Relation Between the nominal rate of return & real rate of return:

Nominal rate of return= (1+ real rate of return) (1+ inflation rate) 1 What is investment? Describe Investors life cycle.

Investment: It is a current commitment of an account for a period in order to derive future earnings. Factors investor consider while committing an investment: Uncertainty of future flow of funds, expected rate of inflation & Time period for which the investment is made. Investors life cycle: Life cycle includes time horizon of working careers of individuals. The four phases of the cycle are described below: 1. Accumulation Phase: This stage consists of individuals early to middle years of working careers. In this phase their net worth is usually small. They attempt to accumulate assets to satisfy immediate needs, long term goals e.g. childrens expenses, post retirement expenses. They can make relatively high risk investment in the hope of making higher returns over time because they have future earning ability. 2. Consolidation Phase: This stage begins after the midpoint of careers of the individuals. Their earnings are greater than the expenses & they have sufficient assets to pay off almost all of their outstanding debts. They plan to use their excess amount of assets to meet expenses after retirement or make planning to build a house. Individuals are more concerned about preservation of capital. So they dont want to take any high risk. 3. Spending Phase: This phase begins after the retirement. Living expenses are met by income from prior investments. Because their earnings concluded they seek greater protection of their capital. 4. Gifting Phase: In this phase individuals have sufficient assets to cover their current & future expenses. Excess assets can be used to provide financial assistance to relatives and friends & to establish charitable funds or to fund trusts. What are asset class and asset allocation decision? Asset Class: An asset class is comprised of related securities that have similar characteristics. A broad assets class is bond that can be divided into small asset classes e.g. Government bond and corporate bonds. Asset Allocation Decision: It is the process of deciding how an investor allocates wealth among different asset classes for investment purpose. Strategy for asset allocation is based on some decisions: 1. What asset class to consider for investment? 2. What weight to assign to each asset class for investment? 3. What amount of funds to allocate in each asset class based on its weight? 4. What specific securities in each class to purchase for the portfolio?

Describe different steps of Portfolio Management process/ Resource Allocation Process. Answer: Different steps of the resource allocation process are described below: 1. Developing Investment Policy Statement: A policy statement is a road map that guides the investment process. An investor should develop it before making any investment decisions. It includes objectives of investors & constraints faced by them. An investor can evaluate the performance of an investor on the basis of policy statement & to find out whether the investment is appropriate for the investor. 2. Examining financial & economic conditions: Before investing it requires to study short term & long term financial & economic conditions and forecast their future trends. Investor needs & expectations from the investment along with financial & economic conditions develop the investment strategy. 3. Implementing the investment plan: With the policy statement and financial forecasts the investor needs to implement the plan and allocate available funds across different securities of different asset classes. This involves the construction of portfolio that will minimize the investors risk. 4. Monitoring & updating the investment: Investors needs might change over time. So it requires monitoring of the investment of the investors needs & financial market conditions. If it does not meet the investors expectations it requires updating the investment portfolio. Investors might feel the need to drop securities from the portfolio and might add some new ones. So that the policy statement can be modified accordingly that could meet the investors expectations.

Mention the objectives of investors. 1. Capital Preservation: Investors want to minimize the risk of loss of investment amount. That means they seek to maintain purchase power of the investment. So, they want the rate of return not less than the inflation rate. 2. Capital Appreciation: Many investors want the amount to grow over time to meet some future needs. E.g. Investment in stocks. 3. Current Income: Many investors want the investment amount to concentrate on generating current income rather on capital gains. E.g. Investment in bonds. 4. Total Return: Many investors seek to increase the investment amount by reinvesting the current income. E.g. Investment in deposit account.

Mention the Investment Constraints. 1. Liquidity Needs: Investors may have liquidity needs that must be considered while making investment plan. Investors may require liquidity to meet various current obligations which may hamper the investment plan. 2. Investment Time Horizon: Investors consider the length of time for which they invest their money. Investors with short term investment generally favor less risky investment because losses are harder to recover during a short time frame. Long term investment carries greater risk and long term investors can tolerate long term risk because any short fall or early losses can be overcome by returns in subsequent years. 3. Tax rate: Investors consider tax rate of the government while planning investment. If more tax is imposed on a particular investment, investors will be inclined to investment which requires paying less or no tax. 4. Uncertainty of Return: If the earnings from the investment is not certain then the investors will require a rate of return to provide risk premium to cover the investment risk.

What is holding period return (HPR)? Answer: It is the return on investment for the period for which the investment is done. HPR= ending value of the investment/ beginning value of the investment HPY= HPR-1 Annual HPR= n (HPR) (n is the number of years for which investment is made) Annual HPY= Annual HPY-1

Mathematical Problems: 1. Investor invests $200 and gets $220 at the end of the year. Find HPY. 2. Find the arithmetic mean and geometric mean of returns: Year Beginning Value Ending Value 1 100 115 2 115 138 3 138 110 3. Find the average return on overall portfolio. Stock No. of Shares Beginning Price A 100,000 $10 B 200,000 $20 C 500,000 $30

Ending Price $12 $21 $33