NISM Series - XV Research Analyst Cert. - Full-Length Test

A good research report will cover the effects of all types of risks to the industry / company to arrive at a sound conclusion.

Under the free cash flow to firm (FCFF) model, the value of the business is derived by discounting the FCFF.

Since FCFF is the cash flow available to all sources of capital, the discount rate is taken as the weighted average cost of capital that factors in all sources of capital and investors’ expected return on the same.

The Department of Economic Affairs is the nodal agency of the Central Government to formulate and monitor India’s macroeconomic policies, covering monetary and fiscal policy as well as the functioning of the capital market, including stock exchanges.

The PE ratio indicates the amount of money an investor needs to invest to receive 1 unit of profit. It is calculated using the current market price and the EPS.

All else held constant, a stock with higher PE ratio compared to the peer group numbers is considered to be an expensive stock. Similarly, a stock with a relatively low PE is considered as undervalued stock.

A fundamental research analyst researches the economy, the industry and the company.

A technical research analyst focuses on forecasting the direction of prices through the study of patterns in historical prices and volume.

Macroeconomic fundamentals are topics that affect an economy at-large, including statistics regarding unemployment, supply and demand, growth, and inflation, as well as considerations for monetary or fiscal policy and international trade. These will be studied by the fundamental analysts.

Warrants are options that entitle an investor to buy equity shares of the issuer company after a specified time period at a given price. These are usually long-term instruments.

Research analysts collect data/information from various sources, analyze the collected data/information, and make their recommendations. The job of analysts also involves close interaction with companies and clients.

Fundamental analysts maintain that the market may misprice securities in the short run, but in the long run, prices would merge with the securities’ fair value or intrinsic value.

Technical analysts do not care to analyze the fundamentals of the business. Instead, the approach is to forecast the direction of prices through the study of patterns in historical market data – price and volume.

Unlike fundamental analysis, technical analysis is not concerned if the stock is trading at a fair price relative to its intrinsic value.

The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act and other allied acts, rules, and regulations framed thereunder, mainly for regulating the functioning of the corporate sector in accordance with law.

Price to Earnings Ratio (PEG) = PE / Growth Rate

PEG Ratio of the first company = 9 / 8 = 1.12

PEG Ratio of the second company = 27 / 32 = 0.84

The PEG ratio of the second company (P/E of 27) is lower so it’s cheaper.

(The lower the PEG Ratio, cheaper the valuations.)

According to technical analysis, there are three essential elements in understanding the price behavior:

1. The history of past prices provides indications of the underlying trend and its direction. 2. The volume of trading that accompanies price movements provides important inputs on the underlying strength of the trend. 3. The time span over which price and volume are observed factors in the impact of long-term factors that influence prices over a period of time.

The Weighted Average Cost of Capital of the firm (WACC) is then calculated as under:

WACC = [Ke * We] + [Kd * (1-Tax)*Wd]

Where Ke = Cost of Equity, We = Weight of Equity, Kd = Cost of Debt, Wd = Weight of Debt

(As Tax is not mentioned, we ignore (1-Tax))

Weight of equity is 60%, the weight of debt will be 100 – 60 = 40%

WACC = [Ke * We] + [Kd *Wd]

(0.11 * 60) + (0.08 * 40)

6.6 + 3.2 = 9.8%

Pricing power refers to a company’s ability to independently determine and charge the price of its products. Companies with strong pricing power would be able to pass on any escalation in input costs to their customers. They can also increase their prices when demand is strong and thus grow their margins.

Entry barriers in an industry would be high if:

1. There are lots of licenses required in the business. 2. Patents and copyrights prevent new entrants. 3. Huge investments in specialized assets pose a challenge. 4. Strong brands, a strong distribution network, specialized execution capabilities, and customer loyalty with existing products/services exist in the business.

When interest rates rise, bondholders experience a fall in the price of bonds they hold, as these bonds are paying a lower interest as compared to new bonds.

Similarly, when rates fall, the old bonds with high coupon rates would become attractive and their prices would rise.

It is given that EV/EBITDA = 6

EBITDA is given as Rs. 275 crores

Therefore EV / 275 crores = 6

EV (Enterprise Value) = 275 x 6 = 1650 crores

Enterprise Value = Value of Equity + Value of Debt

1650 crores = Value of Equity + 520 crores

Value of Equity = 1650 – 520 = Rs. 1130 crore

While the purpose of carrying out valuation could vary from person to person, some of the reasons for carrying out valuations of assets/businesses/liabilities are as follows:

– Buying a business as part of investment exercise

– Selling a business as part of disinvestment exercise

– Mergers and Acquisitions

– General sense of value of business to owners

– Fair treatment to different set of stake holders in case of equity swap

– Accounting, taxation and other regulatory and legal requirements

Country Risk: Country risk refers to the risk related to a country as a whole. There is a possibility that it will not be able to honour its financial commitments. When a country defaults on its obligations, this can affect the performance of all other securities in that country as well as other countries it has relations with. Country risk applies to all types of securities issued in that country.

Re-investment risk arises from the probability that income flows received from an investment may not be able to earn the same interest as the original interest rate. The risk is that intermediate cash flows may be reinvested at a lower return as compared to the original investment.

The rate at which the re-investment of these periodic cash flows is made will affect the total returns from the investment. The reinvestment rates can be high or low, depending on the levels of interest rate at the time when the coupon income is received

Trading or speculating is an act of purchase or sale of an asset in the expectation of a gain from changes in the price of that asset over a short period of time. Traders or speculators seek to benefit from acting on information which bring about changes in prices.

In Options, the buyers have the RIGHT but NO OBLIGATIONS.

The Writers (sellers) have the Obligations.

The Call writer has the obligation to sell / give delivery of the asset to the Call Buyer at a predetermined price.

The Put writer has the obligation to buy / take delivery of the asset from the Put Buyer at a predetermined price.

Call gives the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price on or before a given future date.

Put gives the buyer the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a given date.

USDINR rate, attrition rate among employees, concentration of revenues with selected clients, concentration of geographies etc. are important parameters to watch out for in IT and related sectors.

To be eligible for a share buyback, a company should not have defaulted on its payment of interest or principal on debentures, redemption of preference shares, or payment of declared dividends. Compliance with these financial obligations is typically a prerequisite for undertaking a share buyback program.

Passive investing involves investing in a broad set of securities that fairly represent the asset class the investor needs to invest. Typically, passive investing strategy follows indexing strategy where an investor buys all securities that are part of an index. The objective of a passive investor is to earn the rate of return that the select asset class provides.

A passive investor does not decide upon individual securities to buy or sell but rather their analysis is limited to the broader asset class.

Market Cap = No. of shares x Market price of shares = 10 million x 35 = 350 million

Net worth = Assets – Liabilites = 120 million – 40 million = 80 million

Price to book value ratio = Market capitalization/ Net worth

= 350 million / 80 million

= 4.37x

A company’s board of directors can include independent directors, non-executive directors and executive directors.

For the sake of strong corporate governance standards, the majority of the board should comprise independent directors. Currently, SEBI regulation stipulates that independent directors should constitute at least 50% of the board if the chairman is an executive director. In all other cases, it requires 1/3rd of the board to be comprised of independent directors.

Callable bonds allow the issuer to redeem / buyback the bonds prior to their original maturity date.

So when interest rates fall, the issuer can raise the same amount of loan, at a lower interest rate.

It is to the advantage of the issuer to redeem the existing high-cost bond before maturity and replace it with a new low cost bond.

Per Capita Income is the average income earned by each individual in the economy and is calculated as : National Income / Total population

Great earnings and assets make a business valuable; and, earnings and assets are determined by the qualitative aspects of businesses. Sooner or later, ‘Great Quality’ would reflect into ‘Great Profits’ for investors.

Pledge is an act of taking loan against securities by the investor. The investor is called as ‘pledgor’ and the entity who is giving the loan against the securities is called as ‘pledgee’.

Pledged securities can be unpledged, once the obligations under pledge are fulfilled. In case of default, the pledgee can invoke the pledge.

In an industry where rivalry is high, like the aviation and telecom space, the end result will be lower pricing power and lower incomes for the industry participants.

Innovation in products and customer service and engagement initiatives become essential in such an industry.

In any competitive industry, pricing command is virtually missing. If a competitor reduces prices, others will have to follow to remain in the market. So the companies in a competitive market are price takers and not price makers.

Insider information is a material non-public information that when published would immediately affect an investor’s decision to buy or sell the security. Whether an information can be considered insider depends on the source of the information (how reliable it is), its impact and its certainty.

From the three options given above, the Managing Director mentioning about an acquisition proposal not yet disclosed to the public, will be considered as an insider information.

All type of expenses are included in the Income or the Profit and Loss Statement. Depreciation and amortisation are expenses of a company.

Depreciation refers to gradual and permanent reduction in value of assets on account of ageing, use and obsolescence. Amortisation refers to gradual write-off of intangible assets over the period of its life.

Accounts receivable, Long term debt, Current assets and Current liabilities are all included in the Balance Sheet of the company.

In a Cash Cow the industry grows at a predictable and steady rate each year.

There is a strong brand name, well penetrated distribution channel, ready market, and strong balance sheet, Colgate is one such example

As per Regulation 16, one of the limitations on trading by research analysts is –

Independent research analysts, individuals employed as research analysts by research entity or their associates shall not deal or trade directly or indirectly in securities that he reviews in a manner contrary to his given recommendation.

Markets usually give a fair pricing to the securities.

So when a security is under priced, an investor can buy it and sell it when its fairly priced.

If a security is over priced, the only way to benefit from it is to sell it and buy it back when its fairly priced. But this is Short Selling which speculators indulge in and not investors.

All Investment decisions are evaluated on the basis of risk and return.

The preservation or safety of the capital invested is the most important parameter in evaluating an investment. The investor should be assured that he will atleast get his principal back. Then comes the matters of returns and capital appreciation.

Free Cash Flow for Equity = Free cash flows to the firm (FCFF) – Interest payment on debt + Net borrowings

SEBI merged with the Forward Markets Commission (FMC) and took over its role and now regulates the commodities markets in India. It is the regulatory body that oversees regulating and promoting forward and futures trading in commodities.

Insiders can sell shares for a variety of reasons and its not illegal to sell shares by them.

Key managerial personnel or insiders are allowed to trade, provided they are not in possession of unpublished price sensitive information(UPSI). The Securities and Exchange Board of India(Sebi) has proposed to ease insider trading norms for senior management to trade in company shares.

Insurance Regulatory and Development Authority of India (IRDAI) regulates the insurance sector in India in accordance with the terms of the IRDA Act, 1999.

It regulates the distribution of insurance products by laying down the qualification and training requirements of intermediaries and the payment of commission to distributors. IRDAI supervises the functioning of the Tariff Advisory Committee that determines the rates for general insurance products. It also lays down the modalities for investment of funds by insurance companies.

Structure Conduct Performance (SCP) Analysis method of analysing industries is to look at the industry structure (monopoly, oligopoly), its conduct (commoditized or specialized, seasonal or round the year, cyclical or non-cyclical etc.) and finally its performance (RoE, RoIC, WACC, etc.)

Performance analysis: While analyzing performance of an industry, analysts will also look at the financial aspects like numerical ratios etc

The Ministry of Finance (MoF) handles issues related to taxation, financial legislation, financial institutions, capital markets, state finances, and the Union Budget.

Under the MoF, the Department of Financial Services covers banks, insurance, financial services provided by various government agencies and private corporations, pension reforms, and industrial finance and micro, small, and medium enterprises.

Valuation exercise is undertaken to compare the price with value to arrive at whether a business is overpriced, under-priced or fairly priced by the market.

If the price is higher than the value, then the asset is overpriced.

A rights issue is open for subscription for a minimum period of 15 days and a maximum period of 30 days.

Fiscal policy contains policy measures of the Government which deal with governments’ revenues and expenses

Actions of the Central bank (RBI) are known collectively as Monetary policy.

• Enterprise Value (EV) represents the total value of a firm, including its debt and equity, and is calculated by discounting the Free Cash Flows to the Firm (FCFF) using the appropriate discount rate (typically WACC – Weighted Average Cost of Capital).
• This valuation method is commonly used in Discounted Cash Flow (DCF) analysis to determine the intrinsic value of a company.

Why Not Other Options?

2. Present Value (PV)  – PV refers to the value of future cash flows at today’s date, but does not specifically represent the total firm valuation like EV.
3. Discounted Value (DV)  – This is not a standard financial term in valuation.
4. Future Value (FV)  – FV refers to the value of cash flows at a future date, whereas we are discounting to find the current firm value.

Foreign capital flows to a country can be in :

1 Foreign Direct Investment (FDI) – investing entities participate in decision making and drive the businesses

2. Foreign Portfolio Investment (FPI) – investment in markets – equity or bonds by the Foreign Portfolio Investors without any management participation.

The oragnisation structure and accounting policies can be same in many organisations but what is most important is the quality and integrity of the management.

EPS = Net Profit / Number of shares outstanding

Net profits of the company belong to the shareholders. Earnings per share is the net profit divided by the number of shares. It indicates the amount of profit that company has earned for every share it has issued.

Regulation 17: Compensation of research analysts

The compensation of all individuals employed as research analyst shall be reviewed, documented and approved annually by board of directors/committee appointed by board of directors of the research entity, which does not consist of representation from its merchant banking or investment banking or brokerage services divisions.

From the above given three options, Head of the brokerage division and Head of investment banking division cannot review the salaries of research analyst. Therefore, Head of research division is the right answer.

Inflation risk represents the risk that the money received on an investment may be worth LESS when adjusted for inflation.

For example, if the inflation is 9% and the investments are earning 8%, such investments are exposed to inflation risk.

High industry rivalry occurs when there is intense competition among firms in a particular industry. The key factors contributing to high rivalry include:

• (A) True – Similar products/services with little or no differentiation increase competition, as companies struggle to create unique value propositions.
• (B) False – If switching costs are high, customers are less likely to move to a competitor, reducing rivalry. High rivalry usually exists when switching costs are low.
• (C) True – When many companies exist in the same business segment, competition increases, making it harder for individual firms to dominate.

Thus, statements A and C are correct, making option 3 (A and C only) the right answer.

In recession, their is unemployment, decrease in income levels and in turn decrease in consumption.

During such times, the number of people who can afford travelling by planes fall down considerably and their by negatively affecting the profitability of the airlines industry.

The Code of Ethics for a Research Analyst, as per SEBI regulations, includes guiding principles such as:

• Honesty and fairness: The analyst must act honestly and fairly in conducting their duties.

• Confidentiality: Sensitive information obtained during the course of research must be kept confidential.

• Avoidance of insider trading or front running: Analysts must not misuse non-public information or act ahead of recommendations for personal gain.

Non-compliance is not part of the code it directly contradicts the ethical standards and principles expected from a research analyst. In fact, non-compliance is what the Code of Ethics is designed to prevent.

A key factor to look while studying the business of a company is its pricing power as that would help a company maintain and grow its profit margin.

Pricing power refers to a company’s ability to independently determine and charge the price of its products. Companies with strong pricing power would be able to pass on any escalation in input cost to its customers. They can also increase their prices when demand is strong and thus grow their margins.

Tom trades are the trades where settlement (payment and delivery) occurs on the day next to the trading day ie T + 1.

Cash trades are the trades where settlement occurs on the same trading day, i.e., T+0.

The formula to find the CAGR – Compounded Annual Growth Rate holding period return is:

[ ( End Price / Begin Price) ^ (1/n) ] -1

End Price = 15.70

Begin Price = 13

n = time. We have to find yearly return so 500 / 365 = 1.369

So [( 15.70/13 )^ 1/1.369] – 1

= (1.207 ^ 0.73) – 1

On the scientific calculator of your computer type 1.207 then use x^y key and then type 0.73 = 1.147

1.147 – 1 = 0.147 x 100 = 14.7 %

When interest rates fall, bond prices rise. Bonds with longer maturity and lower coupon have higher duration and are more sensitive to interest rate changes. Therefore, buying long dated low coupon bonds allows a trader to maximize gains from falling interest rates.

In case of Bonus Shares, per share data (earning per share, book value per share, market price per share etc.) will witnesses immediate deterioration as total number of shares go up without any economic change in the profit and loss statement or balance sheet.

Same is the case with Stock Split.

In Stock Consolidation. as total no. of shares go down without any economic change in the Profit and Loss account or Balance Sheet, per share data (earning per share, book value per share, market price per share etc.) witnesses immediate improvement.

A good report always comprises of visuals and exhibits like charts and graphs to make it simple for readers to understand the contents.

Formulas are not considered as visuals.

Technical analysis integrates three elements into price charts – points of support, points of resistance in charts and price trends.

Support level is that price point at which there is a buying support from investors because in the past, prices have risen from these levels. In case this support level is broken due to high selling, the price of the asset is likely to fall more till it reaches the next support level.

• The Primary Market is where newly issued shares and securities are bought and sold for the first time.
• Companies issue shares through Initial Public Offerings (IPOs) or Follow-on Public Offerings (FPOs) to raise capital from investors.
• Once these securities are issued, they are later traded in the Secondary Market.

Why Not Other Options?

2. Secondary Market  – This is where already issued shares are traded among investors, not new issues.
3. Money Market  – Deals with short-term financial instruments like Treasury Bills and Commercial Papers, not equity shares.
4. Currency Market  – Deals with foreign exchange (Forex) transactions, not shares.

Stock dividend or Bonus shares are additional shares are given to the shareholders, without any consideration, in proportion of their holdings by capitalization of revenue reserves.

Companies appoint Compliance Officers for various reasons, including regulatory requirements (it is mandatory in many cases), efficient management of investor complaints to maintain investor confidence, and ensuring smooth channelization of information to regulatory bodies to comply with legal and regulatory obligations. Thus, all these reasons contribute to the appointment of Compliance Officers in companies.

Quick Ratio = (Current Assets – Inventories) / Current liabilities

3 = 75000 – 15000 / Current liabilities

3 = 60000 / Current liabilities

Current liabilities = 60000 / 3 = 20000

Current Ratio = Current Assets / Current liabilities

= 75000 / 20000

= 3.75

As per SEBI (Prohibition of Insider Trading) Regulations, “insider” is any person who is a connected person or one in possession of or having access to unpublished price sensitive information.

The regulations define unpublished price sensitive information that affect the company or its securities as those that is not generally available and which can materially affect the price of the securities.

Macroeconomics is the study of “the big picture” in the economy. While microeconomics focuses on individual households and firms, macroeconomics deals with the economy as a whole.

Macroeconomics helps us understand the general state of the economy – Domestic Production, Domestic Consumption, General Price levels, Growth, Quality of life, etc.

It also helps us understand drivers of income, savings, investments and employment in an economy.

There are three essential elements in understanding price behaviour:

1. The history of past prices provides indications of the underlying trend and its direction.

2. The volume of trading that accompanies price movements provides important inputs on the underlying strength of the trend.

3. The time span over which price and volume are observed factors in the impact of long term factors that influence prices over a period of time.

Stock dividend or Bonus shares are additional shares are given to the shareholders, without any consideration, in proportion of their holdings by capitalization of revenue reserves.

An IDR is in Indian rupees and is created by a domestic depository (custodian of securities registered with SEBI (Securities and Exchange Board of India). It is issued against the underlying equity of the company to enable foreign companies to raise funds from the Indian securities Markets. As foreign companies are not allowed to list on Indian equity markets, IDR is a way to own shares of those companies.

No of Shares = Paidup Capital / Face Value

No of Shares = 800000 / 5 = 160000

PE ratio = Market Price / EPS

7 = Market Price / 5

So the Market Price = 7 x 5 = 35

Market capitalisation = No. of shares x Market Price

= 160000 x 35 = 56,00,000

Enterprise value = Market capitalization + Market value of debt – cash and cash equivalents

= 5600000 + 0 – 1000000 = 4600000

Reserve Bank of India is the Government’s debt manager

A research analyst who is individual or partnership firm shall have net tangible assets of value not less than one lakh rupees.

Ownership bias: Things owned by us appear most valuable to us. Sometimes known as the endowment effect, it reflects the tendency to place a higher value on a position than others would. It can cause investors to hold positions they would themselves not buy at the current level.

Callable bonds allow the issuer to redeem the bonds prior to their original maturity date.

This feature poses a risk for investors but is beneficial for the issuers.

For eg – An issuer issues a callable bond at 11% coupon rate. After 2 years the interest rates fall down in the economy to 8%. The issuer will call back these bonds (11%) and issue new bonds (8%) at lower interest rates if required.

A good businessman or businesswoman would indeed have awareness (cognizance) of the risks inherent in their business operations and understand the potential implications of those risks. This awareness allows them to make informed decisions and take proactive measures to mitigate risks and protect their business interests.

Lets assume the Sales = 100

The sales are 300% of EBIT which means Sales = EBIT X 3

100 = EBIT X 3

EBIT = 100 / 3 = 33.33

Net Profit will be 25 ( As its 25% of Sales )

Now we have to calculate the EBIT as a percentage of Net Profit

= 33.333 / 25 x 100 = 133.33%

Each sector has its own unique parameters for evaluation. For the retail sector, foot falls and same store sales (SSS) are important parameters, whereas for banking it is Net Interest Income (NII)/ Net Interest Margin (NIM). For telecom, it is Average Revenue Per User (ARPU) and for hotels, it is average room tariffs etc.

Depositories hold securities of investors in electronic form and maintain the ownership records.

Systematic risk or market risk refers to those risks that are applicable to the entire financial market or a wide range of investments.

When a company needs additional equity capital, it has two choices – ask more money from existing shareholders or go for fresh set of investors.

Companies Act requires that a company which wants to raise more capital through an issue of shares must first offer them to the existing shareholders and such an offer of shares is called a rights issue.

Current Yield Method – This is a simple method of calculating return on a debt security in which the coupon is divided with the current market price of the bond and the result is expressed as percentage.

This method does not take into account future cash flows coming from the bond, which is the biggest drawback of this method

Holding Period Return (HPR) is the return earned on an investment during a specific period when it was bought and held by the investor.

HPR is not effective as its a single period return and does not annualize the return to the investors.

For a Research Analyst there is Research – collection of information from various sources and then Analysis – processing of data to take decisions.

The main job of a Research Analyst is to help their clients take investment decisions by providing them relevant information. The Research Analyst themselves will not take the decision.

Research reports are generally divided into three broad` sections – Qualitative aspects, Quantitative aspects and then Valuation parameters.

Qualitative parameters take care of aspects like business/revenue model, SWOT analysis, competition in the industry, technology aspects etc.

Quantitative parameters would consist of financial aspects such as ratio analysis, analysis of cash flows , dividend history etc.

Valuation parameters would consist of intrinsic value, P/E, P/BV, margin of safety aspects.

In any competitive industry, pricing command is virtually missing. If a competitor reduces prices, others will have to follow to remain in the market. So the companies in a competitive market are price takers and not price makers

Research Analyst do extensive Research (collection of information from various sources) and then Analysis (processing of data to take decisions)

They do not take the investment decisions but help their clients take investment decisions.

Research Analyst provide indepth knowledge on the status of a company / industry etc by studying various Macro/Micro factors and financial ratios. Based on these, the investors can take decisions on buying and selling the stocks etc.

As per SWOT analysis, threats are essentially risk that comes from external environment.

For Oil and Gas industry :

As renewable energy becomes widely generated and more affordable, it will slowly replace oil and gas.

Discovering large new oil and gas fields is proving difficult and the world is already staring at depletion of this natural resource

Winner’s curse is the tendency to make sure that a competitive bid is won even after overpaying for the asset.

While behaviourally it is a win, financially, it may be a loss.

Structure Conduct Performance (SCP) Analysis look at the industry structure (monopoly, oligopoly), its conduct (commoditized or specialized, seasonal or round the year.) and its performance (RoE, RoIC, etc.).

FDI brings in new and latest technologies and not traditional technologies.

Net Profit Margin = Net Profit / Sales

Net Profit of XYZ Ltd is 18% of its Equity Capital 4,00,000

18% of 400000 = 72000

So Net Profit Margin = 72000 / 1000000 = 0.072, i.e., 7.2%.

Macroeconomics helps us understand the general state of the economy – Domestic Production, Domestic Consumption, General Price levels, Growth, Quality of life etc.