SECURITY ANALYSIS & PORTFOLIO

MANAGEMENT
III B.Com/BBA – VI Semester
Investment - Introduction
• It is the allocation of money to obtain a return in future
• It is the sacrifice of current consumption with an expected benefit
 Savings
• Disposable Income minus Consumption - Surplus Income
• Savings - Not employed - not productive
• Investment - employed - Productive
• Individual Investors/Institutional Investors/Professional Investors
Power of Compounding
Let's compare two friends – Sonia and Peter. Sonia starts saving Rs. 750 per year from the time she is
15. After 15 years, she stops investing money.

On the other hand, Peter starts investing Rs. 5,000 per year when he is 30 and continues investing
this amount every year till he is 60.

If both earn 15% post-tax return per annum on their investments, who will have more wealth when
they retire at age 60?

Sonia. Her Rs. 750 annual savings between age 15 and 30 will aggregate to Rs. 27 lakhs by age 60,
whereas, Peter’s Rs.5,000 annual savings between age 30 and 60 will aggregate Rs. 25 lakhs.

The power of compounding is the single most important reason to start investing early.
Every day that your money is invested, is a day that your money is working for you.
Magic of Compounding
 Financial vs. Economic Meaning of Investment
Financial Sense Economic Sense
1. Commitment of person’s funds 1. Net additions to the economy’s
to derive future income such as capital stock ie. production of
interest, dividends, etc. goods & services
2. Such investments generate 2. Such investments generate
financial assets physical assets
3. Transfer of assets 3. Production of assets that leads
to capital formation
The two types of investments are, however, related and dependent.
The money invested in financial investments is ultimately converted
into physical assets.

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Forms of Investment
• Real Investment – purchase of physical assets like land, machinery…
• Financial Investment – purchase of ‘paper’ contract
Saver
Non-marketable Physical Assets
Financial Assets
Land & Building,
Bank deposit,
Investor Gold & Silver,
PF & LIC Schemes, Consumer
Pension Schemes, Durables
Post Office Certificates
Marketable Financial
Assets
Shares, Bonds,
Govt Securities,
Mutual funds…
Components of Financial Investment
• Markets
• Primary/Secondary Markets
• Capital/Money Markets
• Stocks/Foreign Exchange/Commodities/Derivatives Markets
• Securities
• Equity
• Debt
• Hybrid
• Financial Institutions
• Investment Process
• Investment Theories
Investment - Meaning

• Commitment of Funds
• For a Period of Time
• To derive Future Income
• Regular Returns
• Capital Appreciation
• Rate of Return from investment should compensate the Investor:
i. Time – Nominal Rate
ii. Inflation – Real Rate
iii. Risk – Risk Adjusted Rate
Investment vs. Speculation

Case 1:
After an in depth analysis of the market, Mr. A buys 1000 shares of RIL Ltd. @ of
Rs.1,520 each on 28.6.2020. He decides to hold it for few years as he is satisfied
that the company would do well and would be able to pay regular dividends.
Case 2:
On the same day, Mr. S decides to buy the same company’s shares. After
studying the graphs and the charts of the price movements of RIL stocks he
expects that the price would shoot up in a couple of days when he would sell the
shares and make profit.
Speculation/Speculators
• Speculation is the buying of financial instrument with the hope of increase in
price in the near future
• Speculators are people who engage in speculative investments, a person who
buys financial instruments, commodities, or currencies with the hope of selling
them at a profit on a future date
• Is speculation good or bad?
• Types of Speculators
Speculation vs. Investment

• Speculative investors tend to make decisions more often based on Technical

Analysis of market price action rather than on Fundamental Analysis of a security
• They also tend to be more active market traders – often seeking to profit from
short-term price fluctuations and contribute to market liquidity – as opposed to
being “buy and hold” investors
• Speculators do not hesitate to invest in Penny Stocks which trade at low prices
where more conservative investors shy away
 Investment vs. Speculation

Investment Speculation
1. Long Term 1. Short Term
2. Moderate Returns 2. High Returns
3. High Risk
3. Limited Risk 4. Borrowed Funds
4. Own Funds 5. Greater contribution to
5. Lesser contribution to Market Liquidity
Market Liquidity 6. Technical Analysis
6. Fundamental Analysis

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Arbitrage

• Transaction which makes profit without risk

• Trading (buy & sell) the same security at the same time in different markets
• Taking advantage of price differences
• Enhances liquidity/volume of trade and corrects market inefficiencies

Eg. Suppose a futures contract trades in two different exchanges. If, at one point in
time, the contract is bid at INR 145.02 on one exchange and offered at INR 145.00
on the other, a trader could purchase the contract at one price and sell it at the
other to make a risk-free profit of a INR 0.02.
Hedging
• Insurance against negative event
• Means of reducing risk of loss caused by price fluctuations
• Taking a position in the Derivative Market that is opposite to the one in the
physical market

Eg. A wheat farmer sells wheat futures to protect the value of his crop prior to
harvest. If there is a fall in price, the loss in the cash market will be countered by
a gain in futures position.
Gambling

• Game of chance
• For high profits & associated excitement
• Unplanned & Unscientific
• Purely based on hunches
• Short term
• More risky
What is a Financial Security?
• Financial asset
• Claims on money
• Promissory note
• Intangible investment
• Marketable

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What is Security Analysis?
• In the traditional sense, it involves the projection of future dividend, earnings,
forecast of the future share price and estimating the intrinsic value of the security
• According to the modern theories, it also includes the risk-return analysis depending
on the variability of the returns, a study on the strengths and weaknesses of the
company, projections of expansion, tax planning, etc.
• Purpose is to identify:
• Undervalued securities for buying and
• Overvalued securities for selling

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 What is a Portfolio?

• It a combination of securities with varying risk – return characteristics

• A distinct entity with measureable characteristics and is not just the sum of its
component parts
• Carefully selected after considering the goals and constraints of the investor
• Efficiently diversified
“Don’t put all eggs in one Basket”

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 What is Portfolio Management?
• Investment decision making, applying the principles of management
• Deciding what to buy/sell and when
• Proper money management in terms of ratio of investment in the basket of securities
• To reduce risk and maximise returns
• Includes periodic revision
“Portfolio management may be thought of as a decision making process which has to
do with choosing and revising portfolio of securities so as to satisfy investor objectives”

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Portfolio/Investment Management Process
1. Investment Objectives
2. Investment Constraints
3. Deciding on the Asset Mix
4. Formulation of Portfolio Strategy
5. Selection of Securities
6. Portfolio Execution
7. Portfolio Evaluation
8. Portfolio Revision

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1. Investment Objectives:
 Current/Regular Income
 Capital Appreciation/Growth
 Capital Preservation
 Protection against Inflation
 Specific Goals
2. Investment Constraints:
 Availability of Funds
 Knowledge
 Available Time
 Liquidity
 Time Horizon – Short term/Long term
 Tax Considerations
 Legal and Regulatory concerns
 Risk Factor

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3.Deciding on the Asset Mix
 Proportion of Stock & Bond – according to investor’s requirements i.e. objectives
& constraints

4. Formulation of Investment Strategy

 Value Investing
 Income Investing Passive Strategies
 Growth Investing
 Active Trading - Active Strategy
5. Selection of Securities
 Fundamental Analysis on stocks
 Technical Analysis
 Yield to Maturity - on bonds
 Credit Rating - on debt securities
6. Portfolio Execution/Construction
 practical step when actual buying/selling is implemented
 Timing of the investment is to be determined by observing the movement of the
prices
 Securities with positive correlation should be avoided
7. Portfolio Evaluation
• Risk and Return of the portfolio need to be calculated and compared with
standard yard sticks using quantitative methods
• Find out if returns generated is commensurate with risk undertaken
8. Portfolio Revision
• Periodic rebalancing of the portfolio is required to accommodate fluctuations in
prices
• Unattractive securities have to eliminated from the portfolio
• New and more attractive securities have to be included
• Revision may include shift from stocks to bonds or vice versa and also sector
rotation to maximise returns

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