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` Investment involves making of a sacrifice in the present with thehope of deriving future benefits.

` Two most important features of an investment are currentsacrifice and future benefit.

` Investment is the sacrifice of certain present values for theuncertain future reward.

` It involves numerous decision such as type, mix, amount, timing,

grade etc, of investment.

` The decision making has to be continuous as well as investmentmay be defined as an activity that commits funds in anyfinancial/physical form in the present with an expectation ofreceiving additional return in the future.

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` The expectation brings with it a probability that the quantum of return may vary from aminimum to a maximum. This possibility of variation in the actual return is known asinvestment risk. Thus every investment involves a return and risk.

` Investment has many meaning and facets. However, investment can be interpretedbroadly from three angles

` economic, layman, financial

` Economic investment includes the commitment of the fund for net addition to the capitalstock of the economy. The net additions to the capital stock means an increase in building

equipments or inventories over the amount of equivalent goods that existed, say, one yearago at the same time.

` The layman uses of the term investment as any commitment of funds for a future benefitnot necessarily in terms of return. For example a commitment of money to buy a new caris certainly an investment from an individual point of view.

` Financial investment is the commitment of funds for a future return, thus investment maybe understood as an activity that commits funds in any financial or physical form in thepresence of an expectation of receiving additional return in future.

` In the present context of portfolio management, the investment is considered to befinancial investment, which imply employment of funds with the objective of realizingadditional income or growth in value of investment at a future date

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` Investment is concerned with the management of aninvestors wealth which is the sum of current income andthe present value of all future incomes.

` In this text investment refers to financial assets.

` Financial investments are commitments of funds to deriveincome in form of interest, dividend premium, pensionbenefits or appreciation in the value of initial investment.

` Hence the purchase of shares,debentures,post officesavings certificates and insurance policies all are financialinvestments. Such investment generates financial assets.

` These activities are undertaken by any one who desires areturn, and is willing to accept the risk from the financialinstruments

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` Risk means the uncertainty in the probability distribution ofreturns

` The entire process of estimating return and risk for individualsecurities is known as security analysis

` Securities that have return and risk characteristics of their own,in combination, make up a portfolio

` Portfolios may or may not take on the aggregate characteristicsof their individual parts

` Portfolio analysis takes ingredients of risk and return forindividual securities and considers blending or interactive effectsof combining securities

` Portfolio selection entails choosing the one best portfolio to suitthe risk-return preferences of the investor

` Portfolio management is the dynamic function of evaluating andrevising the portfolio in terms of stated investor objectives

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` INVESTMENT vs SPECULATION

` Often investment is understood as a synonym of speculation.

` Investment and speculation are some what different and yet similarbecause speculation requires an investment and investment are at lestsome what speculative.

`

Probably the best way to make a distinction between investment andspeculation is by considering the role of expectation.

` Investments are usually made with the expectation that a certainstream of income or a certain price that has existed will not change inthe future.

` Where as speculation are usually based on the expectation that somechange will occur in future, there by resulting a return

` Thus an expected change is the basis for speculation but not forinvestment

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` An investment also can be distinguished from speculation by the timehorizon of the investor and often by the risk return characteristic ofinvestment.

` A true investor is interested in a good and consistent rate of return for along period of time.

` In contrast, the speculator seeks opportunities promising very largereturn earned within a short period of time due to changing environment.

` Speculation involves a higher level of risk and a more uncertainexpectation of returns, which is not necessarily the case withinvestment.

` Speculator adds to markets liquidityand depth as he is frequentlyturning over his portfolio. His presence provides a market for securities(depth) and a wider distribution of ownership of securities( breadth), andenhances capital markets{ BULLS and BEARS}

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Basis Investment Speculation

Type of contract Ownership Creditor

Basis of acquisition Outright purchase Often on margin

Length of commitment Long term Short term

Source of income Earnings of enterprise Changes in market price

Quantity of risk small large

Stability of income Very stable Uncertain &erratic

Psychological attitude Cautious &conservative Daring &careless

Reasons for purchase Scientific analysis of

intrinsic worth

On tips, hunches, inside

dope etc.

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` Characteristics of Investment

` The characteristics of investment can be understood in terms of as- return,

- risk,- safety,- liquidity etc.

` Return: All investments are characterized by the expectation of a return.` In fact, investments are made with the primary objective of deriving return.

` The expectation of a return may be from income (yield) as well as throughcapital appreciation.

` Capital appreciation is the difference between the sale price and thepurchase price.

` The expectation of return from an investment depends upon the nature ofinvestment, maturity period, market demand and so on.

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` Risk: Risk is inherent in any investment. Risk mayrelate to loss of capital, delay in repayment of capital,nonpayment of return or variability of returns.

` The risk of an investment is determined by theinvestments, maturity period, repayment capacity,nature of return commitment and so on.

` Risk and expected return of an investment are related.` Theoretically, the higher the risk, higher is the

expected returned. The higher return is acompensation expected by investors for theirwillingness to bear the higher risk.

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` Safety: The safety of investment is identified with thecertainty of return of capital without loss of time or money.

` Safety is another feature that an investordesires frominvestments. Every investor expects to get back the initialcapital on maturity without loss and without delay.

` Liquidity: An investment that is easily saleable withoutloss of money or time is said to be liquid.

` Awell developed secondary market for security increasethe liquidity of the investment.

` An investor tends to prefer maximization of expected

return, minimization ofrisk, safetyof funds and liquidityof investment.

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` INVESTMENT PROCESS:` Given the foundation for making investment decisions

the trade off between expected return and risk- wenext consider the decision process in investments as itis typically practiced today

` This is a two step process- Security Analysis andPortfolio Management

` Security analysis involves the valuation of securities` Portfolio management involves the management of an

investors investment selections as a portfolio(package of assets), with its own uniquecharacteristics.

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` Security Analysis` Traditional investment analysis, when applied to securities,

emphasizes the projection of prices and dividends.` That is, the potential price of a firms common stock and the

future dividend stream are forecasted, then discounted back to

the present.` This intrinsic value is then compared with the securitys current

market price. If the current market price is below the intrinsicvalue, a purchase is recommended, and if vice versa is the casesale is recommended.

` Although modern security analysis is deeply rooted in the

fundamental concepts just outlined, the emphasis has shifted.` The more modern approach to common stock analysisemphasizes return and risk estimates rather than mere price anddividend estimates

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` Portfolio Management` Portfolios are combinations of assets. In this text, portfolios consist of

collections of securities.` Traditional portfolio planning emphasizes on the character and the risk

bearing capacity of the investor.` For example, a young, aggressive, single adult would be advised to buy

stocks in newer, dynamic, rapidly growing firms.` A retired person/widow would be advised to purchase stocks and bonds

in old-line, established, stable firms, such as utilities.

` Modern portfolio theory suggests that the traditional approach toportfolio analysis, selection, and management may yield less thanoptimum results.

`

Hence a more scientific approach is needed, based on estimates of riskand return of the portfolio and the attitudes of the investor toward a risk-return trade-off stemming from the analysis of the individual securities.

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` The term securities used in the broadest sense, consists of thosepapers which are quoted and are transferable.

` Under section 2 (h) of the Securities Contract (Regulation) Act, 1956(SCRA) securities include:

i) Shares, bonds, debentures,or other marketable securities of a likenature in or of any incorporated company or other body corporate.

` ii) Government securities` iii) Such other instruments as may be declared by the central

Government as securities, and,

` iv) Rights of interests in securities.` Therefore, in the above context, security forms of investments include

Equity shares, preference shares, debentures, government bonds,

Units of UTI and other Mutual Funds, and equity shares and bonds ofPublic Sector Undertakings (PSUs)

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` Non-security forms of investments include all those investments, which are not quoted inany stock market and are not freely marketable. viz., bank deposits, corporate deposits,post office deposits, National Savings and other small savings certificates and schemes,provident funds, and insurance policies.

` Another popular investment in physical assets such as Gold, Silver, Diamonds, Realestate,Antiques etc.

` The investor has to choose proper avenues from among them, depending on his specificneed, risk preference, and return expectation.

` Investment avenues can be broadly categorized under the following heads: -

` 1.Corporate securities Equityshares ,DebenturesBonds ,Warrants,Preferenceshares,GDRs /ADRs,Derivatives

` 2.Deposits in banks and non banking companies

` 3.Post office deposits and certificates

` 4.Life insurance policies

` 5.Provident fund schemes

` 6.Government and semi government securities` 7.Mutual fund schemes

` 8.Real assets

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` Equity Shares: Blue chips, Growth stocks, Income stocks, cyclicalstocks, discount stocks, under valued stocks, turn-around stocks

` Preference Shares` Debentures and bonds

` GDR/ADR` Warrants:It can be defined as a long-term call option issued by a

company on its shares.` Derivatives: Futures, Options` Deposits: Savings, Fixed, Cumulative, Recurring

` Company Fixed Deposits` Post office deposits and certificates` Life Insurance Policies` PF schemes, ELSS, Government and semi-government securities and

MF Schemes

` REALASSETS: Real estate, Bullion schemes

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` Return and Risk:

` Underlying all investment decisions is the trade off

between expected return and risk.

` Return:In investments it is critical to distinguishbetween an expected return (the anticipated return for

some future period) and a realized return (the actual

return over some past period).

` MeasuringReturn:Measurement of return occupies a

strategic importance in investment analysis as the

investment is undertaken with a view to get returns in

future

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` Total Return:A correct returns measure mustincorporate the two components of return, yield andprice changes

` TR = { any cash payments received +price changesoverthe period}/price at which the asset is

purchased` TR = {CFt+ (PePb)}/Pb` Two measures while estimating total returns overa

period are Arithmetic mean and geometric mean` Arithmetic mean: X (avg.) =Sum X/n or sum of each

value ofX divided by number of observations, n` Geometric mean : is needed to describe accurately the

true average rate of return over multiple periods

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` Geometric Mean: to understand this we shouldknow RR (Return relative)

` This is particularly true when calculating ageometric mean because negative returns cannotbe used in the calculation

` RR( Return relative) = TR in decimal form +1.00

` Although return relatives may be less than 1.0,they will be greater than zero, thereby eliminating

negative numbers

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Year SensexTRs(%) Sensex RR

1996 -3.14 0.9687

1997 30.00 1.30001

1998 30.00 1.30001

1999 9.94 1.09942

2000 1.29 1.01286

2001 37.11 1.37113

2002 22.68 1.22683

2003 33.10 1.33101

2004 28.34 1.28338

2005 20.88 1.20880

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` Calculation of the Arithmetic and Geometric mean forthe years1996-2005 forthe Sensex Stock Composite Index using theabove table

` Arithmetic mean = [-3.14 + 30.00 +.... + 20.88]/10 = 18.76%` Geometric mean = [(0.9687) (1.30001)(1.30001)(1.09942)...

(1.2088)] (1/10)- 1` = 1.18 - 1

= 0.18, or 18%` The geometric mean returns measure the compound rate of growth

over time.` It is often used in investments and finance to reflect the steady

growth rate of invested funds over some past period` G = [(1+TR1)(1+TR2).... (1+TRn)] 1/n 1 Where TR is a series of

total returns in decimal form

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` RISK: Sources ofRisk:` Risk is explained theoretically as the fluctuation in returns from a

security.` A security that yields consistent returns over a period of time

istermed as risk less security or risk free security

` When one invest, expects some particular return, but there is arisk that he ends up with a different return when he terminatesthe investment.

` The more the difference between the expected and the actualthe more is the risk

` Factors influence risk: What makes financial assets risky.

` Several factors causing risk such as business failure, marketfluctuations, change in the interest rate,inflation in the economy,fluctuations in exchange rate,changes in the political situationetc.

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