Fundamentals of Stock Trading - Important Question/Answers for Examination

Fundamentals of Stock Trading 

Important Question/Answers for Examination

Question 1 

Explain the term investment and factors affecting investment decision. 

Answer: 

Meaning of Investment

Investment refers to the expenditure made on the purchase or creation of new capital assets such as machinery, buildings, tools, equipment, and inventories. It involves sacrificing current consumption to gain future benefits.
In economics, investment means addition to the capital stock of an economy.
In finance, it means allocating money to assets like shares, bonds, or real estate to earn returns in the future.
Thus, investment is a future-oriented activity undertaken with the expectation of earning income, profit, or growth.

Factors Affecting Investment Decisions

Investment decisions are influenced by a combination of economic, financial, and psychological factors. The major factors include:

1. Expected Rate of Return

Higher expected returns motivate investors to invest more. Investment increases when profitability is high and decreases when returns are low.

2. Rate of Interest

Interest rate represents the cost of borrowing funds.

• High interest rates discourage investment because borrowing becomes expensive.

• Low interest rates encourage investment by reducing the cost of capital.

3. Level of Income and Demand

When consumers’ incomes rise and market demand increases, firms expect higher sales in the future. This encourages businesses to invest in expansion.

4. Cost of Capital Assets

If machinery, equipment, and raw materials are expensive, investment becomes less attractive.
Lower cost of capital goods → higher investment
Higher cost → lower investment

5. Technological Advancement

Innovation and new technology encourage firms to replace old machinery and adopt advanced methods, leading to increased investment.

6. Government Policies

Tax incentives, subsidies, lower interest loans, and favourable industrial policies encourage investment.
However, high taxes, strict regulations, or policy uncertainty can reduce investment.

7. Business Expectations

Positive expectations about future economic conditions boost investment.
If businesses fear recession, political instability, or market uncertainty, they postpone investment.

8. Availability of Funds

Firms need internal savings or external finance to invest. Easy availability of credit and strong business profits increase investment.

9. Existing Capital Stock

If firms already have excess production capacity, they delay new investment.
If machinery is outdated or operating at full capacity, new investment becomes necessary.

10. Risk Factor

Investors consider the level of risk associated with each investment.
High risk discourages investment unless it is compensated by higher expected returns.

Conclusion

Investment is a crucial driver of economic growth as it increases productive capacity and generates employment. Investment decisions depend on returns, interest rates, demand, costs, technology, government support, and market expectations. Understanding these factors helps individuals and businesses make informed financial decisions.

Question 2

Explain the different types of investment avenues available to investor in the market

Answer: 

Investment avenues refer to the various options where an investor can allocate funds to earn returns. These avenues differ in terms of risk, return, liquidity, and investment horizon. They are broadly classified into Financial and Non-Financial investments.

A. FINANCIAL INVESTMENT AVENUES

1. Bank Deposits

Includes Fixed Deposits (FDs) and Recurring Deposits (RDs).
They offer fixed and safe returns, suitable for risk-averse investors.

2. Government Securities

Examples: Treasury Bills, Government Bonds, NSC.
Backed by the government, they involve very low risk.

3. Post Office Saving Schemes

Such as PPF, Kisan Vikas Patra, MIS, Senior Citizen Savings Scheme.
Provide secure returns with tax benefits.

4. Equity Shares

Represent ownership in a company.
High returns in the long run but high market risk.

5. Debentures and Corporate Bonds

Issued by companies; offer fixed interest.
Moderate return with moderate risk.

6. Mutual Funds

Professionally managed funds that invest in equities, debt, or both.
Types: Equity Funds, Debt Funds, Hybrid Funds, Index Funds.
Offer diversification and liquidity.

7. Exchange Traded Funds (ETFs)

Trade like shares on stock exchanges.
Low-cost investment option tracking indices or commodities.

8. Derivatives (Futures & Options)

Used for hedging and speculation.
High-risk and suitable for experienced investors.

9. Insurance-Based Investments

Includes ULIPs and traditional life insurance plans.
Offer long-term investment with insurance benefits.

10. Pension & Retirement Funds

Examples: NPS, EPF.
Provide long-term retirement savings with tax advantages.

B. NON-FINANCIAL INVESTMENT AVENUES

11. Real Estate

Investment in land, flats, shops, or commercial property.
High capital requirement; offers rental income and appreciation.

12. Gold & Precious Metals

Options: Physical Gold, Gold ETFs, Sovereign Gold Bonds.
Acts as a hedge against inflation and economic uncertainty.

13. Commodities

Trading in metals (silver, copper), crude oil, agricultural products.
Used for hedging and high-risk trading.

14. Collectibles

Artworks, antiques, rare coins, stamps, etc.
Low liquidity and high risk, suitable for niche investors.

C. DIGITAL / MODERN INVESTMENT AVENUES

15. Cryptocurrency

Digital assets like Bitcoin, Ethereum.
Highly volatile and risky; suitable for high-risk investors.

16. Peer-to-Peer (P2P) Lending

Online platforms connecting lenders and borrowers.
Higher returns but involves credit/default risk.

Conclusion

Investors have multiple avenues ranging from safe and stable options (PPF, FDs, Government Securities) to high-risk opportunities (Equity, Derivatives, Crypto).
A good investment strategy involves diversifying across different avenues based on risk appetite, financial goals, and time horizon.

Question 3

Stock Markets Play an important role in Indian Markets. Explain the statement. 

Answer:

Importance of Stock Markets in Indian Security Markets

The stock market is an essential part of the Indian financial system. It provides a platform for trading shares, debentures, bonds, and other financial instruments. Major Indian stock exchanges include the NSE (National Stock Exchange) and the BSE (Bombay Stock Exchange).
Stock markets play a crucial role in mobilizing savings, providing investment opportunities, and supporting the growth of the economy.

1. Mobilization of Savings

Stock markets encourage individuals and institutions to invest their savings in productive financial assets.
This leads to the efficient utilization of idle funds and promotes capital formation.

2. Facilitates Capital Formation

Companies raise long-term funds by issuing shares and debentures through the stock market.
This helps businesses expand operations, adopt new technologies, and grow, contributing to economic development.

3. Provides Liquidity

One of the most important functions of stock markets is to provide high liquidity.
Investors can buy or sell securities at any time, making investment flexible and attractive.

4. Fair Price Discovery

Share prices are determined through the forces of demand and supply.
This transparent mechanism helps investors know the true value of securities and make informed decisions.

5. Ensures Safety through Regulation

The stock market is regulated by SEBI (Securities and Exchange Board of India).
SEBI ensures:

• fair trading

• investor protection

• transparency

• prevention of fraud

This increases investor confidence in the market.

6. Offers Diversification

Stock exchanges offer a wide range of investment instruments such as:

• Equity shares

• Bonds

• ETFs

• Mutual funds

• Derivatives

This allows investors to spread their risk and earn balanced returns.

7. Indicator of Economic Health

Stock market movements reflect the overall performance of the economy.
A rising stock market shows economic growth and positive business sentiment, while a falling market indicates slowdown.
Thus, the stock market acts as an economic barometer.

8. Promotes Corporate Governance

Listed companies must follow strict disclosure and reporting standards.
This encourages:

• transparency

• accountability

• ethical management practices

Improved governance benefits both investors and the economy.

9. Wealth Creation & Economic Growth

Stock markets help create wealth for investors through capital appreciation and dividends.
A strong stock market attracts domestic and foreign investment, supporting economic growth and job creation.

Conclusion

Stock markets play a vital role in the Indian security market system. They mobilize savings, provide liquidity, ensure transparency, promote corporate growth, and act as an indicator of economic performance. A well-regulated and efficient stock market is essential for a stable and growing economy.

Question 4

Differentiate between Limit Order and Market order

Answer:

Difference Between Limit Order and Market Order

Basis	Limit Order	Market Order
Meaning	An order to buy or sell a security at a specific price or better.	An order to buy or sell a security immediately at the current market price.
Execution Price	Executed only at the price set by the investor (or better).	Executed at the best available price in the market.
Speed of Execution	Execution may take time; not guaranteed.	Executed instantly; guaranteed execution.
Price Control	Gives full control over the buying or selling price.	No control over the exact price; price may vary slightly.
Risk Level	Lower risk because price is predetermined.	Higher price risk because price may change during execution.
Use Case	Used when investors want a specific entry/exit price.	Used when the investor wants quick execution regardless of price.
Best For	Low-volatility strategies and patient investors.	High-speed trades and urgent transactions.

Question 5

Differentiate between Stop Loss Order and Stop Loss Market Order.

Answer:

Difference Between Stop-Loss Order and Stop-Loss Market Order

Basis	Stop-Loss Order (SL Order)	Stop-Loss Market Order (SL-M Order)
Meaning	A stop-loss order that becomes a limit order once the trigger price is hit.	A stop-loss order that becomes a market order once the trigger price is hit.
Execution Price	Executed only at the limit price or better set by the trader.	Executed at the current market price, whatever it may be, after the trigger is hit.
Price Control	Gives price control; execution may not happen if price moves away.	No price control; execution is certain once triggered.
Execution Guarantee	Not guaranteed—may remain pending if price doesn’t match the limit.	Guaranteed execution, but at any available market price.
Risk Level	Risk of non-execution (order may remain open).	Risk of slippage (executed at unfavourable price).
Use Case	Used when the trader wants protection and control over execution price.	Used when the trader wants to exit quickly at any price once trigger hits.

Question 6

Explain the term Indirect Investing. How is it different from Direct Investing?

Answer:

Indirect Investing

Indirect investing means investing in financial assets through an intermediary, such as mutual funds, pension funds, portfolio management services, or insurance-linked investment plans.
The investor does not directly buy shares or bonds. Instead, a professional fund manager invests on behalf of the investor.

Examples of Indirect Investing

• Mutual Funds

• Exchange Traded Funds (ETFs)

• Pension Funds (NPS)

• ULIPs

• Portfolio Management Schemes (PMS)

Difference Between Direct and Indirect Investing

Basis	Direct Investing	Indirect Investing
Decision Making	Investor makes all buy/sell decisions independently.	Fund managers make decisions for the investor.
Ownership	Direct ownership of shares or securities.	Indirect ownership through pooled funds.
Risk Level	Riskier due to lack of diversification.	Lower risk due to diversification.
Expertise Required	Requires good market knowledge and research.	Little or no expertise needed.
Cost	Lower ongoing charges (no fund management fees).	Higher fees like expense ratio, fund management charges.
Time Involvement	High—requires monitoring and analysis.	Low—professionals manage the investment.
Control	Full control over portfolio and timing.	Limited control; decisions made by intermediaries.

Conclusion

• Indirect Investing is suitable for investors who prefer convenience, diversification, and professional management.

• Direct Investing is suited for experienced investors who want full control, higher potential returns, and are willing to take higher risks.

Question 7

Differentiate between open ended and close ended mutual funds. 

Answer:

Difference Between Open-Ended and Close-Ended Mutual Funds

Basis	Open-Ended Mutual Funds	Close-Ended Mutual Funds
Meaning	Funds that allow investors to buy or sell units anytime.	Funds that allow buying only during the initial offer period.
Entry & Exit	Free entry and exit throughout the year.	Entry only at NFO; exit allowed only after maturity (except via stock exchange).
Maturity Period	No fixed maturity.	Have a fixed maturity (e.g., 3–7 years).
Liquidity	Highly liquid; units can be redeemed directly with the AMC.	Low liquidity; units can be sold only on the stock exchange (if listed).
Pricing	Price is based on NAV (Net Asset Value) declared daily.	Traded on exchange; price may differ from NAV.
Flexibility	Very flexible; suitable for regular investing (SIP).	Less flexible; suitable for long-term locked investments.
Fund Size	Keeps changing as investors buy/sell units anytime.	Fixed fund size since no new units are issued after NFO.
Who Should Invest?	Investors looking for liquidity and convenience.	Investors who want disciplined long-term investment.

Question 8

What are mutual funds. Explain the advantages of investing in mutual funds. 

Answer: 

What Are Mutual Funds?

A Mutual Fund is a financial investment vehicle that pools money from many investors and invests it in a diversified portfolio of securities such as shares, bonds, money market instruments, or other assets.
The fund is managed by professional fund managers who make investment decisions on behalf of investors.

Each investor in a mutual fund owns units of the fund, which represent their share in the overall pool of assets. The value of these units is known as the Net Asset Value (NAV).

Mutual funds are regulated by SEBI (Securities and Exchange Board of India) to ensure transparency and investor protection.

Advantages of Investing in Mutual Funds

1. Professional Management

• The fund is managed by qualified and experienced fund managers.

• Investors benefit from expert research, analysis, and decision-making.

2. Diversification

• Mutual funds invest in a wide range of securities.

• Diversification reduces the overall risk because losses in one investment may be offset by gains in another.

3. Liquidity

• Investors can buy or redeem units of open-ended mutual funds at any time.

• Easy entry and exit make mutual funds convenient.

4. Low Cost and Affordable Investment

• Investors can start with a small amount (e.g., ₹500–₹1000 via SIP).

• Total cost is lower due to shared expenses and economies of scale.

5. Transparency and Safety

• SEBI regulations ensure regular disclosures of portfolio, NAV, fees, and performance.

• Higher level of investor protection.

6. Variety of Schemes

• Equity funds, debt funds, hybrid funds, index funds, sectoral funds, tax-saving ELSS, etc.

• Investors can choose according to their risk level, goals, and time horizon.

7. Tax Benefits

• ELSS (Equity Linked Savings Scheme) offers tax deduction under Section 80C up to ₹1.5 lakh.

• Long-term capital gains are taxed at favourable rates.

8. Easy to Invest and Operate

• Investment can be made online, through SIP, or lumpsum.

• No need for expertise in stock markets.

9. Better Returns Compared to Traditional Investments

• Equity and hybrid funds can offer higher returns over the long term due to market-linked growth.

10. Regulated and Well-Structured

• Mutual funds operate under strict guidelines ensuring safe operations and fair practices.

Question 9 

Differentiate between Primary & Secondary markets. 

Answer: 

Difference Between Primary and Secondary Markets

Basis	Primary Market	Secondary Market
Meaning	Market where companies issue new securities to raise funds.	Market where existing securities are bought and sold among investors.
Purpose	To raise capital for business expansion or new projects.	To provide liquidity and enable investors to trade existing shares.
Participants	Issuing company, investors, underwriters.	Investors, brokers, trading members, stock exchanges.
Examples	Initial Public Offer (IPO), Follow-on Public Offer (FPO), Rights Issue.	Stock exchanges like NSE and BSE where shares are traded.
Price Determination	Price is fixed by the company or underwriter before issue.	Price is determined by demand and supply in the market.
Funds Flow	Money flows from investors to the company.	Money flows between investors; company does not receive funds.
Securities	Newly issued shares, debentures, bonds.	Already listed shares, bonds, ETFs, mutual fund units.
Regulation	SEBI regulates issue procedures and disclosure.	SEBI regulates trading, settlement, and transparency.
Liquidity	Less liquid initially; shares are locked until listing.	Highly liquid; investors can buy or sell anytime.

Question 10

What are the procedure followed to invest in stock market. 

Answer:

Procedure to Invest in the Stock Market in India

Investing in the stock market requires a few formalities and steps to ensure safe and legal trading. Here’s the process:

1. Open a Demat Account

• A Demat Account holds all your shares in electronic form.

• Required to buy and sell shares on stock exchanges.

• Opened with a Depository Participant (DP) like ICICI, HDFC, Zerodha, Upstox, etc.

• National Depositories: NSDL and CDSL.

Documents required: PAN card, Aadhaar, bank account details, and address proof.

2. Open a Trading Account

• A Trading Account is needed to place buy or sell orders on the stock exchange.

• Linked with your Demat and bank accounts.

• Can be opened with a broker or brokerage firm.

3. Complete KYC Formalities

• Submit Know Your Customer (KYC) documents.

• Includes PAN, Aadhaar, photographs, and bank account details.

• Mandatory for SEBI compliance.

4. Fund Your Trading Account

• Transfer money from your bank account to your trading account.

• This money will be used to buy shares or securities.

5. Research and Select Stocks

• Study companies’ financials, performance, and market trends.

• Analyze risk, expected returns, and investment horizon.

• Decide the quantity and price at which you want to buy shares.

6. Place Orders

• Log in to your trading account (online platform or broker).

• Types of orders:

  • Market Order: Buy/sell at the current market price.

  • Limit Order: Buy/sell at a specific price or better.

  • Stop Loss / Stop-Loss Market Orders: To limit losses.

• Orders are sent to the stock exchange electronically.

7. Order Execution

• Stock exchange matches buy and sell orders using an electronic order-matching system.

• Once matched, trade is executed and confirmed.

8. Settlement of Trade

• Clearing Corporation ensures delivery of shares to the buyer and payment to the seller.

• Settlement cycle is T+1 (trade date + 1 working day).

• Shares are credited to the Demat account, and money is debited from the bank account.

9. Monitor and Manage Investments

• Keep track of market trends and portfolio performance.

• Decide when to sell or buy more shares based on goals, risk, and market conditions.

10. Maintain Records and Pay Taxes

• Keep transaction records for capital gains tax calculation.

• Pay taxes as per Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG) rules.

Question 11

What do you mean by NAV of a Mutual Fund? How is it determined? 

Answer:

Net Asset Value (NAV) of a Mutual Fund

Meaning:
The Net Asset Value (NAV) of a mutual fund represents the per unit market value of the fund’s assets minus its liabilities. It is the price at which investors buy or redeem units of the mutual fund.

Formula to Calculate NAV

$$\text{NAV per unit} = \frac{\text{Total Assets of the Fund – Total Liabilities}}{\text{Number of Units Outstanding}}$$

Where:

• Total Assets = Market value of all securities held by the fund + cash + receivables

• Total Liabilities = Expenses, fees, or other obligations of the fund

• Units Outstanding = Total units issued to investors

Example

• Total Assets = ₹10 crore

• Total Liabilities = ₹50 lakh

• Units Outstanding = 50 lakh units

$$\text{NAV} = \frac{10,00,00,000 - 50,00,000}{50,00,000} = \frac{9,50,00,000}{50,00,000} = ₹19 \text{ per unit}$$

Key Points About NAV

1. NAV Changes Daily:
   It is calculated at the end of each trading day based on the closing market prices of the fund’s securities.

2. Not the Same as Market Price:

   • Open-ended funds: Units are bought/redeemed at NAV.

   • Close-ended funds: Units may trade at premium or discount to NAV on stock exchanges.

3. Reflects True Value of Fund:
   NAV shows the actual per-unit worth of the mutual fund’s portfolio.

4. Used for Buying and Redemption:
   Investors buy or redeem mutual fund units at the NAV declared on that day, after adding applicable loads (entry/exit fees).