Study of Portfolio Management

Profile and Historical Background of the ‘Shrishma Portfolio & Investment services Ltd.’
Address: 1/D Priya Apt., Opp. Old civil court, Nanpura, Surat.

Shrishma Portfolio & Investment Services Ltd. is an Investment Company registered under Companies Act 1956 since 1995. It provides a proper solution to the investors regarding any investment related queries. The company has all modern communication facilities, infrastructure. The main objective of the company is to help the investors in managing their investment portfolio. The other objective is to provide best service and guideline to the clients for their suitable investment avenue, so they get maximum gain with safety for their future. Generally, people is not aware about different safe and gainful investment avenue, if they invest their money in any investment avenue there are chances to incur a loss and could not get the proper return from it. Shri Satish joshi is a Director of the company. He has more than twenty five year's wide experience in Capital Market, Financial Service Sector, and Equity Research. During his college life in 1976-77 he started applying in equity issues. A small beginning of Rs. 500/- of the year 1976-77 has reached to lacks of Rs. investment. He has done M.Sc. (1st class) in 1982 from S. P. University, Post graduate in computer science (1st class) in 1982-83. He joined PRL (Physical Research Laboratory) as computer scientist. The habit of doing research and analysis has given advantage in equity research. He spend two year in C.F.A and recently passed exam of Association of Mutual Fund Industries (AMFI) for validity of his mutual fund activities. He has spent several years in fundamental analysis. Then
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

he started writing regular articles in various news papers and magazines. He is appearing on T.V. channels for his investment advice. He has been respected by thousand of investors and has earned reputation as one of most successful equity research analyst. He is a regular student of Yoga classes and meditation. His nature of helping everybody has proved beneficial to the society. He believes in and respects GOD. He loves challenge and struggle for excellence. His primary objective of advice is "no investors of him should lose". He is equally efficient in technical analysis. He has attended several seminars on technical analysis. He is a professional advisor to many Charted Accountants, engineers, advocates and managers.

 Saving:

P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

Saving are excess of income over expenditure for any economic unit. Thus, S=Y–E Where, S is saving, Y is income and E is expenditure. Secondly, excess funds or surplus in profits or capital gains are also available for investment. Thus, S = W1 – W2 Where, W1 is wealth in period 2, W2 is wealth in period 1, So, the difference between them is capital gains or losses. Thirdly, investment is also made by many companies and individuals by borrowing, from others. Thus the Corporate Sector and Government Sector are always net borrows, as they invest more than their savings. Thus, S=B–L Where, B is borrowings L is landings Savings can be negative or positive

 Why Saving:
Saving is abstaining from present consumption for a future use. Saving are sometimes autonomous coming from households as a matter of habit. But bulk of the savings come for specific objectives, like interest income, future needs, contingencies, precautionary purposes, or growth in future wealth, leading to rise in the standard of living etc.

 Saving and Investment:
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

Investors are savers but all savers cannot be good investors, as investment is a science and an art. Savings are sometimes autonomous and sometimes induced by the incentives like fiscal concessions or income or capital appreciation. The number of investors is about 50 million out of population of more than one billion in India. Savers come from all classes except in the case of the population who are below the poverty line. The growths of urbanization and literacy have activated the cult of investment. More recently, since the eighties the investment activity has become more popular with the change in the Government Polices towards liberalization and financial deregulation. The process of liberalization and privatization was accelerated by the Government policy changes towards a market oriented economy, through economic and financial reforms stated in July 1991.

 What is investment?
“Investment may be defined as the purchase by an individual or institutional investor of a financial or real asset that produces a return proportional to the risk assumed over some future investment period.” - F. Amling “Investment defined as commitment of funds made in the expectation of some positive rate of return. If the investment is properly undertaken, the return will commensurate with the risk the investor assumes.” - Fisher & Jordan Investment refers to acquisition of some assets. It also means the conversion of money into claims on money and use of funds for productive income earnings assets. In essence, it means the use of funds for productive purpose, for securing some objectives like, income,
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Study of Portfolio Management

appreciation of capital or capital gains, or for further production of goods and services with the objective of securing yield

 Financial and Investment:

Economic

Meaning

of

Financial investment involves of funds in various assets, such as stock, Bond, Real Estate, Mortgages etc. Investment is the employment of funds with the aim of achieving additional income or growth in value. It involves the commitment of resources which have been saved or put away from current consumption in the hope some benefits will accrue in future. Investment involves long term commitment of funds and waiting for a reward in the future. From the point of view people who invest their finds, they are the supplier of ‘Capital’ and in their view investment is a commitment of a person’s funds to derive future income in the form of interest, dividend, rent, premiums, pension benefits or the appreciation of the value of their principle capital. To the financial investor it is not important whether money is invested for a productive use or for the purchase of secondhand instruments such as existing shares and stocks listed on the stock exchange. Most investments are considered to be transfers of financial assets from one person to another. Economic investment means the net additions to the capital stock of the society which consists of goods and services that are used in the production of other goods and services. Addition to the capital stock means an increase in building, plants, equipment and inventories over the amount of goods and services that existed. The financial and economic meanings are related to each other because investment is a part of the savings of individuals which flow into
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

the capital market either directly or through institutions, divided in ‘new’ and secondhand capital financing. Investors as ‘suppliers’ and investors as ‘users’ of long-term funds find a meeting place in the market. So from above we know the term investment. The savers become the investors in the following term and invest in unique assets: FINANICAL ASSETS: cash Bank Deposits P.F.; L.I.C scheme Pension scheme Post office certificates Becomes Saver Investor PHYSICAL ASSETS: House, Land, Building, Flats Gold, Silver and Other Metals Consumer Durables

MARKETABLE ASSETS: Shares, Bonds Government securities Mutual Fund UTI units etc.

Stock & Capital Markets

New Issues

Stock Market

Source: Investment Management By.V.A. Avadhani, Himalaya Publishing, Page 45. 

Need of investment:
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P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

Study of Portfolio Management

Investments are both important and useful in the context of present day conditions. The following points have made investment decision increasingly important. 1. Planning for retirement 2. Interest rate 3. High rate of inflation 4. Increase rate of taxation 5. Income 6. Investment channels 1. Planning for retirement: A tremendous increase in working population, proper plans for life span and longevity have ensured the need for investment decisions. Investment decision have becomes significant as working people retire between the age 55 and 60. The life expectancy has increased due to improved living conditions, medical facilities etc. The earnings from employment should, therefore, be calculated in such a manner that a portion should be put away as savings. Saving from the from the current earning must be invested in a proper way so that principal and income thereon will be adequate to meet expenditure on them after their retirement. 2. Interest rate: The level of interest rates is another factor for a sound investment plan. Interest rates may vary between one investments to other risky and non- risky investments. They may also differ due to different benefit schemes offered by the investments. These aspects must be considered before actually allocating any amount. A high rate of interest may not be the only factor favouring the outlet for investment. The investor has to
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P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

Study of Portfolio Management

include in his portfolio several kinds on investments. Stability of interest is as important as receiving a high rate of interest. 3. High rate of inflation: In the conditions of inflation, the prices will rise and purchasing power of rupee will decline. On account of this, capital is eroded every year to the extent of rise in the inflation. The return on any investment should be regarded as positive, when such return compensates the effect of inflation. For maintaining purchasing power stability, investors should carefully plan and invest their funds by making analysis. a. The rate of expected return and inflation rate. b. The possibilities of expected gain or loss on their investment. c. The limitation imposed by personal and family considerations. 4. Increase rate of taxation: Taxation is one of the crucial factors in a person’s savings. Tax planning is an essential part of over all investment planning. If the investment or disinvestment in securities in made without considering the various provisions of the tax laws, the investor may find that most of his profits have been eroded by the payment of taxes. Proper planning could lead to a substantial increase in the amount of tax to be paid. On the other hand, good tax planning and investing in tax savings schemes not only reduces the tax payable by the investor but also helps him to save taxes on other incomes. Various tax incentives offered by the government and relevant provisions of the Income Tax Act, the Wealth Tax Act, are important to an investor in planning investments.

5. Income:
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Income is also a factor in making a sound investment decision. The general increase in employment opportunities which gave rise to income level and avenues for investment, have lead to the ability and willingness of working population to save and invest such savings. 6. Investment Channels: The growth and development of the country leading to greater economic activity has led to the introduction of a vast array of investments. Apart from putting aside savings in savings banks where interest is low, investors have the choice of a variety of instruments. The question to reason out is which is the most suitable channel? Which media will give a balanced growth and stability of return? The investor in his choice of investment will have to try and achieve a proper mix between high rate of return and stability of return to reap the benefits of both. Some of the instruments available are corporate stock, provident fund, life insurance, fixed deposits in corporate sector, Unit Trust Schemes and so on.

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Study of Portfolio Management

 What Is Portfolio:
A portfolio is a collection of securities. Since it is rarely desirable to invest the entire funds of an individual or an institution in a single security, it is essential that every security be viewed in a portfolio context. A set or combination of securities held by investor. A portfolio comprising of different types of securities and assets. As the investors acquire different sets of assets of financial nature, such as gold, silver, real estate, buildings, insurance policies, post office certificates, NSC etc., they are making a provision for future. The risk of each of such investments is to be understood before hand. Normally the average householder keeps most of his income in cash or bank deposits and assumes that they are safe and least risky. Little does he realize that they also carry a risk with them – the fear of loss or actual loss or theft and loss of real value of these assets through the rise price or inflation in the economy? Cash carries no interest or income and bank deposits carry a nominal rate of 4% on savings deposits, no interest on current account and a maximum of 9% on term deposits of one year. The liquidity on fixed deposits is poor as one has to wait for the period to maturity or take loan on such amount but at a loss of income due to penal rate. Generally risk averters invest only in banks, Post office and UTI and Mutual funds. Gold, silver real estate and chit funds are the other avenues of investment for average Householder, of middle and lower income groups. If the investor desired to have a real rate of return which is substantially higher than the inflation rate he has to invest in relatively more risky areas of investment like shares and debenture of companies or bonds of Government and semi-Government agencies or deposits with companies
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Study of Portfolio Management

and firms. Investment in Chit funds, Company deposits, and in private limited companies has a highest risk. But the basic principle is that the higher the risk, the higher is the return and the investor should have a clear perception of the elements of risk and return when he makes investments. Risk Return analysis is thus essential for the investment and portfolio management.

 Why Portfolio:
You will recall that expected return from individual securities carries some degree of risk. Risk was defined as the standard deviation around the expected return. In effect we equated a security’s risk with the variability of its return. More dispersion or variability about a security’s expected return meant the security was riskier than one with less dispersion. The simple fact that securities carry differing degrees of expected risk leads most investors to the notion of holding more than one security at a time, in an attempt to spread risks by not putting all their eggs into one basket. Diversification of one’s holdings is intended to reduce risk in an economy in which every asset’s returns are subject to some degree of uncertainty. Even the value of cash suffers from the inroads of inflation. Most investors hope that if they hold several assets, even if one goes bad, the others will provide some protection from an extreme loss.

 Portfolio Management:
The portfolio management is growing rapidly serving broad array of investors – both individual and institutional – with investment portfolio ranging in asset size from few thousands to crores of rupees. Despite growing importance, the subject of portfolio and investment management is new in the country and is largely misunderstood. In most
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

cases, portfolio management has been practiced as a investment management counseling in which the investor has been advised to seek assets that would grow in value and / or provide income. Portfolio management is concerned with efficient management of investment in the securities. An investment is defined as the current commitment of funds for a period of time in order to derive a future flow of funds that will compensate the investing unit: funds are committed. rate of inflation, and involved in the future flow of funds. The portfolio management deals with the process of selection of securities from the number of opportunities available with different expected returns and carrying different levels of risk and the selection of securities is made with a view to provide the investors the maximum yield for a given level of risk or ensure minimize risk for a given level of return. Investors invest his funds in a portfolio expecting to get a good return consistent with the risk that he has to bear. The return realized from the portfolio has to be measured and the performance of the portfolio has to be evaluated. It is evident that rational investment activity involves creation of an investment portfolio. Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals specially with security analysis, portfolio analysis, portfolio selection, portfolio revision and
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For the time the For the expected For the uncertainty

portfolio

evaluation.

Portfolio

management makes use of analytical techniques of analysis and
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

Study of Portfolio Management

conceptual theories regarding rational allocation of funds. Portfolio management is a complex process, which tries to make investment activity more rewarding and less risky.

Definition of Portfolio Management: It is a process of encompassing many activities of investment in

assets and securities. The portfolio management includes the planning, supervision, timing, rationalism and conservatism in the selection of securities to meet investor’s objectives. It is the process of selecting a list of securities that will provide the investor with a maximum yield constant with the risk he wishes to assume.

 Application to portfolio Management:
Portfolio Management involves time element and time horizon. The present value of future return/cash flows by discounting is useful for share valuation and bond valuation. The investment strategy in portfolio construction should have a time horizon, say 3 to 5 year; to produce the desired results of say 20-30% return per annum. Besides portfolio management should also take into account tax benefits and investment incentives. As the returns are taken by investors net of tax payments, and there is always an element of inflation, returns net of taxation and inflation are more relevant to tax paying investors. These are called net real rates of returns, which should be more than other returns. They should encompass risk free return plus a reasonable risk premium, depending upon the risk taken, on the instruments/assets invested.

P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

 Objective of Portfolio Management:The objective of portfolio management is to invest in securities is securities in such a way that one maximizes one’s returns and minimizes risks in order to achieve one’s investment objective. A good portfolio should have multiple objectives and achieve a sound balance among them. Any one objective should not be given undue importance at the cost of others. Presented below are some important objectives of portfolio management. 1. Stable Current Return: Once investment safety is guaranteed, the portfolio should yield a steady current income. The current returns should at least match the opportunity cost of the funds of the investor. What we are referring to here current income by way of interest of dividends, not capital gains. 2. Marketability: A good portfolio consists of investment, which can be marketed without difficulty. If there are too many unlisted or inactive shares in your portfolio, you will face problems in encasing them, and switching from one investment to another. It is desirable to invest in companies listed on major stock exchanges, which are actively traded. 3. Tax Planning: Since taxation is an important variable in total planning, a good portfolio should enable its owner to enjoy a favorable tax shelter. The portfolio should be developed considering not only income tax, but

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Study of Portfolio Management

capital gains tax, and gift tax, as well. What a good portfolio aims at is tax planning, not tax evasion or tax avoidance. 4. Appreciation in the value of capital: A good portfolio should appreciate in value in order to protect the investor from any erosion in purchasing power due to inflation. In other words, a balanced portfolio must consist of certain investments, which tend to appreciate in real value after adjusting for inflation. 5. Liquidity: The portfolio should ensure that there are enough funds available at short notice to take care of the investor’s liquidity requirements. It is desirable to keep a line of credit from a bank for use in case it becomes necessary to participate in right issues, or for any other personal needs. 6. Safety of the investment: The first important objective of a portfolio, no matter who owns it, is to ensure that the investment is absolutely safe. Other considerations like income, growth, etc., only come into the picture after the safety of your investment is ensured. Investment safety or minimization of risks is one of the important objectives of portfolio management. There are many types of risks, which are associated with investment in equity stocks, including super stocks. Bear in mind that there is no such thing as a zero risk investment. More over, relatively low risk investment give correspondingly lower returns. You can try and minimize the overall risk or bring it to an acceptable level by developing a balanced and efficient portfolio. A good portfolio of growth stocks satisfies the entire objectives outline above.
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P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

Study of Portfolio Management

 Scope of Portfolio Management:Portfolio management is a continuous process. It is a dynamic activity. The following are the basic operations of a portfolio management. a) Monitoring the performance of portfolio by incorporating the latest market conditions. b) Identification preferences. c) Making an evaluation of portfolio income (comparison with targets and achievement). d) Making revision in the portfolio. e) Implementation of the strategies in tune with investment objectives. of the investor’s objective, constraints and

 Approaches of Portfolio Management:Different investors follow different approaches when they deal with investments. Four basic approaches are illustrated below, but there could be numerous variations. i) The Holy-Cow Approach: These investors typically buy but never sell. He treats his scrips like holy cows, which are never to be sold for slaughter. If you can consistently find and then confine yourself to buying only prized bulls, this holy cow approaches may pay well in the long run. ii) The Pig-Farmer Approach:
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P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

Study of Portfolio Management

The pig-farmer on the other hand, knows that pigs are meant for slaughter. Similarly, an investor adopting this approach buys and sells shares as fast as pigs are growth and slaughtered. Pigs become pork and equity hard cash. iii) The Rice-Miller Approach: The rice miller buys paddy feverishly in the market during the season, then mills, hoards and sells the rice slowly over an extended period depending on price movements. His success lies in his shills in buying and selling, and his financial capacity to hold stocks. Similarly, an investor following this approach grabs the share at the right price, takes a position, holds on to it, and liquidates slowly. iv) The Woolen-Trader Approach: The woolen-trader buys woolen ever a period of time but sells them quickly during the season. Hid success also lies in his skill in buying and selling, and his ability to hold stocks. An investor following this strategy over a period of time but sells quickly, and quits.

 SEBI

Guidelines

to

Portfolio

Management:SEBI has issued detailed guidelines for portfolio management services. The guidelines have been made to protect the interest of investors. The salient features of these guidelines are given here under; 1) The nature of portfolio management services shall be investment consultant. 2) The portfolio manager shall not guarantee any return ti his clients. 3) Client’s funds will be kept in separate bank account. 4) The portfolio manager shall acts as trustee of client’s funds.
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

5) The portfolio manager can invest in money or capital market. 6) Purchase and sale of securities will be at prevailing market price.

 Different Management:

Phases

of

Portfolio

Portfolio management is a process encompassing many activities aimed at optimizing the investment of one’s funds. Main five phases can be identified in this management process: a. Security Analysis b. Portfolio Analysis c. Portfolio Selection d. Portfolio Revision e. Portfolio Evaluation f. Portfolio Construction (A) SECURITY ANALYSIS:The different types of securities are available to an investor for investment. In stock exchange of the country the shares of 7000 companies are listed. Traditionally, the securities were classified into ownership such as equity shares, preference share, and debt as a debenture bonds etc. Recently companies to raise funds for their projects are issuing a number of new securities with innovative feature. Convertible debenture, discount bonds, Zero coupon bonds, Flexi bond, floating rate bond, etc. are some of these new securities. From these huge group of securities the investors has to choose those securities, which he considers worthwhile to be included in his investment portfolio. So for this detailed security analysis is most important.

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Study of Portfolio Management

The aim of the security analysis is to find out intrinsic value of a security. The basic value is also called as the real value of a security is the true economic worth of a financial asset. The real value of the security indicates whether the present market price is over priced or under priced in order to make a right investment decision. The actual price of the security is considered to be a function of a set of anticipated capitalization rate. Price changes, as anticipation risk and return change, which in turn change as a result of latest information. Security analysis refers to analyzing the securities from the point of view of the scrip prices, return and risks. The analysis will help in understanding the behaviour of security prices in the market for investment decision making. If it is an analysis of securities and referred to as a macro analysis of the behaviour of the market. Security analysis entails in arriving at investment decisions after collection and analysis of the requisite relevant information. To find out basic value of a security “the potential price of that security and the future stream of cash flows are to be forecast and then discounted back to the present value.” The basic value of the security is to be compared with the current market price and a decision may be taken for buying or selling the security. If the basic value is lower than the market price, then the security is in the over bought position, hence it is to be sold. On the other hand, if the basic value is higher than the market price the security’s worth is not fully recognized by the market and it is in under bought position, hence it is to be purchased to gain profit in the future. There are mainly three alternative approaches to security analysis, namely fundamental analysis, technical analysis and efficient market theory. The fundamental analysis allows for selection of securities of different sectors of the economy that appear to offer profitable
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

opportunities. The security analysis will help to establish what type of investment should be undertaken among various alternatives i.e. real estate, bonds, debentures, equity shares, fixed deposit, gold, jewellery etc. Neither all industries grow at same rate nor do all companies. The growth rates of a company depend basically on its ability to satisfy human desires through production of goods or performance is important to analyze nation economy. It is very important to predict the course of national economy because economic activity substantially affects corporate profits, investors’ attitudes, expectations and ultimately security price. According to this approach, the share price of a company is determined by these fundamental factors. The fundamental works out the compares this intrinsic value of a security based on its fundamental; them compares this intrinsic value, the share is said to be overpriced and vice versa. The mispricing security provides an opportunity to the investor to those securities, which are under priced and sell those securities, which are overpriced. It is believed that the market will correct notable cases of mispricing in future. The prices of undervalued shares will increase and those of overvalued will decline. Fundamental analysis helps to identify fundamentally strong companies whose shares are worthy to be included in the investor’s portfolio. The second alternative of security analysis is technical analysis. The technical analysis is the study of market action for the purpose of forecasting future price trends. The term market action includes the three principal sources of information available to the technician – price, value, and interest. Technical Analysis can be frequently used to supplement the fundamental analysis. It discards the fundamental approach to intrinsic value. Changes in price movements represent shifts in supply and demand
P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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Study of Portfolio Management

position. Technical Analysis is useful in timing a buy or sells order. The technical analysis does not claim 100% of success in predictions. It helps to improve the knowledge of the probability of price behaviour and provides for investment. The current market price is compared with the future predicted price to determine the extent of mispricing. Technical analysis is an approach, which concentrates on price movements and ignores the fundamentals of the shares. A more recent approach to security analysis is the efficient market hypothesis/theory. According to this school of thought, the financial market is efficient in pricing securities. The efficient market hypothesis holds that market prices instantaneously and fully reflect all relevant available information. It means that the market prices of securities will always equal its intrinsic value. As a result, fundamental analysis, which tries to identify undervalued or overvalued securities, is said to be a useless exercise. Efficient market hypothesis is direct repudiation of both fundamental analysis and technical analysis. An investor can’t consistently earn abnormal return by undertaking fundamental analysis or technical analysis. According to efficient market hypothesis it is possible for an investor to earn normal return by randomly choosing securities of a given risk level. (B) PORTFOLIO ANALYSIS:The main aim of portfolio analysis is to give a caution direction to the risk and return of an investor on portfolio. Individual securities have risk return characteristics of their own. Therefore, portfolio analysis indicates the future risk and return in holding of different individual instruments. The portfolio analysis has been highly successful in tracing the efficient portfolio. Portfolio analysis considers the determination of
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Study of Portfolio Management

future risk and return in holding various blends of individual securities. An investor can sometime reduce portfolio risk by adding another security with greater individual risk than any other security in the portfolio. Portfolio analysis is mainly depending on Risk and Return of the portfolio. The expected return of a portfolio should depend on the expected return of each of the security contained in the portfolio. The amount invested in each security is most important. The portfolio’s expected holding period value relative is simply a weighted average of the expected value relative of its component securities. Using current market value as weights, the expected return of a portfolio is simply a weighted average of the expected return of the securities comprising that portfolio. The weights are equal to the proportion of total funds invested in each security. Tradition security analyses recognize the key importance of risk and return to the investor. However, direct recognition of risk and return in portfolio analysis seems very much a “seat-of-the-pants” process in the traditional approaches, which rely heavily upon intuition and insight. The result of these rather subjective approaches to portfolio analysis has, no doubt, been highly successfully in many instances. The problem is that the methods employed do not readily lend themselves to analysis by others. Most traditional method recognizes return as some dividend receipt and price appreciations aver a forward period. But the return for individual securities is not always over the same common holding period nor are he rates of return necessarily time adjusted. An analyst may well estimate future earnings and P/E to derive future price. He will surely estimate the dividend. But he may not discount the value to determine the acceptability of the return in relation to the investor’s requirements.
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Study of Portfolio Management

A portfolio is a group of securities held together as investment. Investments invest their funds in a portfolio of securities rather than in a single security because they are risk averse. By constructing a portfolio, investors attempt to spread risk by not putting all their eggs into one basket. Thus diversification of one’s holding is intended to reduce risk in investment. Most investor thus tends to invest in a group of securities rather than a single security. Such a group of securities held together as an investment is what is known as a portfolio. The process of creating such a portfolio is called diversification. It is an attempt to spread and minimize the risk in investment. This is sought to be achieved by holding different types of securities across different industry groups. (C) PORTFOLIO SELECTION: Portfolio analysis provides the input for the next phase in portfolio management, which is portfolio selection. The proper goal of portfolio construction is to generate a portfolio that provides the highest returns at a given level of risk. A portfolio having this characteristic is known as an efficient portfolio. The inputs from portfolio analysis can be used to identify the set of efficient portfolios. From this set of efficient portfolios the optimum portfolio has to be selected for investment. Harry Markowitz portfolio theory provides both the conceptual framework and analytical tools for determining the optimal portfolio in a disciplined and objective way. (D) PORTFOLIO REVISION: Once the portfolio is constructed, it undergoes changes due to changes in market prices and reassessment of companies. Portfolio revision means alteration of the composition of debt/equity instruments,
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Study of Portfolio Management

shifting from the one industry to another industry, changing from one company to another company. Any portfolio requires monitoring and revision. Portfolios activities will depend on daily basis keeping in view the market opportunities. Portfolio revision uses some theoretical tools like security analysis that already discuss before this, Markowitz model, Risk-Return evaluation. Portfolio revision involves changing the existing mix of securities. This may be effected either by changing the securities currently included in the portfolio or by altering the proportion of fund invested in the securities. New securities may be added to the portfolio or some of the existing securities may be removed from the portfolio. Portfolio revision thus, leads to purchasing and sales of securities. The objective of portfolio revision is the same as the objective of portfolio selection, i.e maximizing the return for a given level of risk or minimizing the risk foa given level of return. The ultimate aim of portfolio revision is maximization of returns and minimizing of risk. Having constructed the optimal portfolio, the investor has to constantly monitor the portfolio to ensure that it continues to be optimal. As the economy and financial markets are dynamic, changes take place almost daily. As time passes, securities, which were once attractive, may cease to be so. New securities with promises of high returns and low risk may emerge. The investor now has to revise his portfolio in the light of the development in the market. This revision leads to purchase of some new securities and sale of some of the existing securities from the portfolio. The mixture of security and its proportion in the portfolio changes as a result of the revision. Portfolio revision may also be necessitated some investor related changes such as availability of additional funds, changes in risk attitude need of cash for other alternative use etc.
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Study of Portfolio Management

Whatever be the reason for portfolio revision, it has to be done scientifically and objectively so as to ensure the optimality of the revised portfolio. Portfolio revision is not a casual process to be carried out without much care. In fact, in the entire process of portfolio management portfolio revision is as important as portfolio analysis and selection. In portfolio management, the maximum emphasis is placed on portfolio analysis and selection which leads to the construction of the optimal portfolio. Very little discussion is seen on portfolio revision which is as important as portfolio analysis and selection. Portfolio revision involving purchase and sale of securities gives rise to certain problem which acts as constraints in portfolio revision, from those constraints some may be as following: 1. Statutory Stipulations: Investment companies and mutual funds manage the largest portfolios in every country. These institutional investors are normally governed by certain statutory stipulations regarding their investment activity. These stipulations often act as constraints in timely portfolio revision. 2. Transaction cost: Buying and selling of securities involve transaction costs such as commission and brokerage. Frequent buying and selling of securities for portfolio revision may push up transaction cost thereby reducing the gains from portfolio revision. Hence, the transaction costs involved in portfolio revision may act as a constraint to timely revision of portfolio. 3. Intrinsic difficulty:
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Portfolio revision is a difficult and time-consuming exercise. The methodology to be followed for portfolio revision is also not clearly established. Different approaches may be adopted for the purpose. The difficulty of carrying out portfolio revision it self may act as a restriction to portfolio revision. 4. Taxes: Tax is payable on the capital gains arising from sale of securities. Usually, long term capital gains are taxed at a lower than shortterm capital gains. To qualify as long-term capital gain, a security must be held by an investor for a period not less than 12 months before sale. Frequent sales of securities in the course of periodic portfolio revision of adjustment will result in short-term capital gains which would be taxed at a higher rate compared to long-term capital gains. The higher tax on short-term capital gains may act as a constraint to frequent portfolios. (F) PORTFOLIO PERFORMANCE EVALUATION:Portfolio evaluating refers to the evaluation of the performance of the portfolio. It is essentially the process of comparing the return earned on a portfolio with the return earned on one or more other portfolio or on a benchmark portfolio. Portfolio evaluation essentially comprises of two functions, performance measurement and performance evaluation. Performance measurement is an accounting function which measures the return earned on a portfolio during the holding period or investment period. Performance evaluation , on the other hand, address such issues as whether the performance was superior or inferior, whether the performance was due to skill or luck etc.

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The ability of the investor depends upon the absorption of latest developments which occurred in the market. The ability of expectations if any, we must able to cope up with the wind immediately. Investment analysts continuously monitor and evaluate the result of the portfolio performance. The expert portfolio constructer shall show superior performance over the market and other factors. The performance also depends upon the timing of investments and superior investment analysts capabilities for selection. The evolution of portfolio always followed by revision and reconstruction. The investor will have to assess the extent to which the objectives are achieved. For evaluation of portfolio, the investor shall keep in mind the secured average returns, average or below average as compared to the market situation. Selection of proper securities is the first requirement. The evaluation of a portfolio performance can be made based on the following methods: a) Sharpe’s Measure b) Treynor’s Measure c) Jensen’s Measure (a) Sharpe’ Measure: The objective of modern portfolio theory is maximization of return or minimization of risk. In this context the research studies have tried to evolve a composite index to measure risk based return. The credit for evaluating the systematic, unsystematic and residual risk goes to sharpe, Treynor and Jensen. Sharpe measure total risk by calculating standard deviation. The method adopted by Sharpe is to rank all portfolios on the basis of evaluation measure. Reward is in the numerator as risk premium. Total risk is in the denominator as standard deviation of its return. We will get a measure of portfolio’s total risk and variability of
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return in relation to the risk premium. The measure of a portfolio can be done by the following formula: Rt – Rf SI =

σf
Where, SI = Sharpe’s Index Rt = Average return on portfolio Rf = Risk free return σf = Standard deviation of the portfolio return. For instance: Which portfolio perform better performance from following two portfolio, by using Sharpe’s model Portfolio Average return A 50% B 60% Standard deviation 10% 18% Risk free rate 24% 24%

Performance can be finding out by the following formula: For Portfolio A: SI = Rt – Rf

σf
Rt = 50 Rf = 24 σf = 0.10 0.50 – 0.24 SI = = 0.26 / 0.10 0.10 = 2.6 Portfolio A For Portfolio B: SI = Rt – Rf

σf
0.60 – 0.24 SI = 0.18 = 0.36 / 0.18
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= 2, Portfolio B Conclusion: According to the calculated “portfolio A” has better performance than portfolio B (b) Treynor’s Measure: The Treynor’s measure related a portfolio’s excess return to nondiversifiable or systematic risk. The Treynor’s measure employs beta. The Treynor based his formula on the concept of characteristic line. It is the risk measure of standard deviation, namely the total risk of the portfolio is replaced by beta. The equation can be presented as follow: Rn - Rf Tn = βm Where, Tn = Treynor’s measure of performance Rn = Return on the portfolio Rf = Risk free rate of return βm = Beta of the portfolio ( A measure of systematic risk) For instance: Which securities perform better performance from following two portfolios, by using Treynor’s method Portfolio X Z Return 44% 52% Rn - Rf Tn = βm Rn = 0.44 Rf = 0.22 Tn = 2.40 For portfolio Y: 0.52 - 0.22
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βm 0.12% 2.40%

Risk free rate 22% 22%

For portfolio X:

βm = 0.12 0.44 – 0.22 = 2.40 0.30 0.22 = 0.092

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Tn = 2.4 (c) Jensen’s Measure:

= 2.40

= 0.125

Conclusion: Portfolio Y is better than X because Tnx < Tny Jensen attempts to construct a measure of absolute performance on a risk adjusted basis. This measure is based on CAPM model. It measures the portfolio manager’s predictive ability to achieve higher return than expected for the accepted riskiness. The ability to earn returns through successful prediction of security prices on a standard measurement. The Jensen measure of the performance of portfolio can be calculated by applying the following formula: Rp = Rf + (RMI – Rf) x β Where, Rp = Return on portfolio RMI = Return on market index Rf = Risk free rate of return For instance: From the following data, the portfolio performance can be measure according to Jensens model as follow: Portfolio Estimated Return on portfolio I 40% II 34% III 46% Market Index: 36% Risk free rate of return: 20% Market Beta =1.00 For portfolio –I: RMI = 40%, Rf = 20%, = 50% For portfolio – II: RMI = 34%, Rf = 20%, Rp = 20 + (34 – 20) x 1.1 β = 1.1
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Portfolio Beta 1.5 1.1 1.8 1.03

β=3

Rp = 20 + (40 – 20) x 1.5

= 35.4%

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For portfolio – III: RMI = 46%, Rf = 20%, Rp = 20 + (46 – 20) x 1.8 =66.8% The measure of performance = Actual – estimated I II III = 50% - 40% = 10% = 35.4% - 34% = 1.4% = 66.8% - 46% = 20.8% β = 1.8

Here, the portfolio III is better perform then other two (G) PORTFOLIO CONSTRUCTION:Portfolio construction refers to the allocation of funds among a variety of financial assets open for investment. Portfolio theory concerns itself with the principles governing such allocation. The objective of the theory is to elaborate the principles in which the risk can be minimized subject to desired level of return on the portfolio or maximize the return, subject to the constraint of a tolerate level of risk. Thus, the basic objective of portfolio management is to maximize yield and minimize risk. The other ancillary objectives are as per the needs of investors, namely:6  Safety of the investment  Stable current Returns  Appreciation in the value of capital  Marketability and Liquidity  Minimizing of tax liability. In pursuit of these objectives, the portfolio manager has to set out all the various alternative investment along with their projected return and risk and choose investment with safety the requirement of the
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individual investor and cater to his preferences. The manager has to keep a list of such investment avenues along with return-risk profile, tax implications, yield and other return such as convertible options, bonus, rights etc. A ready reckoned giving out the analysis of the risk involved in each investment and the corresponding return should be kept. The portfolio construction, as referred to earlier, be made on the basis of the investment strategy, set out for each investor. Through choice of asset classis, instrument of investment and the specific scripts, save of bond or equity of different risk and return characteristics, the choice of tax characteristics, risk level and other feature of investment, are decided upon.

 Portfolio Investment Process:The ultimate aim of the portfolio manager is to reduce the risk and increase the return to the investor in order to reach the investment objectives of an investor. The manager must be aware of the investment process. The process of portfolio management involves many logical steps like portfolio planning, portfolio implementation and monitoring. The portfolio investment process applies to different situation. Portfolio is owned by different individuals and organizations with different requirements. Investors should buy when prices are very low and sell when prices rise to levels higher that their normal fluctuation. The process used to manage a security portfolio is conceptually the same as that used in any managerial decision. One should (1) Panning, (2) Implement the plan; and (3) Monitor the result. This portfolio investment process is displayed schematically as follow:

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The Portfolio Investment Process

Planning: Investor’s situation Market Condition Speculative policies Strategic asset allocation Implementation: Rebalance Strategic Asset Allocation Tactical Asset Allocation Security Selection

Monitoring: Evaluate Statement of Investment Policy Evaluate Investment Performance

Applying the different steps for portfolio investment process can be complex and opinions are divided for maximization of wealth to the investor. Many differences exist between present investment theory and empirical result and which have often contradictory result the following some basic principles should be applied to all portfolio decisions. 1. The quantum of risk to be acceptable. 2. The profits will vary along with variability of risk. 3. Individual securities affect the aggregate portfolio. 4. Portfolio should provide a sound liquidity position. 5. Diversification of a portfolio may decrease the risk level. 6. Portfolio should be tailored to the needs of investors.
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7. Follow the passive investment strategy or an activity speculative strategy. Portfolio investment process is an important step to meet the needs and convenience of investors. The portfolio investment process involves the following steps: 1. Planning of portfolio 2. Implementation of portfolio plan. 3. Monitoring the performance of portfolio. 1) PLANNING OF PORTFOLIO: Planning is the most important element in a proper portfolio management. The success of the portfolio management will depend upon the careful planning. While making the plan, due consideration will be given to the investor’s financial capability and current capital market situation. After taking into consideration a set of investment and speculative policies will be prepared in the written form. It is called as statement of investment policy. The document must contain (1) The portfolio objective (2) Applicable strategies (3) Investment and speculative constraints. The planning document must clearly define the asset allocation. It means an optimal combination of various assets in an efficient market. The portfolio manager must keep in mind about the difference between basic pure investment portfolio and actual portfolio returns. The statement of investment policy may contain these elements. The portfolio planning comprises the following situation for its better performance:

(A)

Investor Conditions: 34

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The first question which must be answered is this – “What is the purpose of the security portfolio?” While this question might seem obvious, it is too often overlooked, giving way instead to the excitement of selecting the securities which are to be held. Understanding the purpose for trading in financial securities will help to: (1) define the expected portfolio liquidation, (2) aid in determining an acceptable level or risk, and (3) indicate whether future consumption (liability needs) are to be paid in nominal or real money, etc. For example: a 60 year old woman with small to moderate saving probably (1) has a short investment horizon, (2) can accept little investment risk, and (3) needs protection against short term inflation. In contrast, a young couple investing couple investing for retirement in 30 years has (1) a very long investment horizon, (2) an ability to accept moderate to large investment risk because they can diversify over time, and (3) a need for protection against longterm inflation. This suggests that the 60 year old woman should invest solely in low-default risk money market securities. The young couple could invest in many other asset classes for diversification and accept greater investment risks. In short, knowing the eventual purpose of the portfolio investment makes it possible to begin sketching out appropriate investment / speculative policies. Market Condition: -

(B)

The portfolio owner must known the latest developments in the market. He may be in a position to assess the potential of future return on various capital market instruments. The investors’ expectation may be two types, long term expectations and short term expectations. The most important investment decision in portfolio construction is asset allocation. Asset allocation means the investment in different financial instruments at a percentage in portfolio. Some investment strategies are static. The
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portfolio requires changes according to investor’s needs and knowledge. A continues changes in portfolio leads to higher operating cost. Generally the potential volatility of equity and debt market is 2 to 3 years. The another type of rebalancing strategy focuses on the level of prices of a given financial asset. (C) Speculative Policies:

The portfolio owner may accept the speculative strategies in order to reach his goals of earning to maximum extant. If no speculative strategies are used the management of the portfolio is relatively easy. Speculative strategies may be categorized as asset allocation timing decision or security selection decision. Small investors can do by purchasing mutual funds which are indexed to a stock. Organization with large capital can employ investment management firms to make their speculative trading decisions. (D) Strategic Asset Allocation:-

The most important investment decision which the owner of a portfolio must make is the portfolio’s asset allocation. Asset allocation refers to the percentage invested in various security classes. Security classes are simply the type of securities: (1) Money Market Investment, (2) Fixed Income obligations; (3) Equity Shares, (4) Real Estate Investment, (5) International securities. Strategic asset allocation represents the asset allocation which would be optimal for the investor if all security prices trade at their longterm equilibrium values that is, if the markets are efficiency priced. 2) IMPLEMENTATION:-

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In the implementation stage, three decisions to be made, if the percentage holdings of various assets classes are currently different from the desired holdings as in the SIP, the portfolio should be rebalances to the desired SAA (Strategic Asset Allocation). If the statement of investment policy requires a pure investment strategy, this is the only thing, which is done in the implementation stage. However, many portfolio owners engage in speculative transaction in the belief that such transactions will generate excess risk-adjusted returns. Such speculative transactions are usually classified as “timing” or “selection” decisions. Timing decisions over or under weight various assets classes, industries, or economic sectors from the strategic asset allocation. Such timing decision deal with securities within a given asset class, industry group, or economic sector and attempt to determine which securities should be over or under-weighted. Tactical Asset Allocation:-

(A)

If one believes that the price levels of certain asset classes, industry, or economic sectors are temporarily too high or too low, actual portfolio holdings should depart from the asset mix called for in the strategic asset allocation. Such timing decision is preferred to as tactical asset allocation. As noted, TAA decisions could be made across aggregate asset classes, industry classifications (steel, food), or various broad economic sectors (basic manufacturing, interest-sensitive, consumer durables). Traditionally, most tactical assets allocation has involved timing across aggregate asset classes. For example, if equity prices are believes to be too high, one would reduce the portfolio’s equity allocation and increase allocation to, say, risk-free securities. If one is indeed successful
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at tactical asset allocation, the abnormal returns, which would be earned, are certainly entering. (B) Security Selection:-

The second type of active speculation involves the selection of securities within a given assets class, industry, or economic sector. The strategic asset allocation policy would call for broad diversification through an indexed holding of virtually all securities in the asset in the class. For example, if the total market value of HPS Corporation share currently represents 1% of all issued equity capital, than 1% of the investor’s portfolio allocated to equity would be held in HPS corporation shares. The only reason to overweight or underweight particular securities in the strategic asset allocation would be to off set risks the investors’ faces in other assets and liabilities outside the marketable security portfolio. Security selection, temporarily mispriced. (3) PORTFOLIO MONITORING: Portfolio monitoring is a continuous and on going assessment of present portfolio and the portfolio manger shall incorporate the latest development which occurred in capital market. The portfolio manager should take into consideration of investor’s preferences, capital market condition and expectations. Monitoring the portfolio is up-grading activity in asset composition to take the advantage of economic, industry and market conditions. The market conditions are depending upon the Government policy. Any change in Government policy would reflect the
38

however, actively overweight and

underweight holding of particular securities in the belief that they are

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stock market, which in turn affects the portfolio. The continues revision of a portfolio depends upon the following factors: i. Change in Government policy. ii. Shifting from one industry to other iii. Shifting from one company scrip to another company scrip. iv. Shifting from one financial instrument to another. v. The half yearly / yearly results of the corporate sector Risk reduction is an important factor in portfolio. It will be achieved by a diversification of the portfolio, changes in market prices may have necessitated in asset composition. The composition has to be changed to maximize the returns to reach the goals of investor.

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RISK & RETURN IN PORTFOLIO  Return:P Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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`

The typical objective of investment is to make current income from

the investment in the form of dividends and interest income. Suitable securities are those whose prices are relatively stable but still pay reasonable dividends or interest, such as blue chip companies. The investment should earn reasonable and expected return on the investments. Before the selection of investment the investor should keep in mind that certain investment like, Bank deposits, Public deposits, Debenture, Bonds, etc. will carry fixed rate of return payable periodically. On investments made in shares of companies, the periodical payments are not assured but it may ensure higher returns from fixed income securities. But these instruments carry higher risk than fixed income instruments.

 Risk:The Webster’s New Collegiate Dictionary definition of risk includes the following meanings: “……. Possibility of loss or injury ….. the degree or probability of such loss”. This conforms to the connotations put on the term by most investors. Professional often speaks of “downside risk” and “upside potential”. The idea is straightforward enough: Risk has to do with bad outcomes, potential with good ones. In considering economic and political factors, investors commonly identify five kinds of hazards to which their investments are exposed. The following tables show components of risk:

(A) SYSTEMATIC RISK: 1. Market Risk 2. Interest Rate Risk 3. Purchasing power Risk
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(B) UNSYSTEMATIC RISK: 1. Business Risk 2. Financial Risk (A) SYSTEMATIC RISK: Systematic risk refers to the portion of total variability in return caused by factors affecting the prices of all securities. Economic, Political and Sociological charges are sources of systematic risk. Their effect is to cause prices of nearly all individual common stocks or security to move together in the same manner. For example; if the Economy is moving toward a recession & corporate profits shift downward, stock prices may decline across a broad front. Nearly all stocks listed on the BSE / NSE move in the same direction as the BSE / NSE index. Systematic risk is also called non-diversified risk. If is unavoidable. In short, the variability in a securities total return in directly associated with the overall movements in the general market or Economy is called systematic risk. Systematic risk covers market risk, Interest rate risk & Purchasing power risk 1. Market Risk: Market risk is referred to as stock / security variability due to changes in investor’s reaction towards tangible & intangible events is the chief cause affecting market risk. The first set that is the tangible events, has a ‘real basis but the intangible events are based on psychological basis. Here, Real Events, comprising of political, social or Economic reason. Intangible Events are related to psychology of investors or say emotional intangibility of investors. The initial decline or rise in market price will create an emotional instability of investors and cause a fear of
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loss or create an undue confidence, relating possibility of profit. The reaction to loss will reduce selling & purchasing prices down & the reaction to gain will bring in the activity of active buying of securities. Interest Rate Risk: The price of all securities rise or fall depending on the change in interest rate, Interest rate risk is the difference between the Expected interest rates & the current market interest rate. The markets will have different interest rate fluctuations, according to market situation, supply and demand position of cash or credit. The degree of interest rate risk is related to the length of time to maturity of the security. If the maturity period is long, the market value of the security may fluctuate widely. Further, the market activity & investor perceptions change with the change in the interest rates & interest rates also depend upon the nature of instruments such as bonds, debentures, loans and maturity period, credit worthiness of the security issues. 3. Purchasing Power Risk: Purchasing power risk is also known as inflation risk. This risks arises out of change in the prices of goods & services & technically it covers both inflation & deflation period. Purchasing power risk is more relevant in case of fixed income securities; shares are regarded as hedge against inflation. There is always a chance that the purchasing power of invested money will decline or the real return will decline due to inflation. The behaviour of purchasing power risk can in some way be compared to interest rate risk. They have a systematic influence on the prices of both stocks & bonds. If the consumer price index in a country shows a constant increase of 4% & suddenly jump to 5% in the next.
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2.

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Year, the required rate of return will have to be adjusted with upward revision. Such a change in process will affect government securities, corporate bonds & common stocks. (B) UNSYSTEMATIC RISK:The risk arises out of the uncertainty surrounding a particular firm or industry due to factors like labour Strike, Consumer preference & management policies are called Unsystematic risk. These uncertainties directly affect the financing & operating environment of the firm. Unsystematic risk is also called “Diversifiable risk”. It is avoidable. Unsystematic risk can be minimized or Eliminated through diversification of security holding. Unsystematic risk covers Business risk and Financial risk 1. Business Risk: Business risk arises due to the uncertainty of return which depend upon the nature of business. It relates to the variability of the business, sales, income, expenses & profits. It depends upon the market conditions for the product mix, input supplies, strength of the competitor etc. The business risk may be classified into two kind viz. internal risk and External risk. Internal risk is related to the operating efficiency of the firm. This is manageable by the firm. Interest Business risk loads to fall in revenue & profit of the companies. External risk refers to the policies of government or strategic of competitors or unforeseen situation in market. This risk may not be controlled & corrected by the firm. 2. Financial Risk:
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Financial risk is associated with the way in which a company finances its activities. Generally, financial risk is related to capital structure of a firm. The presence of borrowed money or debt in capital structure creates fixed payments in the form of interest that must be sustained by the firm. The presence of these interest commitments – fixed interest payments due to debt or fixed dividend payments on preference share – causes the amount of retained earning availability for equity share dividends to be more variable than if no interest payments were required. Financial risk is avoidable risk to the extent that management has the freedom to decline to borrow or not to borrow funds. A firm with no debt financing has no financial risk. One positive point for using debt instruments is that it provides a low cost source of funds to a company at the same time providing financial leverage for the equity shareholders & as long as the earning of company are higher than cost of borrowed funds, the earning per share of equity share are increased.

 Risk - Return Relationship:The entire scenario of security analysis is built on two concepts of security: Return and risk. The risk and return constitute the framework for taking investment decision. Return from equity comprises dividend and capital appreciation. To earn return on investment, that is, to earn dividend and to get capital appreciation, investment has to be made for some period which in turn implies passage of time. Dealing with the return to be achieved requires estimated of the return on investment over the time period. Risk denotes deviation of actual return from the estimated return. This deviation of actual return from expected return may be on either side – both above and below the expected return. However, investors are more concerned with the downside risk.
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The risk in holding security deviation of return deviation of dividend and capital appreciation from the expected return may arise due to internal and external forces. That part of the risk which is internal that in unique and related to the firm and industry is called ‘unsystematic risk’. That part of the risk which is external and which affects all securities and is broad in its effect is called ‘systematic risk’. The fact that investors do not hold a single security which they consider most profitable is enough to say that they are not only interested in the maximization of return, but also minimization of risks. The unsystematic risk is eliminated through holding more diversified securities. Systematic risk is also known as non-diversifiable risk as this can not be eliminated through more securities and is also called ‘market risk’. Therefore, diversification leads to risk reduction but only to the minimum level of market risk. The investors increase their required return as perceived uncertainty increases. The rate of return differs substantially among alternative investments, and because the required return on specific investments change over time, the factors that influence the required rate of return must be considered. Following chart-A represent the relationship between risk and return. The slop of the market line indicates the return per unit of risk required by all investors highly risk-averse investors would have a steeper line, and Yields on apparently similar may differ. Difference in price, and therefore yield, reflect the market’s assessment of the issuing company’s standing and of the risk elements in the particular stocks. A high yield in relation to the market in general shows an above average risk element. This is shown in the Char-B Chart-A: RELATIONSHIP BETWEEN RISK AND RETURN
46

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Rate of Return

Low Risk

Average Risk

High Risk

Market Line

Slop indicates required return per unit of risk Risk free return Risk Chart-B: RISK RETURN RELATIONSHIP: DIFFERENT STOCKS

Rate of Return

Market Line Risk Premium Ordinary shares Preference shares Subordinate loan stock Unsecured loan Debenture with floating charge Mortgage loan Government (i.e. risk free) stock Degree of risk

Source: Financial Management, By Ravi M. Kishore, Page No: 1145-46

Given the composite market line prevailing at a point of time, investors would select investments that are consistent with their risk preference. Some will consider low risk investments, while others prefer high risk investments. The construction of a best portfolio will depend upon a careful security analysis. The portfolio management always thinks about the return and rewards of different financial assets which are fully involved
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with systematic and unsystematic risk. The portfolio management is mainly concentrated on the stock behaviour in the market. Selection of a particular scrip or financial asset is the responsibility of a security analyst. But the portfolio manager’s obligation is to know best returns to the portfolio owner with a combination of different kinds of financial assets. Portfolio analysis indicates the determination of future risk and return in holding a different set of individual securities. The portfolio analysis contains the important elements as presented below; 1. Return on portfolio 2. Risk of a portfolio

 Return on Portfolio:The portfolio value is highly influenced by return of individual securities. Each security in a portfolio contributes return in the proportion of its investment is security. Thus, the portfolio value may increase and the targeted goals can be achieved. The return on portfolio is the weighted average of the expected returns, from each security with a proportionate weight of the different securities in the total investment. The return on portfolio depends upon the selection of financial asset which was made according to the investor’s perception. The efficiency of a portfolio is highly influenced by a number of factors, i.e. investor’s objective, investor’s risk presumption, safety of investment, capital appreciation, liquidity of financial asset, hedging, time horizon set out by investor, constraints regarding diversification by the investor etc. The data of the following table reveals the calculation of 4 portfolio’s return and risk Proportion of funds Security invested in each security (Weights)
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Expected return on each security

Contribution of each security to return

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A B C D

35% 30% 20% 15% 100%

13% 185 23% 15%

4.55 5.40 4.60 2.25 16.8%

The above portfolio yield 16.8% return on an average of 4 kinds of securities. The portfolio risk can be calculated by using the measure such as standard deviation and variance. These can be calculated by applying the following formula; Standard deviation = √ ∑(x-x1) Variance = ∑(x-x1) 2 = ∑x2 x = is the expected return on security ‘A’ x1= is the mean or the weighted average return on the security ‘A’ so, the co-efficient of variance = σ x 100 x1 The following table will explain the calculation of standard deviation for a given portfolio. Security 1 2 3 Solution: Return Probability (1) (2) (3) 1 2 7% 11% 0.30 0.55 Weighted Return (2 x 3) 0.021 0.060
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Return 7% 11% 15%

Probability 0.30 0.55 0.15

Return deviation from mean - 0.033 0.007

Weighted deviations squared 0.001 0.001

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3 -

15% -

0.15 1.00

0.022 0.103

0.047 -

0.002 0.004

Average expected return 0.103 or 10.3 (mean) The return deviation can be obtained as follows: For security 1 = (0.07 – 0.103) = -0.033 For security 2 = (0.11 – 0.103) = 0.007 For security 3 = (0.15 – 0.103) = 0.047

σ2 = 0.004 σ = √ σ2 =√ 0.004 σ = 0.063 0r 6.3%
The co-efficient of variance = σ x 100 x1 = 6.3 / 10.3 = 61%

 Risk on Portfolio:Risk is the most important element in portfolio management. Risk is reflected in the variability of the returns from Zero to infinity. The risk on a portfolio is different from the risk on individual securities. The expected return of a portfolio depends on the probability of the returns and their weighted contribution to the risk. This is the essence of risk. Risk means, the probability of various possible bad outcomes from a constructed portfolio. The measurement of risk in portfolio involves (a) Finding of average absolute deviation. (b) Standard deviation. These elements can be explained with following illustrations: The probability of each of the return of a portfolio is given below. Calculate the absolute deviations for the given portfolio.
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Event Return 1 0.20 2 0.25 3 0.30 4 0.25 Estimation of absolute deviation:Event Return return

Probability -10 22 27 12

Probability Absolute Probability (X)Absolute deviation deviation (5x2)=(6) 4.92 1.85 3.72 0.65 11.14%

(1) (2) (3) (2x3)=(4) (5) 1 0.20 -10 -2.0 -24.6 2 0.25 22 +5.5 7.4 3 0.30 27 +8.1 12.4 4 40.25 12 +3.0 -2.6 Total +14.6 Probability deviation can be calculated as follows ; -10 - 14.6 22 - 14.6 27 - 14.6 12 - 14.6 = = = = -24.6 +7.4 +12.4 -2.6

The measure of absolute deviation is 11.14 %

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 Different Type of Investment in India and Risk – Return Associated With It:1) Life Insurance Policy:In India the life insurance corporation offers different types of policies tailor made to suit the varied age group in society. The Whole Life Policies, Limited – Payment Life Policy, Convertible Whole Life Assurance Policy, Endowment Assurance Policy, Jeevan Mitra, The Special Endowment Plan with Profits, Jeevan Saathi, The New Money Back Plan, Marriage Endowment, Children’s Differed Endowment Assurance Policy, Jeevan Dhara have gained immense popularity among all classes of people. In LIC there is some scheme have eligible for exemption from tax under section 80C of the Income Tax Act, 1961. Risk associated with Insurance Corporation is as follow:

High
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R I S Moderate K Low

Low

Moderate RETURN

High

2) Bank Deposits:Commercial Bank has been extending deposits facilities to the public and has been the Indian investor’s greatest investment opportunity. The various schemes offered by commercial Banks are in the categories of saving accounts. Fixed Deposits, recurring deposits, monthly repayment plan, cash certificates, children’s deposits schemes and retirement plans. The saving account offers an interest rate of 4% per annum. One fixed deposits the banks give a rate of 6.5% per annum.

High R I S Moderate K
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Low

Low

Moderate RETURN

High

3) Provident Funds:Many employers offer recognized provident Fund schemes for the benefit of their employees. In general employees are obliged to contribute a minimum of 8.33% of their salary every month to the PPF, however, they may in certain cases contribute up to a maximum of 30% of their salary, Whatever, may be the employee’s contribution, the employer’s contribution is generally restricted to 8.33% only. Employees own contribution can be claimed as a deduction form his total income under section 80C of income Tax Act. The interest on Provident Funds is now 10 % per annum. The prime benefit of the provident fund is the facility of loan up to 755 of the sum contributed.

High R I S Moderate K
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Low

Low

Moderate RETURN

High

The SBI and its subsidiaries operate the public provident funds schemes. It is a 15 year scheme. A minimum sum of Rs. 100/- has to be deposited every year in this fund; the maximum amount which can be deposited in this fund, is Rs.20,000/- in one year. The rate of interest on the PPF is 12% per annum. The PPF scheme offers both income Tax and Wealth Tax benefits. The deposits made every year qualify for deduction under section 80C and the interest is completely tax free, in addition, loans can also be taken after one year from the close of the year in which the account was opened. 4) Equity Shares: The investment in equity share has a number of positive aspect associated with it. These are Capital Appreciation as a hedge against inflation, bonus shares, Right shares, voting rights, marketability, annual dividends and fringe benefits etc. Income tax and wealth tax benefits are also available to investment in equity share, 50% of the contribution made by investors in shares of new companies qualifies for deduction under section 80CC. No deduction is available in under section 80CCA with effect from 1993-94 except rebate of Section 88.

High R I
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S Moderate K Low

Low

Moderate RETURN

High

5) Government Bonds:The government bond, there is two categories of these bonds, namely, tax-free and taxable. The tax-free bonds are 9 to 10% bonds issued for Rs.1000; interest compounded half-yearly and payable halfyearly. They have a maturity period of 7 to 10 years with the facility for buy-back sometimes provided to small investors up to certain limits. The taxable bonds yield 13% or above, compounded half-yearly and payable half-yearly. They have normally a face value of Rs.1000/- and have buyback facilities similar to taxable bonds. Income from these bonds is tax exempt up to Rs.12, 000/- under section 80L.

High R I S Moderate K
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Low

Low

Moderate RETURN

High

6) Fixed Deposits with Companies:Fixed Deposits are invited from the public by different private sector companies. Their major selling point is the high rates of interest, which they offer. Some of these companies offer even up to 16% return per annum on deposits; the risk element is high in fixed deposits since they are absolutely unsecured. In addition, there are no tax benefits, An example, may be cited of a well known company. Orkay Silk Mills, The Company delayed the payment of quarterly interest by two months and the matured amount has not been returned to the depositors.

High R I S Moderate K
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Low

Low

Moderate RETURN

High

7) Debentures:A debenture is just a loan bond. Debenture holders are lenders but not owners of the company. They don’t enjoy any voting rights. Usually Debentures are of the face value of Rs.100/- each. They carry a fixed rate of interest. The ruling rate in the market for debentures is 10% to 14%. There are no income tax or wealth tax benefits for an investment in Debenture.

High R I S Moderate K Low

Low

Moderate
58

High

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RETURN

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DIVERSIFICATION  Risk Reduce through Diversification:The process of combining securities in a portfolio is known as diversification. The aim of diversification is to reduce total risk without sacrificing portfolio return. To understand the mechanism and power of diversification, it is necessary to consider the impact of covariance or correlation on portfolio risk more closely. We shall examine three cases: (1) when security returns are perfectly positively correlated, (2) when security returns are perfectly negatively correlated and (3) when security returns are not correlated. Diversification means, investment of funds in more than one risky asset with the basic objective of risk reduction. The lay man can make good returns on his investment by making use of technique of diversification.

 Main three forms of diversification:1. Simple Diversification, 2. Over Diversification,
3.

Efficient Diversification.
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(1) Simple Diversification: It involves a random selection of portfolio construction. The common man could make better returns by making a random diversification of investments. It is the process of altering the mix ratio of different components of a portfolio. The simple diversification can reduce unsystematic risk. The research studies on portfolio found that 10 to 15 securities in a portfolio will bring sufficient amount of returns. Further, this concept reveals that the prediction should be based on a scientific method. (2) Over Diversification: Investors have the freedom to choose many investment alternatives to achieve the desired profit on his portfolio. However, the investor shall have a great knowledge regarding a large number of financial assets spreading different sectors, industries, companies. The investors also more careful about the liquidity of each investment, return, tax liability, the performance of the company etc. Investors find problems to handle the large number of investments. It involves more transaction cost and more money will be spent in managing over diversification. If any investor involves in over diversification, there may be a chance either to get higher return or exposure to more risk. All the problems involved in this process may result in inadequate return on the portfolio. (3) Efficient Diversification:Efficient diversification means a combination of low risk involved securities and high risk instruments. The combination will only be finalized after considering the expected return from an individual security and it does inter relationship with other components in a portfolio. The
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securities shall have to be evaluated and thus diversification to be restricted to some extent. Efficient diversification assures the better return at an accepted level of risk.

 Importance of Diversification:If you invest in a single security, your return will depend solely on that security; if that security flops, your entire return will be severely affected. Clearly, held by itself, the single security is highly risky. If you add nine other unrelated securities to that single security portfolio, the possible outcome changes—if that security flops, your entire return won't be as badly hurt. By diversifying your investments, you have substantially reduced the risk of the single security. However, that security's return will be the same whether held in isolation or in a portfolio. Diversification substantially reduces your risk with little impact on potential returns. The key involves investing in categories or securities that are dissimilar: Their returns are affected by different factors and they face different kinds of risks. Diversification should occur at all levels of investing. Diversification among the major asset categories—stocks, fixed-income and money market investments—can help reduce market risk, inflation risk and liquidity risk, since these categories are affected by different market and economic factors. Diversification within the major asset categories—for instance, among the various kinds of stocks (international or domestic, for
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instance) or fixed-income products—can help further reduce market and inflation risk. And as shown in the 10-security portfolio, diversification among individual securities helps reduce business risk.

 Diversification process:The process of diversification has various phases involving investment into various classes of assets like equity, preference shares, money market instruments like commercial paper, inter-corporate investments, deposits etc. Within each class of assets, there is further possibility of diversification into various industries, different companies etc. The proportion of funds invested into various classes of assets, instruments, industries and companies would depend upon the objectives of investor, under portfolio management and his asset preferences, income and asset requirements. The subject is further elaborated in another chapter. A portfolio with the objective of regular income would invest a proportion of funds in bonds, debentures and fixed deposits. For such investment, duration of the life of the bond/debenture, quality of the asset as judged by the credit rating and the expected yield are the relevant variables. Bond market is not well developed in India but debentures, partly or fully convertible into equity are in good demand both from individuals and mutual funds. The portfolio manager has to use his analytical power and discretion to choose the right debentures with the required duration, yield and quality. The duration and immunization of expected inflows of funds to the required quantum of funds have to be well planned by the
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portfolio manager. Research and high degree of analytical power in investment management and bond portfolio management are necessary. The bond investment are thus equally challenging as equities investment and more so in respect of money market instruments. All these facts bring out clearly the needed analytical powers and expertise of portfolio manager.

 Naïve Diversification:Portfolios may be diversified in a naïve manner, without really applying the principles of Markowitz diversification, which is discussed at length in the next paragraph. Naïve diversification, where securities are selected on a random basis only reduces the risk of a portfolio to a limited extent. When the securities included in such a portfolio number around ten to twelve, the portfolio risk decreases to the level of the systematic risk in the market. It may also be noted that beyond fifteen shares, there is no decrease in the total risk of a portfolio. Before discussing the Markowitz diversification, what the researches of investors and investment analysts have found is to be set out briefly. Firstly, they found that putting all eggs in one basket is bad and most risky. Secondly, there should be adequate diversification of investment into various securities as that will spread the risk and reduce it; if the numbers of them say 10 to 15 it is adequate to enjoy the economies of time, scale of operations and expertise utilized by the investors in his analysis.

 Portfolio With Number of Securities:The benefits from diversification increase, as more and more securities with less than perfectly positively correlated returns are
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included in the portfolio. As the number of securities added to a portfolio increases, the standard deviation of the portfolio becomes smaller and smaller. Hence an investor can make the portfolio risk arbitrarily small by including a large number of securities with negative or zero correlation in the portfolio. But in reality, no securities show negative or even zero correlation. Typically, securities show some positive correlation, which is above zero but less than the perfectly positive value (+1). As a result, diversification (that is , adding securities to a portfolio) results in some reduction in total portfolio risk but not in complete elimination of risk. Moreover, the effects of diversification are exhausted fairly rapidly. That is, most of the reduction in portfolio standard deviation occurs by the time the portfolio size increases to 25 or 30 securities. Adding securities beyond this size brings about only marginal reduction in portfolio standard deviation. Adding securities to a portfolio reduces risk because securities are not perfectly positively correlated. But the effects of diversification are exhausted rapidly because the securities are still positively correlated to each other though not perfectly correlated. Had they been negatively correlated, the portfolio risk would have continued to decline as portfolio size increased. Thus, in practice, the benefits of diversification are limited. The total risk of an individual security comprises two components; the market related risk called systematic risk and the unique risk of that particular security called unsystematic risk. By combining securities into a portfolio the unsystematic risk specific to different securities is cancelled out. Consequently the risk of the portfolio as a whole is reduced as the size of the portfolio increases. Ultimately when the size of the portfolio reaches a certain limit, it will contain only the systematic risk of securities included in the portfolio. The systematic risk, however, cannot
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be eliminated. Thus a fairly large portfolio has only systematic risk and has relatively little unsystematic risk. That is why there is no gain in adding securities to a portfolio beyond a certain portfolio size.

International Diversification:The benefits of diversification are well perceived by portfolio

managers, that many in developed countries started investing in foreign bonds, stocks and other instruments. They found that can extend diversification principle to foreign stocks, bonds etc, to improve returns for a given risk by adopting proper techniques of diversification.

 Need of International Diversification: The size and character of international Equity and bond markets are widely varying that it will increase the scope for larger investment and larger diversification.  The returns in local currencies of some foreign countries are higher than in domestic markets. Thus, for example in Singapore, Malaysia, Taiwan and India the returns in local currencies are higher than in U S economy.  The economic trends, business conditions and local profitability and earnings ratio differ widely among countries that the EPS in some developing countries is higher and give opportunity for better diversification and higher returns, through international investments.  International investment is advantageous due to larger investment avenues now open in the first place and secondly due to the imperfect correlation among the international investment markets.
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The total risk of a portfolio including the international investment will be lower than with only domestic investment. The degree of volatility, and all risk measures, indicates that these risks vary among the countries and in different degrees and the possibility of covariance, or high correlation will be low. The frontier of efficiency portfolio can be widened, by inclusion of foreign investment in a portfolio. Thus many international portfolio managers prefer to invest in India and so will be the case of India n portfolio managers, if they can diversify into international investment. There are some directions however, which will increase risk in such investment.

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ANALYSIS OF PORTFOLIO
We have seen in chapter no 4 about the risk and return, it is clearly shown that when the risk is high, return is also high and when risk is low, return is also low. In the portfolio management risk and return of investment is most important. If management of investment is done well then it is possible to get high return with low risk. This is proved in the following examples of different mutual fund, it compared with portfolio of retire bank officer. Professional fund management is done in the portfolio of mutual fund.

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LICMF BALANCE FUND COMPARED WITH INVESTED . In this scheme the portfolio is hybrid. The fund size as on

PORTFOLIO OF A PERSON WHO IS BANK OFFICER: 31/01/2004 of Rs.1303.35 lakhs, this fund invested in the following manner in different equity and debt with good portfolio. (Figure in Lakhs) Equity portfolio Debt Portfolio Holdings Investment Holdings Investment ACC 102.14 IFCI 150.00 Satyam Computer 101.79 Reliance Industry 121.08 Reliance Industries 89.41 Ashok Leyland FInance 98.71 SBI 77.45 Polaris software 63.77 DR. Reddy’s Lab 55.98 ITC 51.13 Hindustan Lever 47.19 IPCL 44.70 TISCO 38.42 ONGC 36.93 ZEE Tele Films 34.46 Bharti Tele-venture 33.71 GACL 28.86 NALCO 28.32 Hero Honda 22.61 TATA Power 11.25 GAIL 11.02 Ranbaxy Laboratories 9.94 Total Equity 889.08 Total Debt 369.79 Money Market Instruments Investment 44.48

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Portfolio of Balance Fund
Money Mkt. 3.41%

Debt 28.37%

Equity Debt Money Mkt.
Equity 68.21%

Annualized returns of this fund on the basis of fact sheet for last 1st year of 35.01% and last 3 years average 13.28%. Now last years’ returns i.e. 35.01% it would be compared with the bank officer’s portfolio who has invested in following way:  One customer who is bank officer and his portfolio Security Equity share Debenture Bond Expected Return 20 % 20 % 8 % Proportion of Security 60 % 20 % 20 %

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 Return Profile Portfolio Expected Return = R1 X1 + R2 X2 + R3 X3 = (0.60 x 20) + (0.20 x 20) + (0.20 x 8) = 12 + 4 + 1.6 = 17.6 %  Risk Profile Security Equity Shares Debenture Bond Fund Proportion 60 % 20 % 20 % Credit * Risk Medium – Higher Low – Medium LowMedium Market * Risk Medium – Higher Low – Medium Low– Medium Interest * Rate Risk LowMedium Medium – High Mediumhigh Liquidity Risk * Medium – High Low Medium Low– Medium

58. 33 % Portfolio Risk Profile: Lower to Medium Risk  Interpretation: So, LICMF Balance Fund portfolio gave the double return than the bank officer’s portfolio because there fund has invested in number of good companies, so diversified portfolio give good return.

(* For risk categories see in annexure no 1)

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 PORTFOLIO OF LICMF EQUITY FUND COMPARED WITH PORTFOLIO OF RETIRED COLLEGE PROFESSOR . Total fund of this scheme was invested in equity. The fund size as on 31/01/2004 of Rs.6861.79 lakhs, this fund invested in the following manner in different equity with good portfolio. (Figure in Lakhs) Holdings Satyam Computer Maruti Udyog Infosys Technology ITC ONGC Renbaxy Laboratories Concor ACC Grasim Industries GACL BHEL Bajaj Auto TISCO Equity portfolio Investment Holdings 416.34 Tata Power 367.71 Reliance Industries 348.70 SBI 347.27 Larsen & Toubro 347.17 Hindustan Lever 327.97 Dr Reddy’s Lab 325.41 HDFC 306.42 GAIL 277.91 ICICI Bank 274.09 NALCO 273.11 Bharti Tele - Venture 264.26 Zee Telefilms 101.11 Investment 262.57 251.82 250.24 174.83 169.88 167.93 129.96 125.60 118.10 110.30 107.88 101.47 6861.79

FUND SIZE ( AS ON 31/01/2004)

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PORTFOLIO
13.65% 11.68% 7.54% 15.58% 8.10%

2.17%

8.20%

20.34%

12.92%

Auto Banking Telecom

FMCG Money Mkt. & Others IT & Media

Pharma Infrastructure Oil and Gas

Annualized returns of this fund on the basis of fact sheet for last 1st year of 97.23% and last 3 years average 13.00%. Now last years’ returns i.e. 97.23% it would be compared with the portfolio return of retired college professor invested in following way: Security Post Deposit Bond Fund Company Fixed Deposit Expected Return 12 % 08 % 10 % Proportion of Security 40 % 25 % 35%

 Return Profile Portfolio Expected Return = R1 X1 + R2 X2 + R3 X3 = (0.40 x 12) + (0.25 x 8) + (0.35 x 10)
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= 4.8 + 2 + 3.5 = 10.30%  Risk Profile Security Post Deposit Bond Fund Company Fixed Deposit Allocation 40 % 25 % 35 % Credit Risk Low– Medium Mediumhigh Mediumhigh Market Risk Low– Medium Mediumhigh Mediumhigh Interest Liquidity

Rate Risk Risk Low– MediumMedium Low– Medium Mediumhigh high Mediumhigh Low– Medium

58.33% Portfolio Risk Profile: Medium to High Risk
 Portfolio Risk Profile Post deposit: The risk profile of post office deposit is lower to medium because in credit risk, market risk, interest rate risk, it getting lower to medium risk. In liquidity risk the risk is medium to high because before maturity of it if deposit is drawn up the interest rate getting cut down. Bond fund: The risk profile of bond fund is medium to high because in credit risk, market risk, and liquidity risk it getting the medium to high-risk profile. Interest rate risk is lower to medium because it will get the prevailing market interest rate at any time. Company fixed deposit: The risk profile of company fixed deposit is medium to high because company is also giving the high return on deposits.

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Equity Share: The risk profile of equity share is medium to high because in it’s very important credit risk and market risk getting medium to high risk for equity shares.

 Interpretation:
So, LICMF equity Fund portfolio gave the very return than the college professor’s portfolio because there fund has invested in number of good companies, so diversified portfolio gives good return

 The Case study of Two Person’s portfolio, who is Lecturer of

college and Share Broker. One has two investment avenues in his portfolio and other has three securities in his portfolio. So we check out risk and return of both people as follow:
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 Lecturer of college who has two securities in his portfolio: Security First Year: Mutual fund Share market Second Year: Mutual fund Share market

Expected * Return 12 % 8 % 20 % 16 %

Proportion of * Security 50 % 50% 50 % 50%

Return on Portfolio: Rp = Expected return to portfolio R1 = Average Expected return of security one R2 = Average Expected return of security second. X1 = Proportion of security one X2 = Proportion of security second.

Rp = R1X1 + R2X2 Where:

Rp

= = =

[(12+20) / 2] x (0.50) + [(8 + 16) / 2] x (0.50) 8+6 14 %

( * All the data are assumed data ) •

Risk on Portfolio: For the calculation of risk we considered the formula of Markowitz

model it is as follow 6p = X12 Ø12 + X22 Ø22 + 2X1X2 r12 Ø1 Ø2
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Where, 6p = Risk of portfolio X1 = Proportion of security 1 X2 = Proportion of security 2 Ø1 = Standard deviation of security 1 Ø2 = Standard deviation of security 2 r12 = Co-efficient of correlation between security 1 & 2


Year 1 2 Total X = ∑X N Ø1 = =

Standard deviation for Mutual Fund: Return 12 20 32 X 16 16 x–x –4 4 0 (x – x)2 16 16 32

= 32 = 16 2

∑( X – X ) 2
N

32 2

=

16

=4


Year 1 2 Total X = ∑X N

Standard deviation for share market: Return 8 16 24 = 24 2 X 12 12 x–x –4 4 0 (x – x)2 16 16 32

= 12

Ø2 =

∑(X2 – X2)2
N

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=

32 2

=

16

=4

cov12 =

½ [(R1 – R1) + (R2 – R2)]

Where, Cov12 = Co-variance between security one and second R1 = Return on security one R2 = Return on security second. R2 & R1 = Expected return Cov12 = ½ [(12 – 14) (8 – 14) + (20 – 14) (16 – 14)] = ½ [(-2) (- 6) + (6) (2)] = ½ [(12 + 12)] = ½ [24] = 12 r12 = Cov12 Ø1 Ø2 R12= = 0.75 12 4x4

6p = = =

X12 Ø12 + X22 Ø22 + 2X1X2 r12 Ø1 Ø2 [(0.50) 2 (4) 2] + [(0.50) 2 (4) 2] + 2(0.50) (0.50) (0.75) (4) (4) 4+4+6
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= Risk =

16 3.74 %

 Share Broker who has three securities in his portfolio: Security First Year: Mutual fund Share market Debt Security Second Year: Mutual fund Share market Debt Security
o

Expected Return 12 % 8 % 13% 20 % 16 % 10%

Proportion of Security 40% 40% 20% 40 % 40% 20%

Return of Portfolio:

Rp = R1X1 + R2X2 + R3X3 = = = [(12 + 20)/2] x (0.40) + [(8+16)/2] x (0.40) + [(14+10)/2] x (0.20) 6.4 + 4.8 + 2.4 13.6%

o

Risk on Portfolio: Standard deviation for Mutual Fund:
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Year 1 2 Total

Return 12 20 32

X 16 16

x–x –4 4 0

(x – x)2 16 16 32

X = ∑X N Ø1 = = ∑( X – X ) 2
N

= 32 = 16 2

32 2

=

16

=4


Year 1 2 Total X = ∑X N Ø2 =

Standard deviation for share market: Return 8 16 24 = 24 2 X 12 12 = 12 x–x –4 4 0 (x – x)2 16 16 32

∑(X2 – X2)2
N

=

32 2

=

16

=4


Year

Standard deviation for Debt Security: Return X
81

x–x

(x – x)2

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1 2 Total X = ∑X N

14 10 24 = 24 2

12 12 = 12

–2 2 0

4 4 8

Ø3 = =

∑(X3 – X3)2
N

8 2

=

4

=2


cov12 = Cov12 =

Covariance between security 1 and 2 ½ [(R1 – R1) + (R2 – R2)] ½ [(12 – 13.6) (20 – 13.6) + (8 – 13.6) (16 – 13.6)] = ½ [(-1.6) (6.4) + (- 5.6) (2.4)] = ½ [(–10.24 – 13.44)] = ½ [- 23.68] = – 11.84


cov23 = Cov23=

Covariance between security 2 and 3 ½ [(R2– R2) + (R3 – R3)] ½ [(8 – 13.6) (14 – 13.6)] + [(16 – 13.6) (10 – 13.6)] = ½ [(-5.6) (0.40) + (2.4) (- 3.6)] = ½ [(–2.24 – 8.64)] = ½ [- 10.88] = – 5.44


Cov13 =

Covariance between security 1 and 3 ½ [(R1– R1) + (R3 – R3)]
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Cov13=

½ [(12 – 13.6) (14 – 13.6)] + [(20 – 13.6) (10 – 13.6)] = ½ [(- 1.6) (0.40) + (6.4) (- 3.6)] = ½ [(– 0.64 – 23.04)] = ½ [- 23.68] = – 11.84


r12

Co-efficient of correlation between security 1 and 2 = Cov12 Ø1 Ø2 r12 = = - 0.74 Co-efficient of correlation between security 2and 3 = Cov23 Ø2 Ø3 r23 = = - 0.68 - 5.44 4x2 - 11.84 4x4


r23


r23

Co-efficient of correlation between security 1and 3 = Cov13 Ø1 Ø3 r23 = = - 1.48 - 11.84 4x2

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6p = Where,

X12 Ø12 + X22 Ø22 + X32 Ø32 + 2X1X2 r12 Ø1 Ø2 + 2X2X3 r23 Ø2 Ø3 + 2X1X3 r13 Ø1Ø3 6p = Risk of portfolio X1 = Proportion of security 1 X2 = Proportion of security 2 X3 = Proportion of security 3 Ø1 = Standard deviation of security 1 Ø2 = Standard deviation of security 2 Ø3 = Standard deviation of security 3 r12 = Co-efficient of correlation between security 1 & 2 r23 = Co-efficient of correlation between security 2 & 3 r13 = Co-efficient of correlation between security 1 & 3

=

[(0.40) 2 (4) 2] + [(0.40) 2 (4) 2] + [(0.20) 2 (4) 2] + 2(0.40) (0.40) (- 0.74) (4) (4) + 2(0.40) (0.20) (- 0.68) (4) (2) + 2(0.40) (0.20) (- 1.48) (4) (2) 2.56 + 2.56 + 0.64 + (- 3.79) + (- 0.87) + (- 1.89) - 0.79 - 0.88

= = Risk =

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NOW, RETURN

AND RISK OF BOTH PERSON AS

FOLLOW: Person Lecturer of college Share Broker
15.00% 10.00% 5.00% 0.00% Lecturer of college -5.00% Risk Retrun Share Broker 3.74% - 0.88% 14%

Risk 3.74% - 0.88%
13.60%

Return 14% 13.6%

Interpretation: We can see two different portfolios of two persons i.e. Lecturer and Share broker. We calculate the risk and return on it. So lecturer has two securities and share broker has three securities in his portfolio. The investment avenue of the lecturer has high risk and high return. The investment avenue of the share broker has low risk and it get low return in compared to lecturer because of he has low risk. So from above comparison we can find that when risk is high then return also high, when risk is low then return low. diversified portfolio give good return with low risk. Also find that

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CONCLUSION
It is important to understand that equity shares are not recommended for all investors. If you are past sixty, and dependent on your savings for a living, I would strongly advise you not to buy and hold equity shares only but also in other securities which gives a regular income in periodic intervals. The stock markets are by nature volatile and
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unpredictable. Prudence, in such cases, demands that one should never put one’s nest egg in the stock market at such a late stage in life. On the other hand, if you are young and resilient enough to take risks, the stock market can be quite interesting and rewarding. But remember these Ten Commandments and follow them with religious favour: 1. Do not speculate. 2. Do not invest in new issues. 3. Do not put all your eggs in one basket. 4. Limit the number of scrips in your portfolio. 5. Invest for the long term. 6. Invest in real value. 7. Invest in sunrise industries. 8. Disinvest before a company becomes a sunset industry. 9. Do not marry your stocks.
10.

Set a limit to your greed. Investing in portfolio of carefully selected stocks with an

excellent track record can be quite safe in the long run. If you are below fifty, you can build a fortune with an equity stock are even better than gold.

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FINDINGS

Investment in Mutual funds schemes specializes in the for carrying out their activities. Professional

business of investment management, and therefore professional management management ensures that the best investment avenues are tapped with the aid of comprehensive information and detailed research. It also ensures that expenses are kept under tight control and market opportunities are fully utilized. An investor who opts for direct equity investing loses out on these benefits.

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Portfolio management reduces risk & increases return.

Portfolio management renders the services to satisfy the asset preference of investors.

Risk and return has direct relationship with each other, it

was proved in comparative case study, like in portfolio of lecturer has two security and its risk and return 3.74% and 14% respectively and share broker has three security in his portfolio and its risk and return -0.88 % and 13.6% respectively. So here we seen easily that when risk is high then return also high, when risk reduces then return also reduces.

Saving is invests in different investment avenue then it will

be safe for person and give beneficial return and reduce the changes of losses.

A portfolio includes not only equity shares, but all other

major categories of investments, like houses or flats, bank accounts, company deposits and debentures, mutual funds, gold and silver, etc. So investment in these categories also reduced risk and increases your return with safety.

SUGGESTION
A portfolio includes not only equity shares, but all other major categories of investments, like houses or flats, bank accounts, company deposits and debentures, mutual funds, gold and silver, etc. You may also notice that a certain risk-profile is assumed for each investor. If your actual risk profile is different from the ones assumed due to reasons like family background, inheritance, etc. you should modify your investment strategy.
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The main point to be emphasized is that the appropriate portfolio for “a single, highly placed 50-year old executives, living in own flat, with no kids,” would not be the same as that for “ a single-income couple, aged 45 with two college-going children”. The investment strategies discussed cover a range of investors and families with varying incomes, responsibilities and financial goals. Select the investment strategy that best approximates your situation and adapt it to your specific needs.
Age (Years) Single Unmarried 25-35 36-45 The most eligible bachelor The high flying single The confirmed bachelor The most blessed person Couple with double income No kids The 5-star honeymooners The evergreen couple The graying couple With two kids The sweet home family The hard workers Couple with single income No kid With two kids The budget The honeymooners model family The happy pair The sharing caring family The made-forThe each other budget couple family Retired couple with no family responsibilities The liberated souls

46-60 60+

The empire builders Retired couple with some family responsibilities

The ever-responsible couple

Risk categories of different individual profiles

A. The aggressive risk category ∗ The most eligible bachelor ∗ The 5-star honeymooners ∗ The sweet home family ∗ The budget honeymooners
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∗ The model family ∗ The high flying single B. The medium risk category ∗ The ever green couple ∗ The hard workers ∗ The happy pair ∗ The sharing-caring family ∗ The confirmed bachelor ∗ The graying couple ∗ The empire builders ∗ The made for each other couple C. The conservative risk category ∗ The budget family ∗ The most blessed person ∗ The ever responsible couple ∗ The liberated souls There are certain investments, which every investor ought to make, though their relative priority changes with age as given below Young Middle aged Senior Retired 25-35 35-45 45-60 60+ PRIORITY LEVELS Life insurance Medical insurance House / flats Tax oriented savings High Low Low Low
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Medium Medium High High

Low High High High

Nil High High Low

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schemes Also, savings bank accounts have to be maintained by all of us for meeting ongoing liquidity needs. Gold and silver may be acquired only to satisfy some essential family needs like marriage, festivals, and other special occasions.

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ANNEXURE -1

CREDIT RISK

In simple terms this risk means that the issuer of a debenture/bond or a money market instrument may default on interest payment or even in paying back the principal amount on maturity. Even where no default occurs, the price of a security may go down because the credit rating of an issuer goes down. It must, however, be noted that where the scheme has invested in government securities, there is no credit risk to that extent.

All the above factors may not only affect the prices of securities but also the time taken by the fund or redemption of units, which could be
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significant in the event of receipt of a very large number of redemption requests or very large value redemption requests. The liquidity of the assets may be affected by other factors such as civil strife. In view of this, redemption may be limited or suspended after approval from the boards of directors of the AMC and the trustee, under certain circumstances. Should the scheme be permitted to invest in offshore securities, such investment run currency risk in addition to other risks faced by investments? Investments made in US dollar or any other foreign currency denominated securities may lose in value if the Indian rupee appreciates with respect to the foreign currency or gain in value if the Indian if the Indian rupee depreciates. INTEREST-RATE RISK Interest rate fluctuation is a common phenomenon with its consequent impact on investment values and yields. Interest rate risk refers to the risk of the change in value of your investment as a result of movement in interest rates. Suppose you have invested in a security yielding 8% p.a. for 3 years. One year down the line, interest rate have moved and a similar security can be issued only at 9%. Due to the lower yield, the value of your security gets reduced. The current value of a security is calculated by using the market rate as the discount rate for the security’s expected cash flows. Fixed income securities such as bonds, debentures and money market instruments run price-risk or interest rate risk. Generally, when interest rates rise, prices of existing fixed income securities fall and when interest rates drop, such prices increase. The extent of fall or rise in the prices is a function of the existing coupon, days to maturity and the
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increase or decrease in the level of interest rates. The new level of interest rates is determined by the rates at which government and other entities raise new money and/or the price levels at which the market is already dealing in existing securities. The price risk is minimal in the case of floating rate or rating sensitized instruments or inflation linked bonds. The price risk does exist if the investment is made under a redo agreement. MARKET RISK Market risk is the risk of movement in security prices due to factors that affect the market as a whole, rather than particular companies or industries. Natural disasters (and certain man-made ones, like war) can be one such factor. The most important of these factors is the phase the markets are going through. Stock markets and alternating bullish and bearish periods. There are several theories that partially explain why these bull and bear markets keep alternating. Bearish stock markets usually precede economic recessions. Bearish bond markets result generally from high market interest rates, which in turn, are pushed by high rates of inflation. Bullish stock markets are witnessed during economic recovery and boom periods. Bullish bond markets result from low interest rates and low rates of inflation. Thus, experts believe that good economic forecasting is the key to anticipating changes in the stock and bond markets. You need to find answers to the following questions: ∗ When is the economic recession going to end and recovery start? ∗ When is the boom going to peek and recession start? ∗ What will be the rate of inflation next year? ∗ What will be the interest rate next year?
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These questions are easy to ask. But experience indicates that it is quite difficult to find even reasonably approximate answers. No two economists seem to agree on the answers to these questions. LIQUIDITY RISK Money has only a limited value if it is not readily available to you as and when you need it. The ready availability of money is called liquidity in financial jargon. An investment should not only be safe and profitable, but also fairly liquid. Liquidity of an investment can be measured in terms of the speed and ease with which it can be converted into cash, whenever you need it. An asset is said to be liquid if it can be converted into cash quickly, and with little loss in value. Liquidity risk refers to the possibility of the investor not being able to realize its value when required. This may either happen due to the fact that the security cannot be sold in the market or prematurely terminated, or because the resultant loss in value may be unrealistically high. Current and savings accounts in a bank, national savings certificates, actively traded equity shares and debentures, etc. are fairly liquid investments. In the case of a bank fixed deposit, you can raise loans up to 75% to 90% of the value of the deposit; to that extent, it is a liquid investment. Now days there are savings deposits available that automatically sweep-in any amount exceeding a pre-set limit to a fixed deposit; any part of the excess that is needed to be withdrawn is automatically swept back into the savings accounts. This provides an excellent blend of liquidity with returns. Some of the banks have attractive loan schemes against security of approved investments, like selected company shares, debentures, national saving certificates, units, etc. Such schemes add to the liquidity of investments. Some banks also
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offer buy-back schemes for the non-convertible portion of partly convertible debentures of some companies. Similarly, most companies offering fixed deposits provide an opportunity for premature termination under certain circumstances.

ANNEXURE -2
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BIBLIOGRAPHY
 Investment Management  Investment Management  Investment Management  Investment Management 98

V. A. Avadhani

V. K. Bhalla

Preeti Singh

V. Gangadhar G. Ramesh Babu.

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 Management -

Financial Ravi M. Kishore.

ANNEXURE - 3
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