Blue Chip Companies:
Blue chip companies are well known and established companies which have shown consistent growth over the years, and are expected to continue sustained growth in the future.
The aim of any investor is to maximize his earnings. But simple investment without knowledge of security will not give necessary yields. An investor has to observe certain things before making investment in any security. Those are i) Safety ii) Profitability iii) Liquidity and iv) Risk.
The safety factor is primary for an investor rather than profitability. This safety factor varies from investment to investment. If an investor deposits in commercial banks, or highly rated non-banking financial companies, investment in blue chip companies like Reliance, ACC, TELCO, TISCO, there will be higher safety i.e. the money invested will be safe. Whereas investment in low rated debt securities in scrips of companies whose profits are in down trend there will be a little safety and the company may not pay back your invested amount when it becomes due.
Once an investor is assured of reasonable safety of investment, then he will look for expected returns, taking opportunity cost into consideration. Usually debt instruments, highly rated will carry less risk and low returns compared to the low rated debt instruments. The profitability on securities in the stock market also varies from one to another. For example, the scrip of State Bank of India declared dividend of 35% whereas Siemens India declared dividend of 55% for the year 94-95.
An investment has to be only safe and profitable but also fairly liquid. Liquidity of an investment can be measured in terms of the speed and ease with which an investment can be converted into cash whenever you need it. Investments in gold, silver, banks, blue chip companies are considered as highly liquid. Investments in loss making companies low rated instruments are considered as illiquid.
Risk is defined as the extent to which the profits of a company are varied or likely to fluctuate. Risk is influenced by external and internal factors. External risks uncontrollable and broadly affect the investments. These external risks are also called as Systematic risk. Internal risks of a particular industry are also referred to as unsystematic risk.
Risk of an investment is classified into
(1) Systematic Risk
(2) Unsystematic Risk
Market risk: Market risk is referred to as stock variability due to change in investor’s attitudes and expectations. The attitudes and expectations of the investor vary because of many reasons like political, social, economical etc. For example when a no confidence motion is raised against ruling government, one can observe a sharp decline in the sensitive index. Example, BSE Sensex. Market risk cannot be eliminated but can be minimized through diversification i.e. by the process of investing in two or more different stocks rather than one.
Deregulation refers to lending rates determined by supply and demand rather by RBI policy.
Interest Rate Risk:
With the deregulation of lending rates and fluctuations of interest rates an investor is much exposed to this sort of risk. Interest on government securities which are risk free investments act as a basis for evaluating securities. Fluctuation of interest rates mainly affects the debt market. In the periods of raising interest rates the debentures issued at fixed rate of interest will quote at discount and vice versa. Similarly, in the periods of increasing interest rates the opportunity cost for an investor is more and thus reduces the demand of the securities and correspondingly affect the stock market.
Inflation is a persistent rise in the level of prices and wages throughout an economy.
Purchasing Power Risk is also known as inflation risk. This arises out of a change in the prices of goods and services and technically it covers both inflation and deflation.
The Unsystematic risk arises out of the uncertainty surrounding a particular firm or an industry due to factors like labor strikes, consumer preferences and management policies.
Every corporate has its own objectives and goals so as to make a certain level of net income and to provide a certain percentage of dividends.
Business arises due to internal and external factors. A firm with high fixed costs and with great variations in total revenues has greater internal business risk. External factors influencing business risk are demographic factors, business cycle, monetary policies, political factors etc.
Financial risk in a company is associated with capital structure of the company. If the company has high debt-equity ratio i.e. operating on high financial leverage it will have obligatory risk of paying interest and repayment of principal amount when it becomes due. If the firm is unable to earn higher than the cost of borrowed funds then there is a default risk, where the firm is unable to make obligatory interest and principal payments. —