Unit I IAPM

8/7/2019 Unit I IAPM

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Investment Analysis & Portfolio

Management

Unit 1: Introduction to Investment

Management


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Meaning

Investment to a layman means some monetary commitment

Investment is the current commitment of funds for a period oftime to derive a future flow of funds that compensates theinvestor:

1. For the time the funds are committed2. For the expected rate of inflation

3. For the uncertainty involved in the future flow of funds

Investment is the well planned and rationally formulatedprogram which involves deployment of funds on assets with the

aim of earning income/capital appreciation


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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.


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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


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Nature (Contd.)

The sacrifice that has to be borne is certain but thereturn in the future may be uncertain This attributeof 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 arerelatively new & unidentified

Some investments are appropriate for one type ofinvestor others may be suitable to other persons


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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 beadequate for a greater number of retirement years

- There is an increasing no. of working women who areresponsible for planning their own investments during theirworking life so that after retirement they can have stable income

b) TaxationCompulsory Savings which brings down the tax liability


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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

investmentsd) Inflation

- Due to rising prices standard of living is falling

- People seek return to cover any decrease in their income dueto inflation

- People seek safety of principal- People seek return from investment which does not increase

their tax burden


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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 givebalanced growth & stability of return

- Investor makes a choice of investment with a proper mix betweenhigh rate of return & stability of return to reap the benefits of both


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Investment Alternatives

Investments present a wide range of risk from risk-free instruments tohighly 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 withcertainty

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, MutualFunds

iii) Govt. Bonds

iv) Corporate Bonds & Debentures Fixed maturity value & fixed rate ofincome over time


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Direct Investments (Contd.)

vi) Money Market Securities Very short term maturity less than ayear:

- Treasury bills: 14-days, 28-days, 182-days, 91-days by GOI

- Commercial papers: High denominations with fixed maturity periodranging between 30 days to 1year; unsecured promissory note; Soldat a discount & redeemed at face value

- Certificate of Deposit: High denominations marketable receiptof funds deposited in a bank for a fixed period at a specifiedrate of interest; bearer documents & readily negotiable

b. Variable Principle Securities

Terminal values are not known with certaintyi) Preference Shares Price is determined by demand & supply

forces

- fixed return


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ii) Equity Shares no fixed return/maturity date

The stock Mkt. classifies the shares into

- Growth shares: Companies that have higher rate of growththan 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/ preferenceshares can be converted into equity shares

- Features of fixed principal securities & possibility of a variableterminal value


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c. Non-Security Investments

i) Real Estate ownership of residential & commercial properties

- Terminal value is uncertain

- Generally there is a price appreciation

- Less liquidii) Commodities Bought & Sold in spot markets

- Contract to buy & sell commodities at a future date are tradedin future markets

iii) Business Venture Direct ownership investments innew/growing business before firm sell securities on a public

basisiv) Art, Antiques & Other Valuables include Gold, silver, fine

china & jewellery

- Offers aesthetic qualities


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Indirect Investments

Investor does not have direct hold on the invested amount

Contributes savings to organisations such as LifeInsurance/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 investorsobjectives

These should also have additional conveniences & advantages


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Indirect Investments (Contd.)

Mutual Funds

- Investment companies obtain funds from large no. of investorsthrough 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 providingliquidity

- 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


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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


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Mutual Funds (Contd.)

The above schemes are further classified on the basis of theirobjectives

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 instrumentslike treasury bills, commercial paper, etc.

5. Tax saving schemes offers tax rebates to investors6. 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


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Financial & Economic Aspects of

Investment To economist, investment is the net additions made to the

nations capital stock that consist of goods & services used in theproduction 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 additionalincome/growth in value of investment at a future date

The two aspects are related to each other because the savingsof the individual flow into the capital market as financialinvestments to be used in economic investment


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Difference between Investment &

S

pec

ulation Speculation means taking the business risk in the hope of

getting short term gain

It involves buying & selling activities with the expectation ofgetting 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 aresomewhat 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


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Difference between Investor & Speculator

1. Investor is interested in consistent good rate of return for a longperiod whereas speculator is interested in getting abnormal highreturn in the short term

2. Investor constantly evaluates the worth of security whereas

speculator evaluates the market action and its price movement3. The investor matches the risk & return whereas the speculator

assumes greater risk than the investors

4. The negative short term fluctuations affect the speculators worsethan the investors

5. Investor normally uses his own funds while speculator usesborrowed funds to supplement his personal resources

6. Investors are cautious & careful while speculators are daring &careless


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Objectives of Investment

Main Objectives

1. Return Rate of return is the total income the investor receives duringthe holding period stated as a percentage of the purchase price at thebeginning 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 returnbecoming 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 facility2. Hedge against inflation the rate of return should be higher than inflation

rate

3. Safety investment should be approved by law & provide security ofprincipal amount


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Investment Process (Contd.)

2. Investment Analysis

Once the investment policy is formulated the investmentalternatives 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 longrun they move in trends

- Based on technical analysis the investor can decide the timingfor purchase & sale of investments


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Investment Analysis (Contd.)

ii) Industry analysis

- Industry differ in their contribution to the economy& their growth rate

iii) Company Analysis- The Companys earnings, profitability, operating

efficiency, capital structure & management have tobe analysed

- These factors affect the stock prices & the returnof the investors

- If the Co. performs well it is reflected in the rise ofshare price


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3. Valuation

- It determines the return & risk expected from an

investment

- The intrinsic value of the share is measured throughthe 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


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4. Construction of Portfolio

- A portfolio is a combination of investment

- It is constructed to meet the investors 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 areselected & funds are allocated


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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 needto be continuosly tracked

- This enables to take corrective action to avoid losses

ii) Revision: Based on the results of the appraisal the portfolio isreplaced by high return & less risky investments

Unit I IAPM

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