SWATI ROBERT 3RD Semester Roll No.

521021718

MF0010-Security Analysis & Portfolio Management-Aug11
Q.1. Frame the investment process for a person of your age group. Ans. THE INVESTMENT PROCESS It is rare to find investors investing their entire savings in a single security. Instead, they tend to invest in a group of securities. Such a group of securities is called a portfolio. Most financial experts stress that in order to minimize risk; an investor should hold a well-balanced investment portfolio. The investment process describes how an investor must go about making decisions with regard to what securities to invest in while constructing a portfolio, how extensive the investment should be, and when the investment should be made. This is a procedure involving the following five steps:

1. Setting Investment Policy This initial step determines the investor’s objectives and the amount of his investable wealth. Since there is a positive relationship between risk and return, the investment objectives should be stated in terms of both risk and return. This step concludes with the asset allocation decision: identification of the potential categories of financial assets for consideration in the portfolio that the investor is going to construct. Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds and cash. The asset allocation that works best for an investor at any given point in his life depends largely on his time horizon and his ability to tolerate risk. The time horizon is the expected number of months, years, or decades that an investor will be investing his money to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable with a riskier or more volatile investment because he can ride out the slow economic cycles and the inevitable ups and downs of the markets. By contrast, an investor who is saving for his teen-aged daughter’s college education would be less likely to take a large risk because he has a shorter time horizon.
Time Horizon –

SWATI ROBERT 3RD Semester Roll No. 521021718

Risk tolerance is an investor’s ability and willingness to lose some or all of his original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment. The conservative investors keep a "bird in the hand," while aggressive investors seek "two in the bush." While setting the investment policy, the investor also selects the portfolio management style (active vs. passive management).
Risk Tolerance –

is the process of managing investment portfolios by attempting to time the market and/or select ‘undervalued’ stocks to buy and ‘overvalued’ stocks to sell, based upon research, investigation and analysis. Passive Management is the process of managing investment portfolios by trying to match the performance of an index (such as a stock market index) or asset class of securities as closely as possible, by holding all or a representative sample of the securities in the index or asset class. This portfolio management style does not use market timing or stock selection strategies.
Active Management

2. Performing Security Analysis This step is the security selection decision: Within each asset type, identified in the asset allocation decision, how does an investor select which securities to purchase. Security analysis involves examining a number of individual securities within the broad categories of financial assets identified in the previous step. One purpose of this exercise is to identify those securities that currently appear to be mispriced. Security analysis is done either using Fundamental or Technical analysis (both have been discussed in subsequent units).
Fundamental analysis is

a method used to evaluate the worth of a security by studying the financial data of the issuer. It scrutinizes the issuer’s income and expenses, assets and liabilities, management, and position in its industry. In other words, it focuses on the ‘basics’ of the business. is a method used to evaluate the worth of a security by studying market statistics. Unlike fundamental analysis, technical analysis disregards an issuer’s financial statements. Instead, it relies upon market trends to ascertain investor sentiment to predict how a security will perform.
Technical analysis

3. Portfolio Construction This step identifies those specific assets in which to invest, as well as determining the proportion of the investor’s wealth to put into each one. Here selectivity, timing and diversification issues are addressed. Selectivity refers to security analysis and focuses on price movements of individual securities. Timing involves forecasting of price movement of stocks relative to price movements of fixed income securities (such as bonds). Diversification aims 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 passive investor.
Asset Allocation Security Selection

Active investor

Market timing

Stock picking

By providing investors the opportunity to trade financial instruments. Sensex 4. Stock exchange transactions involve the activities of brokers and dealers. options and futures. These exchanges are de-mutualised exchanges (it means that the ownership. Dealers earn income by selling a financial instrument at a price that is greater than the price they paid for the instrument. buy and sell from their own portfolios (inventories of securities). management and trading are in separate hands). the two main exchanges are National Stock Exchange (NSE) and Mumbai (Bombay) Stock Exchange (BSE). The regulatory agency which oversees the functioning of stock markets is the Securities and Exchange Board of India (SEBI). These dealer-brokers sometimes act purely as a client’s agent and at other times buy and sell from their own inventory of financial assets. Ans.From the website of BSE India. which is also located in Mumbai. It was established in 1875. as objectives might change and previously held portfolio might not be the optimal one. on the other hand. 5.SWATI ROBERT 3RD Semester Roll No. More than 6000 stocks are listed here. the stock exchanges support the performance of the primary markets. These individuals facilitate the buying and selling of financial assets. Mumbai (Bombay) Stock Exchange Limited (BSE) is the oldest stock exchange in Asia. Dealers. explain how the BSE Sensex is calculated. There is also an Over the Counter Exchange of India (OTCEI) which allows listing of small and medium-sized companies. Most stock exchanges have specific locations where the trades are completed. Portfolio performance evaluation This step involves determining periodically how the portfolio has performed over some time period (returns earned vs. For the securities to be traded at these exchanges. 521021718 Passive investor Maintain pre-determinedTry to track a well-known selections market index like Nifty. In India. BSE AND OTCEI Stock exchanges are organized markets for buying and selling securities which include stocks. . bonds. risks incurred).2. National Stock Exchange (NSE) was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992. Some exchange participants perform both roles. Brokers execute trades on behalf of clients and receive commissions and fees in exchange for matching buyers and sellers. Portfolio Revision This step is the repetition of the three previous steps. they must be listed at these exchanges. Stock exchanges essentially function as secondary markets. STOCK EXCHANGES: NSE. Q.

Nifty Jr. SENSEX: Sensex till August 31. BSE – Mid cap. The other indices are BSE 200. Internationally. BSE CD. Nikkei 225 Stock Average. The base period selected for Nifty is the close of prices on November 3. It was first compiled in 1986. the best known indices are provided by Dow Jones & Co. Dow Jones alone currently publishes more than 3. people have tracked the market’s daily ups and downs using various indices of overall market performance. Nasdaq 100. . BSE FMCG. 2003. STOCK MARKET INDICES An index is a statistical indicator providing a representation of the value of the securities which constitute it. Morgan Stanley Capital Markets (MSCI). Indexes often serve as barometers for a given market or industry and benchmarks against which financial or economic performance is measured. The base value of index was set at 1000. The base year of SENSEX is 1978-79 and the base value is 100. S&P CNX Nifty is a 50 stock index accounting for 23 sectors of the economy. BSE MCK. BSE 500. 1995. is being constructed on free float market capitalization. without designated market makers. Sensex since 31st September. in terms of transparency. Some of the well-known indices are Dow Jones Industrial Average (DJIA). For more than hundred years. BSE small cap. In India the best known indices are Sensex and Nifty. Standard & Poor’s 500 Index (S&P 500).SWATI ROBERT 3RD Semester Roll No. BSE IT. This task was achieved through the requirement that the BSE must evolve ‘screen-based trading’ and through the creation of the NSE. Sensex is the stock market index for BSE. Nasdaq Composite. liquidity and market efficiency. A stock index reflects the price movement of shares while a bond index captures the manner in which bond prices go up and down. NIFTY: Nifty is the stock market index for NSE. BSE auto.000 indices. A need was felt to switch over to free float wherein non-promoter and non-strategic shareholdings are eliminated and only those outstanding shares that are available for trading are included. Lehman Brothers (bond indices). 521021718 India’s equity market was earlier dominated by the BSE – a market where trading was done by open outcry. liquid and representative companies. It is made of 30 stocks representing a sample of large. S & P. which marked the completion of one-year of operations of NSE’s capital market segment. BSE Metal. Deutscher Aktienindex (DAX). BSE PSU. 2003 was constructed on the basis of full market capitalization. Hang Seng Index. The great scam of 1992 resulted in the finance ministry and SEBI seeking radical reform in the functioning of the equity market. BSE TECK. There are currently thousands of indices calculated by various information providers. BSE Pharma. BSE realty. and without any computerization. Financial Times-Stock Exchange 100 (FTSE 100). The quality of this market was widely considered to be poor.

· the balance of payments (BOP). · domestic legislation (laws and regulations). Ans. the level of index at any point of time reflects the free-float market value of 30 component stocks relative to a base period. Q. Perform an economy analysis on Indian economy in the current situation. replacement of scrips etc. . fundamental analysis helps investors determine whether the economic climate offers a positive and encouraging investing environment. prices of the index scrips. This is often indicated by the notation 1978-79=100. dependent on the economy in which it operates. ECONOMY ANALYSIS In addition to the economy analysis. FACTORS TO BE CONSIDERED IN ECONOMY ANALYSIS The economic variables that are considered in economic analysis are: · gross domestic product (GDP) growth rate. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. · government policy (fiscal and monetary policy). During market hours. · unemployment (the percent of the population that wants to work and is currently not working). 521021718 SENSEX CALCULATION METHODOLOGY SENSEX is calculated using the "Free-float Market Capitalization" methodology. · public attitude (consumer confidence) · inflation (a general increase in the price of goods and services). interest rates. second. The base period of SENSEX is 1978-79 and the base value is 100 index points. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization.3. The calculation of SENSEX involves dividing the free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. at which latest trades are executed. a company’s growth prospects are. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions. · productivity (output per worker). ultimately. are used by the trading system to calculate SENSEX on a continuous basis. · the current account deficit.SWATI ROBERT 3RD Semester Roll No. Economic analysis is done for two reasons: first. as most companies generally perform well when the economy is doing the same. wherein. · exchange rates. share price performance is generally tied to economic fundamentals. The Divisor is the only link to the original base period value of the SENSEX.

Inflation The exchange rate affects the broad economy and companies in a number of ways. The current account is an account of the trade in goods and services. have also . The BOP affects the exchange rate through supply and demand for the foreign currency. deflation (negative inflation) can also hurt the economy. Measures that have been taken by Reserve Bank of India. All other things being equal. as it encourages consumers to postpone spending (as they wait for cheaper prices). if the exchange rate weakens. India economic analysis could also be described as being an explanation of various economic phenomena going on in this country. a decrease causes the interest rates to rise. GDP growth rate shows how fast the economy is growing. However. imports are affected. The capital account is an account of the cross-border transactions in financial assets. changes in the exchange rate affect the exports and imports. First. A current account deficit occurs when a country imports more goods and services than it exports. If exchange rate strengthens. ECONOMIC ANALYSIS ON INDIAN ECONOMY India economic analysis provides various inputs on economic condition of this south-east Asian country. 521021718 · capacity utilization (output by the firm) etc . The currency of a country appreciates when there is more foreign currency coming into the country than leaving it. the cost of borrowing by businesses is not expensive. However. GDP is important for investors. It can be done both at a microeconomic as well as a macroeconomic level. exports are hit. If interest rates are low. RECENT MACROECONOMIC DEVELOPMENTS IN INDIA In April 2008. a surplus in the current or capital account causes the currency to strengthen. It consists of the current account and the capital account. A capital account deficit occurs when the investments made in the country by foreigners is less than the investment in foreign countries made by local players. Much of this critical condition could be attributed to an increase in prices of oil. is the total income earned by a country. this figure is lesser than 11 percent development. an increase in money supply causes the interest rates to fall. all other things being equal. The levels of interest rates (the cost of borrowing money) in the economy and the money supply (amount of money circulating in the economy) also have a bearing on the performance of businesses. Therefore. industrial sector in India had recorded a growth of 7 percent. like upward revision of repo rate and CRR. and companies can easily borrow to expand and develop their activities. Investors know that strong economic growth is good for companies and recessions or full-blown depressions cause share prices to decline. BOP reflects a country’s international monetary transactions for a specific time period. as excessive inflation undermines consumer spending power (prices increase) and so can cause economic stagnation. a deficit causes the currency to weaken.SWATI ROBERT 3RD Semester Roll No. which had been achieved in April 2007.

Industries like crude oil production. For example.7 percent respectively. Price data can be any combination of the open.4 percent in April 2008. then the average of the 3 closing prices is one data point ((41+43+43)/3=42. In 2007-08. rates of interest and prices of goods and services. This rate is significantly low when compared to statistics of April 2007. one data point does not offer much information. In case of manufacturing sector much of this slump could be attributed to increase in input costs like expenses of oil. which is less than 5.6 percent that was achieved in April 2007. Manufacturing and electric sector have suffered as well in recent times. Their growth rates have come down too.66 percent. rate of development stood at 1. Some indicators may use only the closing prices. electricity and petroleum refinery have been performing below expectations but coal.4 percent and 8. fiscal high prices of food items were primary cause behind high rates of inflation. Rs. A series of data points over a period of time is required to enable analysis. INFLATION IN INDIA In financial year 2007-08. where we drop the earliest closing price and use the next closing price for calculations. That high rate of inflation had to be controlled by banning a number of necessary commodities as well as various financial steps.5 percent and for electricity sector.4. average inflation in India was around 4. low or closing price over a period of time.SWATI ROBERT 3RD Semester Roll No. In core infrastructural industries. raw materials. However. but it is still better off compared to non infrastructural industries in India. TECHNICAL INDICATORS A technical indicator is a series of data points that are derived by applying a formula to the price and/or volume data of a security. while others incorporate volume and open interest into their formulae. Thus we can have a 3 period moving average as a technical indicator. when rates of development for manufacturing and electricity were 12. The price data is entered into the formula and a data point is produced. 43. finished steel and cement have performed better than April 2007. High prices of oil were responsible for proportionately high rate of inflation in 2008-09. Identify some technical indicators and explain how they can be used to decide purchase of a company’s stock. Growth in April 2008 has been around 3. 41. Q. For manufacturing sector it was 7. there has been deceleration as well. 43 and Rs. say the closing prices of a stock for 3 days are Rs. This rate was lower than average inflation of financial year 2006-07.9 percent achieved in April 2007. Ans. Mining sector has been comparatively better off as it has managed to grow at a rate of 8 percent in April 2008 compared to 2. If a technical indicator is constructed using the average of the closing prices.6 percent. 521021718 contributed to decrease in industrial production. high. .33).

Technical indicators provide an extremely useful source of additional information. The technical indicators that are not bound within a range also form buy and sell signals and display strength or weakness in the market. represents an average of a certain series of data that moves through time. say between zero and 100. it is best to use them along with price movement. Some of the technical indicators are discussed below for the purpose of illustration of the concept: Moving average: The moving average is a lagging indicator which is easy to construct and is one of the most widely used. 521021718 Technical indicators are constructed in two ways: those that fall in a bounded range and those that do not. making it much easier to view the underlying trend. A moving average filters out random noise and offers a smoother perspective of the price action. to the extent that the number of market participants ‘long’ of the market significantly outweighs those on the sidelines or holding ‘short’ positions. A number of technical indicators are in use. a smoother line is produced. A moving average. These indicators help identify momentum. volatility and various other aspects in a security to aid in the technical analysis of trends. Divergence happens when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction. chart patterns and other indicators. or when two different moving averages cross over each other. While some traders just use a single indicator for buy and sell signals. The two main ways that technical indicators are used to form buy and sell signals is through crossovers and divergence. as the name suggests. The purpose of the moving average is to track the progress of a price trend. but they can vary in the way they do this. Crossovers occur when either the price moves through the moving average. Moving Average Convergence Divergence (MACD): . the most recent close (day 11) is added to the total and the oldest close (day 1) is subtracted. The technical indicators that are bound within a range are called oscillators. The market has been trending lower for some time and is running out of ‘fuel’ for further price declines. and signal periods where the security is overbought (near 100) or oversold (near zero). This means that there are fewer participants to jump onto the back of the trend. The new total is then divided by the total number of days (10) and the resultant average computed. The ‘oversold’ condition is just the opposite. Oscillator indicators move within a range. The most common way to calculate the moving average is to work from the last 10 days of closing prices. This indicates that the direction of the price trend is weakening. Oscillators are the most common type of technical indicators. Oscillators are used as an overbought / oversold indicator. trends. Each day. The moving average is a smoothing device. A market is said to be ‘overbought’ when prices have been trending higher in a relatively steep fashion for some time.SWATI ROBERT 3RD Semester Roll No. By averaging the data.

This indicator measures short-term momentum as compared to longer term momentum and signals the current direction of momentum. signaling upward momentum in the security. some major (such as devaluation of a currency or derivative). the price should be closing near the lows of the trading range. In principle and in academic use. an arbitrage is riskfree. In economics and finance. Momentum measures the rate of change of prices by continually taking price differences for a fixed time interval. A 9-day moving average is generally used as a trigger line. as in statistical arbitrage. Traders use the MACD for indicating trend reversals. The closer the closing price is to the period’s high.SWATI ROBERT 3RD Semester Roll No. it’s a bullish signal. The idea behind this indicator is that in an uptrend. RSI is plotted in a range of 0-100. in common use. Ans. there are always risks in arbitrage. 521021718 MACD is a momentum indicator and it is made up of two exponential moving averages. A reading above 70 suggests that a security is overbought. RSI helps to signal overbought and oversold conditions in a security. The stochastic oscillator is plotted within a range of zero and 100 and signals overbought conditions above 80 and oversold conditions below 20. the more is the selling pressure. though losses may occur. while a reading below 30 suggests that it is oversold. an arbitrage involves taking advantage of differences in price of a single asset or identical cash-flows. In academic use. When the MACD crosses this trigger and goes down it is a bearish signal and when it crosses it to go above it. it may refer to expected profit. Relative Strength Index: The relative strength index (RSI) is another of the well-known momentum indicators. Stochastic Oscillator: The stochastic oscillator is one of the most recognized momentum indicators. in common use. This indicator helps traders to identify whether a security’s price has been unreasonably pushed to its current levels and whether a reversal may be on the way. Q. an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state. it is also used to refer to differences between similar . and in practice. the price should be closing near the highs of the trading range. arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance. signaling downward momentum. and the closer the closing price is to the period’s low. some minor (such as fluctuation of prices decreasing profit margins).5. in simple terms. This indicator provides information about the location of a current closing price in relation to the period’s high and low prices. The MACD plots the difference between a 26-day exponential moving average and a 12-day exponential moving average. the higher is the buying pressure. Compare Arbitrage pricing theory with the Capital asset pricing model. it is the possibility of a risk-free profit at zero cost. When used by academics. the profit being the difference between the market prices. In downtrends.

The term is mainly applied to trading in financial instruments.[note 1] In the simplest example. for example. APT can be extended to multifactor models. purchase the good. The same asset does not trade at the same price on all markets ("the law of one price"). for example. People who engage in arbitrage are called arbitrageurs (IPA: /ˌ ɑrbɨtrɑːˈʒɜr/)—such as a bank or brokerage firm. An asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate (or. Both the CAPM and APT are risk-based models. 2. when each leg of the trade is executed the prices in the market may have moved. With APT it is possible for some individual stocks to be mispriced . and transport it to another region to sell at a higher price. THE CAPITAL ASSET PRICING MODEL • • • • • APT applies to well diversified portfolios and not necessarily to individual stocks. Missing one of the legs of the trade (and subsequently having to trade it soon after at a worse price) is called 'execution risk' or more specifically 'leg risk'.not lie on the SML. Conditions for arbitrage: Arbitrage is possible when one of three conditions is met: 1. derivatives. Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time. stocks. The transactions must occur simultaneously to avoid exposure to market risk. any good sold in one market should sell for the same price in another. ARBITRAGE PRICING THEORY VS. the asset does not have negligible costs of storage. such as bonds. In practical terms. as such. and other factors. 521021718 assets (relative value or convergence trades).Mathematically it is defined as follows: and where Vt means a portfolio at time t. There are alternatives. find that the price of wheat is lower in agricultural regions than in cities. or the risk that prices may change on one market before both transactions are complete. APT is more general in that it gets to an expected return and beta relationship without the assumption of the market portfolio. "True" arbitrage requires that there be no market risk involved. This type of price arbitrage is the most common. as in merger arbitrage. this is generally only possible with securities and financial products which can be traded electronically. storage. . Traders may. 3. and even then. this condition holds for grain but not for securities). commodities and currencies. arbitrage occurs by simultaneously buying in one and selling on the other. Two assets with identical cash flows do not trade at the same price. risk. Where securities are traded on more than one exchange. but this simple example ignores the cost of transport.SWATI ROBERT 3RD Semester Roll No.

Difference in Methodology  CAPM is an equilibrium model and derived from individual portfolio optimization.  CAPM difficult to find good proxy for market returns. This definition of efficient market requires answers to two . FORMS OF MARKET EFFICIENCY A financial market displays informational efficiency when market prices reflect all available information about value. • Q.SWATI ROBERT 3RD Semester Roll No. Relation between sources determined by no Arbitrage condition. Important for hedging in portfolio formation. Be aware that correlation does not imply causality. Empirical models try to capture the relations between returns and stock attributes that can be measured directly from the data without appeal to theory.  CAPM is simpler to communicate.g. 521021718 • • • Empirical methods are based less on theory and more on looking for some regularities in the historical record. A fully diversified portfolio has no unsystematic risk. Related to empirical methods is the practice of classifying portfolios by style e. Discuss the different forms of market efficiency. o Value portfolio o Growth portfolio • The APT assumes that stock returns are generated according to factor models such as: = R = R + β I F I + βGDP FGDP + β S FS + ε • • • • As securities are added to the portfolio.6. the unsystematic risks of the individual securities offset each other. since everybody agrees upon.  APT is a statistical model which tries to capture sources of systematic risk.  APT shows sensitivity to different sources. The CAPM can be viewed as a special case of the APT. Ans. Difference in Application  APT difficult to identify appropriate factors.

rates of return. information that consists of past prices and all public information refers to the semi-strong version of market efficiency and all information (past prices. In sum. 521021718 questions: ‘what is all available information?’ & ‘what does it mean to reflect all available information?’ Different answers to these questions give rise to different versions of market efficiency. The weak form of EMH states that all past prices. The current prices fully reflect all securitymarket information. “Old” information then is already discounted and cannot be used to predict stock price fluctuations. What information are we talking about? Information can be information about past prices.SWATI ROBERT 3RD Semester Roll No. whether it be public (say in SEBI filings) or private (in the minds of the CEO and other insiders). The semi-strong form suggests that stock prices fully reflect all publicly available information and all expectations about the future. all public information and all private information) refers to the strong form version of market efficiency. Lastly. are zero NPV activities. “Prices reflect all available information” means that all financial transactions which are carried out at market prices. . So even with material non-public information. volumes and other market statistics (generally referred to as technical analysis) cannot provide any information that would prove useful in predicting future stock price movements. the strong form of EMH suggests that stock prices reflect all information. EMH asserts that stock prices cannot be predicted with any accuracy. using the available information. the semi-strong form suggests that fundamental analysis is also fruitless. trading volume data. This implies that decisions made on new information after it is public should not lead to aboveaverage risk-adjusted profits from those transactions. This implies that past rates of return and other market data should have no relationship with future rates of return. then technical analysis is fruitless in generating excess returns. knowing what a company generated in terms of earnings and revenues in the past will not help you determine what the stock price will do in the future. including the historical sequence of prices. It would mean that if the weak form of EMH is correct. Information about past prices refers to the weak form version of market efficiency. information that is public information and information that is private information. and other market-generated information.

SWATI ROBERT 3RD Semester Roll No.2 . 521021718 SET .

ADRs can get from level -1 to level –III. 6. Even both GDR & ADR is the proxy way to sell shares in foreign market by India companies ADRs is not substitute of GDRs but GDRs can use on the place of ADRs. 5. 4. GDRs are already equal to high preference receipt of level –II and level –III.1.(A) Patni Computers (B) Tata Motors 7.(A) Bajaj Auto (B) Hindalco (C) ITC ( D) L&T (E) Ranbaxy Laboratories (F) SBI Some of Indian Companies are listed in USA stock exchange only through ADRs :. GDR is negotiable instrument all over the world but ADR is only negotiable in USA. ADR’S and GDR’S 1. Investors of UK can buy GDRs from London stock exchange and luxemberg stock exchange and invest in Indian companies without any extra responsibilities. 521021718 Q. Indian companies prefer to get GDR due to its global use for getting foreign investment for own business projects.SWATI ROBERT 3RD Semester Roll No. 8. 2. Global depository receipt (GDR) is compulsory for foreign company to access in any other country’s share market for dealing in stock. But American depository receipt (ADR) is compulsory for non –us companies to trade in stock market of usa . . Names of these Indian Companies are following :. ADRs up to level –I need to accept only general condition of SEC of USA but GDRs can only be issued under rule 144 A after accepting strict rules of SEC of USA . Differentiate between ADRs and GDRs Ans. Many Indian Companies listed foreign stock market through foreign bank’s GDR. Investors of USA can buy ADRs from New york stock exchange (NYSE) or NASDAQ (National Association of Securities Dealers Automated Quotation). 3.

a certain competitor. and provide a wealth of information that cannot be gotten anywhere else. "Ratio analysis is designed to help you identify those variables which are out of balance. they can only present a picture of the business at the time that the underlying figures were prepared. investors. "Ratios are aids to judgment and cannot take the place of experience. But. In addition." David H. Financial ratios can provide small business owners and managers with a valuable tool to measure their progress against predetermined internal goals. small business owners and managers only need to be concerned with a small set of ratios in order to identify where improvements are needed. wrote in his book managing by the Numbers. One GDR's Value may be on two or six shares Q. In addition. business owners should compute a variety of applicable ratios and attempt to discern a pattern. though they can be quite valuable when a small business tracks them over time or uses them as a basis for comparison against company goals or industry Standards. Ratios are also used by bankers. For example. American investors typically use regular equity trading accounts for buying ADRs but not for GDRs." James O. They will not replace good management. and adjusting the result according to the ordinary share but GDRs is calculated on numbers of Shares. easy to use." It is important to keep in mind that financial ratios are time sensitive. Ans. "As you run your business you juggle dozens of different variables. They involve the comparison of elements from a balance sheet or income statement. and business analysts to assess various attributes of a company's financial strength or operating results. 521021718 9. but they will make a good manager better. They help to pinpoint areas that need investigation and assist in developing an operating strategy for the future. he added. 10. Using financial ratios. "They are simple to calculate. Gill noted in his book Financial Basics of Small Business Success. In reality. As a result. They enable business owners to examine the relationships between seemingly unrelated items and thus gain useful information for decision-making.SWATI ROBERT 3RD Semester Roll No.2. ratios can be misleading when taken singly. . or the overall industry. Ratios are determined by dividing one number by another. Jr. however. tracking various ratios over time is a powerful way to identify trends as they develop. The US dollar rate paid to holders of ADRs is calculated by applying the exchange rate used to convert the foreign dividend payment (net of local withholding tax) to US dollars. study the financial performance of any particular company of your interest. Financial ratios illustrate relationships between different aspects of a small business's operations. Bangs. and are crafted with particular points of focus in mind. rather than relying on the information provided by only one or two ratios." Virtually any financial statistics can be compared using a ratio. a retailer calculating ratios before and after the Christmas season would get very different results. and are usually expressed as a percentage.

liquidity. or 34% of revenues. or 37% of revenues.16 billion.49 in the first quarter of 2009 on 317 million diluted shares outstanding. 521021718 Gill also noted that small business owners should be certain to view ratios objectively. In general.49 billion. in the first quarter of 2009. and operating or efficiency—with several specific ratio calculations prescribed within each. compared to $1.SWATI ROBERT 3RD Semester Roll No. This compares to GAAP operating income of $1.96 billion. if a small business depends on a large number of fixed assets. ratios that measure how efficiently these assets are being used may be the most significant. net income. as well as free cash flow. representing 53% of total revenues in the first quarter of 2010. Non-GAAP operating income and non-GAAP operating margin exclude the expenses related to stock-based compensation (SBC). GAAP net income in the first quarter of 2010 was $1. compared to 53% in the fourth quarter of 2009 and 52% in the first quarter of 2009. This compares to non-GAAP operating income of $2. reviewed. or 41% of revenues. had foreign exchange rates remained constant from the fourth quarter of 2009 through the first quarter of 2010. an increase of 23% compared to the first quarter of 2009. and any specific information sought. In the first quarter of 2010. Determining which ratios to compute depends on the type of business.78 billion. Google reports its revenues.42 billion in the first quarter of 2009. International Revenues . are described below and are reconciled to the corresponding GAAP measures in the accompanying financial tables. or 26% of advertising revenues. GAAP operating income in the first quarter of 2010 was $2. For example.64 billion in the first quarter of 2009. Google reported revenues of $6. Reconciliations of non-GAAP measures to GAAP operating income. The non-GAAP measures. GAAP EPS in the first quarter of 2010 was $6. Non-GAAP EPS in the first quarter of 2010 was $6. compared to $5. an alternative non-GAAP measure of liquidity.88 billion. on a gross basis without deducting traffic acquisition costs (TAC). Non-GAAP net income in the first quarter of 2010 was $2. in the first quarter of 2009.76. . the charge related to SBC was $291 million. compared to $277 million in the first quarter of 2009. Non-GAAP net income and non-GAAP EPS exclude the expenses related to SBC and the related tax benefits. 2010. The tax benefit related to SBC was $65 million in the first quarter of 2010 and $64 million in the first quarter of 2009. TAC totaled $1. Perhaps the best way for small business owners to use financial ratios is to conduct a formal ratio analysis on a regular basis. compared to $4.71 billion. net income. In the first quarter of 2010. Non-GAAP operating income in the first quarter of 2010 was $2. Google reports operating income. Excluding gains related to our foreign exchange risk management program.06 on 323 million diluted shares outstanding.58 billion.77 billion for the quarter ended March 31. The raw data used to compute the ratios should be recorded on a special form monthly. financial ratios can be broken down into four main categories—profitability or return on investment. consistent with GAAP. the age of the business. compared to $1. and EPS are included at the end of this release.18 billion. and earnings per share (EPS) on a GAAP and non-GAAP basis. rather than using them to confirm a particular strategy or point of view. and saved for future comparisons. operating margin. Then the relevant ratios should be computed. or 39% of revenues.16 in the first quarter of 2009.Revenues from outside of the United States totaled $3. leverage. the point in the business cycle. operating margin. our revenues in the first quarter of 2010 would have been $112 million higher. Excluding gains related to our foreign exchange risk management program.

representing 13% of revenues in the first quarter of 2010.GAAP operating income in the first quarter of 2010 was $2. increased to $1. content acquisition costs as well as credit card processing charges. We currently estimate SBC charges for grants to employees prior to April 1. The majority of TAC is related to amounts ultimately paid to our AdSense partners. increased to $741 million.49 billion. or 11% of revenues. amortization of intangible assets. Net – Interest income and other. This compares to GAAP operating income of $1.Other cost of revenues. net increased to $18 million in the first quarter of 2010. compared to TAC of $1. Paid Clicks – Aggregate paid clicks. Non-GAAP net income was $2. 521021718 had foreign exchange rates remained constant from the first quarter of 2009 through the first quarter of 2010. Cost-Per-Click – Average cost-per-click. compared to $277 million in the first quarter of 2009. Operating Income .44 billion in the first quarter of 2009. our revenues in the first quarter of 2010 would have been $242 million lower. GAAP EPS in the first quarter of 2010 was $6. compared to $666 million. Non-GAAP operating income in the first quarter of 2010 was $2. 2010 to be approximately $1. This estimate does not include expenses to be recognized related to employee stock awards that are granted after March 31. Operating Expenses Operating expenses.2 billion for 2010. the portion of revenues shared with Google’s partners. Stock-Based Compensation (SBC) – In the first quarter of 2010. which is comprised primarily of data center operational expenses. or 28% of revenues. or 41% of revenues. increased approximately 15% over the first quarter of 2009 and increased approximately 5% over the fourth quarter of 2009. were $1. Revenues from the United Kingdom totaled $842 million. other than cost of revenues.SWATI ROBERT 3RD Semester Roll No. Other Cost of Revenues . we recognized a benefit of $10 million to revenues through our foreign exchange risk management program.06 on 323 million diluted shares outstanding. TAC as a percentage of advertising revenues was 26% in the first quarter of 2010.84 billion in the first quarter of 2010. or 39% of revenues.49 in the first quarter of 2009 on 317 million diluted shares outstanding. or 34% of revenues. which totaled $265 million in the first quarter of 2010. In the first quarter of 2010. in the first quarter of 2009. the total charge related to SBC was $291 million. in the first quarter of 2010.64 billion in the first quarter of 2009. in the first quarter of 2009. 2010 or non-employee stock awards that have been or may be granted.78 billion. Net Income – GAAP net income in the first quarter of 2010 was $1. compared to $4. which include clicks related to ads served on Google sites and the sites of our AdSense partners. Non-GAAP EPS in the first . or 12% of revenues.42 billion in the first quarter of 2009. TAC also includes amounts ultimately paid to certain distribution partners and others who direct traffic to our website. compared to 27% in the first quarter of 2009. increased approximately 7% over the first quarter of 2009 and decreased approximately 4% over the fourth quarter of 2009. which includes clicks related to ads served on Google sites and the sites of our AdSense partners. compared to 13% in the first quarter of 2009.96 billion. Interest Income and Other. TAC .18 billion in the first quarter of 2010.16 billion. compared to $6 million in the first quarter of 2009. or 37% of revenues. compared to $154 million in the first quarter of 2009. This compares to non-GAAP operating income of $2. compared to $1. or 27% of revenues. compared to $1. in the first quarter of 2009.Traffic Acquisition Costs. Income Taxes – Our effective tax rate was 22% for the first quarter of 2010.88 billion. which totaled $1.52 billion in the first quarter of 2009. compared to $1.45 billion in the first quarter of 2010.71 billion in the first quarter of 2010.

is defined as net cash provided by operating activities less capital expenditures. compared to $5. that picking your fund is like crossing the saddle point – the first time is always the most difficult.35 billion. servers. In the first quarter of 2010. capital expenditures were $239 million. family commitments. compared to $2. What are you looking for when investing in mutual funds? What are your investment needs? The more well defined these answers are the easier it is to find schemes best for you. As an investor how would you select an equity mutual fund scheme? Ans. which is on file with the SEC and is available on our investor relations website at investor. Actual results may differ materially from the results predicted.google. including data centers.gov. We will provide you an easy way to filter this huge number down to a more manageable size so that you can look spend more time looking at schemes in greater detail. Q. Questions can be many but to get cracking ask yourself these two: What are the returns you want on your investments? Do you have well- . our expected stock-based compensation charges and our plans to make significant capital expenditures. free cash flow was $2. The potential risks and uncertainties that could cause actual results to differ from the results predicted include. There is no end to verbosity when educating on funds. There are more than 350 schemes and choosing one of them is not an easy task. 2009. the majority of which was related to IT infrastructure investments.sec. But getting to actually choose a fund may not be eased with more funds.25 billion in the first quarter of 2009. 521021718 quarter of 2010 was $6. Some of the mutual funds have floated "assured" return Funds and more funds.com and on the SEC website at www. How do I choose a Scheme But to begin your selection start from the very beginning: Specify your investment needs While we are on the topic of what returns to expect. FORWARD-LOOKING STATEMENTS This press release contains forward-looking statements that involve risks and uncertainties.76. an alternative non-GAAP measure of liquidity. financial independence. unforeseen changes in our hiring patterns and our need to expend capital to accommodate the growth of the business. and reported results should not be considered as an indication of future performance. But the questions investors ask to assess their needs are possibly the same. You might ask yourself: At my age what am I expecting out of investing? To assess the needs investors look at their lifestyles. These statements include statements regarding our plans to heavily invest in innovation. In the first quarter of 2010. So how do you assess your needs? The answers obviously lie with you.58 billion. among others. Cash Flow and Capital Expenditures – Net cash provided by operating activities in the first quarter of 2010 totaled $2. Free cash flow.SWATI ROBERT 3RD Semester Roll No. like with most ventures in life. as well as those risks and uncertainties included under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31.16 in the first quarter of 2009.3. someone might as well wish for a Fund that assures returns. and level of income and expenses among other things. It often turns out. and networking equipment.

Having defined the needs that direct you to invest.SWATI ROBERT 3RD Semester Roll No. They check is done with the Sharpe ratio . the better the fund's historical risk-adjusted performance.e. that it’s returns are modest and steady and good enough for your needs. If you feel while researching a scheme.000 by the end of one year. To the second query he might say: Yes. could reply: I want a fixed monthly income of about Rs. Given the almost diverse objectives with which schemes operate. You can also select schemes that have invested in companies with a dazzling performance. etc. Because great returns in the past are no guarantee for the fabulous performance to continue in the future. Many of these funds have not earned returns that they promised and the asset management companies of the respective mutual funds or their sponsors have made good their promises. Great returns are not the only thing to look for in a scheme. mutual funds do carry risks. SBI Mutual Fund. schemes that guarantee a certain annual return or guarantee a buyback at a specified price after a specified period. Never forget one of the commonplace morals of investment: The schemes that are expected to give the highest returns have the greatest probability to fall flat! Decide how long you can park your cash Is the cash you have earmarked for your investment meant to be spent for something else? Do you need a regular cash flow? Or you don’t mind locking your cash in the scheme so that your assets can appreciate over time? Settle this question upfront on what your cash flow requirements will be till the time your money is invested in mutual funds Getting the right Fund. 521021718 defined time period for the returns you expect on your investment? The father of an aspiring engineer who would have to shell out the boy's institute fees soon enough. Getting the right answers to these questions does a lot to simply your fund picking exercise. Do you see the scheme behaving rather erratically i. the just out-of-B-school graduate planning for his new Zen could reply: I should make about Rs. the NAV changes just too often? More the volatility more are the risks involved. Evaluate a scheme by looking at how its NAV has behaved over the past. you can select schemes that have invested in that industry. 60. Assess the risk you can take Contrary to the commonplace thinking.5000 per month. Investment mix: If you know of an industry that has been doing particularly well. there are very few funds that come out with such schemes as the funds have realized it is not viable to assure returns in a volatile market. And there are some that can become as risky as stocks. When asked. one can find a category of funds that come close to satisfy your needs with their objectives. A mixed basket for your diverse needs Once . Investors comfortable with numerical recipes do a technical check of what the returns of a scheme would be in the worst case. Examples of these include funds floated by the UTI. avoid other schemes that have recently delivered high returns. Ask yourself if you are ready for a scheme whose investment value might fluctuate every week or one that gives a minimum amount of risk? Or are you in for a short-term loss in order to achieve a long-term potential gain? At this point it is good to ask oneself how will you take it if your investment fails to deliver the returns you expected or makes losses. there are some with more risks and some relatively safer.. Knowing this will reduce your chances (or even temptation) to select a fund that doesn’t come close to your objective. Nowadays. which we will do later.The higher the Sharpe ratio. for the next four years.

Do a check for the expense ratio and sales charges the fund has.10) may make a scheme more affordable as you can acquire more units but chances are the scheme is not performing well. DURATION OF BONDS Bond Duration is a measure of bond price volatility. Formally. Having defined that. The scheme’s performance: Returns from schemes are calculated over various periods from a week to one year or more.PV (Cn) x n} / Current Price of the bond Where PV (Ci) is the present values of cash flow at time i. where the weights are proportional to the present value of cash flows. remember a low NAV (sometimes even below the usual offer price of Rs. Show how duration of a bond is calculated and how is it used. which captures both price and reinvestment risk and which is used to indicate how a bond will react in different interest rate environments. House for long and developed a trust with the fund.5000. You came here looking for schemes that can suffice your investment needs. minimum and average returns for all schemes in the category you have chosen are also displayed. back to the basic question. The criteria you can set are: The scheme’s expense: All schemes have a minimum requirement for the total amount of money you can invest. It is well possible that just by picking more than one scheme from one fund house you can achieve enough diversification. Thus duration of a bond is the weighted average maturity of cash flow stream. You might be like many others who actually have multiple needs. While you enter returns figures the maximum.SWATI ROBERT 3RD Semester Roll No. you can also go for more than one scheme to further diversify your investments. The NAV is good enough to know what each unit of the scheme will cost you. choosing a fund isn’t difficult. But. While you might have selected a scheme that has a diversified portfolio. If you have been recommended a fund house choose the fund to list all schemes under it. For each time period specify the returns. Yet another recap of the basics: one of the things that made these mutual funds great was diversification. it is defined as: Duration = D = {PV (C1) x 1 + PV (C2) x 2+ ----. some investors usually try to satisfy their diverse investments through one fund house. prefer to pick another scheme from the funds but convenience sometimes leads to venerable prejudices that might deprive you of trying something new and better. Our search allows you to set criteria based on your objectives.4. Hence. 521021718 again. There could be a better-managed scheme in a different fund house that you are missing out on if you decide to stick to your old fund house for convenience sake basket for their new investment needs Q. Ans. The duration of a bond represents the length of time that elapses before the average rupee of present value from the bond is received. In fact many investors who have tried out a fund The success of your investment depends in a large measure on the objective you define. Steps in calculating duration: . Through a search of schemes on our advanced search you can draw up a list of schemes that come close to the objectives you have set. Usually they begin from a minimum of Rs. The scheme’s fund house: Over the years fund houses in India have established a name for themselves for their investment style and their performance. Consider going for a combination of schemes.

82645 132. YTM = 10%).68301 218. PORTFOLIO DIVERSIFICATION 'Don't put all your eggs in one basket' is a well-known proverb. The face value of the bond is Rs.90909 72. if you invest all your wealth in the shares of one company.10 = 80 x 0. Annual coupon payment = 8% x Rs.64 = 80 x 0.89% for a 1% increase in the interest rates. Show with the help of an example how portfolio diversification reduces risk. there is a chance that the company will go bust and you will lose all your money. 1080 (t) Annual PVIF Present Explanation Time x Explanation Cash @10% Value PV of flow of Annual cash Cash Flow flow PV(Ct) 1 80 0.89 years.59 = 1080 x 3352.1000.89 x 1% = 3. 1000 = Rs. Ans.73 = 80 x 0.7 8 Price of the bond= Rs 924.3 = 3 x 60. The term D / (1+YTM) is also known as Modified Duration. 521021718 Step 1 : Find present value of each coupon or principal payment. 80 = Rs. the principal of Rs.59 0. Example: Calculate the duration of an 8% annual coupon 5 year bond that is priced to yield 10% (i. Similarly. If you carry your breakable items in several baskets there is a chance that one will be dropped.62092 670. Q.1 4 80 0.28 / (1+10%) = 3. a portfolio of shares in several companies is less .9 = 5 x 670.56 = 4 x 54.12 = 80 x 0. Step 2 : Multiply this present value by the year in which the cash flow is to be received.SWATI ROBERT 3RD Semester Roll No.5. 80 At the end of 5 years.24 = 2 x 66.e.75131 180.90909 72. Step 3 : Repeat steps 1 & 2 for each year in the life of the bond.18 The proportional change in the price of a bond: (ΔP/P) = . and YTM is the yield-to-maturity.62092 5 Total 924.64 5 1080 0. Since it is unlikely that all companies will go bust at the same time.82645 66. Cash flow in year 5= Principal + Interest = Rs. This implies that the price of the bond will decrease by 3. 80.68301 54.{D/ (1+ YTM)} x Δ y Where Δ y =change in Yield. The modified duration for the bond in the example above = 4. 1000 will be returned to the investor.73 = 1 x 72.73 2 80 0.18 3956.75131 60.12 3 80 0. but you are unlikely to drop all your baskets on the same trip. Step 4 : Add the values obtained in step 2 and divide by the price of the bond to get the value of Duration. Therefore cash flows in year 1-4= Rs. which summarizes the message that there are benefits from diversification. 1000 + Rs.

the investor would be indifferent between assets A and B. Diversification does not always reduce the riskiness of a portfolio. In this case both assets have the same expected return (20 per cent) and the same degree of risk. Riskaverse investors would invest only in asset A. both assets have an expected return of 20 per cent. there is a perfect negative correlation between them: when one is high the other is low. We will use the notion of risk-pooling to explain some forms of financial behavior. the risk lover still has a chance of getting a 30 per cent return and the extra risk gives positive pleasure. or risk-loving) because the risk and expected return are identical for both assets. This is because these two companies both compete in the same industry. this is not the end of the story. BP is not independent of the return on an investment in Shell. (The possible range of outcomes is between 10 and 30 per cent on each asset. Portfolio diversification does not reduce risk in this case.) If all that mattered in investment decisions were the risk and return of individual shares. say. What would a sensible investor do if permitted to hold some combination of the two assets? Clearly. but the risk lover may prefer not to diversify. This is because. However. . 521021718 risky. since his return will be 20 per cent whichever situation arises. The reverse is true for asset B. all oil companies might do well when oil prices are high and badly when they are low. However. or the highest expected return for a given level of risk. Part (i) illustrates the return on two assets in two different situations. His risk will then be reduced to zero. For the risk-averse investor asset A dominates asset B. Indeed. by picking one asset alone. However. A portfolio of both assets has the same expected return but lower risk than a holding of either asset on its own. The key difference between risk in the real world of finance and the risk of cointossing is that many of the potential outcomes are not independent of other outcomes. because the returns on these assets are not independent. the probability of yours turning up heads is independent of the probability of my throwing a head. If you and I toss a coin. Assets differ in expected return and variability in returns. if the choice were between holding only A or only B. Risk-averse investors will choose the diversified portfolio. Consider the example in part (ii) of Table 2. so we need to be clear what conditions matter. all investors should be indifferent (whether they were risk-averse. This diversified portfolio will clearly be preferred to either asset alone by riskaverse investors. Consider part (i) of the table. but a full understanding of portfolio diversification involves a slightly wider knowledge of the nature of risk than what is involved in coin-tossing. and risk-pooling is certainly an important reason for diversification.SWATI ROBERT 3RD Semester Roll No. which gives them the lowest risk for a given expected rate of return. Asset A has a high return in situation 2 and a low return in situation 1. In (ii) both assets have a high return in situation 2 and a low return in situation 1. and vice versa. On the other hand. the return on an investment in. Let the investor decide to hold half his wealth in asset A and half in asset B. holding some of each asset can reduce the risk. because it is the same on both assets. The important matter here is that the fortunes of these two companies are not independent of each other. This may sound like the idea of risk-pooling. there is no possible combination that will change the overall expected return. risk-neutral. As in part (i). But asset B is riskier than asset A and it has returns that are positively correlated with A's. while risk-lovers would invest only in asset B. which we discussed earlier in this chapter. The risk-neutral investor is indifferent to all combinations of A and B because they all have the same expected return. Indeed.

you would still have some risk. you reach a point where you have diversified as much as is reasonably possible. Box 3 discusses the issue of whether all firms should diversify the activities in order to reduce risk. a share with a negative beta would be in high demand by investment managers. Beta It is now common to use a coefficient called beta to measure the relationship between the movements in a specific company's share price and movements in the market. For example. 521021718 Combinations of A and B are always riskier than holding A alone. A share that is perfectly correlated with an index of stock market prices will have a beta of 1.6. The specific risk associated with any one company can be diversified away by holding shares of many companies. A beta between 1 and 0 means that the share moves in the same direction as the stock market but is less volatile. Two stocks whose returns move in exactly together have a coefficient of +1. EMERGING MARKET . as asset B will never be held so long as asset A is available. As you increase the number of securities in your portfolio. A negative beta indicates that the share moves in the opposite direction to the market in general. Thus. you should aim to find investments that have a low or negative correlation. The risk attached to a combination of two assets will be smaller than the sum of the individual risks if the two assets have returns that are negatively correlated.SWATI ROBERT 3RD Semester Roll No. while in the former they are negatively correlated. Market risk is non-diversifiable. whereas specific risk is diversifiable through riskpooling. To effectively diversify. or CAPM. When you have about 30 securities in your portfolio you have diversified most of the risk. A beta higher than 1 means that the share moves in the same direction as the market but with amplified fluctuations. Q. Two stocks whose returns move in exactly the opposite direction have a correlation of -1. Hence we talk about market risk and specific risk. But even if you held shares in every available traded company. Study the performance of any emerging market of your choice. we could say that for the risk-averse investor asset A dominates asset B. The capital asset pricing model. Clearly. because the stock market as a whole tends to move up and down over time. Diversifiable and non-diversifiable risk Not all risk can be eliminated by diversification. Ans. The banking stocks (or the technology stocks) would have a high positive correlation as their share prices are driven by common factors. other things being equal. as it would reduce a portfolio's risk.0.0. predicts that the price of shares with higher betas must offer higher average returns in order to compensate investors for their higher risk. The key difference between the example in part (ii) of Table 2 and that in part (i) is that in the second example returns on the two assets are positively correlated.

concluded that stock gains and economic performance can diverge dramatically. a difference that translates into roughly a 3% drag on your cumulative return. Second.8%.99%. while GDP expanded more than 5% annually in South Korea from 1988 to 2002. While there is certainly reasonable evidence to support expectations of long-term growth in markets like India. 521021718 With emerging market economies like India and China growing at nearly 10%.S. the mean stock return was only 0. the 3year standard deviation of emerging market returns is 32. which looked at market returns in 32 nations since the 1970s. 'A healthy economy isn't a guarantee that established companies will attract enough capital and labor to expand sales and earnings strongly—partly because they have to compete with newer ventures for resources. the 60day emerging market volatility actually rose slightly this quarter to 19. at least for the moment. Right now. investors have long ago anticipated potential for equities in places like China. My colleague explains in this article how volatility drag will reduce your returns. shortsighted American for not allocating enough to emerging market equities. 2010): . be properly weighted in emerging markets. even though GDP grew at an annualized pace of just 1. and Europe.studies suggest that strong economic growth often does not translate into strong stock returns. even if average annual returns from emerging markets exceed developed markets. 12% economic growth in a country like India has not necessarily meant 12% market returns. it would appear that valuations for US and MSCI Emerging Markets Index on a trailing P/E basis are roughly inline. it will erode your returns over time through the process of volatility drag. So should emerging market equities be a bigger part of your portfolio? In fact. emerging markets are still materially more volatile.SWATI ROBERT 3RD Semester Roll No.. etc. and this volatility will not just keep you awake at night. Ritter says. since markets are largely efficient. for example.' Dr. US household investors may. as reported in this Wall Street Journal article . that stocks in Sweden posted a mean return of better than 8% a year from 1970 through 2002. Shouldn't the percentage of your equity portfolio invested in emerging markets equities be roughly in line with the proportionate share of emerging-market stocks to total global stock-market capitalization – or around 10% to 15% of an investor's total equity portfolio? It seems natural to expect that the powerful economic growth of emerging markets such as Brazil and China will lead to higher stock market returns than in the slower growing markets such as the U. University of Florida finance professor Jay Ritter found. by many measures. According to Vanguard. Right now.4% a year.83 versus 24.55% (see chart below for period ending December 31. More basically. For the following reasons higher potential growth may not justify investing heavily right now in emerging market equities and instead you may want to be gradually increasing your allocation over time: First. the average allocation to emerging market equities among US household investors is still only 6%. One study. In contrast.27 for the S&P500. Brazil. China. you may be feeling pain from all the criticism from pundits and advisers that you are a myopic. And while the 60day volatility on US Large-Cap Equities has now dropped all the way down to 10.

right now. Most emerging market funds are significantly more expensive than US funds . it appears that the average American household is not necessarily being naive and xenophobic when they choose to be “underweighted” in emerging market equities. If you are investing within a fund family such as Fidelity. Our firm recommends low cost funds such as Shares MSCI Emerging Market Index (EEM). Compare Vanguard's VWO at 0.27 expense ratio vs. 521021718 Third.often hundreds of basis points more.06%. So higher economic growth may not lead to higher returns on emerging markets equities.14% versus Fidelity's S&P500 Index at only 0. .10% (This is why if you really seek more exposure to emerging markets economic growth. In our dynamic asset allocation process. and Vanguard Emerging Markets (VWO). a more efficient way to gain exposure is through multinationals traded on US exchanges – S&P500 companies derive about 50% of their revenue from abroad. Vanguard’s S&P500 Index Fund (VOO) at 0. with about a third of that coming from emerging markets). emerging markets allocations are likely to grow along with other equity allocations over the next few years assuming volatility continues to decline. your choice for emerging markets is an actively managed fund with an annual cost of 1. volatility drag is likely to erode much of this potential higher return. long-term investors. But even these low-cost funds face higher costs than US equity funds. and higher investment costs are certain to drag the return down even further. emerging market indexes are less efficient investment vehicles – which makes a big difference over time for prudent. But.SWATI ROBERT 3RD Semester Roll No.

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