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What is a Portfolio ?
A combination of various investment products like bonds, shares, securities,
mutual funds and so on is called a portfolio.
In the current scenario, individuals hire well trained and experienced
portfolio managers who as per the client’s risk taking
capability combine various investment products and create a customized
portfolio for guaranteed returns in the long run.
It is essential for every individual to save some part of his/her income and put
into something which would benefit him in the
future. A combination of various financial products where an individual
invests his money is called a portfolio.
Who is a Portfolio Manager ?
An individual who understands the client’s financial needs and designs
a suitable investment plan as per his income and risk taking abilities is
called a portfolio manager. A portfolio manager is one who invests on
behalf of the client.
A portfolio manager counsels the clients and advises him the best
possible investment plan which would guarantee maximum returns to
the individual.
A portfolio manager must understand the client’s financial goals and
objectives and offer a tailor made investment solution to him. No two
clients can have the same financial needs.
What is portfolio Evaluation?
The Concept
Portfolio manager evaluates his portfolio
performance and identifies the sources of
strength and weakness.
The evaluation of the portfolio provides a feed
back about the performance to evolve better
management strategy.
Evaluation of portfolio performance is
considered to be the last stage of investment
process.
Sharpe’s Performance Index
Sharpe index measures the risk
premium of the portfolio relative to the
total amount of risk in the portfolio.
Risk premium is the difference between
the portfolio’s average rate of return
and the risk less rate of return.
Formula for
Sharpe’s Performance Index
St= Rp-Rf / Sigma (P)
Rp – Portfolio’s average rate of return
Rf – Riskless rate of return
σp - Standard deviation of the portfolio return
The larger the St, better the fund has performed
Treynor’s Performance Index
The relationship between a given market
return and the fund’s return is given by the
characteristic line.
The fund’s performance is measured in
relation to the market performance.
The ideal fund’s return rises at a faster rate
than the general market performance when
the market is moving upwards.
Its rate of return declines slowly than the
market return, in the decline.
Treynor’s Index Formula
Rp = + Rm + ep
Rp = Portfolio return
Rm = The market return or index return
ep = The error term or the residual
, = Co-efficients to be estimated
Beta co-efficient is treated as a measure
of undiversifiable or systematic risk.
Tn = Portfolio average return – Riskless rate of interest
Beta co-efficient of portfolio
Tn= Rp-Rf
Beta(P)
The larger the Tn, better the fund has performed
Larger Tn is more desirable because it earned more
risk premium per unit of systematic risk .
Jensen’s Performance Index
The absolute risk adjusted return measure
was developed by Michael Jensen.
It is mentioned as a measure of absolute
performance because a definite standard is
set and against that the performance is
measured.
The standard is based on the manager’s
predictive ability.
Jensen Model
The basic model of Jensen is:
Rp = + (Rm – Rf)
Rp = average return of portfolio
Rf = riskless rate of interest
= the intercept
= a measure of systematic risk
Rm = average market return
p represents the forecasting ability of
the manager. Then the equation
becomes
Rp – Rf = p + (Rm – Rf)
or
Rp = p + Rf + (Rm – Rf)
What is Portfolio Revision ?
The art of changing the mix of securities in a portfolio is called as portfolio
revision.
The process of addition of more assets in an existing portfolio or changing
the ratio of funds invested is called as portfolio
revision.
The sale and purchase of assets in an existing portfolio over a certain period
of time to maximize returns and minimize risk is
called as Portfolio revision.
Need for Portfolio Revision
An individual at certain point of time might feel the need to invest more. The
need for portfolio revision arises when an individual
has some additional money to invest.
Change in investment goal also gives rise to revision in portfolio. Depending
on the cash �ow, an individual can modify his
financial goal, eventually giving rise to changes in the portfolio i.e. portfolio
revision.
Financial market is subject to risks and uncertainty. An individual might sell
o� some of his assets owing to fluctuations in the
financial market.
Portfolio Revision Strategies
There are two types of Portfolio Revision Strategies.
Active Revision Strategy
Active Revision Strategy involves frequent changes in an existing portfolio
over a certain period of time for maximum returns and
minimum risks.
Active Revision Strategy helps a portfolio manager to sell and purchase
securities on a regular basis for portfolio revision.
Passive Revision Strategy
Passive Revision Strategy involves rare changes in portfolio only under
certain predetermined rules. These predefined rules are
known as formula plans.
According to passive revision strategy a portfolio manager can bring changes
in the portfolio as per the formula plans only.
What are Formula Plans ?
Formula Plans are certain predefined rules and regulations deciding when and
how much assets an individual can purchase or
sell for portfolio revision. Securities can be purchased and sold only when
there are changes or fluctuations in the financial
market.
Why Formula Plans ?
Formula plans help an investor to make the best possible use of fluctuations
in the financial market. One can purchase shares
when the prices are less and sell o� when market prices are higher.
With the help of Formula plans an investor can divide his funds into
aggressive and defensive portfolio and easily transfer funds
from one portfolio to other.
Aggressive Portfolio
Aggressive Portfolio consists of funds that appreciate quickly and guarantee
maximum returns to the investor.
Defensive Portfolio
Defensive portfolio consists of securities that do not �uctuate much and
remain constant over a period of time.
Formula plans facilitate an investor to transfer funds from aggressive to
defensive portfolio and vice a versa.
3 Different Types of Formula Plans (Numerical Example)
1. Constant-Rupee-Value Plan:
The constant rupee value plan specifes that the rupee value of the stock
portion of the portfolio will remain constant. Thus, as the
value of the stock rises, the investor must automatically sell some of the
shares in order to keep the value of his aggressive
portfolio constant.
If the price of the stock falls, the investor must buy additional stock to keep
the value of aggressive portfolio constant.
2. Constant Ratio Plan:
The constant ratio plan goes one step beyond the constant rupee plan by
establishing a �xed percentage relationship between
the aggressive and defensive components. Under both plans the portfolio is
forced to sell stocks as their prices rise and to buy
stocks as their prices fall.
Under the constant ratio plan, however, both the aggressive and defensive
portions remain in constant percentage of the
portfolio’s total value. The problem posed by re- balancing may mean
missing intermediate price movements.
3. Variable Ratio Plan:
Instead of maintaining a constant rupee amount in stocks or a constant ratio
of stocks to bonds, the variable ratio plan user
steadily lowers the aggressive portion of the total portfolio as stock prices
rise, and steadily increase the aggressive portion as
stock prices fall.
Key Differences Between Stocks and Mutual Funds
The points given below are vital, so far as the difference between
stocks and mutual funds is concerned:
The collection of shares, which are owned by an investor signifying
his/her proportion of ownership is called stock. A fund managed by
the investment company that pools money from numerous investors
and invests them in the basket of assets like equity, debt other money
market instrument is called mutual fund.
While stocks are a form of direct investment, mutual funds are an
indirect investment.
Stocks offer ownership stake to the investor in a company. On the
other hand, mutual funds offer fractional ownership of basket of
assets.
In the case of stocks, trading is done throughout the day when the
market is open. As against this, trading is done only once in a day, in
mutual funds.
The management and administration of stock are done by the investor
himself. Conversely, the fund manager manages and administers
mutual funds.
The per share price multiplied by the number of shares is equal to the
value of stock held by the investor. On the contrary, the value of the
mutual fund can be measured by calculating NAV, which is the total
value of asset net of expenses.
Mutual Funds are comparatively less risky than stocks, due to the
presence of diversification.
What is 'Net Asset Value - NAV'
Net asset value (NAV) is value per share of a mutual fund or
an exchange-traded fund (ETF) on a specific date or time. With both
security types, the per-share dollar amount of the fund is based on the
total value of all the securities in its portfolio, any liabilities the fund
has and the number of fund shares outstanding.
In the context of mutual funds, NAV per share is computed once per
day based on the closing market prices of the securities in the fund's
portfolio. All of the buy and sell orders for mutual funds are processed
at the NAV of the trade date. However, investors must wait until the
following day to get the trade price. Mutual funds pay out virtually all of
their income and capital gains. As a result, changes in NAV are not
the best gauge of mutual fund performance, which is best measured
by annual total return.
The formula for a mutual fund's NAV calculation is straightforward:
NAV = (assets - liabilities) / number of outstanding shares
Net Asset Value Per Share - NAVPS
The net asset value per share (NAVPS), also referred to as the book
value per share, is an expression for net asset value that represents
the value per share of a mutual fund, exchange-traded fund (ETF) or a
closed-end fund. It is calculated by dividing the total net asset value of
the fund or company by the number of shares outstanding.

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Unit 5

  • 1. What is a Portfolio ? A combination of various investment products like bonds, shares, securities, mutual funds and so on is called a portfolio. In the current scenario, individuals hire well trained and experienced portfolio managers who as per the client’s risk taking capability combine various investment products and create a customized portfolio for guaranteed returns in the long run. It is essential for every individual to save some part of his/her income and put into something which would benefit him in the future. A combination of various financial products where an individual invests his money is called a portfolio. Who is a Portfolio Manager ? An individual who understands the client’s financial needs and designs a suitable investment plan as per his income and risk taking abilities is called a portfolio manager. A portfolio manager is one who invests on behalf of the client. A portfolio manager counsels the clients and advises him the best possible investment plan which would guarantee maximum returns to the individual. A portfolio manager must understand the client’s financial goals and objectives and offer a tailor made investment solution to him. No two clients can have the same financial needs. What is portfolio Evaluation? The Concept Portfolio manager evaluates his portfolio performance and identifies the sources of
  • 2. strength and weakness. The evaluation of the portfolio provides a feed back about the performance to evolve better management strategy. Evaluation of portfolio performance is considered to be the last stage of investment process. Sharpe’s Performance Index Sharpe index measures the risk premium of the portfolio relative to the total amount of risk in the portfolio. Risk premium is the difference between the portfolio’s average rate of return and the risk less rate of return. Formula for Sharpe’s Performance Index St= Rp-Rf / Sigma (P) Rp – Portfolio’s average rate of return Rf – Riskless rate of return σp - Standard deviation of the portfolio return The larger the St, better the fund has performed
  • 3. Treynor’s Performance Index The relationship between a given market return and the fund’s return is given by the characteristic line. The fund’s performance is measured in relation to the market performance. The ideal fund’s return rises at a faster rate than the general market performance when the market is moving upwards. Its rate of return declines slowly than the market return, in the decline. Treynor’s Index Formula Rp = + Rm + ep Rp = Portfolio return Rm = The market return or index return ep = The error term or the residual , = Co-efficients to be estimated Beta co-efficient is treated as a measure of undiversifiable or systematic risk. Tn = Portfolio average return – Riskless rate of interest Beta co-efficient of portfolio Tn= Rp-Rf Beta(P)
  • 4. The larger the Tn, better the fund has performed Larger Tn is more desirable because it earned more risk premium per unit of systematic risk . Jensen’s Performance Index The absolute risk adjusted return measure was developed by Michael Jensen. It is mentioned as a measure of absolute performance because a definite standard is set and against that the performance is measured. The standard is based on the manager’s predictive ability. Jensen Model The basic model of Jensen is: Rp = + (Rm – Rf) Rp = average return of portfolio Rf = riskless rate of interest = the intercept = a measure of systematic risk Rm = average market return p represents the forecasting ability of the manager. Then the equation becomes Rp – Rf = p + (Rm – Rf)
  • 5. or Rp = p + Rf + (Rm – Rf) What is Portfolio Revision ? The art of changing the mix of securities in a portfolio is called as portfolio revision. The process of addition of more assets in an existing portfolio or changing the ratio of funds invested is called as portfolio revision. The sale and purchase of assets in an existing portfolio over a certain period of time to maximize returns and minimize risk is called as Portfolio revision. Need for Portfolio Revision An individual at certain point of time might feel the need to invest more. The need for portfolio revision arises when an individual has some additional money to invest. Change in investment goal also gives rise to revision in portfolio. Depending on the cash �ow, an individual can modify his financial goal, eventually giving rise to changes in the portfolio i.e. portfolio revision. Financial market is subject to risks and uncertainty. An individual might sell o� some of his assets owing to fluctuations in the financial market. Portfolio Revision Strategies
  • 6. There are two types of Portfolio Revision Strategies. Active Revision Strategy Active Revision Strategy involves frequent changes in an existing portfolio over a certain period of time for maximum returns and minimum risks. Active Revision Strategy helps a portfolio manager to sell and purchase securities on a regular basis for portfolio revision. Passive Revision Strategy Passive Revision Strategy involves rare changes in portfolio only under certain predetermined rules. These predefined rules are known as formula plans. According to passive revision strategy a portfolio manager can bring changes in the portfolio as per the formula plans only. What are Formula Plans ? Formula Plans are certain predefined rules and regulations deciding when and how much assets an individual can purchase or sell for portfolio revision. Securities can be purchased and sold only when there are changes or fluctuations in the financial market. Why Formula Plans ? Formula plans help an investor to make the best possible use of fluctuations in the financial market. One can purchase shares when the prices are less and sell o� when market prices are higher.
  • 7. With the help of Formula plans an investor can divide his funds into aggressive and defensive portfolio and easily transfer funds from one portfolio to other. Aggressive Portfolio Aggressive Portfolio consists of funds that appreciate quickly and guarantee maximum returns to the investor. Defensive Portfolio Defensive portfolio consists of securities that do not �uctuate much and remain constant over a period of time. Formula plans facilitate an investor to transfer funds from aggressive to defensive portfolio and vice a versa. 3 Different Types of Formula Plans (Numerical Example) 1. Constant-Rupee-Value Plan: The constant rupee value plan specifes that the rupee value of the stock portion of the portfolio will remain constant. Thus, as the value of the stock rises, the investor must automatically sell some of the shares in order to keep the value of his aggressive portfolio constant. If the price of the stock falls, the investor must buy additional stock to keep the value of aggressive portfolio constant. 2. Constant Ratio Plan: The constant ratio plan goes one step beyond the constant rupee plan by establishing a �xed percentage relationship between the aggressive and defensive components. Under both plans the portfolio is forced to sell stocks as their prices rise and to buy
  • 8. stocks as their prices fall. Under the constant ratio plan, however, both the aggressive and defensive portions remain in constant percentage of the portfolio’s total value. The problem posed by re- balancing may mean missing intermediate price movements. 3. Variable Ratio Plan: Instead of maintaining a constant rupee amount in stocks or a constant ratio of stocks to bonds, the variable ratio plan user steadily lowers the aggressive portion of the total portfolio as stock prices rise, and steadily increase the aggressive portion as stock prices fall. Key Differences Between Stocks and Mutual Funds The points given below are vital, so far as the difference between stocks and mutual funds is concerned: The collection of shares, which are owned by an investor signifying his/her proportion of ownership is called stock. A fund managed by the investment company that pools money from numerous investors and invests them in the basket of assets like equity, debt other money market instrument is called mutual fund. While stocks are a form of direct investment, mutual funds are an indirect investment. Stocks offer ownership stake to the investor in a company. On the other hand, mutual funds offer fractional ownership of basket of assets.
  • 9. In the case of stocks, trading is done throughout the day when the market is open. As against this, trading is done only once in a day, in mutual funds. The management and administration of stock are done by the investor himself. Conversely, the fund manager manages and administers mutual funds. The per share price multiplied by the number of shares is equal to the value of stock held by the investor. On the contrary, the value of the mutual fund can be measured by calculating NAV, which is the total value of asset net of expenses. Mutual Funds are comparatively less risky than stocks, due to the presence of diversification. What is 'Net Asset Value - NAV' Net asset value (NAV) is value per share of a mutual fund or an exchange-traded fund (ETF) on a specific date or time. With both security types, the per-share dollar amount of the fund is based on the total value of all the securities in its portfolio, any liabilities the fund has and the number of fund shares outstanding. In the context of mutual funds, NAV per share is computed once per day based on the closing market prices of the securities in the fund's portfolio. All of the buy and sell orders for mutual funds are processed at the NAV of the trade date. However, investors must wait until the following day to get the trade price. Mutual funds pay out virtually all of their income and capital gains. As a result, changes in NAV are not the best gauge of mutual fund performance, which is best measured by annual total return. The formula for a mutual fund's NAV calculation is straightforward:
  • 10. NAV = (assets - liabilities) / number of outstanding shares Net Asset Value Per Share - NAVPS The net asset value per share (NAVPS), also referred to as the book value per share, is an expression for net asset value that represents the value per share of a mutual fund, exchange-traded fund (ETF) or a closed-end fund. It is calculated by dividing the total net asset value of the fund or company by the number of shares outstanding.