. 30 Milestone Graph of S&P BSE SENSEX monthly data Here is a timeline on the rise of the SENSEX through Indian stock market history 1000, 25 July 1990 – On 25 July 1990, the SENSEX touched the four-digit figure for the first time and closed at 1,001 in the wake of a good monsoon and excellent corporate results. 2000, 15 January 1992 – On 15 January 1992, the SENSEX crossed the 2,000 mark and closed at 2,020 followed by the liberal economic policy initiatives undertaken by the then finance minister and current Prime Minister Dr Manmohan Singh. 3000, 29 February 1992 – On 29 February 1992, the SENSEX surged past the 3,000 mark in the wake of the market-friendly Budget announced by Manmohan Singh. 4000, 30 March 1992 – On 30 March 1992, the SENSEX crossed the 4,000 mark and closed at 4,091 on the expectations of a liberal export-import policy. It was then that the Harshad Mehta scam hit the markets and SENSEX witnessed unabated selling.
  31. 31. 31 5000, 11 October 1999 – On 11 October 1999, the SENSEX crossed the 5,000 mark, as the Bharatiya Janata Party-led coalition won the majority in the 13th Lok Sabha election. 6000, 11 February 2000 – On 11 February 2000, the information technology boom helped the SENSEX to cross the 6,000 mark and hit an all-time high of 6,006 points. This record would stand for nearly four years, until 2 January 2004, when the SENSEX closed at 6,026.59 points. 7000, 21 June 2005 – On 20 June 2005, the news of the settlement between the Ambani brothers boosted investor sentiments and the scripts of RIL, Reliance Energy, Reliance Capital and IPCL made huge gains. This helped the SENSEX crossed 7,000 points for the first time. 8000, 8 September 2005 – On 8 September 2005, the Bombay Stock Exchange's benchmark 30-share index – the SENSEX – crossed the 8,000 level following brisk buying by foreign and domestic funds in early trading. 9000, 9 December 2005 – The SENSEX on 28 November 2005 crossed 9,000 and touched a peak of 9,000.32 points during mid-session at the Bombay Stock Exchange on the back of frantic buying spree by foreign institutional investors and well supported by local operators as well as retail investors. However, it was on 9 December 2005 that the SENSEX first closed at over 9,000 points. 10,000, 7 February 2006 – The SENSEX on 6 February 2006 touched 10,003 points during mid-session. The SENSEX finally closed above the 10,000 mark on 7 February 2006. 11,000, 27 March 2006 – The SENSEX on 21 March 2006 crossed 11,000 and touched a peak of 11,001 points during mid-session at the Bombay Stock Exchange for the first time. However, it was on 27 March 2006 that the SENSEX first closed at over 11,000 points. 12,000, 20 April 2006 – The SENSEX on 20 April 2006 crossed 12,000 and touched a peak of 12,004 points during mid-session at the Bombay Stock Exchange for the first time.
  32. 32. 32 13,000, 30 October 2006 – The SENSEX on 30 October 2006 crossed 13,000 for the first time. It touched a peak of 13,039.36, before finally closing at 13,024.26 points. 14,000, 5 December 2006 – The SENSEX on 5 December 2006 crossed the 14,000 mark for the first time. 15,000, 6 July 2007 – The SENSEX on 6 July 2007 crossed the 15,000 mark for the first time. 16,000, 19 September 2007 – The SENSEX on 19 September 2007 crossed the 16,000 mark for the first time. 17,000, 26 September 2007 – The SENSEX on 26 September 2007 crossed the 17,000 mark for the first time. 18,000, 9 October 2007 – The SENSEX on 9 October 2007 crossed the 18,000 mark for the first time. 19,000, 15 October 2007 – The SENSEX on 15 October 2007 crossed the 19,000 mark for the first time. 20,000, 11 December 2007 – The SENSEX on 29 October 2007 crossed the 20,000 mark for the first time during intra-day trading, but closed at 19,977.67 points. However, it was on 11 December 2007 that it finally closed at a figure above 20,000 points on the back of aggressive buying by funds. 21,000, 5 November 2010 – The SENSEX on 8 January 2008 crossed the 21,000 mark for the first time, reaching an intra-day peak of 21,078 points, before closing at 20,873. However, it was not until 5 November 2010 that the SENSEX closed at 21,004.96, for its first close above 21,000 points. To date, this is the all-time record high close for the SENSEX, as well as the only time the index has closed above the 21,000 mark. 19 February 2013 – SENSEX becomes S&P SENSEX as BSE ties up with Standard and Poor have to use the S&P brand for Sensex and other indices. 23 July 2013 – The SENSEX on 23rd July 2013 closed at 20,302.13, for its highest peak in 30 months, a level last seen on January 5, 2011. 2006-2010: The Volatile Journey to 21,000
  33. 33. 33 May 2006 On 22 May 2006, the SENSEX plunged by 1,100 points during intra-day trading, leading to the suspension of trading for the first time since 17 May 2004. The volatility of the SENSEX had caused investors to lose Rs 6 lackh car ore (US$131 billion) within seven trading sessions. The Finance Minister of India, P. Chidambaram, made an unscheduled press statement when trading was suspended to assure investors that nothing was wrong with the fundamentals of the economy, and advised retail investors to stay invested. When trading resumed after the reassurances of the Reserve Bank of India and the Securities and Exchange Board of India (SEBI), the SENSEX managed to move up 700 points, but still finished the session 457 points in the red. The SENSEX eventually recovered from the volatility, and on 16 October 2006, the SENSEX closed at an all-time high of 12,928.18 with an intra-day high of 12,953.76. This was a result of increased confidence in the economy and reports that India's manufacturing sector grew by 11.1% in August 2006. 13,000, 30 October 2006 – The SENSEX on 30 October 2006 crossed 13,000 mark for the first time, touching a peak of 13,039.36, before closing at 13,024.26 points. It took 135 days to reach 13,000 from 12,000, and 124 days to reach 13,000 from 12,500. 14,000, 5 December 2006 – The SENSEX on 5 December 2006 crossed 14,000 mark for the first time, after opening the day with a peak of 14,028 at 9.58 am(IST). 15,000, 6 July 2007- The SENSEX on 6 July 2007 crossed another milestone and reached a magic figure of 15,000. It took 7 months and one day after first reaching the 14,000 milestone to touch this historic milestone. Effects of the subprime crisis in the U.S. On 23 July 2007, the SENSEX touched a new high of 15,733 points. On 27 July 2007 the SENSEX witnessed a huge decline because of selling by Foreign Institutional Investors and global cues to come back to 15,160 points by noon. Following global cues and heavy selling in the international markets, the BSE SENSEX fell by 615 points in a single day on 1 August 2007.
  34. 34. 34 16,000, 19 September 2007- The SENSEX on 19 September 2007 crossed the 16,000 mark, closing at a historic peak of 16,322. The bull hits because of the rate cut of 50 bit/s in the discount rate by the Fed chief Ben Bernanke. 17,000, 26 September 2007- On 26 September 2007, the SENSEX crossed the 17,000 mark for the first time, creating a record for the second fastest 1000 point gain in just 5 trading sessions. It failed however to sustain the momentum and closed below 17,000. The SENSEX closed above 17,000 for the first time on the following day. Reliance group has been the main contributor in this Bull Run, contributing 256 points. This also helped Mukesh Ambani's net worth to grow to over $50 billion or Rs.2 trillion. It was also during this record bull run that the SENSEX for the first time zoomed ahead of the Nikkei of Japan. 18,000, 9 October 2007- The SENSEX crossed the 18,000 mark for the first time on 9 October 2007, gaining 788 points, to close at 18,280. The journey from 17,000 to 18,000 took just 8 trading sessions, which is the third fastest 1000-point rise in the history of the SENSEX. 19,000, 15 October 2007- The SENSEX crossed the 19,000 mark for the first time on 15 October 2007, gaining 640 points, to close at 19,059. It took just 4 trading sessions for the SENSEX to move from 18,000 to 19,000. This is the fastest 1000-point rise ever for the index. In addition, the rise from 16,000 to 19,000 in 17 trading sessions sets a record for the fastest 3,000-point rally in the history of the SENSEX. Participatory notes issue On 16 October 2007, SEBI (Securities & Exchange Board of India) proposed curbs on participatory notes which accounted for roughly 50% of FII investment in 2007. SEBI was not happy with P-notes because it was not possible to know who owned the underlying securities, and hedge funds acting through P-notes might therefore cause volatility in the Indian markets. However the proposals of SEBI were not clear and this led to a knee-jerk crash when the markets opened on the following day (17 October 2007). Within a minute of opening trade, the SENSEX crashed by 1,744 points or about 9% of its value – the biggest intra-
  35. 35. 35 day fall in Indian stock markets in absolute terms till then. This led to the automatic suspension of trade for one hour. Finance Minister P. Chidambaram issued clarifications, in the meantime, that the government was not against FIIs and was not immediately banning PNs. After the market opened at 10:55 am, the index staged a comeback and ended the day at 18715.82, down 336.04 from the last day's close. However, this would not be the end of the volatility. The next day (18 October 2007), the SENSEX tumbled by 717.43 points – 3.83 percent to close at 17,998.39 points. The slide continued the next day (19 October 2007), when the SENSEX fell 438.41 points to settle at 17,559.98 to the end of the week, after touching the lowest level of that week at 17,226.18 during the day. After detailed clarifications from the SEBI Chief M. Damodaran regarding the new rules, the market made a 879-point gain on 23 October, thus signaling the end of the PN crisis. 20,000, 11 December 2007- On 29 October 2007, the SENSEX crossed the 20,000 mark for the first time with a massive 734.5-point gain, but closed below the 20,000 mark. The SENSEX would close above the 20,000 mark for the first time on 11 December 2007. It took 42 days after reaching the 19,000 milestone to close above 20,000 points for the first time. The journey of the last 10,000 points was covered in just 483 sessions, compared to 7,297 sessions taken to touch the 10,000 mark from its base value of 100 points. In the second half of 2007 alone, the SENSEX reached six 1,000-point milestones. May 2009 On 18 May 2009, the SENSEX surged up 2,110.79 points to close at 14,285.21, from its previous closing of 12,174.42, for its largest single day rally. Less than a month later, on 4 June 2009, the SENSEX would cross the 15,000 mark. However, the SENSEX remained volatile during the summer of 2009. The SENSEX plunged by 869.65 points on 6 July 2009, the day of Union Budget presentation in Parliament on concerns over high fiscal deficit. This was the biggest Budget-day loss for the index. On 17 August 2009, the SENSEX lost 626.71 points.
  36. 36. 36 Once again, the SENSEX would recover from the volatility. On 7 September 2009, the SENSEX crossed the 16,000 mark, closing at 16,016.32 points. The index would gain 3,000 points over the next 12 months, as the SENSEX crossed the 19,000 mark on 13 September 2010, closing at 19,208.33 points. 21,000, 5 November 2010 - The SENSEX closed at 21,004.96, for its first close above the 21,000 mark. The Stock Market Crash of 2008 January 2008 In the third week of January 2008, the SENSEX experienced huge falls along with other markets around the world. On 21 January 2008, the SENSEX saw it‘s highest ever loss of 1,408 points at the end of the session. The SENSEX recovered to close at 17,605.40 after it tumbled to the day's low of 16,963.96, on high volatility as investors panicked following weak global cues amid fears of a recession in the US. The next day, the BSE SENSEX index went into a free fall. The index hit the lower circuit breaker in barely a minute after the markets opened at 10 am. Trading was suspended for an hour. On reopening at 10.55 am IST, the market saw its biggest intra- day fall when it hit a low of 15,332, down 2,273 points. However, after reassurance from the Finance Minister of India, the market bounced back to close at 16,730 with a loss of 875 points. Over the course of two days, the BSE SENSEX in India dropped from 19,013 on Monday morning to 16,730 by Tuesday evening or a two-day fall of 13.9%. Less than a month later, on 11 February 2008, the SENSEX lost 833.98 points, when Reliance Power fell below its IPO price in its debut trade after a high profit public offer. March 2008 The free fall of the SENSEX accelerated in March 2008. The month started out with the Sensex losing 900.84 points on 3 March 2008, on concerns emanating from growing credit losses in the US. This would be the first of four one-day falls of greater than 700 points during the month. On 13 March 2008, the SENSEX plummeted another 770.63 points on global economic jitters.
  37. 37. 37 14,810, 17 March 2008 - The SENSEX dropped by 951.03 points on the global credit crisis and distress, to fall below the 15,000 mark, closing at 14,810. The month ended with the SENSEX shedding 726.85 points on 31 March 2008, after heavy selling in blue-chip stocks on global economic fears. 13,802, 27 June 2008 - The SENSEX dropped by 600 points, to fall below the 14,000 mark, closing at 13,802. 12,962, 1 July 2008 - The SENSEX falls below the 13,000 mark, closing at 12,962. 11,802, 6 October 2008 - The SENSEX dropped by 724.62 points amid fears of the US recession and attempts by governments across the world to save their failing banks, to fall below the 12,000 mark, closing at 11,802. 10,527, 10 October 2008 - The SENSEX dropped by 800.51 points amid weak industrial production data and concerns over impact of global economic crisis on IT and banking firms in India to fall below the 11,000 mark, closing at 10,527. 9,975, 17 October 2008 – The SENSEX crashes below the psychological 5-figure mark of 10,000 points, closing at 9,975.35, following extremely negative global financial indications in US and other countries. Just ten months earlier, in December 2007, SENSEX had closed above the 20,000 mark for the first time. 8,701.07, 24 October 2008 - The SENSEX lost 10.96% of its value (1070.63 points) on the intra-day trade, closing at 8,701.07, for its first close below the 9,000 mark since 14 June 2006, after RBI lowered its GDP growth forecasts on global economic concerns. The loss was the 2nd highest in terms of total points, and the 3rd highest percentage-wise, for a one day period in the index's history. 8,509.56, 27 October 2008 - The SENSEX hit an intra-day low of 7,697.39, before closing at 8,509.56 for its lowest close since 14 November 2005. Early 2009 The SENSEX dropped by 749.05 points on 7 January 2009, when the Satyam fraud came to light. 8,160.40, 9 March 2009 - The SENSEX closed at 8,160.40, for its lowest close since 2 November 2005.
  38. 38. 38 NSE building at BKC, Mumbai The National Stock Exchange (NSE) ( is stock exchange located in Mumbai, India. It is the 11th largest stock exchange in the world by market capitalization and largest in India by daily turnover and number of trades, for both equities and derivative trading. NSE has a market capitalization of more than US$1 trillion (67,637.81 billion) and 1,665 companies listed as of December 2012. a number of other exchanges exist, NSE and the Bombay Stock Exchange are the two most significant stock exchanges in India, and between them are responsible for the vast majority of share transactions. The NSE's key index is the S&P CNX Nifty, now known as the NSE/NIFTY (National Stock Exchange Fifty), an index of fifty major stocks weighted by market capitalization. NSE is mutually owned by a set of leading financial institutions, banks, insurance companies and other financial intermediaries in India but its ownership and management operate as separate entities. There are at least 2 foreign investors NYSE Euro next and Goldman Sachs who have taken a stake in the NSE. As of 2006, the NSE VSAT terminals, 2799 in total, cover more than 1500 cities across India. In 2011, NSE was the third largest stock exchange in the world in terms of the number of contracts (1221 million) traded in equity derivatives. It is the second fastest growing stock exchange in the world with a recorded growth of 16.6%. The National Stock Exchange of Independent India was set up by Government of India on the recommendation of Pherwani Committee in 1991. Promoted by leading financial institutions essentially led by IDBI at the behest of the Government of India, it was incorporated in November 1992 as a tax-paying company. In April 1993, it was recognized as a stock exchange under the Securities Contracts (Regulation) Act,
  39. 39. 39 1956. NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital market (Equities) segment of the NSE commenced operations in November 1994, while operations in the Derivatives segment commenced in June 2000. Objectives 1-Establishing nationwide trading facilities for all types of securities. 2-Ensuring equal access to investors all-over the country through an appropriate communication network. 3-Meeting international benchmarks and standards. 4-Enabling shorter settlement cycles and book entry settlements. Markets Currently, NSE has the following major segments of the capital market: Equities Equities Indices Mutual Funds Exchange Traded Funds Initial Public Offerings Security Lending and Borrowing Scheme Derivatives Equity Derivatives (including Global Indices like S&P 500, Dow Jones and FTSE Currency Derivatives Interest Rate Futures Debt New Debt Segment Retail Debt Market Wholesale Debt Market Corporate Bonds
  40. 40. 40 Equity Derivatives The National Stock Exchange of India Limited (NSE) commenced trading in derivatives with the launch of index futures on 12 June 2000. The futures and options segment of NSE has made a mark for itself globally. In the Futures and Options segment, trading in S&P CNX Nifty Index, CNX IT index, Bank Nifty Index, Nifty Midcap 50 index and single stocks are available. Trading in Mini Nifty Futures & Options and Long term Options on S&P CNX Nifty are also available. The average daily turnover in the F&O Segment of the Exchange during 2009-10 was ` 72,392 crore (US $ 16,097 million) On 29 August 2011, National Stock exchange launched derivative contracts on the world‘s most followed equity indices, the S&P 500 and the Dow Jones Industrial Average. This was the first time that derivative contracts on global indices are available in India. This is the also the first time in the world that futures contracts on the S&P 500 index were introduced and listed on an exchange outside of their home country, USA. The new contracts include futures on both the DJIA and the S&P 500, and options on the S&P 500. The first day volumes at the close of trading on 29 August 2011 at 15:30, on the 2 indices in futures and options contracts were nearly Rs 122 crores (1220 million). On 3 May 2012, The National Stock exchange launched derivative contracts (futures and options) on FTSE 100, the widely tracked index of the UK equity stock market. This was the first of its kind for an index of the UK equity stock market to be launched in India. FTSE 100 includes 100 largest UK listed blue chip companies and has given returns of 17.8 per cent on investment over three years. The index constitutes 85.6 per cent of UK‘s equity market cap. NSE recorded a volume of 500 crores (5000 million) on the 1st day of trading. Currency Derivatives In August 2008 currency derivatives were introduced in India with the launch of Currency Futures in USD INR by NSE. It also added currency futures in Euros, pounds and yen. Interest Rate Futures were introduced for the first time in India by NSE on 31 August 2009, exactly one year after the launch of Currency Futures. Debt Market On 13 May, 2013 NSE launched India's first dedicated debt platform to provide a liquid and transparent trading platform or debt related products
  41. 41. 41 NSE became the first stock exchange to get approval for interest rate futures, As recommended by SEBI-RBI committee, on 31 August 2009, a futures contract based on 7% 10 Year Government of India (Notional) was launched with quarterly maturities. Trading schedule Trading takes place on all days of the week except Saturdays & Sundays. The market timings are as follows: (1) Pre-open session (Regular) Order entry & modification Open: 09:00 hrs Order entry & modification Close: 09:08 hrs With random closure in last one minute, Pre-open order matching starts immediately after close of pre-open order entry. (2) Pre-open Session for IPO and Relist Securities Order entry & modification Open: 09:00 hrs Order entry & modification Close: 09:45 hrs With random closure in last one minute, Pre-open order matching starts immediately after close of pre-open order entry. (3) Regular trading session Normal Market Open: 09:15 hrs Normal Market Close: 15:30 hrs Block deal session is held between 09:15 hrs and 09:50 hrs. (4) The Closing Session is held between 15.40 hrs and 16.00 hrs. The Exchange may also extend, advance or reduce trading hours when it deems fit and necessary. Exchange Traded Funds on NSE ETFs launched on NSE Exchange Traded Funds are essentially Index Funds that are listed and traded on exchanges like stocks. An ETF is a basket of stocks that reflects the composition of an Index, like S&P CNX Nifty. The ETFs trading value is based on the net asset value of the underlying stocks that it represents.
  42. 42. 42 ETF Schemes launched on NSE Equity Gold Debt World Indices In recent times, Exchange-traded funds (ETFs) have gained a wider acceptance as financial instruments whose unique advantages over mutual funds have caught the eye of many an investor. These instruments are beneficial for Investors that find it difficult to master the tricks of the trade of analyzing and picking stocks for their portfolio. Various mutual funds provide ETF products that attempt to replicate the indices on NSE, so as to provide returns that closely correspond to the total returns of the securities represented in the index. Certifications NSE also conducts online examination and awards certification, under its programmes of NSE's Certification in Financial Markets (NCFM). Currently, certifications are available in 32 modules, covering different sectors of financial and capital markets, both at beginner and advanced levels. The list of various modules can be found at the official site of NSE India. Branches of the NSE are located throughout India. NSE has been offering a short-term course called NSE Certified Capital Market Professional (NCCMP) since August 2009.
  43. 43. 43 COMPANY PROFILE Reliance Securities comes from the house of Reliance Capital, one of India‘s leading & prominent financial houses. Founded in 1986, Reliance Capital has come a long way from being into steady annuity yielding businesses such as leasing, bill discounting, and inter-corporate deposits to diversifying its activities in the areas of asset management and mutual fund; life and general insurance; consumer finance and industrial finance; stock broking; depository services; private equity and proprietary investments; exchanges, asset reconstruction; distribution of financial products and other activities in financial services. Reliance Capital has a net worth of Rs. 7,887 crore (US$ 2 billion) and total assets of Rs. 32,419 crore (US$ 7 billion) as on June 30, 2011. Reliance Securities Reliance Securities Limited is a Reliance Capital company and part of the Reliance Group. Reliance Securities endeavors to change the way investors transact in equities markets and avails services. It provides customers with access to Equity, Derivatives, Portfolio Management Services*, Investment Banking*, Mutual Funds & IPOs. It also offers secured online share trading platform and investment activities in secure, cost effective and convenient manner. To enable wider participation, it also provides the convenience of trading offline through variety of means, including Call & Trade, Branch dealing Desk and its network of affiliates. Reliance Securities has a pan India presence at more than 1,700 locations. Reliance Capital is one of India's leading and fastest growing private sector financial services companies, and ranks among the top 3 private sector financial services and banking groups, in terms of net worth.
  44. 44. 44 Chairman's Profile Shri Anil D. Ambani, regarded as one of the foremost corporate leaders of contemporary India, Shri Anil D. Ambani, is the Chairman of Reliance Capital Limited, Reliance Infrastructure Limited, Reliance Communications Limited and Reliance Power Limited. He is also on the Board of Reliance Infratel Limited and Reliance Anil Dhirubhai Ambani Group Limited. He is the President of the Dhirubhai Ambani Institute of Information and Communication Technology, Gandhi nagar, Gujarat. An MBA from the Wharton School of the University of Pennsylvania, Shri Ambani is credited with pioneering several path-breaking financial innovations in the Indian capital markets. He spearheaded the country‘s first forays into overseas capital markets with international public offerings of global depositary receipts, convertibles and bonds. Under his Chairmanship, the constituent companies of the Reliance Group have raised nearly US$ 7 billion from global financial markets in a period of less than 3 years. Shri Ambani has been associated with a number of prestigious academic institutions in India and abroad. He is currently a member of: Wharton Board of Overseers, The Wharton School, USA Board of Governors, Indian Institute of Management (IIM), Ahmedabad Executive Board, Indian School of Business (ISB), Hyderabad In June 2004, Shri Ambani was elected as an Independent member of the Rajya Sabha – Upper House, Parliament of India, a position he chose to resign voluntarily on March 29, 2006.
  45. 45. 45 Select Awards and Achievements Awarded by Light Readings as the Person of the Year – 2008 for outstanding achievements in the communication industry. Voted 'the Businessman of the Year' in a poll conducted by The Times of India – TNS, December, 2006. Voted the 'Best role model' among business leaders in the biannual Mood of the Nation poll conducted by India Today magazine, August 2006. Conferred 'the CEO of the Year 2004' in the Platt‘s Global Energy Awards. Conferred ‗The Entrepreneur of the Decade Award‘ by the Bombay Management Association, October 2002. Awarded the First Wharton Indian Alumni Award by the Wharton India Economic Forum (WIEF) in recognition of his contribution to the establishment of Reliance as a global leader in many of its business areas, December, 2001. Awards & Achievements of the company Reliance Securities has been rated no. 1 by Starcom Worldwide for online security and cost effectiveness in 2007 'Debutant Franchisor of the Year' at the 5th International Franchisee & Retail show 2007 'Best in category Service Franchise' at the 6th International Franchise & Retail show 2008 'Best E-Brokerage Houser 2008' (runner's up) by Outlook Money NDTV Profit Awards 'Largest E-Broking House & Best Equity Broking House for the year 2009' by Dun & Bradstreet 'Largest E-Broking House 2010' by Dun & Bradstreet 'My FM Stars of the Industry 2011' for excellence in Online Demat Reliance Securities Limited is now ISO 9001:2008 certified for Online Trading Platform 'Brand Leadership Legacy Award' at the Asian Leadership Awards - Dubai, 2011
  46. 46. 46 Reliance Capital Limited (BSE: 500111, NSE: RELCAPITAL) is a financial services company and part of a reliance Anil Dhirubhai Ambani Group. It is registered with the Reserve Bank of India under section 45-IA of the Reserve Bank of India Act, 1934. as a public limited company in 1986 and is now listed on the Bombay Stock Exchange and the National Stock Exchange (India). It is headed by ANIL AMBANI and is a part of the Reliance ADA Group. Reliance Capital ranks among the top 3 private sector financial services and banking companies, in terms of net worth‘s Interested field Reliance Capital has interests in: Asset management Mutual funds Life and general insurance Private equity and proprietary investments Stock broking Reliance PMS Depository services and financial products Consumer finance and other activities in financial services ICEX Commodity markets regulator FMC said it has given approval to the Anil Ambani Group to acquire 26 per cent stake in Indian Commodity Exchange (ICEX) from one of its promoters, India bulls group. "We have given permission to Anil Ambani Group to buy 26 per cent stake in ICEX from India bulls," Forward Markets Commission (FMC) Chairman B C Khatua said. At present, India bulls holds 40 per cent in ICEX, of which it wants to sell 26 per cent stake in the bourse to ADAG. MMTC has 26 per cent stake in ICEX, which is the country's fourth national commodity exchange launched late last year. "We entered the exchange business in late 2009. We have already started a spot exchange and have a 26 per cent stake in a commodities exchange," ADAG Group Chairman Anil Ambani had said yesterday at the AGM of group firm Reliance Capital. The Group had also announced its intention to enter all
  47. 47. 47 segments of the exchange business. Reliance Capital is already in the spot commodity space. Another group firm Reliance Money also has stake in the national commodity exchange NMCE.ICEX, a national-level commodity bourse, offers futures trading in 18 commodities, including bullion, metals and agricultural items. The exchange clocked a business of Rs 13,009 crore in the first fortnight of September. Reliance Mutual Fund is India's no.1 Mutual Fund. Reliance Life Insurance is one of India's fastest growing life insurance company and among the top 4 private sector insurers. Reliance General Insurance is one of India's fastest growing general insurance company and among the top 3 private sector insurers. Reliance Money is the largest brokerage and distributor of financial products in India with over 2.7 million customers and has the largest distribution network. Reliance Consumer finance has a loan book of over Rs. 8,900 crore at the end of December 2008. Reliance Capital is a constituent of S&P CNX Nifty and MSCI India and also features in the Forbes list of World‘s largest 2000 public companies. Reliance Securities, subsidiary of Reliance Capital achieved a pan-India presence with over 5,000 outlets and the average daily turnover had increased to Rs 2,300 crore (Rs 23 billion) in 2010. Management Team Reliance Securities is lead by a team of distinguished individuals dedicated towards scaling the company to greater heights through innovative products and services that create value for our customers & stake holders.
  48. 48. 48 Reliance Anil Dhirubhai Ambani Group Reliance Group (Anil Dhirubhai Ambani Ventures Limited) Type Private Industry Conglomerate Predecessor(s) Reliance Commercial Corporation Founded 1966 Founder(s) Dhirubhai Ambani Headquarters Dhirubhai Ambani Knowledge City, Navi Mumbai, Maharastra,India Key people Anil Ambani (Chairman) Products Communications, infrastructure, financial, entertainment, power, natural resource, petrochemical, healthcare, BPO Revenue US$15.4 billion (2012) Operating income US$2 billion (2012) Profit US$3.5 billion (2012) Total assets US$29 billion (2012) Total equity US$40 billion (2012) Employees 120,000 (2012) Subsidiaries Reliance Power, Reliance Communications, Reliance
  49. 49. 49 Infrastructure, Capital, Reliance, Reliance Health, Reliance Natural Resources, Venture, Reliance Reliance Anil Dhirubhai Ambani Group (usually referred as Reliance Group and headquartered in Navi Mumbai, India. The company, which was formed after Dhirubhai Ambani‘s business empire was divided up, is headed by his younger son Anil Ambani. It has a market capitalization of 89000 crore (US$14 billion) and net assets worth 180000 crore (US$29 billion). The Reliance Group has a business presence that extends to over 20,000 towns and 450,000 villages in India, and across the globe. The shareholder base is over 12 million, among the largest in the world. The group is present in many sectors including Telecom, Capital, Power, Infrastructure, Entertainment and Health. History “Dhirubhai Ambani” Reliance group was founded by Dhirubhai Ambani in 1966 as a polyester firm. Dhirubhai started the equity cult in India. Reliance later entered into financial services, petroleum refining, power sector. By 2002 Reliance had grown into a U$15 billion conglomerate. After the death of Dhirubhai Ambani on 6 July 2002, Reliance was headed by his sons. The group was formed after the two feuding brothers Mukesh Ambani and Anil Ambani, split Reliance Industries. Anil Ambani got the responsibility of Reliance Infocomm, Reliance Energy, Reliance Capital and RNRL. This led to a new beginning called RELIANCE. Later this group entered the power sector through Reliance Power and the entertainment sector by acquiring Adlabs.
  50. 50. 50 OBJECTIVES OF THE STUDY:- Primary objectives:- 1- Know risk bearing capacity of people. 2-know at which cost people can spent in investment. Secondary objectives:- 1- Know investment behavior of people. 2-know awareness of people about investment. 3-what type of factors affect an investment decision and how much?
  51. 51. 51 Scope and rational of the study The scope of this project report is included all the customer and investors who are interested in investing their money in stock market as well as Reliance securities. Understanding a stock peak as per risk profile of investor in which, I find the problems of customer and investor on the risk bearing capacity of investor and the satisfaction level of investors toward the services offered by reliance securities. In which include the various factors such as risk involved, return and time factor involved in reliance securities. A situation in which an analyst or investor uses a systematic form of analysis to conclude that a particular stock will make a good investment and, therefore, should be added to his or her portfolio. The position can be either long or short and will depend on the analyst or investor's outlook for the particular stock's price. The style / profile is determined by Objective personal or social traits such as age, gender, income, wealth, family, tax situation etc.subjective attitudes, linked to the temper (emotions) and the beliefs (cognition) of the investor. Generally, the investor's financial return / risk objectives, assuming they are precisely set and fully rational. The rise of the institutional investor has brought with it some improvements in market operations. There has been a gradual tendency for "fixed" (and exorbitant) fees being reduced for all investors, partly from falling administration costs but also assisted by large institutions challenging brokers' oligopolistic approach to setting standardized fees. In Finance, Profitable opportunities are considered as an important aspiration (goal). Profitable opportunities signify that the firm must utilize its available resources most efficiently under the conditions of cut-throat competitive markets. Profitable opportunities shall be a vision. It shall not result in short-term profits at the expense of long-term gains. For example, business carried on with non-compliance of law, unethical ways of acquiring the business, etc., usually may result in huge short-term profits but may also hinder the smooth possibility of long-term gains and survival of business in the future.
  52. 52. 52 REVIEW OF LITERATURE ―A small gamble in a large number of different companies where I have no information to reach a good judgment, as compared with a substantial stake in a company where one's information is adequate, strikes me as a travesty of investment policy‖ John Maynard Keynes, 1883-1946 John Maynard Keynes was a good stock picker. From 1928 to 1945, the fund he managed for King‘s College, Cambridge, produced positive returns at a time when the U.K. stock market was declining by 0.5% per year.1 The intellectual foundations of stock picking were laid out in the classic text on valuation by Graham and Dodd (1934), who showed us how to figure out whether a stock was a ―buy.‖ Many of today‘s famous investors like Warren Buffett have been influenced by their theories. Indexing, which is the practice of passively investing in a portfolio containing a large number of stocks, is the philosophical opposite of stock picking. Instead of picking winners and losers, indexing emphasizes diversification. The intellectual foundations of indexing are in Markowitz‘s (1952) paper on modern portfolio theory and Tobin‘s (1958) paper on two-fund separation.2 Indexing also has its fans in the investment world, of which perhaps the most influential is the Vanguard group of mutual funds. Ironically, the index funds that Vanguard popularized as an asset class now face serious competition from Exchange Traded Funds that exchanges have introduced to cash in on the popularity of passive indexing. The purpose of this paper is to find out which investment philosophy, stock picking or indexing, is dominant in the stock markets around the world. This is an important research question because, though there is much anecdotal evidence that the ideas in Markowitz (1952), a paper which led to the ―birth of modern financial economics‖ (Rubinstein (2002)), have permeated investment practice, there has been, to the best of our knowledge, no paper formally measuring this permeation.4 Our paper makes a modest first attempt to formally measure how the investment community has accepted one of the ideas of modern portfolio theory – indexing. The prevalence of indexing can only be measured if there exists a measure for indexing. No such measure exists in the
  53. 53. 53 literature. So the first part of our paper develops a metric for the opposite of indexing – stock picking. The idea behind this measure is inspired by a theoretical insight in Lo and Wang (2000). They proved that, if the two-fund separation theorem holds, dollar turnover of a stock, which is defined as the dollar volume of shares traded divided by the dollar An empirical implication of the above theoretical insight is that if every person in the world indexes between a risk-free portfolio and the market portfolio (or a value-weighted portfolio that is a proxy for the market portfolio), trading volume in stock i should be explained completely by the market capitalization of stock i. This would mean that (1-R2) of the cross-sectional regression of the log of volume against the log of market capitalization would reflect the deviation from the indexing investment philosophy. This deviation will occur because some agents pick individual stocks. This deviation will also occur if some agents index to portfolios other than the value-weighted portfolio. This means that the (1-R2) of the above cross-sectional regression between log dollar volume and log dollar market capitalization will be a measure of the maximum proportion of trade that can be explained by stock picking. We run these cross-sectional regressions every month, for every country for which we have data, for as long as we have the data. We plot the (1-R2) over time for 43 countries. We get two big results, and many small results. Our first big result is that, on an average, there is more stock picking in emerging markets than in developed markets. As a matter of fact, the maximum fraction of volume explained by stock picking in emerging markets in the 1995-2004 period is 63%, whereas the maximum fraction of volume explained by stock picking in developed countries in the same period is only 45%. In our sample of 43 countries, the maximum fraction of volume explained by stock picking in the 1995-2004 period is the least in the United States (29%) and is the most in China (80%). Our second big result is that, on an average, stock picking is declining around the world. Of the 43 countries under investigation, we record that for 38 countries, the maximum fraction of volume explained by stock picking is lower in the last five years (2000-2004) than in the previous five years (1995-1999). The declines in stock picking are quite dramatic, especially in the emerging markets. The most dramatic decline in the popularity of stock picking is recorded in the United States, but that is probably because we have a
  54. 54. 54 longer time series data for the United States. In the United States, the maximum fraction of volume explained by stock picking has secularly declined from a high of 60% in the 1960s to a low of 24% in the 2000s. As we have a lot more data on the United States, we are able to get many small cross- sectional results for the United States. We find that though stock picking is less in S&P 500 stocks than in non S&P stocks, the difference seems to have disappeared in recent times. This fact shows that the though the actual mechanics of indexing in S&P 500 stocks is easier, the mechanics do not matter much anymore because indexing seems to be popular even in stocks not in the S&P 500 index. In terms of exchanges, there is more stock picking in AMEX than in NYSE. NASDAQ starts out looking like the AMEX, but it looks like the NYSE today. In terms of size, there is more stock picking in small stocks than in large stocks. In terms of age, there is more stock picking in young firms than in old firms. In terms of industries, stock picking is highest in the telecommunication industries, and lowest in the utilities industries. Our last cross-sectional result is that there is more stock picking in stocks that are covered by fewer analysts than in stocks that are covered by more analysts. As analysts are the quintessential stock pickers, it seems that investors who pick stocks avoid stocks that analysts pick. Finally, whatever the above cross-sectional results, we record that stock picking is declining over time in each and every category. Our summary of findings from the first two parts of the paper is that stock picking is more pronounced in emerging markets than in developed markets, but it is declining in nearly all stock markets of the world. Though our paper is the first to formally document the declining popularity of stock picking around the world, indications that this may be happening are in a paper by Fernando et al (2003), who document the explosive growth of mutual funds around the world. Also, though our paper is the first paper to formally document the large cross-sectional variation in the popularity of stock picking across countries, indications that this may occur are in a paper by Khorana, Services and Tufano (2004), who document that the mutual fund industry is larger in countries with better laws and regulations and more wealth. Interestingly, these are the countries with the
  55. 55. 55 lowest stock picking in our sample. The above two arguments implicitly assume that mutual funds emphasize diversification over stock picking. That may be a reasonable assumption, but as Wormers (2000) shows, stock picking is alive and well in some United States mutual funds. Further, the explosive growth of hedge funds in recent years also means that stock picking may be making a comeback. Our results show that modern portfolio theory has won. However, it is premature to write the epitaph for stock picking. News of the death of stock picking will be an exaggeration. The reason no stock picking cannot be an equilibrium strategy is because of the Grossman-Stieglitz (1980) paradox: if no one picks stocks, information that stock pickers communicate with their trades cannot be impounded in prices, and so markets become inefficient, and so develops an opportunity to gather information, pick stocks, and make trading profits. This begs the question: how many stock pickers will exist in equilibrium? In other words, what is the long-run steady state fraction of stock pickers? We develop a simple theoretical model. Our theoretical model is based on a crucial insight that comes from an early theoretical model by Treynor and Black (1973): in a mean-variance optimizing framework, even active stock pickers would like to maximize their Sharpe ratio, which is the ratio of the risk premium of the portfolio they choose divided by the standard deviation of the return of the portfolio (assumed to be the measure of risk). This implies that if we restrict an investor to be either a passive investor in the market portfolio or an active investor in a single stock, this would mean that this investor would be indifferent if the Sharpe ratios are the same. The Sharpe ratio of the market portfolio is simply the market price of risk. The active investor, who we allow to hedge the systematic risk of the single stock by taking an opposite position in the market portfolio, has the following Sharpe ratio. It is his excess profit from his superior information divided by the cost of active investing. The voluminous literature on market microstructure, which begins with Kyle (1985) and Glosten and Milgrom (1985), tells us that the excess profit an insider obtains from his inside information is his profit based on his superior information (Jensen‘s alpha) minus his adverse selection cost and other transaction costs of trading. We should also subtract his cost of obtaining the superior information from this number. Modern portfolio theory tells us that the cost of active
  56. 56. 56 investing is the exposure to idiosyncratic risk. Equating the two Sharpe ratios allows us to express the excess profit of the indifferent investor as a product of the market price of risk and the idiosyncratic risk. Note that the excess profit that makes an investor indifferent between stock picking and passive indexing is the product of the market price of risk and the idiosyncratic risk. We call this value the ―indifferent‖ excess profit. This implies that stock picking would become less popular if the market price of risk is increasing and/or idiosyncratic risk is increasing. The intuition is obvious. If the reward for holding market risk is increasing, investing in the market portfolio is more attractive, and so stock picking is less popular. If idiosyncratic risk is increasing, the cost of non-diversification, which is what stock picking entails, is increasing, and so stock picking is less popular. The market price of risk is time-varying. See Lettau and Ludvigson (2003) for an excellent survey of this voluminous literature. There are many methods to estimate the market price of risk. We use the Whitelaw (1994, 1997) methodology as our primary method to estimate the market price of risk, though we report our estimates for the other methods as well. Idiosyncratic risk is also time-varying. As a matter of fact, a growing literature has documented that idiosyncratic risk has secularly increased over time in the United States (see Campbell et al. (2001)) and all over the world (see Morck, Yeung and Yu (2000). We use the method of Morck, Yeung and Yu (2000) to back out idiosyncratic risk for the United States. Our estimate of idiosyncratic risk tallies with their estimate. It also tallies with the estimate of Campbell et al. (2001), who use a variance decomposition method of estimating idiosyncratic risk. What is important, however, is that we get the same result: idiosyncratic risk is increasing in the United States. The market price of risk is time-varying. See Lettau and Ludvigson (2003) for an excellent survey of this voluminous literature. There are many methods to estimate the market price of risk. We use the Whitelaw (1994, 1997) methodology as our primary method to estimate the market price of risk, though we report our estimates for the other