Module 1
Introduction to Investment
and security analysis
WHAT IS INVESTMENT
Meaning of Investment
• Investment is employment of funds on assets with the aim of
earning income or capital appreciation.
• Allocation of money to assets that are expected to yield some gain
over a period of time.
• From an Economist point of view investment is net addition made
to nation’s capital stock that consists of goods and services that
are used in the production process.
Speculation and Gambling
• Speculation-:
• Involves buying and selling activities with the expectation of getting profit
from the price fluctuations.
• Very short period.
• Willing to undertake high risk.
• High returns and high risk.
• Consider insider information and market behavior.
• Uses borrowed fund to supplement his personal resources.
• Gambling-:
• A very short term of investment.
• People gamble as away to entertain themselves.
• Risk in gambling is different from risk in investment.
• Gambling employs artificial risk.
• Does not reduce the risk proportion.
Investment Avenues
• Investor has to choose proper avenues from among them depending
on his/her preferences, needs and ability to assume risk.
• The investment avenues can be broadly categorized under the
following heads-:
1.Corporate securities-:
• Equity shares
• Preference shares
• High risk and high return
2. Deposits-:
• Among non-corporate investments the most popular are deposits
with banks saving a/c and fixed deposits.
3. UTI and Mutual fund schemes-:
4. Post office deposits and certificates-:
• Post office deposits are generally non- marketable and offers tax
concessions.
• National savings certificates issued by post office to investors for
a period of six years.
• Indira Vikas Patra, Kissan Vikas Patra.
5. Life insurance policies-:
• LIC offers many investment schemes to investors.
• Whole life policies
• Jeevan saathi
• Money back plan
• Jeevan dhara etc
6. Provident fund schemes-:
• Recognised provident fund
• Unrecognised provident fund
• Public provident fund
7. Government and semi government funds
• Bonds, Treasury bills .
• 8. Real estate
• 9.Gold and silver
• 10. Art
• 11. Antiques
• 12. Bonds-(secured and unsecured, perpetual and redeemable,
fixed and floating interest rate, zero coupon bonds/deep
discounted bonds)
Par , premium and discount
• 13. Debentures (secured and unsecured, fully convertible, partly
convertible, non convertible) ( sinking fund)
Redeemed in installments
Rated by credit rating agencies
Investment objectives
• Return-: Total income the investor receives during the holding
period.
• Risk
• Liquidity
• Hedge against inflation- rate of return to be higher than
inflation, investing in growth stocks provide a protection
against inflation.
• Safety-legal and regulatory framework.
Investment process
• Investment policy
1. Investible funds
2. Objectives
3. knowledge
Security analysis
• Market analysis
• Industry analysis
• Company analysis
Valuation
• Intrinsic value
• Future value
Portfolio construction
• Diversification
• Debt and equity diversification
• Industry diversification
• Company diversification
• selection
Evaluation
1.Appraisal -: return and risk performance of a security vary
from time to time.
• The appraisal warns the loss and steps to be taken to avoid
such losses.
2. Revision -: revise the components of the portfolio
periodically.
Types of investors
1. Individual investors-:
• Large in number
• Investable resources are comparatively small
• Lack skill to carry out extensive evaluation
• They do not have time and resources to engage in analysis
• 2. Institutional investors-:
• Organizations with surplus money
• Mutual fund companies
• Investment companies
• Banking and non banking companies
• Insurance corporations
• Engage professional fund managers to carry out extensive
analysis of investment opportunities
• Better chance of maximizing return and minimizing risk
Security Analysis
• Involves an examination of expected return and
accompanying risk.
• The entire process of estimating return and risk for individual
securities is know as securities analysis.
• Understanding and measuring risk and return is fundamental
to the investment process.
Risk and uncertainty
• Meaning of Risk-:
• Existence of volatility in occurrence of an expected incident is
called risk.
• Higher the unpredictability greater is the risk
• Risk is associated with the possibility of not realizing returns
expected
Causes of risk
• Wrong method of investment
• Wrong timing of investment
• Wrong quantity of investment
• Interest rate risk
• Nature of investment instrument
• Nature of industry in which the company is operating
Causes of risk
• Length of the investment
• Terms of lending
• National and international factors
• Natural calamities, war etc
Types of risk
• SYSTEMATIC RISK-: undiversifiable risk relates to economic,
social, political changes. Cannot be avoided.
• 1. Market risk-: arises out of changes in demand and supply
pressure.
• 2. Interest rate risk -: changes in interest rates
• 3. Purchasing power risk- due to inflation and deflation
UNSYSTEMATIC RISK
• This type of risk is unique or related to the firm and can be
controlled if proper measures are taken.
• 1. Business risk-: internal and external
• 2. Financial risk
• 3. Credit or default risk
Minimizing risk exposure
• MARKET RISK PROTECTION
• Price behavior of the stock
• Stock showing growth pattern may continue to grow for some more period
• Some stock may be cyclical
• Standard deviation and beta indicate volatility which is included in indices
• The investor can gauge the risk factor according to his risk tolerance
• Investor should be careful about timing of purchase and sale of stock
Minimizing risk exposure
• PROTECTION AGAINST INTEREST RATE RISK
• To hold the investment till maturity and not sell it in the
middle due to fall in interest rate
• The portfolio manager can invest in treasury bills and bonds
of short maturity
• Invest in bonds with different maturity dates, when the bonds
mature reinvestment can be done according to the changes
in investment climate
Minimizing risk exposure
• PROTECTION AGAINST INFLATION
• Generally bonds and debentures provide a hedge against
inflation if their yield is 13 to 15 % with low risk
• Another way to avoid risk is to have investment in short term
securities
• Investment diversification can also solve this problem, as the
investor has to diversify his investment in real estates,
precious metals, art and antiques.
Minimizing risk exposure
• PROTECTION AGAINST BUSINESS AND FINANCIAL RISK
• To guard against business risk investor has to analyze strength and
weakness of the industry
• Analyzing the profitability trend of the company is essential
• The investor has to choose a stock of consistent track record
• The financial risk can be minimized by analyzing capital structure
• In a boom period investor can invest in highly levered firm but not in a
recession
MEASUREMENT OF RISK
Risk measurement refers to evaluating and quantifying potential loss associated with a decision,
action, or investment. It aims at prioritizing the severity of potential consequences of any action
and accordingly planning the resource allocation for maximizing return while taking a
calculative risk.
Methods
1.Standard Deviation: It measures the dispersion of a set of data points from their mean. In finance, it represents
the volatility of an investment's price.
2.Alpha: It gauges the comparative risk profile of a fund concerning the overall market or a given benchmark like the
Russell 2000 Index.
3.Beta Coefficient: Beta measures a stock's volatility about the market or a particular benchmark index. A beta of 1 reflects
that the investment's price will move with the flow of the market. Less than 1 means less systemic risk, and more than 1
means more volatility.
4.R-Squared: R-squared or coefficient of determination represents that in a regression model, the dependent variable's
variance ratio is identifiable from the independent variables.
5.Sharpe Ratio: It measures the excess return (or risk premium) per unit of risk (volatility) an investor is willing to take. An
elevated Sharpe ratio shows better risk-adjusted performance.
6.Value at Risk (VaR): VaR identifies the high possible loss in an investment within a specific time frame when normal
market conditions prevail.
7.Sensitivity Analysis: This method evaluates how the variation in one variable (independent variable) affects the outcome
of another variable (dependent variable). It's commonly used in project management to assess the impact of different project
risks.
8.Coefficient of Variation: CV assesses the relative variability of a dataset in comparison to its mean. The formula is CV =
(Mean/Standard Deviation)x100.
Volatility refers to the degree of variation in the price or value of an
asset, security, or market over a specific period. It measures how much
the price of an asset fluctuates around its average price or return. Higher
volatility indicates greater price swings, while lower volatility suggests
more stable price movements.
