BBA 2nd Year 4th Semester

INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT

Unit-1
(Syllabus: Investments: Meaning, Nature, Scope, Objectives, Process of Investment analysis, Concept of
Risk and Return analysis, Measurement of Risk and Return: Systematic and Unsystematic Risk.)

"An investment in knowledge pays the best interest." — Benjamin Franklin

INTRODUCTION OF INVESTMENT

Only few things in life come entirely without risk, and the same is true in case of investments.
The meaning of investment is putting your money into an asset that can grow in value or produce income or
both. For example, you can buy equity stock of a listed company in the hopes of receiving regular dividends and
capital appreciation in the form of the share price.

Your savings become investments when they are put into assets that carry investment risk or a degree of
illiquidity. Such investments help you create wealth that can be used as an emergency fund, a retirement corpus,
for buying a house, or funding a child's education, etc.

Financial and Economic Meaning of Investment

Financial Investments are the allocation of monetary resources ranging from risk-free to risky investments and
with the expectation of a good return that varies with risk. The investor has to aim at a trade-off between risk
and return. The investors are the suppliers of ‘capital’ and in their view, investment is a commitment of a
person’s funds to derive future income in the form of interest, dividends, rent, premiums, pension
benefits or the appreciation of the value of their principal capital.

To the financial investor, it is not important whether money is invested for a productive use or for the purchase
of secondhand instruments such as existing shares and stocks listed on the stock exchanges.

Most investments are considered to be transfers of financial assets from one person to another.
The economist understands the term ‘Investment’ as net additions to the economy’s capital stock which
consists of goods and services that are used in the production of other goods and services.
For them, the term investment implies the formation of new and productive capital in the form of new
construction, new producers’ durable equipment such as plant and equipment, including inventories and human

Page 1
By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
capital.
The financial and economic meaning of investment cannot be separated because the term draws a relationship
with the economists and financial experts. Investment is a part of the savings of individuals which flow into the
capital market either directly or through institutions; they may be divided in ‘new’ or ‘secondhand’ capital
financing. Investors as ‘suppliers’ and ‘investor as ‘users’ of long-term funds find a meeting place in the market.
However, investment is used in its ‘financial sense’ and investment will include those instruments and
institutional media into which savings are placed.

Key Takeaways

 An investment decision is a well-planned action that allocates financial resources to obtain the highest
possible return. The decision is made based on investment objectives, risk appetites, and the nature of
the investor, i.e., whether they are an individual or a firm.
 Investments are primarily classified into short-term and long-term. Further, they are categorized into a
strategic investment, capital expenditure, inventory, modernization, expansion, replacement, or new
venture investments.
 The investment process involves the following steps: formulating investment objectives, ascertaining the
risk profile, allocating assets, and monitoring performance.

Investment Vs Speculation

The capacity to bear risk distinguishes an investor from a speculator. An investor prefers low risk investments,
whereas a speculator is prepared to take higher risks for higher returns. Speculation is associated with buying
low and selling high with the hope of making large capital gains. Investors are careful while selecting securities
for trading. Investments, in most instances, expect an income in addition to the capital gains that may accrue
when the securities are traded in the market. Investment is long term in nature. An investor commits funds for a
longer period in the expectation of holding period gains. However, a speculator trades frequently; hence, the
holding period of securities is very short.

Investment Vs Gambling

Investment can also to be distinguished from gambling. Examples of gambling are horse race, card games,
lotteries, and so on. Gambling involves high risk not only for high returns but also for the associated excitement.
Gambling is unplanned and unscientific, without the knowledge of the nature of the risk involved. It is
surrounded by uncertainty and a gambling decision is taken on unfounded market tips and rumors. In gambling,
artificial and unnecessary risks are created for increasing the returns. Investment is an attempt to carefully plan,
evaluate, and allocate funds to various investment outlets that offer safety of principal and expected returns over
a long period of time. Hence, gambling is quite the opposite of investment even though the stock market has
been euphemistically referred to as a “gambling den”.

Page 2
By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
Why are Investment Decisions Important?
The investment decision is very important because of the following Objectives:

 Investment decisions are made to reap maximum returns by allocating the right financial resource to the
right opportunity. These decisions are taken considering two important financial management
parameters—risks and returns.

 Investors and managers dedicate a lot of time to investment planning—these decisions involve massive
funds and can be irreversible—impact on the investors and business is long-term.
 Also, individuals and corporate investors have to decide between various options—assets, securities,
bonds, debentures, gold, real estate, etc. For businesses, investments could be in the form of new
ventures, projects, mergers, or acquisitions as well.
 Investment decisions are further classified into short-term and long-term. For example, the final
decision may involve a capital expenditure on assets that pay off in the long run or an investment in
inventory that converts into sales within a short period.
 A company might attempt expansion by taking up new projects; a business might increase the capacity
of an existing facility. Capital investment is required for replacing an obsolete asset as well. In business,
decision-making is everywhere.

Nature of Investment Decisions

1. Require Huge Funds: Investment decisions requires a large amount of funds to be deployed by firm for
earning profits. These decisions are very imperative and requires due attentions as firms have limited

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
funds but the demand for the funds is excessive. Every firm should necessarily plan its investment
programmes and control its expenditures.
2. High Degree of Risk: These decisions involve a high amount of risk as they are taken on the basis of
estimated return. Large funds are invested for earning income in future which is totally uncertain. These
return fluctuates with the changes in fashion, taste, research and technological advancement thereby
leading to a greater risk.
3. Long Term Effect: Investment decisions have a long lasting effects on future profitability and growth
of firm. These decisions decide the position of a firm in future. Any wrong decision may have very
adverse effects on return of an organization and may even endanger its survival. Whereas, right decision
taken brings good returns for firm leading to better growth.
4. Irreversibility: Decisions related to investment are mostly irreversible in nature. It is quite difficult to
revert back from decisions once taken related to the acquisition of permanent assets. Disposing off these
high value assets will cause heavy losses to firm.
5. Impacts Cost Structure: Investment decisions widely impacts the cost structure of an organization.
Firms by taking these decisions commit themselves to various fixed cost such as interest, rent, insurance,
supervision etc. for the sake of earning profits. If these investments do not provide the anticipated return,
then firm overall cost will raise thereby causing losses.
6. Long term Commitment of Funds: Funds are deployed for a longer term by organisations through
these decisions. Firm deployed high amount of capital for long period on permanent basis. Financial risk
in investment decisions increases due to long term commitment of funds. A firm should properly plan
and monitor all of its capital expenditures.
7. Complexity: Investment decision are most complex decisions as they are based on future events which
is totally uncertain. Future cash flows of an investment cannot be estimated accurately as they are
influenced by changes in economic, social, political and technological factors. Therefore, uncertainty of
future conditions makes it difficult to accurately predict the future returns.

Scope of Investment Decisions

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
1. Selection of Right Assets: Investment decisions help in choosing right type of investment plan for
deploying the funds. Each of available opportunity is properly analyzed by management while taking
investment decisions. This way every aspect of asset available for investment is taken into consideration
which leads to building up a strong portfolio.
2. Identify Degree of Risk: These decisions help in identifying the level of risk associated with an
investment opportunity. Decisions are taken on the basis of expected return and risk required for earning
such return. Managers properly evaluate assets using various tools for finding out the risk while taking
investment decisions.
3. Determines firm Profitability: Decisions regarding investment plans determines the future profit
earning potential of a firm. A right decision may bring large amount of funds to an organization leading
to better growth. Whereas, any wrong decision regarding deployment of funds may cause heavy losses
and even adversely affect the continuity of firm.
4. Enhance Financial Understanding: Investment decisions imparts large amount of beneficial financial
knowledge to individuals taking these decisions. Investors while choosing the asset uses a variety of
tools and techniques for analyzing its profitability. It provides a lot of information which enhances the
overall financial knowledge and enables investors in taking rational decisions regarding investment.
5. National Importance: These decisions are of national importance for a nation as it leads to overall
development and growth. Investment decisions taken determines the level of employment, economic
growth and economic activities in a country. More amount of investment creates better supply of funds
in an economy which increase the pace of overall economic development.

Process of Investment Analysis

Investing in an asset, security, or project requires a lot of patience; ideally, the decision-making process should
be analytical. Following is a five-step process decision-making process that guides investors:

1. Analyze Financial Position: For financial management, one has to understand the company or
individual’s current financial condition.
2. Define Investment Objective: Then, investors must set up an investment objective—whether to invest
short-term or long-term. They should also be aware of their risk appetite (level of risk they desire to
take).
3. Asset Allocation: Based on the objective, investors must allocate assets into stocks, debentures, bonds,
real estate, options, and commodities.

Page 5
By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1

4. Select Investment Products: After narrowing down on a particular asset class, investors must further
select a particular asset or security. Alternatively, this could be a basket of assets that fit the
requirements.
5. Monitor and Due Diligence: Portfolio managers keep an eye on the performance of each investment
and monitor the returns. In case of poor performance, they must take prompt action.

Factors Affecting Investment Decision

An investment is a planned decision, and some of the factors that are responsible for these decisions are as
follows:

1. Investment Objective: The purpose behind an investment determines the short-term or long-term fund
allocation. It is the starting point of the decision-making process.
2. Return on Investment(ROI): Managers prioritize positive returns—they try to employ limited funds in
a profitable asset or security.
3. Return Frequency: The number of periodic returns an investment offer is crucial. Financial
management is based on financial needs; investors choose between investments that yield monthly,
quarterly, semi-annual, or annual returns.
4. Risk Involved: An investment may possess high, medium, or low risk, and the risk appetite of every
investor and company is different. Therefore, every investment requires a risk analysis.
5. Maturity Period or Investment Tenure: Investments pay off when funds are blocked for a certain
period. Thus, investor decisions are influenced by the maturity period and payback period.
6. Tax Benefit: Tax liability associated with a particular asset or security is another crucial deciding factor.
Investors tend to avoid investment opportunities that are taxed heavily.
7. Safety: An asset or security offered by a company that adheres to regulatory frameworks and has a
transparent financial disclosure is considered safe. Government-backed assets are considered the most
secure.
8. Volatility: Market fluctuations significantly affect investment returns and, therefore, cannot be
overlooked.

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
9. Liquidity: Investors are often worried about their emergency funds—the provision to withdraw money
before maturity. Hence, investors look at the degree of liquidity offered by a particular asset or security;
they specifically consider withdrawal restrictions and penalties.
10. Inflation Rate: In financial management, investors look for investment opportunities where returns
surpass the nation’s inflation rate.

Concept of Risk and Return Analysis

After investing money in a project a firm wants to get some outcomes from the project. The outcomes or the
benefits that the investment generates are called returns.
Returnreferstoeithergainsorlossesmadefromtradingasecurity.Thereturnonaninvestmentisexpressedasapercentage
andconsideredarandomvariablethattakesanyvaluewithinagivenrange.Severalfactorsinfluencethetypeofreturnsthat
investorscanexpectfromtradinginthemarkets.

Since, future is uncertain, so returns are associated with some degree of uncertainty. In other words, there will
be some variability in generating cash flows, which we call as risk.

Concept of Risk:

 A person making an investment expects to get some returns from the investment in the future. However, as
future is uncertain, the future expected returns too are uncertain. It is the uncertainty associated with the
returns from an investment that introduces a risk into a project. The expected return is the uncertain
future return that a firm expects to get from its project. The realized return, on the contrary, is the certain
return that a firm has actually earned.
 The realized return from the project may not correspond to the expected return. This possibility of variation
of the actual return from the expected return is termed as risk. Risk is the variability in the expected
return from a project. In other words, it is the degree of deviation from expected return. Risk is associated
with the possibility that realized returns will be less than the returns that were expected. So, when
realizations correspond to expectations exactly, there would be no risk.
 Diversificationallowsinvestorstoreducetheoverallriskassociatedwiththeirportfoliobutmaylimitpotentialreturn
s.Makinginvestmentsinonlyonemarketsectormay,ifthatsectorsignificantlyoutperformstheoverallmarket,gener
atesuperiorreturns,butshouldthesectordeclinethenyoumayexperiencelowerreturnsthancouldhavebeenachieve
dwithabroadlydiversifiedportfolio. ("DON’T PUT ALL YOUR EGGS IN ONE BASKET")

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
What Is Risk-Return Tradeoff?
Risk-return tradeoff states that the potential return rises with an increase in risk. Using this principle, individuals
associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high
potential returns.

According to risk-return tradeoff, invested money can render higher profits only if the investor will accept a
higher possibility of losses.

KEY TAKEAWAYS

 Risk-return tradeoff is an investment principle that indicates that the higher the risk, the higher the
potential reward.
 To calculate an appropriate risk-return tradeoff, investors must consider many factors, including overall
risk tolerance, the potential to replace lost funds, and more.
 Investors consider risk-return tradeoff on individual investments and across portfolios when making
investment decisions.

Elements of Risk
Variouscomponentscausethevariabilityinexpectedreturns,whichareknownaselementsofrisk. Below is a list of the
most important types of risk for a financial analyst to consider when evaluating investment opportunities:

Systematic Risk – The overall impact of the market

Unsystematic Risk – Asset-specific or company-specific uncertainty

Purchasing Power Risk - Purchasing power risk is the possibility that you will not be able to buy as much with
your savings in the future. It represents a loss of value due to inflation.

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
Political/Regulatory Risk – The impact of political decisions and changes in regulation

Financial Risk – The capital structure of a company (degree of financial leverage or debt burden)

Interest Rate Risk – The impact of changing interest rates

Country Risk – Uncertainties that are specific to a country

Social Risk – The impact of changes in social norms, movements, and unrest

Environmental Risk – Uncertainty about environmental liabilities or the impact of changes in the environment

Operational Risk – Uncertainty about a company’s operations, including its supply chain and the delivery of
its products or services

Management Risk – The impact that the decisions of a management team have on a company

Legal Risk – Uncertainty related to lawsuits or the freedom to operate

Competition – The degree of competition in an industry and the impact choices of competitors will have on a
company.

So, there are broadly two groups of elements classified as systematic risk and unsystematic risk.

#Systematic Risk:
Businessorganizationsarepartofsocietythatisdynamic.Variouschangesoccurinasocietylikeeconomic,politicalands
ocialsystemsthathaveinfluenceontheperformanceofcompaniesandtherebyontheirexpectedreturns.Thesechangesaf
fectallorganizationstovaryingdegrees.Hencetheimpactofthesechangesissystem-
wideandtheportionoftotalvariabilityinreturnscausedbysuchacrosstheboardfactorsisreferredtoassystematicrisk.Th
eserisksarefurthersub-dividedintointerestraterisk,marketrisk,andpurchasingpowerrisk.

#Unsystematic Risk:
Thereturnsofacompanymayvaryduetocertainfactorsthataffectonlythatcompany.Examplesofsuchfactorsarerawmat
erialscarcity,labourstrike,managementinefficiency,etc.Whenthevariabilityinreturnsoccursduetosuchfirm-
specificfactorsitisknownasunsystematicrisk.Thisriskisuniqueorpeculiartoaspecificorganizationandaffectsitinaddi
tiontothesystematicrisk.Theserisksaresub-dividedintobusinessriskandfinancialrisk.

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)
 BBA 2nd Year 4th Semester
INVESTMENT ANALYSIS & PORTFOLIO MANAGEMENT
Unit-1
Measurement of Risk
Investors who are concerned about market volatility should examine their investment choices from all angles
when constructing a portfolio – evaluating not only by return, but risk, too. Here are five common ways to
calculate an appropriate risk tolerance.

1. Alpha- Alpha is a measure of investment performance that factors in the risk associated with the specific
security or portfolio, rather than the overall market. It is a way of calculating so-called “excess return” – that
exceeds the expectations set by the market.

2. Beta- Beta is the statistical measure of the relative volatility of a security (such as a stock or mutual fund)
compared to the market as a whole. The beta for the market usually represented by 1.00. A security with a beta
above 1.0 is considered to be more volatile (or risky) than the market. The security with a beta of less than 1.0 is
considered to be less volatile.

3. R-squared- R-squared (R2) quantifies how much of a fund’s performance can be attributed to the
performance of a benchmark index. The value of R2 ranges between 0 and 1 and measures the proportion of a
fund’s variation that is due to variation in the benchmark.

4. Sharpe ratio- The Sharpe ratio is a tool for measuring how well the return of an investment rewards the
investor given the amount of risk taken. The higher a portfolio’s Sharpe ratio, the better its risk-adjusted
performance has been.

5. Standard deviation- Standard deviation is a measure of investment risk that looks at how much an
investment’s return has fluctuated from its own longer-term average.

Higher standard deviation typically indicates greater volatility, but not necessarily greater risk. That is because
while standard deviation quantifies the variance of returns, it does not differentiate between gains and losses –
consistency of returns is what matters most.

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By : Rupali Gupta
MBA(F & C),MA (ECO.),UGC-NET (MGMT-FIN.)