A capital market is a marketer that includes all organizations, institutions, and tools that offer medium- and long-term funding. It excludes organizations and products that offer financing for a brief period of time—up to a year. A capital market may include common securities like bonds, shares, mutual funds, debentures, and public deposits. There are two different kinds of capital markets: primary markets and secondary markets.
Primary market-
When securities are sold for the first time with the goal of raising long-term capital for the companies, this is known as a primary market. In essence, it is in charge of creating new problems. As a result, it goes under the name “new issue market.”
Secondary market-
A secondary market is a market that facilitates the buying and selling of both newly issued and used securities. A corporation does not issue its securities to investors directly in this market. Rather, the company’s current investors sell the securities to new investors. In the secondary market, the investor wishing to buy and the investor wanting to sell securities meet and, with the assistance of a broker, exchange the securities for cash.
Qualities of the Primary Market-
When a corporation needs long-term finance, it looks to the primary market. Therefore, one characteristic of a main market is the ability to meet the requirement for long-term capital.
There is a new security offering in the main market. Retail and institutional investors often make up the buyers.
Qualities of the Secondary Market-
The secondary market assists businesses in meeting their immediate liquidity needs. It helps make currently available assets more marketable.
In order to safeguard the interests of the investor, it also guarantees honest and equitable treatment.
Comparing Primary and Secondary Markets-
The primary market is the name given to securities issued in a market. The secondary market is what happens when a firm lists on an exchange and investors trade its stocks there.
“New issue market” is another term for the primary market, and “after issue market” is another term for the secondary market. Prices in the secondary market fluctuate based on supply and demand for the traded securities. However, there are fixed pricing in the primary market.
While investors buy and sell securities among themselves in the secondary market, they might choose to buy shares directly from the company in the primary market.
In a primary market, the selling is done by investment bankers. The broker serves as a middleman between traders in the secondary market.
The corporation benefits from the selling of a security in the primary market. Investors have the opportunity to benefit from any capital appreciation on the securities in the secondary market.
In the secondary market, sales and purchases are ongoing, whereas in the primary market, securities can only be sold once.
A company’s capital is created from the money it receives from its securities, but in the secondary market, the same amount represents investors’ income.
The primary and secondary financial markets are vital to the flow of capital and the growth of the national economy. Strong financial markets facilitate companies’ access to capital and help them expand more quickly.
Purchasing stock on the secondary market is a reasonably easy process. In the secondary market, the following process is adhered to when purchasing or selling shares:
Open a Demat account with IIFL or another depository participant (DP).
Get a broker and open a trading account.
Connect your trading and demat accounts to your bank account.
Using the electronic terminal, the broker executes orders to purchase or sell shares.
The broker issues a contract note that lists the value of the shares he has bought along with his brokerage fee.
Open a trading account and get a broker.
Link your bank account to your trading and demat accounts.
The broker uses the electronic terminal to carry out orders for the purchase or sale of shares.
A contract notes detailing the purchase price of the shares and the broker’s commission is provided by the broker.
RISK ANALYSIS OF MUTUAL FUND
Mutual funds often have a risk profile and invest in ways determined by their mandate. When making an investment in mutual funds, one should take the risk profile into account. There may be funds in a category that are comparatively higher or lower risk than others, but overall, certain funds have a lower risk than others. Certain risk ratios should be taken into account when evaluating the risk as they will help determine whether the fund is appropriate for your risk tolerance. Mutual funds provide unmatched diversification and aid in optimizing returns through effective risk mitigation.
Ratios of risk
Mutual fund financial risk evaluates the possibility of a loss. A mutual fund is a sum of money that is mandated to be invested in several securities. A few key elements related to the underlying assets are used to evaluate the risk of this.
Some of the key ratios considered for assessing mutual fund risk are:
1. Variance
2. Beta
3. Sharpe Ratio
4. Alpha
5. R-squared
6. Standard Deviation
Variance:
This is a metric used to assess how returns deviate from the asset’s mean returns. If the stock’s returns deviate more from the mean returns for the time under consideration, this is referred to as the stock’s volatility.
The variance is applied to the yearly mean returns of mutual funds in order to illustrate their volatility. The mutual fund’s standard deviation, or the square root of its variance, is compared to the variance of the other funds in the same category.
Beta:
The beta coefficient gauges the relative risk of a mutual fund compared to the market and is a measure of systematic risk. Since beta is a relative metric, it is best compared to the variance of the corresponding benchmark indexes when evaluating a specific mutual fund.
The mutual fund’s benchmark will be predetermined in accordance with the mandate and aim of the fund.
1. A beta of 1.0 means that the mutual fund moves in a manner that is comparable to the market.
2. A mutual fund with a beta of less than 1.0 is less volatile than the market as a whole.
3. A mutual fund with a beta greater than 1.0 has greater volatility than that of the market
Sharpe Ratio:
The Sharpe Ratio is a metric that quantifies returns for each unit of incurred risk. It is calculated by dividing the mutual fund’s excess returns over the risk-free rate of return by the square root of the variance, or standard deviation, for the specified time period.
The risk-adjusted performance improves with a higher Sharpe ratio. One considers a ratio of one or higher to be good, two or higher to be very good, and three or higher to be excellent.
Alpha Ratio:
The alpha ratio tells us how well mutual funds have performed in relation to the benchmark index. Greater relative performance in relation to the benchmark is indicated by a higher Alpha. Alpha refers to the excess returns of the investments over the benchmark’s returns.
R-squared:
This additional mutual fund risk ratio assesses the performance of the fund. It calculates the proportion of a fund’s fluctuation that may be attributed to the performance of a benchmark index. This ratio is used by investors to assess the level of active vs passive management of a fund.
A fund that is actively managed beats its benchmark index. Consequently, its r-squared value is smaller. A passively managed fund, on the other hand, mimics the performance of the benchmark. As a result, its r-squared value is usually higher. With the use of this ratio, investors can assess the performance of mutual funds, differentiate between low-risk and high-risk options, and ascertain whether the fund management is actively making choices or just following the benchmark.
Standard Deviation:
The standard deviation serves as a gauge for the total risk associated with mutual funds. This covers portfolio risk, market risk, and risk particular to a given security. It shows the variations in the returns of your mutual fund over a given time frame. To put it simply, standard deviation shows the degree to which your actual returns differ from the projected returns predicted by the fund’s past performance.
This ratio is used by investors to assess a mutual fund’s risk profile and contrast it with that of other funds. The ratio is used to compute the mutual fund Sharpe ratio and is directly related to the volatility of the portfolio.
RISK FACTORS COMMON RISK ELEMENTS
Mutual Fund Plans are not products with guaranteed or assured returns.
Investment risks associated with purchasing mutual fund units include those related to trading volume, settlement risk, liquidity risk, default risk, and potential principal loss.
The value of investing in a mutual fund scheme might increase or decrease based on changes in the price, value, and interest rates of the securities that the scheme owns.
The NAV of the Scheme may fluctuate in response to movements in the larger equity and bond markets as well as factors affecting capital and money markets generally, including but not limited to changes in interest rates, currency exchange rates, government policy, taxation, political, economic, and other developments, as well as increased volatility in the stock and bond markets. These factors are in addition to those that affect the value of individual investments in the Scheme.
Any mutual fund scheme’s past success does not guarantee its future performance.
SPECIFIC RISK FACTORS
RISKS ASSOCIATED WITH INVESTMENTS IN EQUITIES
Risk of losing money:
Investments in equity and equity related instruments involve a degree of risk and investors should not invest in the equity schemes unless they can afford to take the risk of possible loss of principal.
Price Risk:
Equity shares and equity related instruments are volatile and prone to price fluctuations on a daily basis.
Liquidity Risk for listed securities:
The liquidity of investments made in the equities may be restricted by trading volumes and settlement periods. Settlement periods may be extended significantly by unforeseen circumstances. While securities that are listed on the stock exchange carry lower liquidity risk, the ability to sell these investments is limited by the overall trading volume on the stock exchanges. The inability of a mutual fund to sell securities held in the portfolio could result in potential losses to the scheme, should there be a subsequent decline in the value of securities held in the scheme portfolio and may thus lead to the fund incurring losses till the security is finally sold.
Event Risk:
Price risk due to company or sector specific event.
Conclusion-
Hence, it can be said that there will always be some risks associated with mutual funds. Nonetheless, investors can mitigate the influence of the same and prevent their capital from eroding by adopting smart investment techniques.
Author Bio
