investment analysis and portfolio management book

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Investment analysis and portfolio management book




Investment analysis and portfolio management


UNIT I 1. Investment Analysis and Portfolio Management

UNIT II 2. Financial Investment Avenue


3. Investment Analysis


4. Approaches to Investment Analysis


5. Portfolio Construction and Choice


6. Capital Asset Pricing Model


7. Portfolio Performance

Lesson 1

Investment Analysis and Portfolio Management


Investment is the sacrifice of current liquidity or current rupees or current dollars for future liquidity, future rupees or future dollars. There are different concepts and types of investment. In detail, these concepts and types of investment are dealt in this lesson.

Concepts of investment

There are two concepts of investment, viz, the economic concept and the financial concept.

The economic concept of investment refers to investment as expenditures on new plants, machinery, capital equipment and so forth, with the hope of making added wealth. To make added wealth, the rate of return on the investment must be more than the real cost of capital. Suppose, one estimated that his investment in the above referred to assets is giving him a real of return of 15.5% p.a. and his nominal cost of capital is 20% inflation being 10%. The real cost of capital is given by nominal cost inflation rate = 20% - 10% = 10%. Then, the investor makes a net wealth addition to the extent of 1(1 + r) / (1 + K*) I, where I = original investment, r = real rate of return and K* = real cost of capital. If we assume an I = Rs. 100 mn, then

Wealth addition= Rs. 100 mn (1 + 15.5%) / (1+10%) Rs. 100 mn

= Rs. 100 mn (1.155) / (1.1) Rs. 100 mn

= Rs. 105 mn-Rs. 100 mn = Rs. 5 mn

The economic concept of investment is wealth creating oriented and that depends on Return on investment (r) and real cost of capital (K *). Only if r > K * wealth addition result. If r = K *, neither wealth addition nor wealth depletion results. If r < K *, wealth depletion takes places.

The financial concept of investment refers to investment as, commitment of funds in financial assets with the hope of getting current income in the form of dividend or interest and / or capital gain:. It is nothing but sacrificing certain present consumption for a hoped for enhanced future consumption. Put otherwise, investment is postponement of consumption. That is savings are considered as investment. Savings can be in any form. A farmer produces 100 bags of paddy, but consumes only 40 bags of paddy and difference is his savings and hence his investment. A salaried employee earning Rs. 2 lakh p.a. and his consumption expenditure is Rs. 1.5 lakhs and hence his savings Rs. 50,000 amount to investment which may be in the form of undrawn bank balance, shares, debentures, gold, National Savings Certificates Etc.

Goals of Investment Whatever may be the nature of investment, whether it is economic or financial, it has lot of motives. They are as follows:

1. Get decent current income

2. Obtain reasonable capital gain

3. Benefit from tax-off

4. Right to participate in growth

5. Reduce risk, given overall return

6. Maximize return, given risk

7. Ensure safety of investment

8. Provide for liquidity of investment

9. Easy transferability

10. Preference of pledgeability

11. Protection for future

12. Beat the inflation

13. Sense of participation in national economic development

14. Fulfillment of security, social and esteem needs

15. Economic power

Let us explain each of these goals to an extent.

Get decent current income

Current income is the periodic (monthly, quarterly, semi-annual or annual) return in the form of interest or dividend or party-pay back. Usually debt investments or some mutual funds or some life policies give/guarantee periodic income. Shares of companies with unbroken dividend income.

Current income is surer than future income, as it is analogous to a bird in hand, as against two in the bush. Current income is desired by risk-averters, small investors, income mutual funds and such featured investors. Tax benefit u/s 80L is available for current income.

Obtain reasonable capital gain

Capital appreciation is net value addition. If it is available in addition to current income, it is double welcome for investors. Tax benefit u/s (48(2) is available for capital gain, after indexation for inflation. Capital gain is bit riskier as it involves a peep into the future which is beset with uncertainty and risk. Shares in growth companies, good turnaround shares, shares in leveraged buy-outs, shares in successful venture schemes, convertible debentures in blue-chips, global depository and American Depository receipts of growth concerns, zero coupon bonds, deep discount bonds, growth mutual funds, etc promise capital gain. Big investors and risk-seeking investors, prefer capital gain to current income.

Benefit through tax-off

Investors prefer tax-benefit coated investments. Income Tax Act Provisions 80L and 48(2) give tax concessions for current and capital incomes respectively. Besides, tax benefit on investment committed is also available. U/s 88 of the IT Act, investments in NSC, NSS, 10/15 years P.O. savings schemes, LIC policies, Mediclaim policies, PF, PPF, SPF, GIS, equity-committed mutual funds schemes, investment in self-occupied house property to the extent principle repaid, limited to Rs. 10,000 at the maximum out of income, on loans taken for house construction, etc. qualify for tax rebate. Salaried employees in India find this tax-benefit really alluring. The one exception is equity related mutual fund schemes which have not gone fads. There are no investors, and hence no floaters, of late.

Pre-emptive right to participate in growth firms

If a blue-chip company goes to expand, the additional fresh equity capital required to fund expansion is first sought from existing shareholders, giving them a chance to participate in the companys growth. The shares are issued at discount to market price and that for existing shareholders such right offers, are real bonanza. One has to be at least a moderate sized investor, if not big, to benefit from right offers. Of course, rights can be sold in full or part and that all shareholders can benefit. To right holders capital gain results, as well as current income, as their shareholding base is a bit increased.

Reduce risk, given return

The dominant goal of investors is to optimize return and risk. Return is the sum total of all benefit expressed annualized % figures. Risk is the std-deviation. i.e., fluctuation, of the returns. As investments are made in plural number of securities, it is possible to reduce risk, without a fall in the overall return. That is what investors aspire for.

Increase return, given risk

A corollary of the previous goal is, maximize return, keeping risk a constant level. Like the previous one, this goal is possible when one goes for a portfolio of investment.

Ensure safety of investment

Safety of principal is very important. Return of capital invested in fact, at least must be granted. Return of capital is more important than return on capital. Many a stocks are quoting below par, not at all quoted and hence not saleable or quote at below issue price. In these cases, where is safety of capital? Even if principal is in tact, inflation reduces the real value of principal sum. Govt. securities (also called as gifts), bank deposits, blue-chip bonds/shares, etc ensure safety of investment. The fly-by-night finance companies are black-sheep who cheat gullible investors. All investors need safety of principal. If that is not ensured, the whole of capital market system shall go out-of-gear and rubbish.

Provide for liquidity

Investment is postponement of consumption. It is not permanent postponement. So, when needed the investment must be realizable in cash without loss of time and value. Bank deposits generally have liquidity. Gilts have liquidity, Bluechip shares have liquidity. Gold has liquidity. All the rest have limited or no liquidity. Unquoted shares, delisted shares etc virtually have no liquidity. All investors need liquidity of their investments.

Easy transferability

Easy transferability refers to minimum procedures, less paper work, no stamp duty, no-recourse, etc. Perhaps bearer bonds are easiest to transfer. For listed scrips the procedure laid out for share/bond transfer is to be followed. Delay must be avoided.

Preference for pledgeability

Pledgeability refers to ability to raise fund on the collateral of the investment held. Most investments have this. But volatile shocks have less Pledgeability.

Protection for future

Investment is to facilitate and provide for future consumption of the investor and / or his kith and kin. So, one of the investment objectives is to provide for the futures.

Bet the inflation As inflation is inevitable, to suffer not value decrease cash holdings, bank balances, etc be reduces and investment in value-adding investment alternatives is required. Even bonds may not help beating inflation, only growth shares like the MNC scrips, like the sun-rise industries scrips, performing growth mutual funds and convertible scrips can beat inflation.

Sense of nation building

Investments determine economic growth. Higher Investment lead to higher economic growth leading to more employment, more income, more savings and more investment. This is a virtuous cyc


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