Tutorial for Banking

and Finance students

From June 19-24, 2023

How precious is the
program/profession?
•Investment analysis and portfolio management
•Corporate finance/financial management
•Project analysis and financing
•Electronic banking and finance
•Digital finance
•Microfinance
•Interest free banking and finance
Major courses
•International finance
•Money, banking, and finance
•Risk management and insurance
•Banking practice and procedure
•Insurance practice and procedure
Investment Analysis
and Portfolio
Management
by Demis H/Gebreal
Email: [email protected]
course objectives— overall
•upon the completion of this course,
students will be able to:
• understand risk-return trade off and manage
financial risk through the use of various
derivatives and to make them understand
operations of derivatives market.
• understand investment techniques and apply
them to various forms of securities and
acquaint them with the functioning of mutual
funds, investment strategies and portfolio
Tutorial content
•overview of investment
•investemnt management
•Portfolio Management and Evaluation
1. Overview of invetsment －
Contents
•Concept of Investment
•Investment V/S Speculation
•Financial and Economic Aspect of
Investment,
concepts of investment
An investment can be defined as the commitment of funds to
one or more assets that will be held over some future time period.
Investments is concerned with the management of an investor’s
wealth, which is the sum of current income and the present value
of all future income.
Investment: any asset into which funds can be placed with the
expectation that it will generate positive income and/or preserve
or increase its value.
Return: the reward for owning an investment
• Income from investment
• Increase in value of investment
why do we invest?
•We invest to make money! Although everyone
would agree with this statement, we need to be
more precise.
• We invest to improve our welfare, which for our
purposes can be defined as monetary wealth,
both current and future.
•You are probably already an investor.
• If you have money in a savings account, you
already have at least one investment to your
name.
•An investment is simply any asset into which
funds can be placed with the expectation that it
 Types of Investments
Securities or Property
Securities are investments issued by firms, governments,or other
organizations that represent a financial claim on the resources of the issuer.
• Securities: stocks, bonds, options
• Real Property: land, buildings (real estate investment)
• Tangible Personal Property: gold, artwork, antiques, collectables
Direct or Indirect
• Direct: investor directly owns a claim on a security or property. e.g.
buying share.
• Indirect: investor owns an interest in a professionally managed
collection of securities or properties.
• For example, when you send your money to a mutual fund company,
you are making an indirect investment in the assets held by these
mutual funds.

9
Types of Investments----
Debt, Equity or Derivative Securities
• Debt: investor lends funds in exchange for
interest income and repayment of loan in
future (bonds)
• Equity: represents ongoing ownership in a
business or property (common stocks)
• Derivative Securities: neither debt norOption
Future
equity; derive value from an underlying asset
Forward
(options). Swap
Types of Investments----
•Low- or High-risk investments
• Investments also differ on the basis of risk.
• Risk reflects the uncertainty surrounding the
return that a particular investment will
generate.
• To oversimplify things slightly, the more
uncertain the return associated with an
investment, the greater is its risk.
• One of the most important strategies that
investors use to manage risk is
diversification, which simply means holding
Types of Investments----
•Short- or Long-term investments
• The life of an investment may be either short or
long.
• Short-term investments typically mature within
one year. Long-term investments are those with
longer maturities or, like common stock, with no
maturity at all.
•Domestic or Foreign
• Domestic: Ethiopian-based companies
• Foreign: foreign-based companies
Artworks and collection of antiques
13
The structure of the investment Process/fund flow
 Suppliers and Demanders of Funds
Government
Suppliers
• Federal, state and local projects & operations Demanders
• Typically net demanders of funds (Savers) (Spenders)
Business 1. Households 1. Business
• Investments in production of goods and services
• Typically net demanders of funds 2. Business 2. Government
Individuals
3. Government 3. Households
• Some need for loans (house, auto)
• Typically net suppliers of funds 4. Foreigners 4. Foreigners

15
 Investment vs. Speculation
•is a trading activity that involves
Investment Speculation
engaging in a risky financial
•Refers to the sacrifice of transaction, in expectation of
present money or other making enormous profits, from
resources for the benefits that fluctuations in the market value of
will arise in future. financial assets.
•The two main element of •there is a high risk of losing
investment is time and risk maximum or all initial outlay, but it
• e.g. acquisition of the asset to is offset by the probability of
get return. significant profit.
•e.g. Crypto-currencies

16
 Investment vs.
types of Speculators
Speculation

17
Financial and Economic Aspect of Investment
•economci investment:
• refres to the investment in all items which are
required for the production of goods and
services.
• examples of economic investments are
factories, equipents,
•financial investment
• is investing in an asset with a goal of financial
gain.
• for example, investing in stock and/bond.
2. Investemnt management

•risk and return

•bond and equity valuation
 Risk and Return : Two Sides of the Investment
Coin
•Investment decisions are influenced by various motives.
• Some people invest in a business to acquire control and
enjoy the prestige associated with it.
• Some people invest in expensive yatchs and famous villas
to display their wealth.
• Most investors, however, are largely guided by the
pecuniary motive of earning a return on their
investment.
•For earning returns investors have to almost invariably bear
some risk.
•In general, risk and return go hand in hand.
•While investors like returns they abhor risk. Investment
decisions, therefore, involve a trade-off between risk and
return.
 Return
•Return is the primary motivating force that drives
investment.
•It represents the reward for undertaking
investment.
•Income received from an investment plus any
changeComponents
in market price,
of usually expressed as
percent of the beginning market price of the
return
investment.
•

22
 Components of return
•The (cont---)
most
Yield/current
common form of
return •is reflected
Capital in the price
gain/return Total return
return for change called the capital
investors is the return—it is simply the •Total return = Current return
periodic cash flow price appreciation (or + Capital return
(income) on the depreciation) divided by •Total return =yield + price
investment such the beginning price of the change
as: asset. •Mathematically:
• interest from
bonds •For assets like equity •TR=[Dt+(Pt-Pt-1)]/Pt-1
• dividends from stocks, the capital •Where: TR= Total Return, Dt
stock return predominates. =cash dividend at the end of
•It is measured as •The appreciation the period t
the periodic (depreciation) in the price •Pt is the price of stock at the
income in of the assets, commonly time t
relation to the called capital gain (loss). •Pt-1 is the price of stock at a
beginning price of time period t-1
23
the investment. •Capital gain=Pt>Pt-1
 Illustration
•Jifar purchased a stock for price birr 6,000. At the end
of the year, the stock is worth birr 7,500. Jifar was paid
dividends of birr 260.
•Compute the total return received by Jifar.

Solution
•TR=[Dt+(Pt-Pt-1)]/Pt-1
•TR= Br [260+(7,500-6000)]/Br 6, 000
•= 0.2933
•29.33%

24
 Expected return
•The investor can not be sure of the amount of return
s/he is going to receive.
•There can be many possibilities.
•Expected return is the weighted average of possible
returns, with the weights of being the probabilities of
occurrence.
•It can be defined as:
• ER
•Where:
• represents various values of return
• shows probability of various returns

25
 illustration
•Suppose that we knew a given investment had a
50% chance of earning return of birr 10, a 25%
chance of birr 20, and there is a 25% chance of
being a loss of birr 10. what is the expected
Solution
return?
•Or:
Return (x) P(x) ER •E(r)=
10 0.5 5 0.5*10+0.25*20+0.25*(-
10)
20 0.25 5 =5+5-2.5= 7.5
-10 0.25 -2.5
Total 1 7.5
26
 Risk
•Is the variability/deviation between the expected
and actual returns.
•Refers to the possibility that the actual outcome
of an investment will differ from its expected
outcome.
•More specifically, most investors are concerned
about the actual outcome being less than the
expected outcome.
•The wider the range of possible outcomes, the
greater the risk.
•
27
 Types of risks
•Interest rate risk
• Is the risk that an investment value will change
as a result of change in the interest rate
• This risk affects the value of bonds more
directly than stocks.
•Market risk
• Refers to the variability in returns resulting from
fluctuations in the overall market condition
•Financial risk
• Is the risk associated with the use of debt
financing 28
 Types of risks---
•Liquidity risk
• An investment that can be bought or sold quickly without
significant price concession is considered liquid.
• The more uncertainty about time element and the price
concession, the greater the liquidity risk.
•Foreign exchange risk
• When investing in foreign countries, one must consider the
fact that currency exchange rate can change the price of
the assets as well.
• This risk applies for all financial instruments that are in a
currency other than the investors’ domestic currency.
•Country risk (Political risk)
• such risk devalues ones investment
• This types of risk is common in developing countries that29 do
 Measuring risk
•Risk refers to the possibility that the actual
outcome of an investment will differ from the
expected outcome.
•Put differently, risk refers to variability or
dispersion.
•If an asset’s return has no variability, it is
riskless.
•Suppose you are analysing the total return of an
equity stock over a period of time.
•Apart from knowing the mean return, you would
also like to know about the variability in returns
30
 Standard Deviation
•The most commonly used measure of risk in finance is
variance or its square root the standard deviation.
•Is a tool for assessing risk associated with a particular
investment.
•Measures the dispersion or variability around a
mean/expected value.
•Where is return and is probability of return
Illustration
Outcomes Return on Probability Return on Probability
stock stock
Outcome 1 13 0.25 7 0.25
Outcome
Outcome 1
2 13
15 0.25
0.5 7
15 0.25
0.5
Outcome
Outcome 2
3 15
17 0.5
0.25 15
23 0.5
0.25 31
 Solution (S.D for stock x)

* *
13 0.25 3.25 169 42.25
15 0.5 7.5 225 112.5
17 0.25 4.25 289 72.25
Total 15 227

= birr 1.41 32
Solution (S.D for stock y)
* *
7 0.25 1.75 49 12.25
15 0.5 7.5 225 112.5
23 0.25 5.75 529 132.25
Total 15 257

= birr 5.66

33
 Summary
Stock A Stock B
Expected Return 15 birr 15 birr
Standard deviation 1.41 birr 5.66 birr
NB: The same
expected return
but different SD or
risk.
•S.D of stock B is greater than S.D of stock A with the
same expected return.
•Hence, we can say that the return of stock B is prone
higher fluctuation as compared to stock A.

34
 Relationship between risk and return
1. Positive relationship
•High risk-High return
• Investors may take more risk to receive more reward.
• E.g. investing in stock
•Low risk-Low return
• If investors invest in more protected/secured investment, the reward is also very low.
• E.g. investing in bond
2. Negative relationship
•High risk-Low return
• investor increases investment amount for getting high return but with increasing return, he
faces low return because it is nature of that project.
• E.g. lottery
•Low risk-High return
• here are some projects, if you invest low amount, you can earn high return.
• E.g. when the government need money urgently, the government may issue a bond with a
higher rate of return to the public.

35
Equity and Bond valuation
 Equity valuation
Overview and characteristics of Equity securities
•Common Shares
• represent ownership shares in a corporation.
• The two most important characteristics of common shares are:
• Residual claim means the shareholders are the last in line of
all those who have a claim on the assets or income of the
corporation.
• Limited liability means that the greatest amount
shareholders can lose in the event of the failure of the
corporation is the original investment.
• Each share of voting common stock entitles its owner to one vote
on any matters of corporate governance that are put to a vote
at the corporation's annual meeting.
• Shareholders who do not attend the annual meeting can vote by
proxy, empowering another party to vote in their name. 37
 Cont
• Cumulative voting is another procedure of voting for a
company's directors.
• Each shareholder is entitled to one vote per share
times the number of directors to be elected.
• For example, if you owned 100 shares and there were
three directors to be elected, you would have 300 votes.
• This is advantageous for individual investors because
they can apply all of their votes toward one person.
• Common shares can be callable or putable.
• Callable common shares give the issuer the right to
buy back the shares from shareholders at a pre-
determined price.
• Putable common shares give shareholders the right38 to
 Cont---
•Preference Shares
• also called a preference share, has features similar to both
equities and bonds.
• Like a bond, it promises to pay to its holder fixed dividends
each year.
• It also resembles a bond in that it does not convey voting
power regarding the management of the firm.
• It has priority over a common share in the payment of
dividends and upon liquidation.
• Preferred dividends can be cumulative; that is, unpaid
dividends cumulate and must be paid in full before any
dividends may be paid to common shareholders.
• All passed dividends on a cumulative stock are dividends in
arrears. 39
 Valuation: Fundamental
Analysis
•Fundamental analysis models a company’s value by
assessing its current and future profitability.
•The purpose of fundamental analysis is to identify
mispriced stocks relative to some measure of “true” value
derived from financial data.
Models of Equity Valuation
•Balance Sheet Models
•Dividend Discount Models (DDM)
•Price/Earnings Ratios
•Free Cash Flow Models

Valuation by Comparable
•Compare valuation ratios of firm to industry averages.
•Ratios like price/sales are useful for valuing start-ups that have yet to
generate positive earnings. 40
 Intrinsic Value vs. Market Price
•Intrinsic value is, book value, is a company's total
assets minus its total liabilities.
•Market value is determined by supply and demand.
•The price of a stock reflects the current demand for it.
•If a stock has a significantly lower intrinsic value than its
current market price, it looks like a red flag that the stock is
overvalued. But that's not necessarily the case.
•If there is a strong demand from investors for a particular
stock, its market price will rise above its book value.
•The return on a stock is composed of dividends and capital
gains or losses.
•Trading Signal: IV > MV Buy; IV < MV Sell or Short Sell; IV
= MV Hold or Fairly Priced 41
 Holding Period Return (HPR)
•The HPR is the total return on an asset or investment
portfolio over the period for which the asset or portfolio
has been held.
•The holding period return can be realized if the asset or
portfolio has been held, or expected if an investor only
anticipates the purchase of the asset.
•It expressed as a percentage.

•Where is income (dividend), is the ending value of the

investment (ending price), and is the beginning value of
the investment (beginning price). 42
 Example
•Three years ago, Kedir invested birr10,000 in the shares of
ABC Corp. Each year, the company distributed dividends to
its shareholders. Each year, Kedir received birr100 in
dividends. Note that since Kedir received birr100 in
dividends each year, his total income is birr300. Today, Kedir
sold his shares for birr12,000, and he wants to determine
the HPR of his investment.

•HPPR

•= 0.23=23%
•Thus, Kedir’s investment in the shares of ABC Corp. earned
43
Bond Valuation and Analysis
Bonds
•Bonds and debenture are terms used
interchangeably.
•Both represents long term fixed income
securities
•The cash flow stream (in form of interest and
principal) as well as the time horizon (i.e. the
date of maturity) are well specified and fixed.
•Bond returns can be calculated in various
ways 45
Coupon rate
•It is the nominal rate of interest that is fixed and is
printed on the bond certificate.
•Is calculated on the face value of the bond.
•Is the rate at which interest is paid by the company to
the bond holder
•Is the payable by the company at periodical intervals of
time till maturity.
•Example
• A bond has a face value of birr1000 with an interest rate of 12%
per annum.
• It means that birr120 will be paid by the company on an annual
basis to the bond holder till maturity. 46
 Current Yield
•The current market price of the bond in the secondary
market may differ from its face value (i.e., it may be
currently selling at a discount or at a premium).
•Current yield relates the annual interest receivable on a
bond to its current market price.
•It thus measures the annual return accruing to a
bondholder who purchases the bond from the secondary
market and sells it before maturity presumably at a price
at which he bought the bond.
•Example
• A bond has a face value of birr1000 and a coupon interest rate 47
of 12%. It is currently selling of birr800.
Yield to Maturity (YTM)
•Is the rate of return that an investor is expected to earn
on an annualized basis expressed in % terms from a bond
purchased at the current market price and held till
maturity.
•Is the internal rate of discount (r) which makes the
present value of cash inflow from the bond (in form of
interest and redemption value) equal to the cash outflow
on purchase of the bond.
•It can be computed as follows:
•YTM
•Where I is annual interest, RV is Redemption value, MP is
Market price, and N is Number of years remaining to48
 Yield to call (YTC)
•Some bonds may be redeemable before their full maturity at the
option of the issuer or the investor.
•In such cases, two yields are calculated:
• YTM (assuming the bond will be redeemed only at the end of full
maturity period)
• YTC (assuming that the bond will be redeemed at a call date before
maturity)
•YTC is computed on the assumption that the bond’s cash inflow are
terminated at the call date with redemption of the bond at the specific
call price.
•Thus, YTC is that rate of discount which makes the present value of
cash inflows till call equal to the current market price of the bond.
•If YTC>YTM, it would be advantageous to the investor to exercise the
redemption option at the call date.
•If YTM>YTC, it would be better to hold the bond till maturity. 49
3. Portfolio Management and
Evaluation
 What is portfolio?
•Portfolio refers to a collection of financial investment
tools such as stocks, mutual funds, bonds, cash and
cash equivalents depending on the investor’s
income, budget, and convenient time frame.
•It may also contain a wide range of assets including
real estate, arts, and private investments.
•You may choose to hold and manage your portfolio
yourself,Don’torput allyou may
eggs in one
allow a money manager,
financial basket
advisor, or another finance professional to
manage your portfolio.
 Portfolio management
•is the art and science of selecting the right
investment policy for the individuals in terms of
minimum risk and maximum return.
•it refers to managing an individual’s investments
in the form of bonds, shares, mutual funds, cash
and cash equivalents etc. so that s/he earns the
maximum profits within the stipulated time frame.
•In short, it is managing money of an individual
under expert guidance of portfolio managers.
 Purpose of portfolio management
•Portfolio management presents the best
investment plan to the individuals as per their
income, budget, age, and ability to undertake
risks.
•Portfolio management minimizes the risk
involved in investing and also increases the
chance of making profit.
•Portfolio management enables the portfolio
managers to provide customized investment
solutions to clients as per their needs and
requirements.
 Basic principles of portfolio Management
•Effective investment planning based on:
• Fiscal and monetary policies.
• Industrial and economic and its impact on industry.
• Prospect in terms of technology changes, competition in the
market, capacity utilization with industry and demand
prospects
•Constant review of investment
• To assess the quality of management of the companies in
which investment has been made or proposed to be made
• To assess the financial and trend analysis of companies
financials to identify the optimum capital structure and better
performance for the purpose of withholding the investment
from poor companies
• To analyze the security market and its trend in continuous
 Return of a portfolio
• The return of a portfolio is equal to the weighted
average of the returns of individual assets
(securities) in the portfolio with weights being
equal to the proportion of investment value in
each assets.
Return =

Where is the return on the portfolio, is the return

on asset and is the weighting of component
assets (i.e., the proportion of asset in the
portfolio).
Example
•Portfolio value = $2,000,000 (security A) + $5,000,000
(security B)=$7,000,0000
•rA=14%, rB=16%
•wA= weight of security
A=$2,000,000/$7,000,000=0.286=28.6%
•wB=weight of Security B=
$5,000,000/7,000,000=0.714=71.4%
•Solution
•=
(0.286*0.14)+(0.714*0.16)=0.04004+0.04284=0.08288=8.
288%
excersise

Assets Weight Expected return

A 35 6%
B 25 7%
C 40 10%
Portfolio risk
• Standard deviation and variance are measures of
portfolio risk.
•Portfolio risk (standard deviation) can be
computed as follows
•Portfolio return variance can be computed as
follows:
•Where is the correlation coefficient between the
returns on assets and .
 Standard deviation of a Two-Assets portfolio
•The riskiness of a portfolio that is made of
different risky assets is a function of three factors.
• The riskiness of the individual assets that make
up portfolio
• The relative weight of the assets in the portfolio
• The degree of co-movement of returns of the
assets making up the portfolio.
Example
•Consider Securities A and B with the following estimates.
•=8%, =12%, =13%, =20%,
•Also, assume the portfolios that can be formed with
securities A and B.
•And assume that the investment is equal between A and
B (i.e., each has a weight of 50%). What is the portfolio’s
standard deviation if the correlation between A and B for
each of the following?
•(a) =1.0, =0.3, =0.0, =-1.0
 Standard deviation of a Three-Assets portfolio

• Flame International is considering a Portfolio comprising three

stocks, namely Stock A, Stock B & Stock C.

Particular Weight Expected Standard Correlations between these stock’s return is

s return deviation as follows
Stock A 55% 8% 24% Stock A with Stock B 0.85
Stock B 25% 4% 18% Stock A with Stock C 0.3
Stock C 20% 3% 15% Stock B with Stock C -0.15
 Solution

• =18%