ANALYSIS OF AND INVESTMENT IN FINANCIAL ASSETS

UNIT – I

1. Define Investment? Explain objective & characteristics of Investment?

Ans: Definition: Investment is the commitment of current financial resources in

order to achieve higher gains in the future. This is the commitment of funds made in
the expectations of some positive rate of return, expectations of return is an
essential element of an investment.

Investment has two factors: 1) Return 2) Risk.

High Return High Risk

Low Return Low Risk

OBJECTIVES OF INVESTMENT

I. PRIMARY OBJECTIVESS

1. Safety: It is secured investment and government issued securities is safety.

The safest investments are usually found in the money market and include such
securities as Treasury bills, certificate of deposit CD, commercial paper or
bankers acceptances slip etc.
2. Income: The safest investments are also the ones that are likely to have the
lowest rate of income return or yield. Investors must inevitably sacrifice a degree
of safety if they want to increase their yields. This is the inverse relationship
between safety and yield.
3. Growth of capital : Growth of capital is most closely associated with the
purchase of common stock, particularly growth securities, which offer low yields
but considerable opportunity for increase in value.

II. SECONDARY OBJECTIVES

1. Tax minimization: An investor may pursue certain investments in order to

adopt tax minimization as part of his or her investment strategy.
2. Marketability / Liquidity : Most of the assets which are fixed in nature are
not liquid, which means they cannot be immediately sold and easily converted
into cash. Achieving a degree of liquidity, however, requires the sacrifice of a
certain level of income or potential for capital gains.

CHARACTERISTICS OF INVESTMENT OR FACTORS TO BE CONSIDERED IN

INVESTMENT DECISIONS
 1. Return: Return refers to expected rate of return from an investment. It is an
important characteristic of investment and is the major factor which influences
the pattern of investment that is made by the investor. Investor always prefers
high rate of return for his investment.
2. Risk: It is one of the major characteristics of an investment. Risk refers to the
loss of principal amount of an investment. It refers to the possibility of incurring a
loss in financial transactions.
3. Safety: Safety is another feature which an investor desires for his
investments. Safety implies the certainty of return of capital without loss of
money or time. Every investor expects to get back his capital on maturity without
loss and without delay.
4. Liquidity : An investment is easily saleable or marketable without loss of
money without loss of time is said to be posses liquidity. Liquidity means that
investment is easily realizable, saleable or marketable. When the liquidity is high
then the return may be low.
5. Marketability : Marketability is buying and selling of securities in market or
other ways transferability or saleability of an asset. Securities listed in a stock
market which are more easily marketability than which are not listed and public
limited company’s shares are more easily transferable than those of private
limited companies.
6. Capital Growth: Capital growth has become an important characteristic of
investment. Growth of investment depends upon the industry growth. Capital
growth refers to appreciation of investment.
7. Stability of Income: Another major characteristic feature of the investment is
the stability of income. Stability of income looks for different path just as security
of principal.

REASONS OF INVESTMENT:

1. Long life expectancy or planning for retirement

2. Increasingly rates of taxation.

3. Interest Rate

4. Inflation:

5. Income:

6. Investment channels for economic development government takes certain decisions

for investment purpose.
2. Explain the terms of Investment?

Ans Terms of Investments

1. Real Assets V/S Financial Assets

Real Assets Financial Assets

1.It is tangible. Ex: Property, Plant 1. It is intangible. Ex: Shares

and Machinery. certificate, bond certificate,
2. Investing for day to day operation bank balance etc.
of the business. 2. Investing for getting returns
3. Returns are profits. 3. Returns are dividend, interest
rate, capital gains.

2. Speculation : Fluctuation of market. Speculation is a act of financial transaction

leads to substantial risk. Speculation depends upon nature of asset, holding
period, amount of leverage.

Type of speculation
a) Bullish speculation
b) Bearish speculation

3. Hedging: Covering the risk and is used as risk management technique to reduce
substantial loss. Ex. Stock exchange traded funds, insurance, forward contract,
swaps, options, future etc.
Type of Hedging
a) Forward
b) Future
c) Money market
d) Hedging strategies
e) Hedging through asset allocation.
f) Hedging through structure
g) Hedging through options
h) Staying in cash.
4. Arbitrage: Purchasing in low rate market and selling in high rate market. Ex.
Foreign exchange market.
5. Par value: Issue price of shares
6. Book value : Based on depreciation or appreciation of the stock the value will be
changing and carried forward to balance sheet.
7. Market value: Based on market conditions, the value will be changing.
3. Explain about the Investment process?

Ans:
FRAMING OF INVESTMENT POLICY

INVESTMENT ANALYSIS

INVESTMENT VALUATION

PORTFOLIO CONSTRUCTION

PORTFOLIO EVALUATION

1. FRAMING OF INVESTMENT POLICY:

It is systematic functioning of investment process. There are three objectives
of investment.
1) Investable funds: It depends upon availability of investment funds. The
funds may borrowing or owned amount.
2) Objectives of investors: It depends upon required rate of return, need for
regularity of income, risk perception and the need for liquidity. The risk takers
objective is to earn high rate of return in the form of capital appreciation.
3) Knowledge about Market conditions: The knowledge about the
investment alternatives and markets plays a key role in the policy formulation.
The investment alternatives range from security to real assets. The risk and
return associated with investment alternatives differ from each other.
2. INVESTMENT ANALYSIS:
 The investor should be aware of the stock market structure and the functions
of the brokers. The mode of operation varies among BSE, NSE and OTCOEI.
Brokerage charges are also different. The knowledge about the stock
exchange enables him to trade the stock intelligently.

3. INVESTMENT VALUATION: The valuation helps the investors to determine

the return and risk expected from an investment in the common stock. There
are 2 types of valuation

1. Intrinsic value: it is book value of the share. Different discounting models

are used to value the shares. Real worth of share is compared with market
price then investment decisions are made.
2. Future value: Future value of a stock is estimated by using statistical
techniques. Ex. Trend analysis, correlation and regression etc. The
analysis of historical behaviour of a price investor predicts the future
value.

4. PORTFOLIO CONSTRUCTION: It is a combination of securities. Portfolio is

constructed on the basis of investor’s goals and objectives. Investor tries to
attain maximum return with minimum risk. Portfolio management means
diversification of funds.
(i) Diversification
(ii) Debt and equity diversification
(iii) Industry diversification
(iv) Company diversification
(v) Selection.

5. PORTFOLIO EVALUATION: The portfolio has to be managed effectively.

The effective management calls for evaluation of the portfolio.
1. Appraisal: Return & Risk performance of securities from time to time. The
variability of return is measured and compared.
 2. Revision: It depends upon results of the appraisal. Revising the security
values is a major component of portfolio.
4. Define risk? Explain different types of risk?

Ans: Definition: Risk is the potential for variability in returns. Ex. Fluctuations of
stock prices in stock market.

Risk: It is defined as a situation where the possibilities of happening or non

happening of an event can be quantified and measured.

Uncertainty: It is defined as a situation where possibility cannot be measured.

TYPES OF RISK: -

1. FINANCIAL RISK: It is concerned with improper utilisation of financial resources

is called financial risk. It is the risk borne by equity holders due to firms use of
debt. If the company raises capital through debt the company has to pay principle
amount as well as interest amount which increases degree of uncertainty in
company.
2. STATIC AND DYNAMIC RISK:
STATIC RISK: It involves normally even through there is no change in economy.
Such as perils of nature and dishonesty of other individuals.
DYNAMIC RISK: It is raised through changes in economy i.e., change in price
level, consumer taste, income and output and technology.
3. EXCHANGE RATE RISK: Exchange rate risk is important for investors that have
a large amount of overseas investment (foreign investments). If exchange rate
risk is high even through a substantial product may have been made overseas
the value of the home currency may be less than overseas currency.
4. BUSINESS RISK: Business risk is also called as operating risk. It is improper
utilisation of assets of the organisation. The sources of business risk mainly
raises from a company’s product/service, ownership support, industry
environment, market position, management quality etc.
5. LIQUIDITY RISK: Liquidity Risk raises from the situation where the demand for
that stock falls. Liquidity risk becomes more important to parties who hold an
asset.
6. COUNTRY RISK: Country risk is also called as political risk. It is the risk of
investing funds in another country which has major change in the political or
economic environment.
7. MARKET RISK: The price fluctuation or volatility increases and decreases in the
daily market. This implies to both stock as well as option markets.
1. Bullish 2. Bearish
8. CREDIT RISK: It is a risk of loss due to a debtors non-payment of a loan. It is
also called as defaulter risk.
9. OPERATIONAL RISK: Operational risk is defined as the risk of loss resulting
from inadequate or failed internal process people and systems from external
events.
10. INTEREST RATE RISK: Implies to debt investment i.e, is loosing of money due
to change in interested.
11. CURRECY RISK : Apply revenue own foreign investment that is loosing of
money because due to moment to exchange rate.
12. INFLATION RISK: It is a risk of loss in purchasing power due to inflation.

5. What is security analysis? Explain the approaches of security analysis?

(Or) Explain about fundamental analysis and Technical analysis?

Ans: Security Analysis: It refers to analysis of trading securities from the point of
their prices, return and risk. Security analysis is the analysis of tradable financial
instruments called securities. Ex. Stock, bond.

Objectives of Security analysis

1. Regular income:
2. Capital appreciation
3. Safety of capital
4. Liquidity
5. Hedging against inflation

Approaches of Security analysis

There are two types of approaches of security analysis

A. FUNDAMENTAL ANALYSIS: It is a logical and systematic approach to estimate

the future dividend and share price based on economic financial and other
qualitative and quantitative factors. It is concerned with macro economic factors.

OBJECTIVES OF FUNDAMENTAL ANALYSIS

1. Valuating the company stock price and fluctuations of price.
2. To make a projection on its business performance.
3. Evaluate management and internal business decisions.
4. To calculate risk.

FUNDAMENTAL ANALYSIS FRAMEWORK

I. ECONOMIC ANALYSIS
BUSINESS CYCLE

Key economic variables which monitors fundamental analysis

1. GNP (GROSS NATIONAL PRODUCTS): GNP represents the aggregate

value of goods and services produced in the economy.
2. GDP (GROSS DOMESTIC PRODUCTS): it is a measure of all the goods &
services produced in the economy during a specified time period.
3. SAVING AND INVESTMENTS: stock market is a channel through which
savings of investor are made. Ex equity shares, deposits, mutual funds and
real estate’s etc.
4. INFLATION: Inflation effects the purchasing power of consumer which
creates the adverse effect to the company and disturbs the economy.
5. AGRICULTURE: Agriculture decreases or increases in agricultural production
is significantly effects on industrial production and corporate performance.
6. INTEREST RATES: An investor has to consider the interest rate prevailing in
the economy and evaluate their impact on performance and profitability of the
company.

II. INDUSTRY ANALYSIS: An industry is a group of firms that have similar

technological structure of production and produce similar products. Ex.
Automobile industry, textile industry.
Industry analysis is based on SWOT ANALYSIS (Strength, Weakness,
Opportunities, Threat) Environmental scanning.
 Objectives of Industry analysis:
1. Understand the competition and determine the level of industry
profitability.
2. Understanding the structure of forecast future profitability
3. Identifying the key success factors.

Components of Industry analysis

1. Competitive structure:
● What companies are in the industry?
● What are their market shares?
● Which are publicly traded?
● No. of companies entry, exit, constant?

2. Performance
● Industry survival
● Technological threats
● Regulatory threats
3. Vulnerability to external shocks:
Could major portions of the industry be nationalised by foreign
government. Are they subject to fashion trends that may soon change.
4. Regulatory and tax:
● Current regulation faced by industry?
● Any new regulation and any special taxes is implemented.
5. Labour conditions:
● What percentage of the industry workers is unionized?
● Are the unions generally hostile?
6. Financial and financing issues:
● How much debt does the average firm have?
● What is the mix of fixed assets & current assets?
7. Industry stock price valuation:
● What is P/E ratio for the industry?
● What were the economic conditions?
Industry Life cycle
1. Introduction stage
2. Growth stage
3. Maturity stage
4. Decline stage

III. COMPANY ANALYSIS

 1. Earnings of the company: EPS is ratio of PAT and No. Of shares
outstanding. It determines stock price of a share of company in market.
It is a operating profit of a company. An investor should aware the
income of company may change due to following reasons: -
● Change in sales
● Change in cost
● Depreciation method adopted
● Inventory accounting method etc.,
2. Financial Leverage: The degree of utilisation of borrowed money in a
business is called financial leverage. It depends upon financial
decisions. It decides the capital structure. A high degree of financial
leverage results in high interest payment.
3. Operating leverage: Operating leverage focus on total cost which
majorly effected by fixed cost (ex. Rent of factory). High degree of
operating cost results in high payment of expenses.
4. Competitive edge: Major industries in India are composed of
hundreds of companies. Ex. IT industry which has major market share.
These companies are successful in competition. Following are the
aspects is followed in company’s competitiveness:
a) Market share
b) Growth of annual sales
c) Stability of annual sales.

5. Production efficiency: It means producing the maximum output at

minimum cost per unit of output. Which is called high productivity and
possible by production efficiency.
Increase in production efficiency result:-
(i) Increase in profitability
(ii) Low operational cost
(iii) Optimum utilisation of resources
(iv) Enhanced competitiveness & market share.
6. Mode of Analysis: In the part investors relayed on annual EPS and
ROE( Return on Equity) but now-a-days they are focussing on the
value of company shares (market capitalisation etc).

B. TECHNICAL ANALYSIS:

Technical analysis is the oldest form of security analysis. It is occurred in

th
17 century, Japan. Technical analysis is a great tool used for forecasting future
 prices and trends for short term investors. Technical analysis is a method of
evaluating securities by analysing statistics generated by market activity.

Definition: Technical analysis is the study of market action primarily through the
use of charts for the purpose of forecasting future price trend.

Advantages of Technical analysis:

1. Quickly access the market (bullish or bearish).

2. Allows us to spot opportunities.
3. It is a virtual market (stock indices, individual stock, currencies, commodities
etc).
4. Applicable on all time frames (OTC-Over the counter 24/7).
5. Closing price of stock every day is called NAV (Net Asset Value).
6. It is very simple & straight forward.

Assumptions of Technical Analysis

1. The market discounts everything.

2. Price moves in trends.
3. History tends to repeat itself.

Techniques of Technical Analysis: -

1. Bar & Line charts: - Depicts the daily prices changes along with closing price.
Technical analysis is based on information or patterns observed on the chart.
2. Moving average analysis: An average is a sum of prices of a share over some
weekly periods divided by the number of weeks.
3. Relative strength Index:- It emphasis market moves in advance. So the raise or
fall of a market is not smooth.
4. Charles Dow theory:- Charles Dow & Edward Jones were newspaper reporters
working at New York in 1882. They are the partners of a company and
specialised in delivery the financial news.
THE WALL STREET JOURNAL was started in 1899. Dow theory was
formulated from series of wall street journal editorial authorised by Charles H
Dow (1800- 1902).

Dow suggest part, current and future information is discounted into the markets
and reflected in the price of stocks and indexes. That information includes everything
from the emotions of investors to inflation and interest rate.

Dow Theory focuses mainly on price movements. Dow theory has three forces
(trend).
 a) A primary direction or trend (Tide) – long term or secular, Bull or Bear market.
b) Secondary reaction or trend (wave) – weeks to months.
c) Day to day fluctuation (Dow theory is not applicable).

UNIT – 2

UNIT-2

VALUATION OF FIXED INCOME SECURITIES

1. Explain fixed Income securities its objectives, features and types?

Ans: Fixed income security is debt instrument issued by a government,

corporation or other entity to finance and expand their operations. Fixed income
securities provide investors a return in the form of fixed periodic payments and
eventual return of principal at maturity. Ex. Treasury bills, bonds, guaranteed
investment certificate GIC.

Objectives of Fixed Income Securities:-

1. It generates fixed income securities through regular income, reduce overall risk
and protect against volatility (fluctuations) of a portfolio.
2. To appreciate securities in value and offer more stability of principle than other
investments
3. Corporate bonds are more likely than other cooperate investments is be repaid if
a company declares bank rusty (liquidated due to loses insolvency)
4. To maintain the principle balance that may be tied up for a long time i.e.,
resulting in lost income by not investing in their securities.
5. To monitor the interest rate fluctuation that causes bond prices to change
potentially resulting in lost income by having money locked into a lower interest
bond and not being able to invest in a higher interest bond.
Xyz co.

Investors in bonds of a corporation have a higher priority a common and

preferred stock holders of the same corporation should the company declare
bankruptcy.

2.Q) explain the types of fixed income securities

1. Bonds:-
A bond is an obligation or loan made by an invester to an issuer. In
turn issuer promises to repay the principle of the bond on fixed maturity date and
make regular interest payments. Majority the bond issuers are governments and
corporate.
 2. Saving bonds:- saving bonds issued by the Canadian and various provincial
governments are different from conventional bonds. Canada saving bonds(CSB)
pays a minimum guaranteed interest rate (also pay compound interest)
3. Guaranteed Investment Certificates:- (GIC)
GIC is anot issued by a trust company corporation (cdic) insure may GIC’s for
interest and principle totalling upto 1 lakh $ . it is not redeemable.
4. Treasury bills (T-Bills) :-
It is afastest investment with short term period issued by federal government.
The period in treasury bills 1- 12 months and highly liquid and very secured.

5. Bankers Acceptance:-
It is short term premisery note issued by a corporation bearing the unconditioned
guarantee. BA Offers superior yeid to T- bills and higher quality and liquidity.
6. NHA Mortgage paced securities:-
National Housing act MBS is an investment that combines the features of
residential mortgage and Canadian government bends. It includes monthly
income returns consisting of blend of principle and interest payment from a pool
of Mortgage.
7. Shipe Coupons & Residualss:-
These are the instruments purchased at discount and matured at par value. They
grow ever time and while any intere3st income is not payable until maturity. A
nominal amount of interest its occurred (outstanding) each year and must be
claimed as income by the purchaser fro tax purpose.

8. Laddered portfolio:-
It consist of several bends each of which has a successively longer term to
maturity each position in the portfolio is usually the same size as the next with
intervals between maturity dates roughly equal.

3Q) Define bond? Explain characteristics of bonds, types, bond yield measures?

Ans) Bonds are commonly referred to as fixed income securities it which is considered
as dept instruments and traded only OTC (ever the counter /24x7).

Bend contract between bond issuer and bend holder is called bond indenture.

Characteristics of Bonds:-

1) Face Value:-
Face value is called par value. It is the money amount, the bend will be worth at
its maturity and also reference amount to calculate interest rate payment.
2) Coupon rate:-
It is the rate of interest the bond issuer pays either face value of bond.
3) Coupon date:- these are rates on which the bend issuer will make interest
payment. It may be annual or semi- annual coupon payment.
4) Maturity Date:- it is the date on which the bond will mature and bend issuer will
pay the bond holder the face value of the bond.
5) Issue Price:- it is the price at which the bond issuer sells the bond.
6) Redemption value:- redemption means repayment of amount is made as per
the T&C of the agreement i.e, it may a discount or a premium.
7) Market value:- A bond may be traded is a stock exchange the price at which it is
sold or bought is called market value of the bond.

Types of bonds:-
1) Secured & Unsecured Bonds:- the secured bonds is secured by real assets
of the issuers unsecured bonds are not like this
2) Perpetual & Redeemable Bonds:- bonds that are not matured are called
perpetual in which only interest is paid. In redeemable bonds the maturity
date id given at the end of period they will pay interest as well as principal
amount.
3) Fixed interest rate of bonds & floating interest rate Bonds (FIRB)
In FIRB the interest rate is fixed at the time of issue where as in the floating
interest rate bonds interest rate changes.
4) Zero Coupon Bonds:-
This bond sell at discount & face value is repaid at maturity. The origin of
these type of bond can be traced to the US security market. The high value of the
U.S Government security prevented the investors from investing their money in
government security. The difference b/w purchase cost and face value of the
bond is gain for the investor since the investor does not receive any interest on
the bond. The conservation price is suitable arranged to protect the less of interst
to the investor.
Formula:- Face value of the Bond
(HR)n
5) Deep Discount Bonds (DDB)
A deep discount bond is another form of zero coupon bonds. The bonds are
sold at a large discount on those nominal value and interest is not paid on
them also they at par value. The different between the maturity value and the
issue price series as an interest return the DDB maturity period may range
from 3years to 25 years or more.
6) Capital Index Bonds:-
In this types of bonds the principle amount of the bond he adjusted for
inflation for every year. The bond is advantage because it gives the investor
more returns by taking inflation into account.

● Measures of Bonds:-
 1) It is also called as present income bond yield is determined by dividing the
fixed coup amount by the current price value of the particular bond .
Formulae:- Current Bond Yeild:- coupon Amount
Current Price of a Bond
2) Coupon yield:- Coupon yield is also known as nominal yield referred as
coupon rate in the bond market. Bond yield is calculated at the end of the
financial year and paid is fixed coupon amount on the face value.
3) Yield to Maturity (YTM) :-
It is calculated at the end of term for which the bond was issued in the
bond market. This type of bond yield is calculated taking into account the
eventual payment made by the company. In this method we will consider
annual coupon interest payment made by the company to know whether it
is capital gain or capital loss.
PV = C1 + C2 + ........ + CN +FV
(1+Y)1 (1+Y)2 (1+Y)N
4) Holding Period of return (HPR):
Investors buy a bond and sell it after holding for a period.

Holding period return = Price/Loss during the holding period +coupon interest rate
Price of the beginning of holding period

The holding period rate of return is also called as the one period rate of ratio

5) Approximate yield to Maturity(AYTM):-

it requires trial & error method by putting rate into the present value of a
bend until price is equal to actual price of bond .
AYTM= C+F-P X100
n
F+P
2
Where YM = yield to maturity
C= coupon /Interest payment
F= face value
N= years of maturity
6) Yield to call (YTC) : it is the yield of a bond or note if you want to buy and
hold the security until the call date but this yield is the security until the call
date but this yield is valued only if the security is prior method the
calculation of yield to call is based on coupon rate length of time to the call
date & market price.
 The formulae to calculate the yield to call looks slightly complicated but it
is actually quite straight forward. The corporate of the formula are as
Follows:-

P= (C/2) X (1-(1+YTC) X 2t ) (YTC/2) +(CP/1+YTC/2) X2

P= the current market price

C= Annual Coupon payment

CP = Call price

t= number of years remaining until the call date

YTC = Yield to call

UNIT –III
VALUATION OF COMMON STOCK

1Q) what is common stock? Explain the concept of common stock?

Ans) common stock is the security that represents ownership in cooperation. Holders
of common stock exercise control by electing a board of director & voting on
corporate policy.
Common stocks are ladder for ownership structure in liquidation rights of the
company’s assets eic.
Preference given in case of bank rupt i.e.
● First priority creditors
● Second priority- preference here holder
● Last priority- equity holders- common stock
Capital –Equity- JSC Capital Equity Shares
100%

51% 49%

Board of Directors - Free float market (No

Class- A shares restriction for trading stock
Voting rights market)
Annual general Meeting - Class B shares
- No Voting rights( only
investments)

● Valuation of common stocks:-

1) Fundamental analysis 2) Technical Analysis
 Refer Unit-1- Security Analysis- Answer
● Features’ of common stocks:-
1) Common stock is ownership in part of a company who has all rights on
decision making regarding company related matters
2) We have a right on company’s profits & voting rights.
3) The more shares you own the larger the portion of the company you
own.
4) The majority of stock trading today take this form common stock
represents ownership in a company & portion of profits.
5) In the long term common stock by means of capital growth yield higher
rewards than other form of investment securities
6) The higher the return higher the risk and easily liquidated.

2Q) what is dividend? Explain types and determinants of dividend policy?

Ans) Dividend is a distribution of a portion of a company’s earnings decides by the
board of directors paid to a loss of its share holders.
Divided can be issued monthly or quarterly or yearly.

100% Profit EAES

__________________
I I
R/E DP Ratio
I
Investment share Hold Max
EPS = EAFS
No. Of share out standing

EPS- 100% Pa unit share

Dividend Payout Ratio
100% DP Ratio G/R
80% = 100-80% = 20% - G/R Retain earning
60% = 40%
40% = 60%
20% = 80%
10% -= 90%
0% = 100%

Share holder’s Maximisation

I
Corporate Governance

Kr – Cost of retain earning

I
Opportunity cost
● Types of dividend:-
1) Cash dividends:- the cash dividend is most common of the divided
type. On the date of declaration the board of directors resolves to pay&
certain dividend amount in cash to those investor holding the
company’s stock on a specific date.
2) Stock Dividend:- A stock dividend is issued by a company of its
common stock to its common share holders without any consideration
Ex:- Bonus Shares
3) Property Dividend:- A company may issue a non-monitory dividend to
investor rather than making a cash or stock payment.
4) Scrip Dividend:- A company magnet have sufficient funds to issue
dividends in the near future so instead it issues a scrip dividend i.e,
promissory note is issued at later date.
5) Liquidating Dividend:- When the board of directors wishes to return the
capital originally contributed by shareholders as a dividend.

● Determinants of Divided Policy:-

1) Types of industry:- Industries that are characterised by stability of
earning may formulate a more consistent policy as to dividend than
those having an uneven flow of income.
Ex:- Public utility concern
2) Age of Corporation:- newly established enterprise require most of their
earning for plant improvement and expansion while old companies
which have attained a longer earning experience can formulate clear
out dividend policy.
3) Extant of chair distribution:- A closely held company is likely to get
consent of the shareholder for the suspension of dividend. But a
company with a large number of shareholders widely scattered would
face a great difficulty in securing such account.
4) Need for additional capital:- The extent to which the profits are plugged
back into the business has got considerable influence on the dividend
policy.
5) Business Cycle:-
 During boom, prudent corporate management creates good reserve for
facing the crisis( shortage of resources) which flows the inflationary
period.
6) Changes in Government Policy:- Sometimes government limits the rate
of dividend declared by company in a particular industry. An ammonite
is Indian Companies Act 1956.
7) Trends of Profits:- The past trend of the company’s profits should be
thoroughly examined to find out the average earning position of the
company of the company & subject to general economic conditions.
8) Taxation Policy:- corporate factories effect divided directly & indirectly
on the profits of the company so distribution of dividend is subject to
taxation policy.
9) Future requirements:-accumulation of profits becomes necessary to
provide against contingency (risk) of the business. So in this regard the
divided policy may change.
10)Cash balance: If the working capital of the company is small liberal
policy of cash dividend cannot be adopted. Divided has to take the
form of bonus share issued to the members in lieu of cash payment.

3Q) Explain different valuation methods of common stock?

Ans) 1. Dividend discount model
a) The period valuation model
b) Two period valuation model
c) N period valuation model.
2. Dividend Valuation model
a) No growth phase
b) Constant growth phase
c) to stage growth model
3. Saving capitalisation model
a) Gordon Model
b) Walter model.
4 . Price earning multiplier approach

4Q) Explain different valuation methods of common stock?

Ans:- There are two types of equity share valuation models
1. Dividend capitalisation of model
2. Earnings capitalisation of model.

1. Dividend capitalisation of model:-

a) Dividend discount
b) Dividend valuation

a) Dividend discount model:- This method is used after valuating company’s

stock price based on the theory that its stock is worth the sum of all of its
future dividend payment discounted back to their present value.
There are three types of models under dividend capitalisation model. They
are
1) one period valuation model
2) Two period valuation model
3) N period valuation model

An investor plans to buy an equity share hold it for one yeart or more than
itself.
1. One period valuation methods:-
Formula :- P0 = D1 + P1
1+kc 1+kc
Where ; Po = Current value of the share
D1 = Expected dividend at the end of the year.
P1 = Expected price share at the end of the year
Kc = The required rate of return on equity capitalisation/
discount rate
2. Two period valuation Models:- Suppose now that the investor plans to
hold the share for two years and then sell it.
The value of the share to the investor today would be
Po = D1 + D2 + P2
(1+kc) (1+kc)2 (1+kc)2
Where ; D2 = Divided expected at the end of the year 2
P2 = Expected selling at the end of the year 2
3. N- Period valuation model:-Similarly if the investor plans to hold the
share for N- years and then sell, the value of the share would be
Po = D1 + D2 + ..........+ Dn + Pn
(1+ke) (1+ke)2 (1+ke)n (1+ke)n

Po 1 Dt + Pn
(1+ke)t (1+ke)n
If the expected dividend in different period is (D) constant, we can
calculate the value of the share by using amunity discount factor
tables, given below
Po = (D) (PV1Fai,n) +(Pn) (PV1i,n)

Dividend valuation models:-

Valuation model is the generalized model of common stock
valuation.
The concept of these models is that many investors don’t contemplate
selling their stock near in future. They want to hold the share as infinite
stream of future dividend.
Po = 1 Dt
(1+ke)t
1) N o growth
2) Constant growth
3) Two stage growth model
1) No growth case :- If a firm has future dividend pattern with on growth or
where the dividend remain constant ever time, the value of the share shall be
the capitalisation perpetual of constant dividends
Po = D/kc
2. Constant growth cases:- If the dividends of firm are expected to grow at a
constant rate forever into an indefinite future, the value of share can be
calculated as

Po = D1 + Do(1+g)
Kc-g ke-g
Where : Do = Current dividend
D1 = Expected dividend in year 1
Kc = required rate of return on equity
g= Expected percent of return in dividend
This model is also known as goerdon’s share valuation model.

3. Two Stage growth model:- the constant growth model is extended to two
stage growth model. There growth rated are divided into two namely a period
of extraordinary growth will continue for a finite number of years and there
after the normal growth rate will prevail i.e, a constant growth period of infinite
nature.
Farmula: Po = D1 [1- (1+g1)n] + [ D1 (1+g1)n-1 (1+g2) ]
[ (1+r) ] [ r-g2 ]
r-g1
Where : Po = Current price of equality share
D1 = is the dividend expected a year 1
g1 = extra ordinary growth rate
g 2= Normal growth rate
n= No of years
r= Investors required rate of return

4. Earning capitalisation model:- (i) Gordon’s model

(ii) Walter’s Model
(i) Gordon’s Model:- this valuation method presuppose that earning of the
firm are either distributed among the share holders or are reinvested
within the business. The growth in dividend in future would therefore
depend upon the profits retained and the rate on these rational profits.

Assumptions of the models:-

1. The retention ratio is constant
2. The rate of return on reinvestment profit is constant

The Gordon valuation model can be represented as

Po = EPS1 (-b) ..................(1)
kc – br
 where; Po = Price oda share
EPS1 = Retention ratio i.e percent of earnings being retained
r= rate of return on reinvestment i.e, ROI
kc= required rate of return of the entity investors
1. When the retention ratio is zero and 100% earning are distributed as dividend
In the case, the value of b is zero and putting b=c in eq(1)
Po = EPS1(10)
Kc-br

= EPS1 ............ (2)

Kc
2. When the rate of return of the firm, r is equal to the required rate of return of the
equity investors, ke i.e, kc=r; then the equation 1 can be written as ;

Po =EPS1(1-b)
ke-b

Po = EPS1 (1-b)
Ke(1-br)

Po = EPS
Ke

(ii) Walter’s Method:-

The walters model supports the view that the market price of a
share is the sum of
(i) Present value of an infinite stream of dividend
(ii) Present value of an infinite stream of returns from retained earnings

The investors will evaluate the retention of earnings resulting in lesser

dividends in the light of
a) The rate of return (r) earned by the company on these retained
earnings
b) The opportunity cost of equity investors, kc

Depending upon the relationship b/w r & kc, the investors will value the
expected capital gain and will thus value the share. The walter’s model
can be represented as follows:

P= D + r
Kc kc(E-D)
Kc
Where ; P= Market Price of the share
D = Dividend per share
r= rate of return on investment by the firm
ke= equity capitalisation rate of investor
EPS = Equity per share
 As per walter’s model the value of an equity share is the sum of the
components
(i) Present value of infinite of dividends
(ii) Present value of infinite of stream of return from retain earnings

Multiple Approach:-
This ratio most common earning valuation model. It is a ratio b/w
the price & its EPS
Po = D1 -----(1) Pc = D1/E1 -- (2)
Ke-1 E1 k1-g
D = Dividend per share
P = Market Price of the share
E = EPS
K = rate of return
Ke = equity capitalisation rate
g = growth rate

UNIT-4

1. Define portfolio & types of portfolio?

Ans: Definition of portfolio :- A portfolio is a grouping of financial assets such as

stocks, bonds, commodities, currencies and cash equivalents as well as their fund
counter parts including mutual exchange traded and closed funds.

Security means marketable (LIC Bonds, NSE bonds (Post office) Fixed deposit etc
are non-marketable ie. These are not included).

An Investment portfolio is divided into small size representing variety of asset

classes which is called diversification strategy.

Types of Portfolio

1. The Aggressive Portfolio: It includes stock with high risk / high reward proposition it
has high beta (sensitivity) to the over all market. It has constituently high beta stock
experience.

2. The Defensive portfolio:- It doesn’t carry high beta (market risk) and fairly
associated from board market moments. Cyclic stock are more sensitive to the
economic business cycle. The benefits of buying cyclic stock offers extra level of
protection against detrimental (danger events).

3. Income Portfolio:- It focuses on making money through dividends or other types of

distribution to stock holders. This companies are safe defensive stock with high yield.
Ex. REIT (Real Estate Investment Trust) , MLP (Master Limited Partnership).
4. Speculative Portfolio:- It is closest to pure Gamble. It presents more risk. Financial
grooves plays vital role. Ex. IPO (Initial Public Offer).

5. The hybrid Portfolio:- It means venturing into other investments such as bonds,
commodities, real estate etc there is a lot of flexibility in hybrid portfolio approach.

This type of portfolio would contain blue chip stock and sum high grade and government
and corporate bonds.

2. Define Portfolio Management? Explain the need and types of the Portfolio
Management?

Ans: Portfolio Management refers to managing and individual investments in the form of
bonds, shares, cash, mutual funds etc that earns maximum profit with stabilised time.
This money is managed under the guidance of portfolio manager is called portfolio
management.

Need of Portfolio Management:

1. Presents best investment plan to the individuals as per their income, budget, age
and ability to understand risk.
2. Portfolio management minimize risk and maximize the return.
3. Portfolio management understands the clients financial needs and suggest best
investment policy.
4. Portfolio management provides customized investment according to the clients
investment.

Types of Portfolio Management:-

1. Active Portfolio Management: - The Portfolio managers are activity involved in

buying and selling securities to ensure maximum profiles to individuals.
2. Passive Portfolio Management:- Portfolio manager deals with fixed portfolio
design to match the current market scenario.
3. Discretionary Portfolio management service:- An individual authorised the
portfolio manager to care of his financial needs on his behalf. Portfolio manager
take care of investors. Needs paper work documentation and filling soon to take
certain decision.
4. Non-Discretionary Portfolio management Service:- The portfolio manager
advice the client what is good and what is bad for him, but the client will take his
own decision.

3. Explain about Harry Markowitz’s portfolio theory?

 Ans: Harry Markowitz’s Portfolio theory is also called Diversification theory. Harry
Markotwiz is an American Economist and receipt of 1989 John won Neumann theory
price and 1990 noble memorial price in economic science.

Markowitz’s is Professor of finance at Rady school of management at University

of California. He is best person for his pioneering work in modern portfolio theory.
His studies affects of asset risk return. Correlation of diversification or probable
investment portfolio return.

ESSENCE OF MARKOWITZ’S THEORY

1. An investor has a certain amount of capital. He wants to invest over a single time
horizon. “ Do not put all your eggs in one basket”.
2. He can choose different types of investment instruments like stock, bonds,
options currency etc based on risk and return.
3. He assets in the selection of effectively portfolio. This model to investor how to
reduce their risk.
4. The decisions is depend upon hi expectation that is maximise the yield and
minimise the risk.
5. It is also called as mean variance model.

ASSUMPTIONS OF HARRY MARKOWITZ’S THEORY

1. Risk of portfolio is based on variability of returns.

2. An investor is risk aversion (risk taker)
3. An investor prefers to increase consumption.
4. The investor utility of concave is increasing risk due to consumption.
5. Analysis based on single period model of investment.

UNIT-5

UNIT-5

1. Explain about evaluation of portfolio, wrote about need of portfolio?

Ans: Portfolio evaluation refers to the evaluation of the performance of the

portfolio this is the process of comparing the return earned on a portfolio with the
return earned on one or more other portfolio‘s. It is basically a study of impact of
investment decision it involves portfolio management.

Need for portfolio evaluation:-

1. Self Evaluation:- In this, investor under takes the investment activity on their
own and takes investment decision. They construct and manage their own
portfolio of their securities. This is for rectify the mistakes committed by him.
2. Evaluation of portfolio manager:- Investment company usually creates
different portfolio with a different objective for different set of investors. For this
we require professional portfolio manager who is responsible for investment
decisions.
3. Evaluation of Mutual funds: - In India, there are many mutual funds as also
investment companies operating both in the public sector as well as in the private
sector. These compete with each other for mobilising the funds with individual
and organisation by offering attractive returns, minimum risk, high safety and
prompt liquidity. In this regard we need to select best options for that we require
evaluation of mutual funds.
4. Evaluation perspective:- A portfolio comprises several individual securities. In
this regard purchasing and selling of securities takes place to revise a portfolio.
Hence, evaluation is required from different point of view.
5. Transaction view:- An investor may attempt to evaluate every transaction of
purchase and sale of security. Whenever a security is bought or sold. It is
evaluated whether it is correct profitable.
6. Security view:- Securities includes purchased price. At the end of the holding
period the price of the securities may be lower or higher than its cost price.
Furtherly during holding period interest or dividend might have been received on
security. Thus evaluation of profits of holding each security separately called as
evaluation from the security view point.

2. What is portfolio evaluation? Write about the various methods of portfolio

evaluation?

Ans: Portfolio evaluation:- refers to the evaluation of the performance of the

portfolio this is the process of comparing the return earned on a portfolio with the
return earned on one or more other portfolio ‘s. It is basically a study of impact of
investment decision it involves portfolio management.

METHODS OF PORTFOLIO EVALUATION:-

1. SHARPE’S REWARD – TO- VARIABILITY RATIO:- Sharpe ratio is a measure
of an investments excess return, above the risk free rate per unit of standard
deviation. It is calculated by taking the return of the investment subtracting the
risk free and dividing the result by investments standard deviation.
Symbolically it is represented as
Share Index = RP-RF
P
 Where RP = Expected return on the portfolio
RF = Risk free rate of return
P = standard deviation of portfolio return
Sharpe measures of portfolio developed by William Sharpe & referred as Sharpe
ratio. It is used for evaluation of portfolio. The ratio of returns generated by the
fund over and above risk free rate of return and total risk associated with it. It is a
way to examine the performance of an investment by adjusting for its risk.
The sharpe bench mark attempts to statistically calculate whether a
portfolio success was due to good management or not.
2. TREYNOR’S REWARD – TO- VOILATILITY RATIO:- The Treynor ratio is also
called as Reward-to-volatility ratio. It is a metric for determining how much
excess was generated for each unit of risk taken by a portfolio.
Treynor index = RP = RF
B

Where RP = Expected return on portfolio

Rf = Risk free rate of return
B = portfolio beta (market risk)/ systematic risk/portfolio
This measure was developed by JACK TREYNOR. This performance measure
evaluates the funds on the basis of treynor Index. This index is a ratio of return
generated by the fund over and above risk free rate of return during a given
period and systematic risk associated with it.
 3. JENSEN MODEL: This is another model of portfolio evaluation proposed by
MICHAEL JENSEN. It is also referred as differential return method. This
measures involves evaluation of returns that the fund has generated with the
return actually expected out of the fund given the level of its systematic risk.
Surplus between two returns called as ALPHA.
JENSEN’S Performance Index
Jensen’s performance Index = RP –R +B (RM-RF)
Here RP = exceptive return
RF = Risk free rate of return
RM = return on market index
P = systematic risk / portfolio risk
The limitation of this model is that it considers only systematic risk not the entire
risk.

The limitation of this model is that it considers only systemat