Scribd
Upload
411 views47 pages

Security Analysis: Chapter - 1

Here are the steps to calculate the expected return for a single stock in a single period: 1) List the possible states of the economy and the corresponding returns: State of Economy Return Recession -22% Below average -2% Average 20% Above average 35% Boom 50% 2) Assign a probability to each state: P(Recession) = 0.1 P(Below average) = 0.2 P(Average) = 0.4 P(Above average) = 0.2 P(Boom) = 0.1 3) Calculate the expected return using the formula:

Uploaded by

Harsh Gupta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
411 views47 pages

Security Analysis: Chapter - 1

Here are the steps to calculate the expected return for a single stock in a single period: 1) List the possible states of the economy and the corresponding returns: State of Economy Return Recession -22% Below average -2% Average 20% Above average 35% Boom 50% 2) Assign a probability to each state: P(Recession) = 0.1 P(Below average) = 0.2 P(Average) = 0.4 P(Above average) = 0.2 P(Boom) = 0.1 3) Calculate the expected return using the formula:

Uploaded by

Harsh Gupta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 47

Security Analysis

Chapter -1

Dr. Abhay Kumar


Risk and Return: The Basics

 Introduction to Security Analysis


 Basic return concepts
 Basic risk concepts
 Portfolio (market) risk
 Risk and return: CAPM/SML
Investment:
 Investment is a commitment of funds made in the
expectation of some positive rate of return.
Forms of Investments

 Real Investments
 Financial Investments
Real Investments
 Real estate
• Capital appreciation
• Rental income
• Psychological reasons
• Lesser regulation
• No Proper Market
• Open for all.
 Risk factor: Very risky: property specific risk; low
liquidity, high transaction costs, numerous
taxes/costs during the life of the investment
 Return : depends
Financial Investments

 Security Form Financial Investment


 Non-Security forms of Financial
Investment
Forms of Financial Investments

Security Form
Debt instruments
1. Coupon bonds: Issued at par; fixed periodic
interest payments; Principal repayment at maturity or
piecemeal payments spread over time
2. Discount bonds: Issued at discount to par; no
periodic payments; redeemed at par value at maturity
Government debt securities: Different types
depending upon quality (risk), yield, and maturity.
Security Form
of Financial Investments
 Preferred Stock: Hybrid Security
 Equity Stock
Non-Security forms of Financial
Investment

• Non traded
• Non transferable
• - Popular among small investors – typically principal
protection and projection against inflation along with
a small (minimal) real return.
• - Tax savings
• - Mobilize small private savings for public use
• - Why these investments: For a balanced portfolio.
Non-Security forms of Financial
Investment

 National Savings Scheme (NSS )


 Public Provident Fund(PPF)
 Post Office Savings Schemes (8%)
 Deposits with Commercial banks (6%)
 Corporate FDs – only one with reasonable level of
safety and liquidity issues (9-12%)
Real investor vs. Speculator
 A genuine investor invests to earn a “fair return” on a
rather consistent basis for a relatively long period of time

 How is investment different from Speculation?


• Time horizon: Short; will typically base its decision on news
over the short term irrespective of valuation;
• Risk – Return expectation: Abnormally high-risk for return
expected; decisions often based on rumors, unconfirmed news,
event based; high portfolio churn;
• Are speculators needed: Add depth or liquidity to the market
and wider ownership but cause price instability.
Security

 Fischer: “Pieces of paper representing


indirect claims to real assets held by
someone else”
 “Claims on cash flows of a company or an
asset”
Security Analysis

 Fischer: Process of estimating return (value)


and risk for individual securities.
 The greater the risk, greater is the return
required.
Security Analysis is useful for

 Existing Shareholders
 Potential Investors
 For M&A
 Creditors/Financial Institutions
Why are security analysts needed?

 Segregation of ownership and management of


assets/company
 Reduce noise: Analyst reports: Noise cause
price instability, which is due to misinformation.
 Help investors identify stocks with high risk-
adjusted performance by interpreting readily
available but often complex financial data.
Return

Return is the total gain or loss experienced by the owner of a


financial asset or investment over a given period of time.
Investment returns measure the financial results of an
investment.
Returns can be expressed in:
 Rupee terms.
 Percentage terms.
What are investment returns?

If you buy or invest in an asset of any sort, your gain or loss from
that investment is called the return of your investment.
Purpose of return:
a. Time value of Money
b. Inflation
c. Risk Premium

Return can be:


a. High
b. Low
c. Constant
Return

 Realized Return
- Ex-post return which was or could have been earned.
 Expected Return
- Return that an investor expects or anticipates to earn
over some future period Subjected to risk
 Components of return
- Periodic cash receipts, interest , dividends etc.
- Appreciation or depreciation in price of the asset
Return

 Single security return


 Portfolio return
 Single period return
 Multiple period return
 Ex-post / Historical Return
 Ex-ante / Expected Return
Types of risks in financial market

 Risk reflects the chance that the actual return


on an investment may be very different than the
expected return. One way to measure risk is to
calculate the variance and standard deviation of
the distribution of returns.
 Variance of return is known as total risk.
Probability distribution

Stock X

Stock Y

Rate of
-20 0 15 50 return (%)
 Which stock is riskier? Why?
Types of Risk

Diversifiable Non Diversifiable

Controllable Un Controllable

Unsystematic Systematic

Unique Market
Risk: Systematic and Unsystematic

We can break down the total risk into two components:


systematic risk and unsystematic risk:

Total risk; U

Nonsystematic Risk; 

Systematic Risk; m

n
Systematic risk and Unsystematic risk
 Systematic risks affect the market as a whole and can
not be eliminated totally by any means. Though, it can
be minimized having defensive stocks in the portfolio.
Examples of systematic risk include uncertainty about
general economic conditions, such as GNP, interest
rates or inflation.

 Unsystematic risk affects only a specific firm and can be


eliminated totally by proper diversification.
Announcements specific to a company, such as a gold
mining company striking gold, are examples of
unsystematic risk.
Some of the Systematic risks are as
follows;
 
 Country Risk: This risks arises in case of all
investment in a single country. Any change in
political and economic situation of the country
may impact the return.
 Market risk:-It is the risk of decreasing the

capital (or suffering of loss) because of negative


sentiments in the market.
 Interest rate Risk
 Inflation Risk / Purchasing Power Risk
Systematic Risk
•The beta coefficient, , tells us the response of the
stock’s return to a systematic risk.
•In the CAPM,  measured the responsiveness of a
security’s return to a specific risk factor, the return on
the market portfolio.
C o v ( Ri, R M )
i 
 (RM )
2
unsystematic risks
 Financial Risk: This kind of risk arises due to
pattern of financing mix used by the company.
More debt financing will bring more risk. Company
with lesser debt or no debt will have less risk.
 Liquidity Risk: This risk arises when the

investors are unable to exit from the investment at


fair value at the desired date.
 Sector Risk: It is a risk faced by the investors

who invest in sectoral funds or who are more


inclined towards a particular sector.
 Business Risk
 Default Risk
Total risks
Single Stock (Risk &
Return)
Single Stock Risk & Return

 Single Stock
Single Period
Historical
Risk & Return
Example

What is the return on an investment


that costs Rs.1,000 and is sold
after 1 year for Rs.1,100?
Return

 Absolute Return:
Amount Received - Amount Invested
Rs.1,100 - Rs.1,000 = Rs.100

 Percentage return:
Return/ Invested
Rs.100/Rest.1,000 = 0.10 = 10%.
Realized Return (Single Period)

 Realized Return:
 K = DT+(PT – PT-1)
 PT-1
 K= rate of return (HPY)
 Pt = Price of security at time t
 Pt-1 = Price of security at time t-1
 Dt = Income receivable at time t
Ansh purchased a shares of RIL for Rs.1350 and after one year
sold it Rs.1500. In between Ansh has also received a dividend of
Rs 25. What is the return received by Ansh?
Single stock- Multi period
Historical Return (Single Cash flow)

 P0(1+r)n =Pn
or
r0n = (Pn / P0)1/n - 1
Historical Risk

The Standard Deviation Formula


Historical Return (Multiple Cash flow)

r0n = [(1+R1) * (1+R2) * (1+R3)….(1+Rn)]1/n - 1


(By using GM)
Example (Multiple Cash flow)

 Calculate annual return and risk from


given data
 Year Return
1 15%
2 2%
3 25%
4 11%
Example

 Calculate annual return and risk from


given data
(Rs)

 Year Market Price Dividend


0 100
1 105 2
2 115 2
3 80 2
4 125 5
Single Stock – Expected Risk & Return

 Single Stock
Ex-Ante
Risk & Return
Ex-Ante Return( Single Stock-Single
Period)
State of Economy Probability(p) Return(X)
Recession 0.10 -22.00%
Below avg. 0.20 -2%
Average 0.40 20%
Above avg. 0.20 35%
Boom 0.10 50%
Ex-Ante Return

 n
r =  ri Pi .
i =1

rX = Expected returns
ri = rate of return for ith possible outcome

Pi= Probability associated with ith possible outcome


Single stock- single period, Ex-Ante
return

 rX = 0.10(-22%) + 0.20(-2%)
 + 0.40(20%) + 0.20(35%)
 + 0.10(50%) = 19.58%.
Single stock- single period, Ex-Ante
risk
n 2
 
   r
 i
i 1 
 r  Pi .

r = Expected returns ; n = Number of years

r i = rate of return for ith possible outcome

Pi= Probability associated with ith possible outcome


Single stock- single period, Ex-Ante
risk
  = ((-22 - 19.58)20.10 + (-2 -
19.58)20.20 + (20 - 19.58)20.40 + (35 -
19.58)20.20 + (50 - 19.58)20.10)1/2
=
 Thanks

 Any Questions…..

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy