a

1. SECURITY ANALYSIS & PORTFOLIO MANAGEMENT
UNIT – 1: INVESTMENT
Definition of Investment:
Investment involves making of a sacrifice in the present with the hope of deriving future benefits.
Investment has many meanings and facets. The two most important features of an investment are current
sacrifice and future benefit.
Why Invest?
We invest in order to improve our future welfare. Funds to be invested come from assets already
owned, borrowed money, and savings or foregone consumption. By foregoing consumption today and
investing the savings, we expect to enhance our future consumption possibilities. Anticipated future
consumption may be by other family members, such as education funds for children or by ourselves,
possibly in retirement when we are less able to work and produce for our daily needs. Regardless of why
we invest, we should all seek to manage our wealth effectively, obtaining the most from it. This includes
protecting our assets from inflation, taxes and other factors.
Nature of Investment Decisions:
A typical investment decision undergoes a five step procedure which, in turn, forms the basis of the
investment process. Investment decisions are premised on an important assumption that investors are
rational and hence prefer uncertainty. They are risk averse which implies that they would be unwilling to
take risk just for the sake of risk. They would assume risk only if an adequate compensation is
forthcoming. And the dictum of ‘rationality’ combined with the attitude of ‘risk aversion’ imparts to
investment their basic nature. The question to be answered is: how best to enlarge returns with a given
level of risk? Or how best to reduce risk for a given level of return? Obviously, there would be several
different levels of risk and different associated expectations of return. The basic investment decision would
be a trade-off between risk and return.
The Investment Process
These steps are:
1. Determine the investment objectives and policy.
2. Undertake security analysis
. 3. Construct a portfolio.
4. Review the portfolio.
5. Evaluate the performance of the portfolio.
Investment Objectives and Policy
The investor will have to work out his objectives first and then evolve a policy with the amount of
investible wealth at his command. Hence, the objectives of an investor must be defined in terms of risk and
return.
The next step in formulating the investment policy of an investor would be the identification of
categories of financial assets he/she would be interested in.

2. Security Analysis:
This step would consist of examining the risk-return characteristics of individual securities or
groups of securities identified under step one. The aim here is to know if it is worthwhile to acquire these
securities for the portfolio. And there are two broad approaches to finding out the ‘mispriced status’ of
individual securities. One approach is known as ‘technical analyses. The second approach is known as
‘fundamental approach’.
Portfolio Construction:
This consists of identifying the specific securities in which to invest and determining the
proportion of the investor’s wealth to be invested in each.
Portfolio construction address itself to three major problems via., selectivity, timing, and
diversification. The related questions would be: which specific shares/debentures to buy, when to buy, and
how best to combine then in a way that risk is reduced to a minimum for a given level of expected return.
Investment versus speculation
Basis Investment Speculation
Type of contract Creditor Ownership
Basis of acquisition usually by outright purchase Often-on-margin
Psychological attitude of
participants
Cautious and conservative Daring and careless
Reasons for purchase Scientific analysis of intrinsic
worth
Hunches, tips “inside dope", etc.
Quantity of risk Small Large
Stability of income Very stable Uncertain and erratic
Length of commitment Comparatively long-term For a short time only
Source of income Earnings of enterprise Change in market price
Investment versus gambling speculation:
Speculation typically lasts longer than gambles but is briefer than investments. A speculation
usually involves the purchase of a salable asset in hopes of making a quick profit from an increase in the
price of the asset which is expected to occur within a few weeks or months. Those involved in speculations
are reluctant to refer to this activity as speculation because they dislike the connotations of the word; they
prefer to refer to speculations as investment activities.
A gamble is usually a very short-term investment in a game of chance. The holding period for
most gambles can be measured in seconds. That is, the result of so-called investments is quickly resolved
by the roll of the dice or the turn of a card. Such activities have planning horizons that are far too brief to
do the research that should precede any investment activity.
Speculation is not the same as gambling and the two should never be confused. The difference
between speculation and gambling is that in gambling, artificial and unnecessary risks are created whereas
in speculation the risks already exist and the question is simple – who shall bear them? Gambling is a far
cry from the carefully planned research and scientific procedure which underlies the best speculative
practice. The gambler plays rumours, tips, hunches and other unreliable intuitions which should not play
any but a negative role in the trained speculator’s process. Speculation is a reasoned anticipation of future
conditions. It does not rely upon hearsay or labels. It attempts to organise the relevant knowledge as a
support for judgements. It is as legitimate and moral as any other form of risk-taking business activity.
Investment attributes / factors influencing selection of investment:
Investment Alternatives

3. Equity Preference shares
Debentures
Bonds or fixed income securities
 Government securities  Savings bonds
 Private sector debentures
 PSU bonds
 Preference shares
Money market instruments
 Treasury bills
 Certificates of deposits
 Commercial paper
 Repos
Non-marketable financial assets
 Bank deposits
 Post office time deposits (POTD)
 Monthly income scheme of the post office (MISPO)
 Kisan Vikas Patra (KVP)
 National savings certificate
 Company deposits
 Employees provident fund scheme
 Public provident fund scheme
Real estate
 Residential House
 Sources of Housing Finance
 Features of Housing Loans
 Guidelines for Buying a Flat
 Commercial Property
 Agricultural Land  Suburban Land
 Time Share in a Holiday Resort
Precious objects

4.  Gold and Silver
 Precious Stones
 Art Objects
Insurance policies
 Endowment Assurance
 Money Back Plan
 Whole Life Assurance
 Unit Linked Plan  Term Assurance
 Immediate Annuity
 Deferred Annuity
Investments and Innovation Technology
 Advancements in computing power and Internet technology
 More complete and timely information delivery
Globalization
 Domestic firms compete in global markets
 Performance in regions depends on other regions
 Causes additional elements of risk
 Globalization continues and offers more opportunities
 Securitization continues to develop
 Derivatives and exotics continue to develop
 Strong fundamental foundation is critical
 Integration of investments and corporate finance
Types of investor
It is identifies three board types of investors found operating in the stock market-
 The contrarians
 Trend followers and
 Hedgers and holders
Other types according to researcher
 Measured investor

5.  Reluctant investor
 Competitive investor
 Unprepared investor
SYSTEMATIC RISK
Risk
Systematic risk Unsystematic risk
Systematic Risk (Non – Diversifiable Risk)
• Caused by the external factors
• Uncontrollable
• Affects the market as whole
Unsystematic Risk (Diversifiable Risk)
• Specific factors related to the particular industry or a company
Systematic risk
Market risk interest rate risk purchasing power risk
Market Risk:
• Portion of total variability of return caused by the alternate forces caused by bull and bear
markets.
• Forces affect the market are tangible and intangible events
• Tangible Events are real events such as earthquakes, war, etc.
• Example Pokhran Blast on May13, 1998 resulted in fall of Sensex by 162 points.
• Intangible events related to market psychology.
• Example, in 1996 recession in economy resulted in fall of share prices
• These factors are beyond the control of corporate.

6. Interest Rate Risk:
• Variation in single period rates of return caused by fluctuations in market interest rate.
• This will affects commonly price of bonds, debentures and stocks.
• Caused by changes in gov’t monetary policy, interest rates of treasury bills and gov’t bonds.
• Rise or fall in the interest rate affects the cost of borrowings.
Purchasing Power Risk:
• Probable loss in the purchasing power of returns to be received.
• Inflation is the reason behind the loss of purchasing power.
• Inflation is of 2 types
1. Demand-Pull Inflation
2. Cost-Pull Inflation Systematic Risk
Unsystematic Risk Other
 Market Risk
 Unique Risk Names
 Non-
 Diversifiable
Diversifiable Risk
Risk Examples
 Government tax
 A firm’s cut technical wizard
 Interest rate leaves rises
 A competitor enters a firm’s product market Beta(b):
Measure of Market Risk
• if b = 0 – asset is risk free
• if b = 1 – asset return = market return
• if b > 1 – asset is riskier than market index
 b<1 – asset is less risky than market index
– The higher the degree of systematic risk (b), the higher the return expected by
investors.
UNSYSTEMATIC RISK

7. It stems from managerial inefficiency, technological change in the production process,
availability of raw materials, changes in the consumer preference and labour problems
 It differs from industry to industry.
 Technological changes affect the information technology industry more than that of consumer
product industry.
CLASSIFICATION
• BUSINESS RISK
• FINANCIAL RISK BUSINESS RISK
BUSINESS RISK:
 It arises from the inability of the firm to maintain its competitive edge and the growth or the
stability of the earnings.
 Variation that occurs in the operating environment is reflected on the operating income and
expected dividends
 BUSINESS RISK
• INTERNAL BUSINESS RISK
• EXTERNAL BUSINESS RISK INTERNAL BUSINESS RISK
INTERNAL BUSINESS RISK:
 Fluctuations in the sales
 R&D
 Personnel Management
 Fixed cost
 Single Product
EXTERNAL BUSINESS RISK
 Social and regulatory factors
 Political risk
 Business Cycle
FINANCIAL RISK
 It refers to the variability of the income to the equity capital due to the debt capital
 Financial risk In a company is associated with the capital structure of the company
 Capital structure of the company consists of equity funds and borrowed funds

8. Unit II:
Security Analysis
- Fundamental Analysis
- Analysis Industry Analysis

9. - Investments in Industry
- Company Analysis.

13. FUNDAMENTAL ANALYSIS
← ECONOMIC ANALYSIS ← INDUSTRY ANALYSIS ← COMPANY
The analysis of the following factors indicates the trends in macro-economic changes that affect
the risk and return on investments.
 Money supply
 Industrial production
 Capacity utilisation
 Unemployment  Inflation
 Growth in GDP
 Institutional lending
 Stock prices
 Monsoons
 Productivity of factors of production
 Fiscal deficit
 Credit/Deposit ratio
 Stock of food grains and essential commodities  Industrial wages
 Foreign trade and balance of payments position
 Status of political and economic stability
 Industrial wages
 Technological innovations  Infrastructural facilities
 Economic and industrial policies of the government
 Debt recovery and loans outstanding  Interest rates
 Cost of living index
 Foreign investments
 Trends in capital market
 Stage of the business cycle
 Foreign exchange reserves

14. Macroeconomic Analysis
The government employs two broad classes of macroeconomic policies, viz. demand- side policies
and supply-side policies. Fiscal Policy Fiscal policy is concerned with the spending and tax initiatives of
the government. It is the most direct tool to stimulate or dampen the economy.
Monetary Policy
The main tools of monetary policy are:
 Open market operation  Bank rate  Reserve requirements
 Direct credit controls
Economic Forecasting
Economic forecasting is a must for making investment decision. Forecasting techniques can also
be divided and categories: Short-term forecasting techniques and Long-term forecasting techniques.
Techniques used
 Economic indicators
 Diffusion index
 Surveys
 Economic Model Building

15. Industry Analysis
Industry Analysis :
Some of the useful bases for classifying industries from the investment decision-point of view are
as follows:
 Growth Industry
 Cyclical Industry
 Defensive Industry
Based on the stage in the life cycle, industries are classified as follows:
 Pioneering stage
 Fast growing stage
 Security and stabilization stage
 Relative decline stage
IMPORTANCE OF INDUSTRY ANALYSIS:
i. Firms in each different industry typically experience similar levels of risk and similar rates
of return. As such, industry analysis can also be useful in knowing the investment-
Worthiness of a firm.
ii. Mediocre stocks in a growth industry usually outperform the best stocks in a stagnant
industry. This point out the need for knowing not only company prospects but also industry
prospects.
CLASSIFICATION OF INDUSTRIES
There are different ways of classifying industrial enterprises.
i. Classification by Reporting Agencies
ii. Classification by Business Cycle
KEY INDICATORS IN ANALYSIS
The analyst is free to choose his or her own indicators for analysing the prospects of an industry. However,
many commonly adopt the following indicators.
A. Performance factors like
 Past sales
 Past earnings
B. Environment factors like
 Attitude of government
 Labour conditions
 Competitive conditions
 Technological progress
C. Outcome factors like
 Industry share prices
 Price earnings multiples with reference to these key factors, evaluations shall be done to identify.
 Strengths and weaknesses
 Opportunities and threats

16. ANALYTICAL FRAMEWORKS
Industry life-cycle stages (product life cycle theory)
 Pioneering Stage (Introduction)
 Expansion Stage (Growth)
 Stagnation Stage (Maturity)
 Decay Stage (Decline)
FORECASTING METHODS
The techniques for analysing information about industry within a time framework are briefly
explained in this section.
1. The market profile
2. Cumulative methods
a) Surveys
b) Correlation and Regression analysis
c) Time series analysis
Conditions and profitability
Profitability depends upon the state of competition prevalent in the industry. Cost control
measures adopted by its units and the growth in demand for its products. Profitability is another area that
calls for a thorough analysis on the part of investors. No industry can survive in the long run if it is not
making profits. This requires thorough investigation into various aspects of profitability. However, such an
analysis can begin by having a bird's eye view of the situation. In this context, ratio analysis has been
found quite useful.
Industry Analysis factors
The securities analyst will take into consideration the following factors into account in assessing
the industry potential in making investments.
 Post-sales and earnings performance
 The government's attitude towards industry
 Labour conditions
 Competitive conditions
 Performance of the industry
 Industry share prices relative to industry earnings
 Stage of the industry life cycle
 Industry trade cycle
 Inventories build-up in the industry
 Investors' preference over the industry
 Technological innovations
Techniques of Industry Analysis
 End Use and Regression Analysis
 Input Output Analysis

17. Company Analysis
Needs for the company analysis: