PORTFOLIO EVALUATION AND INVESTMENT DECISIONS
Project submitted in partial fulfillment for the award of degree
MASTER OF B S!"ESS MA"A#EME"T
$E%&ARAT!O"
I
hereby
declare
that
this
Project
Report
titled
“PORTFOLIO
MANAGEMENT AND INVESTMENT DECISIONS” submitted by me to the Department of '''' is a bonafide work under taken by me and it is not submitted to 1
any other University or Institution for the award of any degree diploma / certificate or published any time before
ABSTRA%T
Portfolio management can be defined and used in many a ways, because the basic meaning of the word is “combination of the various things keeping intact”. So I considered and evaluated this from the perspective of the investment part in the securities segment. From the investor point of view this portfolio followed by him is very important since through this way one can manage the risk of investing in securities and thereby managing to get good returns from the investment in diversified securities instead of putting all the money into one basket. ow a day!s investors are very cautious in choosing the right portfolio of
!
securities to avoid the risks from the market forces and economic forces. So this topic is chosen because in portfolio management one has to follow certain steps in choosing the right portfolio in order to get good and effective returns by managing all the risks. "his topic covers the how a particular portfolio has to be chosen concerning all the securities individual return and thereby arriving at the overall portfolio return. "his also covers the various techni#ues of evaluation of the portfolio with regarding to all the uncertainties and gives an edge to select the right one. "he purpose of choosing this topic is to know how the portfolio management has to be done in arriving at the effective one and at the same time make aware the investors to choose the securities which they want to put them in their portfolio. "his also gives an edge in arriving at the right portfolio in consideration to different securities rather than one single security. "he pro$ect is undertaken for the study of my sub$ect thoroughly while understanding the different case studies for the better understanding of the investors and my self.
A%("O)&E$#EME"T
I would like to give special acknowledgement to %%%% &irector, %%%% for his consistent support and motivation. I am grateful to %%%%, 'ssociate professor in finance, %%%%% for his technical e(pertise, advice and e(cellent guidance. )e not only gave my pro$ect a scrupulous critical reading, but added many e(amples and ideas to improve it.
"
I am indebted to my other faculty members who gave time and reviewed portions of this pro$ect and provided many valuable comments. I would like to e(press my appreciation towards my friends for their encouragement and support throughout this pro$ect.
%%%%%
TAB&E OF %O"TE"TS
CONTENTS List of tables CHAPTER-1 1. INTRODUCTION7 2. O !ECTI"E O# THE STUD$ % &. 'ETHODOLOG$ ( ). LI'ITATIONS O# THE STUD$ CHAPTER-2 +. IN"EST'ENT DECISIONS 11 1* PAGE NO. 6
#
CHAPTER-& 6. PORT#OLIO 'ANAGE'ENT CHAPTER-) 7. PRACTICAL ANAL$SIS O# PORT#OLIO E"ALUATION CHAPTER-+ %. #INDINGS O# THE STUD$ (. CONCLUSION 1*. I LIOGRAPH$ %1 %2 %* 7) 16
&!ST OF TAB&ES
TAB&E I P$R%&$'I$ ( II P$R%&$'I$ , III P$R%&$'I$ . PA#E "O* )# * )+ )) * ))/
+
INTRODUCTION
"his pro$ect deals with the different investment decisions made by different people and focuses on element of risk in detail while investing in securities. It also e(plains how portfolio hedges the risk in investment and giving optimum return to a given amount of risk. It also gives an in depth analysis of portfolio creation, selection, revision and evaluation. "he report also shows different ways of analysis of securities, different theories of portfolio management for effective and efficient portfolio construction. It also gives a brief analysis of how to evaluate a portfolio.
)
O !ECTI"E O# THE STUD$
? "o help the investors to decide the effective portfolio of securities. ? "o identify the best portfolio of securities. ? "o study the role and impact of securities in investment decisions. ? "o clearly defining the portfolio selection process. ? "o select an optimal portfolio.
-
'ETHODOLOG$
PRI'AR$ DATA ? &ata collected from ewspaper * +aga,ines.
? &ata obtained from the internet. ? &ata collected from brokers. ? &ata obtained from company $ournals.
SE%O"$AR+ $ATA
? &ata collected from various books and sites.
/
&!M!TAT!O"S
? "he data collected is basically confined to secondary sources, with very little amount of primary data associated with the pro$ect.
? "here is a constraint with regard to time allocated for the research study.
? "he availability of information in the form of annual reports * price fluctuations of the companies is a big constraint to the study.
0
IN"EST'ENT DECISION 'A,ING Investment +anagement involves correct decision-making. 's referred to earlier any investment is risky and as such investment decision is difficult to make. Investment decision is based on availability of money and information on the economy, industry and company and the share prices ruling and e(pectations of the market and of the companies in #uestion. IN"EST'ENT 'ANGE'ENT In the stock market parlance, investment decision refers to making a decision regarding the buy and sell orders. 's referred to already, these decisions are influenced by availability of money and flow of information. .hat to buy and sell will also depend on the fair
11
value of a share and the e(tent of over valuation and under valuation and more important e(pectation regarding them. For making such a decision the common investors may have to depend more upon a study of fundamentals rather than technician!s, although technical are more important. /esides, even genuine investors have to guard themselves against wrong timing regarding both buy and sell decisions. Its is necessary for a common investor to study the /alance Sheet and 'nnual 0eport of the company or analysis the #uarterly and half yearly results of the company and decide on whether to buy that company!s shares or not. "his is called fundamental analysis, and then decision-making becomes scientific and rational. "he likelihood of high-risk scenario will come down to a low risk scenario and long-term investors will not lose.
C-ite-ia fo- I./est0e.t De1isio.2 Firstly, the investment decision depends on the mood of the market. 's per the empirical studies, share prices depends on the fundaments for the company only to the e(tent of 123 and the rest is decided the mood of the market and the e(pectations of the company!s performance and its share price. "hese e(pectations depend on the analyst!s ability to foresee and forecast the future performance of the company. For price paid for a share at present depends on the flow of returns in future, e(pected from the company.
11
Secondly and following from the above, decision to invest will be based on the past performance, present working and the future e(pectations of the company!s performance, both operationally and financially. "hese in turn will influence the share prices. "hirdly, investment decision depends on the investor!s
perception on whether the present share price is fair, overvalued or under valued. If the share price is fair he will hold it 4)old &ecision5 if it is overvalued, he will sell it 4sell &ecision5 and if it is undervalued, he will buy it 4/uy &ecision5. "hese are general rules, but e(ceptions may be there. "hus even when prices are rising, some investors may buy as their e(pectations of further rise may outweigh their conception of overvaluation. "hat means, the concepts of over valuation or under valuation are relative to time, space and man. .hat may be over valued a little while ago has become undervalued following later developments6 information or sentiment and mood may change the whole market scenario and of the valuation of shares. "here are two more decisions, namely, 'verage up and average down of prices. "he investment decision may also depend on the investor!s preferences, moods, or fancies. "hus an investor may go on a spending spree and invest in cats and dogs of companies, if he has taken a fancy or he is flooded with money from lottery or pri,es. ' rational investor would however make investment decisions on scientific study of the fundamentals of the company and in a planned manner.
1!
't present, investors mostly depend on hearsay an advice of friends, relatives, sub brokers, etc for the investment decision, but not on any scientific study of the company!s fundamentals. In view of the increasing mushroom growth of companies and lack of any track record of many promoters, investment decision making became on hunches, hearsay etc. RIS, AND IN"EST'ENT2 Stock +arket investment is risky and there are different types of investments, namely e#uity, fi(ed deposits, debentures etc. &iversifying investment into 72 to 71 companies can reduce company specific risk also called unsystematic risk. /ut the systematic risk relating to the market cannot be reduced but can be managed by choosing companies with that much risk 4high or low5 that the investor can bear.
IN"EST'ENT O !ECTI"ES2 75 "he first basic ob$ective of investment is the return on it or yields. "he yields are higher, the higher is the risk taken by investors. "he risk less return is bank deposit rate of 83 at present or /ank rate of 93. )ere the risk is least as funds are safe and returns are certain. :5 Secondly, each investor has his own asset preferences and choice of investments. "hus some risk adverse operators put their funds in bank or post office deposits or deposits;certificates with co-
1"
operatives and PS<!s. Some invest in real estate6 land and building while other invest mostly in gold, silver and other precious stones, diamonds etc. =5 "hirdly, every investor aims at providing for minimum
comforts of house furniture, vehicles, consumer durables and other household re#uirements. 'fter satisfying these minimum needs, he plans for his income, saving in insurance 4>I? and @I? etc.5 pension and provident funds etc. In the choice of these, the return is subordinated to the needs of the investor. A5 >astly, after satisfying all the needs and re#uirements, the rest of the savings would be invested in financial assets, which will give him future incomes and capital appreciation so as to improve his future standard of living. "hese may be in stock;capital market investments.
3UALITIES #OR SUCCESS#UL IN"ESTING ? ? ? ? ? ?ontrary thinking Patience ?omposure Fle(ibility and Bpenness
GUIDELINES #OR E3UIT$ IN"EST'ENT C#uity shares are characteri,ed by price fluctuations, which can produce substantial gains or inflict severe loses. @iven the 1#
volatility and dynamism of the stock market, investor re#uires grater competence and skill along with a touch of good luck too-to invest in e#uity shares. )ere are some general guidelines to play to e#uity game, irrespective of whether you are aggressive or conservative. ? ? ? ? ? ? 'dopt a suitable formula plan Cstablish value anchors 'sses market psychology ?ombine fundamental and technical analysis &iversify sensibly Periodical review and revise your portfolio
Po-tfolio 'a.a4e0e.t
INTRODUCTION2
In simple term Portfolio can be defined as combination of securities that have 0eturn and 0isk characteristic of their own. Portfolio may or may not take on the aggregate characteristics of their individual parts. Portfolio is the collection of financial or real assets such as e#uity shares, debentures, bonds, treasury bills and
1+
property etc.
Port folio is a combination of assets or it consists
of collection of securities. "hese holdings are the result of individual preferences, decisions of the holders regarding risk, return and a host of other considerations. Portfolio management concerns the construction *
maintenance of a collection of investment. It 5-i0a-il6 i./ol/es -e781i.4 -is9s -at:et:a. i.1-easi.4 -et8-.. 0eturn is
obviously important though the ultimate ob$ective of portfolio manager has to get good return to achieve a chosen level of return by immuni,ing the risk. PORT#OLIO 'ANAGE'ENT Investing in securities such as shares, debentures bonds is profitable as well as e(citing. It indeed involves a great deal of risk. Dery few investors invest in single security their entire savings. /ut most of them invest in a group of securities such6 group of securities is called a Portfolio. ?reation of portfolio helps to reduce risk without reducing returns. 's economic and financial environment keeps changing the risk-return characteristics of individual securities and portfolio also change. 'n investor invests in funds in a port folio e(pecting to get a good return with less risk to bear. Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals
1)
specifically with Security analysis, Portfolio analysis, Portfolio selection, Portfolio revision and Portfolio evaluation. O !ECTI"ES O# PORT#OLIO 'ANAGE'ENT "he ob$ective of portfolio management is to invest in securities in such a way thatE a5 b5 +a(imi,e one!s 0eturn and +inimi,e risk
In order to achieve one!s investment ob$ectives, a good portfolio should have multiple ob$ectives and achieve a sound balance among them. 'ny one ob$ective should not be given undue importance at the cost of others. So0e of t:e 0ai. ob;e1ti/es a-e 4i/e. belo<2 ? Safet6 of t:e I./est0e.t Investment safety or minimi,ation of risks is one of the important ob$ectives of portfolio management. "here are many types of risks, which are associated with investment in e#uity stocks, including super stocks. .e should keep in mind that there is no such thing as a Fero-0isk investment. +oreover, relatively >ow0isk investments give correspondingly lower returns. ? Stable C8--e.t Ret8-.s2 Bnce investments safety is guaranteed, the portfolio should yield a steady current income. "he current returns should at least match the opportunity cost of the funds of the investor. .hat we are referring is current income by way of interest or dividends, not capital gains. "he Portfolio should give a steady
1-
yield of income i.e.6 interest or dividends. "he returns have to match the opposite cost of funds of interest. ? 'a-9etabilit62 If there are too many unlisted or inactive shares in our portfolio, we will have to face problems in enchasing them, and switching from one investment to another. ? Li=8i7it6 "he portfolio should ensure that there are enough funds available at short notice to take care of the investor!s li#uidity re#uirements. It is desirable to keep a line of credit from a bank fro use incase it become necessary to participate in 0ight Issues, or for any other personal needs. ? Ta> Pla..i.4 Since ta(ation is an important variable in total planning. ' good portfolio should enable its owner to en$oy a favorable ta( shelter. "he portfolio should be developed considering not only income ta( but capital gains ta(, and gift ta(, as well. .hat a good portfolio aims at is ta( planning, not ta( evasion or ta( avoidance.
PORT#OLIO 'ANAGE'ENT #RA'E?OR, Investment management is also known as Portfolio
+anagement, it is a comple( process or activity that may be divided into seven broad phasesE? Specification of Investment Bb$ectives and ?onstraints.
1/
? ?hoice of 'sset +i(. ? Formulation of Portfolio Strategy. ? Selection of Securities. ? Portfolio C(ecution. ? Portfolio 0ebalancing. ? Performance Cvaluation. S5e1ifi1atio. of I./est0e.t Ob;e1ti/es a.7 Co.st-ai.ts2"he first step in the portfolio management process is to specify one!s investment ob$ectives and constraints. "he commonly stated investment goals areE 7. I.1o0e2 - "o provide a steady stream of income through regular interest;dividend payment. :. G-o<t:2 - "o increase the value of the principal amount through capital appreciation. =. Stabilit62 - "o protect the principal amount invested from the risk of >oss.
Po-tfolio 'a.a4e0e.t i. I.7ia In India, Port folio +anagement is still in its infancy. /arring a few Indian /anks, and foreign banks and <"I, no other agency had professional Portfolio +anagement until 78GH.
10
'fter the setting up of public sector +utual Funds, since 78GH, professional portfolio management, backed by competent research staff became the order of the day. 'fter the success of +utual Funds in portfolio management, a number of brokers and
Investment consultants some of whom are also professionally #ualified have become Portfolio +anagers. "hey have managed the funds of clients on both discretionary and on-discretionary basis. It
was found that many of them, including +utual Funds have guaranteed a minimum return or capital appreciation and adopted all kinds of incentives, which are now prohibited by SC/I. "hey resorted to speculative over trading and insider trading, discounts, etc., to achieve their targeted returns to the clients, which are also prohibited by SC/I. "he recent ?/I probe into the operations of many market dealers has revealed the unscrupulous practices by banks, dealers and brokers in their Portfolio Bperations. "he SC/I has the imposed stricter rules, which included their registration, a code of conduct and minimum infrastructures, e(perience etc. It is no longer possible for my unemployed youth, or retired person or self-styled consultant to engage in Portfolio +anagement without the SC/I!s license. "he guidelines of SC/I are in the direction of making Portfolio +anagement a responsible professional service to be rendered by e(perts in the field. SE I NOR'S2
!1
SC/I has prohibited the Portfolio +anger to assume any risk on behalf of the client. Portfolio +anager cannot also assure any fi(ed return to the client. "he investments made or advised by him are sub$ect to risk, which the client has to bear. "he investment consultancy and management has to be charged at rates, which are fi(ed at the beginning and transparent as per the contract. o sharing of profits or discounts or cash incentives to
clients is permitted. "he Portfolio +anager is prohibited to do lending, badla financing and bills discounting as per SC/I norms. )e cannot put the client!s funds in any investment, not permitted by the contract, entered into with the client. ormally investment can be made in
capital market and money market instruments. ?lient!s money has to be kept in a separate account with the public sector bank and cannot be mi(ed up with his own funds or investments. 'll the deals done for a client!s account are to be entered in his name and ?ontract otes, /ills and etc., are all
passed by his name. ' separate ledger account is maintained for all purchases;sales on client!s behalf, which should be done at the market price. Final settlement and termination of contract is as per the contract. &uring the period of contract, Portfolio +anager is only acting on a contractual basis and on a fiduciary basis. than a year is permitted by the SC/I. o contract for less
!1
SE I GUIDELINES TO THE PORT#OLIO 'ANAGERS2 Bn Hth Ianuary 788= the Securities C(change /oard of India issued regulations to the Portfolio managers for the regulation of portfolio management services by merchant bankers. "hey are as followsE
?
Portfolio management services shall be in the nature of investment or consultancy management for an agreed fee at client!s risk.
?
"he portfolio manager shall not guarantee return directly or indirectly the fee should not be depended upon or it should not be return sharing basis.
?
Darious terms of agreements, fees, disclosures of risk and repayment should be mentioned.
?
?lient!s funds should be kept separately in client wise account, which should be sub$ect to audit.
?
+anager should report clients at intervals not e(ceeding 9 months.
?
Portfolio manager should maintain high standard of integrity and not desire any benefit directly or indirectly form client!s funds.
?
"he client shall be entitled to inspect the documents. Portfolio manager shall not invest funds belonging to clients in badla financing, bills discounting and lending operations.
?
?
?lient money can be invested in money and capital market instruments.
!!
?
Settlement on termination of contract as agreed in the contract.
?
?lient!s funds should be kept in a separate bank account opened in scheduled commercial bank.
?
Purchase or Sale of securities shall be made at prevailing market price.
PORT#OLIO ANAL$SIS2 Portfolios, which are combinations of securities may or may not take the aggregate characteristics of their individual parts. Portfolio analysis considers the determination of future risk and return in holding various blends of individual securities. 'n investor can some times reduce portfolio risk by adding another security with greater individual risk than any other security in the portfolio. "his seemingly curious result occurs because risk depends greatly on the covariance among returns of individual securities. 'n investor can reduce e(pected risk and also can estimate the e(pected return and e(pected risk level of a given portfolio of assets if he makes a proper diversification of portfolios. "here are tow main approaches for analysis of portfolio 1. 2. T-a7itio.al a55-oa1:. 'o7e-. a55-oa1:.
75 TRADITONAL APPROACH2
!"
"he traditional approach basically deals with two ma$or decisions. "raditional security analysis recogni,es the key
importance of risk and return to the investor. +ost traditional methods recogni,e return as some dividend receipt and price appreciation over a forward period. /ut the return for individual securities is not always over the same common holding period, nor are the rates of return necessarily time ad$usted. 'n analysis may well estimate future earnings and a P;C to derive future price. )e will surely estimate the dividend. In any case, given an estimate of return, the analyst is likely to think of and e(press risk as the probable downside rice e(pectation 4ether by itself or relative to upside appreciation possibilities5. Cach security ends up with some rough measures of likely return and potential downside risk for the future Portfolios or combinations of securities, are though of as helping to spread risk over many securities. "his is good. )owever, the interrelationship between securities may e specified only broadly or nebulously. 'uto stocks are, for e(amples, recogni,ed as risk interrelated with fire stocksE utility stocks display defensive price movement relative to the market and cyclical stocks like steel6 and so on. "his is not to say that traditional portfolio analysis is unsuccessful. It is to say that much of it might be more ob$ectively specified in e(plicit terms "hey areE '5 &etermining the ob$ectives of the portfolio.
!#
/5
Selection of securities to be included in the portfolio /efore
ormally this is carried out in four to si( steps.
formulating the ob$ectives, the constraints of the investor should be analy,ed. .ith in the given framework of constraint, ob$ectives are formulated. "hen based on the ob$ectives securities are selected. 'fter that the risk and return of the securities should be studies. "he investor has to assess the ma$or risk categories that he or she is trying to minimi,e. ?ompromise of risk and non-risk factors has to be carried out. Finally relative portfolio weights are assigned to securities like bonds, Stocks and debentures and the diversification is carried out.
'ODERN PORT#OLIO APPROACH2 "he traditional approach is a comprehensive financial plan for the individual needs such as housing, life insurance and pension plans. /ut these types of financial planning approaches are not done in the +arkowit, approach. +arkowit, gives more attention to the process of selecting the portfolio. )is planning can be applied more in the selection of common stocks portfolio than the bond portfolio. "he stocks are not selected on the basis of need for income or appreciation. /ut the selection is based in the risk and return "he
analysis 0eturn includes the market return and dividend.
investor needs return and it may be either in the form of market return or dividend.
!+
"he investor is assumed to have the ob$ective of ma(imi,ing the e(pected return and minimi,ing the risk. Further, it is assumed that investors would take up risk in a situation when ade#uately rewarded for it. "his implies that individuals would prefer the
portfolio of highest e(pected return for a given level of risk. In the modern approach the final step is asset allocation process that is to choose the portfolio that meets the re#uirement of the investor. "he following are that ma$or steps involved in this process. Po-tfolio 'a.a4e0e.t P-o1ess2
?
Security analysis Portfolio analysis Selection of securities Portfolio revision Performance evaluation
?
?
?
?
SECURIT$ ANAL$SIS2 Defi.itio.2 For making proper investment involving both risk and return, the investor has to make a study of the alternative avenues of investment their risk and return characteristics and make a proper pro$ection or e(pectation of the risk and return of the alternative investments under consideration. )e has to tune the e(pectations to this preference of the risk and return for making a proper investment choice. "he process of analy,ing the individual securities and the market has a whole and estimating the risk and return !)
e(pected from each of the investments with a view to identifying undervalues securities for buying and overvalues securities for selling is both an art and a science that is what called security analysis. Se18-it62 "he security has inclusive of share, scripts, stocks, bonds, debenture stock or any other marketable securities of a like nature in or of any debentures of a company or body corporate, the government and semi government body etc. A.al6sis of se18-ities2 Security analysis in both traditional sense and modern sense involves the pro$ection of future dividend or ensuring flows, forecast of the share price in the future and estimating the intrinsic value of a security based on the forecast of earnings or dividend. Security analysis in traditional sense is essentially on analysis of the fundamental value of shares and its forecast for the future through the calculation of its intrinsic worth of the share. +odern security analysis relies on the fundamental analysis of the security, leading to its intrinsic worth and also rise-return analysis depending on the variability of the returns, covariance, safety of funds and the pro$ection of the future returns. If the security analysis based on fundamental factors of the company, then the forecast of the share price has to take into account inevitably the trends and the scenario in the economy, in the
!-
industry to which the company belongs and finally the strengths and weaknesses of the company itself.
A55-oa1:es to Se18-it6 A.al6sis2Fundamental 'nalysis "echnical 'nalysis Cfficient +arket )ypothesis
? ? ?
#UNDA'ENTAL ANAL$SIS "he intrinsic value of an e#uity share depends on a multitude of factors. "he earnings of the company, the growth rate and the risk e(posure of the company have a direct bearing on the price of the share. "hese factors in turn rely on the host of other factors like economic environment in which they function, the industry they belong to, and finally companies own performance. "he
fundamental school of though appraised the intrinsic value of share through ? E1o.o0i1 A.al6sis ? I.78st-6 A.al6sis ? Co05a.6 A.al6sis
ECONO'IC ANAL$SIS2 "he level of economic activity has an investment in many ways. If the economy grows rapidly, the industry can also be e(pected to show rapid growth and vice versa. .hen the level of !/
economic activity is low, stock prices are low, and when the economic activity is high, stock prices are high reflecting the prosperous outlook for sales and profits of the firms. "he analysis of macro economic environment is essential to understand the behavior of the stock prices. "he commonly analy,ed macro economic factors are a followsE a5 &ross domestic pro$ect b5 Savings and investments c5 Inflation d5 Interest rates e5 /udget f5 "he ta( structure g5 /alance of payments h5 +onsoon and agriculture i5 Infrastructure facilities $5 &emographic factors
INDUSTR$ ANAL$SIS 's referred earlier, performance of a company has been found to depend broadly up to 123 on the e(ternal factors of the economy and industry. "hese e(ternalities depend on the
availability of inputs, like proper labor, water, power and interrelations between the economy and industry and the company.
!0
In this conte(t a well-diversified company performs better than a single product company, because while the demand for some products may be declining, that for others may be increasing. Similarly, the input prices and cost factors would vary from product line to product line, leading to different margins and a diversified company is better bet for investor. "he industry analysis should take into account the following factors among others as influencing the performance of the company, whose shares are to be analy,ed. "hey are as followedE a5 Product line b5 0aw materials and inputs c5 ?apacity installed and utili,ed d5 Industry characteristics e5 &emand and market f5 @overnment policy with regard to industry g5 >abour and other industrial problems h5 +anagement
CO'PAN$ ANAL$SIS2 Investor should know the company results properly before making the investment. "he selection of investment is depends on optimum results of the following factors.
1@ 'AR,ETING #ORCES2
"1
+anufacturing
companies
profit
depends
on
marketing
activities. If the marketing activities are favorable then it can be concluded that the co. +ay have more profit in future years. &epends on the previous year results fluctuations in sales or growth in sales can be identified. If the sales are increasing in trend investor any be satisfied.
2@ ACCOUNTING PRO#ILES &ifferent accounting policies are used by organi,ation for the valuation of inventories and fi(ed assets. A@ IN"ENTOR$ POLIC$2 0aw materials and their value at the end of the year is calculated by using FIFB, >IFB or any other average methods. "he particular method is must be suitable to access the particular raw material. @ #IAED ASSET POLC$2 'll the fi(ed assets are valued at the end of every year to know the real value of the business. NET "ALUE O# #IAED ASSETSB "ALUE O# ASSET AT THE EGINNING O# THE $EAR - DEPRECIATION For income ta( purpose written down value method is used as per this separate schedule of assets are to be prepared. &@ PRO#ITA ILIT$ SITUATION2 It is a ma$or factor for investor. Profitability of the company must be better compare with industry. "he efficiency of the profitability position or operating activities can be identified by studying the following factors
"1
A@ G-oss 5-ofit 0a-4i. -atio2 It should more than =23. /ut, other operating e(penses should be less compare to operating incomes. @ O5e-ati.4 C .et 5-ofit -atio2 Bperating profit is the real
income of the business it is calculated before non operating e(penses and incomes. It should be nearly :23. "he net profit ratio must be more than 723 )@ RETURN ON CAPTIAL E'PLO$ED2 It measures the rate of return on capital investment of the business. ?apital employed includes shareholders funds, long-term loans, and other
accumulated funds of the company ROCE B DOPERATING PRO#IT E CAPITAL E'PLO$EDF G1** A@ Ea-.i.4 5e- s:a-e2 it is calculated by the company at the end of the every financial year. In case of more profit and less number of shares CPS will increase. @ Ret8-. o. e=8it62 It is calculated on total e#uity funds 4e#uity share capital, general reserve and other accumulated profits5 +@ DI"IDEND POLIC$2 It is determined in the general body meeting of the company, for e#uity shares at the end of every year. "he dividend payout ratio is determined as per the dividend is paid. &ividend policies are divided into two types. I5 II5 Stable dividend policy. <nstable dividend policy.
"!
.hen company reached to optimum level it may follow stable dividend policy it indicates stable growth rate, no fluctuation are estimated. <nstable dividend policy may used by developing firms. In such a case study growth market value of share is not possible to identify. 6@ CAPITAL STRUCTURE O# THE CO'PAN$2 @enerally capital structure of the company consists of e#uity shares, preferences shares, debentures and other long term funds. Bn the basis of long term financial sources cost of capital is calculated. 7@ OPERATING E##ICIEC$2 It is determined on the basis of capital e(penditure and operating activities of a company. Increase capital e(penditure indicates increase of operating efficiency. C(pected profits may be increased incoming years. "he operating efficiency of a company directly affects the earnings of a company. 'n e(panding company that maintains high operating efficiency with low break even point earns more than the company with high breakeven point. Cfficient use of fi(ed assets with raw materials, labour, and management would lead to more income from sales. %@ OPERATING LE"ERAGE2 "he firm fi(ed costs is high in total cost, the firm is said to have a high degree of operation leverage. )igh degree of operating leverage implies other factors being held constant, a relatively small change in sales result in a large change in return on e#uity.
""
(@ 'ANAGE'ENT2 @ood and capable management generates profits to the investors. "he management of the firm should efficiently plan, organi,e, actuate and control the activities of the company. "he good management depends of the #ualities of the manager. Joont, and B!&onnell suggest the following as special traits of an able manager 'bility to get along with people. >eadership. 'nalytical competency. Industry Iudgment. 1*@ #INANCIAL ANAL$SIS2 "he best source of financial information about a company is its own financial statements. "his is a primary source of information for evaluating the investment prospects in the particular company!s stock. "he statement gives the historical and current information about the company!s information aids to analysis the present status of the company. "he man statements used in the analysis are. 75 :5 /alance sheet Profit and lose account
ALANCE SHEET "he balance sheet shows all the company!s sources of funds 4liabilities and stock holders e#uity5 and uses of funds at a given point of time. "he balance sheet provides an account of the capital
"#
structure of the company. "he net worth and the outstanding longterm debt are known from the balance sheet. "he use of debt creates financial leverage beneficial or detrimental to the
shareholders depending on the si,e and stability of earnings. It is better for the investor to avoid accompany with e(cessive debt components in its capital structure. PRO#IT AND LOSS ACCOUNT "he income statement reports the flow of funds from business operations that take place in between two points of time. It lists down the items of income and e(penditure. "he difference between the income and e(penditure represents profit or loss for the period. It is also called income and e(penditure statement
Li0itatio. of fi.a.1ial state0e.ts. 75 "he financial statements contain historical information. "his information is useful, but an investor should be concerned more about the present and future. :5 Financial statements are prepared on the basis of certain accounting concepts and conventions. 'n investor should know them. =5 "he statements contain only information that can be measured in monetary units. For e(ample, the loss incurred by a firm due to flood or fire is included because it can be e(pressed in monetary terms. ANAL$SIS O# #INANCIAL STATE'ENTS
"+
"he analysis of financial statements reveals the nature of relationship between income and e(penditure, and the sources and application of funds. )e can use the following simple analysisE Co05a-ati/e fi.a.1ial state0e.t2 In the comparative statement balance sheet figures are provided for more than one ear. "he comparative financial statement provides time perspective to the balance sheet figures. "he annual data are compared with similar data of previous years, either in absolute terms.
T-e.7s a.al6sis2 )ere percentages are calculated with a base year. "his would provide insight into the growth or decline of the sale or profit over the years. Sometime sales may be increasing continuously, and the inventories may also be rising. "his would indicate the loss of market share if the particular company!s product.
Co00o. siHe state0e.t2 ?ommon si,e balance sheet shows the percentage of each asset to the total assets and each liability to the total liabilities. Similarly, a common si,e income statement shows each item of e(pense as a percentage of net sales. .ith statements comparison can be made between two different si,e firms belonging to the same
")
industry. For a same company over the years common si,e statement can be prepared.
#8.7 flo< a.al6sis2 "he balance sheet gives a static picture of the company! positions on a particular date. It does not reveal the changes that have occurred in the financial position of the unit over a period of time. "he investor should know, a5 b5 c5 d5 e5 f5 )ow are the profits utili,edK Financial source of dividend Source of finance for capital e(penditures Source of finance for repayment of debt "he destiny of the sale proceeds of the fi(ed assets and <se of the proceeds of he share or debenture issue or fi(ed deposits rise from public. Cas: flo< state0e.t2 "he investor is interested in knowing the cash inflow and outflow of the enterprise. "he cash flow statement is prepared with the help of balance sheet, income statement and some additional information. It can be either prepared in the vertical form or hori,ontal form. ?ash flows related to operations and other transactions are calculated. "he statement shows the causes of changes in cash balance between the two balance sheet dates. .ith the help of these
"-
statements the investors can review the cash movements over an operating cycle. Ratio a.al6sis2 0atio is relationship between two figures e(pressed
mathematically. Financial ration provides numerical relationship between two relevant financial data. Financial ratios are calculated from the balance sheet and profit and loss account. "he relationship can be either e(pressed as a percent or as a #uotient. ?lassification financial ratios are as followedE Li=8i7it6 -atio2 >i#uidity means the ability of the firm to meet its short-tem obligations. ?urrent ratio and acid test ratios are the most popular ratios used to analysis the li#uidity. "he li#uidity ratio indicates the li#uidity in a rough fashion and the ade#uacy of the working capital.
T8-.o/e- -atios2 "he turnovers ratios show how well the assets are used and the e(tent of e(cess inventory, if any. "hese ratios are also known as activity ratio or asset management ratios. ?ommonly calculated ratios are sales to current assets, sales to fi(ed assets, sales to inventory, receivable to sales and total assets to turnover. T:e le/e-a4e -atios2 "he investors are generally interested to find out the debt portion of the capital the debt affects the dividend payment because of the outflow of profit in the form of interest.
"/
"he financial leverage affects the risk and return aspects of holding the shares. "he total debt to total assets ratio indicates the percentage of borrowed funds in the firm!s assets. I.te-est 1o/e-a4e -atio "his shows how many times the operating income covers the interest payment. P-ofitabilit6 -atio2 Profitability ratio relate the firm!s profit with factors that generate the profits "he investor s very particular in knowing net profit to sales, net profit to total assets and net profit to e#uity. "he profitability ratios measure the overall efficiency of the firm. Net 5-ofit 0a-4i. -atio "his ratio indicates the net profit per rupee of sales revenue. Ret8-. o. assets2 "he return on asset measure the overall efficiency of capital invested n business. Ret8-. o. e=8it62 )ere, the net profit is related to the firm!s capital. "al8atio. -atios2 "he shareholders are interested in assessing the value of shares. "he value of the share depends on the performance of the firm and the market factors. "he performance of the firm in turn depends on a host of actors. )ence, the valuation ratios provide a comprehensive measure of the performance of the firm itself. In the subse#uent section, some of the valuation ratios are dealt in detail.
"0
oo9 /al8e 5e- s:a-e2 "his ratio indicates the share of e#uity share holders after the company has paid all its liabilities, creditors, debentures and preference shareholders. P-i1e ea-.i.4 -atio2 Bne of the most common financial parameters used in the stock market is the price earnings ratio 4P;C5. It relates to share price with earnings per share. "he investor generally compares the P;C ratio of the company with that of the industry and market.
TECHNICAL ANAL$SIS "echnical analysis involves identification of share price
fluctuations on short period basis. "his analysis can be made by brokers, dealers. "hey are treated as technicians. "he following are the ma$or factors in technical analysisE 75 ?ompany results are not analysised. "he changes in national and international level about political and other factors.
#1
:5
"he shares are e(changed immediately when there is a small change in price level of shares.
=5
'verage results of the particular industry are identified and they are treated as basic factors.
A5
/rokers do not e(pect any dividend by holding the share. &ividend is not of return for calculated of better return to the technicians.
15
"he holding period is determined very less6 it may range from hours to days. @enerally holding period may not be more than one moth. "he technical analysis can be made in this respect by identifying price fluctuations of the particular share.
95
o capital gains e(pected by transfer of the share so o need to pay any capital gain takes, short run return about e(change in price of share is not treated as capital gain.
H5
CPS declared by company at the end of financial year and dividend declared may be treated as base figures for technical analysis.
G5
Interim dividend if any declared by the company that will analysised to sell the shares.
85
Stock e(change will announce the average result of securities traded on day-to-day basis.
=:
725
/y conducting of the technical analysis technician
anticipate high level of short run profit. 'o/i.4 a/e-a4e2
#1
"he analysis of the moving average of the prices of scripts is another method in technical analysis. @enerally, H days, to days and 71 days moving averages are worked out in respect of scripts studied and depicted on a graph along with similar moving averages of the market inde( like /SC Sensitive Inde(. "here will then be two graphs to be compared and when the trends are similar the scrip and /SC market induces will show comparable averages risks. Os1illato-s2 Bscillators indicate the market momentum or scrip
momentum. Bscillator shows the shares price movement across a reference point from one e(treme to another. CHARTS2 ?harts are the valuable and easiest tools in the technical analysis. "he graphic presentation of the data helps the investor to find out the trend of the price without any difficulty. "he charts also have the following uses. ? Spots the current trend for buying and selling. ? Indicates the probable future action of the market by pro$ection. ? Shows the past historic movement. ? Indicates the important areas of support and resistance.
"he charts do not lie but interpretation differs from analyst to analyst according to their skills and e(perience.
#!
Poi.t a.7 fi48-e 1:a-ts2 "echnical analyst to predict the e(tent and direction of the price movement of a particular stock or the stock market indices uses point and figure charts. "his P.F charts are of one-dimensional and there is no indication of time or volume. "he price changes in relation to previous prices are shown. "he changes of price direction can be interpreted. "he charts are drawn in the ruled paper. a- 1:a-ts2 "he bar chart is the smallest and most commonly used tool of a technical analyst. "he build a bar a dot is entered to represent the highest price at which the stock is traded on that day, week or month. "hen another dot is entered to indicate the lowest price on the particular date. ' line is drawn to connect both the points a hori,ontal nub is drawn to mark the closing price. "he two main components to be studied while construction of a portfolio is 7. :. RIS, C(istence of volatility in the occurrence of an e(pected incident is called risk. )igher the unpredictability greater is the degree of risk. "he risk any or may not involve money. In investment management, risk involving pecuniary matter has importance6 the financial sense of risk can be e(plained as the volatility of e(pected future incomes or outcomes. 0isk may give a Ris9 of a portfolio Ret8-.s on a portfolio
#"
positive or a negative result. If unimagined incident is a positive one, then people have a pleasant surprise. "o be able to take negative risk with the same sprit is difficult but not impossible, if proper risk management techni#ues are followed. 0isk is uncertainty of the income;capital appreciation or loss of the both. "he two ma$or "ypes of risks areE Systematic or market related risks and unsystematic or company related risks. "he systematic risks are the market problems raw materials availability, ta( Policy or any @overnment policy, inflation risk, interest rate risk and financial risk. "he <nsystematic risks are mismanagement, increasing inventory, wrong financial policy. T65es of -is9 0isk consists of two components, the systematic risk and unsystematic risk. "he systematic risk is caused by factors e(ternal to the particular company and uncontrollable by the company. "he systematic risk affects the market as a whole. In the case of unsystematic risk the factors are specific, uni#ue and related to the particular industry or company. S$STE'ATIC RIS,2 "he systematic risk affects the entire market. Bften we read in the newspaper that the Stock market is in the bear hug or in the bull grip. "his indicates that the entire market in ' particular direction either downward or upward. "he economic conditions, Political Situations and the sociological changes affect the security
##
market. "he recession in the economy affects the profit prospect of the industry and the stock market. "he systematic, risk is further divided into = types, they are as follows. 75 'AR,ET RIS,2 Iack ?lark Francis has defined market risk as that portion of total variability of return caused by the alternating forces of bull and bear markets. "he forces that affect the stock market are tangible and intangible events are real events such as earth#uake, war, and political uncertainty and fall in the value of currency. :5 INTEREST RATE RIS,2 Interest rate risk is the variation in the single period rates of return caused by the Fluctuations in the market interest rate. +ost commonly interest rate risk affects the price of bonds, debentures and stocks. "he fluctuations on the interest rates are caused by the ?hanges in the government monetary policy and the changes that occur in the interest rate of the treasury bills and the government bonds. =5 PURCHASING PO?ER RIS,2 Dariations in the returns are caused also by the loss of purchasing power of currency. Inflation is the reason behind the loss of purchasing power. "he level of Inflation proceeds faster than the increase in capital value. Purchasing power risk is the probable loss in the purchasing power of the returns to be received. UNS$STE'ATIC RIS,
#+
's already mentioned, unsystematic risk is uni#ue and peculiar to a firm or an industry. <nsystematic risk stem from managerial inefficiency, ethnological change in the production process, availability of raw material, changes in the consumer preference, and labour problems. "he nature and magnitude of the above-mentioned factors differ from industry to industry, and company to company. "hey have to be analy,ed separately for each industry and firm. 1@ USINESS RIS,2 /usiness risk is that portion of the unsystematic risk caused by the operating environment of the business. /usiness risk arises from the inability of a firm to maintain its competitive edge and the growth and stability of the earnings. "he variationinthe e(pected operating income indicates the business risk. /usiness 0isk can be divided into e(ternal business risk and internal business risk. a@ I.te-.al 8si.ess Ris92
Internal business risk is associated with the operational efficiency of the firm. "he following are the few, 75 :5 =5 A5 15 Fluctuations in the sales 0esearch and &evelopment Personnel management Fi(ed cost Single product
#)
b@ E>te-.al Ris92 C(ternal risk is the result of operating conditions imposed on the firm by circumstances beyond its control. "he e(ternal environment in which it operated e(erts some pressure on the firm. 75 Social and regulatory factors :5 Political risk =5 /usiness cycle 2@ #INANCIAL RIS,2 It refers to the variability of the income to the e#uity capital due to the capital. Financial risk in a company is associated with the capital structure of the company. ?apital structure of the company consists of e#uity funds and borrowed funds. &@ CREDIT OR DE#AULT RIS,2 ?redit risk deals with the probability of meeting with a default. It is primarily the probability that buyers will default. "he chances that the borrower will not pay up can stem from a variety of factors. Ris9 o. a Po-tfolio2 0isk on a portfolio is different from the risk on individual securities. "his 0isk is reflected in the variability of the returns from ,ero to infinity. "he e(pected return depends on the probability of the returns and their weighted contribution to the risk of the portfolio. "here are two measures of risk in this conte(tLone is the absolute deviation and the other standard deviation. Ret8-. of Po-tfolio2
#-
Cach security in a portfolio contributes returns in the proportion of its investment in security. "hus, the portfolio e(pected return is the weighted average of the e(pected returns, from each of the securities, with weights representing the proportionate share of the security in the total investment. .hy does an investor have so many securities in his portfolioK "he answer to this #uestion lie in the investor!s perception of risk attached to investment, his ob$ectives of income, safety, appreciation, li#uidity and hedge against loss of value of money etc., "his pattern of investment in different asset categories security categories types of instruments etc., would all be described under the caption of diversification which aims at the reduction or even elimination of non-systematic or company related risks and achieve the specific ob$ectives of investors. Portfolio management services help investor to make a wise choice between alternative investments without any post training hassles. "his service renders optimum returns to the investors by a proper selection by continuous shifting of portfolio from one scheme to other scheme or from one brand to the other brand within the same scheme. 'ny portfolio manager must specify the ma(imum return, optimum returns and the risk, capital appreciation, safety etc in their offer. #-o0 t:e -et8-. a.4le se18-ities 1a. be 1lassifie7 i.to t<o
#/
7.
#i>e7 I.1o0e Se18-ities2 ? &ebt M partly convertible and tradable warrants ? Preference Shares ? @overnment Securities and /onds ? Bther debt instruments. on convertible debt with
:.
"a-iable I.1o0e Se18-ities2 ? C#uity Shares ? +oney papers. Portfolio manager have to decide upon the mi( of securities market Securities like "-bills, ?ommercial
on basis of contract with the client and ob$ective of the portfolio. Portfolio managers in the Indian conte(t, has been /rokers 4big brokers5 who on the basis of their e(perience, market trend, insider trading, personal contact and speculations are the ones who used to manage funds or portfolios. Ris9 a.7 -et8-. a.al6sis2 "he traditional approach to portfolio building has some basic assumptions. First, the individual prefers larger to smaller returns from securities. "o achieve this foal, the investor has to take more risk. "he ability to achieve higher returns is dependent upon his ability to $udge risk and his ability to take specific risks6 the risks are namely interest rate risk, purchasing power risk, financial risk and market risk. "he investor analyses the varying degrees of risk and constructs his portfolio. 't first, he established the minimum
#0
income that he must have to avoid hardship under most adverse economic condition and then he decides risk of loss of income that can be tolerated. "he investor makes a series of compromises on risk and non-risk factors like ta(ation and marketability after he has assessed the ma$or risk categories, which he is trying to minimi,e Al5:a2 'lpha is the distance between the hori,ontal a(is and line!s intersection with y a(is It 0eas8-es t:e 8.s6ste0ati1 -is9 of t:e 1o05a.6. If alpha is a positive return, then that scrip will have higher returns. If alphaN2 then the regression line goes through the origin and its return simply depends on the /eta times the market returns. eta2 /eta describes the relationship between the stocks return and the +arket inde( returns. "his can be positive and negative. It is the percentage change in the price of the stock regressed 4or related5 to the percentage changes in the market inde(. If beta is I, a one-percentage change in +arket inde( will lead to one percentage change in price of the stock. If /eta is 2, stock price is unrelated to the +arket Inde( and if the market goes up by a O73, the stock price will fall by 73 0a-9et -elate7 -is9I eta 0eas8-es t:e s6ste0ati1 cannot be eliminated by
which
diversification. If the portfolio is efficient, /eta measures the systematic risk effectively. Bn the other hand alpha and Cpsilon
+1
measures the unsystematic risk, which can be reduced by efficient diversification. 'EASURE'ENT O# RIS,2 "he driving force of systematic and unsystematic risk causes the variation in returns of securities. Cfforts have to be made by researchers, e(pert!s analysts, theorists and academicians in the field of investment to develop methods for measuring risk in assessing the returns on investments. Total Ris92 "he total risk of the investment comprises of diversifiable risk and non-diversifiable risk, and this relation can be computed by summing up &iversifiable risk and <ndiversifiable risk. Di/e-sifiable Ris92 'ny risk that can be diversified is referred to as diversifiable risk. "his risk can be totally eliminated through diversification of securities. &iversification of securities means combining a large variety of assets into a portfolio. "he precise measure of risk of a single asset is its contribution to the market portfolio of assets, which is its co-variance with market portfolio. "his measure does not need any additional cost in terms of money but re#uires a little prudence. It is un-diversifiable risk of individual asset that is more difficult to tackle. T-a7itio.al 0et
7 of a11o8.ti.4 C assi4.i.4 -is9 5-e0i80 0et7.
+1
'ssigning of the risk premium is one of the traditional methods of accounting. "he fundamental tenet in the financial management is to trade off between risk and return6 the return from holding e#uity securities is derived from the dividend stream and price changes. Bn of the methods of #uantifying risk and calculating e(pected rate of return would be to e(press the re#uired rate as -BiJ5JbJfJ0Jo .here r N re#uired rate of return i N real interest rate 4risk free rate5 p N purchasing power risk allowance b N business risk allowance f N financial risk allowance m N market risk allowance o N allowances for other risk 'o7e-. 0et7s of 38a.tif6i.4 -is92 Puantification interpretation and of risk is necessary of to ensure uniform
comparison
alternative
investment
opportunities. "he pre-re#uisite for an ob$ective evaluation and comparative analysis of various investment alternatives is a rational method for #uantifying risk and return. Probability distribution of returns is very helpful in identifying C(pected 0eturns and risk. "he spread of dispersion of the probability distribution can also be measured by degree of variation from the C(pected 0eturn.
+!
De/iatio. B o8t1o0e K E>5e1te7 Ret8-. Butcomes on the investments o not have e#ual probability occurrence hence it re#uires weights for each difference by its probability. P-obabilit6 A LO8t1o0e K E>5e1te7 Ret8-.@ For the purpose of computing variance, deviations are to be s#uared before multiplying with probabilities. P-obabilit6 A LO8t1o0e K E>5e1te7 -et8-.s@ M2 PORT#OLIO CONSTRUCTION2 Portfolio is combination of securities such as stocks, bonds and money market instruments. "he process of blending together the broad assets classes so as to obtain optimum return with minimum risk is called portfolio construction. 'i.i0iHatio. of Ris9s "he company specific risks 4unsystematic risks5 can be reduced by diversifying into a few companies belonging to various industry groups, asset group or different types of instruments like e#uity shares, bonds, debentures etc. "hus, asset classes are bank deposits, company deposits, gold, silver, land, real estate, e#uity shares etc. industry group like tea, sugar paper, cement, steel, electricity etc. Cach of them has different risk-return characteristics and investments are to be made, based on individual!s risk preference. "he second category of risk 4systematic risk5 is managed by the use of /eta of different company shares. A55-oa1:es i. 5o-tfolio 1o.st-81tio.2
+"
?ommonly there are two approaches in the construction of the portfolio of securities vi,., traditional approach and +arkowit, efficient frontier approach. In the traditional approach, investors needs in terms of income and capital appreciation are evaluated a appropriate securities are selected to meet the needs of the investors. "he common practice in the traditional approach is to evaluate the entire financial plan of the individual In the modern approach, portfolios are constructed to ma(imi,e the e(pected return for a given level of risk. It view portfolio construction in terms of the e(pected return and the risk associated with obtaining the e(pected return. Effi1ie.t 5o-tfolio2 "o construct an efficient portfolio, we have to conceptuali,e various combinations of investments in a basket and designate them as portfolio one to Q !. "hen the e(pected returns from these portfolios are to be worked out and then portfolios are to be estimated by measuring the standard deviation of different portfolio returns. "o reduce the risk, investors have to diversify into a number of securities whose risk-return profiles vary. ' single asset or a portfolio of assets is considered to be “efficient” if no other asset offers higher e(pected return with the same risk or lower risk with the same e(pected return. ' portfolio is said to be efficient when it s e(pected to yield the highest returns for the level of risk accepted or, alternatively, the smallest portfolio risk or a specified risk for a specified level of e(pected return.
+#
'ai. feat8-e of effi1ie.t set of 5o-tfolio2 7. "he investor determines a set of efficient portfolios from a universe of n securities and an efficient set of portfolio is the subset of n security-universe. :. "he investor selects the particular efficient portfolio that provides him with most suitable combination or risk an return.
'ODERN PORT#OLIO APPROACH2 'AR,O?ITN 'ODEL )arry +. +arkowit, has credited and introduced the new concept of risk measurement and their application to the selection of portfolios. )e started with the idea of risk a version of investors and their desire to ma(imi,e e(pected return with the least risk. +arkowit, model is a theoretical frame wok for analysis of risk and return and their relationships. )e used statisti1al a.al6sis for the measurement of risk and 0at:e0ati1al 5-o4-a00i.4 for selection of assets in a portfolio in an efficient manner. )is framework led to the concept of efficient portfolios, which are e(pected to yield the highest return for given a level of risk or lowest risk for a given level of return 0isk and return two aspects of investment considered by investors. "he e(pected return may very depending on the assumptions. 0isk inde( is measured by the variance or the distribution around the mean its range etc, and traditionally the choice of securities depends on lower variability where as +arkowit,
++
emphasi,es on the need for ma(imi,ation of returns through a combination of securities whose total variability is lower. "he risk of each security is different from that of other and by proper combination of securities, called diversification, one can form a portfolio where in that of the other offsets the risk of one partly or fully. In other words, the variability of each security and covariance for his or her returns reflected through their inter-relationship should be taken into account. "hus, e(pected returns and the covariance of the returns of the securities within the portfolio are to b considered for the choice of a portfolio. ' set of efficient portfolios can be generated by using the above process of combining various securities whose combined risk is lowest for a given level of return for the same amount of investment, that the investor is capable of the theory of +arkowit,, as stated above is based on the number of assumptions. ASSU'PTIONS O# 'AR,O?ITN THEOR$ "he analytical frame work of +arkowit, model is based on several assumptions regarding the behavior of investorE 7. "he investor invests his money for a particular length of time known as )olding Period :. 't the end of holding period, he will sell the
investments. =. "hen he spends the proceeds on either for consumption purpose or for reinvestment purpose or sum of both.
+)
"he approach therefore holds good for a single period holding. A. "he market efficient in the sense that, all investors are well informed of all the facts about the stock market. 1. Since the portfolio is the collection of securities, a decision about an optimal portfolio is re#uired to be made from a set of possible portfolio. 9. "he security returns over the forthcoming period are unknown, the investor could therefore only estimate the C(pected return 4C05. H. G. 'll investors are risk averse. Investors study how the security returns are co-related to each other and combine the assets in an ideal way so that they give ma(imum returns with the lowest risk. 8. )e would choose the best one based on the relative magnitude of these two parameters. 72. "he investors base their decisions on the price-earning ratio. Standard deviation of the rate of return, which is been offered on the investment, from the e(pected rate of return of an investment, is one of the important criteria considered by the investors for choosing
different securities. 'AR,O?ITN DI"ERSI#ICATION +arkowit, postulated that diversification should not only aim at reducing the risk of a security by reducing its variability or
+-
standard deviation, but by reducing the covariance or interactive risk of two or more securities in a portfolio. /y combination of different securities, it is theoretically possible to have a range of risk varying from ,ero to infinity.+arkowit, theory of portfolio
diversification attaches importance to standard deviation, to reduce it to ,ero, if possible, covariance to have as much as possible negative interactive effect among the securities within the portfolio and coefficient of correlation to have -7 4negative5 so that the overall risk of the portfolio as whole is nil or negligible. "hen the securities have to be combined in a manner that standard deviation is ,ero. Effi1ie.t #-o.tie-2 's for +arkowit, model minimum variance portfolio is used for determination of proportion of investment in first security and second security. It means the portfolio consists of two securities only. .hen different portfolios and their e(pected return and standard deviation risk rates are given for determination of best portfolio efficient frontier is used. Cfficient frontier is graphic representation on the basis of the optimum point this is to identify the portfolio which may give better returns at lowest risk. 't that point the investor can choose portfolio. Bn the basis of this holding period of portfolio can be determined. Bn “%” a(is risk rate of portfolio 4s.d.of p5, and on “R” a(is return on portfolios are to be shown. ?alculate return on portfolio
+/
and standard deviation of portfolio for various combinations of weights of two securities. Darious returns are shown on the graphic and identify the optimal point. Cal18latio. of E>5e1te7 Rate of Ret8-. LERR@ ? ?alculate the proportion of each Security!s proportion in the total investment. ? It gives the weights for each component of Securities. ? +ultiply the funds invested in each component with the weights. ? It gives the initial wealth or initial +arket value. E=8atio.2 R5 B <1R1 J<2R2 J <&R& JOOOO..J<.R. .here 0p N C(pected return on portfolio w7, w:, w=, wA, N Proportional weight invested 07, 0:, 0=, 0A N e(pected returns on securities "he rate of return on portfolio is always weighted average of the securities in the portfolio ESTI'ATION O# PORT#OLIO RIS, ' useful measure of risk should take into account both the probability of various possible bad outcomes and their associated magnitudes. Instead of measuring the probability of a number of different possible outcome and ideal measure of risk would estimate the e(tent to which the actual outcome is likely to diverge from the e(pected outcome. "wo measures are used for this purposeE 7. 'verage absolute deviation.
+0
:.
Standard deviation.
In order to estimate the total risk of a portfolio of assets, several estimates are neededE a5 "he predicted return on the portfolio is simply a weighted average of the predicted returns on the securities, using the proportionate values as weights. b5 "he risk of the portfolio depends not only on the risk of its securities considered in isolation, but also on the e(tent to which they are affected similarly by underlying events. c5 "he deviation of each security!s return from its e(pected value is determined and the product of the two obtained. d5 "he variance is a weighted average of such products, using the probabilities of the events as weights Effe1t of 1o0bi.i.4 t<o Se18-ities2 It is believed that spreading the portfolio in two securities is less riskily than concentrating in only one security. If two stocks, which have negative correlation, were chosen on a portfolio risk could be completely reduced due to the gain in one would offset the loss on the other. "he effect of two securities, one more riskily and the other less risky, on one another can also be studied. +arkowit, theory is also applied in the case of multiple securities. Co-.e- 5o-tfolios2 ' number of portfolios on the efficiency frontier are corner portfolios, it may be either new securities or security or securities dropped from previous efficient portfolios. /y swapping one security
)1
with other, the portfolio e(pected return could be increased with no change in its risk. Do0i.a.1e 5-i.1i5le2 It has been developed to understand risk return trade off conceptually. It states that efficient frontier analysis assumes that investors prefer returns and dislikes risk. C-iti1is0 o. 'a-9o<itH t:eo-62 "he +arkowit, model is confronted with several criticisms on both theoretical and practical point of view a5 Dery tedious and invariably re#uired a computer to effect
numerous calculations b5 'nother criticism related to this theory s rational investor can
avert risk. c5 +ost of the works stimulated by +arkowit, uses short term
volatility to determine whether the e(pected rate of return from a security should be assigned a high or a low e(pected variance, /ut if an investor has limited li#uidity constraints, and is truly a longterm holder, then price volatility per se does not really pose a risk. 0ather in this case, the #uestion concern is one ultimate price reali,ation and not interim volatility. d5 'nother apparent hindrance is that practicing investment found it difficult to understand the conceptual
managers
mathematics involved in calculating the various measure of risk and return. "here was a general criticism that an academic approach to portfolio management is essentially unsound.
)1
e5
Security analysts are not comfortable in calculating covariance
among securities while assessing the possible ranges of error in their e(pectations.
CAPITAL ASSETS PRICING 'ODEL LCAP'@ <nder ?'P+ model the changes in prices of capital assets in stock e(changes can be measured by sung the relationship between security return and market return. So it is an economic model describes how the securities are priced in the market place. /y using ?'P+ model the return of security can be calculated by comparing return of security with market rate. "he difference of return of security and market can be treated as highest return and the risk premium of the investor is identified. It is the difference between return of security and risk free rte of return. DRis9 5-e0i80 B Ret8-. of se18-it6 K Ris9 f-ee -ate of -et8-.F So the ?'P+ attempts to measure the risk of a security in the portfolio sense. Ass805tio.s2
)!
"he ?'P+ model depends on the following assumptions, which are to be considered while calculating rate of return. ? "he investors are basically average risk assumers and diversification is needed to reduce the risk factor. ? 'll investors want to ma(imi,e the return by assuming e(pected return of each security. ? ? 'll investors assume increase of net wealth of the security. 'll investors can borrow or lend an unlimited amount of fund at risk free rate of interest. ? "here are no transaction costs and no ta(es at the time of transfer of security. ? 'll investors have identical estimation of risk and return of all securities. 'll the securities are divisible and tradable in capital market ? Systematic risk factor can be calculated and it is assumed perfectly by the investor. ? ?apital market information must be available to all the investor. eta2 /eta describes the relationship between the stock return and the +arket inde( returns. "his can be positive and negative. It is the percentage change is the price of he stock regressed 4or related5 to the percentage changes in the market inde( If beta is 7, a one-percentage change in +arket inde( will lead to one percentage change in price of the stock. If /eta is2, stock price is
)"
unrelated to the +arket Inde( and if the market goes u by a O73, the stock price will fall by 73 /eta measures the systematic market related risk, which cannot be eliminated by diversification. If the portfolio is efficient, /eta measures the systematic risk effectively. E/al8atio. 5-o1ess2 7. 0isk is the variance of e(pected return of portfolio. :. "wo types of risk are assumed they are a5 b5 Systematic risk <nsystematic risk
=. Systematic risk is calculated by the investor by comparison of security return with market return. ? N ?o M Dariance of security and market Dariance of +arket )igher value of beta indicates higher systematic risk and vice versa. .hen numbers of securities are holded by the investor, composite beta or portfolio can be calculated by the use of weights of security and individual beta. A5 0isk free rate of return is identified on the basis of the market
conditions. "he following : methods are used for calculation of return of security or portfolio. Ca5ital 0a-9et Li.e2 <nder ?'P+ model capital market line determined the relationship between risk and return of efficient portfolio. .hen the risk rates of market and portfolio risk are given, e(pected return of
)#
security or portfolio can be calculated by using the following formula. ERP B T J? 5 LR50 K T@ ?' C0P N C(pected return of portfolio " N risk free rate of return ?p N Portfolio of standard deviation 0pm N 0eturn of portfolio and market ?+ N 0isk rate of the market.
Se18-it6 'a-9et Li.e2 Identifies the relationship of return on security and risk free rate of return. /eta is used to identify the systematic risk of the premium. "he following e#uation is used for e(pected return. ERP B T J? LR0 K T@ R0 B 0eturn of market T B 0isk free rate
Li0itatio.s of CAP'2 In practical purpose ?'P+ can!t be applied due to the following limitations. 7. "he calculation of beta factor is not possible in certain situation due to more assets are traded in the market.
)+
:.
"he assumption of unlimited borrowings at risk free rate is not certain. For every individual investor borrowing
facilities are restricted. =. "he wealth of the share holder or investor is assessed by sing security return. /ut it is not only the factor for calculation of wealth of the investor. A. For every transfer of security transition cost is re#uired on every return ta( must be paid.
TECHNI3UES O# PORT#OLIO 'ANAGE'ENT
's of now the under noted techni#ues of Portfolio +anagement are in vogue in our countryE 7. E=8it6 Po-tfolioE C#uity portfolio is influenced buy internal and e(ternal factors. Internal factors affect inner working of the company. "he company!s growth plans are analy,ed with respect to /alance sheet and Profit * >oss 'ccounts of the company. C(ternal factors are changes in @overnment Policies, "rade cycles, Political stability etc. 2. E=8it6 a.al6sis2
))
<nder this method future value of shares of a company is determined. It can be done by ratios of earning per shares and price earning ratio. EPS B Profit after ta( o. of C#uity Shares
PEE Ratio
N +arket Price per Share o. of e#uity Shares
Bne can estimate the trend of earning by analy,ing CPS which reflects the trend of earnings, #uality of earning, dividend policy and #uality of management. Further price earnings ratio indicates the confidence of market about company!s future.
SELECTION O# PORT#OLIO ?ertain assumptions were made in the traditional approach for portfolio selection, which are discussed belowE 7. Investors prefer large to smaller returns from securities and take more risk. :. 'bility to achieve higher returns depends upon investors $udgment of risk. =. Spreading money among many securities can reduce risk.
'n investor can select the best portfolio to meet his re#uirements from the efficient frontier, by following the theory propounded by +arkowit,. Selection process is based on the satisfaction level that can be achieved from various investment avenues. )-
STAGES IN THE SELECTION PROCESS2 "he process of selecting a portfolio is very crucial in the investment management and involves four stages which are given belowE 7. &etermination of assets, which are eligible for constructing of a portfolio. :. ?omputation of the e(pected 0eturn for the eligible assets over a holding period. =. 'rriving at an acceptable balance between risk and return for constructing optimum a portfolio i.e. selecting such a portfolio for which there is highest return for each level of risk.
SELECTING THE
EST PORT#OLIO 'IA
.hen an infinite number of portfolios are available, investor selects the best portfolio by using the +arkowit, Portfolio "heory. "he investors base their selection on the C(pected return and Standard &eviation of the portfolio and decide the best portfolio mi( taking the magnitude of these parameters. "he investors need not evaluate all the portfolios however he can look at only the available portfolios, which lie on the Cfficient Frontier. T:e -e=8i-e7 feat8-es of t:e s8bset of 5o-tfolio a-e E
)/
"hey should offer ma(imum C(pected 0eturn for varying levels of risk, and also offer minimum risk for varying levels of C(pected 0eturns. If the above two conditions are satisfied then it is deemed as an efficient set, from this set investors have to select the best setoff portfolios Co.st-81tio. of effi1ie.t set of 5o-tfolios. ?onsiderable effort is re#uired to construct a efficient set of portfolios. Following parameters are essential for constructing the efficient setE 7. :. C(pected returns for each security must be estimated. Dariance of each security must be calculated.
O5ti080 Po-tfolio2 Sharpe has identified the optimal portfolio through his single inde( model, according to Sharpe6 the beta ratio is the most important in portfolio selection.
"he optimal portfolio is said to relate directly to the beta value. It is the e(cess return to the beta ratio. "he optimal portfolio is selected by finding out he cu-off rate ScT. "he stock where the e(cess return to the beta ratio is greater than cutoff rate should only be selected for inclusion in the optimal portfolio. Sharp proposed that
desirability of any stock is directly referred to its e(cess returns to betas coefficient. Ri K Rf ? )0
.here Ri Rf ? N C(pected return on stock N 0eturn on risk free asset N C(pected change in the rate of return on stock 7 associated
with 73 change in the market runt Following procedure is involved to select he stocks for the optimum portfolios. 7. :. Finding out the stocks of different risk M return ratios ?alculate e(cess return beta ratio for each stock and rank them from highest to lowest =. A. Finding out the cur-off rate for each security. Selecting securities of high rank above the cur-off rate which is common to all stocks "hus, the optimum portfolio consists of all stocks for which LRi K Rf@ is grater than a particular cut-off pointS?UT. "he selection number of stocks depends upon the uni#ue cut-off rate, where all stocks with higher rate LRi K Rf@ will be selected and stocks with lower rates will be eliminated.
PORT#OLIO RE"ISION )aving constructed the optimal portfolio, the investor has to constantly monitor the portfolio to ensure that it continues to be optimal. 's the economy and financial markets are dynamic, the changes take place almost daily. "he investor now has to revise his
-1
portfolio. "he revision leads to purchase of new securities and sale of some of the e(isting securities from the portfolio. NEED #OR RE"ISION2? 'vailability of additional funds for investment ? 'vailability of new investment avenues ? ?hange in the risk tolerance ? ?hange in the time hori,on ? ?hange in investment goals ? ?hange in li#uidity needs ? ?hanges in ta(es
PORT#OLIO E"ALUATION Portfolio managers and investors who manage their own portfolios continuously monitor and review the performance of the portfolio. "he evaluation of each portfolio, followed by revision and management. reconstruction are all steps in the portfolio
-1
"he ability to diversify with a view to reduce and even eliminate all unsystematic risk and e(pertise in managing the systematic risk related to the market by use of appropriate risk measures, namely, /etas. Selection of proper securities is thus the first re#uirement.
'et7s of E/al8atio.2 ? S:a-5e i.7e> 0o7el2 it depends on total risk rate of the portfolio. 0eturn of the security compare with risk free rate of return, the e(cess return of security is treated as premium or reward to the investor. "he risk of the
-!
premium is calculated by comparing portfolio risk rate. .hile calculating return on security any one of the previous methods is used. If there is no premium Sharpe inde( shows negative value 4-5. In such a case the portfolio is not treated as efficient portfolio. S:a-5ePs -atio LS5@ N rp-rf;?p .here, SpN Sharpe inde( performance model
rpN return of portfolio rfN risk free rate of return ?pN portfolio standard deviation
"his method is also called “0eward to Dariability” method. .hen more then one portfolio is evaluated highest inde( is treated as first rank. "hat portfolio can be treated as better portfolio compare to other portfolios. 0anks are prepared on the basis of descending order. ? T-e6.o-s i.7e> 0o7el2 It is another method to measure the portfolio
performance. .here systematic risk rate is used to compare the unsystematic risk rate. Systematic risk rate is measure by beta. It is also called “0eward to Systematic 0isk”.
9:
T-e6.o-s Ratio LTp@ B
rp M rf;?p
.here, "pN "reynors portfolio performance model -"
rpN return of portfolio rf N risk free rate of return
?p N portfolio standard deviation.
If the beta portfolio is not given market beta is considered for calculation of the performance inde(. )ighest value of inde( portfolio is accepted. ? !e.se.Ps i.7e> 0o7el2 It is different method compared to the previous
methods. It depends on return of security which is calculated by using ?'P+. If the actual security returns is less than the e(pected return of ?'P+ the difference is treated as negative 4-5 then the portfolio is treated as inefficient portfolio. !5B -5-D-fJ? 5 L-0--f@F .here, IpN Iensen!s inde( performance model rfN risk free rate of return rpN return of portfolio ?pN portfolio standard deviation rmN return on market "his method is also called “reward to variability” method. .hen more than one portfolio is evaluated highest inde( is treated as first rank. "hat portfolio can be treated as better portfolio compared to other portfolios. 0anks are prepared on the basis of descending order.
-#
PRACTICAL ANAL$SIS
Po-tfolio A
-+
Note2 -CG is the cut-off point to include the securities in to portfolio.
Un ,eta R3 2yste Risk 2ecurities Returns 4alues metic 5?6
78cess Return $ver 5?6 Ri 9 Rf
:::::::::::::
5Ri*Rf6 ?
:::::::::::::
.u mulative 5Ri*Rf6 ?
:::::::::::::
.umulative ?
!
::::::::::
.;
n
?!
::::::::::
?m ?t;1 5Ri*Rf6 ?
!
::::::::::::::::::::
?!e
?e
!
?!e
!
?!e
n
?!e
?!e 536 !0 1/ )+ "+ 1! "" "1 + 1# /" 1# !/ 1! "! !) !1
?
1< ?m ?t;1 ?!
::::::::
?!e ,harti (irtel I%. =uj 1# ! 11 1 11 + 1 // 1 00 1 1" 1 01 1 1) 1 0) 1 1" 1 1) 1 !0 1 /! 1 1" 1 )0 11 + +! #+ #" # !# #! " "0 " "1 !! "0 10 1+ 1 !/!! 1 !)+# 1 1)1/ 1 !/-/ 1 1+)# 1 !+01 1 !+-+ 1 1"!+ 1 "-)! 1 1#)1 1 1-0! 1 1"#+ 1 !/!! 1 +#-) 1 -10# 1 00-! 1 1+") 1 #1!) 1 )-11 1 /1!) ! 1-// ! !!#0 ! "1#1 ! ""/) 1 1!/) 1 11"" 1 1"1" 1 1/11 1 1")/ 1 101/ 1 1"!) 1 1#11 1 1))# 1 1!11 1 1#1/ 1 1!"/ 1 1!// 1 1#!1 1 1-!" 1 !+!# 1 !/0! 1 #-00 1 )1!# 1 )+!) 1 /101 1 /# 1 //1/ 1 01#) ! 10 ! !) ! )1) ! /"1 ! 0)# ! #+ ! "# ! "0 ! "! ") ! "# ! "!
(mb com I.I.I // ,ank ,>7' >D&. ,ajaj 0# 01 /#
(uto (cc /) >indalco / " >D&. ,ank >'' Dr Reddys )) -1 )1
c?
INTERPRETATION2 ? ?onstruction of optimal portfolio starts with determines which securities are included in the portfolio, for this the following steps necessary. -)
? ?alculation of! e(cess return to beta ratio! for each securities under review and rank from highest to lowest.
? "he above table shows that the construction of optimal portfolio from /SC SC SC% scripts.
? In the above table all the securities whose Qe(cess return to beta Qratio are above the cut-off rate are selected and all those whose ratios are below are re$ected.
? For the portfolio-' selected scripts are 72 out of twelve whose “e(cess return to beta” ratio are above the cutoff rate 4:.=9 ?U5 are included in the portfolio basket. )>> 47.8 V :.=A5 &r.0eddy!s 47.1 V :.=:5 securities e(cess return to beta ratios are less than the cut-off so those are e(cluded from the portfolio.
PORT#OLIO
--
Un ,eta R3 2yste Risk 2ecurities Returns 4alues metic 5?6
78cess Return $ver 5?6 Ri 9 Rf
:::::::::::::
5Ri*Rf6 ?
:::::::::::::
.u mulative 5Ri*Rf6 ?
:::::::::::::
.umulative ?
!
::::::::::
.;
n
?
!
?m ?t;1 5Ri*Rf6 ?
!
::::::::::::::::::::
::::::::::
?!e
?e
!
?e
! !
?!e
n
?!e
? e 536
!
?
1< ?m ?t;1 ?!
::::::::
?!e ,harti (irtel I%. =uj 1# ! 11 1 11 + 1 // 1 00 1 1" 1 01 1 1) 1 0) 1 1" 1 1) 1 !0 1 /! 1 1" 1 )0 !0 1/ )+ "+ 1! "" "1 + 1# /" 1# !/ 1! "! !) !1 11 + +! #+ #" # !# #! " "0 " "1 !! "0 10 1+ 1 !/!! 1 !)+# 1 1)1/ 1 !/-/ 1 1+)# 1 !+01 1 !+-+ 1 1"!+ 1 "-)! 1 1#)1 1 1-0! 1 1"#+ 1 !/!! 1 +#-) 1 -10# 1 00-! 1 1+") 1 #1!) 1 )-11 1 /1!) ! 1-// ! !!#0 ! "1#1 ! ""/) 1 1!/) 1 11"" 1 1"1" 1 1/11 1 1")/ 1 101/ 1 1"!) 1 1#11 1 1))# 1 1!11 1 1#1/ 1 1!"/ 1 1!/) 1 1#10 1 1-!! 1 !+!" 1 !/01 1 #-0 1 )1!+ 1 )+!+ 1 /101 1 /# 1 //1/ 1 01#) ! 10 ! !) ! )1) ! /"1 ! 0)# ! #+ ! "# ! "0 ! "! ") ! "# ! "!
(mb com I.I.I // ,ank ,>7' >D&. ,ajaj 0# 01 /#
(uto (cc /) >ilbalco / " >D&. ,ank >'' Dr Reddys )) -1 )1
c?
Note2 -CG is the cut-off point to include the securities in to portfolio
INTERPRETATION2 ? "he desirability of any securities to include in the portfolio is directly related to e(cess return to beta ratio and cut-off rate.
-/
? "he above information shows that for securities of Satyam computers to "P? 0i M 0f ; ? is less than ?U. .hile securities "P? all the
77*7: are less than ?U. So from Satyam computers to
ten securities are included in the portfolio and B @? * "'"' consultancy services are not added in the optimal portfolio.
? )ere optimal portfolio consists of securities of 72 companies
PORT#OLIO C2
-0
Un 2ecurities R3 ,eta 2yste Risk Returns 4alues metic 5?6
78cess Return $ver 5?6 Ri 9 Rf
:::::::::::::
5Ri*Rf6 ?
:::::::::::::
.u mulative 5Ri*Rf6 ?
:::::::::::::
.umulative ?
!
::::::::::
.;
n
?
!
?m ?t;1 5Ri*Rf6 ?
!
::::::::::::::::::::
::::::::::
?!e
?e
!
?e
! !
?!e
n
?!e
? e 536
!
?
1< ?m ?t;1 ?!
::::::::
?!e 2atyam .om ,harthi (irtel Reliance 11 " comm 2,I 11 )! Reliance / 7ne '@% >ero >onda =uj (mboja Ranba8y I.I.I ,>7' Infosys ++ #/ /+ )/ ) ) ) 1 0+ 1 1! 1 )) 1 /1 1 11 1 #! 1 /! 1 -# 1 )0 1 /0 10 !1 + !! 1! 1+ 1! -) "! #+ !1 + /# +) +! # +# #+ ## #" # !# #! 1 !)+1 1 "1-1 1 1011 1 !""" 1 !+"" 1 "/0# 1 1#)1 1 1)## 1 1"#+ 1 1-/ 1 /!1 1 1!/ 1 !1/ 1 #+1" 1 -1#) ! 10# ! 1#11 ! "1#+ ! ""01 ! +11 1+!+ 1 1-11 1 1!11 1 1+## 1 )--1 1+/1 1 1))# 1 1!11 1!"/ 1 1+/#! 1 11-# 1 1-/) 1 !1/) 1 !)" 1 0#11 10/1 !)+1 1 "/)/ 1 #11) 1 +)01 " 0+) # 1#/ " 0# "0 1 )"1 01+ 1 +)1 +#0 1 +#// 1 +1/ 1/ 1# " 1 10 1 // #+ !0 11 11 + 1 !01) 1 !)+# 1 !01) 1 ++) 1 1!)# 1 1!/) 1 1!)# 1 1++ ! !0 " +/-
INTERPRETATION ? For the portfolio-? selected scripts are 7:companies and portfolio basket consists of all the selected scripts whose e(cess return to beta ratios are always greater than cutoff rates. /1
? So the optimal portfolio consists of selected all 7: securities.
FINDINGS
? "he investor can recogni,e and analy,e the risk and return of the shares by using this analysis. ? "he investor who bears high risk will be getting high returns.
/1
?
"he investor who is having optimum portfolio will be taking optimum returns with minimum risk.
?
"he
investor
should
include
all
securities
which
are
undervalued in their portfolio and remove those securities that are over valued. ? "he investor has to maintain a portfolio of diversified sector stocks rather than investing in a single sector of different stocks. ? People who are investing in them mostly depend on the advice of their friends, relatives and financial advisors. ? People generally invest their savings in fi(ed deposits, recurring deposits, and national savings certificate and
government securities as they are less risky and the returns are guarantied. ? Cvery investor invests in basic necessities. "hey plan to invest in insurance 4>I?, @I?5 and pension funds as these give guarantied returns and are less risky. ? +ost of the investors feel that investing in stock;capital market is of high risk therefore they don!t invest in them.
CONCLUSIONS
? .hen compared to other portfolios, portfolio-? gives him the ma(imum return with twelve scripts.
/!
? "he diversification of funds in different company scripts is possible from the portfolio-? when compared to others.
? +arket risk is also less when compared to the other portfolio.
? If the portfolio manager is efficient and the investor is -is9 tole-a.t 5e-so. a.7 t:e i./est0e.t is a lo.4 te-0 5e-s5e1ti/e t:e. it is bette- to i./est i. t:e 'ID-Ca5s C S'ALL-Ca5s 1o05a.ies se18-itiesI <:e-e t:e 4-o<t: of -et8-.s a-e :i4:e- t:a. t:e LARGE-Ca5s .
? If investor is not risk tolerant person * short-term perspective it!s good to invest in large caps companies! securities.
? I feel that this year small cap and mid cap companies will be performing well when compared to large cap as we have observed last year.
I LIOGRAPH$
TEAT
OO,S
I./est0e.ts
/"
/y S)'0PC * '>C%' &C0 Security 'nalysis and Portfolio +anagement /y FIS?)C0 * IB0&' Investment 'nalysis and Portfolio +anagement. /y P0'S' ' ?)' &0'
?E SITES www.bseindia.com www.nseindia.co www.economictimes.com www.moneycontrol.com www.yahoofinance.com
/#
doc_536374855.doc
Project submitted in partial fulfillment for the award of degree
MASTER OF B S!"ESS MA"A#EME"T
$E%&ARAT!O"
I
hereby
declare
that
this
Project
Report
titled
“PORTFOLIO
MANAGEMENT AND INVESTMENT DECISIONS” submitted by me to the Department of '''' is a bonafide work under taken by me and it is not submitted to 1
any other University or Institution for the award of any degree diploma / certificate or published any time before
ABSTRA%T
Portfolio management can be defined and used in many a ways, because the basic meaning of the word is “combination of the various things keeping intact”. So I considered and evaluated this from the perspective of the investment part in the securities segment. From the investor point of view this portfolio followed by him is very important since through this way one can manage the risk of investing in securities and thereby managing to get good returns from the investment in diversified securities instead of putting all the money into one basket. ow a day!s investors are very cautious in choosing the right portfolio of
!
securities to avoid the risks from the market forces and economic forces. So this topic is chosen because in portfolio management one has to follow certain steps in choosing the right portfolio in order to get good and effective returns by managing all the risks. "his topic covers the how a particular portfolio has to be chosen concerning all the securities individual return and thereby arriving at the overall portfolio return. "his also covers the various techni#ues of evaluation of the portfolio with regarding to all the uncertainties and gives an edge to select the right one. "he purpose of choosing this topic is to know how the portfolio management has to be done in arriving at the effective one and at the same time make aware the investors to choose the securities which they want to put them in their portfolio. "his also gives an edge in arriving at the right portfolio in consideration to different securities rather than one single security. "he pro$ect is undertaken for the study of my sub$ect thoroughly while understanding the different case studies for the better understanding of the investors and my self.
A%("O)&E$#EME"T
I would like to give special acknowledgement to %%%% &irector, %%%% for his consistent support and motivation. I am grateful to %%%%, 'ssociate professor in finance, %%%%% for his technical e(pertise, advice and e(cellent guidance. )e not only gave my pro$ect a scrupulous critical reading, but added many e(amples and ideas to improve it.
"
I am indebted to my other faculty members who gave time and reviewed portions of this pro$ect and provided many valuable comments. I would like to e(press my appreciation towards my friends for their encouragement and support throughout this pro$ect.
%%%%%
TAB&E OF %O"TE"TS
CONTENTS List of tables CHAPTER-1 1. INTRODUCTION7 2. O !ECTI"E O# THE STUD$ % &. 'ETHODOLOG$ ( ). LI'ITATIONS O# THE STUD$ CHAPTER-2 +. IN"EST'ENT DECISIONS 11 1* PAGE NO. 6
#
CHAPTER-& 6. PORT#OLIO 'ANAGE'ENT CHAPTER-) 7. PRACTICAL ANAL$SIS O# PORT#OLIO E"ALUATION CHAPTER-+ %. #INDINGS O# THE STUD$ (. CONCLUSION 1*. I LIOGRAPH$ %1 %2 %* 7) 16
&!ST OF TAB&ES
TAB&E I P$R%&$'I$ ( II P$R%&$'I$ , III P$R%&$'I$ . PA#E "O* )# * )+ )) * ))/
+
INTRODUCTION
"his pro$ect deals with the different investment decisions made by different people and focuses on element of risk in detail while investing in securities. It also e(plains how portfolio hedges the risk in investment and giving optimum return to a given amount of risk. It also gives an in depth analysis of portfolio creation, selection, revision and evaluation. "he report also shows different ways of analysis of securities, different theories of portfolio management for effective and efficient portfolio construction. It also gives a brief analysis of how to evaluate a portfolio.
)
O !ECTI"E O# THE STUD$
? "o help the investors to decide the effective portfolio of securities. ? "o identify the best portfolio of securities. ? "o study the role and impact of securities in investment decisions. ? "o clearly defining the portfolio selection process. ? "o select an optimal portfolio.
-
'ETHODOLOG$
PRI'AR$ DATA ? &ata collected from ewspaper * +aga,ines.
? &ata obtained from the internet. ? &ata collected from brokers. ? &ata obtained from company $ournals.
SE%O"$AR+ $ATA
? &ata collected from various books and sites.
/
&!M!TAT!O"S
? "he data collected is basically confined to secondary sources, with very little amount of primary data associated with the pro$ect.
? "here is a constraint with regard to time allocated for the research study.
? "he availability of information in the form of annual reports * price fluctuations of the companies is a big constraint to the study.
0
IN"EST'ENT DECISION 'A,ING Investment +anagement involves correct decision-making. 's referred to earlier any investment is risky and as such investment decision is difficult to make. Investment decision is based on availability of money and information on the economy, industry and company and the share prices ruling and e(pectations of the market and of the companies in #uestion. IN"EST'ENT 'ANGE'ENT In the stock market parlance, investment decision refers to making a decision regarding the buy and sell orders. 's referred to already, these decisions are influenced by availability of money and flow of information. .hat to buy and sell will also depend on the fair
11
value of a share and the e(tent of over valuation and under valuation and more important e(pectation regarding them. For making such a decision the common investors may have to depend more upon a study of fundamentals rather than technician!s, although technical are more important. /esides, even genuine investors have to guard themselves against wrong timing regarding both buy and sell decisions. Its is necessary for a common investor to study the /alance Sheet and 'nnual 0eport of the company or analysis the #uarterly and half yearly results of the company and decide on whether to buy that company!s shares or not. "his is called fundamental analysis, and then decision-making becomes scientific and rational. "he likelihood of high-risk scenario will come down to a low risk scenario and long-term investors will not lose.
C-ite-ia fo- I./est0e.t De1isio.2 Firstly, the investment decision depends on the mood of the market. 's per the empirical studies, share prices depends on the fundaments for the company only to the e(tent of 123 and the rest is decided the mood of the market and the e(pectations of the company!s performance and its share price. "hese e(pectations depend on the analyst!s ability to foresee and forecast the future performance of the company. For price paid for a share at present depends on the flow of returns in future, e(pected from the company.
11
Secondly and following from the above, decision to invest will be based on the past performance, present working and the future e(pectations of the company!s performance, both operationally and financially. "hese in turn will influence the share prices. "hirdly, investment decision depends on the investor!s
perception on whether the present share price is fair, overvalued or under valued. If the share price is fair he will hold it 4)old &ecision5 if it is overvalued, he will sell it 4sell &ecision5 and if it is undervalued, he will buy it 4/uy &ecision5. "hese are general rules, but e(ceptions may be there. "hus even when prices are rising, some investors may buy as their e(pectations of further rise may outweigh their conception of overvaluation. "hat means, the concepts of over valuation or under valuation are relative to time, space and man. .hat may be over valued a little while ago has become undervalued following later developments6 information or sentiment and mood may change the whole market scenario and of the valuation of shares. "here are two more decisions, namely, 'verage up and average down of prices. "he investment decision may also depend on the investor!s preferences, moods, or fancies. "hus an investor may go on a spending spree and invest in cats and dogs of companies, if he has taken a fancy or he is flooded with money from lottery or pri,es. ' rational investor would however make investment decisions on scientific study of the fundamentals of the company and in a planned manner.
1!
't present, investors mostly depend on hearsay an advice of friends, relatives, sub brokers, etc for the investment decision, but not on any scientific study of the company!s fundamentals. In view of the increasing mushroom growth of companies and lack of any track record of many promoters, investment decision making became on hunches, hearsay etc. RIS, AND IN"EST'ENT2 Stock +arket investment is risky and there are different types of investments, namely e#uity, fi(ed deposits, debentures etc. &iversifying investment into 72 to 71 companies can reduce company specific risk also called unsystematic risk. /ut the systematic risk relating to the market cannot be reduced but can be managed by choosing companies with that much risk 4high or low5 that the investor can bear.
IN"EST'ENT O !ECTI"ES2 75 "he first basic ob$ective of investment is the return on it or yields. "he yields are higher, the higher is the risk taken by investors. "he risk less return is bank deposit rate of 83 at present or /ank rate of 93. )ere the risk is least as funds are safe and returns are certain. :5 Secondly, each investor has his own asset preferences and choice of investments. "hus some risk adverse operators put their funds in bank or post office deposits or deposits;certificates with co-
1"
operatives and PS<!s. Some invest in real estate6 land and building while other invest mostly in gold, silver and other precious stones, diamonds etc. =5 "hirdly, every investor aims at providing for minimum
comforts of house furniture, vehicles, consumer durables and other household re#uirements. 'fter satisfying these minimum needs, he plans for his income, saving in insurance 4>I? and @I? etc.5 pension and provident funds etc. In the choice of these, the return is subordinated to the needs of the investor. A5 >astly, after satisfying all the needs and re#uirements, the rest of the savings would be invested in financial assets, which will give him future incomes and capital appreciation so as to improve his future standard of living. "hese may be in stock;capital market investments.
3UALITIES #OR SUCCESS#UL IN"ESTING ? ? ? ? ? ?ontrary thinking Patience ?omposure Fle(ibility and Bpenness
GUIDELINES #OR E3UIT$ IN"EST'ENT C#uity shares are characteri,ed by price fluctuations, which can produce substantial gains or inflict severe loses. @iven the 1#
volatility and dynamism of the stock market, investor re#uires grater competence and skill along with a touch of good luck too-to invest in e#uity shares. )ere are some general guidelines to play to e#uity game, irrespective of whether you are aggressive or conservative. ? ? ? ? ? ? 'dopt a suitable formula plan Cstablish value anchors 'sses market psychology ?ombine fundamental and technical analysis &iversify sensibly Periodical review and revise your portfolio
Po-tfolio 'a.a4e0e.t
INTRODUCTION2
In simple term Portfolio can be defined as combination of securities that have 0eturn and 0isk characteristic of their own. Portfolio may or may not take on the aggregate characteristics of their individual parts. Portfolio is the collection of financial or real assets such as e#uity shares, debentures, bonds, treasury bills and
1+
property etc.
Port folio is a combination of assets or it consists
of collection of securities. "hese holdings are the result of individual preferences, decisions of the holders regarding risk, return and a host of other considerations. Portfolio management concerns the construction *
maintenance of a collection of investment. It 5-i0a-il6 i./ol/es -e781i.4 -is9s -at:et:a. i.1-easi.4 -et8-.. 0eturn is
obviously important though the ultimate ob$ective of portfolio manager has to get good return to achieve a chosen level of return by immuni,ing the risk. PORT#OLIO 'ANAGE'ENT Investing in securities such as shares, debentures bonds is profitable as well as e(citing. It indeed involves a great deal of risk. Dery few investors invest in single security their entire savings. /ut most of them invest in a group of securities such6 group of securities is called a Portfolio. ?reation of portfolio helps to reduce risk without reducing returns. 's economic and financial environment keeps changing the risk-return characteristics of individual securities and portfolio also change. 'n investor invests in funds in a port folio e(pecting to get a good return with less risk to bear. Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals
1)
specifically with Security analysis, Portfolio analysis, Portfolio selection, Portfolio revision and Portfolio evaluation. O !ECTI"ES O# PORT#OLIO 'ANAGE'ENT "he ob$ective of portfolio management is to invest in securities in such a way thatE a5 b5 +a(imi,e one!s 0eturn and +inimi,e risk
In order to achieve one!s investment ob$ectives, a good portfolio should have multiple ob$ectives and achieve a sound balance among them. 'ny one ob$ective should not be given undue importance at the cost of others. So0e of t:e 0ai. ob;e1ti/es a-e 4i/e. belo<2 ? Safet6 of t:e I./est0e.t Investment safety or minimi,ation of risks is one of the important ob$ectives of portfolio management. "here are many types of risks, which are associated with investment in e#uity stocks, including super stocks. .e should keep in mind that there is no such thing as a Fero-0isk investment. +oreover, relatively >ow0isk investments give correspondingly lower returns. ? Stable C8--e.t Ret8-.s2 Bnce investments safety is guaranteed, the portfolio should yield a steady current income. "he current returns should at least match the opportunity cost of the funds of the investor. .hat we are referring is current income by way of interest or dividends, not capital gains. "he Portfolio should give a steady
1-
yield of income i.e.6 interest or dividends. "he returns have to match the opposite cost of funds of interest. ? 'a-9etabilit62 If there are too many unlisted or inactive shares in our portfolio, we will have to face problems in enchasing them, and switching from one investment to another. ? Li=8i7it6 "he portfolio should ensure that there are enough funds available at short notice to take care of the investor!s li#uidity re#uirements. It is desirable to keep a line of credit from a bank fro use incase it become necessary to participate in 0ight Issues, or for any other personal needs. ? Ta> Pla..i.4 Since ta(ation is an important variable in total planning. ' good portfolio should enable its owner to en$oy a favorable ta( shelter. "he portfolio should be developed considering not only income ta( but capital gains ta(, and gift ta(, as well. .hat a good portfolio aims at is ta( planning, not ta( evasion or ta( avoidance.
PORT#OLIO 'ANAGE'ENT #RA'E?OR, Investment management is also known as Portfolio
+anagement, it is a comple( process or activity that may be divided into seven broad phasesE? Specification of Investment Bb$ectives and ?onstraints.
1/
? ?hoice of 'sset +i(. ? Formulation of Portfolio Strategy. ? Selection of Securities. ? Portfolio C(ecution. ? Portfolio 0ebalancing. ? Performance Cvaluation. S5e1ifi1atio. of I./est0e.t Ob;e1ti/es a.7 Co.st-ai.ts2"he first step in the portfolio management process is to specify one!s investment ob$ectives and constraints. "he commonly stated investment goals areE 7. I.1o0e2 - "o provide a steady stream of income through regular interest;dividend payment. :. G-o<t:2 - "o increase the value of the principal amount through capital appreciation. =. Stabilit62 - "o protect the principal amount invested from the risk of >oss.
Po-tfolio 'a.a4e0e.t i. I.7ia In India, Port folio +anagement is still in its infancy. /arring a few Indian /anks, and foreign banks and <"I, no other agency had professional Portfolio +anagement until 78GH.
10
'fter the setting up of public sector +utual Funds, since 78GH, professional portfolio management, backed by competent research staff became the order of the day. 'fter the success of +utual Funds in portfolio management, a number of brokers and
Investment consultants some of whom are also professionally #ualified have become Portfolio +anagers. "hey have managed the funds of clients on both discretionary and on-discretionary basis. It
was found that many of them, including +utual Funds have guaranteed a minimum return or capital appreciation and adopted all kinds of incentives, which are now prohibited by SC/I. "hey resorted to speculative over trading and insider trading, discounts, etc., to achieve their targeted returns to the clients, which are also prohibited by SC/I. "he recent ?/I probe into the operations of many market dealers has revealed the unscrupulous practices by banks, dealers and brokers in their Portfolio Bperations. "he SC/I has the imposed stricter rules, which included their registration, a code of conduct and minimum infrastructures, e(perience etc. It is no longer possible for my unemployed youth, or retired person or self-styled consultant to engage in Portfolio +anagement without the SC/I!s license. "he guidelines of SC/I are in the direction of making Portfolio +anagement a responsible professional service to be rendered by e(perts in the field. SE I NOR'S2
!1
SC/I has prohibited the Portfolio +anger to assume any risk on behalf of the client. Portfolio +anager cannot also assure any fi(ed return to the client. "he investments made or advised by him are sub$ect to risk, which the client has to bear. "he investment consultancy and management has to be charged at rates, which are fi(ed at the beginning and transparent as per the contract. o sharing of profits or discounts or cash incentives to
clients is permitted. "he Portfolio +anager is prohibited to do lending, badla financing and bills discounting as per SC/I norms. )e cannot put the client!s funds in any investment, not permitted by the contract, entered into with the client. ormally investment can be made in
capital market and money market instruments. ?lient!s money has to be kept in a separate account with the public sector bank and cannot be mi(ed up with his own funds or investments. 'll the deals done for a client!s account are to be entered in his name and ?ontract otes, /ills and etc., are all
passed by his name. ' separate ledger account is maintained for all purchases;sales on client!s behalf, which should be done at the market price. Final settlement and termination of contract is as per the contract. &uring the period of contract, Portfolio +anager is only acting on a contractual basis and on a fiduciary basis. than a year is permitted by the SC/I. o contract for less
!1
SE I GUIDELINES TO THE PORT#OLIO 'ANAGERS2 Bn Hth Ianuary 788= the Securities C(change /oard of India issued regulations to the Portfolio managers for the regulation of portfolio management services by merchant bankers. "hey are as followsE
?
Portfolio management services shall be in the nature of investment or consultancy management for an agreed fee at client!s risk.
?
"he portfolio manager shall not guarantee return directly or indirectly the fee should not be depended upon or it should not be return sharing basis.
?
Darious terms of agreements, fees, disclosures of risk and repayment should be mentioned.
?
?lient!s funds should be kept separately in client wise account, which should be sub$ect to audit.
?
+anager should report clients at intervals not e(ceeding 9 months.
?
Portfolio manager should maintain high standard of integrity and not desire any benefit directly or indirectly form client!s funds.
?
"he client shall be entitled to inspect the documents. Portfolio manager shall not invest funds belonging to clients in badla financing, bills discounting and lending operations.
?
?
?lient money can be invested in money and capital market instruments.
!!
?
Settlement on termination of contract as agreed in the contract.
?
?lient!s funds should be kept in a separate bank account opened in scheduled commercial bank.
?
Purchase or Sale of securities shall be made at prevailing market price.
PORT#OLIO ANAL$SIS2 Portfolios, which are combinations of securities may or may not take the aggregate characteristics of their individual parts. Portfolio analysis considers the determination of future risk and return in holding various blends of individual securities. 'n investor can some times reduce portfolio risk by adding another security with greater individual risk than any other security in the portfolio. "his seemingly curious result occurs because risk depends greatly on the covariance among returns of individual securities. 'n investor can reduce e(pected risk and also can estimate the e(pected return and e(pected risk level of a given portfolio of assets if he makes a proper diversification of portfolios. "here are tow main approaches for analysis of portfolio 1. 2. T-a7itio.al a55-oa1:. 'o7e-. a55-oa1:.
75 TRADITONAL APPROACH2
!"
"he traditional approach basically deals with two ma$or decisions. "raditional security analysis recogni,es the key
importance of risk and return to the investor. +ost traditional methods recogni,e return as some dividend receipt and price appreciation over a forward period. /ut the return for individual securities is not always over the same common holding period, nor are the rates of return necessarily time ad$usted. 'n analysis may well estimate future earnings and a P;C to derive future price. )e will surely estimate the dividend. In any case, given an estimate of return, the analyst is likely to think of and e(press risk as the probable downside rice e(pectation 4ether by itself or relative to upside appreciation possibilities5. Cach security ends up with some rough measures of likely return and potential downside risk for the future Portfolios or combinations of securities, are though of as helping to spread risk over many securities. "his is good. )owever, the interrelationship between securities may e specified only broadly or nebulously. 'uto stocks are, for e(amples, recogni,ed as risk interrelated with fire stocksE utility stocks display defensive price movement relative to the market and cyclical stocks like steel6 and so on. "his is not to say that traditional portfolio analysis is unsuccessful. It is to say that much of it might be more ob$ectively specified in e(plicit terms "hey areE '5 &etermining the ob$ectives of the portfolio.
!#
/5
Selection of securities to be included in the portfolio /efore
ormally this is carried out in four to si( steps.
formulating the ob$ectives, the constraints of the investor should be analy,ed. .ith in the given framework of constraint, ob$ectives are formulated. "hen based on the ob$ectives securities are selected. 'fter that the risk and return of the securities should be studies. "he investor has to assess the ma$or risk categories that he or she is trying to minimi,e. ?ompromise of risk and non-risk factors has to be carried out. Finally relative portfolio weights are assigned to securities like bonds, Stocks and debentures and the diversification is carried out.
'ODERN PORT#OLIO APPROACH2 "he traditional approach is a comprehensive financial plan for the individual needs such as housing, life insurance and pension plans. /ut these types of financial planning approaches are not done in the +arkowit, approach. +arkowit, gives more attention to the process of selecting the portfolio. )is planning can be applied more in the selection of common stocks portfolio than the bond portfolio. "he stocks are not selected on the basis of need for income or appreciation. /ut the selection is based in the risk and return "he
analysis 0eturn includes the market return and dividend.
investor needs return and it may be either in the form of market return or dividend.
!+
"he investor is assumed to have the ob$ective of ma(imi,ing the e(pected return and minimi,ing the risk. Further, it is assumed that investors would take up risk in a situation when ade#uately rewarded for it. "his implies that individuals would prefer the
portfolio of highest e(pected return for a given level of risk. In the modern approach the final step is asset allocation process that is to choose the portfolio that meets the re#uirement of the investor. "he following are that ma$or steps involved in this process. Po-tfolio 'a.a4e0e.t P-o1ess2
?
Security analysis Portfolio analysis Selection of securities Portfolio revision Performance evaluation
?
?
?
?
SECURIT$ ANAL$SIS2 Defi.itio.2 For making proper investment involving both risk and return, the investor has to make a study of the alternative avenues of investment their risk and return characteristics and make a proper pro$ection or e(pectation of the risk and return of the alternative investments under consideration. )e has to tune the e(pectations to this preference of the risk and return for making a proper investment choice. "he process of analy,ing the individual securities and the market has a whole and estimating the risk and return !)
e(pected from each of the investments with a view to identifying undervalues securities for buying and overvalues securities for selling is both an art and a science that is what called security analysis. Se18-it62 "he security has inclusive of share, scripts, stocks, bonds, debenture stock or any other marketable securities of a like nature in or of any debentures of a company or body corporate, the government and semi government body etc. A.al6sis of se18-ities2 Security analysis in both traditional sense and modern sense involves the pro$ection of future dividend or ensuring flows, forecast of the share price in the future and estimating the intrinsic value of a security based on the forecast of earnings or dividend. Security analysis in traditional sense is essentially on analysis of the fundamental value of shares and its forecast for the future through the calculation of its intrinsic worth of the share. +odern security analysis relies on the fundamental analysis of the security, leading to its intrinsic worth and also rise-return analysis depending on the variability of the returns, covariance, safety of funds and the pro$ection of the future returns. If the security analysis based on fundamental factors of the company, then the forecast of the share price has to take into account inevitably the trends and the scenario in the economy, in the
!-
industry to which the company belongs and finally the strengths and weaknesses of the company itself.
A55-oa1:es to Se18-it6 A.al6sis2Fundamental 'nalysis "echnical 'nalysis Cfficient +arket )ypothesis
? ? ?
#UNDA'ENTAL ANAL$SIS "he intrinsic value of an e#uity share depends on a multitude of factors. "he earnings of the company, the growth rate and the risk e(posure of the company have a direct bearing on the price of the share. "hese factors in turn rely on the host of other factors like economic environment in which they function, the industry they belong to, and finally companies own performance. "he
fundamental school of though appraised the intrinsic value of share through ? E1o.o0i1 A.al6sis ? I.78st-6 A.al6sis ? Co05a.6 A.al6sis
ECONO'IC ANAL$SIS2 "he level of economic activity has an investment in many ways. If the economy grows rapidly, the industry can also be e(pected to show rapid growth and vice versa. .hen the level of !/
economic activity is low, stock prices are low, and when the economic activity is high, stock prices are high reflecting the prosperous outlook for sales and profits of the firms. "he analysis of macro economic environment is essential to understand the behavior of the stock prices. "he commonly analy,ed macro economic factors are a followsE a5 &ross domestic pro$ect b5 Savings and investments c5 Inflation d5 Interest rates e5 /udget f5 "he ta( structure g5 /alance of payments h5 +onsoon and agriculture i5 Infrastructure facilities $5 &emographic factors
INDUSTR$ ANAL$SIS 's referred earlier, performance of a company has been found to depend broadly up to 123 on the e(ternal factors of the economy and industry. "hese e(ternalities depend on the
availability of inputs, like proper labor, water, power and interrelations between the economy and industry and the company.
!0
In this conte(t a well-diversified company performs better than a single product company, because while the demand for some products may be declining, that for others may be increasing. Similarly, the input prices and cost factors would vary from product line to product line, leading to different margins and a diversified company is better bet for investor. "he industry analysis should take into account the following factors among others as influencing the performance of the company, whose shares are to be analy,ed. "hey are as followedE a5 Product line b5 0aw materials and inputs c5 ?apacity installed and utili,ed d5 Industry characteristics e5 &emand and market f5 @overnment policy with regard to industry g5 >abour and other industrial problems h5 +anagement
CO'PAN$ ANAL$SIS2 Investor should know the company results properly before making the investment. "he selection of investment is depends on optimum results of the following factors.
1@ 'AR,ETING #ORCES2
"1
+anufacturing
companies
profit
depends
on
marketing
activities. If the marketing activities are favorable then it can be concluded that the co. +ay have more profit in future years. &epends on the previous year results fluctuations in sales or growth in sales can be identified. If the sales are increasing in trend investor any be satisfied.
2@ ACCOUNTING PRO#ILES &ifferent accounting policies are used by organi,ation for the valuation of inventories and fi(ed assets. A@ IN"ENTOR$ POLIC$2 0aw materials and their value at the end of the year is calculated by using FIFB, >IFB or any other average methods. "he particular method is must be suitable to access the particular raw material. @ #IAED ASSET POLC$2 'll the fi(ed assets are valued at the end of every year to know the real value of the business. NET "ALUE O# #IAED ASSETSB "ALUE O# ASSET AT THE EGINNING O# THE $EAR - DEPRECIATION For income ta( purpose written down value method is used as per this separate schedule of assets are to be prepared. &@ PRO#ITA ILIT$ SITUATION2 It is a ma$or factor for investor. Profitability of the company must be better compare with industry. "he efficiency of the profitability position or operating activities can be identified by studying the following factors
"1
A@ G-oss 5-ofit 0a-4i. -atio2 It should more than =23. /ut, other operating e(penses should be less compare to operating incomes. @ O5e-ati.4 C .et 5-ofit -atio2 Bperating profit is the real
income of the business it is calculated before non operating e(penses and incomes. It should be nearly :23. "he net profit ratio must be more than 723 )@ RETURN ON CAPTIAL E'PLO$ED2 It measures the rate of return on capital investment of the business. ?apital employed includes shareholders funds, long-term loans, and other
accumulated funds of the company ROCE B DOPERATING PRO#IT E CAPITAL E'PLO$EDF G1** A@ Ea-.i.4 5e- s:a-e2 it is calculated by the company at the end of the every financial year. In case of more profit and less number of shares CPS will increase. @ Ret8-. o. e=8it62 It is calculated on total e#uity funds 4e#uity share capital, general reserve and other accumulated profits5 +@ DI"IDEND POLIC$2 It is determined in the general body meeting of the company, for e#uity shares at the end of every year. "he dividend payout ratio is determined as per the dividend is paid. &ividend policies are divided into two types. I5 II5 Stable dividend policy. <nstable dividend policy.
"!
.hen company reached to optimum level it may follow stable dividend policy it indicates stable growth rate, no fluctuation are estimated. <nstable dividend policy may used by developing firms. In such a case study growth market value of share is not possible to identify. 6@ CAPITAL STRUCTURE O# THE CO'PAN$2 @enerally capital structure of the company consists of e#uity shares, preferences shares, debentures and other long term funds. Bn the basis of long term financial sources cost of capital is calculated. 7@ OPERATING E##ICIEC$2 It is determined on the basis of capital e(penditure and operating activities of a company. Increase capital e(penditure indicates increase of operating efficiency. C(pected profits may be increased incoming years. "he operating efficiency of a company directly affects the earnings of a company. 'n e(panding company that maintains high operating efficiency with low break even point earns more than the company with high breakeven point. Cfficient use of fi(ed assets with raw materials, labour, and management would lead to more income from sales. %@ OPERATING LE"ERAGE2 "he firm fi(ed costs is high in total cost, the firm is said to have a high degree of operation leverage. )igh degree of operating leverage implies other factors being held constant, a relatively small change in sales result in a large change in return on e#uity.
""
(@ 'ANAGE'ENT2 @ood and capable management generates profits to the investors. "he management of the firm should efficiently plan, organi,e, actuate and control the activities of the company. "he good management depends of the #ualities of the manager. Joont, and B!&onnell suggest the following as special traits of an able manager 'bility to get along with people. >eadership. 'nalytical competency. Industry Iudgment. 1*@ #INANCIAL ANAL$SIS2 "he best source of financial information about a company is its own financial statements. "his is a primary source of information for evaluating the investment prospects in the particular company!s stock. "he statement gives the historical and current information about the company!s information aids to analysis the present status of the company. "he man statements used in the analysis are. 75 :5 /alance sheet Profit and lose account
ALANCE SHEET "he balance sheet shows all the company!s sources of funds 4liabilities and stock holders e#uity5 and uses of funds at a given point of time. "he balance sheet provides an account of the capital
"#
structure of the company. "he net worth and the outstanding longterm debt are known from the balance sheet. "he use of debt creates financial leverage beneficial or detrimental to the
shareholders depending on the si,e and stability of earnings. It is better for the investor to avoid accompany with e(cessive debt components in its capital structure. PRO#IT AND LOSS ACCOUNT "he income statement reports the flow of funds from business operations that take place in between two points of time. It lists down the items of income and e(penditure. "he difference between the income and e(penditure represents profit or loss for the period. It is also called income and e(penditure statement
Li0itatio. of fi.a.1ial state0e.ts. 75 "he financial statements contain historical information. "his information is useful, but an investor should be concerned more about the present and future. :5 Financial statements are prepared on the basis of certain accounting concepts and conventions. 'n investor should know them. =5 "he statements contain only information that can be measured in monetary units. For e(ample, the loss incurred by a firm due to flood or fire is included because it can be e(pressed in monetary terms. ANAL$SIS O# #INANCIAL STATE'ENTS
"+
"he analysis of financial statements reveals the nature of relationship between income and e(penditure, and the sources and application of funds. )e can use the following simple analysisE Co05a-ati/e fi.a.1ial state0e.t2 In the comparative statement balance sheet figures are provided for more than one ear. "he comparative financial statement provides time perspective to the balance sheet figures. "he annual data are compared with similar data of previous years, either in absolute terms.
T-e.7s a.al6sis2 )ere percentages are calculated with a base year. "his would provide insight into the growth or decline of the sale or profit over the years. Sometime sales may be increasing continuously, and the inventories may also be rising. "his would indicate the loss of market share if the particular company!s product.
Co00o. siHe state0e.t2 ?ommon si,e balance sheet shows the percentage of each asset to the total assets and each liability to the total liabilities. Similarly, a common si,e income statement shows each item of e(pense as a percentage of net sales. .ith statements comparison can be made between two different si,e firms belonging to the same
")
industry. For a same company over the years common si,e statement can be prepared.
#8.7 flo< a.al6sis2 "he balance sheet gives a static picture of the company! positions on a particular date. It does not reveal the changes that have occurred in the financial position of the unit over a period of time. "he investor should know, a5 b5 c5 d5 e5 f5 )ow are the profits utili,edK Financial source of dividend Source of finance for capital e(penditures Source of finance for repayment of debt "he destiny of the sale proceeds of the fi(ed assets and <se of the proceeds of he share or debenture issue or fi(ed deposits rise from public. Cas: flo< state0e.t2 "he investor is interested in knowing the cash inflow and outflow of the enterprise. "he cash flow statement is prepared with the help of balance sheet, income statement and some additional information. It can be either prepared in the vertical form or hori,ontal form. ?ash flows related to operations and other transactions are calculated. "he statement shows the causes of changes in cash balance between the two balance sheet dates. .ith the help of these
"-
statements the investors can review the cash movements over an operating cycle. Ratio a.al6sis2 0atio is relationship between two figures e(pressed
mathematically. Financial ration provides numerical relationship between two relevant financial data. Financial ratios are calculated from the balance sheet and profit and loss account. "he relationship can be either e(pressed as a percent or as a #uotient. ?lassification financial ratios are as followedE Li=8i7it6 -atio2 >i#uidity means the ability of the firm to meet its short-tem obligations. ?urrent ratio and acid test ratios are the most popular ratios used to analysis the li#uidity. "he li#uidity ratio indicates the li#uidity in a rough fashion and the ade#uacy of the working capital.
T8-.o/e- -atios2 "he turnovers ratios show how well the assets are used and the e(tent of e(cess inventory, if any. "hese ratios are also known as activity ratio or asset management ratios. ?ommonly calculated ratios are sales to current assets, sales to fi(ed assets, sales to inventory, receivable to sales and total assets to turnover. T:e le/e-a4e -atios2 "he investors are generally interested to find out the debt portion of the capital the debt affects the dividend payment because of the outflow of profit in the form of interest.
"/
"he financial leverage affects the risk and return aspects of holding the shares. "he total debt to total assets ratio indicates the percentage of borrowed funds in the firm!s assets. I.te-est 1o/e-a4e -atio "his shows how many times the operating income covers the interest payment. P-ofitabilit6 -atio2 Profitability ratio relate the firm!s profit with factors that generate the profits "he investor s very particular in knowing net profit to sales, net profit to total assets and net profit to e#uity. "he profitability ratios measure the overall efficiency of the firm. Net 5-ofit 0a-4i. -atio "his ratio indicates the net profit per rupee of sales revenue. Ret8-. o. assets2 "he return on asset measure the overall efficiency of capital invested n business. Ret8-. o. e=8it62 )ere, the net profit is related to the firm!s capital. "al8atio. -atios2 "he shareholders are interested in assessing the value of shares. "he value of the share depends on the performance of the firm and the market factors. "he performance of the firm in turn depends on a host of actors. )ence, the valuation ratios provide a comprehensive measure of the performance of the firm itself. In the subse#uent section, some of the valuation ratios are dealt in detail.
"0
oo9 /al8e 5e- s:a-e2 "his ratio indicates the share of e#uity share holders after the company has paid all its liabilities, creditors, debentures and preference shareholders. P-i1e ea-.i.4 -atio2 Bne of the most common financial parameters used in the stock market is the price earnings ratio 4P;C5. It relates to share price with earnings per share. "he investor generally compares the P;C ratio of the company with that of the industry and market.
TECHNICAL ANAL$SIS "echnical analysis involves identification of share price
fluctuations on short period basis. "his analysis can be made by brokers, dealers. "hey are treated as technicians. "he following are the ma$or factors in technical analysisE 75 ?ompany results are not analysised. "he changes in national and international level about political and other factors.
#1
:5
"he shares are e(changed immediately when there is a small change in price level of shares.
=5
'verage results of the particular industry are identified and they are treated as basic factors.
A5
/rokers do not e(pect any dividend by holding the share. &ividend is not of return for calculated of better return to the technicians.
15
"he holding period is determined very less6 it may range from hours to days. @enerally holding period may not be more than one moth. "he technical analysis can be made in this respect by identifying price fluctuations of the particular share.
95
o capital gains e(pected by transfer of the share so o need to pay any capital gain takes, short run return about e(change in price of share is not treated as capital gain.
H5
CPS declared by company at the end of financial year and dividend declared may be treated as base figures for technical analysis.
G5
Interim dividend if any declared by the company that will analysised to sell the shares.
85
Stock e(change will announce the average result of securities traded on day-to-day basis.
=:
725
/y conducting of the technical analysis technician
anticipate high level of short run profit. 'o/i.4 a/e-a4e2
#1
"he analysis of the moving average of the prices of scripts is another method in technical analysis. @enerally, H days, to days and 71 days moving averages are worked out in respect of scripts studied and depicted on a graph along with similar moving averages of the market inde( like /SC Sensitive Inde(. "here will then be two graphs to be compared and when the trends are similar the scrip and /SC market induces will show comparable averages risks. Os1illato-s2 Bscillators indicate the market momentum or scrip
momentum. Bscillator shows the shares price movement across a reference point from one e(treme to another. CHARTS2 ?harts are the valuable and easiest tools in the technical analysis. "he graphic presentation of the data helps the investor to find out the trend of the price without any difficulty. "he charts also have the following uses. ? Spots the current trend for buying and selling. ? Indicates the probable future action of the market by pro$ection. ? Shows the past historic movement. ? Indicates the important areas of support and resistance.
"he charts do not lie but interpretation differs from analyst to analyst according to their skills and e(perience.
#!
Poi.t a.7 fi48-e 1:a-ts2 "echnical analyst to predict the e(tent and direction of the price movement of a particular stock or the stock market indices uses point and figure charts. "his P.F charts are of one-dimensional and there is no indication of time or volume. "he price changes in relation to previous prices are shown. "he changes of price direction can be interpreted. "he charts are drawn in the ruled paper. a- 1:a-ts2 "he bar chart is the smallest and most commonly used tool of a technical analyst. "he build a bar a dot is entered to represent the highest price at which the stock is traded on that day, week or month. "hen another dot is entered to indicate the lowest price on the particular date. ' line is drawn to connect both the points a hori,ontal nub is drawn to mark the closing price. "he two main components to be studied while construction of a portfolio is 7. :. RIS, C(istence of volatility in the occurrence of an e(pected incident is called risk. )igher the unpredictability greater is the degree of risk. "he risk any or may not involve money. In investment management, risk involving pecuniary matter has importance6 the financial sense of risk can be e(plained as the volatility of e(pected future incomes or outcomes. 0isk may give a Ris9 of a portfolio Ret8-.s on a portfolio
#"
positive or a negative result. If unimagined incident is a positive one, then people have a pleasant surprise. "o be able to take negative risk with the same sprit is difficult but not impossible, if proper risk management techni#ues are followed. 0isk is uncertainty of the income;capital appreciation or loss of the both. "he two ma$or "ypes of risks areE Systematic or market related risks and unsystematic or company related risks. "he systematic risks are the market problems raw materials availability, ta( Policy or any @overnment policy, inflation risk, interest rate risk and financial risk. "he <nsystematic risks are mismanagement, increasing inventory, wrong financial policy. T65es of -is9 0isk consists of two components, the systematic risk and unsystematic risk. "he systematic risk is caused by factors e(ternal to the particular company and uncontrollable by the company. "he systematic risk affects the market as a whole. In the case of unsystematic risk the factors are specific, uni#ue and related to the particular industry or company. S$STE'ATIC RIS,2 "he systematic risk affects the entire market. Bften we read in the newspaper that the Stock market is in the bear hug or in the bull grip. "his indicates that the entire market in ' particular direction either downward or upward. "he economic conditions, Political Situations and the sociological changes affect the security
##
market. "he recession in the economy affects the profit prospect of the industry and the stock market. "he systematic, risk is further divided into = types, they are as follows. 75 'AR,ET RIS,2 Iack ?lark Francis has defined market risk as that portion of total variability of return caused by the alternating forces of bull and bear markets. "he forces that affect the stock market are tangible and intangible events are real events such as earth#uake, war, and political uncertainty and fall in the value of currency. :5 INTEREST RATE RIS,2 Interest rate risk is the variation in the single period rates of return caused by the Fluctuations in the market interest rate. +ost commonly interest rate risk affects the price of bonds, debentures and stocks. "he fluctuations on the interest rates are caused by the ?hanges in the government monetary policy and the changes that occur in the interest rate of the treasury bills and the government bonds. =5 PURCHASING PO?ER RIS,2 Dariations in the returns are caused also by the loss of purchasing power of currency. Inflation is the reason behind the loss of purchasing power. "he level of Inflation proceeds faster than the increase in capital value. Purchasing power risk is the probable loss in the purchasing power of the returns to be received. UNS$STE'ATIC RIS,
#+
's already mentioned, unsystematic risk is uni#ue and peculiar to a firm or an industry. <nsystematic risk stem from managerial inefficiency, ethnological change in the production process, availability of raw material, changes in the consumer preference, and labour problems. "he nature and magnitude of the above-mentioned factors differ from industry to industry, and company to company. "hey have to be analy,ed separately for each industry and firm. 1@ USINESS RIS,2 /usiness risk is that portion of the unsystematic risk caused by the operating environment of the business. /usiness risk arises from the inability of a firm to maintain its competitive edge and the growth and stability of the earnings. "he variationinthe e(pected operating income indicates the business risk. /usiness 0isk can be divided into e(ternal business risk and internal business risk. a@ I.te-.al 8si.ess Ris92
Internal business risk is associated with the operational efficiency of the firm. "he following are the few, 75 :5 =5 A5 15 Fluctuations in the sales 0esearch and &evelopment Personnel management Fi(ed cost Single product
#)
b@ E>te-.al Ris92 C(ternal risk is the result of operating conditions imposed on the firm by circumstances beyond its control. "he e(ternal environment in which it operated e(erts some pressure on the firm. 75 Social and regulatory factors :5 Political risk =5 /usiness cycle 2@ #INANCIAL RIS,2 It refers to the variability of the income to the e#uity capital due to the capital. Financial risk in a company is associated with the capital structure of the company. ?apital structure of the company consists of e#uity funds and borrowed funds. &@ CREDIT OR DE#AULT RIS,2 ?redit risk deals with the probability of meeting with a default. It is primarily the probability that buyers will default. "he chances that the borrower will not pay up can stem from a variety of factors. Ris9 o. a Po-tfolio2 0isk on a portfolio is different from the risk on individual securities. "his 0isk is reflected in the variability of the returns from ,ero to infinity. "he e(pected return depends on the probability of the returns and their weighted contribution to the risk of the portfolio. "here are two measures of risk in this conte(tLone is the absolute deviation and the other standard deviation. Ret8-. of Po-tfolio2
#-
Cach security in a portfolio contributes returns in the proportion of its investment in security. "hus, the portfolio e(pected return is the weighted average of the e(pected returns, from each of the securities, with weights representing the proportionate share of the security in the total investment. .hy does an investor have so many securities in his portfolioK "he answer to this #uestion lie in the investor!s perception of risk attached to investment, his ob$ectives of income, safety, appreciation, li#uidity and hedge against loss of value of money etc., "his pattern of investment in different asset categories security categories types of instruments etc., would all be described under the caption of diversification which aims at the reduction or even elimination of non-systematic or company related risks and achieve the specific ob$ectives of investors. Portfolio management services help investor to make a wise choice between alternative investments without any post training hassles. "his service renders optimum returns to the investors by a proper selection by continuous shifting of portfolio from one scheme to other scheme or from one brand to the other brand within the same scheme. 'ny portfolio manager must specify the ma(imum return, optimum returns and the risk, capital appreciation, safety etc in their offer. #-o0 t:e -et8-. a.4le se18-ities 1a. be 1lassifie7 i.to t<o
#/
7.
#i>e7 I.1o0e Se18-ities2 ? &ebt M partly convertible and tradable warrants ? Preference Shares ? @overnment Securities and /onds ? Bther debt instruments. on convertible debt with
:.
"a-iable I.1o0e Se18-ities2 ? C#uity Shares ? +oney papers. Portfolio manager have to decide upon the mi( of securities market Securities like "-bills, ?ommercial
on basis of contract with the client and ob$ective of the portfolio. Portfolio managers in the Indian conte(t, has been /rokers 4big brokers5 who on the basis of their e(perience, market trend, insider trading, personal contact and speculations are the ones who used to manage funds or portfolios. Ris9 a.7 -et8-. a.al6sis2 "he traditional approach to portfolio building has some basic assumptions. First, the individual prefers larger to smaller returns from securities. "o achieve this foal, the investor has to take more risk. "he ability to achieve higher returns is dependent upon his ability to $udge risk and his ability to take specific risks6 the risks are namely interest rate risk, purchasing power risk, financial risk and market risk. "he investor analyses the varying degrees of risk and constructs his portfolio. 't first, he established the minimum
#0
income that he must have to avoid hardship under most adverse economic condition and then he decides risk of loss of income that can be tolerated. "he investor makes a series of compromises on risk and non-risk factors like ta(ation and marketability after he has assessed the ma$or risk categories, which he is trying to minimi,e Al5:a2 'lpha is the distance between the hori,ontal a(is and line!s intersection with y a(is It 0eas8-es t:e 8.s6ste0ati1 -is9 of t:e 1o05a.6. If alpha is a positive return, then that scrip will have higher returns. If alphaN2 then the regression line goes through the origin and its return simply depends on the /eta times the market returns. eta2 /eta describes the relationship between the stocks return and the +arket inde( returns. "his can be positive and negative. It is the percentage change in the price of the stock regressed 4or related5 to the percentage changes in the market inde(. If beta is I, a one-percentage change in +arket inde( will lead to one percentage change in price of the stock. If /eta is 2, stock price is unrelated to the +arket Inde( and if the market goes up by a O73, the stock price will fall by 73 0a-9et -elate7 -is9I eta 0eas8-es t:e s6ste0ati1 cannot be eliminated by
which
diversification. If the portfolio is efficient, /eta measures the systematic risk effectively. Bn the other hand alpha and Cpsilon
+1
measures the unsystematic risk, which can be reduced by efficient diversification. 'EASURE'ENT O# RIS,2 "he driving force of systematic and unsystematic risk causes the variation in returns of securities. Cfforts have to be made by researchers, e(pert!s analysts, theorists and academicians in the field of investment to develop methods for measuring risk in assessing the returns on investments. Total Ris92 "he total risk of the investment comprises of diversifiable risk and non-diversifiable risk, and this relation can be computed by summing up &iversifiable risk and <ndiversifiable risk. Di/e-sifiable Ris92 'ny risk that can be diversified is referred to as diversifiable risk. "his risk can be totally eliminated through diversification of securities. &iversification of securities means combining a large variety of assets into a portfolio. "he precise measure of risk of a single asset is its contribution to the market portfolio of assets, which is its co-variance with market portfolio. "his measure does not need any additional cost in terms of money but re#uires a little prudence. It is un-diversifiable risk of individual asset that is more difficult to tackle. T-a7itio.al 0et
7 of a11o8.ti.4 C assi4.i.4 -is9 5-e0i80 0et7.+1
'ssigning of the risk premium is one of the traditional methods of accounting. "he fundamental tenet in the financial management is to trade off between risk and return6 the return from holding e#uity securities is derived from the dividend stream and price changes. Bn of the methods of #uantifying risk and calculating e(pected rate of return would be to e(press the re#uired rate as -BiJ5JbJfJ0Jo .here r N re#uired rate of return i N real interest rate 4risk free rate5 p N purchasing power risk allowance b N business risk allowance f N financial risk allowance m N market risk allowance o N allowances for other risk 'o7e-. 0et
7s of 38a.tif6i.4 -is92 Puantification interpretation and of risk is necessary of to ensure uniformcomparison
alternative
investment
opportunities. "he pre-re#uisite for an ob$ective evaluation and comparative analysis of various investment alternatives is a rational method for #uantifying risk and return. Probability distribution of returns is very helpful in identifying C(pected 0eturns and risk. "he spread of dispersion of the probability distribution can also be measured by degree of variation from the C(pected 0eturn.
+!
De/iatio. B o8t1o0e K E>5e1te7 Ret8-. Butcomes on the investments o not have e#ual probability occurrence hence it re#uires weights for each difference by its probability. P-obabilit6 A LO8t1o0e K E>5e1te7 Ret8-.@ For the purpose of computing variance, deviations are to be s#uared before multiplying with probabilities. P-obabilit6 A LO8t1o0e K E>5e1te7 -et8-.s@ M2 PORT#OLIO CONSTRUCTION2 Portfolio is combination of securities such as stocks, bonds and money market instruments. "he process of blending together the broad assets classes so as to obtain optimum return with minimum risk is called portfolio construction. 'i.i0iHatio. of Ris9s "he company specific risks 4unsystematic risks5 can be reduced by diversifying into a few companies belonging to various industry groups, asset group or different types of instruments like e#uity shares, bonds, debentures etc. "hus, asset classes are bank deposits, company deposits, gold, silver, land, real estate, e#uity shares etc. industry group like tea, sugar paper, cement, steel, electricity etc. Cach of them has different risk-return characteristics and investments are to be made, based on individual!s risk preference. "he second category of risk 4systematic risk5 is managed by the use of /eta of different company shares. A55-oa1:es i. 5o-tfolio 1o.st-81tio.2
+"
?ommonly there are two approaches in the construction of the portfolio of securities vi,., traditional approach and +arkowit, efficient frontier approach. In the traditional approach, investors needs in terms of income and capital appreciation are evaluated a appropriate securities are selected to meet the needs of the investors. "he common practice in the traditional approach is to evaluate the entire financial plan of the individual In the modern approach, portfolios are constructed to ma(imi,e the e(pected return for a given level of risk. It view portfolio construction in terms of the e(pected return and the risk associated with obtaining the e(pected return. Effi1ie.t 5o-tfolio2 "o construct an efficient portfolio, we have to conceptuali,e various combinations of investments in a basket and designate them as portfolio one to Q !. "hen the e(pected returns from these portfolios are to be worked out and then portfolios are to be estimated by measuring the standard deviation of different portfolio returns. "o reduce the risk, investors have to diversify into a number of securities whose risk-return profiles vary. ' single asset or a portfolio of assets is considered to be “efficient” if no other asset offers higher e(pected return with the same risk or lower risk with the same e(pected return. ' portfolio is said to be efficient when it s e(pected to yield the highest returns for the level of risk accepted or, alternatively, the smallest portfolio risk or a specified risk for a specified level of e(pected return.
+#
'ai. feat8-e of effi1ie.t set of 5o-tfolio2 7. "he investor determines a set of efficient portfolios from a universe of n securities and an efficient set of portfolio is the subset of n security-universe. :. "he investor selects the particular efficient portfolio that provides him with most suitable combination or risk an return.
'ODERN PORT#OLIO APPROACH2 'AR,O?ITN 'ODEL )arry +. +arkowit, has credited and introduced the new concept of risk measurement and their application to the selection of portfolios. )e started with the idea of risk a version of investors and their desire to ma(imi,e e(pected return with the least risk. +arkowit, model is a theoretical frame wok for analysis of risk and return and their relationships. )e used statisti1al a.al6sis for the measurement of risk and 0at:e0ati1al 5-o4-a00i.4 for selection of assets in a portfolio in an efficient manner. )is framework led to the concept of efficient portfolios, which are e(pected to yield the highest return for given a level of risk or lowest risk for a given level of return 0isk and return two aspects of investment considered by investors. "he e(pected return may very depending on the assumptions. 0isk inde( is measured by the variance or the distribution around the mean its range etc, and traditionally the choice of securities depends on lower variability where as +arkowit,
++
emphasi,es on the need for ma(imi,ation of returns through a combination of securities whose total variability is lower. "he risk of each security is different from that of other and by proper combination of securities, called diversification, one can form a portfolio where in that of the other offsets the risk of one partly or fully. In other words, the variability of each security and covariance for his or her returns reflected through their inter-relationship should be taken into account. "hus, e(pected returns and the covariance of the returns of the securities within the portfolio are to b considered for the choice of a portfolio. ' set of efficient portfolios can be generated by using the above process of combining various securities whose combined risk is lowest for a given level of return for the same amount of investment, that the investor is capable of the theory of +arkowit,, as stated above is based on the number of assumptions. ASSU'PTIONS O# 'AR,O?ITN THEOR$ "he analytical frame work of +arkowit, model is based on several assumptions regarding the behavior of investorE 7. "he investor invests his money for a particular length of time known as )olding Period :. 't the end of holding period, he will sell the
investments. =. "hen he spends the proceeds on either for consumption purpose or for reinvestment purpose or sum of both.
+)
"he approach therefore holds good for a single period holding. A. "he market efficient in the sense that, all investors are well informed of all the facts about the stock market. 1. Since the portfolio is the collection of securities, a decision about an optimal portfolio is re#uired to be made from a set of possible portfolio. 9. "he security returns over the forthcoming period are unknown, the investor could therefore only estimate the C(pected return 4C05. H. G. 'll investors are risk averse. Investors study how the security returns are co-related to each other and combine the assets in an ideal way so that they give ma(imum returns with the lowest risk. 8. )e would choose the best one based on the relative magnitude of these two parameters. 72. "he investors base their decisions on the price-earning ratio. Standard deviation of the rate of return, which is been offered on the investment, from the e(pected rate of return of an investment, is one of the important criteria considered by the investors for choosing
different securities. 'AR,O?ITN DI"ERSI#ICATION +arkowit, postulated that diversification should not only aim at reducing the risk of a security by reducing its variability or
+-
standard deviation, but by reducing the covariance or interactive risk of two or more securities in a portfolio. /y combination of different securities, it is theoretically possible to have a range of risk varying from ,ero to infinity.+arkowit, theory of portfolio
diversification attaches importance to standard deviation, to reduce it to ,ero, if possible, covariance to have as much as possible negative interactive effect among the securities within the portfolio and coefficient of correlation to have -7 4negative5 so that the overall risk of the portfolio as whole is nil or negligible. "hen the securities have to be combined in a manner that standard deviation is ,ero. Effi1ie.t #-o.tie-2 's for +arkowit, model minimum variance portfolio is used for determination of proportion of investment in first security and second security. It means the portfolio consists of two securities only. .hen different portfolios and their e(pected return and standard deviation risk rates are given for determination of best portfolio efficient frontier is used. Cfficient frontier is graphic representation on the basis of the optimum point this is to identify the portfolio which may give better returns at lowest risk. 't that point the investor can choose portfolio. Bn the basis of this holding period of portfolio can be determined. Bn “%” a(is risk rate of portfolio 4s.d.of p5, and on “R” a(is return on portfolios are to be shown. ?alculate return on portfolio
+/
and standard deviation of portfolio for various combinations of weights of two securities. Darious returns are shown on the graphic and identify the optimal point. Cal18latio. of E>5e1te7 Rate of Ret8-. LERR@ ? ?alculate the proportion of each Security!s proportion in the total investment. ? It gives the weights for each component of Securities. ? +ultiply the funds invested in each component with the weights. ? It gives the initial wealth or initial +arket value. E=8atio.2 R5 B <1R1 J<2R2 J <&R& JOOOO..J<.R. .here 0p N C(pected return on portfolio w7, w:, w=, wA, N Proportional weight invested 07, 0:, 0=, 0A N e(pected returns on securities "he rate of return on portfolio is always weighted average of the securities in the portfolio ESTI'ATION O# PORT#OLIO RIS, ' useful measure of risk should take into account both the probability of various possible bad outcomes and their associated magnitudes. Instead of measuring the probability of a number of different possible outcome and ideal measure of risk would estimate the e(tent to which the actual outcome is likely to diverge from the e(pected outcome. "wo measures are used for this purposeE 7. 'verage absolute deviation.
+0
:.
Standard deviation.
In order to estimate the total risk of a portfolio of assets, several estimates are neededE a5 "he predicted return on the portfolio is simply a weighted average of the predicted returns on the securities, using the proportionate values as weights. b5 "he risk of the portfolio depends not only on the risk of its securities considered in isolation, but also on the e(tent to which they are affected similarly by underlying events. c5 "he deviation of each security!s return from its e(pected value is determined and the product of the two obtained. d5 "he variance is a weighted average of such products, using the probabilities of the events as weights Effe1t of 1o0bi.i.4 t<o Se18-ities2 It is believed that spreading the portfolio in two securities is less riskily than concentrating in only one security. If two stocks, which have negative correlation, were chosen on a portfolio risk could be completely reduced due to the gain in one would offset the loss on the other. "he effect of two securities, one more riskily and the other less risky, on one another can also be studied. +arkowit, theory is also applied in the case of multiple securities. Co-.e- 5o-tfolios2 ' number of portfolios on the efficiency frontier are corner portfolios, it may be either new securities or security or securities dropped from previous efficient portfolios. /y swapping one security
)1
with other, the portfolio e(pected return could be increased with no change in its risk. Do0i.a.1e 5-i.1i5le2 It has been developed to understand risk return trade off conceptually. It states that efficient frontier analysis assumes that investors prefer returns and dislikes risk. C-iti1is0 o. 'a-9o<itH t:eo-62 "he +arkowit, model is confronted with several criticisms on both theoretical and practical point of view a5 Dery tedious and invariably re#uired a computer to effect
numerous calculations b5 'nother criticism related to this theory s rational investor can
avert risk. c5 +ost of the works stimulated by +arkowit, uses short term
volatility to determine whether the e(pected rate of return from a security should be assigned a high or a low e(pected variance, /ut if an investor has limited li#uidity constraints, and is truly a longterm holder, then price volatility per se does not really pose a risk. 0ather in this case, the #uestion concern is one ultimate price reali,ation and not interim volatility. d5 'nother apparent hindrance is that practicing investment found it difficult to understand the conceptual
managers
mathematics involved in calculating the various measure of risk and return. "here was a general criticism that an academic approach to portfolio management is essentially unsound.
)1
e5
Security analysts are not comfortable in calculating covariance
among securities while assessing the possible ranges of error in their e(pectations.
CAPITAL ASSETS PRICING 'ODEL LCAP'@ <nder ?'P+ model the changes in prices of capital assets in stock e(changes can be measured by sung the relationship between security return and market return. So it is an economic model describes how the securities are priced in the market place. /y using ?'P+ model the return of security can be calculated by comparing return of security with market rate. "he difference of return of security and market can be treated as highest return and the risk premium of the investor is identified. It is the difference between return of security and risk free rte of return. DRis9 5-e0i80 B Ret8-. of se18-it6 K Ris9 f-ee -ate of -et8-.F So the ?'P+ attempts to measure the risk of a security in the portfolio sense. Ass805tio.s2
)!
"he ?'P+ model depends on the following assumptions, which are to be considered while calculating rate of return. ? "he investors are basically average risk assumers and diversification is needed to reduce the risk factor. ? 'll investors want to ma(imi,e the return by assuming e(pected return of each security. ? ? 'll investors assume increase of net wealth of the security. 'll investors can borrow or lend an unlimited amount of fund at risk free rate of interest. ? "here are no transaction costs and no ta(es at the time of transfer of security. ? 'll investors have identical estimation of risk and return of all securities. 'll the securities are divisible and tradable in capital market ? Systematic risk factor can be calculated and it is assumed perfectly by the investor. ? ?apital market information must be available to all the investor. eta2 /eta describes the relationship between the stock return and the +arket inde( returns. "his can be positive and negative. It is the percentage change is the price of he stock regressed 4or related5 to the percentage changes in the market inde( If beta is 7, a one-percentage change in +arket inde( will lead to one percentage change in price of the stock. If /eta is2, stock price is
)"
unrelated to the +arket Inde( and if the market goes u by a O73, the stock price will fall by 73 /eta measures the systematic market related risk, which cannot be eliminated by diversification. If the portfolio is efficient, /eta measures the systematic risk effectively. E/al8atio. 5-o1ess2 7. 0isk is the variance of e(pected return of portfolio. :. "wo types of risk are assumed they are a5 b5 Systematic risk <nsystematic risk
=. Systematic risk is calculated by the investor by comparison of security return with market return. ? N ?o M Dariance of security and market Dariance of +arket )igher value of beta indicates higher systematic risk and vice versa. .hen numbers of securities are holded by the investor, composite beta or portfolio can be calculated by the use of weights of security and individual beta. A5 0isk free rate of return is identified on the basis of the market
conditions. "he following : methods are used for calculation of return of security or portfolio. Ca5ital 0a-9et Li.e2 <nder ?'P+ model capital market line determined the relationship between risk and return of efficient portfolio. .hen the risk rates of market and portfolio risk are given, e(pected return of
)#
security or portfolio can be calculated by using the following formula. ERP B T J? 5 LR50 K T@ ?' C0P N C(pected return of portfolio " N risk free rate of return ?p N Portfolio of standard deviation 0pm N 0eturn of portfolio and market ?+ N 0isk rate of the market.
Se18-it6 'a-9et Li.e2 Identifies the relationship of return on security and risk free rate of return. /eta is used to identify the systematic risk of the premium. "he following e#uation is used for e(pected return. ERP B T J? LR0 K T@ R0 B 0eturn of market T B 0isk free rate
Li0itatio.s of CAP'2 In practical purpose ?'P+ can!t be applied due to the following limitations. 7. "he calculation of beta factor is not possible in certain situation due to more assets are traded in the market.
)+
:.
"he assumption of unlimited borrowings at risk free rate is not certain. For every individual investor borrowing
facilities are restricted. =. "he wealth of the share holder or investor is assessed by sing security return. /ut it is not only the factor for calculation of wealth of the investor. A. For every transfer of security transition cost is re#uired on every return ta( must be paid.
TECHNI3UES O# PORT#OLIO 'ANAGE'ENT
's of now the under noted techni#ues of Portfolio +anagement are in vogue in our countryE 7. E=8it6 Po-tfolioE C#uity portfolio is influenced buy internal and e(ternal factors. Internal factors affect inner working of the company. "he company!s growth plans are analy,ed with respect to /alance sheet and Profit * >oss 'ccounts of the company. C(ternal factors are changes in @overnment Policies, "rade cycles, Political stability etc. 2. E=8it6 a.al6sis2
))
<nder this method future value of shares of a company is determined. It can be done by ratios of earning per shares and price earning ratio. EPS B Profit after ta( o. of C#uity Shares
PEE Ratio
N +arket Price per Share o. of e#uity Shares
Bne can estimate the trend of earning by analy,ing CPS which reflects the trend of earnings, #uality of earning, dividend policy and #uality of management. Further price earnings ratio indicates the confidence of market about company!s future.
SELECTION O# PORT#OLIO ?ertain assumptions were made in the traditional approach for portfolio selection, which are discussed belowE 7. Investors prefer large to smaller returns from securities and take more risk. :. 'bility to achieve higher returns depends upon investors $udgment of risk. =. Spreading money among many securities can reduce risk.
'n investor can select the best portfolio to meet his re#uirements from the efficient frontier, by following the theory propounded by +arkowit,. Selection process is based on the satisfaction level that can be achieved from various investment avenues. )-
STAGES IN THE SELECTION PROCESS2 "he process of selecting a portfolio is very crucial in the investment management and involves four stages which are given belowE 7. &etermination of assets, which are eligible for constructing of a portfolio. :. ?omputation of the e(pected 0eturn for the eligible assets over a holding period. =. 'rriving at an acceptable balance between risk and return for constructing optimum a portfolio i.e. selecting such a portfolio for which there is highest return for each level of risk.
SELECTING THE
EST PORT#OLIO 'IA
.hen an infinite number of portfolios are available, investor selects the best portfolio by using the +arkowit, Portfolio "heory. "he investors base their selection on the C(pected return and Standard &eviation of the portfolio and decide the best portfolio mi( taking the magnitude of these parameters. "he investors need not evaluate all the portfolios however he can look at only the available portfolios, which lie on the Cfficient Frontier. T:e -e=8i-e7 feat8-es of t:e s8bset of 5o-tfolio a-e E
)/
"hey should offer ma(imum C(pected 0eturn for varying levels of risk, and also offer minimum risk for varying levels of C(pected 0eturns. If the above two conditions are satisfied then it is deemed as an efficient set, from this set investors have to select the best setoff portfolios Co.st-81tio. of effi1ie.t set of 5o-tfolios. ?onsiderable effort is re#uired to construct a efficient set of portfolios. Following parameters are essential for constructing the efficient setE 7. :. C(pected returns for each security must be estimated. Dariance of each security must be calculated.
O5ti080 Po-tfolio2 Sharpe has identified the optimal portfolio through his single inde( model, according to Sharpe6 the beta ratio is the most important in portfolio selection.
"he optimal portfolio is said to relate directly to the beta value. It is the e(cess return to the beta ratio. "he optimal portfolio is selected by finding out he cu-off rate ScT. "he stock where the e(cess return to the beta ratio is greater than cutoff rate should only be selected for inclusion in the optimal portfolio. Sharp proposed that
desirability of any stock is directly referred to its e(cess returns to betas coefficient. Ri K Rf ? )0
.here Ri Rf ? N C(pected return on stock N 0eturn on risk free asset N C(pected change in the rate of return on stock 7 associated
with 73 change in the market runt Following procedure is involved to select he stocks for the optimum portfolios. 7. :. Finding out the stocks of different risk M return ratios ?alculate e(cess return beta ratio for each stock and rank them from highest to lowest =. A. Finding out the cur-off rate for each security. Selecting securities of high rank above the cur-off rate which is common to all stocks "hus, the optimum portfolio consists of all stocks for which LRi K Rf@ is grater than a particular cut-off pointS?UT. "he selection number of stocks depends upon the uni#ue cut-off rate, where all stocks with higher rate LRi K Rf@ will be selected and stocks with lower rates will be eliminated.
PORT#OLIO RE"ISION )aving constructed the optimal portfolio, the investor has to constantly monitor the portfolio to ensure that it continues to be optimal. 's the economy and financial markets are dynamic, the changes take place almost daily. "he investor now has to revise his
-1
portfolio. "he revision leads to purchase of new securities and sale of some of the e(isting securities from the portfolio. NEED #OR RE"ISION2? 'vailability of additional funds for investment ? 'vailability of new investment avenues ? ?hange in the risk tolerance ? ?hange in the time hori,on ? ?hange in investment goals ? ?hange in li#uidity needs ? ?hanges in ta(es
PORT#OLIO E"ALUATION Portfolio managers and investors who manage their own portfolios continuously monitor and review the performance of the portfolio. "he evaluation of each portfolio, followed by revision and management. reconstruction are all steps in the portfolio
-1
"he ability to diversify with a view to reduce and even eliminate all unsystematic risk and e(pertise in managing the systematic risk related to the market by use of appropriate risk measures, namely, /etas. Selection of proper securities is thus the first re#uirement.
'et
7s of E/al8atio.2 ? S:a-5e i.7e> 0o7el2 it depends on total risk rate of the portfolio. 0eturn of the security compare with risk free rate of return, the e(cess return of security is treated as premium or reward to the investor. "he risk of the-!
premium is calculated by comparing portfolio risk rate. .hile calculating return on security any one of the previous methods is used. If there is no premium Sharpe inde( shows negative value 4-5. In such a case the portfolio is not treated as efficient portfolio. S:a-5ePs -atio LS5@ N rp-rf;?p .here, SpN Sharpe inde( performance model
rpN return of portfolio rfN risk free rate of return ?pN portfolio standard deviation
"his method is also called “0eward to Dariability” method. .hen more then one portfolio is evaluated highest inde( is treated as first rank. "hat portfolio can be treated as better portfolio compare to other portfolios. 0anks are prepared on the basis of descending order. ? T-e6.o-s i.7e> 0o7el2 It is another method to measure the portfolio
performance. .here systematic risk rate is used to compare the unsystematic risk rate. Systematic risk rate is measure by beta. It is also called “0eward to Systematic 0isk”.
9:
T-e6.o-s Ratio LTp@ B
rp M rf;?p
.here, "pN "reynors portfolio performance model -"
rpN return of portfolio rf N risk free rate of return
?p N portfolio standard deviation.
If the beta portfolio is not given market beta is considered for calculation of the performance inde(. )ighest value of inde( portfolio is accepted. ? !e.se.Ps i.7e> 0o7el2 It is different method compared to the previous
methods. It depends on return of security which is calculated by using ?'P+. If the actual security returns is less than the e(pected return of ?'P+ the difference is treated as negative 4-5 then the portfolio is treated as inefficient portfolio. !5B -5-D-fJ? 5 L-0--f@F .here, IpN Iensen!s inde( performance model rfN risk free rate of return rpN return of portfolio ?pN portfolio standard deviation rmN return on market "his method is also called “reward to variability” method. .hen more than one portfolio is evaluated highest inde( is treated as first rank. "hat portfolio can be treated as better portfolio compared to other portfolios. 0anks are prepared on the basis of descending order.
-#
PRACTICAL ANAL$SIS
Po-tfolio A
-+
Note2 -CG is the cut-off point to include the securities in to portfolio.
Un ,eta R3 2yste Risk 2ecurities Returns 4alues metic 5?6
78cess Return $ver 5?6 Ri 9 Rf
:::::::::::::
5Ri*Rf6 ?
:::::::::::::
.u mulative 5Ri*Rf6 ?
:::::::::::::
.umulative ?
!
::::::::::
.;
n
?!
::::::::::
?m ?t;1 5Ri*Rf6 ?
!
::::::::::::::::::::
?!e
?e
!
?!e
!
?!e
n
?!e
?!e 536 !0 1/ )+ "+ 1! "" "1 + 1# /" 1# !/ 1! "! !) !1
?
1< ?m ?t;1 ?!
::::::::
?!e ,harti (irtel I%. =uj 1# ! 11 1 11 + 1 // 1 00 1 1" 1 01 1 1) 1 0) 1 1" 1 1) 1 !0 1 /! 1 1" 1 )0 11 + +! #+ #" # !# #! " "0 " "1 !! "0 10 1+ 1 !/!! 1 !)+# 1 1)1/ 1 !/-/ 1 1+)# 1 !+01 1 !+-+ 1 1"!+ 1 "-)! 1 1#)1 1 1-0! 1 1"#+ 1 !/!! 1 +#-) 1 -10# 1 00-! 1 1+") 1 #1!) 1 )-11 1 /1!) ! 1-// ! !!#0 ! "1#1 ! ""/) 1 1!/) 1 11"" 1 1"1" 1 1/11 1 1")/ 1 101/ 1 1"!) 1 1#11 1 1))# 1 1!11 1 1#1/ 1 1!"/ 1 1!// 1 1#!1 1 1-!" 1 !+!# 1 !/0! 1 #-00 1 )1!# 1 )+!) 1 /101 1 /# 1 //1/ 1 01#) ! 10 ! !) ! )1) ! /"1 ! 0)# ! #+ ! "# ! "0 ! "! ") ! "# ! "!
(mb com I.I.I // ,ank ,>7' >D&. ,ajaj 0# 01 /#
(uto (cc /) >indalco / " >D&. ,ank >'' Dr Reddys )) -1 )1
c?
INTERPRETATION2 ? ?onstruction of optimal portfolio starts with determines which securities are included in the portfolio, for this the following steps necessary. -)
? ?alculation of! e(cess return to beta ratio! for each securities under review and rank from highest to lowest.
? "he above table shows that the construction of optimal portfolio from /SC SC SC% scripts.
? In the above table all the securities whose Qe(cess return to beta Qratio are above the cut-off rate are selected and all those whose ratios are below are re$ected.
? For the portfolio-' selected scripts are 72 out of twelve whose “e(cess return to beta” ratio are above the cutoff rate 4:.=9 ?U5 are included in the portfolio basket. )>> 47.8 V :.=A5 &r.0eddy!s 47.1 V :.=:5 securities e(cess return to beta ratios are less than the cut-off so those are e(cluded from the portfolio.
PORT#OLIO
--
Un ,eta R3 2yste Risk 2ecurities Returns 4alues metic 5?6
78cess Return $ver 5?6 Ri 9 Rf
:::::::::::::
5Ri*Rf6 ?
:::::::::::::
.u mulative 5Ri*Rf6 ?
:::::::::::::
.umulative ?
!
::::::::::
.;
n
?
!
?m ?t;1 5Ri*Rf6 ?
!
::::::::::::::::::::
::::::::::
?!e
?e
!
?e
! !
?!e
n
?!e
? e 536
!
?
1< ?m ?t;1 ?!
::::::::
?!e ,harti (irtel I%. =uj 1# ! 11 1 11 + 1 // 1 00 1 1" 1 01 1 1) 1 0) 1 1" 1 1) 1 !0 1 /! 1 1" 1 )0 !0 1/ )+ "+ 1! "" "1 + 1# /" 1# !/ 1! "! !) !1 11 + +! #+ #" # !# #! " "0 " "1 !! "0 10 1+ 1 !/!! 1 !)+# 1 1)1/ 1 !/-/ 1 1+)# 1 !+01 1 !+-+ 1 1"!+ 1 "-)! 1 1#)1 1 1-0! 1 1"#+ 1 !/!! 1 +#-) 1 -10# 1 00-! 1 1+") 1 #1!) 1 )-11 1 /1!) ! 1-// ! !!#0 ! "1#1 ! ""/) 1 1!/) 1 11"" 1 1"1" 1 1/11 1 1")/ 1 101/ 1 1"!) 1 1#11 1 1))# 1 1!11 1 1#1/ 1 1!"/ 1 1!/) 1 1#10 1 1-!! 1 !+!" 1 !/01 1 #-0 1 )1!+ 1 )+!+ 1 /101 1 /# 1 //1/ 1 01#) ! 10 ! !) ! )1) ! /"1 ! 0)# ! #+ ! "# ! "0 ! "! ") ! "# ! "!
(mb com I.I.I // ,ank ,>7' >D&. ,ajaj 0# 01 /#
(uto (cc /) >ilbalco / " >D&. ,ank >'' Dr Reddys )) -1 )1
c?
Note2 -CG is the cut-off point to include the securities in to portfolio
INTERPRETATION2 ? "he desirability of any securities to include in the portfolio is directly related to e(cess return to beta ratio and cut-off rate.
-/
? "he above information shows that for securities of Satyam computers to "P? 0i M 0f ; ? is less than ?U. .hile securities "P? all the
77*7: are less than ?U. So from Satyam computers to
ten securities are included in the portfolio and B @? * "'"' consultancy services are not added in the optimal portfolio.
? )ere optimal portfolio consists of securities of 72 companies
PORT#OLIO C2
-0
Un 2ecurities R3 ,eta 2yste Risk Returns 4alues metic 5?6
78cess Return $ver 5?6 Ri 9 Rf
:::::::::::::
5Ri*Rf6 ?
:::::::::::::
.u mulative 5Ri*Rf6 ?
:::::::::::::
.umulative ?
!
::::::::::
.;
n
?
!
?m ?t;1 5Ri*Rf6 ?
!
::::::::::::::::::::
::::::::::
?!e
?e
!
?e
! !
?!e
n
?!e
? e 536
!
?
1< ?m ?t;1 ?!
::::::::
?!e 2atyam .om ,harthi (irtel Reliance 11 " comm 2,I 11 )! Reliance / 7ne '@% >ero >onda =uj (mboja Ranba8y I.I.I ,>7' Infosys ++ #/ /+ )/ ) ) ) 1 0+ 1 1! 1 )) 1 /1 1 11 1 #! 1 /! 1 -# 1 )0 1 /0 10 !1 + !! 1! 1+ 1! -) "! #+ !1 + /# +) +! # +# #+ ## #" # !# #! 1 !)+1 1 "1-1 1 1011 1 !""" 1 !+"" 1 "/0# 1 1#)1 1 1)## 1 1"#+ 1 1-/ 1 /!1 1 1!/ 1 !1/ 1 #+1" 1 -1#) ! 10# ! 1#11 ! "1#+ ! ""01 ! +11 1+!+ 1 1-11 1 1!11 1 1+## 1 )--1 1+/1 1 1))# 1 1!11 1!"/ 1 1+/#! 1 11-# 1 1-/) 1 !1/) 1 !)" 1 0#11 10/1 !)+1 1 "/)/ 1 #11) 1 +)01 " 0+) # 1#/ " 0# "0 1 )"1 01+ 1 +)1 +#0 1 +#// 1 +1/ 1/ 1# " 1 10 1 // #+ !0 11 11 + 1 !01) 1 !)+# 1 !01) 1 ++) 1 1!)# 1 1!/) 1 1!)# 1 1++ ! !0 " +/-
INTERPRETATION ? For the portfolio-? selected scripts are 7:companies and portfolio basket consists of all the selected scripts whose e(cess return to beta ratios are always greater than cutoff rates. /1
? So the optimal portfolio consists of selected all 7: securities.
FINDINGS
? "he investor can recogni,e and analy,e the risk and return of the shares by using this analysis. ? "he investor who bears high risk will be getting high returns.
/1
?
"he investor who is having optimum portfolio will be taking optimum returns with minimum risk.
?
"he
investor
should
include
all
securities
which
are
undervalued in their portfolio and remove those securities that are over valued. ? "he investor has to maintain a portfolio of diversified sector stocks rather than investing in a single sector of different stocks. ? People who are investing in them mostly depend on the advice of their friends, relatives and financial advisors. ? People generally invest their savings in fi(ed deposits, recurring deposits, and national savings certificate and
government securities as they are less risky and the returns are guarantied. ? Cvery investor invests in basic necessities. "hey plan to invest in insurance 4>I?, @I?5 and pension funds as these give guarantied returns and are less risky. ? +ost of the investors feel that investing in stock;capital market is of high risk therefore they don!t invest in them.
CONCLUSIONS
? .hen compared to other portfolios, portfolio-? gives him the ma(imum return with twelve scripts.
/!
? "he diversification of funds in different company scripts is possible from the portfolio-? when compared to others.
? +arket risk is also less when compared to the other portfolio.
? If the portfolio manager is efficient and the investor is -is9 tole-a.t 5e-so. a.7 t:e i./est0e.t is a lo.4 te-0 5e-s5e1ti/e t:e. it is bette- to i./est i. t:e 'ID-Ca5s C S'ALL-Ca5s 1o05a.ies se18-itiesI <:e-e t:e 4-o<t: of -et8-.s a-e :i4:e- t:a. t:e LARGE-Ca5s .
? If investor is not risk tolerant person * short-term perspective it!s good to invest in large caps companies! securities.
? I feel that this year small cap and mid cap companies will be performing well when compared to large cap as we have observed last year.
I LIOGRAPH$
TEAT
OO,S
I./est0e.ts
/"
/y S)'0PC * '>C%' &C0 Security 'nalysis and Portfolio +anagement /y FIS?)C0 * IB0&' Investment 'nalysis and Portfolio +anagement. /y P0'S' ' ?)' &0'
?E SITES www.bseindia.com www.nseindia.co www.economictimes.com www.moneycontrol.com www.yahoofinance.com
/#
doc_536374855.doc