Dayananda Sagar Academy of Technology & Management

Department of Management Studies

MBA- THIRD SEMESTER ( Batch of 2022-2024)

Course Code: 22MBAFM304

Course Title: Security Analysis of Portfolio Management

Faculty Instructor: Dr. Praveen Kumar Sinha

Email ID: Praveen-mba@dsatm.edu.in

1
Syllabus

Introduction to Investment: Investment Avenues, Attributes,

Investor V/s speculator, Features of a good Investment, Investment
Process. Financial Instruments: Money Market Instruments, Capital
Market Instruments, Derivatives. Securities Market: Trading &
Settlement Procedure, Stock Market Indicators- Indices of Indian Stock
Exchanges (only Theory).
Investment

• An activity that commits funds in any financial/physical form in the

present with an expectation of receiving additional return in the future.
• The expectation brings with it a probability that the quantum of return
may vary from a minimum to a maximum.
• This possibility of variation in the actual return is known as investment
risk. Thus every investment involves a return and risk.

Investment can be defined as the process of “ sacrificing something new

for the prospect of gaining something later”.
Investment Attributes
Every investor has certain specific objectives to achieve through his long term/short term
investment. Such objectives may be monetary/financial or personal in character. The
objectives include safety and security of the funds invested (principal amount),
profitability (through interest, dividend and capital appreciation) and liquidity
(convertibility into cash as and when required). These objectives or factors are known as
investment attributes.

To enable the evaluation and a reasonable comparison of various

investment avenues, the investor should study the following attributes:
a) Rate of Return
Rate of return= Annual Income+(Ending Price- Beginning price)
Beginning Price
b) Risk: The risk of an investment refers to the variability of its rate of return. Commonly
used in finance to measure risk are Variance, Standard deviation and beta.
c) Marketability: An investment is highly marketable or liquid if:
• It can be transacted easily
• The transaction cost is low
• The prices change between two successive transactions is negligible.
d) Tax shelter: Some investment provides tax benefits. It is of three kinds:
• Initial tax benefits: tax relief enjoyed at the time of making an
investment. Ex: PPF
• Continuing tax benefits: it represents the tax shield associated with
periodic returns from the investment. Ex: dividend income.
• Terminal tax benefits: relief from taxation when an investment is
realised or liquidated. Ex: withdrawal from PPF.
e) Convenience: it refers to the ease with which the investment can be
made and looked after. To judge convenience :
• Can the investment be made readily?
• Can the investment be looked after easily?
 Economic v/s Financial Investment
1. Financial Investment: A financial investment allocates resources into a
financial asset, such as a bank account, stocks, mutual funds, foreign
currency and derivatives.
It is a commitment of persons’ funds to derive future income in
the form of interest, dividend, rent, premiums, pension benefits or the
appreciation of their principle capital. However, businesses gain from
placing money into financial investments because many safe assets, such
as an interest-bearing savings account, may yield enough of a return to
protect it from inflation. Essentially, some financial investments offer
protection against rising prices.
2. Economic Investment: An economic investment may include buying or
upgrading machinery and equipment or adding to a labor force. It means
net addition to the capital stock of the society which consist of goods and
services that are used in production of other goods and services.
Investment and speculation

Investor Speculator

Planning Horizon Longer planning horizon at least one Very short planning horizon. Very
year few days to a few months.
Risk Disposition An investor is not willing to assume Willing to assume high risk
more than moderate risk rarely high
risk.
Return Expectation Modest rate of return High rate of return in exchange for
commensurate with limited risk high risk.
Basis of decisions Greater significance to fundamental Technical chars and market
factors. psychology
Leverage Own funds and eschwes borrowed Resorts to borrowing can be
funds. substantial.
Investment Process

1. Specification of investment objective and constraints: the typical objective sought by the
investors are current income, capital appreciation, safety of principal. The relative importance
should be specified.
2. Choices of asset mix: one of the most important decision in portfolio management. The
appropriate mix depends mainly on risk tolerance and investment horizon of the investor.
3. Formulation of portfolio strategy: once a certain mix is chosen, an appropriate portfolio
strategy has to be hammered out. Two broad choices are available: an active portfolio
strategy and passive portfolio strategy.
4. Selection of securities: investor pursue an active stance with respect to security selection. For
stocks investors go by fundamental and technical analysis for bonds yield to maturity, credit
ratings, tax shelter liquidity.
5. Portfolio execution: in this phase the investors is concerned with implementing the portfolio
plan by buying and selling specified securities in given amounts.
6. Portfolio revision: The value of portfolio as well as its composition, the relative proportion of
the stocks and bonds may change as sotcks and bonds value fluctuate. In response to such
changes, periodic rebalancing of the portfolio is required.
7. Performance evaluation: to be done periodically, the key dimensions of portfolio evaluation
are risk and return and the key issue is whether the portfolio return is commensurate with its
risk exposure.
Approaches to investment Decision

1. Fundamental approach: The basic approach, most commonly advocated by

investment professionals are as follows:
• There is an intrinsic value of a security, which depends upon underlying
economic factors.
• At any given point of time, there are some securities for which prevailing
market price will differ from the intrinsic value.
• Superior return can be earned by buying under valued securities and selling
over valued securities.
2. Psychological approach: is based on the premises that stocks price are guided by
emotion that reasons.
3. Academic approach: in the last five decades, the academic community has
studied various aspects of the capital market, in the advanced countries, with the
help of fairly sophisticated method of investigation.
• Stock market is reasonably efficient in reacting quickly and rationally to the
flow of information.
• Stock price behaviour corresponds to random walk.
• In the capital market there is positive relationship between risk and return.
4. Eclectic/Free Approach: it draws all the three different
approaches. The operational implications are:
• Conduct fundamental analysis to establish certain value anchors.
• Do technical analysis to assess the state of market psychology.
• Combine fundamental and technical analyses to determine which
securities are worth buying, holding and disposing of.
• Respect market prices and do not show excessive zeal in ‘beating the
market’.
• Accept the fact that search for higher rate of return often
necessitates the assumption of higher level of risk.
 Financial Instruments

1. Money Market instruments

• Treasury Bills: Treasury Bills are basically instruments for short term (maturities less
than one year) borrowing by the Central Government. Treasury Bills were first issued
in India in 1917. At present, the active T-Bills are 91-days T-Bills, 182-day T-Bills and
364-days T-Bills.
• Certificate of deposits: it represents short term deposits which are transferable from
one party to another. Banks and financial institutions are major issuers of CDs. A
certificate of deposit (CD) is a savings certificate with a fixed maturity date, specified
fixed interest rate and can be issued in any denomination aside from minimum
investment requirements. A CD restricts access to the funds until the maturity date of
the investment.
• Commercial papers: it represents short term unsecured promisory notes issued by
firms that are generally considered to be financially strong. It has the maturity period
of 90 to 180 days. It is sold at a discount and redeemed at par.
• Repos: (Repurchase agreement or ready forward). Party A sells securities to party B at
a certain price and simultaneously agrees to repurchase the same after a specified
time at a slightly higher prices. The difference between the sale price and repurchase
price represents the interest cost and interest income for party B.
2. Bonds or Fixed Income Securities: it represents long term debt instruments. The issuer of the
bond promises to pay a stipulated stream of cash flows. (periodic interest payment and principal
payment at the time of redemption).
a) Government securities: securities issued by central, state and quasi government agencies are
referred to as government securities or gilt-edged securities.
• An investment that resembles a company debenture. It carries the name of the holders
and is registered with public debt office.
• A promissory note issued to the original holder, which contains a promise by government
of India to pay as per the given schedule. It can be transferrable.
b) Savings Bonds: it is issued in the form of bond ledger account or in the form of promissory
notes. Bond ledger account can be opened in the name of investors at the receiving officers
and at the public debt offices at the RBI.
c) Private sector debentures: A debenture is a type of debt instrument that is not secured by
physical assets or collateral. Debentures are backed only by the general creditworthiness
and reputation of the issuer. Both corporations and governments frequently issue this type
of bond to secure capital. Like other types of bonds, debentures are documented in an
indenture.
d) Public sector undertaking bonds: PSU are medium and long term obligations issued by
public sector companies in which the government share holding is generally greater than
51%. some PSU Bonds carry tax exemptions. the minimum maturity is 5 years for taxable
bonds and 7 years for tax-free bonds. PSU bonds are generally not guaranteed by the
government and are in the form of promissory notes transferable by endorsement and
delivery.
Equity Shares
1. Stock market classification of Equity shares
• Blue chip shares: Shares of large, well established, and financially strong companies with an
impressive record of earnings and dividends.
• Growth Shares: shares of companies that have a fairly entrenched position in the growing
market and will enjoy an above average growth as well as profitability.
• Income Shares: shares of companies that have fairly stable operations, relatively limited
growth opportunities and high dividend payout ratios.
• Cyclical Shares: those shares that have profound cyclicality in their operations.
• Defensive shares: shares of companies that are relatively unaffacted by the ups and down in
general business conditions.
• Speculative shares: shares that tends to fluctuate widely because there is lot of speculative
trading in them.
2. Peter Lynch’s classification
• Slow Growers: large and ageing companies that are expected to grow slightly faster than the
GNP.
• Stalwarts: Giant companies that are faster than slow growers.
• Fast Growers: small, aggressive new enterprise s that grow at the rate of 10 to 25 in a year.
• Cyclical: companies whose sales and profit rise and fall in a regular, though not completely
predictable fashion.
• Turnarounds: companies which are steeped in accumulated losses but which shows sign of
recovery.
Derivatives
• A derivative can be defined as a financial instrument whose value
depends on (or derives from) the values of other, more basic underlying
variables.
• Very often the variables underlying derivatives are the prices of traded
assets. The underlying asset could be a financial asset such as currency,
stock and market index, an interest bearing security or a physical
commodity.
 Trading and Settlement

Each stock exchange has certain listed securities and permitted

securities which are traded in it, investors interested in buying and selling
securities should place their orders with the members of the exchange. There
are two way of organising the trading activity: open outcry system and the
screen based system.
a) Open outcry system: Traders shout and resort to signals on the trading floor
of the exchange which consists of several notional trading posts for
different securities. A member wishing to buy and sell a certain security
reached the trading post where the security is traded. Hence, he comes in
contact with others interested in transacting in that security. Buyers make
their bids and sellers make their offers and bargains are closed at mutually
agreed upon prices.
b) Screen based system: the trading ring is replaced by the computer screen
and the distant participants can trade with each other through the
computer network. A large number of participants, geographically
separated can trade simultaneously at high speeds.
The key features of the system are as follows:
• Buyers and sellers place their orders on the computer.
• These orders may be limit orders and market orders.
• A limit orders pre specifies the price limit.
• A market order is an order to buy or sell at the best prevailing prices. A market order
to sell will be executed at the highest bid price whereas a market order to buy will be
executed at the lowest ask price.
• The computers constantly tries to match mutually compatible orders. The
matching would be done on a price time priority ; implying that price is given
preference over time in the process of matching.
• The limit order book I;e., the list of unmatched limit orders displayed on the
screen open for inspection for all traders.
• Settlement: To mitigate the cost and risks associated with physical delivery,
security transactions in developed market are settled through electronic
delivery facilitated by depositories.
 Shifting to Rolling System

• In the stock market, settlement refers to the process of transferring the

ownership of securities from the seller to the buyer. There are two types of
settlement - Rolling Settlement and Account Settlement. Rolling settlement
is a process where trades are settled on T+1 day.
• SEBI decided to introduce rolling settlement in a phased manner from
2002.
• The trade settlement process on the Stock Exchange is based on the rolling
settlement system. The settlement period for the BSE is T+1, which means
that the trades are settled within one business day of the trade date.
• Due to the T+1 settlement cycle, trade-related settlements must be made a
day, or 24 hours, after a transaction is completed. According to T+1, for
instance, if a consumer purchased shares on Wednesday, they would be
deposited to their DEMAT Account on Thursday.
Transaction Cost
It may be divided into three broad categories: Trading costs, clearing costs
and settlement costs.
a) Trading costs: it consists of brokerage cost, market impact cost and
securities transaction tax.
• A brokerage cost is the brokerage paid to the broker.
• Market impact cost is the difference between the actual transaction
price and the ideal price (price at which trade will occur if the market
for the stock were perfectly liquid).
• securities transaction tax is a tax being levied on all transactions
done on the stock exchanges.
b) Clearing costs: when a negotiate trade take place, the counterparty may
default or when a trade takes place on an exchange, the exchange may
default in payout. Clearing costs are costs experienced in resolving such
defaults
c) Settlement costs: costs associated with transfer of funds and securities
Index Calculation

• Price weighted Index: it is an index reflecting the sum of the prices of the
sample stocks on a certain date in relation to a base index. It assumes that
the investor buys one share of each stock included in the index.
• Equal weighted Index: it is an index reflecting the simple arithmetic average
of the prices relatives of the sample stocks on a certain date in relation to
a base date. It assumes that the investor invests an equal amount of money
in each stock included in the stock.
• Value weighted Index: it is an index reflecting the aggregate market
capitalization of the sample stocks on a certain date in relation to a base
date. It assumes that the investor allocates money across various stock
included in the stock in such a way that the weight assigned to various
stocks are proportional to the market capitalization.
Stock market indices around the world

• The Dow Jones industrial average (DJIA) is based on 30 large, “blue chip”
corporations in the US. It is a price weighted Index.
• The Standard and poor’s composite 500 (S&P 500) stock index is a broad
based index of 500 US stocks. It is market value weighted index.
• The Nikkei 225 is based on the largest 225 stocks of Tokyo stock
exchange. It is a price weighted index.
• FTSE published by the financial times of London is based on 100 large
stock exchange stocks. It is a value weighted index.
STOCK MARKET ABROAD
• NYSE world’s biggest stock exchange in terms of market capitalization.,
TSE and many more.