Investment Analysis &

Portfolio Management

Unit 1: Introduction to Investment

Management
 Meaning
 Investment to a layman means some monetary commitment
 Investment is the current commitment of funds for a period of
time to derive a future flow of funds that compensates the
investor:
1. For the time the funds are committed
2. For the expected rate of inflation
3. For the uncertainty involved in the future flow of funds
 Investment is the well planned and rationally formulated
program which involves deployment of funds on assets with the
aim of earning income/capital appreciation
 Definition

 Fischer & Jordan : “An investment is a

commitment of funds made in the expectation
of some positive rate of return. If the
investment is properly undertaken the return
will commensurate with the risk the investor
assumes.”
 Nature
 It is an art and science to deploy funds in such
growth oriented channels which can generate
some yield
 All investments are risky to some degree or other
 Investments has two attributes
a. Time
b. Risk
 Consumption is sacrificed to get a return in future
 Nature (Contd.)
 The sacrifice that has to be borne is certain but the
return in the future may be uncertain This attribute of
investment indicates the risk factor
 The risk is undertaken to gain some return from the
investment
 Some Investments are simple & direct while others
present complex problems of analysis &
investigation
 Some investments are familiar while others are
relatively new & unidentified
 Some investments are appropriate for one type of
investor others may be suitable to other persons
 Scope
a) Longer life expectancy/planning for retirement
- Increase in working population, proper planning for life span &
longevity have ensured the need for balanced investments
- Savings by themselves cannot increase wealth
- They need to be invested so that the principal & income will be
adequate for a greater number of retirement years
- There is an increasing no. of working women who are
responsible for planning their own investments during their
working life so that after retirement they can have stable income
b) Taxation
Compulsory Savings which brings down the tax liability
 Scope (Contd.)
c) Interest Rates
- Interest rates vary between one investment & another
- Vary between risky & safe investments
- Differ due to different benefit schemes offered by the
investments
d) Inflation
- Due to rising prices standard of living is falling
- People seek return to cover any decrease in their income due
to inflation
- People seek safety of principal
- People seek return from investment which does not increase
their tax burden
 Scope (Contd.)
e) Income
- General increase in employment opportunities
- This opportunities gave rise to both male & female working force
- More incomes & more avenues of investment have led to the ability &
willingness of working people to save & invest their funds
f) Investment Channels
- Growth & Devlpt. of the country leading to greater economic activity
has led to the introduction of a vast array of investment outlets
- Investors have the choice of a variety of instruments
- Investors need to choose the most suitable channel that will give
balanced growth & stability of return
- Investor makes a choice of investment with a proper mix between
high rate of return & stability of return to reap the benefits of both
 Investment Alternatives
 Investments present a wide range of risk from risk-free instruments to
highly speculative shares & debentures
1. Direct Investments
Those where the investor makes his own choice & investment decisions
a. Fixed Principle Investments
Those whose principal amount & the terminal values are known with
certainty
i) Cash kept in a bank/box - Does not earn any return
ii) Bank Deposits – FD, RD, Savings Accounts, etc.
ii) Post office deposits - Savings, MIS - Fixed Return
iii) NBFC Deposits
iv) Tax sheltered Saving schemes – NSC, PPF, LIC, Pension plans, Mutual
Funds
iii) Govt. Bonds
iv) Corporate Bonds & Debentures – Fixed maturity value & fixed rate of
income over time
 Direct Investments (Contd.)
vi) Money Market Securities – Very short term maturity – less than a
year:
- Treasury bills: 14-days, 28-days, 182-days, 91-days by GOI
- Commercial papers: High denominations with fixed maturity period
ranging between 30 days to 1year; unsecured promissory note; Sold
at a discount & redeemed at face value
- Certificate of Deposit: High denominations marketable receipt
of funds deposited in a bank for a fixed period at a specified
rate of interest; bearer documents & readily negotiable
b. Variable Principle Securities
Terminal values are not known with certainty
i) Preference Shares – Price is determined by demand & supply
forces
- fixed return
 Direct Investments (Contd.)
ii) Equity Shares – no fixed return/maturity date
The stock Mkt. classifies the shares into
- Growth shares: Companies that have higher rate of growth
than the industrial growth rate in profitability
- Income Shares: companies that have stable operations &
limited growth opportunities
- Defensive Shares: unaffected by the market movements
- Cyclical Shares: Affected by the business cycle
- Speculative Shares
iii) Convertible Securities – Convertible debentures/ preference
shares can be converted into equity shares
- Features of fixed principal securities & possibility of a variable
terminal value
 Direct Investments (Contd.)
c. Non-Security Investments
i) Real Estate – ownership of residential & commercial properties
- Terminal value is uncertain
- Generally there is a price appreciation
- Less liquid
ii) Commodities – Bought & Sold in spot markets
- Contract to buy & sell commodities at a future date are traded
in future markets
iii) Business Venture – Direct ownership investments in
new/growing business before firm sell securities on a public
basis
iv) Art, Antiques & Other Valuables – include Gold, silver, fine
china & jewellery
- Offers aesthetic qualities
 Indirect Investments
 Investor does not have direct hold on the invested amount
 Contributes savings to organisations such as Life
Insurance/Unit Trust/PPF/Pension, Mutual Funds, etc.
 Funds are managed according to the investment policy by a
group of trustees on behalf of the investor
 Investors need definite ideas regarding a number of features
their portfolio should have
 These features should be consistent with the investors
objectives
 These should also have additional conveniences &
advantages
 Indirect Investments (Contd.)
 Mutual Funds
- Investment companies obtain funds from large no. of investors
through sale of units
- Funds collected are professionally managed for the benefit of the
investors
- Classified into
i) Open-ended Schemes
- offers & accepts units on a continuous basis thus providing
liquidity
- free entry & exit into the funds
- No maturity period
- Not listed on the stock exchange (SE)
- Repurchase price is fixed on the basis of the net asset value
(NAV) of the unit
 Mutual Funds (Contd.)

ii) Close-ended Schemes

- Fixed maturity period
- When the scheme is floated, it is kept open for a
limited period
- Once closed the units are listed on the SE
- The market price may not be the same as the NAV
iii) Interval Schemes
- Schemes with open-ended & close-ended features
- Can be listed in the SE/available for repurchase during
specified periods at NAV/ related prices
 Mutual Funds (Contd.)
 The above schemes are further classified on the basis of their
objectives
1. Growth scheme – equity oriented
2. Income scheme – funds invested in fixed income securities
3. Balanced scheme – a combination of steady income &
reasonable growth
- Funds invested in equities & debt
4. Money market scheme – invest on money market instruments
like treasury bills, commercial paper, etc.
5. Tax saving schemes – offers tax rebates to investors
6. Index scheme – made on the equities of the index
- Benchmark index is BSE Sensex/ NSE-50
- Returns are approximately equal to the return on the index
 Financial & Economic Aspects of
Investment
 To economist, investment is the net additions made to the
nation’s capital stock that consist of goods & services used in the
production process/ to produce other goods & services
- Net addition means increase in the buildings, equipments &
inventories
 Financial Aspect of investment means an exchange of financial
claims – stocks & bonds, real estate mortgages, etc.
- It is the employment of funds with the objective of additional
income/growth in value of investment at a future date
 The two aspects are related to each other because the savings
of the individual flow into the capital market as financial
investments to be used in economic investment
 Difference between Investment &
Speculation
 Speculation means taking the business risk in the hope of
getting short term gain
 It involves buying & selling activities with the expectation of
getting profit from the price fluctuations
 If we buy shares for dividend it is investment
 If we expect anticipation of price rise in near future & hope to sell
it at a gain price it is speculation
 Speculation requires an investment & investments are
somewhat speculative
 Investment may not be marketable in the short run
 An investor is an ostrich burying its head in the ground during
danger & feeling himself secure
Difference between Investor &
Speculator
1. Investor is interested in consistent good rate of return for a long
period whereas speculator is interested in getting abnormal high
return in the short term
2. Investor constantly evaluates the worth of security whereas
speculator evaluates the market action and its price movement
3. The investor matches the risk & return whereas the speculator
assumes greater risk than the investors
4. The negative short term fluctuations affect the speculators worse
than the investors
5. Investor normally uses his own funds while speculator uses
borrowed funds to supplement his personal resources
6. Investors are cautious & careful while speculators are daring &
careless
 Objectives of Investment
 Main Objectives
1. Return – Rate of return is the total income the investor receives during the
holding period stated as a percentage of the purchase price at the
beginning of the holding period
Return = (End period value – Beginning period value + Dividend )/
(Beginning period value) x 100
Rate of return is stated annually/semi-annually
2. Risk – Risk of holding is related with the probability of actual return
becoming less than the expected return
Variability of return implies more risk & stable returns less risk
investor reduces risk by diversifying its portfolio
 Subsidiary Objectives
1. Liquidity – It depends on the marketing & trading facility
2. Hedge against inflation – the rate of return should be higher than inflation
rate
3. Safety – investment should be approved by law & provide security of
principal amount
 The Investment Process
 A series of activities leading to the purchase of
investment alternatives
1. Framing of investment policy
related to investible funds, objectives & the
knowledge about the investment alternatives &
market
i) Investible funds: may be savings or from
borrowings
ii) Objectives: formulated based on the required rate
of return, need for regularity of income, risk
perception & the need for liquidity
 Investment Process (Contd.)
2. Investment Analysis
Once the investment policy is formulated the investment
alternatives need to be evaluated through the market, Industry
& Company Analysis
i) Market Analysis
- The growth in GDP & inflation are reflected in the stock prices
- recession leads to bear market
- Stock prices may be fluctuating in the short run but in the long
run they move in trends
- Based on technical analysis the investor can decide the timing
for purchase & sale of investments
 Investment Analysis (Contd.)

ii) Industry analysis

- Industry differ in their contribution to the economy
& their growth rate
iii) Company Analysis
- The Company’s earnings, profitability, operating
efficiency, capital structure & management have to
be analysed
- These factors affect the stock prices & the return
of the investors
- If the Co. performs well it is reflected in the rise of
share price
 Investment Process (Contd.)

3. Valuation
- It determines the return & risk expected from an
investment
- The intrinsic value of the share is measured through
the book value of the share & price earning ratio
- Models are adopted to value the shares

- The real worth so determined is compared with the

Mkt. price & decisions are made

- Future value of the securities is estimated based on

the analysis of the historical behaviour of the price

 Investment Process (Contd.)
4. Construction of Portfolio
- A portfolio is a combination of investment
- It is constructed to meet the investor’s objectives
- Attain maximum return with minimum risk
- Diversifies the risk
- Ways to diversify the portfolio:
i) Debt & Equity
ii) Industry
iii) Company
- Based on the diversification level, investments are
selected & funds are allocated
 Investment Process (Contd.)
5. Portfolio Evaluation
- The portfolio has to be managed efficiently
- Consists of portfolio appraisal & revision
i) Appraisal: The return & risk performance of the investment
vary with time
- The variability is measured & compared
- The developments in the economy, industry & Company need
to be continuosly tracked
- This enables to take corrective action to avoid losses
ii) Revision: Based on the results of the appraisal the portfolio is
replaced by high return & less risky investments