Chapter 1 of NISM Series XXI-A is titled simply “Investments”, and it is easy to underestimate. If you work in banking or mutual fund distribution, or are studying finance, much of it will feel familiar. It still tests precise definitions, and it sets up the language you will need for the PMS-specific chapters later on.
At a glance: XXI-A has 12 chapters. Chapters 1–6 are foundational, with about five questions each. Chapters 7–12 cover PMS structure, code of conduct and the investment policy statement, and carry roughly 60–65% of the weightage.
What Chapter 1 covers
By the end of this chapter, you should be able to explain:
- The meaning of investment, and how it differs from saving and speculation
- Investment objectives and the components of the required rate of return
- The relationship between risk and return
- The main types of risk
- The investment opportunities and channels open to an investor
Saving, investing and speculating
People pass through different life phases. Some years they earn more than they spend, some years they need to borrow, and after retirement they live on what they built earlier.
Surplus money can sit as cash or in a bank account, or it can be invested in the expectation of a return. Over 10–15 years, the gap between the two outcomes can be very large.
Assets fall into two broad groups:
- Financial assets: stocks, debentures and fixed deposits. These offer greater liquidity, convenience, wide choice and a strong regulatory framework.
- Physical assets: gold, silver, base metals such as zinc, copper, lead and aluminium, and real estate.
Why speculation is different
Take a trader who puts ₹1 lakh in a trading account and uses 5x margin to buy ₹5 lakh of shares intraday. Now suppose the stock falls 10%.
| Capital put in | Exposure | Loss on a 10% fall | Hit to capital | |
|---|---|---|---|---|
| Margin trader | ₹1 lakh | ₹5 lakh | ₹50,000 | 50% |
| Mutual fund investor | ₹1 lakh | ₹1 lakh | ₹10,000 | 10% |
The trader loses half their capital in one day, while the investor is down 10% and has a far better chance of recovering.
Exam tip: Speculation is typically driven by profit motive and done without significant analysis. It does not automatically lead to higher returns, and that claim is a classic false statement in MCQs.
The three investment objectives
- Capital preservation: Protecting the principal comes first, even if returns fall short of inflation. This suits money needed in the short term.
- Capital appreciation: The investor wants the portfolio to grow over a longer period, often 10–20 years, to fund future financial goals.
- Current income: The investor wants regular cash flow through dividends, interest or rent. This is common among retired people.
Risk premium and the types of risk
Government securities, currently yielding around 7–7.5%, are treated as the risk-free benchmark. When future payments are uncertain, investors demand more than this nominal risk-free rate. That additional component is the risk premium.
Know these five risks by definition:
- Business risk: Uncertainty in income flows caused by the nature of the firm’s business.
- Financial risk: Uncertainty caused by debt financing, because fixed interest must be paid regardless of earnings. This raises the stock’s risk premium.
- Liquidity risk: The risk of not being able to convert an investment into cash easily. Mutual funds and listed shares are highly liquid, while real estate can take much longer to sell.
- Exchange rate risk: A foreign investor’s returns change with the currency. A weaker rupee reduces what they receive when converting back, and a stronger rupee increases it.
- Political risk: Major political events can move markets. The market rally after the 2014 general election is a well-known example, and an unwelcome outcome can do the opposite.
The rule to remember is that higher risk brings higher expected return, not guaranteed return. As you move from risk-free assets to debt, equity and then leveraged derivatives, both the potential return and the chance of losing capital rise.
Types of investments
Equity
Equity represents ownership in a company, with a share in its profits and a right to vote on its affairs. Bonds and commercial papers do not give you ownership.
Equity is risky over short periods and is best held for the long term, since you are buying into a company’s future earnings. If you buy direct equity, focus on fundamentally strong companies and a buy-and-hold approach, and avoid margin and leveraged positions.
Fixed income and credit ratings
Fixed income securities pay known cash flows, but whether you actually receive them depends on the borrower’s credit quality. CRISIL’s long-term rating scale is worth memorising:
| Rating | Meaning |
|---|---|
| CRISIL AAA | Highest safety |
| CRISIL AA | High safety |
| CRISIL A | Adequate safety |
| CRISIL BBB | Moderate safety |
| CRISIL BB | Moderate risk |
| CRISIL B | High risk |
| CRISIL C | Very high risk |
| CRISIL D | Default |
Lower-rated borrowers must offer higher yields to attract investors. If a AAA company pays 10%, a weaker issuer may have to offer 12–16%. Such high-yield debt is also called junk bonds.
Money market versus capital market
- Money market: Maturity of up to one year. Instruments include treasury bills, commercial papers (issued by corporates) and certificates of deposit (issued by banks).
- Capital market: Long-term fund mobilisation through stocks and bonds, with a horizon above one year. The extra compensation for holding longer-dated debt is the term premium.
Commodities, real estate and distressed securities
- Precious metals: Gold and silver can be held physically or traded on the Multi Commodity Exchange. Gold prices are set largely by international demand and supply, which makes it a truly global asset class.
- Base metals and energy: These include zinc, copper, lead, aluminium and crude oil.
- Agri commodities: Corn, wheat, soybean, soybean oil and sugar are listed on NCDEX.
- Real estate: This is the largest asset class in the world. It needs a large ticket size, tends to track economic growth and can act as an inflation hedge.
- Distressed securities: These are companies close to bankruptcy, often trading at steep discounts. Both risk and potential return are very high, so this is only for skilled investors.
Channels for making investments
Direct investment and advisers
Investors can buy gold and silver directly from dealers, or buy securities through brokers and depository participants.
Registered Investment Advisers are registered under the SEBI (Investment Advisers) Regulations, 2013. Only registered entities can act as advisers and charge an advisory fee. For more, read who SEBI Registered Investment Advisers are and how to find one.
Managed portfolios compared
| Feature | Mutual fund | AIF | PMS |
|---|---|---|---|
| Structure | Trust pooling money from many investors | Pooled vehicle for sophisticated investors | SEBI-registered body corporate managing portfolios |
| Minimum investment | Low | ₹1 crore | ₹50 lakh |
| Typical portfolio | Often 40–50 stocks in an equity fund | Varies by category | Concentrated, perhaps 20–25 stocks |
Mutual funds offer professional management, diversification and economies of scale.
The three AIF categories
- Category I: Venture capital, SME, social venture and infrastructure funds. These are close-ended, can receive government incentives and do not use leverage for investing.
- Category II: Private equity, debt, fund of funds and real estate funds. These are not permitted to use leverage for investing, apart from limited temporary borrowing.
- Category III: Hedge funds and long-only or long-short equity funds. These can be open-ended or close-ended, may use derivatives and leverage, and aim for shorter-term returns.
A long-short manager can, for example, hedge a portfolio with Nifty derivatives when markets look expensive, so that gains on the short position offset part of a fall. For a deeper look, see AIF Category I, II and III explained.
Portfolio Management Services
PMS comes in two main forms:
- Discretionary: The portfolio manager decides what to buy and when. Most PMS money sits here.
- Non-discretionary: The investor decides, and the manager executes.
Chapters 7–12 go into this in depth, but how PMS works in India is a useful preview of fees, rules and selection.
Practice questions from this chapter
- The extra return required over the nominal rate for uncertain future payments is called? Risk premium.
- Future value of an investment is influenced by? Both the time period and the rate of return.
- What represents ownership in a company, with rights to profits and voting? Equity shares.
- Which statement about speculation is false? That it leads to higher returns.
- Liquidity refers to? Both the ease of converting an asset into cash and the possibility of realising almost its entire worth.
Exam tip: Watch for “both A and B” options. In Questions 2 and 5, picking the first correct-looking statement without reading the rest would cost you a mark.
Practise Chapter 1 before moving on
Don’t spend too long here, since most of the marks lie in Chapters 7–12. Lock in the definitions, ratings scale and minimum investment figures, then move on.
Start with the free XXI-A practice quiz to test what you have just read. The NISM Exam Prep app has 13,000+ practice questions across all 31 NISM exams, and the quick reference guides and finance calculators are handy for revising concepts such as future value.
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