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MBA –III SEMESTERMF0001 – SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT – 2 CREDITS(BOOK ID-B1035)ASSIGNMENT SET 1 – (30 MARKS)
Note: Answer all the questions. Each question carries 10 marks.
1.
In Portfolio construction three issues are addressed – selectivity, timing anddiversification. Explain. 
Portfolio Construction
 This step identifies those specific assets in which to invest as well as determining theproportion of the investor’s wealth to put into each one. Here selectivity, timing andiversification issues are addressed. Selectivity refers to security analysis and focuses onprice movements of individual securities. Timing involves forecasting of price movements of stock relative to price movements of fixed income securities (such as bonds). Diversificationaims at constructing a portfolio in such a way that the investor’s risk is minimized.The Following table summarizes how the portfolio is constructed for an active and a passiveinvestor Asset AllocationSecurity SelectionActive investor Market timing Stock pickingPassive investor Maintain pre-determinedselectionsTry to track a well-knownmarket index like Nifty,Sensex2.Briefly explain money market instrument bringing in the latest updates.
The money market exists as a result of the interaction between the suppliers anddemanders of short-term funds (those having a maturity of a year or less). Mostmoney market transactions are made in marketable securities which are short-termdebt instruments such as T-bills and commercial paper. The term “money market” is
 
a misnomer. Money (currency) is not actually traded in the money markets. Thesecurities traded in the moneymarket are short-term with high liquidity and low-risk; therefore they are close tobeing money. Money market provides investors a place for parking surplus funds for short periods of time. It also provides low-cost source of temporary funds toborrowers like firms, government and financial intermediaries. The money marketsare associated with the issuance and trading of short-term (less than 1 year) debtobligations of large corporations, financial institutions (FIs) and governments. Only high-quality entities can borrow in the money markets. Individual issues are large. Thusthe money market is characterized by low default risk and large denomination of instruments. Money market transactions can be executed directly or through anintermediary. Investors in money market Instruments include corporations and FIswho have idle cash but are restricted to a short-term investment horizon. Themoney markets essentially serve to allocate the nation’s supply of liquid funds amongmajor short-term lenders and borrowers. The characteristics of money marketinstruments are: Short-term debt instruments (maturity of less than 1 year)Services immediate cash needsBorrowers need short-term “working capital”.Lenders need an interest-earning “parking space” for excess funds.Instruments trade in an active secondary market.Liquid market provides easy entry & exit for participants.Speed and efficiency of transactions allows cash to be “active” evenfor very short periods of time (over night).Large denominationsTransactions costs are low in relative terms.Individual investors do not actively participate in this market.Low default riskOnly high quality borrowers participate.Short maturities reduce the risk of “changes” in borrower quality.Insensitive to interest rate changes
 
They mature in one year or less from their issue date. Maturity of less than 1 year is too short for securities to be adversely affected, ingeneral, by changes in rates.In theory, the banking industry should handle the needs for short-term loans and acceptshort-term deposits and therefore there should not be any need for money markets toexist. Banks have an information advantage on the creditworthiness of participants- they are better able to deal with the asymmetric information between saversand borrowers. However banks have certain disadvantages. They are heavilyregulated. Regulation creates a distinct cost advantage for money markets over banks.Banks also have to deal with reserve requirements; these create additional expense for banks that money markets do not have. Also money markets deal with creditworthyentities- governments, large corporations and banks; therefore the problem of asymmetric information is not severe for money markets. Thus money market existsfor short term loans and short term deposits of high-quality entities likegovernments, large corporations and banks.
3.Explain the misconception about EMH.
Misconceptions about EMH
There are three classic misconceptions:
Any share portfolio will perform as well as or better than a special tradingrule designed to outperform the market:
A monkey choosing a portfolio of shares for a ‘buy and hold’ strategy is nearly,but not exactly, what the EMH suggests as a strategy that is likely to be as rewarding asany trading rule proposed to exploit inefficiencies in the market. The portfolio requiredby EMH for investing must be a fully diversified one. A monkey does not havethe financial expertise that is required to construct a broad-based portfolio.Therefore, it is wrong to conclude from Efficient Market Hypothesis that it does notmatter what the investor does, and that any portfolio is acceptable. Market efficiencydoes not mean that it does not make a difference how you invest, since the risk/returntrade-off applies at all times. What it means is that you cannot expect to consistently"beat the market" on a risk-adjusted basis using costless trading strategies.
There should be fewer price fluctuations:
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