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 Title Name Amity Solved Assignment MFM 3rd Sem for Security Analysis University AMITY Service Type Assignment Course Master-in-Finance-Management-(MFM) Semister Semester-III Cource: Master-in-Finance-Management-(MFM) Short Name or Subject Code Security Analysis Commerce line item Type Semester-III Cource: Master-in-Finance-Management-(MFM) Product Assignment of Master-in-Finance-Management-(MFM) Semester-III (AMITY)

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Questions :-

Security Analysis

Assignment A:

Q.1 what is meant by Fundamental Analysis? How does it differ from technical Analysis?

Q.2 Define risk & distinguish between Systematic & Unsystematic risk

Q.3 Explain the Whitebeck Kisor model?

Q.4 What is Macaulay’s Duration?

Q.5 Explain Efficient market Hypothesis?

Assignment B

Q.1 Explain bond value theorems?

Q.2 determine the price of Rs.1, 000 zero coupon bond with yield to maturity of 18% and 10 years to maturity & determine yield to maturity of this bond if its price is Rs 220?

Q.3 Explain in detail the Dow Theory and how it is used to determine the direction of stock market?

Case study:

Mr.Jose wants to invest in bonds a sum of Rs.1,00,000. Three bonds are being examined by him with a holding period of three years. Each bond is given AAA rating by Crisil. In the economic scenario, the economic cycle is beginning to mature & inflation is expected to increase. In an effort to contain the inflation, Reserve Bank of India is moving towards credit squeeze. Mr.Jose’s tax bracket is 50%. The details of the bond are given:

 Bond  A Bond B Bond C Coupon rate 0% 10% 10% Maturity(years) 5 7 5 Yield to maturity 11% 12% 11% Duration 5 6.58 4.68

Question No.

1. If Mr.Jose has to pick up any two bonds what would be his choice.What are the reasons you cite for picking up the particular bonds?

Assignment C (40 multiple choice questions)

Q.1 Duration is the measure of

(a) Time structure of the bond

(b) Interest rate risk

(c) Time structure & market risk

(d) Time structure & the interest rate risk

Q.2 The statistical tool used to measure a company’s risk is

(a) Mean

(b) Mode

(c) Variance

(d) Co-variance

Q.3 Interest rate risk occurs when

(a) The market price of bond moves inversely to the prevailing market interest rate

(b) The variability in yield is due to the market interest rate fluctuations

(c) There is variability in the coupon interest rates

(d) All

Q.4 Uncontrollable risk of a company is

(a) Labour problem

(b) Increase in loan service charge

(c) Cut in subsidy

(d) Technological obsolescence

Q.5 Conceptual framework of valuation through P/E ratio arises from

(a) Multiple year holding model

(b) Constant growth model

(c) Two stage growth model

(d) Three stage growth model

Q.6 An investor purchases a stock in the stock market. His holding period return depends on the

(a) Purchase price of the stock

(b) Selling price of the stock

(c) Dividend paid to the stock

(d) All the above

Q.7 Inter Connected Stock exchange is to interlink

(a) The BSE, NSE & OTCEI

(b) All the stock exchanges

(c) Fifteen regional stock exchanges

(d) Fourteen regional stock exchanges

Q.8 Over the Counter Exchange of India was started after the role model of

(a) NASAQ

(b) JASAQ

(c) NASDAQ & JASDAQ

(d) NSE

Q.9 Customer’s protection fund is set up

(a) To protect the investors against price fluctuations

(b) To protect the broker in case of non payment of money by investors

(c) To provide insurance to investors incase of default by the members

(d) To protect the member & the investor

Q.10 The oldest stock exchange in India is

(a) BSE

(b) NSE

(c) Nifty

(b) ISE

Q.11 The accounting period cycle of NSE is

(a) Wednesday to next Tuesday

(b) Tuesday to next Wednesday

(c) Monday to next Friday

(d) Wednesday to next Wednesday

Q.12 Marketability risk of bond is

(a) The market risk which affects all the bonds

(b) Variation in return caused by difficulty in selling bonds

(c) The failure to pay the agreed value of the bond by the issuer

(d) Both a b &

Q.13 Default risk is lower in

(a) Treasury bills

(b) Government bonds

(c) ICICI Bonds

(d) IDBI bonds

Q.14 The value of bond depends on

(a) The coupon rate

(b) Years to maturity

(c) Expected yield to maturity

(d) All the above

Q.15 The bond yield remains constant over its life and the discount or premium amount will decrease

(a) At a decreasing rate as its life gets shorter

(b) At a decreasing rate as its life gets longer

(c) At an increasing rate as its life gets shorter

(d) At an increasing rate as its life gets longer

Q.16 Investment is the

(a) Net additions made to the national capital stocks

(b) Person’s commitment to buy a flat or a house

(c) Employment of funds on assets to earn returns

(d) Employment of funds on goods and services that are used in production process

Q.17 Speculator is a person

(a) Who evaluates the performance of the company

(b) Who uses his own funds only

(c) Who is willing to take high risk for high return

(d) Who considers heresays & market behaviours

Q.18 To frame the investment policy the investor should have

(a) Knowledge about the company and the brokers

(b) Investible funds

(c) Knowledge about investment alternatives

(d) Knowledge about the market with funds

Q.19 The main objective of a rational investor is

(a) Maximising returns & minimizing risk

(b) Minimising return & maximizing risk

(c) Short term gains

(d) Safety of the principal

Q.20 Clearing & settlement operations of the NSE is carried out by

(a) National Security Depository Ltd

(b) National Security Clearing Co-operation

(c) State Bank of India

(d) By the exchange itself

Q.21 In the stock market psychology

(a) Investors forget the past

(b) History repeats itself

(c) More faith in future prediction

(d) Both a &b

Q.22 Gross domestic product is a logical factor to analyse the economy in picking up a stock because it indicates

(a) Inflation or deflation

(b) The market value of assets

(c) The status of the economy

(d) The condition of the stock market

Q.23 One of the following factors leads the activity of the stock market

(a) Money supply

(b) Per capita income

(c) Unemployment rate

(d) Manufacturing & trade

Q.24 The fall in interest rate is conducive to the stock market because

(a) Money may flow from the bond market to stock market

(b) Corporate can borrow at easy terms

(c) Brokers can do business at borrowed funds

(d) Both b & c

Q.25 The growth in book value per share shows the

(a) Rise in the share price

(b) Increase in the physical assets of the form

(c) Increase in the net worth

(d) Growth in reserves

Q.26 The price earnings ratio of a stock reflects

(a) The growth of the company

(b) The market mood for the company’s stock

(c) The earnings retained and invested in the company

(d) The dividend paid out for the company’s stock

Q.27 NBFC’s offers higher interest rate because of

(a) The best management funds

(b) The competition amongst NBFCs

(c) The risk involved

(d) The credit rating

Q.28 Open ended schemes are

(a) Open for a particular period

(b) Have fixed period of maturity

(c) Listed in the stock exchanges

(d) Open on a continuous basis

Q.29 Interval fund is

(a) Index fund

(b) Open fund

(c) A closed end fund

(d) A combination of close & open end fund

Q.30 Index schemes

(a) Returns equal to index returns

(b) Reflect the market

(c) Are income schemes

(d) Are tax saving schemes

Q.31 Stock exchange

(a) Helps in the fixation of stock prices

(b) Ensure safe & fair dealing

(c) Induces good performance by the company

(d) All the above

Q.32 __________ was the grandfather of technical analysis.

1. A) Harry Markowitz
2. B) William Sharpe
3. C) Charles Dow
4. D) Benjamin Graham
5. E) None of the above

Q.33 The goal of the Dow theory is to

1. A) Identify head and shoulder patterns.
2. B) Identify breakaway points.
3. C) Identify resistance levels.
4. D) Identify support levels.
5. E) Identify long-term trends.

Q.34 Technical indicators help

(a)To find out the present state of the stock market

(b)To estimate the growth of stock market

(c)To indicate the economic activity

(d)To show the direction of the overall market

Q.35 The market value of the scrip is determined by

(a) The dividend declared by the company

(b) The present status of the stock market

(c) The number of floating shares

(d) The interaction of demand & supply

Q.36 The negotiable financial investment is different from the non-negotiable financial investment in terms of

(a) Maturity period

(b) Interest rate

(c) Transferability

(d) Face value

Q.37 Investment made on a house property is a

(a) Financial investment

(b) Economic investment

(c) Non-negotiable financial investment

(d) Non-financial investment

Q.38 Which one of the following is not a money market security?

(a) Treasury bills

(b) National savings certificate

(c) Certificate of deposit

(d) Commercial paper

Q.39Commercial papers are

(a) Unsecured promissory notes

(b) Secured promissory notes

(c) Sold at a premium

(d) Issued for a period of 1-2 years

Q.40 This particular scheme helps in deferring the tax payment

(a) Public provident fund

(b) National savings scheme

(c) National savings certificate

(d) Life insurance scheme

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Security Analysis

Assignment A:

Q.1 what is meant by Fundamental Analysis? How does it differ from technical Analysis?

A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security´s value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management).

The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security´s current price, with the aim of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell or short).

1. Fundamental Analysis

In fundamental analysis, the key measure used by analysts in selecting a stock to invest in is its fundamentals, which is rather broad because this is comprised of financial strength, industry leadership, and good quality management, among others. Most investors look for companies that have good governance that can be obtained by studying how decisions have paid off in the past. Fundamentalists look for those that are relatively undervalued, have high profitability and increasing revenues from its core businesses, have the ability to pay off debts, and have a significant level of free cash flow including the ability to put it into productive uses, among others. The financial ratios that investors pay attention to include earnings per share (EPS), price-to-earnings ratio (PE/ ratio), price-to-book ratio (P/B ratio), net profit margins, and return on equity (ROE), among others.

EPS is a gauge of profitability. Given two companies with similar earnings per share, the one that is able to produce the same amount of earnings using relatively lower amount of equity or investment money is the more efficient company. Meanwhile, the P/E ratio refers the amount that investors are willing to shell out for each dollar of earnings. While a high P/E ratio signals that investors have high valuation for the company, it can also indicate that the stock is overvalued. In addition to the P/E ratio, investors also use the PEG ratio which is just the P/E ratio but adjusted for growth. Fundamentalists also use the P/B ratio which indicates market expectations of the company’s future earnings. It is often used in combination with return on equity, a measure for profitability. Investors usually look for companies that are able to surpass earnings estimates and those that experience positive revisions in the earnings projections.

Companies that pay safe and growing dividend income are also preferred by income-seeking investors. Therefore, they seek fast-growing dividend payments, high dividend yield, and low payout ratio. A company that has a low payout ratio indicates that despite paying its investors dividend income, it is has a substantial amount left for reinvestment. People give due credit to significant level of free cash flow which is a gauge for the company’s ability to fund its future expansions or acquisitions that can enhance the value of the company.

In addition, robust industry growth and large market share are also the most sought-after indicators. Even with a relatively low market share if the company demonstrates the ability to expand its market by venturing in emerging markets, for instance, or steal the current market share of other companies. When considering investing in other countries, fundamentalists also weigh the overall condition of the economy and regulatory environment.

1. Technical Analysis

In technical analysis, price trend and volume of shares traded are important metrics. To confirm the price patterns of a stock, technical analysts use volume. Any trend that is coupled with a relatively higher volume indicates a stronger trend than that when the volume is low. For instance, if the price is going down and the volume of shares being traded is high, it is a strong downward trend. If suddenly, a stock has gained 5 percent over one day after being in a sustained downward activity, traders can confirm that this is a real trend reversal if the volume is higher on that day than the average of the past days. But if it is a below-average volume, this does not support a true reversal of the trend. If you are waiting for a sustained upward movement in the price, look for an increasing trend in price backed by higher volume or the upturn may end immediately.

Technical analysis uses two key indicators – leading and lagging where the former goes before price movements which can have predictive power and the latter acts as confirmation tool since it chases a price movement. Meanwhile, buy and sell signals are formed based on two ways – crossovers and divergence. Crossovers are reflected when two varying moving average cross over one another or the price goes through the moving average. Divergence is simply the case when the price trend and indicator trend move in the opposite direction. Such indicator signals a weakening price trend.

One of the most popular indicators of technical analysis is the moving average convergence/ divergence (MACD). It is used to determine the strength, momentum, direction, and even duration of a trend. The MACD is just the gap between the shorter term moving average and the longer term moving average. If the MACD turns in a positive result, it indicates a shorter term moving average that is higher than the longer term moving average suggesting an upward momentum. The opposite suggests a downward momentum. Another tool used is the MACD histogram where the differences between the MACD and the exponential moving average of the MACD, called the signal line, are expressed in bars. The higher bars indicate greater momentum behind a certain direction to which the bars point. If the signal line is below the MACD, buy signals generated. On the other hand, if the signal line crosses above the MACD, sell signals occur.

Technical analysis also uses volume indicators like the accumulation/distribution line. This line indicates the ratio of buying to selling. Furthermore, analysts use the average directional index to determine the strength of a current trend. There is also a relatively new indicator called Aroon indicators which being used to predict when a trend is likely to begin.

Fundamental analysis differs from technical analysis in various aspects which include the nature of participation, main objectives, time horizon, and tools. While they differ in many ways, they both pay attention to market sentiments and seek opportunities to increase the possibility of gaining while reducing the risk of losing. They both seek for moves that have a margin of safety.

Both of these types of analyses have their arguments and there is actually no right answer as to which is the superior one. The choice of an investor depends on the situation and investment objectives and these two approaches can actually co-exist. For fundamental analysts, determining when to best enter the market through technical analysis is very important to achieve great success. On the other hand, if you are a technical analyst, you might want to check some vital fundamental data to reaffirm your decision that is based on some buying signals in the technical trend. Many participants have gained quite remarkably by combining the two. But in the end, what is important is to do the homework and apply the investment philosophy that fits best into your investment plans, preferences, and circumstances.

To end, here is a terrific chart that details the varying differences between the two methods.  See which type of investing fits your personality and financial goals.

Q.2 Define risk & distinguish between Systematic & Unsystematic risk

A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action.

1. Finance: The probability that an actual return on an investment will be lower than the expected return. Financial risk is divided into the following categories: Basic risk, Capital risk, Country risk, Default risk, Delivery risk, Economic risk, Exchange rate risk, Interest rate risk, Liquidity risk, Operations risk, Payment system risk, Political risk, Refinancing risk, Reinvestment risk, Settlement risk, Sovereign risk, and underwriting risk.

1. Food industry: The possibility that due to a certain hazard in food there will be a negative effect to a certain magnitude.
2. Insurance: A situation where the probability of a variable (such as burning down of a building) is known but when a mode of occurrence or the actual value of the occurrence (whether the fire will occur at a particular property) is not. A risk is not an uncertainty (where neither the probability nor the mode of occurrence is known), a peril (cause of loss), or a hazard (something that makes the occurrence of a peril more likely or more severe).
1. Securities trading: The probability of a loss or drop in value. Trading risk is divided into two general categories: (1) Systemic risk affects all securities in the same class and is linked to the overall capital-market system and therefore cannot be eliminated by diversification. Also called market risk. (2) Nonsystematic risk is any risk that isn´t market-related or is not systemic. Also called nonmarket risk, extra-market risk, or systemic risk.
1. Workplace: Product of the consequence and probability of a hazardous event or phenomenon. For example, the risk of developing cancer is estimated as the incremental probability of developing cancer over a lifetime as a result of exposure to potential carcinogens (cancer-causing substances).
 Systematic Risk Unsystematic Risk This type of risk affects over all securities in a market. This type of risk is unique to a security or a company. This risk is dependent of political or economic factors. This risk is independent of political or economic factors. It is also known as Market Risk. It is also known as Diversifiable Risk. This risk arises from management inefficiency, unsuccessful planning etc. It occurs due to imbalance in the political situation or fluctuation in the market etc. It can be reduced by holding large number of securities. It can be reduced by holding better portfolios of company’s securities.

Q.3 Explain the Whitebeck Kisor model?

In 1963 Whitbeck- Kisor model was introduced which attempt to use multiple regressions to explain price earnings ratios. According to this model,

Price earnings ratio= 8.2 +1.50(earnings growth rate) +0.067 (dividend payout rate) – 0.200 (standard deviation in growth rate)

This equation represents the estimate of stock at a point of time and the impact of three variables, earnings growth rate, dividend payout and standard deviation on the price earnings ratio. The numbers represent the weight that the market placed on each variable at the point of time and the signs represent the direction of impact of each variable on the price earnings ratio.

There are three reasons suggesting Whitbeck- kisor model does not work. They are:

1. i) Market tastes changes and with change in tastes the weight on each variable also changes over time.
2. ii) Inputs like dividend and growth in earning changes over time

iii) This model has failed to show the firm effects.

Q.4 What is Macaulay’s Duration?

The Macaulay duration (named after Frederick Macaulay, an economist who developed the concept in 1938) is a measure of a bond´s sensitivity to interest rate changes. Technically, duration is the weighed average number of years the investor must hold a bond until the present value of the bond’s cash flows equals the amount paid for the bond.

How it works/Example:

There is more than one way to calculate duration, but the Macaulay duration is the most common. The formula is:

Where:

t = period in which the coupon is received

C = periodic (usually semiannual) coupon payment

y = the periodic yield to maturity or required yield

n = number periods

M = maturity value (in \$)

P = market price of bond

The formula is complicated, but it boils down to: Duration = Present value of a bond´s cash flows, weighted by length of time to receipt/ bond’s current market value. For example, let´s calculate the duration of a three-year \$1,000 Company XYZ bond with a semiannual 10% coupon.

Notice in the table above that we first multiplied the cash flows by the periods in which they occurred and then calculated the present value of each of these weighted cash flows.

To calculate the Macaulay duration, we then divide the sum of the present values of these cash flows by the current bond price (which we are assuming is \$1,000):

Company XYZ Macaulay duration = \$5,329.48 / \$1,000 = 5.33

Duration can help investors understand how sensitive a bond is to changes in prevailing interest rates. By multiplying a bond´s duration by the change, the investor can estimate the percentage price change for the bond. For example, consider the Company XYZ bonds with a duration of 5.33 years. If for whatever reason market yields increased by 20 basis points (0.20%), the approximate percentage change in the XYZ bond´s price would be:

-5.33 x .002 = -0.01066 or -1.066%

Note that this is an approximation. The formula assumes a linear relationship between bond prices and yields (that is, they always change by the same degree) even though the relationship is actually convex (meaning that when one changes, the other changes but to varying degrees). Thus, the formula is less reliable when there is a large change in yield.

In general, six things affect a bond´s duration:

Bond´s Price: Note that if the bond in the above example were trading at \$900 today, then the duration would be \$5,329.48 / \$900 = 5.92. If the bond were trading at \$1,200 today, then the duration would be \$5,329.48 / \$1,200 = 4.44.

Coupon: The higher a bond´s coupon, the more income it produces early on and thus the shorter its duration. The lower the coupon, the longer the duration (and volatility). Zero-coupon bonds, which have only one cash flow, have durations equal to their maturities.

Maturity: The longer a bond´s maturity, the greater its duration (and volatility). Duration changes every time a bond makes a coupon payment. Over time, it shortens as the bond nears maturity.

Yield to Maturity: The higher a bond´s yield to maturity, the shorter its duration because the present value of the distant cash flows (which have the heaviest weighting) become overshadowed by the value of the nearer payments.

Sinking Fund: The presence of a sinking fund, which is a scheduled prepayment of the bond before it matures, lowers a bond´s duration because the extra cash flows in the early years are greater than those of a bond without a sinking fund.

Call Provision: Bonds with call provisions also have shorter durations because the principal is repaid earlier than a similar non-callable bond.

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Q.5 Explain Efficient market Hypothesis?

An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis.

Meanwhile, while academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example, investors, such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the EMH. Detractors of the EMH also point to events, such as the 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, as evidence that stock prices can seriously deviate from their fair values.

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Assignment B

Q.1 Explain bond value theorems?

Bond Theorems

Price and interest rates move inversely

A decrease in interest rates raises bond prices by more than a corresponding increase in rates lowers the price

Price volatility is inversely related to coupon

Price volatility is directly related to maturity

Price volatility increases at a diminishing rate as maturity increases

Let’s understand the theorems with illustrations:

Theorem-1: Price and interest rates move inversely

Let’s assume 3 year 10% coupon paying bond for illustration

When YTM = 10%       Price = 100

When YTM = 11%       Price = 97.55

When YTM = 9% Price = 102.53

Hence it can be concluded that as yield increase price of the bond decline and vice-versa.

Theorem-2: A decrease in interest rates raises bond prices by more than a corresponding increase in rates lowers price

Let’s assume 3 year 10% coupon paying bond for illustration

When YTM = 10%       Price = 100

When YTM = 11%       Price = 97.55      Change in price = -2.45%

When YTM = 9% Price = 102.53    Change in price = +2.53%

This the most important theorem of bond which says that price movement of bond with change is interest rate either side is not equal. Price of the bond increases more than it declines when equal change in interest rate is given. In above illustration you can clearly see that when yield declines by 1% price increases by 2.53% while in case of increase in yield by 1%, price decline is 2.45%. As price curve of the bond is convex, you gain more than you lose.

Theorem-3: Price volatility is inversely related to coupon

Let’s assume 3 year 10% coupon paying bond and 3 year 11% coupon paying bond for illustration.

3 year 10% coupon paying bond

When YTM = 10%       Price = 100

When YTM = 11%       Price = 97.55      Change in price = -2.45%

When YTM = 9% Price = 102.53    Change in price = +2.53%

3 year 11% coupon paying bond

When YTM = 10%       Price = 102.48

When YTM = 11%       Price = 100 Change in price = -2.42%

When YTM = 9% Price = 105.06    Change in price = +2.52%

Let’s assume current YTM is 10% and then it increases to 11% and declines to 9%. You can clearly see in the above tables that price movement of the 11% coupon bond is lower than 10% coupon bond. It can be concluded that higher coupon bonds are less volatile than smaller coupon bonds.

Q.2 determine the price of Rs.1, 000 zero coupon bond with yield to maturity of 18% and 10 years to maturity & determine yield to maturity of this bond if its price is Rs 220?

Yield to Maturity (YTM) for a bond is the total return, interest plus capital gain, obtained from a bond held to maturity. It´s expressed as a percentage and tells investors what their return on investment will be if they purchase the bond and hold on to it until the bond issuer pays them back.

Yield to Maturity:

818.18%

Q.3 Explain in detail the Dow Theory and how it is used to determine the direction of stock market?

Dow Theory

The theory is named after Charles Dow who was editor of The Wall Street Journal. He is not its creator. SA Nelson and W. Hamilton who were using his research and written articles created this theory. Although it was written more than 100 years ago, it is still base of research of every technician.

In 1884, Dow created the first index which was calculated using prices of the shares of 11 companies. Later, in 1897 he came to the conclusion that it is better to use two indices: index of 12 shares of industrial companies (Dow Jones Industrial Index) and Index of 20 shares of railway companies (Dow Jones Rail Index). By the 1928 the industrial index grown up to include 30 stocks. On that number it stands today.

The basic principles of the theory are:

(1) The averages disccount everything

Price changes on stock exchange include all knowledge of Wall Street. So it´s enough to analyze price.

This principle is identical to the first axiom of technical analysis (everything is included in price), just this principle is applied to the entire exchange not only to specific stock. The principle is the same whether it is applied on one or more stocks.

(2) Prices are moving in trends

Dow defined uptrend as a situation in which each successive rally closes higher then previous rally high and each successive rally low closes higher than previous rally low. This means that the uptrend consisting of rising peaks and troughs. For downward opposite logic is applied.

Dow believed that every trend consists of three parts: primary, secondary and minor. He compared the trend with the movement of the sea. The primary trend is tide, secondary waves make up the tide, and the minor trend is a small wave.

The observer can see the tide if each successive wave comes further than it did in prior movement. If the farest point of the coming waves begins to move towards the sea, it means that the tide disappears.

The secondary trend is a correction of the primary and usually lasts from three weeks to three months. Typically, retracements are between a third and two thirds of previous trend and often that value is 50% of previous trend.

Minor trend usually lasts less than 3 weeks and represents the fluctuations of the secondary trend.

(3) Primary trend has three phases

Uptrend or bullish trend has three phases: accumulation, phase of growth and market expansion phase. Accumulation phase is characterized by extreme pessimism. News is bad as the estimates of market movement. At this stage, investors are able to buy stocks that nobody wants and can become rich. It can be considered that this is an ideal time to buy. The second phase is the longest and it is characterized by growth and optimism. In the third phase there are signs of inflation. A volume of trading is high and traders have high confidence in market.

Downward trend or bearish trend also consists of three phases: distribution, panic and phase of dissapointment. Distribution phase is the beginning of the price declining. There is nothing in the media to indicate the beginning of this phase and people are still buying stocks. After corrections prices are rising, but they stabilize on lower level than they were before the fall. If the price falls below the previous bottom, a downtrend is confirmed and next phase begins. In phase of panic stocks are soled massively and the prices are falling quickly. The last phase is characterized by pessimism, no one wants to buy although prices are low. Until all bad news do not incorporate in the price, falling continues. After that, the cycle starts from the beginning.

(4) The averages must confirm each other

Dow believed that the signal for growth or decline in the market can not be identified on the basis of one index. Both of the indices, Dow Jones Industrial and Dow Jones Rail must give a signal. Of course signals do not have to occur simultaneously, they can occur in a short period of time.

(5) The trend should be confirmed by volume

If the price changes with a small trading volume, there are various explanations for that: for example, presence of aggressive sellers. But the right picture of the market is seen only when the price changes with large volume. Dow beleived that volume is secondary indicator and that volume has to grow in the direction of the primary trend. Thus, in an uptrend volume should increase when prices rise and fall as well as prices fall. For downtrend the oposite statement is true.

(6) It is considered that the trend remains in force until it gives definite signals that it has reversed

This principle is basic rule of technical analysis. Practically if it is not true, the entire technical analysis would not make sense. The principle is linked to the law of motion in general: anything that moves is likely to continue to move until an external force does not prevent it.

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Case study:

Mr.Jose wants to invest in bonds a sum of Rs.1,00,000. Three bonds are being examined by him with a holding period of three years. Each bond is given AAA rating by Crisil. In the economic scenario, the economic cycle is beginning to mature & inflation is expected to increase. In an effort to contain the inflation, Reserve Bank of India is moving towards credit squeeze. Mr.Jose’s tax bracket is 50%. The details of the bond are given:

 Bond  A Bond B Bond C Coupon rate 0% 10% 10% Maturity(years) 5 7 5 Yield to maturity 11% 12% 11% Duration 5 6.58 4.68
1. If Mr.Jose has to pick up any two bonds what would be his choice.What are the reasons you cite for picking up the particular bonds?

In the economy, inflation and restrictive credit policy are reported. If there is inflation there would be two effects

Purchasing power of money may decline affecting the real rate of return from the bond.

The interest rate may increase .in this situation holding a bond with long years of maturity is not advisable because the value of the bond may fall with the rising interest rate.

Compared to bond a bond c, maturity period is lesser. Even though the yield is higher in bond B, Mr. Jose would prefer bond C on the basis of the maturity period.

Considering the tax bracket, Mr. Jose has to pay tax on return he receives from the bond. In the case of the discount bond the payment of the tax can be postponed for five years. Depending upon Mr. Jose’s other income sources he would allot some amount of money for bond A.

Assignment C (40 multiple choice questions)

Q.1 Duration is the measure of

(a) Time structure of the bond

(b) Interest rate risk

(c) Time structure & market risk

(d) Time structure & the interest rate risk

Q.2 The statistical tool used to measure a company’s risk is

(a) Mean

(b) Mode

(c) Variance

(d) Co-variance

Q.3 Interest rate risk occurs when

(a) The market price of bond moves inversely to the prevailing market interest rate

(b) The variability in yield is due to the market interest rate fluctuations

(c) There is variability in the coupon interest rates

(d) All

Q.4 Uncontrollable risk of a company is

(a) Labour problem

(b) Increase in loan service charge

(c) Cut in subsidy

(d) Technological obsolescence

Q.5 Conceptual framework of valuation through P/E ratio arises from

(a) Multiple year holding model

(b) Constant growth model

(c) Two stage growth model

(d) Three stage growth model

Q.6 An investor purchases a stock in the stock market. His holding period return depends on the

(a) Purchase price of the stock

(b) Selling price of the stock

(c) Dividend paid to the stock

(d) All the above

Q.7 Inter Connected Stock exchange is to interlink

(a) The BSE, NSE & OTCEI

(b) All the stock exchanges

(c) Fifteen regional stock exchanges

(d) Fourteen regional stock exchanges

Q.8 Over the Counter Exchange of India was started after the role model of

(a) NASAQ

(b) JASAQ

(c) NASDAQ & JASDAQ

(d) NSE

Q.9 Customer’s protection fund is set up

(a) To protect the investors against price fluctuations

(b) To protect the broker in case of non payment of money by investors

(c) To provide insurance to investors incase of default by the members

(d) To protect the member & the investor

Q.10 The oldest stock exchange in India is

(a) BSE

(b) NSE

(c) Nifty

(b) ISE

Q.11 The accounting period cycle of NSE is

(a) Wednesday to next Tuesday

(b) Tuesday to next Wednesday

(c) Monday to next Friday

(d) Wednesday to next Wednesday

Q.12 Marketability risk of bond is

(a) The market risk which affects all the bonds

(b) Variation in return caused by difficulty in selling bonds

(c) The failure to pay the agreed value of the bond by the issuer

(d) Both a b &

Q.13 Default risk is lower in

(a) Treasury bills

(b) Government bonds

(c) ICICI Bonds

(d) IDBI bonds

Q.14 The value of bond depends on

(a) The coupon rate

(b) Years to maturity

(c) Expected yield to maturity

(d) All the above

Q.15 The bond yield remains constant over its life and the discount or premium amount will decrease

(a) At a decreasing rate as its life gets shorter

(b) At a decreasing rate as its life gets longer

(c) At an increasing rate as its life gets shorter

(d) At an increasing rate as its life gets longer

Q.16 Investment is the

(a) Net additions made to the national capital stocks

(b) Person’s commitment to buy a flat or a house

(c) Employment of funds on assets to earn returns

(d) Employment of funds on goods and services that are used in production process

Q.17 Speculator is a person

(a) Who evaluates the performance of the company

(b) Who uses his own funds only

(c) Who is willing to take high risk for high return

(d) Who considers heresays & market behaviours

Q.18 To frame the investment policy the investor should have

(a) Knowledge about the company and the brokers

(b) Investible funds

(c) Knowledge about investment alternatives

(d) Knowledge about the market with funds

Q.19 The main objective of a rational investor is

(a) Maximising returns & minimizing risk

(b) Minimising return & maximizing risk

(c) Short term gains

(d) Safety of the principal

Q.20 Clearing & settlement operations of the NSE is carried out by

(a) National Security Depository Ltd

(b) National Security Clearing Co-operation

(c) State Bank of India

(d) By the exchange itself

Q.21 In the stock market psychology

(a) Investors forget the past

(b) History repeats itself

(c) More faith in future prediction

(d) Both a &b

Q.22 Gross domestic product is a logical factor to analyse the economy in picking up a stock because it indicates

(a) Inflation or deflation

(b) The market value of assets

(c) The status of the economy

(d) The condition of the stock market

Q.23 One of the following factors leads the activity of the stock market

(a) Money supply

(b) Per capita income

(c) Unemployment rate

(d) Manufacturing & trade

Q.24 The fall in interest rate is conducive to the stock market because

(a) Money may flow from the bond market to stock market

(b) Corporate can borrow at easy terms

(c) Brokers can do business at borrowed funds

(d) Both b & c

Q.25 The growth in book value per share shows the

(a) Rise in the share price

(b) Increase in the physical assets of the form

(c) Increase in the net worth

(d) Growth in reserves

Q.26 The price earnings ratio of a stock reflects

(a) The growth of the company

(b) The market mood for the company’s stock

(c) The earnings retained and invested in the company

(d) The dividend paid out for the company’s stock

Q.27 NBFC’s offers higher interest rate because of

(a) The best management funds

(b) The competition amongst NBFCs

(c) The risk involved

(d) The credit rating

Q.28 Open ended schemes are

(a) Open for a particular period

(b) Have fixed period of maturity

(c) Listed in the stock exchanges

(d) Open on a continuous basis

Q.29 Interval fund is

(a) Index fund

(b) Open fund

(c) A closed end fund

(d) A combination of close & open end fund

Q.30 Index schemes

(a) Returns equal to index returns

(b) Reflect the market

(c) Are income schemes

(d) Are tax saving schemes

Q.31 Stock exchange

(a) Helps in the fixation of stock prices

(b) Ensure safe & fair dealing

(c) Induces good performance by the company

(d) All the above

Q.32 __________ was the grandfather of technical analysis.

1. A) Harry Markowitz
2. B) William Sharpe
3. C) Charles Dow
4. D) Benjamin Graham
5. E) None of the above

Q.33 The goal of the Dow theory is to

1. A) Identify head and shoulder patterns.
2. B) Identify breakaway points.
3. C) Identify resistance levels.
4. D) Identify support levels.
5. E) Identify long-term trends.

Q.34 Technical indicators help

(a)To find out the present state of the stock market

(b)To estimate the growth of stock market

(c)To indicate the economic activity

(d)To show the direction of the overall market

Q.35 The market value of the scrip is determined by

(a) The dividend declared by the company

(b) The present status of the stock market

(c) The number of floating shares

(d) The interaction of demand & supply

Q.36 The negotiable financial investment is different from the non-negotiable financial investment in terms of

(a) Maturity period

(b) Interest rate

(c) Transferability

(d) Face value

Q.37 Investment made on a house property is a

(a) Financial investment

(b) Economic investment

(c) Non-negotiable financial investment

(d) Non-financial investment

Q.38 Which one of the following is not a money market security?

(a) Treasury bills

(b) National savings certificate

(c) Certificate of deposit

(d) Commercial paper

Q.39Commercial papers are

(a) Unsecured promissory notes

(b) Secured promissory notes

(c) Sold at a premium

(d) Issued for a period of 1-2 years

Q.40 This particular scheme helps in deferring the tax payment

(a) Public provident fund

(b) National savings scheme

(c) National savings certificate

(d) Life insurance scheme

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