module 1 inv

8/3/2019 Module 1 Inv.

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SECURITY ANALYS`IS

AND

PORTFOLIO MANAGEMENT


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Module 1

Introduction to the landscape ofInvestment

Indian Capital Markets World markets and various indices

Risk and Return in Investment


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Introduction to the landscape

of Investment InvestmentInvestment refers to the purchasing of

securities or other financial assets from thecapital market. It also means buying moneymarket or real properties with high marketliquidity. Some examples are gold, silver, realproperties, and deposits.


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Introduction of Investment

Financial investments are in stocks, bonds,and other types of security.

Indirect financial investments can also bedone with the help of mediators or thirdparties, such as pension funds, mutual funds,

commercial banks, and insurancecompanies.


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Modes of Investment

A. Security forms of Investment

1. Corporate Bonds/Debentures2. Public Sector Bonds

3. Preference Shares

4. Equity Shares


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Modes of Investment

B. Non-Security Forms of Investment

1. National Savings Scheme2. National Savings Certificates

3. Provident Funds

4. Corporate Fixed Deposits5. Life Insurance Policies

6. Unit Schemes

7. Post Savings Bank Accounts


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Portfolio Management

Portfolios are combinations of assets held bythe investors.

Selection of such securities that would fit inwell with the assets preferences, needs andchoice of the investors.


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Investment Alternatives

Real Estate

Gold

Shares Mutual Funds

Bonds

Fixed Deposits Insurance/ ULIP


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Real Estate

Commercial Real Estate:Commercial real estate involves a real estateinvestment in properties for commercial

purposes such as renting.

Residential Real Estate:

This is the most basic type of real estate

investment, which involves buying houses asreal estate properties.


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Gold

Gold ETFs allow investment in gold in smalldenominations, which makes it easier for theretail investor to participate.

Physical Gold


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Shares

Investment in Stock market for long term,trading with margins or doing short sales


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Investor

FundManger

Securities

Returns

Pool their money with

Invest InGenerates

passed back to

Mutual Funds


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Mutual Funds

A professionally managed type of collectiveinvestment scheme that pools money frommany investors and invests it in stocks,

bonds, short-term money market instruments,and/or other securities.


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Bonds / Fixed Deposits

A fixed deposit account allows to depositmoney for a set period of time, therebyearning a higher rate of interest in return.

Bonds are fixed interest bearing certificatesissued by government or similar for a fixedperiod of time.


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Insurance / ULIP

Unit linked Insurance plans provides safetyfor life as well as financial security for the oldage, critical situations etc.


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Structure of Capital Market

Primary MarketNew Issue Market

Secondary MarketStock market

Public Issue

Bonus Issue

PrivatePlacement

Right Issue


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Primary Market

Public Issue The company issuesshares or debentures from the generalpublic and collect necessary funds.

Right Issue It is the method ofraising capital from existingshareholders by offering additionalsecurities on Pro-rata basis.


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Primary Market

Bonus Issue It is issued to itsexisting shareholders when theaccumulated profits and reserves arevery high.

Private Placement It is way of sellingsecurities privately to small group ofinvestors i.e. UTI, LIC, GIC, GSFCetc.


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Development in

Indian Capital Market

Secondary Markets

23 Stock Exchanges in India BSE and NSE leading Stock

exchange of India


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The Process of Investment Trading

NSE Introduced a nation wide fullyautomated screen based tradingsystem (SBTS)

BSE switched to fully automatedtrading on 14 march 1995, (known asBSE On Line Trading BOLT)


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NSE Member enter the price and shares he want to buy or sale

Transaction gets executed as soon as the system finds

matching sale or by order

SBTS matches orders on strict price/time priority


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Pune 11:09Buy IOC @ 300

Mumbai 11:08Buy IOC @ 300

Delhi 11:05Buy IOC @ 301

Agra 11:04Buy IOC @ 302

Bhuj 11:00Sell IOC @ 300

Goa 11:00Sell IOC @ 301


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Trading in rolling settlement aresettled on T + 2 basis

Activity Day

Trading Rolling Settlement Trading T

Clearing Custodial Confirmation T + 1 WD

Delivery Generation T + 1 WD

Settlement Securities and Funds Pay in T + 2 WD

Securities and Funds Pay out T + 2 WD


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TYPES OF ORDERS


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Types of Orders

1. Market Order

Market orders are simply buy or sell

orders that are to be executedimmediately at current market price.


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Types of Orders

2. Limit orders

Investors specify prices at which they

are willing to buy or sell a security.

if the stock falls below the limit on a

limit buy order then the trade is to beexecuted.


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Types of Orders

2. Limit orders

Investor placed a buy order for 50

shares of ABB at Rs. 345 as Limitbuy order. If the price of ABB falls at344.20, than the order is executed.


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Types of Orders

3. Best orders

Best orders are at the top of the list:

the offers to buy at the lowest priceand to sell at the highest price.

The buy and sell orders at the top ofthe list Rs. 235 and Rs. 242


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Types of Orders

4. Day Orders

It expires at the close of the trading

days.5. Open or good till canceled

Remain in force for up to 6 Months

unless canceled by the customer


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Types of Orders

6. Fill or Kill Orders expire if thebroker cannot fill them immediately.


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Margin Trading

The act of taking advantage ofbrokers loans is called buying onmargins.

In the US, the current marginrequirement is 50%

There may be for intra-day or weeklymargin trading facility


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Margin Trading

The percentage margin is defined asthe ratio of the networth of theaccount to the market value of thesecurities.


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Margin Trading

If the stock price decline to Rs.70 per share,the account balance becomes:

Assets Liability_____________ Value 7000 Margin 4000

Equity trader 3000

Percentage of margin 43%


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Maintenance Margin

If the stock value fall below Rs.4000, equitywould become negative.

If margin falls below level, the broker willissue a Margin Call


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Short Sales

A short sale allows investors to profitfrom a decline in a securitys price

An investors borrows a share of stockfrom a borrower and sells it. Later theshort seller must purchase the samestock in the market


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VARIOUS INDICES

ANDITS CONSTRUCTION


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World Markets

India

Bombay Stock Exchange Limited:

National Stock Exchange of India:United States

American Stock Exchange

Chicago Stock ExchangeNasdaq-Amex

New York Stock Exchange


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World Markets

Great Britain

The London Stock Exchange

Japan

Tokyo Stock Exchange (TSE):


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NASDAQ

In 1971, the National Association ofSecurities Dealers AutomatedQuotation System (NASDAQ) beganto offer immediate information oncomputer linked system of bid andasked prices for stocks offered by

various dealers.


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NASDAQ

Bid price is that at which a dealer iswilling to purchase a security

Asked price is that at which thedealers sell a security


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NASDAQ

Nasdaq is divided into 2 sectors,

1. Nasdaq national market system2. Nasdaq Small Cap Market


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NASDAQ

Nasdaq has 3 levels of Subscribers

I. Level I are not actively buying orselling security

II. Level II tend to be brokerage firms

III. Level III are making markets buying and selling stock actively


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London Stock Exchange

Untill 1997, trading arrangements inLondon were similar to those onnasdaq.

In 1997, LSE introduced an electronictrading system named SETS (StockExchage Electonic Trading Service).


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Euronext

Euronext was formed in 2000 by amerger of the paris, Amsterdam andBrussels exchange.

It uses an electronic trading systemcalled NSC (New Quotation System)


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Euronext

In 2001, it also purchased LIFFE, theLondon International Financial Futuresand Options Exchange


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Tokyo Stock Exchange (TSE)

TSE is the largest stock exchange injapan. A saitori maintains theoperations of the stock exchange.


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Tokyo Stock Exchange (TSE)

TSE organizes stock into twocategories

1. The first sections consists of about1200 of the most actively tradedstock

2. Second section is for less activelytraded stock.


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Nifty - Sensex

It is constructed as a value-weightedindex. Market capitalization of eachstock is multiplied with a free floatfactor to arrive at the modified marketcapitalization of the stocks.


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Nifty - Sensex

Total market cap of Infosys 59080 Cr

Free float adjustment factor 0.8

Free float market cap of infosys

= 59080 x 0.8 = 47264 cr.


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Nifty - Sensex

Combine Free-float market cap ofSensex = 387067

Weight of infosys in sensex

= 47264 = 12.21%

387067


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Types of Risk

Real Return and Nominal Return

Historical and Expected Return


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1. Systematic Risk

2. Unsystematic Risk


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1. Market Risk

2. Interest Rate Risk

3. Purchasing Power or Inflation Risk4. Credit Risk

5. Economic Risk


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1. Business Risk

2. Financial Risk

3. Management Risk4. Input Risk


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Market Risk

This is the risk to an institution'sfinancial condition resulting fromadverse movements in the level orvolatility of market prices of interestrate instruments, equities,

commodities and currencies.


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Market Risk

A. liquidity risk

Funding liquidity risk is defined as theinability to obtain funds to meet cashflow obligations.


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Market Risk

B. Legal Risk

Which is the risk that a transactionproves unenforceable in law orbecause it has been inadequatelydocumented


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Market Risk

C. Operational risk

The risk of unexpected losses arisingfrom deficiencies in a firm'smanagement information, support andcontrol systems and procedures.


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Inflation Risk

Risk of fluctuating in the prices of thesecurities due to the adverse effect ofInflation and other economicconditions is known as Inflation Risk.


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Credit Risk

The risk of a trading partner notfulfilling his obligations in full on duedate or at any time thereafter is a riskthat affects all aspects of business.


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Credit Risk

With traditional instruments such asloans, bonds or currency trading, theamount which the counterparty isobliged to repay is the amount ofCredit Risk


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Credit Risk

In derivatives credit risk is equals tothe amount due or margin money incase the trader default to pay back.


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Portfolio

Investors Portfolio are composed ofdiverse types of assets.

Investing in an asset with a payoffpattern that offsets exposure to aparticular source of risk is calledHedging.


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Portfolio Risk

The risk that remains even afterextensive diversification is calledPortfolio risk.

Such risk is also called systematicriskornon diversifiable risk.


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Portfolio Risk

The risk that can be eliminated bydiversification is called Unique riskordiversifiable risk


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1. The supply funds from savers,primarily households

2. The demand for funds frombusinesses

3. The governments net supply ordemand for funds as modified by

actions of RBI.


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The growth rate of the money isknown as Nominal rates of interest

Suppose FD amount = 10000FD rate of interest(Nominal)(R) = 10%

According to Nominal rates of Interest,interest amount received is 1000.


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The growth rate of the purchasingpower is called real interest rate.

Suppose rate of inflation (i) = 6%Nominal rate of interest ( R) = 10%

Real rate (r) = 10 6 = 4%


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1 + r = 1 + R

1 + i

1 + 0.04 = 1 + 0.10

1 + 0.06

Growth factor of purchasing powerequals to the growth factor of moneydivided by the new price level


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r = R i

1 + i


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Historical Rate of Return

The records of past rates of return isone possible source of informationabout risk premium and standard

deviation.


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Historical Rate of ReturnYear Small Stocks

(ROR)Large Stocks(ROR)

2000 8 14

2001 11 15

2002 14 22

2003 8 18

2004 15 24


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2000 2001 2002 2003 2004

0

20

10

30

40

Large Cap

Small Cap


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The formula for historical varianceW

2 = Sum total ( rt r)2

n

rt = each years outcomer = Historical averagen = Probability


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Historical returnsYearLast 10 Years

Small Stocks Large Stocks T-bills

Standard

Deviation

39.30 20.55 3.18

AverageROR

17.74 12.04 3.82


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Large stock portfolio with a standarddeviation of 20.55% would represent avery volatile investment.

But T-bills portfolio will represent astable investment.


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If stock returns are normallydistributed with SD of 20.55% andexpected ROR of 12.04% the returns

will be less than 8.51% (12.04 20.55) or greater than 32.59% (12.04+ 20.55)


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The Normal distribution

12.04%-8.5% 32.6% 53.1%- 29.1%


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Expected Rate of Return

The expected rate of return is theweighted average of all possiblereturns multiplied by their respective

probabilities


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Expected Rate of Return

E(R) = Sum total of PiRi

E (R) = Expected Return Pi = Probability of outcome

Ri = Rate of Return


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Expected Rate of ReturnState of Economy Probabilityof

growthRate of Return

Boom 0.25 35

Normal Growth 0.50 20

Recession 0.25 10

E(R) = 8.75 + 10 + 2.5 = 21.25


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Expected Return Equation

The formula for historical variance

W = Sum total ( Ri R)2 Pi

Ri = Possible return of the i yearR = Expected rate of returnPi = Probability


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Value at Risk

Valuation of a stock is based on itsexpected future cash flow and theequilibrium price is set so as to yield a

fair expected return appropriate withits risk.


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Value at Risk

Professional investors extensively usea risk measure that highlights thepotential loss from extreme negative

returns called value at risk denoted byVaR.


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Portfolio Risk

Return on 2 Assets

Move Together

Covariance is Positive Risk is more onPortfolio

Returns Move

Independently

Covariance isnegative

Risk will be lower


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Portfolio Risk

The covariance for portfolio risk

W = 1 Sum total ( Rx Rx) ( Ry Ry)N

Rx = Return on Security XR = Expected rate of returnN = Number of Observations


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Portfolio Risk

Coeeficient of correlation of x and yare

Y x y = Cov x yW x W y


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Power of Diversification

Diversification into many moresecurities, continues to spread outexposure to firm-specific factors and

portfolio volatility should continue tofall.


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Portfolio risk does fall withdiversification.

However even extensivediversification cannot eliminate risk.


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Finding by Obaidullah

The total risk of an individual stock ison average 11.7%. It falls to about9.5% when a second stock is added tocreate a two-stock portfolio.


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Stock Quantity Purchase price Low Price High Price

TCS 100 550 500 610

Adani 100 900 850 1000

Return @ Low price = Total Purchase price Risk at Low price

1,45,000 1,35,000 = 10000

Risk of Return Loss = (- 6.8%)

Return @ High Price = Profit at High price - Total Purchase price

1,61,000 1,45,000 = 10000

f f


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Stock Quantity Purchase price Low Price

TCS 100 550 500

Adani 100 900 850

RPL 100 900 880

Ultratech 100 400 380

Return @ Low price = Total Purchase price Risk at Low price

2,75,000 2,61,000 = 14000

Risk of Loss = (- 5.09 %)

P f Di ifi i


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10 20 30 40 50

0

20

10

30

40

Number of Stock in Portfolio

AveragePortfolioRis

k50


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REVISION

Thank You..

module 1 inv

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