2. investment
Investment refers to the buying of financial product or any valued
item with an anticipation that positive return will be received in the
future.
The investor can be an Individual,
Government, Pension fund,
or a Corporation.
3. Investment process
The investment process involves a series of activities leading to the
purchase of securities or other investment alternatives. The
investment process can be divided into five stages:
1. Framing of the investment policy,
2. Security analysis,
3. Valuation,
4. Portfolio construction, and
5. Portfolio evaluation.
5. Step 1:-Framing of the Investment Policy
For systematic functioning, the government or investor, formulates the
investment policy before proceeding to invest. The essential ingredients of
the policy are investible funds, objectives and knowledge about investment
alternatives and the market.
Investible funds:- The entire investment procedure revolves around the
availability of investible funds. Funds may be generated through savings or
from borrowings.
Objectives:- The objectives are framed on the premises of the required rate
of return, need for regular income, risk perception and the need for liquidity.
Knowledge:- Knowledge about investment alternatives and markets plays a key
role in policy formulation. Investment alternatives range from security to real
estate.
6. Step 2:-Security Analysis
Securities to be bought are scrutinized through market, industry and company
analysis after the formulation of investment policy.
Market analysis:- The stock market mirrors the general economic scenario.
The growth in gross domestic product and inflation is reflected in stock
prices. Recession in the economy results in a bear market. Stock prices may
fluctuate in the short-run but in the long-run, they move in trends.
Industry analysis:- Industries that contribute to the output of major
segments of the economy vary in their growth rates' overall contribution to
economic activity. Some industries grow faster than the GDP and are
expected to continue in their growth.
Company analysis:- The purpose of company analysis is to help the investors
make better decisions. The company's earnings, profitability, operating
efficiency, capital structure and management have to be screened.
7. Step 3:- Valuation
Valuation helps the investor determine the return and risk expected from an
investment The intrinsic value of the share is measured through the book
value of the share and price earning ratio, Simple discounting models also can
be adopted to value the shares. Stock market analysts have developed of
Valuation in common stock many advanced models to value shares. The real
worth of the share is compared with the market price, and investment
decisions are then made.
Future value:- The future value of securities can be estimated by using a
simple statistical technique trend analysis. The analysis of the historical
behavior of price enables the investor to predict value.
8. Step 4:- Construction of a Portfolio
A portfolio is a combination of securities. It is constructed in a manner so as
to meet the investor's and objectives. The investor should decide how best to
reach the goals with the securities available. The investor tries to attain
maximum return with minimum risk. Towards this end, he diversifies his
portfolio and allocates funds among the securities.
Diversification:-The main objective of diversification is the reduction of risk
in the form of loss of capital and income. diversified portfolio is comparatively
less risky than holding a single portfolio. Several modes are available to
diversify a portfolio.
Debt and equity diversification:- Debt instruments provide assured returns
with limited capita Common stocks provide income and capital gain but with a
flavour of uncertainty. Both and equity are combined to complement each
other.
9. Step 4:- Construction of a Portfolio
Industry diversification:- Industries' growth and their reaction to government
policies differ from each other. Banking industry shares may provide regular
returns but with limited capital appreciation. Information technology stocks yield
higher returns and capital appreciation, but their growth potential in the post-
global crisis years was unpredictable. Thus, industry diversification is needed, and
it reduces the risk.
Company diversification:- Securities from different companies are purchased to
reduce the risk. Technical analysts suggest that investors buy securities based on
price movement. Fundamental analysts suggest the selection of financially sound
and investor-friendly companies.
Selection:- Securities have to be selected based on the level of diversification,
industry and company analyses. Funds are allocated for selected securities.
Selection of securities and the allocation of funds seal the construction of
portfolio.
10. Step 5:- Evaluation
A portfolio has to be managed efficiently. Efficient management calls for
evaluation of the portfolio. process consists of portfolio appraisal and revision.
Appraisal:- The return and risk performance of security varies from time to
time. The variability in returns of securities is measured and compared.
Developments in the economy, industry and relevant companies from which stocks
are bought have to be appraised. The appraisal warns of the loss and steps can be
taken to avoid such losses.
Revision:- It depends on the results of the appraisal. Low-yielding securities with
high risk are replaced with high-yielding securities with low risk factor. The
investor periodically revises the components of the portfolio to keep the return
at a level.
11. Approaches of investment
Top three approaches to investment :-
1. The Fundamental Approach
2. The Technical Approach
3. Efficient Market Theory.
12. Fundamental approach
Fundamental approach is a combination of economic, industry,
and company analyses to obtain a stock’s current fair value and
predict its future value. This is also called EIC (economics
,industry and company) analysis.
Components of Fundamental Analysis
Fundamental analysis consists of three main parts:
Economic analysis
Industry analysis
Company analysis
13. Economic analysis
Economic analysis is a study of general economics factors that go into
an evaluation of a security’s value. The stock market is an integral part
of the economy. When the level of economic activity is low, stock
prices are low, and when the level of economic activity is high, stock
prices are high, reflecting a booming outlook for the sales and profits
of firms.
The commonly analyzed economic factors are: GDP. Savings and
investment, Inflation, Interest rates, Budget and fiscal deficit, Tax
structure, Balance of payment, Foreign investment, Infrastructure
facilities, Demographic factors etc.
14. INDUSTRY ANAlYSIS
An analysis of the performance, prospects, and problems of an
industry of interest is known as industry analysis. The economic
analysis gives an indication about the direction of the economy and the
stock market. Industry analysis is required because the return and
risk level of industries differ. An industry is a group of firms that
have a similar technological structure of production and produce
similar products.
Industries can be classified on the basis of the business cycle, i.e.,
classified according to their reactions to the different phases of the
business cycle. They are classified as growth, cyclical, defensive, and
cyclical growth industries.
15. Company analysis
Evaluating the financial performance of a company on the basis of
qualitative and quantitative factors is called company analysis.
Qualitative factors : The qualitative factors that effect the value
of a company’s share are business model, management, corporate
governance, and corporate culture .
Quantitative factors: The quantitative factors that influence stock
value are earning of the company , competitive edge, financial leverage
, operational leverage and production efficiency .
16. Technical approach
Technical analysis involves predicting the future price movements of the
stocks by analyzing their past prices and volumes. It takes into consideration
different graphical representation of the movement of the prices and trading
volumes of the stock in the past, which are depicted through different chart
patterns like line, bar, and candlestick etc. These charts illustrate different
trends of the stocks, their market movement and help to determine whether
the stocks are worth buying or selling.
The technical analysis time frames shown on charts range from one-minute to
monthly, or even yearly, time spans. Popular time frames that technical analysts
most frequently examine include:
5-minute chart
15-minute chart
Hourly chart
4-hour chart
Daily chart
17. Efficient market hypothesis
Efficient market theory states that the price fluctuations
are random and do not follow any regular pattern. A
market theory that evolved from a 1960's Ph.D.
dissertation by Eugene Fama and, Fama suggested that
efficient market hypothesis can be divided into three
categories. They are: (1)the weak form, (2) the semi-
strong form, and (3) the strong form. The level of
information being considered in the market is the basis
for this segregation.
18. Weak Form EMH: Suggests that all past information is priced into securities.
Fundamental analysis of securities can provide an investor with information to
produce returns above market averages in the short term, but there are no
"patterns" that exist. Therefore, fundamental analysis does not provide long-
term advantage and technical analysis will not work. This weak form of the
efficient market hypothesis is popularly known as the random-walk theory.
Semi-Strong Form EMH: Implies that neither fundamental analysis nor
technical analysis can provide an advantage for an investor and that new
information is instantly priced in to securities.
Strong Form EMH. Says that all information, both public and private, is
priced into stocks and that no investor can gain advantage over the market as
a whole. Strong Form EMH does not say some investors or money managers
are incapable of capturing abnormally high returns because that there are
always outliers included in the averages.
19. security return
Return expresses the amount which an investor actually earned on an
investment during a certain period. Return includes the interest,
dividend and capital gains; while risk represents the uncertainty
associated with a particular task. The income and capital gain are
expressed as a percentage of money invested in the beginning.
The historical returns or ex-post returns are derived from the cash
flows received as well as the price changes that occur during the
period of holding the stock or any asset. The income flow is the
dividend an investor receives during the holding period. The period
may be days, weeks, months, years or even just a single d Usually, this
is presented in the form of percentages.
20. The Rate of Return Formula
The rate of return formula is an easy-to-use tool. There are two major
numbers needed to calculate the rate of return:
Current value: the current value of the item.
Original value: the price at which you purchased the item.
Then, apply these values to the rate of return formula:
(Current value - original value) / original value) x 100 = rate of return
Remember, the outcome is always reflected as a percentage, so the
formula requires you to multiply by 100 to get the percentage. If this
percentage is a positive number, then you have a profit or gain on your
investment. If the percentage is a negative number, then you have a loss on
the investment.
