Investment Management BBA
Investment Management BBA
Investment Management BBA
"Sacrifice of certain present value for some uncertain future value" – WILLIAM F. SHARPE
FEATURES OF INVESTMENT
1. Return: Investors buy or sell financial instruments in order to earn return on them. The
return on investment is the reward to the investors.
2. Risk: Risk is inherent in any investment. Risk may relate to loss of capital, delay in
repayment of capital, non-payment of return or variability of returns. Theoretically, the higher
the risk, higher is the expected return. The higher return is a compensation expected by
investors for their willingness to bear the higher risk.
3. Safety: Safety refers to the protection of investor principal amount and expected rate of
return. The safety of investment is identified with the certainty of return of capital without loss
of time or money.
4. Liquidity: An investment that is easily saleable without loss of money or time is said to be
liquid.
5. Tax Considerations: There are certain investments which provide tax exemption to the
investor. Interest, dividends, capital gains and capital losses are all treated differently for tax
purposes. Some type of investment enjoys special tax incentives. The tax saving
investments increases the return on investment.
INVESTMENT OBJECTIVES
a) Short term high priority objectives: Investors have a high priority towards achieving
certain objectives in a short time.
For example, a young couple will give high priority to buy a house.
b)Long term high priority objectives: investment is done on the basis of objectives of long
term needs. They want to achieve financial independence in long period.
For example, investing for post retirement period or education of a child etc.
c) Low priority objectives: These objectives are not painful. After investing in high priority
assets, investors can invest in these low priority assets.
For example, provision for tour, purchasing domestic appliances etc.
d) Money making objectives: Investors may invest their surplus money just to make more
money. Their objective is to maximize wealth. Usually, the investors invest in shares of
companies which provide capital appreciation apart from regular income from dividend.
Other objectives
a. Lifestyle - Investors want to ensure that their assets can meet their financial needs
over their lifetimes.
b. Financial security - Investors want to protect their financial needs against financial
risks at all times.
c. Return - Investors want a balance of risk and return that is suitable to their personal
risk preferences. -
d. Value for money - Investors want to minimise the costs of managing their assets and
their financial needs.
e. Peace of mind – Investors do not want to worry about the day to day movements of
markets and their present and future financial security.
2. Capital Appreciation: Investments not only gives regular income but it also provides
long-term price appreciation leads to growth in capital, and wealth for investors.
3. Highly Regulated: Investment in the capital market is highly regulated through the
statutory agency like SEBI. Any investor that is wronged can have his case taken up by the
market regulators.
4. Tax Advantages: Tax on dividends and bonds is very low when compared to alternative
investments.
5. Collateral: Securities represent stocks of wealth, and can be used as collateral to secure
financing such as loans from lending institutions. It will interest investors that they can use
their share certificates as collateral to obtain bank loans for individual use or business
development.
7. Flexibility: Shares are traded in units and lots that are affordable by investors of different
income levels. Bonds are also fairly affordable when compared to alternative investments
such as real estate. As such, investment in securities can be customised to the specific
incomes of investors.
10. Hedge against inflation: Securities prices over the long term tend to outperform
inflation, therefore investment in securities can be a reliable hedge against inflation in the
long term.
2. Form of return: Investments in securities yield two types of return. They are periodic
cash receipts and capital gain. Some investors want periodical cash receipts in the form of
interest and dividend. Some investors are interested in capital gain in the form of increase in
the price of investment. While selecting the investment, the investor is required to consider
the form of return.
3. Risk appetite: The ability to tolerate risk differs from person to person. The level of risk
depends on the objective of investment. An investor who expects greater returns should also
be prepared to take higher risk.
4. Objectives of investment: Some investors may prefer safety of their principal amount
(low risk) and may be satisfied with lower rate of return. An aggressive investor, on the other
hand, may be willing to take a high risk in order to have high capital appreciation.
6. Safety of funds: The important consideration in making investment is that the funds so
invested should be safe and secure. The investor should get back his investment without
loss. He will generally select only those investments or securities which are safe.
7. Liquidity:Before making investment, the investor should keep in mind the degree of
liquidity required. Some securities can be sold very easily. Such investments are said to be
liquid. Some investments are illiquid.
8.Tax considerations: Before selecting the securities for investment, the investor will take
into consideration the provisions of income tax, capital gain tax, wealth tax etc. He wants to
minimise his tax burden and avail all tax exemptions available to him.
9. Investment period: The investment decisions may also depend on the period of
investment. The longer the time-horizon, the greater are the returns that investors should
expect. Further, the risk element reduces with time.
10. Investible surplus: The investible surplus plays a vital role in making investment
decisions. The money available for investment determines the selection of various asset
classes and so do the risks and returns.
11. Investment need: The amount investor need at the time of maturity is factor deciding
investment. This helps him determine the amount of money he needs to invest every month
or year to reach the required figure.
12. Past market trends: Sometimes history repeats itself; sometimes markets learn from
their mistakes. We need to understand how various asset classes have performed in the
past before planning finances.
1. Risk:An investor prefers low risk investments, whereas a speculator is prepared to take
higher risks for higher returns.
The investment tends to be speculative investment when the investor does not make
adequate analysis
2. Price Change: 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.
3. Holding Period: 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.
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INVESTMENT SPECULATION
1. Investment is made for a long period 1. Speculation is made for a short (few days
period (one year to few years) to months).
4. Investor uses his own funds and avoids 4. Speculator uses own funds as well as
borrowed funds. borrowed funds
INVESTMENT AND GAMBLING
Gambling is a combination of pleasure and pain. It can be described as easy money for lazy
people. Gambling is a very short-term investment in a game or chance.
Investing is any activity in which money is put at risk for the purpose of making a profit.
GAMBLING INVESTMENT
2. Analysing securities: There are two approaches used for analysing securities; Technical
analysis and Fundamental analysis.
INVESTMENT POLICY
An investment policy describes the parameters for investing funds and identifies the
investment objectives, preferences or tolerance for risk, constraints on the investment
portfolio, and how the investment program will be managed and monitored.
2. Return and Risk: Investment policy includes the risk tolerance levels of investors. It
provides a guide to the portfolio manager while choosing particular asset classes to invest..
3. Asset Selection: the investors mention the type of asset which seems closer to their
investment goal. This is where the investors say which variety of asset classes they wish to
invest.
4. Asset Allocation: a diversified portfolio will reduce the volatility of the investment
portfolio. As a result, one asset's positive performance offsets a negative performance of
another asset.
5. Review: one should control and check the performance of the portfolio, either monthly,
quarterly, half-yearly or even on an annual basis. This helps the investors to rebalance their
portfolio at the same time based on current market conditions.
INVESTMENT AVENUES
1. REAL INVESTMENTS
Real assets are physical investments which would include real estate, gold and silver,
precious stones rare coins and stamps, and art objects.
a. Real estate: It is investments in land and house or property. Real estate investment
has seen a lot of capital appreciation over the last few years
b. Bullion: Gold and Silver is still a traditional investment avenue. Investing in gold and
precious stones always has a guaranteed return.
c. Commodities: Commodities are simply raw materials that we use to make some of
the essential products we employ daily. An individual can estimate the commodity
price and the fluctuation by the trends in export and import.
d. Art: Art and antiques as investments have caught the fancy of many. Today,
investment in art is catching on and people are making a lot of gains through it.
2. FINANCIAL INVESTMENTS
These investments are freely tradable and negotiable.
a. Debts: These are instruments, which give a fixed rate of interest for a fixed period of
maturity. Hence they are low risk, low return investments.
b. Equities: These investments carry more risk than investing in debt instruments.
There is no assured return but when we invest in a share of a company, we become
an owner of the company to the extent of the capital invested.
c. Mutual Funds: A mutual fund pools money from investors and invests in different
securities. A professional fund manager decides the investment strategies and
securities, where one can purchase units of a fund.
a. Fixed Deposit: Investors deposit a certain amount for a specified period. He can earn a
predetermined interest rate on that amount from the bank or any other financial institution.
An individual can also help with loan services based on the fixed deposit.
b. Public Provident Fund (PPF): The impact of compounding of tax free interest is hefty,
especially in the later years. It is a safe investment as the interest earned and the principal
invested is backed by sovereign guarantee.
d. Life Insurance: Insurance plans sold as life insurance shall not be considered as
investment options as they provide risk coverage in case of any mishap. However, many
Indians consider insurance as an investment. It is an instrument for the security of life.
CHAPTER 2
Investment Analysis
TIME VALUE OF MONEY
This means that a rupee received now is worth more than a rupee to be received in future.
An individual would be ready to invest a rupee only if he receives more than a rupee in
exchange in the future. There will be a fall in the value of money tomorrow due to inflation
and similar reasons. The time value of money concept states that earlier receipts are worth
more than later receipts because earlier receipts can be reinvested to bring additional
returns before the later receipts are generated.
RETURN
Return is the reward of making investment. General definition of return is the benefit
associated with an investment.
Meaning of Risk
Risk is the quantifiable likelihood of loss or less-than-expected returns. Risk includes the
possibility of losing some or all of the original investment. risk can be defined as the
measurable possibility of loss on an investment. There is risk involved if the outcome of an
investment is uncertain at the time the investment is made.
TYPES OF INVESTMENT RISKS
The general market component of risk is called systematic risk and a specific (issuer)
component of the risk is called unsystematic risk. Thus;
1. SYSTEMATIC RISK
Occurrence of certain events can affect all firms at the same time. Events such as inflation,
war and fluctuating interest rates influence the entire economy and not just a specific firm or
industry. This is known as systematic risk. Diversification cannot eliminate this type of risk.
Therefore, it is considered a non-diversifiable risk.
SOURCES OF RISK
1. Market Risk: The variability in a security's returns resulting from fluctuations in the
aggregate market is known as market risk. All securities are exposed to market risk including
recessions, wars, structural changes in the economy, tax law changes, even changes in
consumer preferences. Market risk occurs due to the reaction of investors in the stock
market.
2. Interest Rate Risk: The variability in a security's return resulting from changes in the level
of interest rates is referred to as interest rate risk. Such changes generally affect securities
inversely
3. Purchasing Power Risk: A Factor affecting all securities is purchasing power risk, also
known as inflation risk. It is arising from decline in purchasing power on account of inflation.
There is the chance that the purchasing power of invested amount will decline.
6. Reinvestment Risk: The YTM (The Yield To Maturity) calculation assumes that the
investor reinvests all coupons received from a bond at a rate equal to the computed YTM on
that bond, thereby earning interest on interest over the life of the bond at the computed YTM
rate. In effect, this calculation assumes that the reinvestment rate is the yield to maturity.
7. International Risk: International Risk can include both Country risk and Exchange Rate
risk.
8. Liquidity Risk: Liquidity risk is the risk associated with the particular secondary market in
which a security trades. An investment that can be bought or sold quickly and without
significant price concession is considered liquid.
MEASUREMENT OF RISK
1. Standard Deviation
The standard deviation measures how much returns change over a period. This is also
known as the volatility of returns. The standard deviation measures the typical deviation from
the mean return. The mean return is the average return of the asset over a specified period.
The square root of the variance is the standard deviation, which is simply the average
deviation from the expected return.
2. Coefficient of variation
The coefficient of variation is a better measure of risk, quantifying the dispersion of an
asset's returns in relation to the expected return, and, thus, the relative risk of the
investment. Hence, the coefficient of variation allows the comparison of different
investments. This can be calculated as follows.
Beta > 1 - Aggressive securities. A beta of greater than 1 indicates that the security's price
will be more volatile than the market.
Beta < 1 - Defensive securities. A beta of less than 1 means that the security will be less
volatile than the market.
Beta = 1 - Neutral securitiees . A beta of 1 indicates that the security's price will move with
the market.
CHAPTER 3
Approaches to Security Analysis
Fundamental analysis
fundamental analysis is a method used to determine the value of stock by analyzing the
financial data that is ‘fundamental to the company. fundamental analysis is the analysis,
wherein the investment decisions are taken on the basis of the financial strength of the
company.
Fundamental analysis is a method of evaluating the intrinsic value of an asset and analysing
the factors that could influence its price in the future..
3. Management evaluation
fundamental analysis helps in evaluating management and also to make internal business
decisions. Fundamental analysis helps in understanding the structure of the management
and how it has been performing over the years.
E-I-C ANALYSIS
1. E - Economic (macroeconomic) analysis: This describes the macroeconomic situation
in the particular country and its potential influence on the profitability of stocks.
2. I- Industry analysis: This evaluates the situation in the particular industry/ economic
sector and its potential influence on the profitability of stocks.
3. C - Company analysis: This involves financial analysis of the individual companies from
the shareholder approach.
1. ECONOMIC ANALYSIS
The first step in fundamental analysis involves analysing the overall economy.
Macroeconomic factors are given importance in this phase of analysis. It aims to evaluate
the economic climate of a country which is suitable for the growth of the business sector,
especially the capital market.
1. Agricultural Growth: Agriculture is directly and indirectly linked with the industries.
Hence increase or decrease in agricultural production has a significant impact on the
industrial production and corporate performance. Companies using agricultural raw materials
as inputs or supplying inputs to agriculture are directly affected by change in agriculture
production.
2. Industrial Growth: The industrial growth is a major contributor to the national income of a
country. Industrial growth helps the overall development of different industrial sectors and
that finally reflects in the return and price of securities. The GDP growth rate represents the
average of the growth rate of agricultural sector, industrial sector and the service sector.
3. Type of Economy: India follows a pattern of mixed economy where both public and
private sector receives equal importance. Government is major investor in industries. The
industrial and fiscal policy of the government also plays a very important role for the
performance of the Indian economy.
4. Business Cycle: In all capitalist economies we find business cycle. Such economies
pass through different phases of prosperity. The different stages of business cycle are
depression, recovery, boom and rescission. These different stages of business cycle will
have a direct connection on the performance of industries and companies.
5. Gross Domestic Product (GDP): Investors have to consider the rate of growth of the
economy. An important variable to know the rate of growth of the economy is GDP. It is the
aggregate value of goods and services produced in the economy for the specific period. The
increase of GDP has the favourable impact on the stock market and the decrease of it
weakens the financial market.
7. Interest Rates: Interest rates are a good indicator of economic growth. A lower rate of
interest means a lower cost of financing and thereby gives more profit to companies. Higher
rate of interest will lead to higher cost of finance and reduces the profits.
8. Price level and Inflation: The inflation rate is defined as the rate of change in the price
level. Most economies face positive rates of inflation year after year. The price level, in turn,
is measured by a price index, which measures the level of prices of goods and services at a
given time.
10. The tax structure: The business community eagerly awaits the government
announcements regarding the tax policy in March every year. The type of tax exemption has
impact on the profitability of the industries. Concession and incentives given to certain
industry encourages investment in that industry and have favourable impact on stock
market.
2. INDUSTRY ANALYSIS
Another important aspect of fundamental analysis is industry analysis. An industry is
generally described as a homogenous group of companies. Industry as a group of firms
produces similar products which serves the same needs of common set of buyers. Certain
industries are likely to benefit more than others when the economy is expanding. Therefore
an investor can narrow the analysis from general economy to those industries that are best
suited to benefit from the current or future economic environment. To assess an industry
group's potential, an investor would consider the overall growth rate, market size, and
importance to the economy.
3. Industry life cycle: All industries exhibit a life cycle characterised by pioneering stage,
growth, maturity and decline. However, the length of each stage varies from industry to
industry and from company to company.
4. Raw material and other inputs: Another important factor which decides the prosperity of
industries is the availability of raw materials and other inputs required for production. Easy
availability of raw material is highly necessary for an uninterrupted flow of production
activities.
5. Production Cost and Profit: The lowest cost producer in an industry is best able to
withstand intense price competition, either by pricing its product to maximize profits or
setting prices at low levels to keep potential competitors from entering the business.
7. Cyclical Industries: cyclical industries are sensitive to global economic conditions and
swings in the prices of international commodities markets. When business conditions are
improving, earnings tend to rise dramatically.
8. Capacity utilisation: If the products offered by an industry are good, there will be great
demand for such products and consequently industry would be able to achieve high growth
and prosperity. In such a case industry can function at its full capacity.
10. Govt. Policy: The policy announced by the government will also affect the industry as a
whole such as industrial policy and fiscal policies of the government have a direct connection
on the performance of industries. Likewise, relief, rebate and concessions declared by the
government to certain class of industries also influence the functioning of organisations.
3. COMPANY ANALYSIS
Company analysis is the study of various characteristics of a company regarding its
operating and financial performance and future prospects. Once an investor decides to
invest in a particular industry on the basis of economic and industry analysis, it is important
to select the company in which investment is to be made.
1. Business Model: The business model is the basis upon which all other things are built. If
model is not good, there is little hope for the success of the business. Even before an
investor looks at a company's financial statements or does any research, one of the most
important questions that should be asked is: What exactly does the company do?
This is referred to as a company's business model. Investors can get a good overview of a
company's business model by checking out its website. Sometimes business models are
easy to understand. Take McDonalds, for instance, which sells hamburgers, fries, soft drinks,
salads and whatever other new special they are promoting at the time. It is a simple model,
easy enough for anybody to understand. Unless investors understand a company's business
model, they don't know what the drivers are for future growth.
2. Market Share: It is necessary to consider the market share of the company in which
investors are going to invest. If the market share is high, the company would be able to meet
the competition successfully. While analysing the market share, the size of the company
should also be considered because it is difficult for small companies to survive in the future.
It is also wise to make a comparison with similar companies, for example, an IT company
can be compared with another IT company to assess the viability to invest.
3. Customers: Some companies serve only a handful of customers, while others serve
millions. In general, it is not desirable if a business relies on a small number of customers for
a large portion of its sales because the loss of each customer could dramatically affect
revenues. For example, think of a military supplier who has 100% of its sales with the
Government of India. One change in government policy could potentially wipe out all of its
sales.
4. Growth of Sales: An investor must also see the growth of sales before taking an
investment decision. A leading company of today may turn out to be a bad company in future
unless there is a steady growth in the sales. The investors normally would not prefer to
invest in the stocks of a big company with inadequate growth. Not only the growth of sales,
but also the stability in the growth of sales should also be considered. If firm has stable
revenue from sales, it will likely to make stable earnings also.
7. Labour and other industrial problems: A cordial relationship between management and
employees is necessary for the smooth functioning of organisations. A company with skilled
and expertise labour and high labour productivity can achieve prosperity within a short
period. On the other hand, frequent labour problems like strike may worsen the relation
between management and employees. Companies with acute labour problems are not
popular for investment.
8. Financial Analysis: The final step to the fundamental analysis process would be to
evaluate the financial statements to determine the value. Many techniques such as financial
ratios like current ratio, acid test ratio, gross profit ratio etc., can be used for financial
analysis.
2. Unscientific Process: The other major argument against fundamental analysis is that it is
more practical than theoretical. These critics charge that fundamental analysis is an
unscientific process, and that it is difficult to get a clear picture of a company's value when
there are so many qualitative factors such as a company's management and its competitive
environment.
3. Time Consuming: Fundamental analysis may provide excellent insights, but it can be
extraordinarily time-consuming.
6. False or Biased Information: Since all information during fundamental analysis come
from the direct source of companies itself, it may be hampered or biased to attract investors.
Companies are capable of manipulating figures in financial statements that can mislead the
investors.
CHAPTER 4
TECHNICAL ANALYSIS
Technical analysis
Technical analysis seeks to predict price movements by examining historical data, mainly
price and volume. Technical analysis is the study of chart patterns and statistical figures to
understand market trends and pick stocks accordingly.
TRADING STRATEGIES
1. Pick a Strategy or Develop a Trading System
2. Identify Securities
3. Find the Right Brokerage:
4. Track and Monitor Trades:
5. Use Additional Software or Tools:
PRICE FIELDS
Open - This is the price of the first trade for the period (e.g., the first trade of the day).
High - This is the highest price that the security traded during the period. It is the point at
which there were more sellers than buyers
Low - This is the lowest price that the security traded during the period. It is the point at
which there were more buyers than sellers
Close - This is the last price that the security traded during the period. Due to its availability,
the Close is the most often used price for analysis.
Volume - This is the number of shares that were traded during the period.
Open Interest - This is the total number of outstanding contracts
Bid - This is the price a market maker is willing to pay for a security
Ask - This is the price a market maker is willing to accept
2. Trend Prediction: The main advantage of technical analysis is that is helps investors and
traders predict the trend of the market. Up trend, downtrend, and sideways moves of the
market are easy to predict, with the help of chart analysis.
3. Entry and exit recommendations: With the help of technical analysis, traders and
investors can predict the right time to enter and exit a trade thereby enabling good returns..
4. Provides Valuable Information: A price chart can offer plenty of valuable information.
Information like support, resistance, chart pattern, momentum of the market, volatility, and
trader's psychology are some examples of types of information provided by technical
analysis and used by traders.
5. Provides Early Signal: Technical analysis gives early signals and also exhibits the
psychology of investors and traders. Price-volume analysis indicates the movement of
market makers and their activities related to a particular market.
6. Quick and Less Expensive: Technical analysis is less expensive as compared to the
fundamental analysis.
1. Primary trend: The Primary trend is the largest trend and once the primary trend has
been identified, it will remain in effect until proved otherwise. The Primary trend usually lasts
more than one year and may last for several years.
2. Secondary (reaction) trend: Secondary trends are intermediate, corrective reactions to
the Primary trend. These reactions typically last from one to three months. Secondary
movements run counter to the primary trend and are reactionary in nature. A secondary
trend moves in the opposite direction of the primary trend, or as a correction to the primary
trend.
3. Minor trend or Daily fluctuations: Minor trends are simply the daily price fluctuations.
Minor trends are short-term movements lasting from one day to three weeks. The minor
trend is generally the corrective moves within a secondary move, or those moves that go
against the direction of the secondary trend.
1. Primary Bull Market: A primary bull market consists of three stages namely
Accumulation, Public participation and Excess.
Stage 1 - Accumulation: The first stage of a bull market is called the accumulation phase,
which is the starting point of the upward trend. The accumulation phase starts at the end of a
downtrend, when whole condition in the market remains at its worst.
Stage 2 - Public Participation or Big move: The second stage of a primary bull market is
usually the longest, and sees the largest advance in prices. As the good news starts to
spread the market, more and more investors come back into the market; resulting higher
prices.
Stage 3 - Excess:. At this point, the market is attractive again for all investors. The excess
phase, is the one in which the smart investors starts to sell their holdings to those now
entering the market. This is usually the time when the last of the buyers start to enter the
market after large gains have been achieved by smart investors. The late entrants hope that
recent returns will continue. Unfortunately for them, they are buying at top prices.
Stage 1 - Distribution: The first phase in a bear market is known as the distribution phase
and marks the beginning of a bear market. This is a period in which informed buyers start to
sell (distribute) their stocks.
Stage 2 – Public Participation or Big move: During this phase it is clear that the business
conditions in the market are getting worse and the sentiment is becoming more negative as
time goes on. As business conditions worsen, the sell-off continues.
Stage 3 - Panic or Despair: The last phase of the primary downward market tends to be
filled with market panic and can lead to very large sell-offs in a very short period of time.
During this phase many investors selling off their stocks in panic.
3. MINOR TRENDS
It is a market movement lasting less than three weeks. The minor trend is generally the
corrective moves within a secondary move, or those moves that go against the direction of
the secondary trend. They are simply the daily price fluctuations. It tries to correct the
secondary movements. This can be compared with Ripple.
3. One of the criticisms is that following the theory will result in an investors acting after
rather than before or at market tops and bottoms.
4. A second criticism of Dow Theory is that the different trends are not strictly defined.
Often the interpretation of price swings is difficult to assign to a specific trend type.
5. Dow theory provides only directional indication and only for the longer duration and
does not indicate the shorter reflections in the market.
STOCK CHARTS
This uses charts to identify recognisable trends and patterns in the formation of stock
price.Stock charts, like all other charts, have two axis—the vertical axis and the horizontal
axis. The horizontal axis represents the historical time periods for which a technical chart
has been constructed
TYPES OF CHARTS
1. Line Charts
A line chart is the simplest type of stock chart. Each closing price point is represented by a
dot and all dots are connected by lines to get graphical representation. It gives a bird's eye
view of the historical price action in a single line.
2. Bar Charts
Bar chart considers the open, high and low of a security along with its closing price. This
type of chart in technical analysis provides us more information like where the stock had
opened and closed, the high and low point for that trading period and hence the range for
the day.
They are also called as OHLC charts or Open-High Low-Close charts. The advantage of
using a bar chart over a straight line graph is that it shows the high, low, open and close for
each particular day.
A candlestick is composed of three parts; the upper shadow, lower shadow and body. The
body is coloured green or red.
Bullish Candle: When the close is higher than the open (usually green or white)
Bearish Candle: When the close is lower than the open (usually red or black) Upper
Shadow: The vertical line between the high of the day and the close (bullish candle) or open
(bearish candle)
Lower Shadow. The vertical line between the low of the day and the open (bullish candle) or
close (bearish candle)
Real Body. The difference between the open and close; coloured portion of the candlestick.
1. Strong-form: The strong-form of market efficiency states that the current price of stock
reflects all information available. It does not matter if this information is available to the public
or to top management. If it exists, it is definitely reflected in the current price.
2. Semi-Strong Form: The semi strong form EMH states that all publicly available
information is similarly already incorporated into asset prices. In another word, all publicly
available information is fully reflected in a security's current market price.
3. Weak-form: The weak-form of market efficiency states that the current price does not
reflect fair value and is only a reflection of past prices. Furthermore, the future price cannot
be determined using past or current prices.
The theory says that future stock prices are completely independent of past stock prices. In
other words, the path that a stock's price follows is a "random walk" that cannot be
determined from historical price information, especially in the short term.
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CHAPTER 5
Portfolio Management
PORTFOLIO
A portfolio is a collection of securities. It is a collection of a wide range of assets that are
owned by investors. A portfolio refers to set of financial assets owned by an investor that
may include bonds, stocks, currencies, cash and cash equivalents, and commodities.
TYPES OF PORTFOLIOS
1. Aggressive Portfolio: An aggressive portfolio includes those stocks that offer high
returns and carry high risks. Stocks in this category typically have a high beta, or sensitivity
to the overall market. Higher beta stocks consistently experience larger fluctuations relative
to the overall market.
2. Defensive Portfolio: Defensive stocks do not usually carry a high risk. They are relatively
free from broad market movements. Defensive stocks do well in bad times as well as good
times. Even during the bad times of the economy, companies that make products that are
essential to everyday life will survive. A defensive portfolio is a better choice for most
investors.
4. Income Portfolio: This is another common type of portfolio that focuses on investments
making money from dividends or other types of distributions. Generally speaking, an income
portfolio is more focused on securing regular income from investments as opposed to
focusing on potential capital gains. Generating a positive cash flow, an income portfolio
invests in companies that return a major share of their profits to shareholders.
5. Efficient Portfolio: The proper goal of portfolio construction is to generate a portfolio that
provides the highest returns at a given level of risk. An efficient portfolio, also known as an
'optimal portfolio', is one that provides that best expected return on a given level of risk, or
alternatively, the minimum risk for a given expected return.
PORTFOLIO MANAGEMENT
Investment management, also called portfolio management is a branch of investment
analysis that looks into the process of managing investments. The art of selecting the right
investment policy for the individuals in terms of minimum risk and maximum return is called
portfolio management. It refers to managing an individual's investments in the form of bonds,
shares, cash, mutual funds etc so that he earns the maximum profits within the stipulated
time frame..
NEED AND IMPORTANCE OF PORTFOLIO MANAGEMENT
1. Stable Current Return: One of the main objectives of portfolio management is to ensure
a stable return. Once investment safety is guaranteed, the portfolio should bring a steady
current income. The current returns should at least match the opportunity cost of the funds of
the investor. Current income means income by way of interest of dividends, not capital gains.
3. Tax Planning: Since taxation is an important variable in total planning, a good portfolio
should enable its owner to enjoy a favourable tax planning. The portfolio should be
developed considering not only income tax, but capital gains tax, and gift tax, as well. A
good portfolio always aims at is tax planning, not tax evasion or tax avoidance.
4. Capital Growth: A good portfolio should appreciate in value in order to protect the
investor from any erosion in purchasing power due to inflation. In other words, a balanced
portfolio must consist of certain investments, which tend to appreciate in real value after
adjusting for inflation.
5. Liquidity: The portfolio should ensure that there are enough funds available at short
notice to meet the investor's liquidity requirements. It is desirable to keep some stocks which
can easily be converted into cash in case of urgent financial requirements.
6. Safety of the investment: Safety of investment is all the more important. The investment
should be absolutely safe. Other considerations like income, growth, etc., only come into the
picture after the safety of investment is ensured. Investment safety or minimization of risks is
one of the important objectives of portfolio management.
2. Selection of Asset Mix: The second activity in portfolio management is to decide the
proportion of the various asset categories to include in the investor's portfolio. The various
asset categories include bonds and debentures, stocks, cash investments, precious metals
like gold and silver, investment in real estate etc.
3. Formulation of Portfolio Strategy: After fixing the asset mix, the next step for the
investor is to formulate a portfolio strategy. Portfolio strategy includes both active portfolio
strategy and passive portfolio strateg.
4. Security analysis: In this step, an investor actively involves himself in selecting
securities. Security analysis requires the sources of information on the basis of which
analysis is made. The selection of securities involves technical and fundamental analysis.
5. Portfolio Execution: After the formulation of investment objectives, choosing asset mix,
formulating portfolio strategy and selection of securities, the portfolio has to be executed by
buying or selling specified securities in given amounts.
6. Portfolio Revision: Portfolio revision is one of the most important steps in portfolio
management. A portfolio manager has to constantly monitor and review portfolio according
to the market condition.
PORTFOLIO DIVERSIFICATION
Diversification is a risk reduction concept that involves the allocation of investments among
various financial instruments, industries and other investment categories. diversification can
be achieved by investing in different stocks, different asset classes such as shares, bonds,
real estate, etc. A well-diversified portfolio consists of different types of securities from
diverse industries, with varying degrees of risk.
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BENEFITS OF DIVERSIFICATION
1. Less impact of market volatility: A diversified portfolio minimizes the overall risk
associated with the portfolio. Since investment is made across different asset classes and
sectors, the overall impact of market volatility comes down.
2. Less time for monitoring the portfolio: A diversified portfolio is more stable because
not all investments will perform badly at the same time.
3. Benefit from different instruments: diversification of the portfolio will balance the risk
and return associated with different funds. Even if one fund does not perform well, the loss
may be compensated by the profits made from other funds.
6. Safety of capital: Diversification allows investors to achieve their investment plans while
maintaining the investment risk at a minimum. It is also a method of playing safe in the
volatile market.
7. Practical approach: Diversification is a practical approach that every investor should take
advantage of. It allows investors to shuffle their investments and take advantage of the
market movement. It lets investors spread their investment across different asset classes
and increase annual returns.
8. Peace of mind: The great advantage of diversification is peace of mind. When the total
investment is divided amongst a number of asset classes, an investor will not be stressful
about the performance of the portfolio.
Disadvantages of Diversification
1. Investing in unnecessary assets: Sometimes in the name of portfolio diversification,
investors may invest in too many assets that they don't even require.
Assumptions
1. Investors are rational. They seek to maximize returns while minimizing risk.
2. Investors are only willing to accept higher amounts of risk if they are compensated by
higher expected returns,
3. Investors
4. Investors can borrow or lend an unlimited amount of capital at a risk free rate of interest,
timely receive all pertinent information related to their investment decision.
5. Markets are perfectly efficient and absorb information quickly and perfectly.
6. Markets do not include transaction costs or taxes,
7. It is possible to select securities whose individual performance is independent of other
portfolio investments.
ADVANTAGES OF CAPM
1) Eliminates unsystematic risk: CAPM assumes that investor holds a diversified portfolio,
similar to a market portfolio. Diversified portfolio eliminates unsystematic (specific) risk.
2) Systematic risk: CAPM takes into account systematic risk, which is left out of other
3) Easy to use: CAPM is simple to calculate and to derive a range of possible outcomes.
Those outcomes provide confidence around the required rate of returns.
DISADVANTAGES OF CAPM
1) Too many assumptions: The CAPM model is based on too many assumptions, which
many criticize as being unrealistic.
2) Ability to borrow at risk free rate: There are four major assumptions of CAPM. One of
the assumptions is that investor can borrow & lend the funds at the risk-free rate. This
assumption is unrealistic for the real world.
3) Determination of project proxy beta: The problem may arise in using the CAPM to
calculate a project-specific discount rate. Generally, equity beta & portfolio/investment beta
are different. Therefore, the company needs to find a proxy beta for the project.
Various RAPMs are employed for portfolio performance. These include the Sharpe's ratio,
Treynor's ratio, and Jensen's Alpha.
PORTFOLIO REVISION
The art of changing the mix of securities in a portfolio is called as portfolio revision. It
involves the process of addition of more assets in an existing portfolio or changing the ratio
of funds invested. The sale and purchase of assets in an existing portfolio over a certain
period of time to maximize returns and minimize risk is called as Portfolio revision.
2. Passive Revision Strategy: Passive Revision Strategy involves rare changes in portfolio
only under certain predetermined rules. These predefined rules are known as formula plans.
According to passive revision strategy a portfolio manager can bring changes in the portfolio
as per the formula plans only.