ASSIGNMENT OF

FINANCIAL
MANAGEMENT

MADE BY:-
JITENDRA PAREEK
Basics of Securities Analysis & Portfolio Management
The different types of securities are available to an investor for investment. In stock exchange of
the country the shares of 7000 companies are listed. Traditionally, the securities were classified
into ownership such as equity shares, preference share, and debt as a debenture bonds etc.
Recently companies to raise funds for their projects are issuing a number of new securities with
innovative feature. Convertible debenture, discount bonds, Zero coupon bonds, Flexi bond,
floating rate bond, etc. are some of these new securities. From these huge group of securities the
investors has to choose those securities, which he considers worthwhile to be included in his
investment portfolio. So for this detailed security analysis is most important.
The aim of the security analysis is to find out intrinsic value of a security. The basic value is also
called as the real value of a security is the true economic worth of a financial asset. The real
value of the security indicates whether the present market price is over priced or under priced in
order to make a right investment decision. The actual price of the security is considered to be a
function of a set of anticipated capitalization rate. Price changes, as anticipation risk and return
change, which in turn change as a result of latest information.
Security analysis refers to analyzing the securities from the point of view of the scrip prices,
return and risks. The analysis will help in understanding the behaviour of security prices in the
market for investment decision making. If it is an analysis of securities and referred to as a macro
analysis of the behaviour of the market. Security analysis entails in arriving at investment
decisions after collection and analysis of the requisite relevant information. To find out basic
value of a security “the potential price of that security and the future stream of cash flows are to
be forecast and then discounted back to the present value.” The basic value of the security is to
be compared with the current market price and a decision may be taken for buying or selling the
security. If the basic value is lower than the market price, then the security is in the over bought
position, hence it is to be sold. On the other hand, if the basic value is higher than the market
price the security’s worth is not fully recognized by the market and it is in under bought position,
hence it is to be purchased to gain profit in the future.
There are mainly three alternative approaches to security analysis, namely fundamental analysis,
technical analysis and efficient market theory.
The fundamental analysis allows for selection of securities of different sectors of the economy
that appear to offer profitable opportunities. The security analysis will help to establish what type
of investment should be undertaken among various alternatives i.e. real estate, bonds,
debentures, equity shares, fixed deposit, gold, jewellery etc. Neither all industries grow at same
rate nor do all companies. The growth rates of a company depend basically on its ability to
satisfy human desires through production of goods or performance is important to analyze nation
economy. It is very important to predict the course of national economy because economic
activity substantially affects corporate profits, investors’ attitudes, expectations and ultimately
security price.
According to this approach, the share price of a company is determined by these fundamental
factors. The fundamental works out the compares this intrinsic value of a security based on its
fundamental; them compares this intrinsic value, the share is said to be overpriced and vice
versa. The mispricing security provides an opportunity to the investor to those securities, which
are under priced and sell those securities, which are overpriced. It is believed that the market will
correct notable cases of mispricing in future. The prices of undervalued shares will increase and
those of overvalued will decline. Fundamental analysis helps to identify fundamentally strong
companies whose shares are worthy to be included in the investor’s portfolio.
The second alternative of security analysis is technical analysis. The technical analysis is the
study of market action for the purpose of forecasting future price trends. The term market action
includes the three principal sources of information available to the technician – price, value, and
interest. Technical Analysis can be frequently used to supplement the fundamental analysis. It
discards the fundamental approach to intrinsic value. Changes in price movements represent
shifts in supply and demand position. Technical Analysis is useful in timing a buy or sells order.
The technical analysis does not claim 100% of success in predictions. It helps to improve the
knowledge of the probability of price behaviour and provides for investment. The current market
price is compared with the future predicted price to determine the extent of mispricing. Technical
analysis is an approach, which concentrates on price movements and ignores the fundamentals of
the shares.
A more recent approach to security analysis is the efficient market hypothesis/theory.
According to this school of thought, the financial market is efficient in pricing securities. The
efficient market hypothesis holds that market prices instantaneously and fully reflect all relevant
available information. It means that the market prices of securities will always equal its intrinsic
value. As a result, fundamental analysis, which tries to identify undervalued or overvalued
securities, is said to be a useless exercise.
Efficient market hypothesis is direct repudiation of both fundamental analysis and technical
analysis. An investor can’t consistently earn abnormal return by undertaking fundamental
analysis or technical analysis. According to efficient market hypothesis it is possible for an
investor to earn normal return by randomly choosing securities of a given risk level.
Portfolio Management
Portfolio construction refers to the allocation of funds among a variety of financial assets open
for investment. Portfolio theory concerns itself with the principles governing such allocation.
The objective of the theory is to elaborate the principles in which the risk can be minimized
subject to desired level of return on the portfolio or maximize the return, subject to the constraint
of a tolerate level of risk.
Thus, the basic objective of portfolio management is to maximize yield and minimize risk. The
other ancillary objectives are as per the needs of investors, namely:
• Safety of the investment
• Stable current Returns
• Appreciation in the value of capital
• Marketability and Liquidity
• Minimizing of tax liability.
In pursuit of these objectives, the portfolio manager has to set out all the various alternative
investment along with their projected return and risk and choose investment with safety the
requirement of the individual investor and cater to his preferences. The manager has to keep a
list of such investment avenues along with return-risk profile, tax implications, yield and other
return such as convertible options, bonus, rights etc. A ready reckoned giving out the analysis of
the risk involved in each investment and the corresponding return should be kept.
The portfolio construction, as referred to earlier, be made on the basis of the investment strategy,
set out for each investor. Through choice of asset classis, instrument of investment and the
specific scripts, save of bond or equity of different risk and return characteristics, the choice of
tax characteristics, risk level and other feature of investment, are decided upon.

Capital Market Line

The relation between an asset’s risk premium and its market beta is called the
“Security Market Line” (SML).

Capital Market Line - CML Mean?

A line used in the capital asset pricing model to illustrate the rates of return
for efficient portfolios depending on the risk-free rate of return and the level of risk
(standard deviation) for a particular portfolio.

Capital Market Line - CML

The CML is derived by drawing a tangent line from the intercept point on the
efficient frontier to the point where the expected return equals the risk-free rate of
return.

The CML is considered to be superior to the efficient frontier since it takes into
account the inclusion of a risk-free asset in the portfolio. The capital asset pricing
model (CAPM) demonstrates that the market portfolio is essentially the efficient
frontier. This is achieved visually through the security market line (SML).

A capital market line (CML) is a line intersecting returns on risk investment and returns on the
entire market. The difference between capital market line and efficient frontier is that the capital
market line includes no-risk investments. All portfolios along the capital market line are efficient
portfolios.

Capital market line is referred to as a measure employed to evaluate portfolio performance.

Capital market line or CML is a graph employed in asset pricing models to depict rate of return
in a market portfolio. Capital market line describes rates of return for efficient portfolios that are
dependent on level of risk and risk free rate of return for a specific portfolio. CML originates
from the assumption that all investors will possess market portfolio. Quantum of risk is
positively correlated to the expected return. Thus, equation representing expected return is as
follows:
Expected return= portfolio beta + risk-free rate
Capital market line is deduced by drawing a tangent line that starts from the intercept point
located on efficient frontier and extends to the point where expected return matches risk free rate
of return. Capital market line is believed to be a better measure than efficient frontier as it takes
into consideration risk free asset in a portfolio. All points on the CML have better risk-return
profiles when compared to any portfolio.
Capital Asset Pricing Model - CAPM
What Does Capital Asset Pricing Model - CAPM Mean?
A model that describes the relationship between risk and expected return and that is used in the
pricing of risky securities.

The general idea behind CAPM is that investors need to be compensated in two ways: time value
of money and risk. The time value of money is represented by the risk-free (rf) rate in the
formula and compensates the investors for placing money in any investment over a period of
time. The other half of the formula represents risk and calculates the amount of compensation the
investor needs for taking on additional risk. This is calculated by taking a risk measure
(beta) that compares the returns of the asset to the market over a period of time and to the market
premium (Rm-rf).

Capital Asset Pricing Model - CAPM

The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free
security plus a risk premium. If this expected return does not meet or beat the required return,
then the investment should not be undertaken. The security market line plots the results of the
CAPM for all different risks (betas).

Using the CAPM model and the following assumptions, we can compute the expected return of a
stock in this CAPM example: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2
and the expected market return over the period is 10%, the stock is expected to return 17% (3%
+2(10%-3%))