Capital Markets and Portfolio Analysis KEY LEARNINGS Capital markets trade securities with lives of more than one year CAPITAL MARKETS 5 Investments Security Analysis A three-step process 1)The analyst considers prospects for the economy, given the state of the business cycle. 2)The analyst determines which industries are likely to fare well in the forecasted economic conditions. 3)The analyst chooses particular companies within the favored industries (EIC Analysis) Portfolio Management 7 The Six Steps of Portfolio Management 1. Learn the basic principles of finance. 2. Set portfolio objectives. 3. Formulate an investment strategy. 4. Have a game plan for portfolio revision. 5. Evaluate performance. 6. Protect the portfolio when appropriate. RISK & RETURN: Measuring Returns Capital gain(loss) return= P1-P0 P0 Total return = Dividend + Capital gain Average rate of return [8-2] T he return of a portfolio is equal to the weighted average of the returns of individual assets (or securities) in the portfolio with weights being equal to the proportion of investment value in each asset. STYLES OF INVESTMENT ValueGrowthMomentum Capital Market Primary Market Stock Market Secondary Market Bond Market The market for long term securities like bonds, equity stocks is divided into PRIMARY MARKET and SECONDARY MARKET. PRIMARY MARKET Deals with the new issues of securities. SECONDARY MARKET Deals with outstanding securities. Also known as STOCK MARKET. For securities, where companies and governments can raise long-term funds Components: Stock markets Bond markets Stock Market market for the trading of company stock and derivatives securities listed on a stock exchange Bond Market financial market where participants buy and sell debt securities refers to the government bond market Trading Pattern spot delivery transactions forward delivery transactions Role of the Capital Market canalize investments from the investors types of financial instruments equity instruments credit market instruments insurance instruments foreign exchange instruments hybrid instruments derivative instruments. Experienced sweeping changes Indias government bond segment is comparable Innovative products Facilitate investment and economic growth. Improving macroeconomic fundamentals, A sizeable skilled labour force and Greater integration with the world economy And, despite its increasing correlation with world markets in recent years (see chart 2), India still offers diversification in global portfolios. Nearly 90% of total domestic bonds outstanding are government issuances (i.e. Treasury bills, notes and bonds), squeezing out corporate and other marketable debt securities. 1 And unlike the derivative instruments that are available for equities, those for fixed income instruments (e.g. options in interest rates) in the organised exchanges have failed to take off, limiting the price discovery in the secondary markets. 2 Although India does have a functional legal system, the countrys law enforcement still lags behind the more advanced economies of Hong Kong and Singapore according to the World Bank This implies that efforts to raise corporate governance need to be accompanied by a stronger legal framework to bring greater stability in its capital markets and foster investor confidence. In total, Indias debt and equity markets were equivalent to 130% of GDP at the end of This is an impressive stride, coming from just 75% in 1995, suggesting issuers growing confidence in market based financing. Investment positions are undertaken with the goal of earning some expected return. Diversification is essentialreduce the variability of returns A single asset or portfolio of assets is considered to be efficient if no other offers higher expected return with the same risk Portfolio Analysis is a study of the performance of specific portfolios under different circumstances. Includes the efforts made to achieve the best trade-off between risk tolerance and returns Involves quantifying the operational and financial impact of the portfolio. Extends to all classes of investments Bonds Equities Indexes Commodities Funds Options Securities Portfolio analysis is broadly carried out for each asset at two levels: Risk aversion Analyzing returns Risk aversion Analyzes the portfolio composition while considering the risk appetite of an investor Analyzing returns Prospective returns are calculated through the average and compound return (arithmetic mean that considers the cumulative effect on overall returns) methods Portfolio Analysis Markowitz Mean-Variance Analysis Considers the correlation between individual securities Three types of correlation Perfect positive correlation Perfect negative correlation Zero correlation Capital Asset Pricing Model (CAPM) Determine a theoretically appropriate required rate of return of an asset The model takes into account the asset's sensitivity to non-diversifiable risk () Alpha a risk-adjusted measure of the so-called active return on an investment indicates how an investment has performed after accounting for the risk it involved Portfolio Analysis tools Determining dispersion of returns the measure of volatility or standard deviation of returns for a particular asset Portfolio Expected Return Portfolio Risk STANDARD DEVIATION Association between the returns for a pair of securities - COVARIANCE Use these risk and return statistics in choosing/combining assets in such a way that will result in minimum risk at a given level of return, also called efficient portfolios Formulates an investment strategy based on the investment policy statement. Must understand the basic elements of capital market theory. Various stock categories have to be analyzed. Subsequently, portfolio has to be managed o_theory al-market/ Group 2 Akanki Agarwal Sheetal Shokeen Varuna Madaan Amita Esha Kukreja Dixit Goyal Kapial Sharma Harneet Kaur