Security Analysis and portfolio

management

Module 1: Basics of Investment

What Is an Investment?
An investment is an asset or item acquired with the goal of generating income and
appreciation. Appreciation refers to an increase in the value of an asset over time.
When an individual purchases a good as an investment, the intent is not to consume
the good but rather to use it in the future to create wealth.

For example, an investor may purchase a monetary asset now with the idea that the
asset will provide income in the future or will later be sold at a higher price for a profit.

Characteristics/Nature of investment

1.Risk Factor: Every investment contains certain portion of risk. It is a key feature of
investment which refers to loss of principal, delay in payment of interest and capital etc.
Most investors prefer to invest in less riskier securities.

2. Expectation Of Return: Return expectation is the main objective of investment. Investors

expect regularity of high and consistent income for their capital.

3. Safety: Investors expect safety for their capital. They desire certainty of return and
protection of their investment or principal amount.

4. Liquidity: Liquidity means easily sale or convert the capital or investment into cash
without any loss. So, most investors prefer liquid investments.

5. Marketability: It is another feature of investment that they are marketable. It means

buying and selling or transferability of securities in the market.

6. Stability Of Income: Investors invest their capital with high expectation of income. So,
return on their investment should be adequate and stable.
Investment options in India
In India, you have several investment options. You need to select based on their financial goals, risk
tolerance and investment horizon. Some of the popular investment options available in India are:

o Direcr equity
It is commonly referred to as a stock investment. It is one of the most preferred
investment options among investors. When you buy shares of a company, you
indirectly acquire an ownership stake in the company. Long-term stock investment
aids in capital appreciation. Stock investment has enormous potential to earn
attractive returns, but there are associated risks in this type of investment.
o Mutual Funds
A mutual fund comprises a pool of money collected from many investors who share a
common investment objective. The money so collected is invested in various
instruments such as stocks, bonds, money market, etc. Mutual fund investment is
considered to be flexible as you can start or stop investing as per your wish. They offer
moderate returns, but the risk is lower than equity investment.
o Public Provident Fund (PPF)
PPF is a government-backed savings scheme that aims to mobilise small savings and
provide a secure post-retirement life to individuals. It is a long-term savings scheme
with a lock-in period of 15 years. PPF investments are eligible for tax deductions under
section 80C of the Income Tax Act, 1961 and are also considered relatively safe.

o Employee Provident Fund (EPF)

Just like PPF, EPF is also a retirement-oriented investment scheme that is specifically
designed for salaried employees. Under this scheme, a certain percentage is deducted
from the employee’s monthly salary with an equal contribution from the employer. EPF
contribution is eligible for a tax deduction, and the final amount received upon maturity
is also entirely tax-free.

o National Pension System (NPS)

NPS is a retirement pension scheme introduced by the government to build a corpus
that can provide a monthly pension to people post-retirement. It has a mandatory lock-
in period till retirement; however, you can make partial withdrawals after retirement.
Investments made towards NPS are also eligible for a tax deduction.
o Fixed Deposits
Fixed deposits are regarded as an ideal investment option for conservative investors.
They provide a fixed rate of return for a specific period of investment,

2
Definition of Speculation

Speculation is a trading activity that involves engaging in a risky financial

transaction, in expectation of making enormous profits, from fluctuations in
the market value of financial assets. In speculation, there is a high risk of
losing maximum or all initial outlay, but it is offset by the probability of
significant profit.

Difference between Investment and speculation

3
Difference between Investment trading and
speculation

4
Process of making and managing investment
1. Setting Investment Goals

The first step in the Investment Process is to set clear and specific investment goals. You need
to be clear about what you want to achieve, whether it may be short-term or long-term
objectives.

2. Determining Risk and Returns

The second step is to determine the level of risk you are willing to take and the potential
returns you expect to receive. Investing involves risks but can also be a rewarding option.
High-risk investments often have the potential to generate higher returns, while low-risk
investments generally offer lower returns.

3. Asset Allocation

The third step is to decide on the asset allocation that fits your investment plans and risk-
taking ability. It is the strategy of dividing your investment portfolio into different securities
such as stocks, bonds, commodities, derivatives, etc.

4. Creating Investment Portfolio

The next step after assessing the fund allocation is to create an investment portfolio that
reflects your investment strategy. Your portfolio should be diversified and include a
combination of high-risk and low-risk investments that match your investment objectives.

5. Monitoring and Reviewing

Investment monitoring and reviewing is a crucial steps to ensure that your portfolio is
performing as expected. You should regularly check the performance of your investments
and adjust your portfolio as per market conditions.

5
Investment constraints
Investment constraints are restrictions or limitations that investors face when building
and managing their investment portfolios. They can be both internal, relating to the
investor's personal situation, and external, relating to market or regulatory conditions.

Types of Investment Constraints

Time Horizon
The time horizon is the length of time an investor plans to hold an investment before
needing to access the funds.

It is an essential consideration when making investment decisions, as it impacts

the types of investments and the level of risk an investor is willing to take.

Liquidity Constraints
Liquidity refers to the ease with which an investment can be converted to cash without
significantly impacting its price. Investors should consider their liquidity needs when
making investment decisions.

Risk Tolerance
Risk tolerance is an investor's willingness to accept fluctuations in investment value. It
is a crucial factor in determining the appropriate investment strategy and portfolio
composition.

Legal and Regulatory Constraints

Legal and regulatory constraints are rules and restrictions imposed by governments and
regulatory authorities that can impact investment decisions. Investors must be aware of
these constraints when constructing and managing their portfolios

Tax Considerations
Tax implications play a critical role in shaping an investor's investment strategy.
Different investments have varying tax treatments, and investors should consider the tax
consequences when selecting investments.

6
Unique Circumstances
Every investor has unique circumstances that can impact their investment decisions.
These factors may include ethical or social considerations, as well as personal
preferences.

Investment Objectives
The investment objectives are mainly of two types:

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

The following steps are undertaken to determine the risk objective:

1. Specify Measure of Risk: Measurement of risk is the most

important issue in portfolio management. Risk is either measured in
absolute or relative terms. Absolute risk measurement will include a
specific level of variance or standard deviation of total return.
Relative risk measurement will include a specific tracking risk.
2. Investor’s Willingness: Individual investors’ willingness to take
risks is different from institutional investors. For individual investors,
willingness is determined by psychological or behavioral factors.
Spending needs, long-term obligations or wealth targets, financial
strength, and liabilities are examples of factors that determine an
investor’s willingness to take the risk.
3. Investor’s Ability: An investor’s ability to take risk depends on
financial and practical factors that bound the amount of risk taken
by the investor. An investor’s short-term horizon will negatively
affect his ability. Similarly, if the investor’s obligation and spending
are less than his portfolio, he clearly has more ability.
Return Objective
The following steps are required to determine the return objective of the
investor:

7
 1. Specify Measure of Return: A measure of return needs to be
specified. It can be specified in an absolute term or a relative term.
It can also be specified in nominal or real terms. Nominal returns are
not adjusted for inflation, whereas real returns are. One may also
distinguish pre-tax returns from post-tax returns.
2. Desired Return: A return desired by the investor needs to be
determined. The desired return indicates how much return is
expected by the investor. E.g., higher or lower than average returns.
3. Required Return: A return required by the investor also needs to
be determined. A required return indicates the return which needs to
be achieved at the minimum for the investor.
4. Specific Return Objectives: The investor’s specific return
objectives also need to be determined so that they are consistent
with his risk objectives. An investor having a high return objective
needs to have a portfolio with a high level of expected risk.