SECURITY PORTFOLIO ANALYSIS

UNIT-1 INVESTMENT
Meaning & definition:

AND

According to f. Amling defined as, the purchase by a individual or institutional investor of a financial or real asset that produces a return in proportion to the risk assumed over some future investment period".

Inve t!ent of o"#e$tive%

1) Ret&'n(

Investors always expect a good rate of return from their investments. ate of return could be defined as the total income the investor receives during the holding period stated as a percentage of the purchasing price at the beginning of the holding period. !)Ri *% isk is holding securities is related with the probality of actual return becoming less than the expected return. "he word risk is synonyms with the pha.rse variability of return. #very investors likes to reduce the risk of his investment by proper combination of different securities. +),i-&idit.$ %arketability of the investment provides li&uidity to the investment. "he li&uidity depends upon the marketing and trading facility. /) 0edge again t inf,ation% 'ince their inflation in almost all the economy, the rate return should ensure a cover against the inflation. "he return thus earned should assure the safety of the principle amount regular flow of income and be a hedge against inflation. 1) Safet.%

"he selected investment avenue should be under the legal and regulatory frame work. If it is not under the legal frame work it is difficult to represent the grievances if any.

SECURITIES MAR2ET
Meaning%
marketing of securities means sale and purchase of securities, share and debentures and includes the services and functions performed by all such agencies. (here security is traded)primary or secondary trading*is called market.

T.3e Of P'i!a'. Ma'*et$

1) 3'i!a'. o' ne4 i &e !a'*et(

primary market also known as new issue market is a market for raising fresh capital in the form of shares and debentures. Issues exchanges financial securities for long term funds. 2) e$onda'. !a'*et%

A market, which deals in securities that have been already issued by companies, is known as the +secondary market+. It is also called the stock exchange or the share market. SE5MENT OF FINANCIAL MAR2ET Int'od&$tion% ,n the basis of credit re&uirement for short - term and long - term purpose, financial markets are dividend into two segments. .money market .capital market /) Mone. !a'*et( "he term money market is used in a composite sense to mean financial institution, which deals with short-term fund in the economy. It refer to the institutional arrangements facilitating borrowing and lending of short term

funds. 3) Ca3ita, !a'*et( "he term capital market+ refer to the institutional arrangements for facilitating the borrowing and lending of long-term funds.

MET0ODS OF FLOATIN5 OF NE6 ISSUES

1) P&",i$ i &e$

0y far the most important method of issuing securities, a public issue, involves sale of securities to the public at large. 1ublic issues in India are governed by the provision of the companies A2"/345. 2) Rig7t i &e (

A right issue involves selling securities in the primary market by issuing rights to the existing shareholders. (hen a company issues additional e&uity capital, it has to be offered in the first instance to the existing shareholders on a pro-rata basis. "his is re&uired under section6/ of the companies A2"/345. "he shareholders, however may by a special resolution forfeit this right, partially or fully, to enable a company to issue additional capital to the public.

ECONOMIC FORCASTIN5
Meaning(
#conomic forecasting is a term is a term used to apply to any methods that are utilised to predict the future movement of an economy.

T.3e Of E$ono!i$ Fo'e$a ting(

1) 7o't te'! fo'e$a ting(

A short term forecast generally refers to a period covering three years or less. %ore fre&uently shorter period, such as a &uarter or half year. 2) Inte'!ediate fo'e$a t( An intermediate forecast refers to a three to five year period.

3) Long te'! fo'e$a t( A long term forecast refers to forecast for more than five year.

FACTOR AFFECTIN5 ECONOMIC FORCASTIN5

1) 5'o do!e ti$ 3'od&$t(

781 indicates the rate of growth of the economy. "he rate of growth of 781 is around 59 in the nineties. "he 781 growth in /336-33 has accelerate to 4.69 compared to 49 of the previous year. "he higher growth rate is more favorable to the stock market. 2) Saving and inve t!ent( it is obvious that growth re&uires investment which in turn re&uired substantial amount of domestic savings. "he savings and investments patterns of the public affect the stock to the extent. 3) inte'e t 'ate ( "he interest rates affects the cost of financing to the firms.a decrease in interest rate implise lower cost of finance for firms and more profitability. 4) inf'a t'&$t&'e fa$i,itie ( Infrastructure facilities are essential for the growth of industrial and agricultural sector. egular supply of power without any power out would boost the production. the government has libralised its policy regarding the communication,transport and power sector. 5) !oneta'. 3o,i$.% monetary policy is concerned with then manipulation of money supply in the economy. monetary policy affects the economy mainly through its impact on interest rate: .open market operation .bank rate

.reserve re&uirements .direct credit control.

RIS2 & RETURN

Meaning of Ri *(
"he dictionary meaning of risk is the possibility of loss or in;ury, the degree or probability of such loss. isk is composed of the demand that bring in variation in return of income. "he main forces contributing to risk are price and interest. All investments are risky, whether in stock or capital marketer banking and financial sector, real estate, bullion gold, etc. "he degree of risk, however, varies on the basis of features of assets, investment instrument or issuer of security, etc

CAUSES OF RIS2%
1) (rong 8ecision$ (rong decision of what to invest in. 2) (rong "iming$ wrong timing of investment. 3) <ature of instrument$ <ature of instrument invested such as shares or bonds, chit funds, benefit funds are highly risky than bank deposits or 1.,.certificates of etc. 4) 2redit worthiness of issuers$ securities of government and semigovernment bodies and more creditworthy than those issued by the corporate sector. 5) %aturity period or length of investment$ longer the period, the more risky is the investment normally. 6) Amount of investment$ higher the invested in any security the larger is the risk. 7) %ethod of investment$ method of investment, namely, secured by

collateral or not. 8) "erms of lending$ terms of lending such as periodicity of servicing, redemption period, etc. 9) <ature of industry$ nature of industry or business in which the company is operating. 10) <ational and international factors$ national and international factors, acts of god, etc.

TYPES8CLASSIFICATION OF RIS2
1) systematic risk market risk-9 interest rate riskpurchasing power risk 2) unsystematic riskbusiness riskfinancial risk 0usiness risk classified in two type=s internal risk, external risk 'ystematic risk$

(1) S. te!ati$ Ri *% 'ystematic risk is also referred as uncontrollable risk. 'ystematic risk non-diversifiable and is associated with the securities market as well as economic, sociological, political and legal considerations of the prices of all securities in the economy.

Co!3onent of . te!ati$ 'i *(

A) Ma'*et 'i *$ %arket risk is that portion of total variability of return caused by the alternating forces of bull and bear market. (hen the security index moves upward haltingly for a significant period of time, it is known as bull market. 8uring the bull > bear market more than 6?9 of the securities= prices rise or fall with the stock market indicates. B) Inte'e t 'ate 'i *% Interest rate risk is the variation in the single period rates of return caused by the fluctuations in the market interest rate. C) P&'$7a ing 3o4e' 'i *%

@ariations in the returns are caused also by the loss of purchasing power of currency. Inflation is the reason behind the loss of purchasing power. (2) Un . te!ati$ 'i *( Ansystematic risk is also referred as controllable risk. Ansystematic risks stems from a managerial inefficiency, technological changes in the production process, availability of raw material, changes in the consumer preference, and labor problems. Co!3onent of &n . te!ati$ 'i *( A) :& ine 'i *(

"he risk that a business will experience a period of poor earning and resultant failure. 0usiness risk is greatest for firms in cyclical or relatively new industries, business risk affects holders of stocks and bonds, since a firm may be unable to pay dividends and interest. 0usiness risks are two types. 1) Internal risk 2) #xternal risk B) Finan$ia, 'i *% "he risk that a firm will be unable to meet its financial obligations. "his risk is primarily a function of the relative amount of debt that the firm uses to finance its assets. Mea &'ing of Ri *( isk can be measured through statistical measures of standard deviation and variance. isk and return have a relationship. isk must be &uantified. "o &uantify systematic and unsystematic risk separately is rather a difficult task because their effects are involved. A) Standa'd Deviation( It is measures of the values of the variables around its mean or it is the s&uare root of the sum of the s&uared deviations from the mean divided by the number of observances. "he arithmetic mean of the returns may be same for two companies but the returns may vary widely. B) Va'ian$e(

"he most used measures of risk in finance is variance. It is s&uare root of standard deviation. "he variance and the standard deviation of a historical return series are defined as follows$

Con$e3t of Ret&'n
"he ob;ective of investors is to maximiBe expected returns from his investments, sub;ect to various constraints, primarily risk. eturn is the motivating force, inspiring the investors in the form of rewards, for undertaking the investment. "he importance of returns in any investment decision can be traced to the following factors: /* It enables investors to compare alternative investments in terms of what they have to offer the investors. !* %easurement of historical )past* returns enables the investors to assess how well they have done. C* %easurement of historical returns also helps in estimation of future returns.

TYPES OF RETURNS(
1) Rea,i;ed Ret&'n ( "his is ex-post )after the fact* return, or return that was or could have been earned. 2) E<3e$ted Ret&'n ( "his is the return from as assets that investors anticipate to earn over some future period. "he expected return is sub;ect to uncertainty, or risk, and may or not occurs.

Co!3onent of Ret&'n (
1) C&''ent 'et&'n ( "he first component that often comes to mind when one is thinking

about return is the periodic cash flow )income*, such as dividend or interest, generated by the investment. 2urrent return is measured as the periodic income in relation to the beginning price of the investment. 2) Ca3ita, 'et&'n( "he second component of return is reflected in the price changes called the capital return. it is simply the price appreciation )or depreciation* divided by the beginning price of the assets. Dor assets like e&uity stocks, the capital return predominates. "otal eturnE2urrent eturn F 2apital eturn

Mea &'ing Ret&'n(

"hey are following two categories for measuring the return on investment$ 1) "raditional method 2) %odern method 1) "raditional methods of measurement$ 2omputation of yield to measure a financial assets return is the simplest and oldest techni&ue of measurement. Gield can be found out by following formula$ #stimated yield E expected cash income H current price of assets Actual yieldE cash income H amount invested

Unit = /
MEANIN5 OF PORTFOLIO MANA5EMENT(
I=1ortfolio management is the process of selecting a bunch of securities that will provide the investing organiBation a maximum yield for a given level of risk for a given level==.

PORTFOLIO MANA5EMENT PROCESS

a) identifi$ation of o"#e$tive and $on t'aint $ "he first and foremost step in the portfolio management process is the identification of ob;ectives and constraints.

b) Se,e$tion of t7e a

et !i<(

"he next important step in the portfolio management process is the selection of various assets to be included in one=s portfolio. c) Fo'!&,ation of 3o'tfo,io t'ateg.$ After an assets mix is chosen, the next step in the portfolio management process is formulation of an appropriate portfolio strategy. d) Se$&'it. ana,. i ( Ander security analysis, investors actively involve themselves in the selection of securities. 'ecurities are analyBed from the point of view of their prices, returns and risks. e) Po'tfo,io e<e$&tion( After the selection of securities for the purpose of investment, the next step in the portfolio management process will be the execution of the portfolio plan. f) Po'tfo,io 'evi ion( Investment activity starts with selection of scrip=s to be included in the portfolio. 'uch a revision generally involves a shift from one stock to another from to bond and vice versa.

POLICIES OF PORTFOLIO MANA5EMENT(

1) Agg'e ive 3o,i$.$

An aggressive policy is one which place more emphasis on the yield of securities. According to the aggressive policy, investment portfolio is constructed with common stock. 2) Defen ive 3o,i$.( 8efensive policy lays much emphasis on safety of principals invested in securities. According to this policy, securities which resist a decline in price are chosen for investment.

3) Agg'e

ive defen ive 3o,i$.(

Aggressive defensive policy lays emphasis on a 0alanced portfolio constructed with varied type of securities. "his type of policy safeguards the investors against any possible rise or fall in the stock market. 4) In$o!e v > 5'o4t7 3o,i$.( Income vs. 7rowth policy resolves the conflicting issues between current income or capital gains. "his policy suggests medium grade bonds, dividend-paying common stock and tax exempt securities for their inclusion in the portfolio. :ENEFITS OF PORTFOLIO MANA5EMENT( 1) Increased decision making transparency through a more consistent evaluation of all business units and option. 2) A consistent approach to risk measurement. 3) A systematic way of including different views of risk in decision making process. 4) A clear enhancement to the due diligence process. 5) 0etter understanding of value creation among investment opportunities. 6) 2onsideration of the correlation and diversification effects of the organiBation=s different business and investment options. 7) 7uidance for strategic planning. 8) 2onsideration of &ualitative and non-financial implication.

PORTFOLIO ANALYSIS
Meaning( 1ortfolio is combination of securities such as stock, bonds and money market instrument. "he process of blending together the broad asset classes so as to obtain optimum return with minimum risk is called portfolio analysisHconstruction.

Po'tfo,io 'i * and 'et&'n( Any investment decision involves selection of a combination or group of securities for investment. "his group of securities is referred to as a portfolio. "he portfolio can be a combination of securities irrespective of their nature, maturity, profitability, or risk characteristics.

PORTFOLIO SELECTION
Meaning( 1ortfolio analysis provides the input for the next phase in portfolio management which is portfolio selection. "he goal of portfolio construction is to generate a portfolio that provides the highest return at a given level of risk.a portfolio having this characteristics is known as an efficient portfolio. A33'oa$7e in 3o'tfo,io e,e$tion( 2ommonly, there are two approaches in the construction of the portfolio of securities viB., traditional approaches and modern approaches 1) "raditional approaches$ "wo ma;or decisions are traditional approaches$ 1) 8etermining the ob;ective of the portfolio. 2) 'election of securities to be included in the portfolio.

'teps in the traditional approach Analysis of constraints 8etermination of ob;ectives

'election of portfolio 0onds > common stock

bonds

2ommon stock

Assessment of risk and return 8iversification <ormally this carried out in the following steps, 1) Analysis of constraints$ a) Income needs b* Ji&uidity c* 'afety of principal d* "ime horiBon e* "ax consideration d* "emperament !* 8etermination of ob;ective$ a* 2urrent income b* 7rowth income 2* 2apital appreciation d* 1reservation of capital C* 'election of portfolio$ a* ,b;ectives of asset mix b* 7rowth of income and asset mix c* 2apital appreciation and asset mix d* 'afety of principal and asset mix

K* Assessment of risk and return$ %,8# < A11 ,A2L$ Dactor influencing portfolio selection$ 1) 'ecurity$

4* 8iversification$

An Investor is not prepared to lose money. 'o, the security of the investment becomes an important consideration. 2) eturn$ "he expected return may be the dominant consideration. %oney put into investment is expected to earn a satisfactory rate of return. 3) 7rowth prospects$ "he return from investments should not only be satisfactory but also, over time, grow to keep the investors happy. "herefore, the most profitable investment opportunities are likely to be found in businessHfirms with good growth prospects. 4) Ji&uidity$ "his refers to the convertibility of investments back into cash at short notice. "his is true in the case of investments made out of short-term funds. 5) isk$ An investor generally wants to maximiBe gains from investments with as minimum a risk as possible. Lere, risk represents the variability of the expected return from investment. isk can be reduces by diversification. ,1"I%A% 1, "D,JI, '#J#2"I,< 1) #stablishing efficient portfolios )minimum risk for a given expected return* comprising broad classes of assets )example, stocks, bonds, real estate* lends itself to the mean-variance methodology suggested by %arkowitB. 2) 8etermining efficient portfolios within an asset class can be achieved with the single index model proposed by 'harpe. 1, "D,JI, %,8#J

1) %arkowitB model 2) 'harp single index model 3) 2apital asset pricing model %A M,(I"N %,8#J$ Larry %arkowitB model, shortly known as L% model, was developed by Larry %arkowitB in /34!. It analyses the various possible portfolios of a given number of securities and identifies the most efficient portfolio. Assumption of %arkowitB model$ 1) Investors consider each investment alternative as being represented by a profitability distribution of expected returns over some holding period. 2) Investors maximiBe one period expected utility and possess utility curve, which demonstrates diminishing marginal utility of wealth. 3) Individuals estimate risk on the basis of the variability of expected returns. 4) Investors base decision solely on expected return and variance or returns only. 5) Dor a given risk level, investors prefer high returns to lower returns. 'imilarly, for a given level of expected return, investors prefer less risk to more risk.

"he efficient given by the arc A0, is a boundary of the attainable set.

"he shaded area represents set of portfolio considerations, which their own risks and expected returns. )"wo different portfolios may have the same expected return and risk.* Any point inside the shaded area is not as efficient as a corresponding point on the efficient frontier-the arc A0.

'LA 1# 'I<7J# I<8#O %,8#J$ 1rof. (illiam 'harpe developed a simplified model involving reduced amount of data. Le published his model in the article A simplified model for portfolio analysisP in Qanuary /35C. Lis work is a single index model, and is a substantially simplification of %arkowitB model. Assumption of 'harpe model$ 1) 'ecurity returns are linear in a common index. 2) "he parameters of the index model, and are computed through a linear regression procedure such that the risk premium is purely a function of the index, not security-specific risk. 3) "he index represents the only source of covariance between assets returns. isk R return and the 'harpe model$ According to him, the return for each security is calculated by the following formula. E F IFe E expected return on security E intercept of a straight line or alpha coefficient E slope of straight line or beta coefficient I E expected return on index )market*

e E error term with a mean of Bero and a standard constant.

deviation which is a