SECURITY ANALYSIS AND PORTFOLO

MANAGEMNT: UNIT -1
 UNIT - 1 INTRODUCTION

OF INVESTMENT

CONTENTS:
1.Meaning and Objective of/Investment
2. Investment Decision Process
3.Categories of Investment
4.Phases of Portfolio Management
 Investment is the allocation of monetary resources to
assets that are expected to yield some returns over a period
of time. It involves the commitment of resources which
have been saved with the expectation that some benefits
will accrue in future.
In other words, Investment is a commitment of
funds to derive the future income in the form of interest,
dividend, rent, premium or appreciation in the value of
principal capital .

Definitions

•Generally, “investments” refers to financial assets and in particular to

marketable securities.
•Financial assets are paper or electronicclaims on some issuer, such
as the government or a company.

•Marketable securities financial assets that are easily and cheaply

tradable in organized markets

•Real assets are tangible assets such asgold, silver, diamonds, real
estate.

Why to invest?
Investment increases futureconsumption
possibilities
 ◦ By foregoing consumption today and investing the
savings, investors expect to increase their future
consumption possibilities by increasing their
wealth
If we If we do not do not invest,invest,then?then?
If we have savings and we do not invest, we
can’t earn anything on our savings.
Second, the purchasing power of cash
diminishes in inflation
This means that if savers do not invest their
savings, they will not only lose possible return
 on their savings, but will also lose value of
their money due to inflation
But investment has problems
• Investment has the following three problems:
• A. Sacrifice
• While investing, investor delay their current
consumption (delaying consumption is kind of
sacrifice)
• B. Inflation - Investment loses value in periods of
inflation
• C. Risk - giving your money to someone else
involves risk

Compensation to investors
• Due to the three problems, investors will not
invest until they are compensated for these
problems

• Required rate of return = compensation for

(sacrifice , inflation, risk)
• RRR= opportunity cost + risk premium
Liquidity
Safety of principal
Tax benefits
Income stability
Purchasing power
Capital growth

Minimum comforts
Future return or income
Capital appreciation
 Choice of investment

 Non – Marketable FinancialAssets:-

- Bank Deposits (Savings account, Current account, Fixed
Deposits, Recurring Deposits etc.)
- Post office SavingsAccounts.
- Post office Time Deposits.
- Monthly Income Scheme of the Post Office.
- National Savings Certificate (NSC).
- Company Deposits.
- Employee Provident Fund Scheme.
- Public Provident Fund Scheme.
Money Market Instruments :-
- Treasury Bills
- Certificates of Deposits
- Commercial Paper
- Repos
Bonds or Debentures and Preference Shares
- Government Securities
- Savings Bonds
- Private Sector Debentures
- Public Sector Undertaking Bonds
- Preference Shares
Equity Shares
Mutual Fund Schemes
Life Insurance
Financial Derivatives
 It is considered as an involvement of funds of high risk
and more uncertain expectation of returns. It is basically a
short term phenomenon where people tend to buy assets
with the hope that a profit can be earned from a
subsequent price change. It is based on the expectation
that some change will occur.
The stock brokers may be cited as an
example. Some brokers buy shares with a view to make
quick profit by selling within few days, when the prices of
such shares shoot up.

BASIS SPECULATION INVESTMENT

 Contract Type Ownership Creditor

Source of income Change in market price Earning of enterprise

Objective of purchase Tips, Hunches etc. Higher Return

Stability of income Uncertain Stable

Risk involved High Low

Duration Short Long

Acquisition On margin Outright purchase

Attitude Aggressive Conservative

BASIS INVESTOR SPECULATOR

Planning An investor has a relatively longer A speculator has a very short
Horizon planning horizon. planning horizon.
Time His holding period is usually at least His holding period may be a few
one year. days to a few months.
Risk disposition An investor is normally not willing to A speculator is ordinarily willingto
assume more than moderate risk. assume high risk.
Return An investor usually seeks a moderate A speculator looks for a high rateof
expectation rate of return. return.
Basis of An investor attaches greater A speculator relies more
decisions significance to fundamental factors on technical charts and
and attempts a careful evaluation of market psychology.
the prospects of the firm.
Leverage An investor uses his own funds and A speculator normally resortsto
eschews borrowed funds. borrowings, which can be very
substantial, to supplement his
personal resources.

A gamble is a very short term investment in a game of

chance. Gambling involved high risk and the expectations
 of high returns. It consists of uncertainty and high stackers
for thrill and excitement.
The example of gambling are horse racing, card
game, lottery etc.

Compared to investment and speculation, the result of

gambling is known more quickly.
Rational people gamble for fun, not for income.
Gambling does not involve a bet on an economic activity.
It is based on risk that is created artificially.
 Arbitrage is a planned methods of putting the savings
safely into different investments to get a better return. An
investor can also be an arbitrageur if he buys and sells
securities in more than one stock exchange to take
advantage of the price differentials in such exchanges.
Derivative market is an example of Arbitrage transactions.

Characteristics and Types of

Investments
Objective fulfillment

An investment should fulfil the objective of the savers. Every

individual has a definite objective in making an investment. When the
investment objective is contrasted with the uncertainty involved with
investments, the fulfilment of the objectives through the chosen
investment avenue could become complex.
Safety
• The first and foremost concern of any ordinary investor is that
his investment should be safe.
• That is he should get back the principal at the end of the
maturity period of the investment.
• There is no absolute safety in any investment, except
probably with investment in government securities or such
instruments where the repayment of interest and principal is
guaranteed by the government.
Return
The return from any investment is expectedly consistent with the extent of risk
assumed by the investor. Risk and return go together. Higher the risk, higher the
chances of getting higher return. An investment in a low risk - high safety
 investment such as investment in government securities will obviously get the
investor only low returns.

Liquidity
Given a choice, investors would prefer a liquid investment than a higher return
investment. Because the investment climate and market conditions may change or
investor may be confronted by an urgent unforeseen commitment for which he
might need funds, and if he can dispose of his investment without suffering unduly
in terms of loss of returns, he would prefer the liquid investment.
Hedge against inflation

The purchasing power of money deteriorates heavily in a country which is not

efficient or not well endowed, in relation to another country. Investors who save for
the long term, look for hedge against inflation so that their investments are not
unduly eroded; rather they look for a capital gain which neutralises the erosion in
purchasing power and still gives a return.
Tax shield
Investment decisions are highly influenced by the tax system in the
country. Investors look or front-end tax incentives while making an
investment and also rear-end tax reliefs while reaping the benefit of their
investments.

Types of Investments
1.Growth investments
These are more suitable for long term investors that are willing and able to withstand market ups and
downs.

Shares
Shares are considered a growth investment as they can help grow the value of your original
investment over the medium to long term.
If you own shares, you may also receive income from dividends, which are effectively a
portion of a company’s profit paid out to its shareholders.
Of course, the value of shares may also fall below the price you pay for them. Prices can be
volatile from day to day and shares are generally best suited to long term investors, who are
comfortable withstanding these ups and downs.
Also known as equities, shares have historically delivered higher returns than other assets,
shares are considered one of the riskiest types of investment.
Property

Property is also considered as a growth investment because the price of

houses and other properties can rise substantially over a medium to long term
 period. However, just like shares, property can also fall in value and carries the
risk of losses.
It is possible to invest directly by buying a property but also indirectly, through a property
investment fund.
2.Defensive investments
These are more focused on consistently generating income, rather than growth, and are considered
lower risk than growth investments.

Cash
Cash investments include everyday bank accounts, high interest savings accounts and term deposits.
They typically carry the lowest potential returns of all the investment types.
While they offer no chance of capital growth, they can deliver regular income and can play an
important role in protecting wealth and reducing risk in an investment portfolio.
Fixed interest

The best known type of fixed interest investments are bonds, which are
essentially when governments or companies borrow money from
investors and pay them a rate of interest in return.
Bonds are also considered as a defensive investment, because they
generally offer lower potential returns and lower levels of risk than
shares or property.
They can also be sold relatively quickly, like cash, although it’s important
to note that they are not without the risk of capital losses.

Understanding the investment

decision process
• The basis of all investment decisions is to earn
return and assume risk
• By investing, investors expect to earn a return
(expected return)
 Different approaches to investment
decision making
• Fundamental Approach: Believed that there is
an intrinsic value of a security that can be
company, industry and economy.
• Psychological Approach: This approach based
on the premises that stock prices are guided
by the emotions. It is more important to
analyse that how investor tend to behave as
the market is swept by the waves of optimism
and pessimism.
 Different approaches to investment
decision making
• Academic Approach: Suggest that:
-Stock market is efficient in reacting quickly
and rationally hence it reflects intrinsic
value fairly well.
-Stock price behavior correspond to the
random walk, hence past price behavior can
not be used to predict the future price.
- There is positive relationship between risk
and return.
 Different approaches to investment
decision making
• Electric Approach: This approach draws on all
the three approaches.
-Fundamental analysis is helpful in
establishing basic standard benchmarks.
- Technical analysis is useful in broadly
gauging the mood of the investor.
- there is a strong correlation between risk
and return.
Investment Decision Process
 There are 5 investment process steps that help you in selecting
and investing in the best asset class according to your needs and
preferences.

Step 1- Understanding the need

The first and the foremost step of investment process is to
understand the client or the investor his/her needs, his risk taking
capacity and his tax status. After getting an insight of the goals and
restraints , it is important to set a benchmark for the one’s portfolio
management process which will help in evaluating the
performance and check whether the objectives are achieved or
not.
Step 2- Asset allocation decision
This step involves decision on how to allocate the investment
across different asset classes, i.e. fixed income securities,
equity, real estate etc. It also involves decision of whether to
invest in domestic assets or in foreign assets. The investor will
make this decision after considering the macroeconomic
conditions and overall market status.
Step 3- Portfolio strategy selection
Third step in the investment process is to select
the proper strategy of portfolio creation. Choosing
the right strategy for portfolio creation is very
important as it forms the basis of selecting the
assets that will be added in the portfolio
management process. The strategy that conforms
to the investment policies and investment
objectives should be selected.
There are two types of portfolio strategy1.Active
Management
2.Passive Management
Active portfolio management process refers to a strategy
where the objective of investing is to outperform the market
return compared to a specific benchmark by either buying
securities that are undervalued or by short selling securities
that are overvalued. In this strategy, risk and return both are
high. This strategy is a proactive strategy it requires close
attention by the investor or the fund manager.
Passive portfolio management process refers to the strategy
where the purpose is to generate returns equal to that of the
market. It is a reactive strategy as the fund manager or the
investor reacts after the market has responded.
Step 4- Asset selection decision
The investor needs to select the assets to be placed in the
portfolio management process in the fourth step. Within each
asset class, there are different sub asset-classes. For example,
in equity, which stocks should be chosen? Within the fixed
income securities class, which bonds should be chosen?
Also, the investment objectives should conform to the
investment policies because otherwise the main purpose of
investment management process would become meaningless.
Step 5- Evaluating portfolio performance
This is the final step in the investment process
which evaluates the portfolio management
performance. This is an important step as it
measures the performance of the investment with
 respect to a benchmark, in both absolute and
relative terms. The investor would determine
whether his objectives are being achieved or not.
After all the above points have been followed, the
investor needs to keep monitoring the portfolio
management performance at an appropriate interval. If
the investor finds that any asset is not performing well,
he/she should ‘re balance’ the portfolio. Re balancing
means adding or removing (or better call it adjusting)
some assets from the portfolio to maintain the target
level. Re balancing helps the investor to maintain his/her
level of risk and return.
Phases of Portfolio Management
Phases of Portfolio Management
Portfolio Management comprises of many activities that are targeted at optimizing the investment of
client’s funds. There are basically five phases in the portfolio management and each of these phases
makes up an integral part of the Portfolio Management and the success of it depends on the
effectiveness in implementing these phases.
Security Analysis:
There are many types of securities available in the market including equity shares, preference shares,
debentures and bonds. Apart from it, there are many new securities that are issued by companies such
as Convertible debentures, Deep Discount bonds, floating rate bonds, flexi bonds, zero coupon bonds,
global depository receipts, etc.
It forms the initial phase of the portfolio management process and involves the evaluation and analysis
of risk return features of individual securities. The basic approach for investing in securities is to sell
the overpriced securities and purchase underpriced securities. The security analysis comprises of
Fundamental Analysis and technical Analysis.
Portfolio Analysis:
A portfolio refers to a group of securities that are kept together as an investment.
Investors make investment in various securities to diversify the investment to make it
risk averse. A large number of portfolios can be created by using the securities from
desired set of securities obtained from initial phase of security analysis.
 By selecting the different sets of securities and varying the amount of investments in
each security, various portfolios are designed. After identifying the range of possible
portfolios, the risk-return characteristics are measured and expressed quantitatively.
It involves the mathematically calculation of return and risk of each portfolio.
Portfolio Selection
During this phase, portfolio is selected on the basis of input from previous phase
Portfolio Analysis. The main target of the portfolio selection is to build a portfolio that
offer highest returns at a given risk. The portfolios that yield good returns at a level of
risk are called as efficient portfolios. The set of efficient portfolios is formed and from
this set of efficient portfolios, the optimal portfolio is chosen for investment.
The optimal portfolio is determined in an objective and disciplined way by using the
analytical tools and conceptual framework provided by Markowitz’s portfolio theory.

Portfolio Revision
• After selecting the optimal portfolio, investor is required to monitor it constantly to ensure that the portfolio
remains optimal with passage of time. Due to dynamic changes in the economy and financial markets, the
attractive securities may cease to provide profitable returns. These market changes result in new securities that
promises high returns at low risks.
• In such conditions, investor needs to do portfolio revision by buying new securities and selling the existing
securities. As a result of portfolio revision, the mix and proportion of securities in the portfolio changes.
• Portfolio Evaluation
• This phase involves the regular analysis and assessment of portfolio performances in terms of risk and returns over a
period of time. During this phase, the returns are measured quantitatively along with risk born over a period of
time by a portfolio. The performance of the portfolio is compared with the objective norms. Moreover, this
procedure assists in identifying the weaknesses in the investment processes.
•

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