SFM Theory Notes - Adish Jain - Unacademy

CA Final
Strategic Financial Management
THEORY
NOTES
Relevant for May- 23 & onwards...
Adish Jain CA CFA

Meet Adish Jain
Chartered Accountant (CA) & Chartered
Financial Analyst (CFA)
Ex-Morgan Staley & ICICI Securities with

2+ years work-ex
Teaches CA Final-SFM, CFA and Financial

Modelling
Taught 4000+ students across courses
His 2 core mantra for students:

Conceptual Clarity
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Adish Jain CA CFA
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UNIQUE STRUCTURED
CONCEPT NOTES
Important Instructions
before we read this book...
Content and language of this book has been picked from Institute’s material.
This book has been creatively designed to help students understand and
remember the content easily. For this purpose, certain concepts have been
presented in diagrams and charts format. However, in exams, answers must be
written in simple pointers and paragraph format.
The purpose of text in GREY COLOUR is to give students an understanding of

the main concept and is not recommended to be written in the exam while
answering the questions.
Below chapters & topics have more importance and should be studied on
priority to other chapters:
Chapters: Topics:
1. Start-Up Finance Side Pocketing Fixed Maturity Plans
2. Securitization Tracking Error Quant Funds
3. Risk Management Direct Plan in Mutual Immunization
4. Security Analysis Funds
5. Financial Policy and
Corporate Strategy
All the best!

CA Final SFM: Theory Notes
1. Financial Policy And Corporate Strategy............................................................................3
2. Risk Management .............................................................................................................7
3. Security Analysis..............................................................................................................11
4. Security Valuation ...........................................................................................................19
5. Portfolio Management ....................................................................................................21
6. Securitization ..................................................................................................................28
7. Mutual Funds ..................................................................................................................33
8. Derivatives Analysis And Valuation .................................................................................37
9. Foreign Exchange Exposure And Risk Management ........................................................40
10. International Financial Management ...........................................................................45
11. Interest Rate Risk Management ...................................................................................47
12. Corporate Valuation.....................................................................................................48
13. Mergers, Acquisitions And Corporate Restructuring .....................................................49
14. Start-Up Finance ..........................................................................................................52
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1. FINANCIAL POLICY AND CORPORATE STRATEGY

1. Strategic Financial Management & it’s Functions
SFM means application of financial management techniques to strategic decisions in order to help achieve
the decision-maker's objectives. It is basically about the identification of the possible strategies capable
of maximizing an organization's market value. It involves the allocation of scarce capital resources among
competing opportunities.
Investment and financial decisions involve the following functions:
a. Continual search for best investment opportunities;
b. Selection of the best profitable opportunities;
c. Determination of optimal mix of funds for the opportunities;
d. Establishment of systems for internal controls; and
e. Analysis of results for future decision-making.
2. Key Decisions falling within the Scope of Financial Strategy

1. Financing decisions: These decisions deal with the mode of financing and mix of equity and debt in the
capital structure.
2. Investment decisions: These decisions involve the profitable and optimum utilization of firm's funds
especially in long-term capital projects. Since the future benefits associated with such projects are not
known with certainty, investment decisions necessarily involve risk. The projects are therefore
evaluated in relation to their expected return and risk.
3. Dividend decisions: These decisions determine the division of earnings between payments to
shareholders as dividends and retention with the company for future reinvestment.
4. Portfolio decisions: These decisions involve evaluation of investments based on their contribution to
the aggregate performance of the entire company rather than on the characteristics of individual
investments (Just like we read in portfolio management that risk & return of entire portfolio is to be
considered rather than individual securities).
3. Strategy at different Hierarchy Levels
Let us take the example of Corporate Level Strategy

Reliance Industries Limited (RIL)...
RIL
Business Level Strategy
Oil Telecom
Business Business
Manufacturing
Operations
Marketing
Marketing
Functional Level Strategy

Finance
HR
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a) Corporate Level Strategy:

 Corporate level strategy fundamentally is concerned with selection of businesses in which a
company should compete. It also deals with the development and coordination of that portfolio
of such businesses. (Strategy at RIL level will come under this)
 Corporate level strategy should be able to answer three basic questions:
Suitability: Whether the strategy would work for the accomplishment of common
objective of the company.
Feasibility: Determines the kind and number of resources required to formulate and
implement the strategy.
Acceptability: It is concerned with the stakeholders’ satisfaction and can be financial and
non-financial.
b) Business Level Strategy

 Strategic Business Unit (SBO) is a profit centre that can be planned independently from the other
business units of a corporation. Strategies formed to accomplish objectives of SBOs are Business
Level Strategies. (Oil Business Unit or Telecom Business Unit is an SBO)
 Business Level Strategy deals with practical coordination of operating units and developing and
sustaining a competitive advantage for the products and services that are produced.
c) Functional Level Strategy
 Functional Level Strategies include strategies at the level of operating departments like R&D,
operations, manufacturing, marketing, finance, and human resources.
 Functional level strategies involve the development and coordination of resources through which
business unit level strategies can be executed effectively and efficiently.
4. Financial Planning & Outcomes of Financial Planning

Financial Planning = Financial Resources + Financial Tools + Financial Goal
Financial planning is a systematic approach to maximize his existing financial resources by utilizing
financial tools to achieve his financial goals. Financial planning is the backbone of the business planning
and corporate planning.
Outcome of Financial Planning = Financial Objective, Financial decision-making & Financial measures
Financial objectives are to be decided at the very beginning so that rest of the decisions can be taken
accordingly. The objectives need to be consistent with the corporate mission and corporate objectives.
Financial decision making helps in analysing the financial problems that are being faced by the corporate
and accordingly deciding the course of action to be taken by it.
Financial measures like ratio analysis, analysis of cash flow statement is used to evaluate the
performance of the Company.
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5. Interface of Financial Policy and Corporate Strategic Management
CORPORATE FINANCIAL
Interface
STRATEGY PLAN
The interface of strategic management and financial policy will be clearly understood if we appreciate
the fact that the starting point of an organization is money and the end point of that organization is also
money.
Dimensions of interface between Corporate Strategic Management and Financial Policy:
(Interface in general means point of connection between two things. Here, ‘Dimensions of interface
between Corporate Strategic Management and Financial Policy’ means in which all ways, Corporate
Strategic Management is connected to Financial Policy)
a) Sources of Finance and Capital Structure Decisions
 To support any expansion activity, funds may be mobilized (generated) through owner’s capital
(equity or preference shares) or borrowed capital (debt like debentures, public deposits, etc.).
 Along with mobilization of funds, policy makers must also decide on the capital structure i.e.,
appropriate mix of equity and debt capital. This mix varies from industry to industry.
b) Investment and Fund Allocation Decisions
 A planner must frame policies for regulating investment in fixed and current assets.
 Planners task is to make best possible allocation under resource constraints.
 Investment proposals by different business units can be divided as:
 Addition of new product by the firm (i.e., diversification)
 Increasing the level of operation of an existing product (i.e., expansion)
 Cost reduction or efficient utilization of resource
c) Dividend Policy Decisions
 Dividend policy decision deals with the extent of earnings to be distributed as dividend and the
extent of earnings to be retained for future growth of the firm.
It may be noted from the above discussions that financial policy cannot be worked out in isolation of
corporate strategy. Since, financial planning and corporate strategy are interdependent of each other,
attention of the corporate strategy makers must be drawn while framing the financial plans not at a later
stage.
6. Sustainable Growth Rate

The sustainable growth rate (SGR) of a firm is the maximum rate of growth in sales that can be achieved,
given the firm's profitability, asset utilization, and desired dividend payout and debt (financial leverage)
ratios.
SGR is a measure of how much a firm can grow without borrowing more money. After the firm has passed
this rate, it must borrow funds from another source to facilitate growth.
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SGR is calculated as: ROE x (1- Dividend payment ratio)

Variables of SGR formula typically include:
1. Net profit margin on new and existing revenues;
2. Asset Turnover ratio,
3. Assets to equity ratio (Financial Leverage Ratio)
4. Retention rate
Sustainable growth models assume that the business wants to:
1. maintain a target capital structure without issuing new equity;
2. maintain a target dividend payment ratio; and
3. increase sales as rapidly as market conditions allow.
7. Financially Sustainability of an Organisation

To be financially sustainable, an organisation must:
 have more than one source of income (say, multiple businesses)
 have more than one way of generating income (say, both online and offline sales)
 do strategic, action and financial planning regularly
 have adequate financial systems
 have a good public image
 have financial autonomy (ability to take financial decisions independently)
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2. RISK MANAGEMENT
1. Types of Risks a Business Faces
Strategic Risk Compliance Risk Operational Risk Financial Risk
It is the risk that Every business needs to It refers to the risk It refers to the risk
company’s strategy comply with rules and that company of unexpected
might become less regulations. If the company might fail to changes in
effective and fails to comply with laws manage day to day financial conditions
company struggles related to an area or operational prevailing in an
to achieve its goals. industry or sector, it will problems. economy such as
pose a serious threat to its prices, interest
It could be due to This type of risk
survival. rates, inflation, etc.
technological relates to internal
reasons, new It refers to the risk that risk as risk relates All these factors
competitors, shift company might not be able to ‘people’ as well have direct impact
in customer’s to company with the rules as ‘process’. on the profitability
demand, etc. and regulation applicable to of the company.
the business.
Counter Party Risk

It refers to the risk of non-honouring of obligation by counterparty. It can be failure to deliver goods
against payment already made or failure to make payment against goods delivered. This risk also
covers the credit risk i.e., default by the counter party.
Hints used to identify this risk:
1. Failure to obtain necessary resources to complete the project.
2. Any regulatory restrictions from the Government.
3. Hostile action of foreign government.
4. Let down by third party.
5. Have become insolvent.
Techniques to manage this risk:
1. Carrying out Due Diligence before dealing with any third party.
2. Do not over commit to a single entity or group or connected entities.
3. Know your exposure limits.
4. Review the limits and procedure for credit approval regularly.
5. Rapid action in the event of any likelihood of defaults.
6. Use of performance guarantee, insurance or other instruments.
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Interest Rate Risk

It refers to the risk of change in interest rates which further leads to change in assets and liabilities.
This risk is more important to financial companies whose balance sheet items are sensitive to
interest rates.
1. Monetary Policy of the Government.
2. Any action by Government such as demonetization etc.
3. Economic Growth
4. Investment by foreign investors
5. Stock market changes
1. Traditional Methods:
a) Asset and Liability Management (ALM): It is the management of liabilities and assets in the
balance sheet in such a way that the net earnings from interest are maximized within the
overall risk preference.
b) Forward Rate Agreement (FRA): It is an agreement between two parties through which a
borrower or lender protects itself from the changes to the interest rate by agreeing to a
forward rate.
2. Modern Methods:
a) Interest Rate Futures (IRF): It is a contract between the buyer and seller agreeing to the
future delivery of any interest-bearing asset at a predetermined price.
b) Interest Rate Options (IRO): It is a right but not an obligation and acts as insurance by
allowing businesses to protect themselves against adverse interest rate movements while
allowing them to benefit from favourable movements.
c) Interest Rate Swaps: In this, the parties to it agree to exchange payments indexed to two
different interest rates.
Liquidity Risk
It refers to the inability of organization to meet it liabilities whenever they become due. This risk
arises when a firm is unable to generate adequate cash when needed. This type of risk is more
prevalent in banking business where there may be mismatch in maturities and receiving fresh
deposits pattern.
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Currency Risk
It refers to the risk of change in cash flows due to unfavourable changes in exchange rates. This risk
mainly affects the firms dealing in foreign currency denominated transactions. This risk can be
affected by cash flow adversely or favourably.
1. Government Action: The Government action of any country has impact on its currency, because
government has powers to enact laws and formulate policies that can affect flow to foreign
funds in an economy.
2. Nominal Interest Rate: As per interest rate parity (IRP), the currency exchange rate depends on
the nominal interest of that country.
3. Inflation Rate: As per Purchasing power parity theory, the currency exchange rate depends on
the inflation of that country.
4. Natural Calamities: Any natural calamity can have negative impact on the exchange rates.
5. War, Coup, Rebellion etc.: All these actions can have far reaching impact on currency’s exchange
rates (Coup means sudden change in government illegally & Rebellion means organised protest
against any authority).
6. Change of Government: The change of government and its attitude towards foreign investment
also helps to identify the currency risk.
Already covered in Foreign Exchange as Internal & External Hedging Techniques.
Political Risk
This type of risk is faced by and overseas investors, as the adverse action by the government of host
country may lead to huge loses.
1. Insistence on resident investors or labour.
2. Restriction on conversion of currency.
3. Confiscation of foreign assets by the local govt.
4. Price fixation of the products.
5. Restriction of remittance to home country.
1. Local sourcing of raw materials and labour.
2. Entering into joint ventures
3. Local financing
4. Prior negotiations
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2. Evaluation of Financial Risk from the point of view of Different Stakeholders

1. From Shareholder’s point of view: Equity shareholders view financial risk as financial gearing i.e. ratio
of debt in capital structure of company since in event of winding up of a company they will be given
least priority in capital repayment.
2. From Lenders point of view: Lenders view risk as existing gearing ratio since company having high
gearing faces more risk of default of payment of interest and principal repayment.
3. From Company’s point of view: A company views risk from the point of view of company’s ability to
exist. If a company borrows excessively or lends someone who defaults, then it can be forced to go into
liquidation.
4. From Government’s point of view: Government views financial risk as failure of any bank or down
grading of any financial institution leading to spread of distrust among society at large.
3. Value at Risk (VaR)

VAR is a measure of risk of investment (just like standard deviation which is also a measure of risk). Given
the normal market condition, it estimates how much an investment might lose during a given time
period at a given confidence level.
Main Features of VaR:

1. Components: VaR Calculation is based on following three components:
 Maximum Loss
 Confidence Level
 Time Period
2. Statistical Method: VaR is a statistical method of measuring risk since it is based on standard
deviation
3. Time Horizon: It can be applied for different time periods say one day, week, month, etc.
4. Probability: It is based on assumption of normal probability distribution
5. Z-Score: Z-Score indicates how many standard deviation, value is away for means. Z-score multiplied
with Standard deviation gives the amount of maximum loss.
6. Control over Risk: It helps to control risk by setting limits of maximum loss.
4. Applications of Value at Risk

VaR can be applied:
 to measure the maximum possible loss on any portfolio or on a trading position.
 as a benchmark for performance measurement of any operation or trading.
 to fix limits for individuals dealing in front office of a treasury department.
 to enable the management to decide the trading strategies.
 as a tool for Asset and Liability Management especially in banks.
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3. SECURITY ANALYSIS
1. Security Analysis and its approaches
Investment decision of securities to be bought, held or sold depends upon the return and risk profile of
that security. Security Analysis involves a systematic analysis of the risk-return profiles of various
securities to help a rational investor take an investment decision.
There are two approaches viz. fundamental analysis and technical analysis for carrying out Security
Analysis. In fundamental analysis, factors affecting risk-return characteristics of securities are looked into
while in technical analysis, demand and supply position of the securities along with prevalent share price
trends are examined.
2. Fundamental Analysis and its stages

Economic Analysis
Industry Analysis
Company Analysis
Fundamental analysis is based on the assumption that value of a share today is the present value of future
dividends expected by the shareholders, discounted at an appropriate discount rate and this value is
known as the 'intrinsic value of the share'(i.e., Fundamental Principal of Valuation). The intrinsic value of
a share, depicts the true value of a share. A share that is priced below the intrinsic value must be bought,
while a share quoting above the intrinsic value must be sold.
(Therefore, while calculating intrinsic value, we must analyse all those factors that can impact the future
revenue, earnings, cash flows or dividends of the company)
Stages of Fundamental Analysis:

a) Economic Analysis
Factors to be considered in Economic Analysis (It includes factors at economy level (say India as an
economy) that can affect the future cash flows or dividends of all the companies operating in India):
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 Growth rate for National Income and GDP: The estimates of GDP growth rate further helps to
estimate growth rate of an industry and a company. For this purpose, it is also important to know
Real and Nominal GDP growth rates.
 Inflation: Inflation is a strong determinant of demand in some industries mainly in consumer
product industry. Estimating inflation in an economy helps to estimate the expected revenue from
the product. Inflation can be measured either in terms of Retail prices or Wholesale prices.
 Monsoon: Monsoon is also a key determinant of supply and demand of many products therefore
it is also of great concern to investors in stock market.
 Interest Rates: Interest rates in an economy helps in estimating the flow of cash and savings &
consumption patterns in an economy.
b) Industry Analysis
Factors to be considered in Industry Analysis (It includes factors at industry level (say Pharma or
telecom as an industry) that can affect the future cash flows or dividends of all the companies
operating in that industries):
 Product Life-Cycle: An industry usually exhibits high profitability in the initial and growth stages,
medium but steady profitability in the maturity stage and a sharp decline in profitability in the last
stage of growth. Therefore, understanding the product life-cycle is important while estimating the
future cash flows from any product.
 Demand Supply Gap: Excess supply relative to demand reduces the profitability of the industry
because of the decline in prices, while insufficient supply tends to improve the profitability because
of higher price.
 Barriers to Entry: Any industry with high profitability would attract new entrants. However, the
potential entrants to the industry face different types of barriers to entry. Restriction on entry to
new participants helps to analyse impact on the future revenues of the company operating in that
industry.
 Government Attitude: The attitude of the government towards an industry is a crucial
determinant of future prospects of an industry.
 Technology and Research: They play a vital role in the growth and survival of a particular industry.
Technology is subject to very fast change leading to obsolescence.
c) Company Analysis
Factors to be considered in Company Analysis (It includes company specific factors (say TCS or Infosys
as a company) that can affect the future cash flows or dividends of that company):
 Net Worth and Book Value: Net Worth is sum of equity & preference share capital and free
reserves less intangible assets and any carry forward of losses. The total net worth divided by the
number of shares is the much talked about book value of a share. Though, book value may not be
a true indicator of Intrinsic Value of share.
 Sources and Uses of Funds: The identification of sources and uses of funds is known as Funds Flow
Analysis. One of the major uses of funds flow analysis is to find out whether the firm has used
short-term sources of funds to finance long term assets. Since, financing long term assets using
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short term source of finance may create liquidity crunch to the firm while making repayment of
liabilities.
 Cross-Sectional and Time Series Analysis: Analysis of financial statement is important to evaluate
fundamental strength of a company. It involves comparing a firm against some benchmark figures
for its industry (Cross-sectional) and analysing the performance of a firm over time (time-series).
The techniques that are used to do such proper comparative analysis are: common-sized
statement, and financial ratio analysis.
 Growth Record: The growth in sales, net income, net capital employed and earnings per share of
the company in the past few years should be examined. Historical growth numbers are also
important to determine expected growth.
 Quality of Management: Quality of management has to be seen with reference to the experience,
skills and integrity (ethics) of the people involved at board and managerial level. Quality of
management decides the confidence of investors on the decisions and action of management.
Shares will good management quality trades at premium as compared to shares with low
management quality.
3. Techniques used in Economic Analysis

a) Anticipatory Surveys:
Anticipatory Surveys help investors to form an opinion about the future state of the economy. It
involves taking expert opinion on certain parameters that helps estimating the level of expected
economic activities. It involves construction activities, expenditure on plant and machinery, levels of
inventory.
b) Barometer/Indicator Approach
Various indicators are used to find out how the economy shall perform in the future. The indicators
have been classified as under:
1. Leading Indicators: They lead the economic activity in terms of their outcome. They relate to the
time series data of the variables that reach high or low points in advance of economic activity. (It
means, these indicators lead the economic event i.e., first they take place and then economic event
occurs. It means with the help of occurrence of such indicator, future economic event which is
going to take place can be estimated.)
2. Roughly Coincidental Indicators: They reach their peaks and troughs (i.e., high and lows) at
approximately the same time in the economy.
3. Lagging Indicators: They are time series data of variables that lag behind as a consequence of
economy activity. They reach their turning points after the economy has reached its own already.
All these approaches suggest direction of change in the aggregate economic activity but nothing
about its magnitude. The various measures obtained from such indicators may give conflicting signals
about the future direction of the economy.
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c) Economic Model Building Approach

A precise and clear relationship between dependent and independent variables is determined under
this approach (This process is called as building Economic Model). It is the most scientific and complex
way of economic analysis requiring high skill set, time, data and efforts.
4. Technical Analysis | Assumptions | Principles

Technical Analysis is a method of estimating share price movements based on a study of price charts on
the assumption that share price trends are repetitive, that since investor psychology follows a certain
pattern, what has happened before is likely to be repeated.
Technical Analysis is based on the following FOUR assumptions:

1. The market value of stock depends on the supply and demand for a stock
2. The supply and demand is actually governed by several factors in the market. For instance, recent
initiatives taken by the Government to reduce the NPA of banks may actually increase the demand
for banking stocks.
3. Stock prices generally move in trends which continue for a substantial period of time. And there is
possibility that there will soon be a substantial correction which will provide an opportunity to the
investors to buy shares at that time.
4. Technical analysis relies upon chart analysis which shows the past trends in stock prices rather than
the information in the financial statements.
Technical analysis is based on the following THREE principals:

1. The market discounts everything: Many experts criticize technical analysis because it only considers
price movements and ignores fundamental factors. The argument against such criticism is based on
the Efficient Market Hypothesis, which states that a company’s share price already reflects
everything that has or could affect a company.
2. Price moves in trends: Technical analysts believe that prices move in trends. In other words, a stock
price is more likely to continue a past trend than move in a different direction.
3. History tends to repeat itself: Technical analysts believe that history tends to repeat itself. Technical
analysis uses chart patterns to analyse subsequent market movements to understand trends.
5. Theories of Technical Analysis:

a) The Dow Theory
 It is one of the oldest and most famous technical theories. It can also be used as a barometer of
business.
 The Dow Theory is based upon the movements of two indices, Dow Jones Industrial Average (DJIA)
and Dow Jones Transportation Average (DJTA). These averages reflect the aggregate impact of all
kinds of information on the market.
 The movements of the market (or these indices) are divided into three classifications (all happening
at the same time):
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 The primary movement: It is the main trend of the market, which lasts from 1 year to 36 months
or longer. This trend is commonly called bear or bull market.
 The secondary movement: It is shorter in duration than the primary movement, and is opposite
to primary movement in direction. It lasts from 2 weeks to 1 month or more.
 The daily fluctuations: They are the narrow day-to-day movements. These fluctuations are also
required to be studied thoroughly since they ultimately form the secondary and primary
movements.
 The Dow Theory’s purpose is to determine where the market is and where is it going. The theory
states that if the highs and lows of the stock market are successively higher, then the market trend
is up and a bullish market exists. Contrarily, if the successive highs and successive lows are lower,
then the direction of the market is down and a bearish market exists.
b) Elliot Wave Theory
 This theory was based on analysis of 75 years’ stock price movements and charts. Elliot found that
the markets exhibited certain repeated patterns or waves.
 He defined price movements in terms of waves. As per this theory wave is a movement of the market
price from one change in the direction to the next change in the direction.
 As per this theory, waves can be classified into two
parts:
 Impulsive Patterns (Basic Waves): In this pattern,
there will be 3 or 5 waves ((i) to (v) in figure 1) in
a given direction (going upward or downward).
These waves shall move in the direction of the
basic movement. This movement can indicate bull
phase or bear phase.
 Corrective Patterns (Reaction Waves): These 3
waves (a, b & c in figure 1) are against the
direction of the basic waves. Correction involves
correcting the earlier rise in case of bull market
and fall in case of bear market.
c) Random Walk Theory
 This theory states that the behaviour of stock market prices is unpredictable and that there is no
relationship between the present prices of the shares and their future prices.
 This theory says that the peaks and troughs in stock prices are just are statistical happening and
successive peaks and troughs are unconnected.
 In the layman's language, it may be said that prices on the stock exchange behave exactly the way a
drunk would behave while walking in a blind lane, i.e., up and down, with an unsteady way going in
any direction he likes (i.e., without following a fixed pattern and in a totally unpredictable manner).
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6. Charting Techniques
Technical analysts use three types of charts for analysing data
1. Bar Chart: In a bar chart, a vertical line (bar) represents the lowest to the highest price, with a short
horizontal line protruding from the bar representing the closing price for the period. Since volume and
price data are often interpreted together, it is a common practice to plot the volume traded, immediately
below the line and the bar charts.
2. Line Chart: In a line chart, lines are used to connect successive day’s prices. The closing price for each
period is plotted as a point. These points are joined by a line to form the chart. The period may be a day,
a week or a month.
3. Japanese Candlestick Chat: Like Bar chart this chart also shows the same information i.e., Opening,
Closing, Highest and Lowest prices of any stock on any day but this chart more visualizes the trend as
change in the opening and closing prices is indicated by the colour of the candlestick. While Black
candlestick indicates closing price is lower than the opening price the white candlestick indicates its
opposite i.e., closing price is higher than the opening price.
4. Point and Figure Chart: Point and Figure charts are more complex than line or bar charts. They are used
to detect reversals in a trend. For plotting a point and figure chart, we have to first decide the box size
and the reversal criterion.
7. Market Indicators
1. Breadth Index: It is an index that covers all securities traded. It is computed by dividing the net advances
or declines in the market by the number of securities traded (‘advances’ & ‘declines’ means number of
securities whose price has moved up & down respectively during the relevant period & ‘net’ means net of
up & down). The breadth index either supports or contradicts the movement of the Dow Jones Averages.
If it supports the movement of the Dow Jones Averages, this is considered sign of technical strength and
if it does not support the averages, it is a sign of technical weakness
2. Volume of Transaction: The volume of shares traded in the market provides useful clues on how the
market would behave in the near future. A rising index/price with increasing volume would signal buy
behaviour because the situation reflects an unsatisfied demand in the market. Similarly, a falling market
with increasing volume signals a bear market and the prices would be expected to fall further.
3. Confidence Index: It is supposed to reveal how willing the investors are to take a chance in the market It
is the ratio of high-grade bond yields to low-grade bond yields. rising confidence index is expected to
precede a rising stock market, and a fall in the index is expected to precede a drop in stock prices.
4. Relative Strength Analysis: The relative strength concept suggests that the prices of some securities rise
relatively faster in a bull market or decline more slowly in a bear market than other securities i.e. some
securities exhibit relative strength. Investors will earn higher returns by investing in securities which have
demonstrated relative strength in past.
5. Odd - Lot Theory: This theory is a contrary - opinion theory. It assumes that the average person is usually
wrong and that a wise course of action is to pursue strategies contrary to popular opinion. The odd-lot
theory is used primarily to predict tops in bull markets, but also to predict reversals in individual securities.
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8. Evaluation of Technical Analysis

Advocates of technical analysis offer the following interrelated argument in their favour:
a. Under influence of crowd psychology trend persist for some time. Tools of technical analysis help in
identifying these trends early and help in investment decision making.
b. Shift in demand and supply are gradual rather than instantaneous. Technical analysis helps in
detecting this shift rather early and hence provides clues to future price movements.
c. Fundamental information about a company is observed and assimilated by the market over a period
of time. Hence price movement tends to continue more or less in same direction till the information
is fully assimilated in the stock price.
Detractors of technical analysis believe that it is a useless exercise; their arguments are:
a. Most technical analysts are not able to offer a convincing explanation for the tools employed by
them.
b. Empirical evidence in support of random walk hypothesis cast its shadow over the useful ness of
technical analysis.
c. By the time an up-trend and down-trend may have been signalled by technical analysis it may already
have taken place.
In a nutshell, it may be concluded that in a rational, well ordered and efficient market, technical analysis
may not work very well. However, with imperfection, inefficiency and irrationalities that characterizes
the real world market, technical analysis may be helpful.
9. Efficient Market Theory or Efficient Market Hypothesis

 As per this theory, at any given point in time, all available price sensitive information is fully reflected
in share’s prices. Thus, this theory implies that no investor can consistently outperform the market as
every stock is appropriately priced based on available information.
 Level of market efficiency (i.e., how efficient is the market):
 Weak form efficiency: Price of a share reflect all information found in the record of past prices
and volumes.
 Semi-strong form efficiency: Price reflect not only all information found in the record of past
prices and volumes but also all other publicly available information.
 Strong form efficiency: Price reflect all available information public as well as private.
10. Challenges to Efficient Market Theory

1. Information Inadequacy: Information is neither freely available nor rapidly transmitted to all
participants in the stock market. There is a calculated attempt by many companies to circulate
misinformation.
2. Limited information processing capabilities: Human information processing capabilities are sharply
limited. According to great economist, every human organism lives in an environment which generates
millions of new bits of information every second, but we are able to take as input and process very less
of it.
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3. Irrational Behaviour: It is generally believed that investors’ rationality will ensure a close
correspondence between market prices and intrinsic values. But in practice this is not true. The market
seems to function largely on hit or miss tactics rather than on the basis of informed beliefs about the
long-term prospects of individual enterprises.
4. Monopolistic Influence: A market is regarded as highly competitive. No single buyer or seller is
supposed to have undue influence over prices. But in reality, powerful institutions and big operators
have influence over the market. The monopolistic power enjoyed by them diminishes the
competitiveness of the market.
11. Difference between Fundamental & Technical Analysis

Basis Fundamental Analysis Technical Analysis
Method It involves forecasting future cashflows of the Predicts future price & its
company by analysing: direction using purely
historical data of share price,
Economy’s Macro factors: GDP, Interest rates,
its volume, etc.
Inflation, etc.
Company’s Micro factors: Profitability, Solvency
position, Operational efficiency, etc.
Rule Price of share discounts everything. Price captures everything.
Usefulness For Long-term investing. For short term investing.
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4. SECURITY VALUATION
1. Immunization
 We know that when interest rate (or yield) goes up, value of bond falls but return on re-investment (of
coupon receipts) improves and vice versa. Thus, an investor in bonds has to face two types of interest
rate risks (i.e., change in interest rates affects an investor in two ways):
 Price Risk: Risk that price of bond will fall with the increase in interest rates and rise with its
decrease.
 Reinvestment Risk: Risk that coupon receipts will be reinvested at a lower rate if interest rate falls
and at higher rate if interest rate rise.
 We can see that, with the change in interest rates, two risks move in the opposite direction. Through
the process of immunization selection of bonds shall be in such manner that the effect of above two
risks shall offset each other. Duration of the bonds is that point where these two risks exactly offset
each other. If the duration of a bond is equal to its holding period, then we ensure immunization of the
same and hence, the bond is not having interest rate risk. It means that immunization takes place
when the changes in the YTM in market has no effect on the promised rate of return on a bond.
 It means that if a bond is bought today and rate of interest in the market changes, then, value of bond
portfolio (including the reinvested coupons) at the end of its duration (not maturity; duration here
means Macaulay’s Duration) will not change. This is because the decrease (increase) in value of bond
due to increase (decrease) in interest rates will be equal to the increase (decrease) in income on
reinvested coupons received till the end of duration.
 Therefore, when a liability (say future planned cash outflow) is planned to be funded through the sale
of bond portfolio, duration of that bond portfolio (asset) should be made equals to the duration of
liability, so that even if the interest rates change, value of portfolio will not change and liability can be
fully funded through the sale of bond portfolio as planned.
2. Term Structure Theories

The term structure theories explain the relationship between interest rates or bond yields and different
terms or maturities.
1. Expectation Theory: As per this theory, the long-term interest rates can be used to forecast short-term
interest rates in the future as long-term interest rates are assumed to unbiased estimator of the short
term interest rate in future.
2. Liquidity Preference Theory: As per this theory, investors are risk averse and they want a premium for
taking risk. Long-term bonds have higher risk due to longer maturity. Hence, long-term interest rates
should have a premium for such a risk. Further, people prefer liquidity and if they are forced to sacrifice
the same for a longer period, they need a higher compensation for the same. Hence, longer term bonds
have higher interest rates and the normal shape of a yield curve is Positive sloped one.
3. Preferred Habitat Theory (Market Segmentation Theory): This theory states that different investors
may have different preference for shorter and longer maturity periods and therefore, they have their
own preferred habitat. Hence, the interest rate structure depends on the demand and supply of fund
for different maturity periods for different market segments. Accordingly, shape of yield curve can be
sloping upward, falling or flat.
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3. Reverse Stock Split and its reasons

 Reverse Stock Split is a process whereby a company decreases the number of shares outstanding by
combining the shares into lesser number of shares. It can be also understood as opposite of stock split.
 Although, reverse stock split does not result in change in Market value or Market Capitalization of the
company but it results in increase in price per share.
 Reasons for Reverse Split Up:
1. Avoid Delisting: Sometimes, as per the regulation of stock exchange, if the price of shares of a
company goes below a limit it can be delisted. To Avoid such delisting company may resort to
reverse stock split up.
2. To avoid tag of Penny Stock: If the price of shares of a company goes below a limit it may be
called as penny stock. In order to improve that image, company may opt reverse stock split.
3. To attract Institutional Investors: It might be possible that institutional investors may be shying
away from acquiring low value shares. To attract these investors, the company may adopt the
route of Reverse Stock Split.
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5. PORTFOLIO MANAGEMENT
1. Objectives of Portfolio Management
4. Security of Principal: Security of principal not only involves keeping the principal sum intact but also
its purchasing power (i.e., value of portfolio should increase atleast by the percentage of inflation so
that purchasing power of portfolio is maintained)
5. Capital Growth: It can be attained by investing in growth securities or by reinvesting the income
received on securities in the portfolio.
6. Stability of Income is important to facilitate planning of reinvestment or consumption of income
accurately and systematically.
7. Diversification (risk minimisation): The basic objective of building a portfolio is to reduce the risk of
loss by investing in various types of securities and over a wide range of industries.
8. Liquidity is desirable for the investor so as to take advantage of attractive opportunities upcoming in
the market.
9. Favourable Tax Status: The effective yield, an investor gets from his investment, depends on tax to
which it is subjected to. By minimising the tax burden, yield can be effectively improved.
2. Discretionary and Non-Discretionary Portfolio Management

1. Under Discretionary Portfolio Management:
 The portfolio manager has the full discretion and freedom of investment decisions of portfolio of
the client.
 Scope of discretion and freedom of portfolio manager is agreed and noted in Investment Policy
Statement.
 Degree of freedom is more as compared to non-discretionary portfolio management.
2. Under Non-Discretionary Portfolio Management:
 The portfolio manager manages the funds in accordance with the directions and instruction of the
client.
 He advices client based on available information and analysis but final decision is of client.
 Degree of freedom is less as compared to discretionary portfolio management.
3. Active and Passive Portfolio Strategy for Equity Portfolio

a) Active Portfolio Strategy
APS is followed by most investment professionals and aggressive investors, who strive to earn
superior return after adjustment for risk. This strategy involves finding investment opportunity to
beat the overall market. It involves researching individual companies, gathering extensive data about
financial performance, business strategies and management of the companies.
There are four principles of on active strategy:
1. Market Timing: This involves departing for normal long run strategy and forecast market
movement in near future. This involves taking entry and exit from the market at the right time
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by estimating market movements. A variety of tools are employed for market timing analysis
namely business cycle analysis, moving average analysis, advance-decline analysis, Econometric
models.
2. Sector Rotation: It involves shifting funds from one sector to another based on sector outlook. If
a sector is expected to perform well in future, the portfolio manager might overweigh that sector
relative to market and under-weigh if the sector is expected to perform poor. (For example, if an
index has 25% value of stock in technology sector and portfolio on the other hand, has invested
28% of the funds in stock of technology sector, then portfolio is overweight on technology sector.)
3. Security Selection: Security selection involves a search for under-priced security. If one has to
resort to active stock selection, he may employ fundamental and technical analysis to identify
stocks which seems to promise superior return relative to risk.
4. Use of Specialised Investment Concept: To achieve superior return, one has to employ a
specialised concept with respect to investment in stocks. The concept which have been exploited
successfully are growth stock, neglected stocks, asset stocks, technology stocks, etc.
b) Passive Portfolio Strategy
Passive strategy, on the other hand, rests on the belief that the capital market is fairly efficient with
respect to the available information. Basically, passive strategy involves creating a well-diversified
portfolio at a predetermined level of risk and holding the portfolio relatively unchanged over time
unless it became adequately diversified or inconsistent with the investor risk-return preference.
4. Active and Passive Portfolio Strategy for Fixed Income Portfolio

a) Passive Portfolio Strategy
As mentioned earlier Passive Strategy is based on the premise that securities are fairly priced
commensurate with the level of risk. Though investor does not try to outperform the market but it
does not imply they remain totally inactive.
Common strategies by passive investors of fixed income portfolio:
1. Buy and Hold Strategy: This technique is do nothing technique and investor continues with initial
selection and do not attempt to churn bond portfolio to increase return or reduce the level of
risk. However, sometime to control the interest rate risk, the investor may set the duration of
fixed income portfolio equal to benchmarked index.
2. Indexation Strategy: This strategy involves replication of a predetermined benchmark well
known bond index as closely as possible.
3. Immunization: This strategy cannot exactly be termed as purely passive strategy but a hybrid
strategy. This strategy is more popular among pension funds. Since pension funds promised to
pay fixed amount to retired people, any inverse movement in interest may threaten fund’s ability
to meet their liability timely.
4. Matching Cash Flows: Another stable approach to immunize the portfolio is Cash Flow
Matching. This approach involves buying of Zero Coupon Bonds to meet the promised payment
out of the proceeds realized.
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b) Active Portfolio Strategy

As mentioned earlier Active Strategy is usually adopted to outperform the market.
Common strategies by active investors of fixed income portfolio:
1. Forecasting Returns and Interest Rates: This strategy involves the estimation of return on basis
of change in interest rates. Since interest rate and bond values are inversely related, if portfolio
manager is expecting a fall in interest rate of bonds, he should buy with longer maturity period.
On the contrary, if he expected a fall in interest then he should sell bonds with longer period.
Based on short term yield movement, three strategies can be followed:
a. Bullet Strategy: This strategy involves concentration of investment in one particular bond.
This type of strategy is suitable for meeting the fund after a point of time such as meeting
education expenses of children etc. For example, if 100% of fund meant for investing in bonds
is invested in 5-years Bond.
b. Barbell Strategy: As the name suggests this strategy involves investing equal amount in short
term and long term bonds. For example, half of fund meant for investment in bonds is invested
in 1-year Bond and balance half in 10-year Bonds.
c. Ladder Strategy: This strategy involves investment of equal amount in bonds with different
maturity periods. For example if 20% of fund meant for investment in bonds is invested in
Bonds of periods ranging from 1 year to 5 years.
2. Bond Swaps: This strategy involves regularly monitoring bond process to identify mispricing and
try to exploit this situation.
Some of the popular swap techniques are as follows:
a. Pure Yield Pickup Swap - This strategy involves switch from a lower yield bond to a higher
yield bonds of almost identical quantity and maturity. This strategy is suitable for portfolio
manager who is willing to assume interest rate risk as in switching from short term bond to
long term bonds to earn higher rate of interest, he may suffer a capital loss.
b. Substitution Swap - This swapping involves swapping with similar type of bonds in terms of
coupon rate, maturity period, credit rating, liquidity and call provision but with different
prices. This type of differences exits due to temporary imbalance in the market.
c. International Spread Swap – In this swap portfolio manager is of the belief that yield spreads
between two sectors is temporarily out of line and he tries to take benefit of this mismatch.
Since the spread depends on many factor and a portfolio manager can anticipate appropriate
strategy and can profit from these expected differentials.
d. Tax Swap – This is based on taking tax advantage by selling existing bond whose price
decreased at capital loss and set it off against capital gain in other securities and buying
another security which has features like that of disposed one.
3. Interest Rate Swap: Interest Rate Swap is another technique that is used by Portfolio Manager.
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5. Risk in holding a Security

Risk
Systematic Risk Unsystematic Risk

This risk is due to risk factors that affects all the This risk is due to risk factors that affects a specific
companies in the market, i.e., Macro Factors. company, i.e., Company Specific Factors.
Example: Demonetisation, change in Example: Fire in the factory, CEO of the company
government, etc. resigning, etc.
 Since, this risk is faced by all the companies in  Since this risk is faced by a specific company, it
the market, it cannot be avoided even by can be avoided by adding securities (shares of
adding more securities (shares of the the companies) in the portfolio (i.e., by
companies) in the portfolio (i.e., even if we diversifying the portfolio)
diversify)  Since, it is avoidable in nature, return is not
 Since, it is unavoidable in nature, return is rewarded for taking this risk.
rewarded for taking this risk.
 Interest Rate Risk: This arises due to variability  Business Risk: Business risk arises from
in the interest rates from time to time. Price of a variability in the operating profits of a company.
security has inverse relationship with interest Higher the variability in the operating profits of
rates. Discounting rate which is used to calculate a company, higher is the business risk. Such a risk
intrinsic value depends upon the interest rates. can be measured using operating leverage.
 Purchasing Power Risk: It is also known as  Financial Risk: It arises due to presence of debt
inflation risk. Inflation affects the purchasing in the capital structure of the company. It is also
power adversely which further affects the known as leveraged risk and expressed in terms
demand of a product. of debt-equity ratio. Excess of debt vis-à-vis
 Market Risk: This risk affects the prices of any equity in the capital structure indicates that the
share positively or negatively in line with the company is highly geared and hence, has higher
market. Bullish or bearish trend in the market financial risk.
also affect the price of security in the market.
6. Risk Aversion, Risk Appetite & Risk Premium

1. Risk Aversion is an inherent attribute (behavioural feature) of investor makes him avoid risk unless
adequate return is awarded for taking that risk.
2. Risk Appetite is willingness and ability to take risk. It helps an investor to decide the securities in which
funds can be invested based of the risk involved in the securities.
3. Risk premium is the additional return for taking the additional risk by investing into a risky security
rather than risk-free security.
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How does investor’s expectation vary with variation in level of risk appetite?
 Investor with high-risk appetite will invest in riskier securities such as Equity or Alternative Investments
and therefore they will seek higher returns.
 Similarly, investor with low-risk appetite invest in low risky securities such as debt instruments.
Therefore, they expect lower rate of return.
 Investor who wants to take moderate risk will invest in balanced funds and accordingly the return they
will expect will also be between the above two categories.
7. Assumptions of CAPM
1. Efficient market is the first assumption of CAPM. Efficient market refers to the existence of competitive
market where securities are bought and sold with full information of risk and return available to all
participants.
2. Investor has rational investment goals. Investors desire higher return for any acceptable level of risk
or the lowest risk for any desired level of return.
3. CAPM assumes that all assets are divisible and liquid.
4. Investors are able to borrow at a risk free rate of interest
5. Securities can be exchanged at no transaction cost like payment of brokerage, commissions or taxes.
6. Securities or capital assets face no bankruptcy or insolvency.
8. Portfolio Rebalancing Strategies

Constant Proportion
Particulars Buy & Hold Policy Constant Mix
Insurance Policy
Also called as ‘Do Also called as ‘Do
Under this strategy, an
nothing policy’, under something policy’, under
Meaning investor sets the floor
this strategy, an this strategy, an investor
value below which he
investor does not maintains the proportion
does not what the value
rebalance the of stock as a constant % of
of his portfolio to fall.
portfolio. total portfolio.
Balancing? No Yes Yes
Whose ability to take

Whose ability to take
risk increases Whose ability to take risk
risk increases
Suitable to (decreases) linearly decreases (increases) with
(decreases) with the
investor.. with the increase the increase (decrease) in
increase (decrease) in
(decrease) in the value the value of portfolio.
the value of portfolio.
of portfolio.
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PF dependency
on stock price
(x axis: value of
share portfolio)
y axis: Value of Payoff Line: Linear Payoff Line: Concave
total portfolio) Payoff Line: Convex
9. Alternative Investment and its Features

Plainly speaking, Alternative Investments (AIs) are investments other than traditional investments (stock,
bond and cash). Over the time various types of AIs have been evolved but some of the important AIs are
Mutual Funds, Real Estates, Private Equity, Hedge Funds, Distressed Securities, Commodities, etc.
Common Features of AIs:
1. High Fees: Being a specific nature product the transaction fees on AIs is quite high.
2. Limited Historical Rate: The data for historic return and risk is verity limited where data for equity
market for more than 100 years in available.
3. Illiquidity: The liquidity of AIs is not good as next buyer not be easily available due to limited market.
4. Less Transparency: The level of transparency is not adequate due to limited public information
available about AIs.
5. Extensive Research Required: Due to limited availability of market information, the extensive
analysis is required by the Portfolio Managers.
6. Leveraged Buying: Generally, investment in alternative investments is highly leveraged.
10. Important Alternative Investments

1. Real Estates
Real estate is a tangible form of assets which can be seen or touched. Real Assets consists of land,
buildings, offices, warehouses, shops etc. Real Estate Funds invest in Real Assets.
Following characteristics of Real Estate make valuation of Real Estate Funds complex:
 Inefficient market: Information may not be as freely available as in case of financial securities.
 Illiquidity: Real Estates are not as liquid as that of financial instruments.
 Comparison: Real estates are only approximately comparable to other properties.
 High Transaction cost: In comparison to financial instruments, the transaction and management
cost of Real Estate is quite high.
 No Organized market: There is no such organized exchange or market as for equity shares and
bonds.
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2. Hedge Funds:
 Hedge fund is a lightly regulated investment fund that escapes most regulations by being a private
investment vehicle being offered to selected clients.
 It does not reveal anything about its operations and also charges performance fees.
 Hedge funds are aggressively managed portfolio of investments which use advanced investment
strategies such as leveraged, long & short and derivative positions in both domestic and
international markets with the goal of generating higher returns.
 Risk involved under hedge funds in higher than that under Mutual Funds
 It is important to note that hedging is actually the practice of attempting to reduce risk, but the
goal of most hedge funds is to maximize return on investment.
3. Exchange Traded Funds or Index Shares
 An ETF is a hybrid product that combines the features of an Index Mutual Fund and Shares, therefore
also called as Index Shares. Like Index Funds (see Mutual Fund Chapter), these funds also follow
(i.e., track) underlying index. Like Shares, these can be traded.
 ETFs are listed on the stock exchanges and their prices are linked to underlying index. They can be
bought or sold any time during the market hours at a price which may be more or less than its NAV.
NAV of an ETF is the value of components of the benchmark index (i.e., the index that ETF tracks).
 There is no paper work involved for investing in ETF and they can be bought and sold just like any
other stock. They are attractive as investments because of their low cost tradability and stock-like
features.
 Following types of ETF products are available:
a. Index ETFs - Most ETFs are index funds that hold securities and attempt to replicate the
performance of a stock market index.
b. Commodity ETFs - Commodity ETFs invest in commodities, such as precious metals and futures.
c. Bond ETFs - Exchange-traded funds that invest in bonds are known as bond ETFs. They thrive
during economic recessions because investors pull their money out of the stock market and into
bonds.
d. Currency ETFs - The funds are total return products where the investor gets access to the FX
spot change, local institutional interest rates and a collateral yield.
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6. SECURITIZATION
1. Concept and Mechanism of Securitisation
The process of securitization typically involves the creation of pool of assets from the illiquid financial
assets, such as receivables or loans and their repackaging or rebundling into marketable securities. These
securities are then issued to investor. Example of such illiquid financial assets can be automobile loans,
credit card receivables, residential mortgages or any other form of future receivables.
Mechanism or steps involved in Securitisation process:
Step 1: Creation of Pool of Assets
The process of securitization begins with creation of pool of assets by originator (originator is the entity who
owns the illiquid financial assets). This involves segregating the assets backed by similar type of mortgages in
terms of interest rate, risk, maturity, etc.
Step 2: Transfer to Special Purpose Vehicle/Entity

Once the assets have been pooled, they are transferred by originator to SPV/SPE for consideration. SPV/SPE is
the entity especially created for the purpose of securitization.
Step 3: Sale of Securitized Papers

SPV designs the instruments (marketable securities) based on interest rate, risk, tenure etc. of pool of assets.
These instruments can be Pass Through Security or Pay Through Certificates. These certificates or securities are
issued to investors against consideration. (The amount raised through the issue is used by SPV to pay the
originator for the pool of asset bought from him.)
Step 4: Administration of Assets

The administration of assets in subcontracted back to originator which collects principal and interest from
underlying assets and transfer it to SPV.
Step 5: Recourse to Originator

Performance of securitized papers depends on the performance of securitised assets unless specified that, in
case of default, such illiquid assets will go back to originator from SPV.
Step 6: Repayment of funds

SPV will repay the amount to the investors in form of interest and principal, that are recovered by originator
and passed on to SPV.
Step 7: Credit Rating to Instruments

Sometime, before the sale of securitized instruments, credit rating can be done to help investors assess the risk
of the issuer.
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2. Participants in Securitisation Process and their Role

Role of Primary Participants:
1. Originator/Securitiser:
He is the initiator of the securitisation deal and also termed as Securitiser. It the entity that sells the
financial assets to the SPV and receive the funds from SPV. It transfers both legal and beneficial
interest in those assets to SPV. (The purpose of initiation of securitisation deal is to release the
amount blocked in illiquid financial assets).
2. SPV/SPE
SPVs are created especially for the purpose of deal i.e., converting illiquid financial assets into
marketable securities. For this purpose, it buys the financial assets to be securitised from the
originator by making an upfront payment. Then, they issue securities to the investors. SPV could be
in the form of company, firm or trust.
3. Investors
Investors are the buyer of securitized papers. They can be an individual or an institutional investor
like mutual funds, provident fund or insurance company. They acquire the securitised papers initially
and receive their money back at redemption in the form of interest and principal as per the agreed
terms.
Role of Secondary Participants:
1. Obligors
Actually, they are the main source of the whole securitization process. They are the parties who owe
money to the originators and are assets in the Balance Sheet of Originator. The amount due from the
obligor is transferred to SPV and hence they form the basis of securitization process.
2. Rating Agency
Since the securitization is based on the pools of assets rather than the originators, the assets have to
be assessed in terms of its credit quality and credit support available.
3. Receiving and Paying agent
Also, called Servicer or Administrator, it collects the payment due from obligors and passes it to SPV.
It also follows up with defaulting borrower and if required initiate appropriate legal action against
them.
4. Credit Enhancer
Since investors in securitized instruments are directly exposed to performance of the underlying
financial assets, they seek additional comfort in the form of credit enhancement.
5. Structurer
It brings together the originator, investors, credit enhancers and other parties to the deal of
securitization. Normally, these are investment bankers also called arranger of the deal.
6. Agent or Trustee
They take care of interest of investors who acquires the securities. They also make sure that all the
parties perform in true spirit.
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3. Features of Securitisation
1. Creation of Financial Instruments – The process of securities can be viewed as process of creation of
additional financial instruments in the market backed by collaterals.
2. Bundling and Unbundling – When all the assets are combined in one pool it is bundling and when
these are broken into instruments of fixed denomination it is unbundling.
3. Tool of Risk Management – In case of assets are securitized on non-recourse basis, then
securitization process acts as risk management as the risk of default is shifted on SPV.
4. Structured Finance – In the process of securitization, financial instruments are structured in such a
way that they meet the risk and return profile of investors, and hence, these securitized instruments
are considered as best examples of structured finance.
5. Tranching – Portfolio of different receivable or loan or other illiquid asset is split into several parts
based on risk and return they carry, called ‘Tranche’.
6. Homogeneity – Under each tranche the securities issued are of homogenous nature and even meant
for small investors who can afford to invest in small amounts.
4. Types of Securitization Instruments

1. Pass Through Certificate (PTC):
 As the title suggests, originator transfers (pass through) to SVP the entire receipt of cash in the
form of interest or principal repayment from the securitized assets. SPV further distributes it to
the investors.
 PTC securities represent direct claim of the investors on all the assets that has been securitized
through SPV and the investors carry proportional beneficial interest in the asset held in the trust
by SPV. (Just like how unitholders of any mutual fund have direct claim on the assets owned by
mutual fund).
 It should be noted that since it is a direct route, any prepayment of principal is also proportionately
distributed among the securities holders.
2. Pay Through Security (PTS)
 In case of PTS, securities are backed by financial asset of SVP (rather than having a direct claim on
the assets, these securities are secured these assets.)
 This structure permits desynchronization of ‘servicing of securities issued’ from ‘cash flow
generating from the financial asset’.
 Hence, it can restructure different tranches from varying maturities of receivables.
 Further, this structure also permits the SPV to reinvest surplus funds for short term as per their
requirement.
3. Stripped Securities
 Stripped Securities are created by dividing the cash flows associated with underlying securities into
two or more new securities. Those two securities are as follows:
i. Interest Only (IO) Securities
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ii. Principle Only (PO) Securities

 As each investor receives a combination of principal and interest, it can be stripped into two
portions as Principal and Interest.
 Accordingly, the holder of IO securities receives only interest while PO security holder receives only
principal. Being highly volatile in nature these securities are less preferred by investors.
5. Pricing of the Securitized Instruments

Pricing of securitized instruments in an important aspect of securitization. While pricing the instruments,
it is important that it should be acceptable to both originators as well as to the investors. On the same
basis pricing of securities can be divided into following two categories:
1. From Originator’s Angle
From originator’s point of view, the instruments can be priced at a rate at which originator has to
incur an outflow and if that outflow can be amortized over a period of time by investing the amount
raised through securitization.
2. From Investor’s Angle
From an investor’s angle security price can be determined by discounting best estimate of expected
future cash flows using rate of yield to maturity of a security of comparable security with respect to
credit quality and average life of the securities. This yield can also be estimated by referring the yield
curve available for marketable securities, though some adjustments is needed on account of spread
points, because of credit quality of the securitized instruments.
6. Benefits of Securitisation
From the point of Originator From the point of Investor
 Off-Balance Sheet Financing: When receivables

 Diversification of Risk: Purchase of
are securitized, it releases a portion of capital
securities backed by different types of
blocked in these assets resulting in off Balance
assets provides the diversification of
Sheet financing & improving liquidity position.
portfolio resulting in reduction of risk.
 More specialization in main business: By
 Regulatory requirement: Acquisition of
transferring the assets, the entity could
asset backed belonging to a particular
concentrate more on core business as servicing of
industry say micro industry helps banks to
loan is transferred to SPV. Further, in case of non-
meet regulatory requirement of
recourse arrangement even the burden of default
investment of fund in industry specific.
is shifted.
 Protection against default: In case of
 Helps to improve financial ratios: Especially in
recourse arrangement if there is any
case of Financial Institutions and Banks, it helps to
default by any third party, then originator
manage financial position related ratios
shall make good the least amount.
effectively.
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Adish Jain CA CFA
7. Problems Faced in Securitisation

1. Stamp Duty: Stamp Duty is one of the obstacle in India. Mortgage debt stamp duty which even goes
upto 12% in some states of India has impeded the growth of securitization in India.
2. Taxation: Taxation is another area of concern in India. In the absence of any specific provision
relating to securitized instruments in Income Tax Act, experts’ opinion differs a lot. Some are of
opinion that, SPV, as a trustee, is liable to be taxed in a representative capacity. While, others are of
view that instead of SPV, investors will be taxed on their share of income.
3. Accounting: Accounting and reporting of securitized assets in the books of originator is another area
of concern. Although, securitization is designated as an off-balance sheet instrument but in true sense
receivables are removed from originator’s balance sheet. Problem arises especially when assets are
transferred without recourse.
4. Lack of Standardisation: Every originator following his own format for documentation and
administration having lack of standardization is another obstacle in the growth of securitization.
5. Inadequate Debt Market: Lack of existence of a well-developed debt market in India is another
obstacle that hinders the growth of secondary market of securitized assets.
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7. MUTUAL FUNDS
1. Classification of Mutual Funds: On the basis of:
1. FUNCTIONS 2. PORTFOLIO 3. OWNERSHIP
Open ended funds Equity Funds: means Public Sector MF: are
 The investor can make entry (invest) the mutual funds that sponsored by companies
and exit (redeem) any time directly invest primarily (i.e., not of Public Sector.
with mutual fund. entirely) in stocks.
 The capital of the fund is unlimited.
 The redemption period is indefinite. Private Sector MF: are
Debt Funds: means the sponsored by companies
mutual funds that invest of Private Sector.
Close ended Funds primarily in debt
 Investor can buy directly from MF securities.
during IPO or from the stock market Foreign Mutual Funds
after listing. Similarly, redeem from are sponsored by foreign
MF at maturity or sell it in the stock Special Funds: companies for raising
market before maturity. discussed below... funds in India, operate
 Capital is limited. from India and invest in
 Redemption is finite. India.
A. Equity Funds C. Debt Fund B. Special Fund

Growth Funds: invest in Bond Funds: They invest in fixed Index Funds: Every market has a stock Index
securities which have long income securities e.g., government that measures the movement of the market.
term capital growth. These bonds, corporate debentures, etc. Index funds follows the stock index and are
MF provide long term Investors seeking tax free income low-cost funds. The investor will receive
capital appreciation to the go in for government bonds while whatever the market delivers.
investors. those looking for safe, steady International Funds are located in India to
Income Funds seek to income buy government or high- raise money in India for investing globally.
maximize present income grade corporate bonds. Offshore Funds is a mutual fund located in
of investors by investing in Bond funds are less volatile than India to raise money globally for investing in
safe stocks paying high stock funds and often produce India.
cash dividends. regular income. Investors often Sector Funds: They invest their entire fund in
Aggressive Funds look for invest in bond funds to diversify a particular sector say Technology, Pharma,
super normal returns for their portfolio, to get a regular
etc.
which investment is made income or to invest for medium
term goals. Quant Funds: works on a data-driven
in start-ups, IPOs and
approach for stock selection and investment
speculative shares. Gilt Funds invest in Govt Securities.
decisions based on a pre-determined rules
using statistics or mathematics-based
models. (discussed in details below)
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Adish Jain CA CFA
2. Benefits of Mutual Fund

1. Professional Management: The funds are managed by skilled and professionally experienced
managers with a back-up of a Research team.
2. Diversification: Mutual Funds offer diversification in portfolio by investing in large number of securities
which reduces the risk.
3. Economies of Scale: The “pooled” money from a number of investors ensures that mutual funds enjoy
economies of scale. It is cheaper compared to investing directly in the capital markets which involves
higher charges.
4. Transparency: The SEBI Regulations now compel all the Mutual Funds to disclose their portfolios on a
half-yearly basis. However, many Mutual Funds disclose this on a quarterly or monthly basis to their
investors.
5. Flexibility: There are a lot of features in a mutual fund scheme, which imparts flexibility to the scheme.
An investor can opt for Systematic Investment Plan (SIP), Systematic Withdrawal Plan etc. to plan his
cash flow requirements as per his convenience.
3. Short note on Quant Funds:

Quant Fund works on a data-driven approach for stock selection and investment decisions based on a
pre-determined rules or parameters using statistics or mathematics-based models.
While an active fund manager selects the volume and timing of investments (entry or exit) based on
his\her analysis and judgement, in this type of fund, complete reliance is placed on an automated
programme that decides making decision for volume and timings of investments and concerned manager
has to act accordingly.
However, it is to be noted it does not mean that in this type of Fund there is no human intervention at all,
because the Fund Manager usually focuses on the robustness of the Models being used and also monitors
their performance on continuous basis and if required some modification is done in the same.
The prime advantage of Quant Fund is that it eliminates the human biasness and subjectivity and using
model-based approach also ensures consistency in strategy across the market conditions.
Sometime the term ‘Quant Fund Manager’ is confused with the term ‘Index Fund Manager’ but it should
be noted that both terms are different. While the Index Fund Manager entirely hands off the investment
decision purely based on the concerned Index, the Quant Fund Manager designs and monitors models
and makes decisions based on the outcomes.
4. Fixed Maturity Plans

Fixed maturity plans (FMPs) are a debt mutual funds that mature after a pre-determined time period.
FMPs are closely ended mutual funds in which an investor can invest during a New Fund Offer (NFO).
FMPs, which are issued during NFO, are later traded on the stock exchange where they are listed. But,
the trading in FMPs is very less. So, basically FMPs are not liquid instruments.
FMPs usually invest in Certificates of Deposits (CDs), Commercial Papers (CPs), Money Market Instruments
and Non-Convertible Debentures over fixed investment period. Sometimes, they also invest in Bank Fixed
Deposits.
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Adish Jain CA CFA
Presently, most of the FMPs are launched with tenure of three years to take the benefit of indexation.
The main advantage of Fixed Maturity Plans is that they are free from any interest rate risk because FMPs
invest in debt instruments that have the same maturity as that of the fund. However, they carry credit
risk, as there is a possibility of default by the debt issuing company. So, if the credit rating of an instrument
is downgraded, the returns of FMP can come down.
5. Direct Plan in Mutual Funds

Direct plan means plans where an investor can directly invest in the mutual funds without involving
distributor or broker. This helps mutual funds to save the distribution charges they have to pay to
distributors. Mutual funds pass on this benefit to the investor by keeping the NAV of direct plan higher
than NAV of a distributor plan (plans that involve distributor, also called as regular plan) by the amount
of distribution charges.
Mutual Funds have been permitted to take direct investments in mutual fund schemes even before 2011.
But there were no separate plans for these investments. These investments were made in distributor plan
itself and were tracked with single NAV i.e., NAV of the distributor plans. Therefore, even when an investor
bought direct mutual funds, he had to buy it based on the NAV of the distributor plans.
However, things changed with introduction of direct plans by SEBI on January 1, 2013. Mutual fund direct
plans are the plans in which Asset Management Companies or mutual fund Houses do not charge
distributor expenses, trail fees and transaction charges. NAV of the direct plan are generally higher in
comparison to a regular plan. Studies have shown that the ‘Direct Plans’ have performed better than the
‘Regular Plans’ for almost all the mutual fund schemes.
6. Tracking Error
 Tracking error can be defined as the divergence or deviation of a fund’s return from the return of
benchmark it is tracking (following). In other words, it is the error made by MF while tracking an index,
i.e., difference between ‘return from fund’ and ‘return from index which it was following’.
 The passive fund managers design their investment strategy to closely track the benchmark index.
However, often it may not exactly replicate the index return. In such situation, there is possibility of
deviation between the returns.
 Higher the tracking error, higher is the risk profile of the fund. Whether the funds outperform or
underperform their benchmark indices, it clearly indicates that of fund managers are not following the
benchmark indices properly. In addition to the same, other primary reason for tracking error are
Transaction cost, Fees charged by AMCs, Fund expenses and Cash holdings.
7. Side Pocketing
Understanding the lengthy yet simple concept:
 Suppose, a mutual fund (say XYZ) has total investment of ₹1000 in the bonds of different companies,
out of which ₹200 is invested in a particular company (say Bad Ltd.). Now, if Bad Ltd defaults in making
the coupon payment or principal repayment on its bond, then, as per SEBI norms, XYZ will have to write
down such investment in its books and consequently NAV of the fund will fall and also its credit ratings.
Due to such event and out of fear, the unitholders might sell or redeem their units at the reduced NAV
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Adish Jain CA CFA
which may be less than its true NAV because even if investment in Bad Ltd is fully written down, there
is possibility of recovering some amount from Bad Ltd.
 In such a situation, both XYZ and its unitholders will suffer. XYZ might suffer liquidity issue, if large
number to unit holders come to redeem their units. And, unitholders might sell their units at a NAV
lower than its true NAV.
 To avoid such situations, XYZ will separate investment of ₹200 in Bad Ltd.’s bonds (now onwards
referred as risky or illiquid assets) from its other good investments of ₹800 and shift it in the SIDE
POCKET. So, now there are two categories of assets lying with XYZ- Good or liquid assets (of ₹800) and
risky or illiquid assets (of ₹200).
 Note that, since XYZ has side-pocketed illiquid investments, the NAV of the fund will now reflect the
value of only liquid assets of ₹800. Therefore, for illiquid assets, unitholders are issued units of a new
scheme of mutual fund (now onwards referred as ‘new units’) in addition to original units already held
by them. This new scheme will represent the claim of unitholders in the risky assets of ₹200.
 Hence, we can say that, unitholders will now have two types of units- original units (which represent
the claims in good or liquid assets) and new units (which represent the claim in risky assets)
 Original units of the fund can be bought and sold normally as they were done earlier, but investors are
not interested to sell them, since, now they represent only liquid assets. Whereas, with respect to new
units, there are certain restrictions its sale imposed by SEBI due to which, they cannot be redeemed for
some period.
 Hence, side pocketing will help both XYZ and its unitholders to not suffer on the event of default by any
company.
Answer from exam point of view from Study Material:
 Side Pocketing in Mutual Funds means separation of risky or illiquid assets from other investments and
cash holdings.
 Whenever, the rating of a mutual fund decreases, the fund shifts the illiquid assets into a side pocket
so that unitholders can be benefitted atleast from the liquid assets held by the fund. Consequently, the
NAV of the fund will now reflect the value of only liquid assets.
 The purpose is to also make sure that money invested in MF, which is linked to illiquid asset, gets
locked, until the MF recovers the money from the company.
 Side Pocketing is beneficial for those investors who wish to hold the units of the original scheme for
long term. Therefore, the process of Side Pocketing ensures that liquidity is not the problem with MF
even in the circumstances of frequent allotments and redemptions of units.
 In India, recent case of IL&FS has led to many discussions on the concept of side pocketing as IL&FS
and its subsidiaries have failed to fulfil its repayments obligations due to severe liquidity crisis. The MF
had given negative returns because they have completely written off their exposure to IL&FS
instruments.
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Adish Jain CA CFA
8. DERIVATIVES ANALYSIS AND VALUATION

1. Difference between Spot/Cash Market and Derivatives Market
BASIS SPOT or CASH MARKET DERIVATIVES MARKET
Market where assets itself are traded for Financial market where contracts based on
Meaning immediate delivery. such assets are traded.
Quantity Even one share can be purchased Futures and options has minimum lot size
Investment Full amount is required to be paid Only margin or premium is to be paid
Risk More risky than derivatives market Less risky than cash market
Purpose Consumption or investment Hedging, Arbitrage or Speculation
Example Example: shares, forex, commodity Example: stock futures, currency options
2. Difference between Futures and Forwards

BASIS FORWARD FUTURE
Forward are entered into on personal Futures are entered into by buying or selling
Contract type
basis through phone or meeting. on exchange.
Fully tailored. Not standardised about Standardised in term of quality, quantity
Standardised
quality, quantity or time. and time.
Market Over the counter market Exchange traded
Margin Not required Required
Credit Risk Risk of default Guarantee of performance
Liquidity Less Liquidity More liquidity
3. Physical Settlement and Cash Settlement of Derivatives Contract

 The physical settlement in case of derivative contracts means that underlying assets are actually
delivered on the specified delivery date. In other words, traders will have to take delivery of the shares
against position taken in the derivative contract.
 In case of cash settlement, the seller of the derivative contract does not deliver the underlying asset
but transfers the amount of gain or loss on the contract in cash. It is similar to Index Futures where the
trader, who wants to settle the contract in cash, will have to pay or receive the difference between the
Spot price of the asset on the settlement date and the Futures price agreed to.
 The main advantage of cash settlement in derivative contract is high liquidity because of more
derivative volume in cash settlement option, since traders can trade in derivatives segment without
taking position in spot market.
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Adish Jain CA CFA
 Also, a liquid derivative market facilitates the traders to do speculation. The speculative trading may
worry the regulators but it is also true that without speculative trading, it will not be possible for the
derivative market to stay liquid.
4. Difference between Futures or Forwards and Options

BASIS FORWARDS / FUTURES OPTIONS
Performance of Obligation to buy or sell the asset In case of long position, choice to buy or sell
contract under the contract. the asset under the contract.
Initial Forwards: No investment
Premium is paid to buy the option
investment Futures: Margin is paid
Gain or Loss Unlimited gain/loss on the contract In case of long position: Limited gain/loss
Duration of the
Generally, longer than option Generally, shorter than futures/forwards
contract
5. Greeks- Factors affecting value of an option

Factors that affect the value of an option and Change in the value of option due to these
how they affect it... factors is measured by Greeks:
1. PRICE of the underlying asset: DELTA

Then, Value of: It is the ratio by which value of an option will
If price of the
change due to change in price of underlying
underlying asset: Call Option Put Option
asset. It is used for hedging through options.
 Rises Increases Decreases  Delta of call option is Positive.
 Falls Decreases Increases  Delta of put option is Negative.
2. VOLATILITY of price of underlying asset: VEGA
It indicates the change in value of option for
If volatility of price: a one percent change in volatility. Like delta,
 Increases: Value of option increases. Vega is also used for hedging.
 Decreases: Value of option decreases.
3. TIME till expiry of the option. THETA

It indicates the change in the value of option
As the time passes and time period till expiry
for one day decrease in period till expiration.
of the option reduces, price of call and put
It is a measure of time decay.
option falls.
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Adish Jain CA CFA
4. RISK FREE RATE OF INTEREST: RHO
If risk free rate of interest: It indicates the value of option for one
percent change in risk free rate of interest.
 Increases: Value of option decreases.
 Decreases: Value of option increases.
(there are only four factors, Gamma is an GAMMA

additional Greek used in calculations related to Measures how fast delta change due to
options) small change in price of underlying asset.
6. Intrinsic Value and Time Value of an Option

 Intrinsic Value
 It is the value that an option would fetch if it is exercised today.
 It means, for call option it is the value by which today’s spot price is higher than exercise price and
for put option it is the value by which exercise price is higher than today’s spot price.
 The minimum intrinsic value of any option can be zero (i.e., it cannot be negative), since in case of
negative value, option will not be exercised.
 Time Value
 It is the value of premium over and above the Intrinsic Value.
 It is the risk premium that option writer requires to give buyer the right to exercise the option.
7. Explain Co-Location Facility or Proximity Hosting

 The co-location or proximity hosting is a facility which is offered by the stock exchanges to stock
brokers and data vendors, whereby, their trading or data-vending systems are allowed to be located
within or at close proximity to the premises of the stock exchanges. They are allowed to connect to the
trading platform of stock exchanges through direct and private network.
 Stock exchanges are advised to allow direct connectivity between co-location facility of one recognized
stock exchange and the co-location facility of other recognized stock exchanges.
 Stock exchanges are also advised to allow direct connectivity between servers of a stock broker placed
in colocation facility of a recognized stock exchange and servers of the same stock broker placed in
colocation facility of another recognized stock exchange.
 In order to facilitate small and medium sized members, who otherwise find it difficult to own and
maintain a co-location facility due to cost or other reasons, SEBI has directed the stock exchanges to
introduce ‘Managed Co-location Services’.
 Under this facility, some space in co-location facility shall be allotted to eligible vendors by the stock
exchange along with arrangement for receiving market data for its further dissemination to their
clients.
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Adish Jain CA CFA
9. FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT

1. Interest Rate and Purchase Power Parity Theorem
1. Interest Rate Parity Theorem (IRPT)
 IRP Theorem defines the relationship between exchange rate between currencies of two countries
and interest rates of those countries.
 Interest rate parity is a theory which states that the forward premium (or discount) of any currency
with respect to another currency should be equal to the interest rate differential of the two
countries.
(1 + interest rate of price currency)
 According to IRPT, Forward rate: Spot rate ×
(1 + interest rate of base currency)
 Hence, currency of the country with higher interest rate will trade at forward discount and
currency of the country with lower interest rate will trade at forward premium.
 When IRPT holds true, covered interest arbitrage is not feasible.
2. Purchase Power Parity Theorem (PPPT)
 PPP is based on “Law of one price”. It says that price of same product in two different countries
should be equal when measured in common currency.
 Similar to IRP Theorem, PPPT defines the relationship between exchange rate between currencies
of two countries and inflation rates of those countries.
 According to PPPT, expected appreciation (or depreciation) of any currency with respect to
another currency should be equal to the inflation differential between the two countries.
(1 + inflation rate of price currency)
 According to PPPT, Expected Spot rate: Spot rate ×
(1 + inflation rate of base currency)
 Hence, currency of the country with higher inflation rate is expected to depreciate and currency
of the country with lower inflation rate is expected to appreciate.
1. Non-Deliverable Forward Contract

 As name says, NDFC is a forward contract where the profit/loss on the contract is settled in cash.
 Profit is calculated by taking the difference between the agreed upon exchange rate (i.e., the forward
rate) and the spot rate at the time of settlement, for an agreed upon notional amount of currency.
NDFs are commonly quoted for time periods of one month up to one year.
2. Types of currency exposures

A. Translation Exposure: Also known as ‘Accounting Exposure’, it refers to the gain/loss caused by the
translation of foreign currency asset or liability. It arises because ‘the exchange rate on the date when
transaction was recorded’ was different from ‘the exchange rate on the date when financial
statements are reported.
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Example: An exporter has sold goods worth $500 and exchange rate is ₹/$ 65. Now, at year end, if
exchange rate changes to ₹/$ 60. Loss due to Translation Exposure is (65-60)*500= ₹2,500.
B. Transaction Exposure: It refers to the gain/loss which arises due to difference in the exchange rates
on ‘the date when transaction was entered into’ and ‘the date when the transaction is settled’. It deals
with the higher or lower cash flows in home currency required to settle any obligation in foreign
currency.
Example: An importer purchased goods worth $100 and exchange rate is ₹/$ 55. Now, at the time of
payment, if exchange rate changes to ₹/$ 60. Loss due to Transaction Exposure is ₹500.
C. Economic Exposure: It refers to the extent to which economic value of a company can decline due
to change in exchange rates. Even if the company is not directly dealing in transactions denominated
in foreign currency, it is exposed to economic risk. The exposure is on account of macro level factors
such as:
 Change in the prices of inputs used or output sold by competitors (giving them advantage)
 Reduction in demand by the foreign importer due increased prices in his HC (if invoicing is done in
exporter’s HC, then importer will have to pay more in his HC to by same amount of FC)
Difference between Transaction and Economic Exposure:
TRANSACTION EXPOSURE ECONOMIC EXPOSURE
 Is direct in Nature  Is indirect in Nature
 Amount of exposure is known  Amount of exposure in unknown
 Faced by only firms who have entered into FC  Faced by all the firms whether they have entered
transactions into FC transactions or not
 Easy to hedge  Difficult to hedge
3. Techniques of hedging transaction exposure or currency risk

Internal Hedging Techniques External Hedging Techniques
 Invoicing  Forward Cover

 Leading & Lagging  Money Market Cover
 Netting  Future Cover
 Matching  Options Cover
 Price Variation  Swap Cover
 Asset & Liability Management
 Invoicing: Companies engaged in export and import are concerned with decisions relating to the
currency in which goods and services are to be traded (invoiced). Trading in a foreign currency gives
rise to transaction exposure whereas, trading purely in a company's home currency has no currency
risk.
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Adish Jain CA CFA
 Leading & Lagging: Leading and Lagging refer to adjustments in the times of payments in foreign
currencies. Leading means advancing the timing of payments and receipts. Lagging means
postponing (delaying) the timing of payments and receipts. These techniques are aimed at taking
advantage of expected appreciation or depreciation of relevant currencies.
 Settlement Netting or (only) Netting: Netting means adjusting receivable and payables. Under this
technique, group companies merely settle inter affiliate indebtedness for the net amount owing.
The reduced number and amount of transaction leads to savings in transaction cost (such as
buy/sell spreads in the spot and forward markets) and administrative cost resulting from currency
conversion.
 Matching: Although, ‘netting’ and ‘matching’ are used interchangeably, there is a difference
between the two. Netting is a term applied to potential cash flows within group companies whereas
matching can be applied to both inter-company and to third-party balancing. Matching is a
mechanism whereby a company matches its foreign currency inflows with its foreign currency
outflows in respect of amount and approximate timing. Receipts in a particular currency are used
to make payments in that currency thereby reducing the need for a group of companies to go to the
foreign exchange markets only for the unmatched portion of foreign currency cash flows.
 Price Variation: Price variation involves increasing selling prices to counter the adverse effects of
exchange rate change.
 Asset and liability management: can involve aggressive or defensive postures. In the aggressive
attitude, the firm increases exposure of inflows denominated in strong currencies or increases
exposure of outflows denominated in weak currencies. The defensive approach involves matching
cash inflows and outflows according to their currency of denomination, irrespective of whether they
are in strong or weak currencies.
4. Exposure Netting
 Exposure Netting refers to offsetting exposure in one currency with exposure in the same or another
currency, where exchange rates are expected to move in such a way that loses (or gains) on the first
exposed position are offset by gains (or losses) on position in the second currency.
 The objective of the exercise is to offset the likely loss in one exposure by likely gain in another.
 This is a method of hedging foreign exchange exposure is different from forward and option contracts. This
method is similar to portfolio approach in handling systematic risk. (Recollect that to reduce the beta of
the portfolio, position on index futures was taken such that loss (gain) on portfolio is offset by gain (loss)
on index futures).
5. Strategies for Exposure Management

There are four strategies of foreign exchange exposure management:
1. High risk – High reward
These strategies can be remembered
2. Low risk – Reasonable reward easily by understanding below graph
3. Low risk – Low reward showing different combinations of risk
and reward.
4. High risk – Low reward
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Adish Jain CA CFA
 This strategy involves active trading in

 Perhaps the worst strategy is to leave the currency market through
all exposures unhedged. continuous booking and cancellations
High Risk
 The risk of destabilization of cash flows of forward contracts.
is very high,  In effect, this requires the trading
 The merit is zero investment of function to become a profit centre.
managerial time or effort. All  This strategy requires high skills to
exposure Active identify profit opportunities.
left Trading
unhedged
Low Reward High Reward
All
Selective
Exposure  This strategy requires selective hedging
 This option involves automatic hedging Hedging
Hedged
of exposures in the forward market as of exposures whenever forward rates
soon as they arise irrespective of the are attractive but keeping exposures
attractiveness or otherwise of the unhedged whenever they are not.
forward rate.  Successful pursuit of this strategy
 This option doesn't require any Low Risk requires quantification of expectations
investment of management time or about the future and the rewards
effort. would depend upon the accuracy of
the prediction.
6. Foreign Currency Accounts

Nostro (Our account with you): This is a current account maintained by a domestic bank with a foreign
bank in foreign currency.
Indian Bank Foreign Bank

(HDFC) (Swiss Bank)
HDFC will call its account with

Swiss Bank as Nostro Account.
Vostro (Your account with us): This is a current account maintained by a foreign bank with a domestic
bank in home currency.
We can say that, in the given

case, the same account, if seen,
Indian Bank Foreign Bank from HDFC’s point of view, is
(HDFC) (Swiss Bank) Vostro account, whereas, from
Swiss Bank’s point of view, it is
HDFC will call, the account of Swiss Bank Nostro account.
maintained with it, as Vostro Account.
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Adish Jain CA CFA
Loro Account (Their account with you): This is a current account maintained by one domestic bank on
behalf of other domestic bank in foreign bank in a foreign currency.
Indian Bank
(say HDFC)
Foreign Bank
(Swiss Bank)
Indian Bank
SBI will call, the Nostro account of HDFC
(SBI)
maintained with Swiss bank, as Loro Account.
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Adish Jain CA CFA
10. INTERNATIONAL FINANCIAL MANAGEMENT

1. International or Multinational Cash Management
Cash Management Systems (CMS) in case of companies operating in multiple countries includes:
Centralized CMS: Each branch’s cash position is Decentralized CMS: Each branch is viewed as separate
managed by single centralized authority. undertaking and cash positions are managed separately.
There is a Cash Management Centre. There is no Cash Management Centre.

Local borrowings & investments are not allowed. Local borrowings & investments are allowed.
Net cash requirement is lower. Net cash requirement is higher.
Involves flow of excess or deficit cash among
No such flows are involved.
branches.
2. Sources of International Finance

3. Short note on FCCBs, Euro Convertible Bonds, ADR and GDR.
1. Foreign Bonds
2. Euro Bonds:
Bond issued by any company in a
native to the company not native to the company
currency which is:
native to the country where the bond
is issued
Domestic Bond Foreign Bond
not native to the country where the
bond is issued
Eurobond
Hence, we can say that:
Domestic Bond: Though, we can understand meaning of domestic bond from the above table, but it
is not a source of international finance, hence won’t form part of the answer here.
Foreign bonds are debt instrument denominated in a currency not native to borrower (borrower
means the company issuing the bonds) but native to the country where the bonds are issued. For
example: Rupee denominated bonds of Apple Inc. issued in India or Dollar denominated bonds of TCS
Ltd. issued in USA. These bonds have restrictions placed by government of the country where they
are issued.
Euro bonds are debt instrument denominated in a currency which is not native to the country where
the bonds are issued. For example: Dollar denominated bond of any company issued in India or Yen
denominated bond issued in USA. (Note that, its name ‘Euro Bond’ has no relation with Europe or
Euro currency).
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3. Foreign Currency Convertible Bonds (FCCBs): Foreign bonds are debt instrument denominated in a
currency not native to borrower but native to the country where the bonds are issued. FCCB is a type
of foreign bond which gives the bondholder an option to convert the bond into the stocks of the
company. It is a mix of debt and equity instrument, as it acts like a bond by making regular coupon
and principal payments and also gives the bondholder an option to convert it into stock.
 Benefit to investor: Buyer of this bond is benefitted by appreciation in the price of company’s
stock.
 Benefit to issuer: Due to attached equity option, coupon rate on such bonds is relatively lower.
4. Euro Convertible Bond: Euro bonds are debt instrument denominated in a currency which is not
native to the country where the bonds are issued. Euro Convertible bond is a type of euro bond which
has an option, attached to it, to convert it into the equity shares of the company. Euro option may
carry two options:
 Call option: Issuer has the option to call (buy) the bonds before redemption and issue equity
shares.
 Put option: Investor (holder) has the option to put (sell) the bonds before redemption and get
equity shares against such bonds.
5. ADR and GDR: Since ADR and GDR are similar instruments and also because it becomes easy to
remember, they have been explained together. But these concepts may be asked individually in
exams, in which case below answer to be made specific. Depository receipt is a negotiable certificate
denominated in currency not native to the company issuing it, representing its one or more local
currency equity shares publically traded in its home country. When such receipt is issued in:
in US it is called ADR
Outside of USA it is called GDR
Mechanism of DRs: Other Important Points:
Company issues local currency equity

 ADR is denominated in USD whereas, GDR
shares
can be denominated in USD, EUR or GBP.
 ADR and GDR trade in the same way as any
other security, either on stock exchange
Such shares are kept with depository
or OTC market.
bank or depository’s local custodian banks
 Holders of ADR & GDR participate in the
same economic benefits as an ordinary
shareholder, however, they do not have
Against which, ADRs/GDRs are issued to
voting rights.
foreign investors.
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11. INTEREST RATE RISK MANAGEMENT

1. Interest Rate Swaps
Interest Rate Swap is an agreement to exchange cash flows linked to different interest rates.
Types of interest rate swaps:
1. Plain Vanilla Swap: Also called as Generic Swap, it involves the exchange of interest on fixed rate
loan for interest on floating rate loan. Floating rate can be LIBOR, MIBOR, Prime Lending Rate etc.
Fixed interest payments are calculated on 30 days/360 days basis whereas, Floating interest payment
is calculated on actual number of days/360 days basis.
2. Basis Rate Swap: Also called as Non-Generic Swap, it is similar to plain vanilla swap with the
difference that payments to be exchanged under the swap are based on the two different variable
rates (variable rates means floating rates only). For example, 1 month LIBOR may be exchanged for
3-months LIBOR. In other words, Both the legs of swap are floating but are measured against
different benchmarks.
3. Asset Swap: It is also like plain vanilla swaps, with the difference that it is an exchange of fixed rate
investments such as bonds which pay a guaranteed coupon rate with floating rate investments such
as an index.
4. Amortising Swap: It is an interest rate swap in which the notional principal, on which interest
payments are calculated, declines during the life of the swap. They are particularly useful for
borrowers who have issued redeemable bonds or debentures. It enables them to hedge interest
payments based on the redemption profile of bonds or debentures.
2. Swaption
An interest rate swaption is simply an option on interest rate swap. It gives the holder the right but not
the obligation to enter into an interest rate swap at a specific date in the future, at a particular fixed rate
and for a specified term.
 A 3-month into 5-year swaption would mean an option to enter into a 5-year interest rate swap after
3 months.
 The swaption premium is expressed as basis points.
 There are two types of swaption contracts: -
 A fixed rate payer swaption gives the owner of the swaption the right but not the obligation to
enter into a swap where they pay the fixed leg and receive the floating leg.
 A fixed rate receiver swaption gives the owner of the swaption the right but not the obligation to
enter into a swap in which they will receive the fixed leg, and pay the floating leg.
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12. CORPORATE VALUATION

1. Enterprise Value
 Enterprise value is the true economic value of a company. It is the theoretical value of business of
target company under the takeover.
 It is calculated as:
Market Capitalization + Long Term Debt + Minority Interest - Cash and Cash Equivalents
 Enterprise value considers both equity and debt in its valuation of the firm, and therefore it is least
affected by the capital structure of the firm.
 Enterprise Value based multiples (such as EV/sales, EV/EBITDA, etc.) are more reliable than Equity
Value based multiples (such as P/E, P/B Ratio, etc.) because Equity Value based multiples focus only
on equity claim.
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13. MERGERS, ACQUISITIONS AND CORPORATE

RESTRUCTURING
1. Rationale behind Mergers | Benefits of Mergers
1. Synergy:
 Synergy means the combined value of two firms or companies is more than their individual value.
 Cost saving due to non-duplication of functions and economics of large scale are few reasons for
synergy benefits.
 These economies can be real economies, which means reduction in factor input per unit of output
(means per unit fixed cost will reduce), or pecuniary economics which means actually paying lower
prices for factor inputs for bulk transactions.
2. Diversification: Merger between two unrelated companies would lead to reduction in business risk,
which in turn will increase the market value consequent upon the reduction in discount rate/ required
rate of return. (meaning to say lower the risk, lower is the required rate of return).
3. Taxation: The provisions of set off and carry forward of losses as per Income Tax Act may be another
strong season for the merger and acquisition. Thus, there will be Tax saving or reduction in tax liability
of the merged firm.
4. Growth: Growth of any company by way of acquiring companies is called as inorganic growth. Merger
and acquisition mode enables the firm to grow at a rate faster than the other mode like organic growth
mode. The reason being the shortening of ‘Time to Market’.
5. Consolidation of Production Capacities and increasing market power: Due to reduced competition,
marketing power increases. Further, production capacity is increased by combining of two or more
plants.
2. Types of Merger
1. Horizontal Merger: The two companies that merge, are in the same industry selling similar or
competing products. Normally the market share of the new consolidated company would be larger
and it is possible that it may move near monopoly to avoid competition.
2. Vertical Merger: This merger happens when two companies having buyer-seller relationship come
together to merge.
3. Conglomerate Mergers: Such mergers involve firms engaged in unrelated type of business operations.
In other words, the business activities of acquirer and the target are related neither horizontally nor
vertically.
4. Congeneric Merger: In these mergers, the acquirer and the target companies are related through basic
technologies, production processes or market. The acquired company represents an extension of
product-line or technologies of the acquirer.
5. Reverse Merger: Next question...
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3. Reverse Merger or Takeover by Reverse Bid

Normally, the company taken over is the smaller company than acquirer. But, in a 'reverse merger', a
smaller company gains control of a larger one.
Below three tests should be fulfilled before an arrangement can be termed as a reverse takeover:
1. the assets of the target company are greater than acquirer company,
2. equity capital to be issued by acquirer against acquisition exceeds its existing issued capital and
3. the change of control in the acquirer company through the introduction of a minority holder or group
of holders.
Such mergers normally involve acquisition of a public by a private company, as it helps private company
to by-pass lengthy and complex process required for public issue. This type of merger is also known as
back door listing.
4. Demerger or Disinvestment or Divestitures: Meaning and Reasons

It means a company selling one of its divisions or undertakings to another company or creating an
altogether separate company. It has following advantages:
 Attention on core areas of business
 Division not contributing to revenues
 Size of the firm may be too big to handle
 Need cash in for other investment opportunity
5. Types of Demerger
1. Sell-off: A sell off is the sale of an asset, factory, division or subsidiary by one entity to another for a
purchase consideration payable either in cash or in the form of securities.
2. Split-up: This involves breaking up of the entire firm into separate legal entities for each business
division. The parent firm no longer legally exists and only the newly created entities survive individually.
3. Spin-off: In this case, a part of the business is separated and created as a separate firm. The existing
shareholders of the firm get proportionate ownership. So, there is no change in ownership and the
same shareholders continue to own the newly created entity.
4. Equity Carve Outs: This is like spin off, however, some shares of the new company are sold in the
market by making a public offer. This brings cash in the company.
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Adish Jain CA CFA
6. Management Buy-outs (MBO) & Leveraged Buy-out (LBO)

1. Management Buy Outs: Since, management of the company has better understanding of the business
and operations of the company, they sometimes consider buying out a company facing financial
difficulties. Buyouts initiated by the management team of a company are known as a management
buyout. In this type of acquisition, the company is bought by its own management team.
2. Leveraged Buyout:
 An acquisition of a company or a division of that company which is financed entirely or partially
(50% or more) using borrowed funds is termed as a leveraged buyout.
 The target company no longer remains public after the leveraged buyout, hence the transaction is
also known as going private.
 After an LBO, the target entity is managed by private investors, which makes it easier to have a
close control of its operational activities. The intention behind LBO transaction is to improve
operational efficiency of a firm and increase sales volumes, which leads to improved cash flows.
 The extra cash flow generated will be used to pay back the debts in LBO transaction.
 The LBO does not stay permanent. Once the LBO is successful in increasing profit margins & cash
flows and debt is paid back, it will go public again.
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14. Start-up Finance

1. Innovative ways of financing or Sources of funding a Start-up
1. Personal financing: Personal financing means investing one’s own money. It is important because
most of the investors will not put money in your start-up if they see that you have not contributed any
money from your personal sources.
2. Family and friends. These are the people who generally believe in you, without even thinking that your
idea works or not. However, the loan obligations to friends and relatives should always be in writing
as a promissory note.
3. Crowdfunding. Crowdfunding is the use of small amounts of capital from a large number of individuals
to finance a new business. Crowdfunding makes use of vast networks of people on social media and
crowdfunding websites to bring entrepreneurs and investors together.
4. Microloans. Microloans are small loans given by individuals at a lower interest to new business
ventures. These loans can be issued by a single individual or group of individuals who in aggregate
contribute to the total loan amount.
5. Peer-to-peer landing: In this process group of people come together and lend money to each other.
Many small and ethnic business groups having similar faith or interest generally support each other in
their start up endeavours.
6. Vendor Financing. Vendor financing is the form of financing in which a company lends money to its
customers so that he can buy products from the company itself. Vendor financing also takes place
when many manufacturers and distributors are convinced to defer payment until the goods are sold.
However, this depends on one’s credit worthiness.
7. Factoring accounts receivables. In this method, a facility is given to the seller who has sold the good
on credit to fund his receivables till the amount is fully received. So, when the goods are sold on credit,
the factor will pay most of the amount up front and rest of the amount later.
2. Modes of Financing a Start-up

1. Angel Investors
 Angel investors are affluent individuals who inject capital for start-ups in exchange for ownership
equity or convertible debt.
 Angel investors invest in small start-ups. The capital that angel investors provide may be a one-
time investment to help the business propel or an ongoing injection of money to support and
carry the company through its difficult early stages.
 Angel investors are focused on helping start-ups take their first steps, rather than the possible
profit they may get from the business.
 Angel Investors typically invest their own money, unlike venture capitalists who invest money
pooled from many investors.
 Angel investors are also called informal investors, angel funders, private investors, seed investors
or business angels. Angel Investors usually represent individuals, but the entity that actually
provides the funds may be an LLP, trust, etc.
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2. Venture Capital Funds

 Venture capital is the money provided by professionals who invest in young and rapidly growing
companies that have the potential to develop into significant economic contributors.
 Venture Capital Fund (just like a mutual fund) means investment vehicle that manage funds of
investors seeking to invest in startup and small businesses with exceptional growth potential.
Venture Capital funds invest in equity and debt instruments of these businesses.
 Investors in Venture Capital Funds include Financial Institutions, Banks, Pension Funds, HNIs, etc.
3. Bootstrapping
English word ‘Bootstrap’ means ‘get oneself out a situation using existing resources’. Bootstrapping
means when an individual attempt to found and build a company from personal finances or from the
operating revenues of the new company.
Methods in which a start-up firm can bootstrap:
A. Trade Credit
 When a person is starting his business, suppliers are reluctant to give trade credit. They insist
to make upfront payment for the goods supplied.
 Preparing a well-crafted financial plan and convincing supplier about it can help to get credit.
For small business organization, the owner can be directly contacted and for big firm, the Chief
Financial Officer (CFO) can be contacted.
 Along with financial plan, the owner or the CFO has to be explained about the business and the
need to get the first order on credit in order to launch the venture.
B. Factoring
 This is a financing method where accounts receivable of a business organization is sold to a
commercial finance company to raise capital.
 Factoring frees up the money that would otherwise be tied to receivables. This money can be
used to generate profit through other avenues of the company.
 It can also reduce costs associated with maintaining accounts receivable such as bookkeeping,
collections and credit verifications
C. Leasing
 This method of bootstrapping involves taking the equipment on lease rather than purchasing.
 It reduces the amount of capital to be employed in the business along with reducing the risk of
incurring fixed capital expenditure.
 Both lessor and lessee enjoy the tax benefit, respectively on depreciation on fixed asset and
lease rentals under the agreement.
3. Pitch Presentation and its Approach

While raising funds from the investors like Angel Investors or Venture Capital Funds, a presentation is
required to be made to them; called as Pitch Presentation. Pitch deck presentation is a short and brief
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Adish Jain CA CFA
presentation to investors explaining about the prospects of the company and why they should invest into
the start-up business. It is a quick overview of business plan and convincing the investors to put some
money into the business.
How to approach a pitch presentation?
1. Introduction: First step is to give a brief account of yourself i.e. who are you? What are you doing?
Use this opportunity to get your investors interested in your company.
2. Team: The next step is to introduce the team to the investors. The reason is that the investors will
want to know the people who are going to make the product or service successful.
3. Problem: In a pitch presentation, the promoter should be able to explain the problem he is going to
solve.
4. Solution: It is very important to describe how the company is planning to solve the problem and the
investors should be convinced that the newly introduced product or service will solve it.
5. Marketing or Sales: The market size of the product must be communicated to the investors.
Marketing strategy of the start-up is also required to be explained.
6. Projections or Milestones: Projected financial statements give a brief idea about where is the
business heading. It tells us that whether the business will be making profit or loss. Financial
projections include three basic documents that make up a business’s financial statements. (covered
specifically in the next heading...)
7. Competition: Every business organization has competition even if the product or service offered is
new and unique. It is necessary to highlight in the pitch presentation as to how the products or
services are different from their competitors.
8. Business Model: The term business model is a wide term denoting core aspects of a business
including operational process, offerings, target customers, strategies, infrastructure, organizational
structures, etc. It is important to explain investors about the business model to generate revenues.
9. Financing: If a start-up has already raised money, it is preferable to talk about how much money
has been raised, who invested money into the business and what they did about it. If no money has
been raised till date, an explanation can be made regarding how much work has been accomplished
with the help of limited funds available with the company.
4. Documents for Financial Projections during Pitch Presentation

1. Income statement: A projected income statement shows much money the business will generate by
projecting income and expenses, such as sales, cost of goods sold and expenses. For your first year in
business, you’ll want to create a monthly income statement. For the second year, quarterly statements
will suffice. For the following years, you’ll just need an annual income statement.
2. Cash flow statement: A projected cash flow statement will depict how much cash will be coming into
the business and out of that cash how much cash will be utilized into the business. At the end of each
period (e.g., monthly, quarterly, annually), one can tally it all up to show either a profit or loss.
3. Balance sheet: The balance sheet shows the business’s overall finances including assets, liabilities and
equity. Typically, one will create an annual balance sheet for one’s financial projections.
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Adish Jain CA CFA
5. Characteristics of Venture Capital Financing

1. Long time horizon: The VC fund would invest with a long-time horizon in mind. Minimum period of
investment would be 3 years and maximum period can be 10 years.
2. Lack of liquidity: When VC fund invests, it takes into account the liquidity factor. It assumes that there
would be less liquidity on the equity shares of business it invested in. They adjust this liquidity premium
against the price and required return. It will plan its investments into different businesses accordingly.
3. High Risk: VC fund would not hesitate to take risk. It works on principle of high risk and high return.
So, high risk would not eliminate the investment choice for a venture capital, if it is commensurately
rewarded for taking high risk.
4. Equity Participation: Most of the time, VC fund would be investing in the form of equity of a company.
This would help the Venture Capitalist participate in the management and help the company grow.
This would also help them to supervise a lot of board decisions.
6. Advantages of bringing Venture Capital in the company:

1. VC brings long- term equity capital into the company which provides a solid capital base for future
growth.
2. The venture capitalist is a business partner, sharing both, the risks and rewards. Venture capitalists
are rewarded with business success and capital gain.
3. The venture capitalist is able to provide practical advice and assistance to the company based on past
experience with other companies which were in similar situations.
4. The venture capitalist also has a network of contacts in many areas that can add value to the
company.
5. The venture capitalist may be capable of providing additional rounds of funding which the company
would require to finance the growth.
6. Venture capitalists are experienced in the process of preparing a company for an initial public offering
(IPO) of its shares onto the stock exchanges.
7. Stages of Venture Capital Funding

Stage of Funding Risk Activity to be Financed
Seed Money Extreme Low level financing needed to prove a new idea.
Early stage firms that need funding for expenses associated
Start-up Very High
with marketing and product development.
First-Round High Early sales and manufacturing funds.
Working capital for early stage companies that are selling
Second-Round Sufficiently High
product, but not yet turning in a profit.
Expansion of a newly profitable company (also called as
Third Round Medium
Mezzanine financing)
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Adish Jain CA CFA
Finance the "going public" process (also called as bridge

Fourth-Round Low
financing)
8. Venture Capital Investment Process

Deal VC operates directly or through intermediaries who get them deal. Start-up would
Origination give a detailed business plan to VC, called as Investment Memorandum which
consists of business model, financial plan and exit plan.
Screening Screening process would help to select the company for further processing. The
screening decision would take place based on the information provided by the
company.
Due Diligence Due diligence is the process by which the VC would try to verify the correctness of the
documents taken. This is generally handled by external bodies, mainly renowned
consultants.
Deal The deal is structured in such a way that both parties win. In many cases, the
Structuring convertible structure is brought in to ensure that the promoter retains the right to
buy back the share.
Post Investt In this section, the company has to adhere to certain guidelines like strong MIS,
Activity strong budgeting system, strong corporate governance and other covenants of the
VC and periodically keep the VC updated about certain milestones.
Exit plan Exit happens in two ways: one way is ‘sell to third party’. This sale can be in the form
of IPO or Private Placement to other VCs. The second way to exit is that promoter
would give a buy back commitment at a pre agreed rate.
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Adish Jain CA CFA
9. Structure of Venture Capital Fund in India

Offshore Funds
Domestic Funds
Offshore Structure Unified Structure
Domestic Funds are the funds which Under this structure, an When both domestic and
raises money domestically. They are offshore investment vehicle offshore investors are
usually structured as: which is an LLC or LP expected to participate in
i) a domestic vehicle for the pooling registered outside India, the fund, a unified structure
of funds from the investor, and makes investments directly is used.
ii) a separate investment vehicle that into Indian portfolio Overseas investors pool their
carries the duties of asset companies.
assets in an offshore vehicle
manager.
The assets are managed by that invests in a locally
The choice of entity for the pooling the offshore manager, while managed trust, whereas
vehicle falls between a trust and a the investment advisor in domestic investors directly
company, with the trust form India carries out the due contribute to the trust.
prevailing due to its operational diligence and identifies This trust makes the local
flexibility. deals. portfolio investments with
Unlike most developed countries, the help of asset manager.
India does not recognize a LP.
10. Difference between start-ups and entrepreneurship. Priorities and

challenges which start-ups in India are facing
Start-ups are different from entrepreneurship in the following way:
1. Start- up is a part of entrepreneurship. Entrepreneurship is a broader concept and it includes a
start-up firm.
2. The main aim of start-up is to build a concern and conceptualize the idea into a reality and build
a product or service. On the other hand, the major objective of an already established
entrepreneurship concern is to attain opportunities with regard to the resources they currently
control.
3. A start-up generally does not have a major financial motive whereas an established
entrepreneurship concern mainly operates on financial motive.
Priority related to start-ups in India:
 The priority is on bringing more and more smaller firms into existence. The objective is to encourage
self-employment rather than large, scalable concerns.
 The focus is on need based, instead of opportunity based entrepreneurship.
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Adish Jain CA CFA
Challenges related to start-ups in India:

 The main challenge with the start-up firms is in getting the right talent. Lack of skilled workforce can
hinder the chances of a start-up succeeding.
 Further, start-ups had to comply with numerous regulations which escalate its cost.
11. Definition of Start-up under Start-up India Initiative to avail benefits

Startup India scheme was initiated by the Government of India on 16th of January, 2016. As per GSR
Notification 127 (E) dated 19th February 2019, an entity shall be considered as a Startup:
1. Upto a period of ten years from the date of incorporation/ registration, if it is incorporated as a
private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm
(registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the
Limited Liability Partnership Act, 2008) in India.
2. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded
₹ 100 crores.
3. Entity is working towards innovation, development or improvement of products or processes or
services, or if it is a scalable business model with a high potential of employment generation or wealth
creation.
Provided that an entity formed by splitting up or reconstruction of an existing business shall not be
considered a ‘Startup’.
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CA Final

Strategic Financial Management

Adish Jain CA CFA

Ex-Morgan Staley & ICICI Securities with

Teaches CA Final-SFM, CFA and Financial

Taught 4000+ students across courses

His 2 core mantra for students:

The purpose of text in GREY COLOUR is to give students an understanding of

All the best!

1. Financial Policy And Corporate Strategy............................................................................3

2. Risk Management .............................................................................................................7

4. Security Valuation ...........................................................................................................19

5. Portfolio Management ....................................................................................................21

7. Mutual Funds ..................................................................................................................33

8. Derivatives Analysis And Valuation .................................................................................37

9. Foreign Exchange Exposure And Risk Management ........................................................40

10. International Financial Management ...........................................................................45

11. Interest Rate Risk Management ...................................................................................47

12. Corporate Valuation.....................................................................................................48

13. Mergers, Acquisitions And Corporate Restructuring .....................................................49

14. Start-Up Finance ..........................................................................................................52

1. FINANCIAL POLICY AND CORPORATE STRATEGY

2. Key Decisions falling within the Scope of Financial Strategy

3. Strategy at different Hierarchy Levels

Let us take the example of Corporate Level Strategy

Functional Level Strategy

a) Corporate Level Strategy:

b) Business Level Strategy

4. Financial Planning & Outcomes of Financial Planning

5. Interface of Financial Policy and Corporate Strategic Management

6. Sustainable Growth Rate

SGR is calculated as: ROE x (1- Dividend payment ratio)

7. Financially Sustainability of an Organisation

Counter Party Risk

Interest Rate Risk

2. Evaluation of Financial Risk from the point of view of Different Stakeholders

3. Value at Risk (VaR)

Main Features of VaR:

4. Applications of Value at Risk

2. Fundamental Analysis and its stages

Stages of Fundamental Analysis:

3. Techniques used in Economic Analysis

c) Economic Model Building Approach

4. Technical Analysis | Assumptions | Principles

Technical Analysis is based on the following FOUR assumptions:

Technical analysis is based on the following THREE principals:

5. Theories of Technical Analysis:

8. Evaluation of Technical Analysis

9. Efficient Market Theory or Efficient Market Hypothesis

10. Challenges to Efficient Market Theory

11. Difference between Fundamental & Technical Analysis

Rule Price of share discounts everything. Price captures everything.

Usefulness For Long-term investing. For short term investing.

2. Term Structure Theories

3. Reverse Stock Split and its reasons

2. Discretionary and Non-Discretionary Portfolio Management

3. Active and Passive Portfolio Strategy for Equity Portfolio

4. Active and Passive Portfolio Strategy for Fixed Income Portfolio