Market & Brokers

Primary Market
The primary market is that part of the capital markets that deals with the issuance of new
securities. Companies, governments or public sector institutions can obtain funding through the sale of a
new stock or bond issue.
This is typically done through a syndicate of securities dealers. The process of selling new issues
to investors is called underwriting.
(Underwriting refers to the process that a large financial service provider (bank, insurer,
investment house) uses to assess the eligibility of a customer to receive their products)
Features of primary markets are:
This is the market for new long term equity capital. The primary market is the market where the
securities are sold for the first time. Therefore it is also called the new issue market (NIM).
In a primary issue, the securities are issued by the company directly to investors.
The company receives the money and issues new security certificates to the investors.
Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business.
The primary market performs the crucial function of facilitating capital formation in the
economy.
The new issue market does not include certain other sources of new long term external finance,
such as loans from financial institutions.
The financial assets sold can only be redeemed by the original holder
Methods of issuing securities in the primary market are:
Initial Public Offering
Right Issue
Preferential Issue
Initial Public Offering
An initial public offering (IPO) or stock market launch, is the first sale of stock by a company to
the public. It can be used by either small or large companies to raise expansion capital and
become publicly traded enterprises.
Right Issue
A rights issue is an issue of additional shares by a company to raise seasoned equity offering.
The rights issue is a special form of shelf offering or shelf registration.
With the issued rights, existing shareholders have the privilege to buy a specified number of
new shares from the firm at a specified price within a specified time. A rights issue is in contrast
to an initial public offering, where shares are issued to the general public through market
exchanges.
A Seasoned equity offering or secondary equity offering (SEO) is a new equity issue by an
already publicly-traded company.
Preferential Issue
A Preferential issue is an issue of stocks or of convertible securities through listed firms to a
select number of persons under Section 81 of the Companies Act, 1956 that is neither a public
issue nor a rights issue. This is a speedier path for a firm to increase equity funds.
Secondary Market
The secondary market, also called aftermarket, is the financial market in which previously
issued financial instruments such as stock, bonds, options, and futures are bought and sold.
Third Market
Third market in finance, refers to the trading of exchange-listed securities in the over-the-
counter (OTC) market.
These trades allow institutional investors to trade blocks of securities directly, rather than
through an exchange, providing liquidity and anonymity to buyers.
Fourth Market
Fourth market trading is direct institution-to-institution trading without using the service of
broker-dealers.
It is impossible to estimate the volume of fourth market activity because trades are not subject
to reporting requirements. Studies have suggested that several million shares are traded per day.
Brokers
A broker is an individual or party (brokerage firm) that arranges transactions between a buyer
and a seller, and gets a commission when the deal is executed.
A broker who also acts as a seller or as a buyer becomes a principal party to the deal.

Distinguish agent: one who acts on behalf of a principal.
A broker is the third -person facilitator between a buyer and a seller. An example would be a
real estate broker who facilitates the sale of a property.
Types of Broker
Commission Broker
A broker on the floor of an exchange who acts as agent for a particular brokerage house and
buys and sells stocks for the brokerage house on a commission basis.
Jobber
A jobber is a professional speculator. He works for a profit called Turn.
Floor Broker
The floor broker buys and sells shares for other brokers on the floor of the exchange.
Odd Lot Dealer
A dealer who buys and sells securities on his/her own account in portions smaller than 100
shares apiece. An odd-lot dealer may be a market maker for a given security on an exchange.
A member of an organized securities exchange that buys and sells in less than round lots. On
most exchanges, this dealer is the specialist in a particular stock.
Arbitrageur
An Arbitrageur is a specialist in dealing with securities in different exchanges at the same time.
He makes profit by the difference in prices prevailing in different centers of market.









Investment process
PORTFOLIO MANAGEMENT


Portfolio management is a complex process or activity that may be divided into seven broad
phases:
Specification of Investment Objectives and
Investment Constraints

In the first step of Portfolio Management process investor has to specify the investment
policy which summarizes the
objectives, Constraints and preferences of the investor

The investor policy may be summarized as follows:
Objectives
Return Requirements
Risk Tolerance
Constraints and Preferences
Liquidity
Investment Horizon
Taxes
Regulations
Unique Circumstances
Objectives
Most common investment objectives are:
Income: To provide a steady stream of income through regular interest and dividend
payment.
Growth: To increase the value of the principal amount through capital appreciation.
Stability: To protect the principal amount invested from the risk of loss.
Contd..
Specify your investment objectives in one of the following ways
Maximize the rate of return, for a given level of risk.
Minimize the risk exposure, for a given level of Return.
Risk you can bear depends on two key factors
1. Your Financial situation,
What is the position of your wealth?
what major expenses can be anticipated in the near future?
What is your earning capacity?
How much money you can loose without seriously hurting your standard of living?

2. Your temperament
Even though your financial situation permit you to absorb losses easilybut.
You may become extremely upset over small losses.
On the other hand, despite a not so strong financial position, you may can easily manage with losses.

Your risk tolerance level is set by either your financial situation or your financial temperament
,which ever is lower.
Constraints
Liquidity: It refers to the speed which an asset can be sold, with out suffering any losses.
Investment Horizon: It is the time when the investment or part thereof is planned to be
liquidated to meet a specific need.
Taxes: Post tax returns
Regulation: Individual investors are not much constrained by law, Institutional investors have
to conform to various regulation.
Unique Circumstances: Ageing parents, Children Education, Buying a house etc.
II Selection of Asset Mix
Based on your objectives and constraints, investor has to specify his asset allocation, that is he
has to decide hoe much of the portfolio has to be invested in each of the following asset categories:
Cash
Bonds
Stocks
Real Estate
Precious Metals
Other

A popular rule of thumb for asset allocation says that the percentage allocation to debt must
be equal to the age of the individual.
III Formulation of Portfolio Strategy
After choosing certain asset mix, appropriate portfolio strategy has to be formulated.
Two road choices are available
Active Strategy
Passive Strategy
Active Portfolio Strategy
An active portfolio strategy is followed by most investment professionals and aggressive investors
who strives to earn superior returns, after adjustment of risk.

An active portfolio management is an attempt to outperform the market on a risk adjusted
basis.

The goal active strategy is to earn a portfolio return that exceeds the return of a passive
benchmark
Four important aspect of active strategy
Market Timing: This involves departing from the normal (long run) asset mix to reflect ones
assessment of the prospect of various assets in the near future .
Sector Rotation: It essentially involves shifting the weightings for various industrial sectors
based on their assessed outlook.
With respect to bonds, sector rotation implies a shift in the composition of the bond portfolio
in terms of quality( as reflected in Credit rating), coupon rate, term to maturity and so on.
Security Selection: Security selection involve search for under priced security.
Passive Strategy

Passive strategy rest on the theory that the capital market is fairly efficient with respect to the
available information. Hence, the search for superior returns through an active strategy is considered
as futile.
Passive portfolio strategy is a long term buy and hold .
How passive strategy is implemented??????
1. Create a well diversified portfolio at a pre-determined level of risk.
2. Hold the portfolio relatively unchanged over time, unless it becomes inadequately diversified
or inconsistent with the investors risk-return preferences.
IV Selection of Securities
Selection of Bonds- on the basis of credit rating, yield to maturity, tax shield and liquidity.
Selection of stocks- on the basis of Fundamental Analysis and Technical Analysis.
V Portfolio Execution
Buying and selling of shares
VI Portfolio Revision

Irrespective of how well you have constructed your portfolio, it soon tends to become
inefficient and hence need to be monitored and revised periodically.
Portfolio revision if required because..
The asset allocation in the portfolio may have drifted away from the target.
The risk and return characteristics of various securities have altered.
The objectives and preferences of investors may have changed.

Portfolio revision always involves two things
Portfolio Rebalancing : It involves reviewing and revising the portfolio composition mix (i.e. ..
stock-bond mix)
Three basic policies with respect to portfolio rebalancing.
1. Buy and Hold Policy
2. Constant Mix Policy
3. Portfolio Insurance Policy
Portfolio Upgrading
Portfolio rebalancing involves shifting from stock to bonds or vice-versa, portfolio upgrading
calls for re-assessing the risk-return characteristics of various securities (stocks as well as bonds),
selling over-priced securities, and buying under-priced securities.
VII Performance Evaluation
1. Treynors Measure
2. Sharpe Measure
3. Jensen Measure
Beta
A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the
market as a whole.
Beta is calculated using regression analysis, and you can think of beta as the tendency of a
security's returns to respond to swings in the market.

The general rule for is as follows:
If = 1.0 then the investment has "normal" market risk
If < 1.0 then the investment has below normal market risk
(for example U.S. securities' = 0 or zero risk)
If > 1.0 then the investment has a greater than normal
market risk (higher risk)
Sharpes Measure
The Sharpes performance measure makes a measurement of the risk premium of portfolios.
Sharpes Index is given by the following equation:
St = Rt Rfr
SDt
St Sharpes Index
Rt Average Rate of Return of the portfolio t
RFr Risk less rate of return
SDt Standard Deviation of portfolio t
This figure graphical presentation of Sharpes Index. Larger the St the better the performance
of the portfolio.
Risk
St


Return
Treyners Measure
The relationship between a given market return and the funds return is given by
characteristic line.
The funds performance is measured in relation to the market performance.
The ideal funds return rises at a faster rate than the general market performance when the
market is moving upwards.
The rate of return of ideal fund declines slowly than the market return declines.
Tn = Portfolios Average Return- Riskless rate of Interest
Beta Coefficient of Portfolio
Jensens Performance Index
Jensen measures the absolute performance because a definite standard is set and against
that the performance is measured.
The standard is based on the predictive ability of the manager.
Successful prediction of a security price would enable the manager to earn high returns than
the ordinary investor expects to earn.
Basic model of Jensen
Rp= a + b (Rm- Rf)