Name: Ketaki Dilip Nikam

Class: MBA 1ST Year

Specialisation: Finance

Roll No: 2019-20-098

Subject: Security Analysis & Portfolio Management

Assignment No. 2
Q1. You are the top technical analyst in a broking firm and your manager has turned to you for an
answer to a difficult question. He wants to know what the different Technical Indicators are and
which single indicator you think is the best and why you think so? What is your answer?

Ans:

1. Trend indicators: These technical indicators measure the direction and strength of a trend by
comparing prices to an established baseline. a. Moving Averages: Used to identify trends and reversals, as
well as to set up support and resistance levels. b. Parabolic Stop and Reverse (Parabolic SAR): Used to
find potential reversals in the market price direction. c. Moving Average Convergence Divergence
(MACD): Used to reveal changes in the strength, direction, momentum, and duration of a trend in a
stock’s price.

2. Momentum indicators: These technical indicators may identify the speed of price movement by
comparing the current closing price to previous closes.

a. Stochastic Oscillator: Used to predict price turning points by comparing the closing price to its price
range.

b. Commodity Channel Index (CCI): An oscillator that helps identify price reversals, price extremes, and
trend strength.

c. Relative Strength Index (RSI): Measures recent trading strength, velocity of change in the trend, and
magnitude of the move.

3. Volatility Indicators: These technical indicators measure the rate of price movement, regardless of
direction. a. Bollinger bands: Measures the “highness” or “lowness” of price, relative to previous trades.
b. Average True Range: Shows the degree of price volatility. c. Standard Deviation: Used to measure
expected risk and to determine the significance of certain price movements. 4. Volume Indicators: These
technical indicators measure the strength of a trend based on volume of shares traded. a. Chaikin
Oscillator: Monitors the flow of money in and out of the market, which can help determine tops and
bottoms. b. On-Balance Volume (OBV): Attempts to measure level of accumulation or distribution, by
comparing volume to price. c. Volume Rate of Change: Highlights increases in volume. These normally
happen mostly at market tops, bottoms, or breakouts.
According to my opinion TREND Technical Indicator I the best indicator because,

a. A trend is the general direction of a market, asset, or metric.

b. There are uptrends, downtrends, or trendless periods.

c. Uptrends are marked by rising data points, such as higher swing highs and higher swing lows.

d. Downtrends are marked by falling data points, such as lower swing lows and lower swing highs.

e. Many traders opt to trade in the same direction as the trend, attempting to profit from a continuation of
that trend.

f. Price action, trend lines and technical indicators are all tools that can help identify the trend and warn
when it is reversing.

CONCLUSION:

a. Technical indicators, by and large, fit into five categories - trend, mean reversion, relative strength,
volume, and momentum.

b. Leading indicators attempt to predict where the price is headed while lagging indicators offer a
historical report of background conditions that resulted in the current price being where it is. c. Popular
technical indicators include SMAs, EMAs, Bollinger bands, stochastic, MACD, and on-balance volume.

Q2. What is an optimum portfolio? According to Traditional Portfolio selection theory which
factors need to be taken into consideration while deciding an optimum portfolio?

DEFINITION: Optimal portfolio is a term used in portfolio theory to refer to the one portfolio on the
Efficient Frontier with the highest return-to-risk combination given the specific investor's tolerance for
risk. It's the point where the Efficient Frontier (supply) and the Indifference Curve (demand) meet.

According to Traditional Portfolio selection theory: factors need to be taken into consideration while
deciding an optimum portfolio are as follows:

1. Defining investment objectives: The objective of portfolio is to reconcile variables such as time
horizons, Risk thresholds and Cash flows in such a manner so as to minimize risk & maximize returns.
The degree of risk taken should vary in each case based on time Factor within which we can work & the
livelihood that the portfolio will enjoy a net cash inflow or it will be subject to cash withdrawal.
Traditionally investors differentiate among four goals: a. Current Income b. Growth in Current Income c.
Capital Appreciation d. Preservation of Capital

2. Investment constraints: Following factors to be considered while assessing the investment constraints
in selection of optimal portfolio using traditional approach

a. Time Horizon: These constraints are related to the time periods over which returns are expected from
portfolio to meet specific needs in the future. An investor may have to pay for college education for
children or needs the money after his retirement. Such constraints are important to determine the
proportion of investments in long-term and short-term asset classes.

b. Liquidity: Such constraints are associated with cash outflows expected and required at a specific time
in future and are generally in excess of income available. Moreover, prudent investors will want to keep
aside some money for unexpected cash requirements. The financial advisor needs to keep liquidity
constraints in mind while considering an asset’s ability to be converted into cash without impacting the
portfolio value significantly.

c. Tax Considerations: These constraints depend on when, how and if returns of different types are
taxed. For an individual investor, realized gains and income generated by his portfolio are taxable. The
tax environment needs to be kept in mind while drafting the policy statement. Often, capital gains and
investment income are subjected to differential tax treatments.

d. Risk Consideration: Risk objectives are the factors that are associated with both the willingness and the
ability of the investor to take the risk. When the ability to accept all types of risks and willingness is
combined, it is termed as risk tolerance. When the investor is unable and unwilling to take the risk, it
indicates risk aversion.

e. Legal & regulatory: Such constraints are mostly externally generated and may affect only institutional
investors. These constraints usually specify which asset classes are not permitted for investments or
dictate any limitations on asset allocations to certain investment classes. A trust portfolio for individual
investors may have to follow substantial regulatory and legal constraints.

CONCLUSION:

A financial advisor/portfolio manager design and manages the portfolio for an investor after formally
documenting the investment policy statement. The job starts from the moment the investor articulates his
objectives and constraints. It is for the benefit of both the investor and the manager that the objectives and
constraints are correctly determined and not just documented for formality.

The more diligence is paid while formalizing objective and constraints, the better is portfolio aligned with
the needs of the investor.

Q3. The Capital Asset Pricing Model CAPM when applied to the portfolio analysis provides a
useful technique of measuring the risk factor as well as the required rate of return from a security.
Elaborate CAPM and evaluate the expected return of a security by using following information.
Assume Irf – 9% Rm – 18% If a security has beta factor of 1.4, find out the expected rate of
return.

Ans. [CAPM] Capital Asset Pricing Model:

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and
expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky
securities and generating expected returns for assets given the risk of those assets and cost of capital.

Understanding the Capital Asset Pricing Model (CAPM):

The formula for calculating the expected return of an asset given its risk is as follows:

ERi = Rf+βi (ERm−Rf)

Where:

ERi = Expected return of investment

Rf = Risk-free rate (Risk where there is no cost or sure returns )

βi = Beta of the investment (Our share c with respect to market)

(ERm − Rf) = Market risk premium

The goal of the CAPM formula is to evaluate whether a stock is fairly valued when its risk and the time
value of money are compared to its expected return. The CAPM uses the principles of Modern Portfolio
Theory to determine if a security is fairly valued. It relies on assumptions about investor behaviors, risk
and return distributions, and market fundamentals that don’t match reality.
However, the underlying concepts of CAPM and the associated efficient frontier can help investors
understand the relationship between expected risk and reward as they make better decisions about adding
securities to a portfolio. Evaluation of expected return of a security given information.

Rf = 9% Rm = 18% beta factor (βi) = 1.4.

Expected return on investment (ERi)

= Rf + βi (ERm − Rf)

= 9% + 1.4 (18% - 9%)

= 0.216