1. Meaning of Financial Management
Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and
utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.
Scope/Elements
1. Investment decisions includes investment in fixed assets (called as capital budgeting). Investment in current assets are
also a part of investment decisions called as working capital decisions.
2. Financial decisions - They relate to the raising of finance from various resources which will depend upon decision on
type of source, period of financing, cost of financing and the returns thereby.
3. Dividend decision - The finance manager has to take decision with regards to the net profit distribution. Net profits are
generally divided into two:
a. Dividend for shareholders- Dividend and the rate of it has to be decided.
b. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion
and diversification plans of the enterprise.
Objectives of Financial Management
The financial management is generally concerned with procurement, allocation and control of financial resources of a
concern. The objectives can be-
1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price
of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum
possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of
return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is
maintained between debt and equity capital.
Functions of Financial Management
1. Estimation of capital requirements: A finance manager has to make estimation with regards to capital
requirements of the company. This will depend upon expected costs and profits and future programmes and
policies of a concern. Estimations have to be made in an adequate manner which increases earning
capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital structure have to
be decided. This involves short- term and long- term debt equity analysis. This will depend upon the
proportion of equity capital a company is possessing and additional funds which have to be raised from
outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many choices like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of financing.
4. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that
there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in
two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional, innovational,
diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash management. Cash is
required for many purposes like payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw materials,
etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has
to exercise control over finances. This can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.
Definition of Financial Planning

2. Financial Planning is the process of estimating the capital required and determining it‟s competition. It is the process
of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.
Objectives of Financial Planning
Financial Planning has got many objectives to look forward to:
a. Determining capital requirements- This will depend upon factors like cost of current and fixed assets,
promotional expenses and long- range planning. Capital requirements have to be looked with both aspects:
short- term and long- term requirements.
b. Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and
proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term
and long- term.
c. Framing financial policies with regards to cash control, lending, borrowings, etc.
d. A finance manager ensures that the scarce financial resources are maximally utilized in the best possible
manner at least cost in order to get maximum returns on investment.
Importance of Financial Planning
Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding the
financial activities of a concern. This ensures effective and adequate financial and investment policies. The
importance can be outlined as-
1. Adequate funds have to be ensured.
2. Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that
stability is maintained.
3. Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise
financial planning.
4. Financial Planning helps in making growth and expansion programmes which helps in long-run survival of
the company.
5. Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily
through enough funds.
6. Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company.
This helps in ensuring stability an d profitability in concern.
Finance Functions
The following explanation will help in understanding each finance function in detail
Investment Decision
One of the most important finance functions is to intelligently allocate capital to long term assets. This activity is also known as
capital budgeting. It is important to allocate capital in those long term assets so as to get maximum yield in future. Following are
the two aspects of investment decision
a. Evaluation of new investment in terms of profitability
b. Comparison of cut off rate against new investment and prevailing investment.
Since the future is uncertain therefore there are difficulties in calculation of expected return. Along with uncertainty comes the
risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return
of the prospective investment. Therefore while considering investment proposal it is important to take into consideration both
expected return and the risk involved.
Investment decision not only involves allocating capital to long term assets but also involves decisions of using funds
which are obtained by selling those assets which become less profitable and less productive. It wise decisions to
decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets.
An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is
calculated by using this opportunity cost of the required rate of return (RRR)
Financial Decision
Financial decision is yet another important function which a financial manger must perform. It is important to make
wise decisions about when, where and how should a business acquire funds. Funds can be acquired through many
ways and channels. Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix of equity
capital and debt is known as a firm‟s capital structure. A firm tends to benefit most when the market value of a
company‟s share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On
the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the

3. return on equity funds. A sound financial structure is said to be one which aims at maximizing shareholders return
with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital
structure would be achieved. Other than equity and debt there are several other tools which are used in deciding a
firm capital structure.
Dividend Decision
Earning profit or a positive return is a common aim of all the businesses. But the key function a financial manger
performs in case of profitability is to decide whether to distribute all the profits to the shareholder or retain all the
profits or distribute part of the profits to the shareholder and retain the other half in the business. It‟s the financial
manager‟s responsibility to decide a optimum dividend policy which maximizes the market value of the firm. Hence an
optimum dividend payout ratio is calculated. It is a common practice to pay regular dividends in case of profitability
Another way is to issue bonus shares to existing shareholders.
Liquidity Decision
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm‟s profitability, liquidity and risk all
are associated with the investment in current assets. In order to maintain a tradeoff between profitability and liquidity
it is important to invest sufficient funds in current assets. But since current assets do not earn anything for business
therefore a proper calculation must be done before investing in current assets. Current assets should properly be
valued and disposed of from time to time once they become non profitable. Currents assets must be used in times of
liquidity problems and times of insolvency.
Role of a Financial Manager
Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these
activities a financial manager performs all the requisite financial activities.
A financial manger is a person who takes care of all the important financial functions of an organization. The person in charge
should maintain a far sightedness in order to ensure that the funds are utilized in the most efficient manner. His actions directly
affect the Profitability, growth and goodwill of the firm.
Following are the main functions of a Financial Manager:
1. Raising of Funds
In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm can raise funds by
the way of equity and debt. It is the responsibility of a financial manager to decide the ratio between debt and equity. It is
important to maintain a good balance between equity and debt.
2. Allocation of Funds
Once the funds are raised through different channels the next important function is to allocate the funds. The
funds should be allocated in such a manner that they are optimally used. In order to allocate funds in the
best possible manner the following point must be considered
 The size of the firm and its growth capability
 Status of assets whether they are long term or short tem
 Mode by which the funds are raised.
These financial decisions directly and indirectly influence other managerial activities. Hence formation of a
good asset mix and proper allocation of funds is one of the most important activity
3. Profit Planning
Profit earning is one of the prime functions of any business organization. Profit earning is important for
survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by
the firm. Profit arises due to many factors such as pricing, industry competition, state of the economy,
mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production
can lead to an increase in the profitability of the firm. Fixed costs are incurred by the use of fixed factors of
production such as land and machinery. In order to maintain a tandem it is important to continuously value
the depreciation cost of fixed cost of production. An opportunity cost must be calculated in order to replace
those factors of production which has gone thrown wear and tear. If this is not noted then these fixed cost
can cause huge fluctuations in profit.
4. Understanding Capital Markets
Shares of a company are traded on stock exchange and there is a continuous sale and purchase of
securities. Hence a clear understanding of capital market is an important function of a financial manager.
When securities are traded on stock marketthere involves a huge amount of risk involved. Therefore a
financial manger understands and calculates the risk involved in this trading of shares and debentures. Its
on the discretion of a financial manager as to how distribute the profits. Many investors do not like the firm to

4. distribute the profits amongst share holders as dividend instead invest in the business itself to enhance
growth. The practices of a financial manager directly impact the operation in capital market.
Meaning of Capital Structure
Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance. The
capital structure involves two decisions-
a. Type of securities to be issued are equity shares, preference shares and long term borrowings(
Debentures).
b. Relative ratio of securities can be determined by process of capital gearing. On this basis, the companies
are divided into two-
a. Highly geared companies- Those companies whose proportion of equity capitalization is small.
b. Low geared companies- Those companies whose equity capital dominates total capitalization.
For instance - There are two companies A and B. Total capitalization amounts to be Rs. 20 lakh in each
case. The ratio of equity capital to total capitalization in company A is Rs. 5 lakh, while in company B, ratio
of equity capital is Rs. 15 lakh to total capitalization, i.e, in Company A, proportion is 25% and in company B,
proportion is 75%. In such cases, company A is considered to be a highly geared company and company B
is low geared company.
Factors Determining Capital Structure
1. Trading on Equity- The word “equity” denotes the ownership of the company. Trading on equity means
taking advantage of equity share capital to borrowed funds on reasonable basis. It refers to additional profits
that equity shareholders earn because of issuance of debentures and preference shares. It is based on the
thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower
than the general rate of company‟s earnings, equity shareholders are at advantage which means a company
should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity
becomes more important when expectations of shareholders are high.
2. Degree of control- In a company, it is the directors who are so called elected representatives of equity
shareholders. These members have got maximum voting rights in a concern as compared to the preference
shareholders and debenture holders. Preference shareholders have reasonably less voting rights while
debenture holders have no voting rights. If the company‟s management policies are such that they want to
retain their voting rights in their hands, the capital structure consists of debenture holders and loans rather
than equity shares.
3. Flexibility of financial plan- In an enterprise, the capital structure should be such that there is both
contractions as well as relaxation in plans. Debentures and loans can be refunded back as the time requires.
While equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in order to
make the capital structure possible, the company should go for issue of debentures and other loans.
4. Choice of investors- The company‟s policy generally is to have different categories of investors for
securities. Therefore, a capital structure should give enough choice to all kind of investors to invest. Bold
and adventurous investors generally go for equity shares and loans and debentures are generally raised
keeping into mind conscious investors.
5. Capital market condition- In the lifetime of the company, the market price of the shares has got an
important influence. During the depression period, the company‟s capital structure generally consists of
debentures and loans. While in period of boons and inflation, the company‟s capital should consist of share
capital generally equity shares.
6. Period of financing- When company wants to raise finance for short period, it goes for loans from banks
and other institutions; while for long period it goes for issue of shares and debentures.
7. Cost of financing- In a capital structure, the company has to look to the factor of cost when securities are
raised. It is seen that debentures at the time of profit earning of company prove to be a cheaper source of
finance as compared to equity shares where equity shareholders demand an extra share in profits.
8. Stability of sales- An established business which has a growing market and high sales turnover, the
company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of
profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet
such fixed commitments like interest on debentures and dividends on preference shares. If company is
having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital
proves to be safe in such cases.
9. Sizes of a company- Small size business firms capital structure generally consists of loans from banks and
retained profits. While on the other hand, big companies having goodwill, stability and an established profit
can easily go for issuance of shares and debentures as well as loans and borrowings from financial
institutions. The bigger the size, the wider is total capitalization.
What is Capitalization
Capitalization comprises of share capital, debentures, loans, free reserves,etc. Capitalization represents permanent investment in
companies excluding long-term loans. Capitalization can be distinguished from capital structure. Capital structure is a broad term
and it deals with qualitative aspect of finance. While capitalization is a narrow term and it deals with the quantitative aspect.

5. Capitalization is generally found to be of following types-
Normal
Over
Under
Overcapitalization
Overcapitalization is a situation in which actual profits of a company are not sufficient enough to pay interest on
debentures, on loans and pay dividends on shares over a period of time. This situation arises when the company
raises more capital than required. A part of capital always remains idle. With a result, the rate of return shows a
declining trend. The causes can be-
1. High promotion cost- When a company goes for high promotional expenditure, i.e., making contracts,
canvassing, underwriting commission, drafting of documents, etc. and the actual returns are not adequate in
proportion to high expenses, the company is over-capitalized in such cases.
2. Purchase of assets at higher prices- When a company purchases assets at an inflated rate, the result is
that the book value of assets is more than the actual returns. This situation gives rise to over-capitalization
of company.
3. A company’s floatation n boom period- At times company has to secure it‟s solvency and thereby float in
boom periods. That is the time when rate of returns are less as compared to capital employed. This results
in actual earnings lowering down and earnings per share declining.
4. Inadequate provision for depreciation- If the finance manager is unable to provide an adequate rate of
depreciation, the result is that inadequate funds are available when the assets have to be replaced or when
they become obsolete. New assets have to be purchased at high prices which prove to be expensive.
5. Liberal dividend policy- When the directors of a company liberally divide the dividends into the
shareholders, the result is inadequate retained profits which are very essential for high earnings of the
company. The result is deficiency in company. To fill up the deficiency, fresh capital is raised which proves
to be a costlier affair and leaves the company to be over- capitalized.
6. Over-estimation of earnings- When the promoters of the company overestimate the earnings due to
inadequate financial planning, the result is that company goes for borrowings which cannot be easily met
and capital is not profitably invested. This results in consequent decrease in earnings per share.
Effects of Overcapitalization
1. On Shareholders- The over capitalized companies have following disadvantages to shareholders:
a. Since the profitability decreases, the rate of earning of shareholders also decreases.
b. The market price of shares goes down because of low profitability.
c. The profitability going down has an effect on the shareholders. Their earnings become uncertain.
d. With the decline in goodwill of the company, share prices decline. As a result shares cannot be
marketed in capital market.
2. On Company-
a. Because of low profitability, reputation of company is lowered.
b. The company‟s shares cannot be easily marketed.
c. With the decline of earnings of company, goodwill of the company declines and the result is fresh
borrowings are difficult to be made because of loss of credibility.
d. In order to retain the company‟s image, the company indulges in malpractices like manipulation of
accounts to show high earnings.
e. The company cuts down it‟s expenditure on maintainance, replacement of assets, adequate
depreciation, etc.
3. On Public- An overcapitalized company has got many adverse effects on the public:
a. In order to cover up their earning capacity, the management indulges in tactics like increase in
prices or decrease in quality.
b. Return on capital employed is low. This gives an impression to the public that their financial
resources are not utilized properly.
c. Low earnings of the company affects the credibility of the company as the company is not able to
pay it‟s creditors on time.
d. It also has an effect on working conditions and payment of wages and salaries also lessen.
Undercapitalization
An undercapitalized company is one which incurs exceptionally high profits as compared to industry. An
undercapitalized company situation arises when the estimated earnings are very low as compared to actual profits.
This gives rise to additional funds, additional profits, high goodwill, high earnings and thus the return on capital shows
an increasing trend. The causes can be-
1. Low promotion costs
2. Purchase of assets at deflated rates
3. Conservative dividend policy

6. 4. Floatation of company in depression stage
5. High efficiency of directors
6. Adequate provision of depreciation
7. Large secret reserves are maintained.
Efffects of Under Capitalization
1. On Shareholders
a. Company‟s profitability increases. As a result, rate of earnings go up.
b. Market value of share rises.
c. Financial reputation also increases.
d. Shareholders can expect a high dividend.
2. On company
a. With greater earnings, reputation becomes strong.
b. Higher rate of earnings attract competition in market.
c. Demand of workers may rise because of high profits.
d. The high profitability situation affects consumer interest as they think that the company is
overcharging on products.
On Society
a. With high earnings, high profitability, high market price of shares, there can be unhealthy
speculation in stock market.
b. „Restlessness in general public is developed as they link high profits with high prices of product.
c. Secret reserves are maintained by the company which can result in paying lower taxes to
government.
The general public inculcates high expectations of these companies as these companies can import innovations, high
technology and thereby best quality of product.
Financial Goal - Profit vs Wealth
Every firm has a predefined goal or an objective. Therefore the most important goal of a financial manager is to increase the
owner‟s economic welfare. Here economics welfare may refer to maximization of profit or maximization of shareholders
wealth. Therefore Shareholders wealth maximization (SWM) plays a very crucial role as far as financial goals of a firm are
concerned.
Profit is the remuneration paid to the entrepreneur after deduction of all expenses. Maximization of profit can be
defined as maximizing the income of the firm and minimizing the expenditure. The main responsibility of a firm is to
carry out business by manufacturing goods and services and selling them in the open market. The mechanism of demand
and supply in an open market determine the price of a commodity or a service. A firm can only make profit if it produces a
good or delivers a service at a lower cost than what is prevailing in the market. The margin between these two prices would
only increase if the firm strives to produce these goods more efficiently and at a lower price without compromising on the
quality.
The demand and supply mechanism plays a very important role in determining the price of a commodity. A
commodity which has a greater demand commands a higher price and hence may result in greater profits.
Competition among other suppliers also effect profits. Manufacturers tends to move towards production of those
goods which guarantee higher profits. Hence there comes a time when equilibrium is reached and profits are
saturated.
According to Adam Smith - business man in order to fulfill their profit motive in turn benefits the society as
well. It is seen that when a firm tends to increase profit it eventually makes use of its resources in a more effective
manner. Profit is regarded as a parameter to measure firm‟s productivity and efficiency. Firms which tend to earn
continuous profit eventually improvise their products according to the demand of the consumers. Bulk production due
to massive demand leads to economies of scale which eventually reduces the cost of production. Lower cost of
production directly impacts the profit margins. There are two ways to increase the profit margin due to lower cost.
Firstly a firm can produce at lower sot but continue to sell at the original price, thereby increasing the revenue.
Secondly a firm can reduce the final price offered to the consumer and increase its market thereby superseding its
competitors.
Both ways the firm will benefit. The second way would increase its sale and market share while the first way only tend
to increase its revenue. Profit is an important component of any business. Without profit earning capability it is very
difficult to survive in the market. If a firm continues to earn large amount of profits then only it can manage to serve
the society in the long run. Therefore profit earning capacity by a firm and public motive in some way goes hand in
hand. This eventually also leads to the growth of an economy and increase in National Income due to increasing
purchasing power of the consumer.

7. Profit Maximization Criticisms
Many economists have argued that profit maximization has brought about many disparities among consumers
and manufacturers. In case of perfect competition it may appear as a legitimate and a reward for efforts but in case of
imperfect competition a firm‟s prime objective should not be profit maximization. In olden times when there was not too
much of competition selling and manufacturing goods were primarily for mutual benefit. Manufacturers didn‟t produce to
earn profits rather produced for mutual benefit and social welfare. The aim of the single producer was to retain his
position in the market and sustain growth, thereby earning some profit which would help him in maintaining his position.
On the other hand in today‟s time the production system is dominant by two tier system of ownership and management.
Ownership aims at maximizing profit and management aims at managing the system of production thereby indirectly
increasing the income of the business.
These services are used by customers who in turn are forced to pay a higher price due to formation of cartels and
monopoly. Not only have the customers suffered but also the employees. Employees are forced to work more than their
capacity. they is made to pay in extra hours so that production can increase.
Many times manufacturers tend to produce goods which are of no use to the society and create an artificial demand
for the product by rigorous marketing and advertising. They tend to make the product so tempting by packaging and
labeling that its difficult for the consumer to resist. These happen mainly with products which aim to target kids and
teenagers. Ad commercials and print ads tend to provide with wrong information to artificially hike the expectation of
the product.
In case of oligopoly where the nature of the product is more or less same exploit the customer to the max. Since they
form cartels and manipulate prices by giving very less flexibility to the consumer to negotiate or choose from the
products available. In such a scenario it is the consumer who becomes prey of these activities. Profit maximization
motive is continuously aiming at increasing the firm‟s revenue and is concentrating less on the social welfare.
Government plays a very important role in curbing this practice of charging extraordinary high prices at the cost of
service or product. In fact a market which experiences a high degree of competition is likely to exploit the customer in
the name of profit maximization, and on the other hand where the production of a particular product or service is
limited there is a possibility to charge higher prices is greater. There are few things which need a greater clarification
as far as maximization of profit is concerned
Profit maximization objective is a little vague in terms of returns achieved by a firm in different time period.
The time value of money is often ignored when measuring profit.
It leads to uncertainty of returns. Two firms which use same technology and same factors of production may
eventually earn different returns. It is due to the profit margin. It may not be legitimate if seen from a different stand
point.

8. It is essential for individuals to invest wisely for the rainy days and to make their future secure.
What is a Portfolio ?
A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds, cash and so on depending
on the investor‟s income, budget and convenient time frame.
Following are the two types of Portfolio:
1. Market Portfolio
2. Zero Investment Portfolio
What is Portfolio Management ?
The art of selecting the right investment policy for the individuals in terms of minimum risk and maximum return is
called as portfolio management.
Portfolio management refers to managing an individual‟s investments in the form of bonds, shares, cash, mutual funds etc so
that he earns the maximum profits within the stipulated time frame.
Portfolio management refers to managing money of an individual under the expert guidance of portfolio managers.
In a layman‟s language, the art of managing an individual‟s investment is called as portfolio management.
Need for Portfolio Management
Portfolio management presents the best investment plan to the individuals as per their income, budget, age and
ability to undertake risks.
Portfolio management minimizes the risks involved in investing and also increases the chance of making profits.
Portfolio managers understand the client‟s financial needs and suggest the best and unique investment policy for
them with minimum risks involved.
Portfolio management enables the portfolio managers to provide customized investment solutions to clients as
per their needs and requirements.
Types of Portfolio Management
Portfolio Management is further of the following types:
 Active Portfolio Management: As the name suggests, in an active portfolio management service, the
portfolio managers are actively involved in buying and selling of securities to ensure maximum profits to
individuals.
 Passive Portfolio Management: In a passive portfolio management, the portfolio manager deals with a
fixed portfolio designed to match the current market scenario.
 Discretionary Portfolio management services: In Discretionary portfolio management services, an
individual authorizes a portfolio manager to take care of his financial needs on his behalf. The individual
issues money to the portfolio manager who in turn takes care of all his investment needs, paper work,
documentation, filing and so on. In discretionary portfolio management, the portfolio manager has full
rights to take decisions on his client‟s behalf.
 Non-Discretionary Portfolio management services: In non discretionary portfolio management
services, the portfolio manager can merely advise the client what is good and bad for him but the client
reserves full right to take his own decisions.
Who is a Portfolio Manager ?
An individual who understands the client‟s financial needs and designs a suitable investment plan as per his income
and risk taking abilities is called a portfolio manager. A portfolio manager is one who invests on behalf of the client.
A portfolio manager counsels the clients and advises him the best possible investment plan which would guarantee
maximum returns to the individual.
A portfolio manager must understand the client‟s financial goals and objectives and offer a tailor made investment
solution to him. No two clients can have the same financial needs.

9. Financial Investment - Meaning, its Need and Different
Types of Investments
It is human nature to plan for rainy days. An individual must plan and keep aside some amount of money for any unavoidable
circumstance which might arise in days to come.
Future is uncertain and one must invest wisely to avoid financial crisis in any point of time.
Let us first understand what is investment ?
Investment is nothing but goods or commodities purchased today to be used in future or at the times of crisis. An
individual must plan his future well to ensure happiness for himself as well as his immediate family members. Consuming
everything today and saving nothing for the future is foolish. Not everyday is a bed of roses, you never know what your future
has in store for you.
What is Financial Investment ?
Financial investment refers to putting aside a fixed amount of money and expecting some kind of gain out of it within a
stipulated time frame.
What is Important in Financial Investment ?
Planning plays a pivotal role in Financial Investment. Don‟t just invest just for the sake of investing. Understand
why you really need to invest money? Investing just because your friend has said you to do so is foolish. Careful
analysis and focused approach are mandatory before investing.
Explore all the investment plans available in the market. Go through the pros and cons of each plan in detail.
Analyze the risk factors carefully before finalizing the plan. Invest in something which will give you the maximum
return.
Appoint a good financial planning manager who takes care of all your investment needs. He must understand
your requirement, family income, stability etc to decide the best plan for you.
One needs to be a little careful and sensible while investing. An individual must read the documents carefully before
investing.
Types of Financial Investment
An individual can invest in any of the following:
 Mutual Funds
 Fixed Deposits
 Bonds
 Stock
 Equities
 Real Estate (Residential/Commercial Property)
 Gold /Silver
 Precious stones
Need for Financial Investment
Financial Investment ensures all your dreams turn real and you enjoy life to the fullest without actually worrying about
the future.
Financial investment ensures you save for rainy days. Careful investment makes your future secure.
Financial investment controls an individual‟s spending pattern. It decides how and what amount one should spend so
that he has sufficient money for future.
Tips for Financial investment
Don‟t just blindly trust your financial advisor. Read the terms and conditions and go through all the related documents
carefully before signing. Check out risk factors, tenure, clauses etc before selecting the plan.
Avoid cash transactions. It is always advisable to issue an account payee cheque in favour of the company rather
than giving cash to your advisor. You never know when he disappears with all your hard earned money.
Carefully staple all the related documents and put it in a folder. Keep it at a proper and safe place. Loosing even a
single paper might land you in trouble later on.

10. Make sure your investment plan is the best in the market and guarantees sufficient return in future.
If you plan to invest in property, ensure it is at a prime location and would have takers in the near future. Investing in
non approved properties is worthless.
What is a Financial Market ?
A market is a place where two parties are involved in transaction of goods and services in exchange of money. The two
parties involved are:
 Buyer
 Seller
In a market the buyer and seller comes on a common platform, where buyer purchases goods and services from the seller in
exchange of money.
What is a Financial Market ?
A place where individuals are involved in any kind of financial transaction refers to financial market. Financial market
is a platform where buyers and sellers are involved in sale and purchase of financial products like shares, mutual funds, bonds
and so on.
Let us go through the various types of financial market:
Capital Market
A market where individuals invest for a longer duration i.e. more than a year is called as capital market. In a capital
market various financial institutions raise money from individuals and invest it for a longer period.
Capital Market is further divided into:
i. Primary Market: Primary Market is a form of capital market where various companies issue new stock,
shares and bonds to investors in the form of IPO‟s (Initial Public Offering). Primary Market is a form of
market where stocks and securities are issued for the first time by organizations.
ii. Secondary Market: Secondary market is a form of capital market where stocks and securities which have
been previously issued are bought and sold.
Types of Capital Market
1. Stock Markets: Stock Market is a type of Capital market which deals with the issuance and trading of
shares and stocks at a certain price.
2. Bond Markets: Bond Market is a form of capital market where buyers and sellers are involved in the trading
of bonds.
3. Commodity Market: A market which facilitates the sale and purchase of raw goods is called a commodity
market.
Commodity market like any other market includes a buyer and a seller. In such a market buyer purchases
raw products like rice, wheat, grain, cattle and so on from the seller at a mutually agreed rate.
4. Money Market: As the name suggests, money market involves individuals who deal with the lending and
borrowing of money for a short time frame.
5. Derivatives Market: The market which deals with the trading of contracts which are derived from any other
asset is called as derivative market.
6. Future Market: Future market is a type of financial market which deals with the trading of financial
instruments at a specific rate where in the delivery takes place in future.
7. Insurance Market: Insurance market deals with the trading of insurance products. Insurance companies
pay a certain amount to the immediate family members of owner of the policy in case of his untimely death.
8. Foreign Exchange Market: Foreign exchange market is a globally operating market dealing in the sale and
purchase of foreign currencies.
9. Private Market: Private market is a form of market where transaction of financial products takes place
between two parties directly.
10. Mortgage Market: A type of market where various financial organizations are involved in providing loans to
individuals on various residential and commercial properties for a specific duration is called a mortgage
market. The payment is made to the individual concerned on submitting certain necessary documents and
fulfilling certain basic criteria.

11. Shares and Stock Market - An Overview
An organization in order to raise money divides its entire capital into small units of equal value. Each unit is called a share.
A share is nothing but an indivisible unit of a company‟s capital to be sold among individuals to increase profit of the
organization.
Shareholder
An individual owning one or more than one share of an organization is called a shareholder. In simpler words, an individual
purchasing one or more than one share from any private or public organization is called a shareholder.
 A shareholder can sell his shares anytime depending on the current value of the share.
 He/she can purchase any new share issued by any other or same organization.
 A shareholder has the right to declared dividend.
Dividend
Why do people invest in shares ?
An organization pays the shareholders for investing in their company‟s shares. The income earned by an individual
by investing in an organization‟s share (private or public) is called as dividend.
What is Retained Earnings ?
The profit earned by an organization is put into use in the following two ways:
 It is paid to the shareholders as dividend.
 The profit earned by the organization is not distributed amongst the shareholders but is retained and
reinvested in the organization. This portion of the income is called retained earnings.
What is a Share Certificate ?
When an individual purchases shares from any organization, he/she is issued a certificate as a proof of his
investment. Such a certificate issued by an organization to the shareholders is called a share certificate.
Types of Shares
1. Equity Shares
Equity shares also called as ordinary shares are the shares where the payment of dividend is directly
proportional to the profits earned by the organization. Higher the profits earned, higher the dividend, lower
the profits, and lower the dividend. In an equity share, dividends are paid at a fluctuating/floating rate.
2. Preference Shares
Shares which enjoy preference over payment of dividends are called preference shares. Shareholders enjoy
fixed rate of dividends in case of preference shares.
3. Founder Shares
Shares held by the management or founders of the organization are called as founder shares.
4. Bonus Shares
Bonus shares are often issued to the shareholders when the organization earns surplus profits. The
company officials may decide to pay the extra profits to the shareholders either as cash (dividend) or issue a
bonus share to them.
Bonus shares are often issued by organizations to the shareholders free of charge as a gift in proportion to
their existing shares with the organization.
How to buy shares ?
 Find a good broker for yourself. Make sure he has good knowledge about the share market and can
guide you properly.
 To invest in shares one needs to open a DEMAT Account for online trading. A DEMAT Account is
mandatory for sale and purchase of shares anytime and anywhere.

12.  An individual needs to have his PAN Card, a bank account, other necessary Identity proofs, address
proofs and so on.
What is a Stock Market ?
A stock market is a platform for trading of company‟s shares at an agreed rate.
Portfolio Management Models
Portfolio management refers to the art of managing various financial products and assets to help an individual earn maximum
revenues with minimum risks involved in the long run. Portfolio management helps an individual to decide where and how to
invest his hard earned money for guaranteed returns in the future.
Portfolio Management Models
1. Capital Asset Pricing Model
Capital Asset Pricing Model also abbreviated as CAPM was proposed by Jack Treynor, William Sharpe, John
Lintner and Jan Mossin.
When an asset needs to be added to an already well diversified portfolio, Capital Asset Pricing Model is used to
calculate the asset‟s rate of profit or rate of return (ROI).
In Capital Asset Pricing Model, the asset responds only to:
 Market risks or non diversifiable risks often represented by beta
 Expected return of the market
 Expected rate of return of an asset with no risks involved
What are Non Diversifiable Risks ?
Risks which are similar to the entire range of assets and liabilities are called non diversifiable risks.
Where is Capital Asset Pricing Model Used ?
Capital Asset Pricing Model is used to determine the price of an individual security through security market
line (SML) and how it is related to systematic risks.
What is Security Market Line ?
Security Market Line is nothing but the graphical representation of capital asset pricing model to determine
the rate of return of an asset sensitive to non diversifiable risk (Beta).
2. Arbitrage Pricing Theory
Stephen Ross proposed the Arbitrage Pricing Theory in 1976.
Arbitrage Pricing Theory highlights the relationship between an asset and several similar market risk factors.
According to Arbitrage Pricing Theory, the value of an asset is dependent on macro and company specific
factors.
3. Modern Portfolio Theory
Modern Portfolio Theory was introduced by Harry Markowitz.
According to Modern Portfolio Theory, while designing a portfolio, the ratio of each asset must be chosen
and combined carefully in a portfolio for maximum returns and minimum risks.
In Modern Portfolio Theory emphasis is not laid on a single asset in a portfolio, but how each asset changes
in relation to the other asset in the portfolio with reference to fluctuations in the price.
Modern Portfolio theory proposes that a portfolio manager must carefully choose various assets while
designing a portfolio for maximum guaranteed returns in the future.
4. Value at Risk Model

13. Value at Risk Model was proposed to calculate the risk involved in financial market. Financial markets are
characterized by risks and uncertainty over the returns earned in future on various investment products.
Market conditions can fluctuate anytime giving rise to major crisis.
The potential risk involved and the potential loss in value of a portfolio over a certain period of time is
defined as value at risk model.
Value at Risk model is used by financial experts to estimate the risk involved in any financial portfolio over a
given period of time.
5. Jensen’s Performance Index
Jensen‟s Performance Index was proposed by Michael Jensen in 1968.
Jensen‟s Performance Index is used to calculate the abnormal return of any financial asset (bonds, shares,
securities) as compared to its expected return in any portfolio.
Also called Jensen‟s alpha, investors prefer portfolio with abnormal returns or positive alpha.
Jensen‟s alpha = Portfolio Return – [Risk Free Rate + Portfolio Beta * (Market Return – Risk Free Rate)
6. Treynor Index
Treynor Index model named after Jack.L Treynor is used to calculate the excess return earned which could
otherwise have been earned in a portfolio with minimum or no risk factors involved.
Where T-Treynor ratio
Roles and Responsibilities of a Portfolio Manager
A portfolio manager is one who helps an individual invest in the best available investment plans for guaranteed returns in the
future.
Let us go through some roles and responsibilities of a Portfolio manager:
 A portfolio manager plays a pivotal role in deciding the best investment plan for an individual as per his
income, age as well as ability to undertake risks. Investment is essential for every earning individual. One
must keep aside some amount of his/her income for tough times. Unavoidable circumstances might arise anytime
and one needs to have sufficient funds to overcome the same.
 A portfolio manager is responsible for making an individual aware of the various investment tools available
in the market and benefits associated with each plan. Make an individual realize why he actually needs to invest
and which plan would be the best for him.
 A portfolio manager is responsible for designing customized investment solutions for the clients.
No two individuals can have the same financial needs. It is essential for the portfolio manager to first
analyze the background of his client. Know an individual‟s earnings and his capacity to invest. Sit with
your client and understand his financial needs and requirement.
 A portfolio manager must keep himself abreast with the latest changes in the financial market.
Suggest the best plan for your client with minimum risks involved and maximum returns. Make him
understand the investment plans and the risks involved with each plan in a jargon free language. A
portfolio manager must be transparent with individuals. Read out the terms and conditions and never
hide anything from any of your clients. Be honest to your client for a long term relationship.
 A portfolio manager ought to be unbiased and a thorough professional. Don‟t always look for your
commissions or money. It is your responsibility to guide your client and help him choose the best
investment plan. A portfolio manager must design tailor made investment solutions for individuals which
guarantee maximum returns and benefits within a stipulated time frame. It is the portfolio manager‟s
duty to suggest the individual where to invest and where not to invest? Keep a check on the market
fluctuations and guide the individual accordingly.

14.  A portfolio manager needs to be a good decision maker. He should be prompt enough to finalize the
best financial plan for an individual and invest on his behalf.
 Communicate with your client on a regular basis. A portfolio manager plays a major role in setting
financial goal of an individual. Be accessible to your clients. Never ignore them. Remember you have
the responsibility of putting their hard earned money into something which would benefit them in the
long run.
 Be patient with your clients. You might need to meet them twice or even thrice to explain them all the
investment plans, benefits, maturity period, terms and conditions, risks involved and so on. Don‟t ever
get hyper with them.
 Never sign any important document on your client’s behalf. Never pressurize your client for any
plan. It is his money and he has all the rights to select the best plan for himself.
Selecting the right Portfolio Manager
What is Investment ?
It is essential for every individual to keep aside some amount of his income for a secure future. The art of assigning some
amount of money into something, which would benefit the individual concerned in the near future, is called as investment.
Why Investment ?
 Investment helps an individual to save money for the times when he would no longer be able to earn.
 Investment makes an individual‟s future secure and stable.
Where to Invest ?
An individual can invest in any of the following:
Gold/Silver
Mutual Funds
Shares and Stocks
Bonds
Property (Residential as well as commercial)
How to Invest ?
An individual should not invest just for the sake of investing. One should understand as to why he needs to invest?
Don‟t just invest in any plan available in the market. Decide the best plan for yourself as per your income, age and
financial requirements. One must go through the terms and conditions before investing in any market plan.
Who decides where to invest ?
How would one come to know where to invest and where not to invest ?
How would an individual decide which organization‟s share would yield him the best results in the near future and
which should be sold off immediately ?
Here comes the role of a Portfolio Manager.
Who is a Portfolio Manager ?
An individual who understands the client‟s financial needs and designs tailor made investment solutions with
minimum risks involved and maximum profits is called a portfolio manager.
A portfolio manager invests money on behalf of the client in various investment tools such as mutual funds, bonds,
shares and so on to ensure maximum profitability.
It is the responsibility of the portfolio manager to choose the best plan for his client as per his financial requirements,
income and ability to undertake risks.
How to choose the right portfolio manager ?
Portfolio managers charge a good amount of money form their clients for their services. One must be careful while
selecting the right portfolio manager.
 Make sure the portfolio manager you choose has complete market knowledge and knows about the
existing investment plans and the various risks involved. Taking the assistance of someone who himself
is not clear about the market policies does not make sense.
 A portfolio manager should be trustworthy. You will find all types of portfolio managers in the market -
cheat, dishonest, unprofessional. An individual must hire the best portfolio manager who understands
the market well and can guide him correctly. Don‟t give money to someone who does not have a good
background. You never know he might run away with all your hard earned money. Ask for his business
card. Check his reputation in the market.

15.  An individual must not blindly trust his portfolio manager. Make it a point to read the related documents
carefully before investing. A/C payee cheques must be issued and one should never sign any blank
document.
 A good portfolio manager should be transparent with his client. One should not try to confuse his client by
using complicated terminologies and professional jargons. The various plans must be explained to the
client in the easiest possible way.
 Select a portfolio manager who does not have any personal interests in your investing in any particular
plan. He should be able to help you decide the best plan available in the market.
What are Bonds ?
Why Investment is Important ?
Every individual needs to put some part of his income into something which would benefit him in the long run. Investment is
essential as unavoidable circumstances can arise anytime and anywhere. One needs to invest money into something which
would guarantee maximum returns with minimum risks in future. Money saved now will help you overcome tough times in the
best possible way.
What are Bonds ?
Bonds are issued by organizations generally for a period of more than one year to raise money by borrowing.
Organizations in order to raise capital issue bond to investors which is nothing but a financial contract, where the organization
promises to pay the principal amount and interest (in the form of coupons) to the holder of the bond after a certain date. (Also
called maturity date).Some Bonds do not pay interest to the investors, however it is mandatory for the issuers to pay the
principal amount to the investors.
What is a Maturity Date ?
Maturity date refers to the final date for the payment of any financial product when the principal along with the interest
needs to be paid to the investor by the issuer.
Characteristics of a Bond
 A bond is generally a form of debt which the investors pay to the issuers for a defined time frame. In a
layman‟s language, bond holders offer credit to the company issuing the bond.
 Bonds generally have a fixed maturity date.
 All bonds repay the principal amount after the maturity date; however some bonds do pay the interest
along with the principal to the bond holders.
Types of Bonds
Following are the types of bonds:
1. Fixed Rate Bonds
In Fixed Rate Bonds, the interest remains fixed through out the tenure of the bond. Owing to a constant
interest rate, fixed rate bonds are resistant to changes and fluctuations in the market.
2. Floating Rate Bonds
Floating rate bonds have a fluctuating interest rate (coupons) as per the current market reference rate.
3. Zero Interest Rate Bonds
Zero Interest Rate Bonds do not pay any regular interest to the investors. In such types of bonds, issuers
only pay the principal amount to the bond holders.
4. Inflation Linked Bonds
Bonds linked to inflation are called inflation linked bonds. The interest rate of Inflation linked bonds is
generally lower than fixed rate bonds.
5. Perpetual Bonds
Bonds with no maturity dates are called perpetual bonds. Holders of perpetual bonds enjoy interest
throughout.
6. Subordinated Bonds
Bonds which are given less priority as compared to other bonds of the company in cases of a close down
are called subordinated bonds. In cases of liquidation, subordinated bonds are given less importance as
compared to senior bonds which are paid first.
7. Bearer Bonds

16. Bearer Bonds do not carry the name of the bond holder and anyone who possesses the bond certificate can
claim the amount. If the bond certificate gets stolen or misplaced by the bond holder, anyone else with the
paper can claim the bond amount.
8. War Bonds
War Bonds are issued by any government to raise funds in cases of war.
9. Serial Bonds
Bonds maturing over a period of time in installments are called serial bonds.
10. Climate Bonds
Climate Bonds are issued by any government to raise funds when the country concerned faces any adverse
changes in climatic conditions.
Security Analysis and Portfolio Management
What is a Security ?
Assets with some financial value are called securities.
Characteristics of Securities
 Securities are tradable and represent a financial value.
 Securities are fungible.
Classification of Securities
 Debt Securities: Tradable assets which have clearly defined terms and conditions are called debt securities.
Financial instruments sold and purchased between parties with clearly mentioned interest rate, principal amount,
maturity date as well as rate of returns are called debt securities.
 Equity Securities: Financial instruments signifying the ownership of an individual in an organization are called
equity securities. An individual buying equities has an ownership in the company‟s profits and assets.
 Derivatives: Derivatives are financial instruments with specific conditions under which payments need to be made
between two parties.
What is Security Analysis ?
The analysis of various tradable financial instruments is called security analysis. Security analysis helps a financial
expert or a security analyst to determine the value of assets in a portfolio.
Why Security Analysis ?
Security analysis is a method which helps to calculate the value of various assets and also find out the effect of
various market fluctuations on the value of tradable financial instruments (also called securities).
Classification of Security Analysis
Security Analysis is broadly classified into three categories:
1. Fundamental Analysis
2. Technical Analysis
3. Quantitative Analysis
What is Fundamental Analysis ?
Fundamental Analysis refers to the evaluation of securities with the help of certain fundamental business factors such
as financial statements, current interest rates as well as competitor‟s products and financial market.
What are Financial Statements ?
Financial statements are nothing but proofs or written records of various financial transactions of an investor or
company.
Financial statements are used by financial experts to study and analyze the profits, liabilities, assets of an
organization or an individual.
What is Technical Analysis ?
Technical analysis refers to the analysis of securities and helps the finance professionals to forecast the price trends
through past price trends and market data.
What is Quantitative Analysis ?

17. Quantitative analysis refers to the analysis of securities using quantitative data.
Difference between Fundamental Analysis and Quantitative Analysis
Fundamental analysis is done with the help of financial statements, competitor‟s market, market data and other
relevant facts and figures whereas technical analysis is more to do with the price trends of securities.
What is Portfolio Management ?
The stream which deals with managing various securities and creating an investment objective for individuals is
called portfolio management. Portfoilo management refers to the art of selecting the best investment plans for an
individual concerned which guarantees maximum returns with minimum risks involved.
Portfolio management is generally done with the help of portfolio managers who after understanding the client‟s
requirements and his ability to undertake risks design a portfolio with a mix of financial instruments with maximum
returns for a secure future.
Portfolio Theory
Portfolio theory was proposed by Harry M. Markowitz of University of Chicago. According to Markowitz‟s portfolio
theory, portfolio managers should carefully select and combine financial products on behalf of their clients for
guaranteed maximum returns with minimum risks.
Portfolio theory helps portfolio managers to calculate the amount of return as well as risk for any investment portfolio.
Portfolio Revision - Meaning, its Need and Strategies
What is a Portfolio ?
A combination of various investment products like bonds, shares, securities, mutual funds and so on is called a portfolio.
In the current scenario, individuals hire well trained and experienced portfolio managers who as per the client‟s risk taking
capability combine various investment products and create a customized portfolio for guaranteed returns in the long run.
It is essential for every individual to save some part of his/her income and put into something which would benefit him in the
future. A combination of various financial products where an individual invests his money is called a portfolio.
What is Portfolio Revision ?
The art of changing the mix of securities in a portfolio is called as portfolio revision.
The process of addition of more assets in an existing portfolio or changing the ratio of funds invested is called as portfolio
revision.
The sale and purchase of assets in an existing portfolio over a certain period of time to maximize returns and
minimize risk is called as Portfolio revision.
Need for Portfolio Revision
 An individual at certain point of time might feel the need to invest more. The need for portfolio revision
arises when an individual has some additional money to invest.
 Change in investment goal also gives rise to revision in portfolio. Depending on the cash flow, an
individual can modify his financial goal, eventually giving rise to changes in the portfolio i.e. portfolio
revision.
 Financial market is subject to risks and uncertainty. An individual might sell off some of his assets owing
to fluctuations in the financial market.
Portfolio Revision Strategies
There are two types of Portfolio Revision Strategies.
1. Active Revision Strategy
Active Revision Strategy involves frequent changes in an existing portfolio over a certain period of time for
maximum returns and minimum risks.
Active Revision Strategy helps a portfolio manager to sell and purchase securities on a regular basis for
portfolio revision.
2. Passive Revision Strategy
Passive Revision Strategy involves rare changes in portfolio only under certain predetermined rules. These
predefined rules are known as formula plans.

18. According to passive revision strategy a portfolio manager can bring changes in the portfolio as per the
formula plans only.
What are Formula Plans ?
Formula Plans are certain predefined rules and regulations deciding when and how much assets an
individual can purchase or sell for portfolio revision. Securities can be purchased and sold only when there are
changes or fluctuations in the financial market.
Why Formula Plans ?
 Formula plans help an investor to make the best possible use of fluctuations in the financial market. One
can purchase shares when the prices are less and sell off when market prices are higher.
 With the help of Formula plans an investor can divide his funds into aggressive and defensive portfolio
and easily transfer funds from one portfolio to other.
Aggressive Portfolio
Aggressive Portfolio consists of funds that appreciate quickly and guarantee maximum returns to the investor.
Defensive Portfolio
Defensive portfolio consists of securities that do not fluctuate much and remain constant over a period of time.
Formula plans facilitate an investor to transfer funds from aggressive to defensive portfolio and vice a versa.