INVESTMENT PLANNING

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INVESTMENT PLANNING

  1. 1. INVESTMENT PLANNING Module 4 : Workbook The Indian Institute of Financial Planning
  2. 2. Contents Copyright: IIFP 1st Edition : September 2008 The course material is exclusively designed and published for the use of the Students of the IIFP. It is not a priced publication. No part of this publication may be reproduced or copied or sold/ distributed in any form or any means, electronic, mechanical, photocopying, and recording or stored in a data base or retrievable system without the explicit permission of the institute. Price: Not for Sale Printed in INDIA Publication: September 2008 The Indian Institute of Financial Planning
  3. 3. Contents FOREWORD Welcome to IIFP- Power Your Growth….. We thank you for choosing the IIFP as your preferred education provider for CFP certification program. We are one of the leading education providers for CFP certification program and we are basically a No Frills-Pure Education institute imparting high quality financial planning education in India. IIFP has been promoted by Kush Education Society which has been formed and backed by eminent industrialists and educationists of India. Kush Education Society was formed in the year 2001 and it also runs the prestigious Delhi Public School (DPS), Varanasi. We are constantly engaged in research and development of new study tools which can help our students to crack this highly professional CFP certification program in the first attempt itself and in light of this we feel pleasure in presenting before you first edition of our Work book, Module 4 (Investment Planning). We hope that this tool will help you in your studies and we assure you that we will always be there to help and guide you. Wishing you Good Luck…. Faculty and Content Team, IIFP The Indian Institute of Financial Planning
  4. 4. Contents Index Page No. 1. List of Important Formulas 1 - 10 2. Types of Risk and General Economics 11 - 16 3. Measuring Risk 17 - 38 4. Measuring Return 39 - 56 5. CAPM 57 - 62 6. Risk Adjusted Return 63 - 68 7. Fixed Income Securities 69 - 82 8. Equity Valuation 83 - 98 9. Forward and Futures 99 - 106 10. Options 107 - 132 11. Real Estate and Other Investments 133 - 138 12. Mutual Funds 139 - 142 13. Other Fixed Income Instruments and SSI 143 - 146 14. Asset Allocation Strategies 147 - 152 15. Financial Statement Analysis 153 - 172 16. Regulations 173 - 177 The Indian Institute of Financial Planning
  5. 5. Chapter 1 List of Important Formulas
  6. 6. Chapter 1 : List of Important Formulas Chapter 1 List of Important Formulas Measuring Risk 1. Range = Highest Value – Lowest Value 2. Variance= P1[r1-E(r)]2+ P2[r2-E(r)]2+ P3[r3-E(r)]2 + ... +Pn(rn–E(r)]2 where, r1,r2,r3,...,rn = Observed Returns E(r) = Expected return P1,P2,P3,......, Pn = Probability 3. Standard Deviation = Variance Standard Deviation 4. Coefficient of variation = X 100 Mean C o v im 5. B e ta (β i m ) = σ2m Where, Covim = Co-variance between market return and security ‘i’ return σ 2m = Variance of market return 6. Covariance of two securities n ∑ i =1 (xi - x ) (yi - y ) n-1 Where, xi = Return on Security ‘i’ yi = Return on security ‘i’ x = Mean of return on Security ‘x’ y = Mean of return on Security ‘y’ n = Number of observations 7. Cov12 = r12 * σ 1 * σ 2 Where, Cov12 = Co – variance between return on asset ‘1’ & asset ‘2’ r12 = Coefficient of correlation between two securities σ1 = Standard Deviation of asset ‘1’ return σ2 = Standard Deviation of asset ’2’ return The Indian Institute of Financial Planning 1
  7. 7. Investment Planning (Workbook) 8. Co-efficient of correlation of security ‘i’ return with security k return Covik r = σi * σ k Where, Covik = Co – variance Between asset ‘i’ & asset ‘k’ σ i = Standard Deviation of asset ‘i’ return σ m = Standard Deviation of asset ’k’ return Return 1. Cumulative Wealth Index (CWIn) = WI0 (1+R1) (1+R2) ........ (1+Rn) CWIn = Cumulative wealth index at the end of n years WI0 = The begning index value which is typically one rupee Ri = Total return for year i (i = 1, .......n) 2. Arithmetic Return = R1 + R2 + R3 + ........... + Rn n n = ∑R i =1 i n Where, R1, R2, R3, ..... R4 = Returns for the different periods n = Number of periods n ∑R i =1 i = Summation of the returns for the period 3. Holding Period Return = [(Ending Price – Beginning Price + Cash Dividend) /Beginning Price] x 100. 4. Geometic Mean (G.M.) = { ( 1+ TR1) ( 1+ TR2)….(1+ TRn)]1/n -1} x 100 TRi = Total return for period i, where i = (1, 2, 3...... n) n = Total holding period 5. CAGR (Compounded Annual Growth Rate) {[ BeginningV alue ] EndingV alue 1/n -1 } x100 6. Real rate of Return = { [ 1 + ei ] - 1 } x 1 0 0 1 + i = Interest Rate e = Inflation Rate 2 The Indian Institute of Financial Planning
  8. 8. Chapter 1 : List of Important Formulas 7. Post Tax Return = Return * (1 – Tax Rate) n 8. Expected return : E(R) = ∑R P i=1 i i Where, E(R) = Expected return from the stock Ri = Return form the stock Pi = Probability associated with the possible outcome n = Number of possible states of the world 9. Treynor Measure = (Return on portfolio - risk free return) / beta of portfolio r p – rf Ti = ß Where, Ti = Treynor Index rp = Return on Portfolio Risk rf = Risk Free Return ß = Beta of Portfolio 10. Sharpe Measure = (Return on portfolio - risk free return)/ standard deviation of portfolio rp – rf Si = σp Where, si = Sharpe Performance Index rp = Return on Portfolio rf = Risk Free Return s p= Standard Deviation of Portfolio 11. Jensen Measure (ALPHA) = Portfolio return – [Risk free rate + (market return- risk free rate) * portfolio beta] Jensen Measure = Rp – [Rf + (Rm – R f)* ß p ] Where, Rp = Portfolio Return Rf = Risk free rate R = Market Return ßp = Portfolio Beta The Indian Institute of Financial Planning 3
  9. 9. Investment Planning (Workbook) Portfolio Investment 1. Portfolio variance: = [Standard Deviation of Portfolio]2 2. For a two asset portfolio: Portfolio return: E ( R p ) = w A E ( R A ) + (1 − w A )E ( RB ) = w A E ( R A ) + wB E ( R B ) Where, E(RP) = Expected return of the portfolio wA = Weight of security A wB = Weight of security B E(RA) = Expected return of the security A E(RB) = Expected return of the security B 3. Variance of Portfolio Returns= W12s12 + W22s22 + 2 W 1W2 Cov12 Where co – variance is given W1 = Weight of security 1 W2 = Weight of security 2 s1 = Standard deviation of security 1 s2 = Standard deviation of security 2 Cov12 = Covariance between return on security 1 & 2 4. Variance of Portfolio Returns = W12 s12 + W22s22 + 2 W1W2 r12 s1 s 2 Where correlation is given r12 = coefficient of correlation between security 1 & 2 5. For a three asset portfolio, the variance is: w2 σ2 +w2 σ2 + w2 σC + 2wAwBrABσAσB +2wAwCrACσAσC +2wBwCrBCσBσC A A B B C 2 Where, rAB = Coefficient of correlation between security A and B rBC = Coefficient of correlation between security B and C rAC = Coefficient of correlation between security A and C wA = Weight of security A wB = Weight of security B wC = Weight of security C σA = Standard deviation of security A σB = Standard deviation of security B σC = Standard deviation of security C 4 The Indian Institute of Financial Planning

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