INVESTMENT AND PORTFOLIO MANAGEMENT

UNIT: 1: INTRODUCTION TO
INVESTMENT (15%)
1. BASIC CONCEPT AND DEFINITIONS OF INVESTMENT.

Investment refers to the act of committing funds to assets with the goal of
generating income or capital growth. It involves two main elements: time and
risk. Essentially, investment is the choice to forgo present consumption in hopes
of gaining returns in the future. This decision requires a certain sacrifice today,
although the future return remains uncertain, highlighting the inherent risk in
investments. Investors accept this risk with the anticipation of earning returns.

For the average person, the idea of investment may simply mean a financial
commitment. For instance, buying a home for personal use might be seen as an
investment because it requires money and involves a sacrifice. However, since it
doesn’t produce financial returns, it is not classified as a true investment in the
financial sense.

From an economist’s perspective, investment is defined as an addition to the

nation’s capital stock, which includes goods and services used in the production
process. This might involve new buildings, equipment, or inventory that
contributes to the production of other goods and services.

Financial investment, in contrast, is the allocation of funds to assets expected to

generate returns over time, such as stocks or bonds. These investments are a form
of financial commitment made with the expectation of yielding income and
potentially experiencing capital growth. Financial investments channel individual
savings into the capital market, where they can be used for economic investments.

While financial and economic investments are interconnected, our focus is

primarily on financial investments in securities. In this context, investment can
be defined as the commitment of funds with an expectation of achieving a positive
rate of return. However, since returns are expected in the future, there’s a chance
that actual returns may fall short of expectations. This potential difference
between expected and actual returns represents investment risk. Therefore, all
investments carry both potential returns and associated risks.

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DEFINITIONS:-

Investment is when you put your money into something (like stocks, real estate,
or a business) hoping to make more money in the future. It’s about giving up
some cash now in exchange for the chance to earn a profit later.

The book definition of investment is often stated as:

“Investment is the commitment of funds made in anticipation of a positive rate of

return. It involves the sacrifice of current resources in the hope of future benefits
or profits.”

This definition emphasises that investment requires an initial outlay or sacrifice,

with the aim of generating income or growth in value over time.

Other definition:

Investment is the commitment of funds or resources with the expectation of

earning a return or profit in the future. It involves allocating money, time, or effort
to an asset or venture, with the goal of generating income, capital appreciation,
or other positive returns over a period of time. Investment inherently carries a
level of risk, as future returns are not guaranteed and may vary from the expected
outcome.

2. OBJECTIVES OF INVESTMENT.

I. The main objective of investment is to increase at the rate of return and reduce
the risk.
II. other objectives like

1) Safety
2) Liquidity
3) Return
4) Hedge against inflation
5) tax benefit
6) Risk

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1. Safety: The selected investment should be under the legal and regulatory
Framework. Every investor before investing his money he looked into safety
for his/her investment.

2. Liquidity: Other objectives of investment are liquidity. Liquidity means

easily converted into cash marketability of the investment provides liquidity
to the investment. The liquidity depends upon the marketing and trading
facility.

3. Return: Every investor another objective is excess of investment. Investor

always expects a good rate of return from their investment.

4. Hedge against inflation: Since there is inflation in almost all the economy
the rate of return should ensure a cover against the inflation. The returns rate
should be higher than the rate of inflation.

5. Tax benefit: Tax benefit is on one of important objective of the investor this
allows investor to reduce it taxable amount this is a Economics bonus which
applies to certain investment that are by statute, tax reduced

6. Risk: Risk of hold securities is related with the probability of actual returns
becoming less than the expected returns. The risk is just an as important as
measuring its expected rate of return because minimizing risk and maximizing
the rate of return are interrelated objectives in the investment

3. CHARACTERISTICS OF INVESTMENT.

1. Safety: Safety means protecting the money you’ve invested. Many investors
look for options where their initial money (the principal) is less likely to be
lost. While no investment is 100% safe, some like government bonds are
considered more secure than riskier options, like certain stocks.

2. Earnings: The main goal of investing is to make money over time. Earnings
can come from interest on a bond, dividends from stocks, or the increase in
value of a property or stock (called capital gains). This potential to grow your
money is what makes investment appealing.

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3. Convertibility: Convertibility, or liquidity, is how easily you can turn your

investment back into cash when you need it. Some investments, like stocks,
can be sold quickly, while others, like real estate, might take longer to sell
without a loss. Liquidity is important if you want the option to access your
money easily.

4. Underlying Risk: Every investment carries some risk, which is the chance
that it might not perform as expected, or you might lose money. For instance,
stocks can drop in value, and even seemingly safe investments can sometimes
have risks. Knowing and accepting the level of risk is a crucial part of
investing.

5. Return Potential: Investors expect their money to grow, which we call

returns. The potential return varies by investment type. Typically, higher
returns come with higher risks—like in stocks—while safer investments, such
as bonds, might offer lower returns. Balancing risk and return is key in
investment choices.

6. Economic Impact: Investments don’t just help the investor; they often
contribute to the broader economy. For instance, buying stocks or investing in
a business can support job creation and economic growth, so investments can
have a positive ripple effect.

7. Security of Capital: Investors typically want to ensure that the original

amount they invested remains intact. This is particularly important for
conservative investors who prioritize preserving their principal. Security of
capital helps provide peace of mind that their money is not at high risk of
complete loss.

The “SECURES” acronym covers the essential things most people consider to
make smart and suitable investment decisions, balancing potential gains with
protection and flexibility.

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4. INVESTMENT VS. SPECULATION AND GAMBLING.

Differences between investment, speculation, and gambling in easy-to-

understand terms, with key points and examples for each.

1. Purpose and Mindset

 Investment: The main goal is to grow wealth steadily over time by putting
money into assets like stocks, bonds, or real estate, hoping for stable, long-
term returns.
 Speculation: Here, the aim is to make quick gains by predicting short-term
price movements. This approach often involves higher risk and uncertainty.
 Gambling: In gambling, the purpose is often for entertainment, with a bet
placed in hopes of winning quickly, but with a very high risk of losing money.

Example: Buying a house to sell it in 10 years is investing; buying and quickly

reselling rare coins is speculation; betting on a sports game is gambling.

2. Risk Level

 Investment: Investments typically involve lower risk because they are based
on data and research, though some risk is always present.
 Speculation: Speculation carries a high level of risk, as it often relies on
market timing or unpredictable price swings.
 Gambling: Gambling has the highest level of risk, as outcomes are mostly
luck-based and unpredictable.

Example: Investing in a broad stock market index fund is lower risk; trading
cryptocurrency for fast gains is speculation; betting on a roulette wheel is
gambling.

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3. Decision Basis

 Investment: Decisions are based on research, financial analysis, and long-term

trends, such as a company’s performance.
 Speculation: Decisions are based on market conditions or news that might
cause quick price changes, with less emphasis on long-term trends.
 Gambling: Decisions are mostly guesswork or luck, without a basis in analysis
or research.

Example: Analyzing a company’s earnings before buying its stock is investing;

buying stock based on a sudden news event is speculation; picking numbers in a
lottery is gambling.

4. Time Horizon

 Investment: Investments are generally held over a long period, like years or
decades, to allow for steady growth.
 Speculation: Speculators focus on short-term gains, often buying and selling
assets within days, weeks, or months.
 Gambling: Gambling has an immediate time frame, as bets are typically
placed and resolved quickly.

Example: Saving in a retirement fund is investing; buying stocks with the

intention of selling in a few weeks is speculation; a poker game that’s over in
minutes is gambling.

5. Expectation of Returns

 Investment: Returns are generally expected to be steady but lower, reflecting

the lower risk over the long term.
 Speculation: Expected returns are high, as speculators take on more risk for a
chance at larger gains in a short period.
 Gambling: Returns are highly uncertain, with the odds usually stacked against
the gambler.

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Example: Expecting a modest yearly return from a bond is investing; expecting a

high return from a fast stock trade is speculation; hoping to double money in a
slot machine is gambling.

6. Control Over Outcome

 Investment: Investors have some control by choosing stable, research-backed

options and diversifying their portfolios.
 Speculation: Control is limited, as speculators are often at the mercy of market
volatility and external factors.
 Gambling: No control over the outcome; it’s entirely chance-based.

Example: A diversified portfolio provides some control over risks in investing;

speculation on stocks affected by economic news has less control; gambling on a
dice roll has no control.

7. Examples in Real Life

 Investment: Buying stocks in a stable company like Apple, purchasing real

estate, or investing in mutual funds for the long term.
 Speculation: Day trading in volatile stocks, trading options, or flipping newly
released tech products for quick profit.
 Gambling: Playing blackjack, betting on horse races, or playing the lottery.

In summary, investment focuses on long-term, steady growth, speculation aims

for short-term gains with higher risk, and gambling is about taking a high-stakes
chance with little control. Each has a distinct purpose, risk level, and approach.

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5. INVESTMENT DECISION MAKING PROCESS.

Step 1: Set Investment Policy

This step is about planning and setting goals for the investment. The investor
defines their approach, risk tolerance, and objectives. This policy acts like a
blueprint, guiding decisions and setting boundaries for what types of investments
to pursue.

Key parts of the investment policy:

 Mission Statement: Defines the purpose of the investment.

 Risk Tolerance: Understands how much risk the investor is willing to take.
 Investment Objectives: Sets clear goals, like growth, income, or a mix of both.
 Policy Asset Mix: Decides on the allocation of funds to different assets like
stocks and bonds.
 Active Management: Determines whether the investments will be actively
managed or passively followed.

Step 2: Perform Security Analysis

In this step, the investor analyzes different securities (such as stocks, bonds, etc.)
to identify the ones that fit their goals and offer fair returns.

This analysis includes:

 Economic Analysis: Understanding overall economic trends.

 Industry Analysis: Studying specific industries to find profitable sectors.
 Company Analysis: Looking at individual companies to assess their potential.

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There are two main approaches:

 Fundamental Analysis: Examines financial statements, earnings, and growth

potential.
 Technical Analysis: Looks at stock price trends and market patterns.

Step 3: Construct the Portfolio

The investor now builds their portfolio by choosing the specific assets and
deciding how much to allocate to each. The focus here is on selectivity (choosing
the best assets), timing (when to buy), and diversification (spreading risk across
different assets).

Approaches to portfolio construction:

 Traditional Approach: Focuses on balancing income and growth.

 Modern Approach: Uses models like Markowitz Risk-Return Optimization
and Sharpe’s Optimal Portfolio Model to balance risk and return.

Step 4: Portfolio Revisions

Over time, investments might need adjustments. This step is about updating the
portfolio by selling assets that aren’t performing well and buying new ones. It’s
a regular review to keep the portfolio aligned with goals and market conditions.

Some strategies used in revisions:

 Aggressive Portfolio: Higher risk for potentially higher returns.

 Conservative Portfolio: Lower risk with steadier, safer returns.
 Formula Plans: Help manage timing and emotional decisions in investing,
with approaches like:
 Constant Rupee Plan: Invests a fixed amount regularly.
 Constant Ratio Plan: Keeps a fixed ratio of different assets.
 Variable Ratio Plan: Adjusts ratios based on market performance.

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 Rupee Cost Averaging: Invests fixed amounts over time, reducing risk by
averaging costs.

Step 5: Evaluate Portfolio Performance

Finally, the investor evaluates how well the portfolio is performing in terms of
returns and risks. This is usually done by comparing the portfolio’s performance
against a benchmark.

Performance measures include:

 Sharpe’s Performance Measure: Assesses return per unit of risk.

 Treynor’s Performance Measure: Similar to Sharpe’s but uses a different risk
measure.
 Jensen’s Performance Measure: Compares actual returns to expected returns,
considering risk.

This evaluation helps the investor decide if changes are needed and ensures
they’re on track to meet their investment goals.

6. DIFFERENT INVESTMENT ALTERNATIVES AND THEIR RISK &

RETURN PROFILE.

1. Savings Accounts

Description: Savings accounts are offered by banks and post offices, allowing
individuals to deposit their money while earning a small amount of interest. They
are easy to open, and you can withdraw money anytime, making them ideal for
emergency funds or short-term savings.

Risk: Savings accounts are considered very low-risk because deposits are insured
by the government up to ₹5 lakh, meaning your money is safe even if the bank
faces financial difficulties.

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Return: The interest rates for savings accounts typically range from 2.5% to 4%
per year. While this is safe, it often doesn’t keep pace with inflation, so the real
value of your savings may decrease over time.

2. Fixed Deposits (FDs)

Description: Fixed deposits involve depositing a lump sum amount with a bank
for a fixed tenure, usually ranging from a few months to several years, at a
predetermined interest rate. It’s a popular choice for conservative investors
seeking guaranteed returns.

Risk: Like savings accounts, FDs are low-risk, with deposits also insured up to
₹5 lakh.

Return: You can expect interest rates from 5% to 8%. FDs provide better returns
than savings accounts, but you generally cannot access your funds before the term
ends without incurring penalties.

3. Public Provident Fund (PPF)

Description: The PPF is a long-term savings scheme backed by the government,

designed to promote savings for retirement. It has a minimum investment term of
15 years, making it suitable for long-term financial planning.

Risk: PPF is very safe since it’s government-backed, providing security for your
investment.

Return: The interest rate for PPF is around 7.1% per year, and the returns are
tax-free. This combination of safety, decent returns, and tax benefits makes it a
popular choice among savers.

4. Bonds

Description: Bonds are essentially loans that you provide to governments or

corporations, and in return, they pay you periodic interest and return your
principal at maturity. They come in various forms, including government bonds,
corporate bonds, and tax-free bonds.

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Risk: Government bonds are typically low-risk, while corporate bonds may carry
higher risks depending on the issuing company’s creditworthiness.

Return: Government bonds generally yield about 6% to 7%, while corporate

bonds can offer returns ranging from 8% to 10%. Higher yields usually indicate
greater risk.

5. Stocks

Description: Investing in stocks means purchasing shares of publicly traded

companies, allowing you to own a part of the business. This investment is suitable
for those looking for potential capital appreciation and dividends over time.

Risk: Stocks are more volatile compared to other investments, meaning their
prices can fluctuate significantly due to market conditions, company
performance, and economic factors.

Return: Historically, stocks have provided average returns of around 12% to

15% over the long term, making them a solid option for wealth accumulation.
However, it’s essential to be prepared for the possibility of short-term losses.

6. Mutual Funds

Description: Mutual funds pool money from multiple investors to create a

diversified portfolio of stocks, bonds, or other securities. They are managed by
professional fund managers who make investment decisions on behalf of
investors.

Risk: The risk associated with mutual funds varies based on their composition.
Equity mutual funds are generally riskier due to stock market volatility, while
debt mutual funds are considered safer.

Return: Equity mutual funds can offer returns of 10% to 15%, while debt funds
may provide 5% to 8%. Some funds also offer tax benefits under Section 80C of
the Income Tax Act, making them an attractive option for investors looking to
save on taxes.

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7. Exchange-Traded Funds (ETFs)

Description: ETFs are similar to mutual funds but trade on stock exchanges like
individual stocks. They often track specific indexes, such as the Nifty 50 or
Sensex, and provide an easy way to invest in a diversified portfolio.

Risk: The risk profile of ETFs depends on the underlying assets they hold, which
can range from low to high depending on whether they focus on stocks or bonds.

Return: Typically, ETFs yield returns similar to the index they track, often
around 10% to 12%. They offer liquidity and flexibility, allowing investors to
buy and sell throughout the trading day.

8. Real Estate

Description: Real estate investment involves purchasing property, such as

residential or commercial buildings, with the intention of generating rental
income or capital appreciation over time.

Risk: The real estate market can be subject to fluctuations based on economic
conditions, location, and market demand. It is also less liquid, meaning properties
can take time to sell.

Return: Real estate can yield returns ranging from 8% to 15%, especially in
growing urban areas. It’s often considered a good hedge against inflation, but it
requires a significant initial investment and ongoing management.

9. Gold

Description: Investing in gold can be done through physical gold, gold ETFs, or
sovereign gold bonds. Gold has traditionally been viewed as a safe-haven asset
in India, especially during economic uncertainty.

Risk: While generally stable, gold prices can fluctuate based on market
conditions, making it less predictable than fixed-income investments.

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Return: Over the long term, gold has historically provided returns of around
10%. Its value often rises during times of economic instability, making it a
valuable addition to a diversified portfolio.

10. Cryptocurrencies

Description: Cryptocurrencies like Bitcoin, Ethereum, and others are digital

assets that use blockchain technology. They have gained popularity in recent
years as alternative investments.

Risk: Cryptocurrencies are highly speculative and can experience extreme

volatility, with prices swinging dramatically within short periods.

Return: Potential returns can be substantial, with some investors reporting gains
of over 100%. However, many have also faced significant losses due to market
fluctuations, making them suitable only for risk-tolerant investors.

Conclusion

In India, investors have a wide range of options to choose from, each with its own
unique risk and return profile. Understanding these investment alternatives can
help you make informed decisions that align with your financial goals, risk
tolerance, and investment horizon. A well-balanced, diversified portfolio can
mitigate risk while aiming for better returns over time, ultimately supporting your
financial growth and stability.

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