Professional Documents
Culture Documents
Meaning of investment
Investment is the employment of funds with the aim of getting return on it.
Investing is a way to make money with your money. Generally, investment
is the application of money for earning more money. Investment also means
savings or savings made through delayed consumption . In its broadest sense,
an investment is sacrifice of current money or other resources for future
benefit. It is rare to find investor investing their entire savings in a single
security. Instead, they tend to invest in a group of securities. Such a group of
securities is called portfolio. Portfolio management deals with the analysis
of individual securities as well as theory and practice of optimally
combining securities into portfolios
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Why should invest?
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Provide enough money for meeting uncertain future needs
Elements of investments-
Investment avenues
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Types of money market instruments:
Traditional instruments:
Treasury Bills
Money at call and short notice
Banker’s acceptance
Modern Instruments:
Commercial Papers
Repo Instruments
Money Market Mutual Funds
Inter-Corporate Deposits
Euro Dollar
Features:
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Modern Instruments:
Repo Instruments:
Features:
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3) Real estate is probably the most illiquid of all common investment
avenues.
4) Real estate attracts capital gains tax. The capital gains can also be
invested in low interest yielding Capital Gains Bonds.
5) Real estate has a low level of convenience. It requires a large corpus
Gold:
Of all the precious metals, gold is the most popular as an investment.
Investors generally buy gold as a hedge or safe haven against any economic,
political, social or currency-based crises.Commodities like gold are a hedge
against inflation.
Provident Fund:
Mutual Funds:
• Diversification: There is an opportunity to invest in a number of blue
chip companies which would ensure a fairy good and dependable rate
of return.
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• Cost advantages: The risk is split between all. Hence it works out
advantageous for the investors.
• Managerial expertise: The presence of expertise in deciding which
fund to invest in is another very useful aspect of the same as an
investment avenue..
Any resident adult individual singly or jointly with one or two other adults
can open account. A minor, who has attained 10 years age, can also open the
account. Current Interest Rate for the Post Office Savings Bank Account is
3.5 per cent. There is nomination facility available .
Post Office Recurring Deposit Scheme provides the facility of saving small
sums of money every month to meet future financial goals and earn
relatively higher risk free returns.
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CHAPTER 2: PORTFOLIO MANAGEMENT
“It is rare to find investors investing their entire savings in a single security.
Instead, they tend to invest in a group of securities. Such a group of
securities is called portfolio”. Creation of a portfolio helps to reduce risk,
without sacrificing returns. Portfolio management deals with the analysis of
individual securities as well as with the theory and practice of optimally
combining securities into portfolios. An investor who understands the
fundamental principles and analytical aspects of portfolio management has a
better chance of success
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investor tries to choose the optimal portfolio taking into consideration the
risk return characteristics of all possible portfolios.
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Selection of Portfolio
The selection of portfolio depends upon the objectives of the investor. The
selection of portfolio under different objectives are dealt subsequently :
Objectives and asset mix If the main objective is getting adequate amount
of current income, sixty percent of the investment is made in debt
instruments and remaining in equity. Proportion varies according to
individual preference.
Growth of income and asset mix Here the investor requires a certain
percentage of growth as the income from the capital he has invested. The
proportion of equity varies from 60 to 100 % and that of debt from 0 to 40
%. The debt may be included to minimize risk and to get tax exemption.
Capital appreciation and Asset Mix It means that value of the investment
made increases over the year. Investment in real estate can give faster capital
appreciation but the problem is of liquidity. In the capital market, the value
of the shares is much higher than the original issue price.
Safety of principle and asset mix Usually, the risk adverse investors are
very particular about the stability of principal. Generally old people are more
sensitive towards safety.
Risk and return analysis The traditional approach of portfolio building has
some basic assumptions. An investor wants higher returns at the lower risk.
But the rule of the game is that more risk, more return. So while making a
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portfolio the investor must judge the risk taking capability and the returns
desired.
Though portfolio management has been in existence for a very long time, its
treatment in various works of literature on the subject has not been
systematic. The focus has been on matching the characteristics of the assts
with the needs of the investors on an ad hoc basis. Ignoring the fact that
portfolio management is continuous process and not a set of discrete events.
Portfolio management can be described as a systematic continuous dynamic
and a flexible process which involves:
C. Monitoring the market conditions relative asset values, and the investor’s
circumstances.
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D. Making adjustment in the portfolio to reflect significant changes in one
or more relevant variables
1) Stability of income
An investor considers stability income from his investment. He also
considers stability of purchasing power of income.
2) Capital growth
Capital appreciation has become an important investment principle.
Investors seek growth stocks which provide a very large capital
appreciation by way of rights bonus and appreciation in the price of share
3) Liquidity
An investment is a liquid asset. It can be converted into cash with the
help of a stock exchange. Investment should be liquid as well as
marketable. The portfolio should contain a planned proportion of high
grade readily salable investment
4) Safety
Safety means protection for investment against loss under reasonably
variations .in order to provide safety careful review of economic and
industry trends is necessary
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5) Tax incentives
The portfolio manager has to keep a list of such investment avenues
along with the return risk, profile, tax implications, yields and other
returns
Construction of portfolio
Portfolio construction means determining the actual composition of
portfolio. it refers to the allocation of funds among a variety of financial
assets open for investment .the portfolio manager has to set out all the
alternative investments along with their projected re turn and risk and choose
investments which satisfy the requirements of the investor
Portfolio construction requires knowledge of the different aspects of
securities. The components of portfolio construction are asset allocation,
security selection, portfolio structure .asset allocation means setting the asset
mix. Security selection involves choosing the appropriate security to meet
the portfolio targets and portfolio structure involves setting the amount of
each security to be included in the portfolio. Investing in securities
presupposes risk. A common way of reducing risk s to follow the principle
of diversification
1. Safety principle
The safety principle means that the portfolio must maintain its principal
value in the event forced liquidation. There are two important
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considerations involved in determining the need for safety principal-
tenure of ownership and the effect of inflation. If the tenure of ownership
is weak, the portfolio may be liquidated to meet some contingencies.
Another consideration is the effect of rising price level on the principal
invested initially in the portfolio. For this purpose many portfolio
managers attempt against inflation
3. Taxation
There may be strong incentive for many investors in the high tax brackets
to invest in tax exempt securities rather than common stock. it offers
investors to combine a high effective yield with relatively low risk
4. Temperament
A higher return may be expected from a well diversified portfolio. Some
investors may not be willing to accept the greater risk associated with the
common stock. Thus temperament is the most important principle on the
formulation of portfolio objectives. It indicates the investor’s willingness
to accept risk. Some investors are able to accept risk
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Formulating the portfolio objectives
The following are the six possible portfolio constructions which are
evaluated to determine the appropriate objectives;
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CHAPTER 3: RELEVANCE OF PORTFOLIO MANAGEMENT
Portfolio diversification
Diversification is a technique of reducing the risk involved in a portfolio. It
is also a process conscious selection of assets i.e. securities in a manner that
a total risk is brought down. This helps to reduce the unsystematic risk and
promotes the optimization of returns for a given level of risks in a portfolio.
Here are two types of risk in a portfolio, systematic and unsystematic risk.
Systematic risk is the fluctuation in an investment return attributable to
change sin broad economic, social, political sectors which influence the
returns on an investment on portfolio. Therefore, systematic risk is
undiversifiable risk because the investors cannot avoid or reduce the risk
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arising form the above factors. On the other hand, unsystematic risk is the
variation in returns on an investment due to factors related to the individual
company or security.
The diversification of portfolio risk can be made in the following manner
1) Changing the type of asset
2) Changing the type of instrument
3) Changing the industry line
4) Changing the companies
Portfolio evaluation
A portfolio manager by evaluating his own performance can identify sources
of strength or weakness .good performance in the past might have resulted
from good luck, in which case such performance may not be expected to
continue in the future. On the other hand poor performance in the past might
have been the result of bad luck. Therefore the first takes in performance in
performance evaluation is to determine whether past performance was good
or poor. Then the second task is to determine whether such performance was
due to skill or luck. Good performance in the past may have resulted from
the actions of a highly skilled portfolio manager .the performance of a
portfolio should be measured periodical, preferably once in a month or a
quarter. The performance of an individual stock should be compared with
the overall performance of the market as indicated by a market index like the
BSE Sensex
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time period. Investment analysts and portfolio managers have to monitor and
evaluate the results of their performance. The ability of managers to
outperform the market depends on their expertise and experience. The basic
features of good portfolio managers are their ability of perceive the market
trends correctly and make correct estimates regarding the risk returns, ability
to make proper diversification. The performance also depends on the timing
of investment and superior and superior investment analysis and security
selection
Diversification involves not putting all eggs into basket. Thus, it is good to
have as many companies or avenues as possible in one’s portfolio
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Six steps process guided by seven key principles:
Align your investment strategy with your long term objectives and
tolerance for risk: Rational investor must accurately assess where they
are today and where to go in order to determine the appropriate path they
will take towards achieving their goals. This requires identifying crucial
but often overlooked issues such as your objectives, the amount of
financial resources you can commit, your time horizon, how much money
you are comfortable losing without altering your investment plan, and an
understanding of various types of investment risk.
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Emphasize the importance of asset allocation: The world’s best
institutional investors recognized a fact that may surprise you; the
decision about with specific stocks, bonds, or either investment you
select your portfolio has little bearing of your returns. A much more
important factor is how the dollars your invest are divided up amount
various types of broad asset categories such as stock, bonds, international
investments, cash and so on. Yet, despite its importance, few investors
fully grasp the concept of asset allocation
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manager opportunistically make subtle shifts to their portfolios when
they identify areas of the market that their research indicates are over or
undervalued. These firms also regularly monitor investment managers in
order to hold them accountable, asking such question: is the manager
with whom they investor asserts still at the firm? Are the decisions
making process and capabilities still in place? And are they adding value
by delivering competitive performance?
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2) determining and maintaining optimal target mixes of those asset
classes
3) Selecting and monitoring investment managers
Portfolio strategists address the key factors that are responsible for portfolio
performance. They make the full range of asset allocation decisions. They
also decide on the most appropriate money manager for each asset classes by
rigorously evaluating hundreds of mutual funds and individual managers.
All their efforts are focused on determining optimal asset allocation
strategies and identifying and monitoring superior investment managers
Portfolio strategists offer expertise and capabilities in 3 main areas:
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policy committees (IPCs) to scrutinize and evaluate their
recommendations. IPCs are made up of investment firm’s most senior
professionals, who typically have several decades of experience
managing assets.
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CHAPTER 4: RISK
Low levels of uncertainty (low risk) are associated with low potential
returns, whereas high levels of uncertainty (high risk) are associated with
high potential returns. According to the risk-return tradeoff, invested money
can render higher profits only if it is subject to the possibility of being lost.
Because of the risk-return tradeoff, you must be aware of your personal risk
tolerance when choosing investments for your portfolio. Taking on some
risk is the price of achieving returns; therefore, if you want to make
money, you can't cut out all risk. The goal instead is to find an
appropriate balance - one that generates some profit, but still allows you
Deciding what amount of risk you can take while remaining comfortable.
In the investing world, the dictionary definition of risk is the chance that an
investment's actual return will be different than expected. Technically, this is
measured in statistics by standard deviation. Risk means you have the
possibility of losing some, or even all, of our original investment.
Low levels of uncertainty (low risk) are associated with low potential
returns. High levels of uncertainty (high risk) are associated with high
potential returns. The risk return tradeoff is the balance between the desire
for the lowest possible risk and the highest possible return. This is
demonstrated graphically in the chart below. A higher standard deviation
means a higher risk and higher possible return.
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higher returns. There are no guarantees. Just as risk means higher potential
returns.
Types of risk
Market Risk - This is the most familiar of all risks. Also referred to as
volatility, market risk is the day-to-day fluctuation in a stock's price. Market
risk applies mainly to stocks and options. As a whole, stocks tend to perform
well during a bull market and poorly during a bear market - volatility is not
so much a cause but an effect of certain market forces. Volatility is a
measure of risk because it refers to the behavior, or "temperament", of your
investment rather than the reason for this behavior. Because market
movement is the reason why people can make money from stocks, volatility
is essential for returns, and the more unstable the investment the more
chance there is that it will experience a dramatic change in either direction.
Interest Rate Risk – change in interest rate will impact price of bonds (or
NCDs). There is negative relation between price of bond & interest rates – if
interest rate will increase price of bond will go down & vice versa. This risk
can be reduced if you hold bonds till maturity. Interest rate risk also affects
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Bank Fixed Deposit investor – he was having Rs 5 Lakh & he invests at a
prevailing rate of 9%. What will happen if interest rate increase to 10% – he
will be losing 1% interest
Default risk
It is the risk of issuer of investment getting bankrupt. An investor who
purchases shares will have to face the possibility of bankruptcy of the
company. In case of fixed income securities such as debenture, the investor
may take the care to see the credit rating given to the company so that the
risk can be minimized
Business risk
Business risk means the risk of a particular business failing and thereby your
investment is lost. It is identifiable as the variation in the earnings due to its
business or product line. The principal determinants of a firm’s business risk
are the variability of sales and its operating leverage.
Financial risk
Financial risk is a function of the company’s capital structure of financial
leverage. The company may fall on financial grounds. If its capital structure
tends to make earnings unstable. Financial leverage is the percent change in
net earnings for a given results from the use of debt financing in the capital
structure .the like hood of a company defaulting on its debt servicing
obligations is known as financial risk
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Purchasing power risk of a security is the variation of real returns on the
security caused by inflation. Inflation reduces the purchasing power of
money over time. as price rise, the purchasing power of money falls and the
real return on an investment may fall even though the nominal return in
current rupee rise .the impact of inflation is felt greater in case of fixed
income investments. The returns on your investments after adjusting for
inflation is known as real rate of return
Liquidity risk
Liquidity risk arises from the inability to convert an investment quickly into
cash it refers to the ease with which a stock may be sold. if a stock is highly
liquid, it can be sold very quickly at a price which is more or less equal to its
previous market price .in a security market, liquidity risk is a function of the
marketability of the security
When an investor wants to sell a stock he is concerned with its liquidity. On
the other hand when an investor wants to buy a stock he is interested in its
availability. Lower marketability of stock gives a degree of liquidity risk that
makes the price of stock a bit more uncertain
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Unsystematic risk is the variation in the returns due to factors related to the
individual firm or security. That portion of total risk which arises from
factors that are specific to a particular firm such as plant breakdown, labors
strikes, sources of materials unsystematic risk is referred as diversified risk,
the sum of systematic risk and unsystematic risk is the total risk of a security
Variance: variance is the better measure of risk than the range. It takes into
account the derivations of all possible re turns from their mean or expected
value .the statistical measure that accomp0lishes this purpose is the variance
of returns. The greater the variance of a security the higher the security’s
total risk
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estimate the standard deviation of expected future return distribution .we
could then estimate the probability of any particular level of return
occurring.
PORTFOLIO RISK
Modern port folio theory believes in the maximization of returns through a
combination of securities. Although the expected returns for a portfolio is an
average of the individual securities returns, a portfolio risk can be less than
the average of the risk of its component securities. This fact yields the risk-
reducing benefits of diversifying. The key to the amount of risk reduction
that diversification can be achieved is the degree of correlation between the
returns on the security and the returns on the existing portfolio. Correlation
is the strength of the relationship between two variables.
It is positive when the two variables move together a majority of the time
and negative when they move primarily in opposite directions. if the action
of one variable is completely independent of the other variable, then the two
variables have no correlation. the measure of degree of correlation is the
correlation coefficient which always takes a value between -1 and +1.a
correlation coefficient of 0 indicates no correlation .when the correlation co
efficient is greater then zero it is positive correlation and when the
coefficient is less than 0 it is negative correlation. Modern portfolio theory
states that by combining a security of a low risk with another security of
high risk, success can be achieved by an investor.
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Factors affecting performance measures
1) Return:
The basic objective of any investment is to get return. This return should
be reasonable. It should be higher than the risk free return. Higher the
return the better will be the performance of the portfolio. The return may
be post tax return, real return and yield. The tax benefits are also adjusted
while calculating the return.
2) Risk
The performance of the portfolio depends upon risk undertaken by the
portfolio manager. However, higher the risk higher the return is the
general rule of investment. The performance will depend upon how much
risk is undertaken by the managers .the risk undertaken by the portfolio
manager to generate the return is the most important factor in the
performance evaluation of portfolio. Technical measures of the highest
degree are also employed to affect a sharper analysis. Superior
performance attached to a portfolio can also be due to the fund manager’s
efficiency and his ability in timing the market
3) Marketability
Proper asset allocation is of utmost importance for the success of overall
portfolio strategy. There are various investment alternatives available in
the financial market and investors can choose an appropriate one
depending on their needs. some of the most common investment
alternatives are bonds, stocks ,convertibles, mutual funds ,real estates and
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commodities futures and options .however these investment should have
marketability. That means, whenever the portfolio manager wants to sell
or buy the investment it should have marketability
4) Liquidity
Liquidity is the ability of an investment to be converted into cash easily.
The portfolio manager meets funds from time to time and also needs to
invest fund from time to time. The portfolio has to be reviewed and
revised from time to time. Liquidity of an investor is an important factor
to be considered while investing the portfolio funds
5) Diversification
In recent years, there is a vast increase in the investment of alternative
assets. The most important determinant of the alternative investment is to
understand the nature and the risks involved in these investments .the
benefits of investing in alternative investment give potential ways to
reach lucrative market and different asset classes. It also provides
diversification benefits and good returns. The diversification includes
selling certain assets and invests these proceeds in other new investment
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CHAPTER 5: PORTFOLIO MANAGEMENT SERVICE
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A non discretionary portfolio manager manages funds in accordance with
the directions of the clients. In order to carry out portfolio management
service a certificate of registration from the SEBI is mandatory.
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CHAPTER 6: CONCLUSION
Investment is the employment of funds with the aim of getting return on it.
Investing is a way to make money with your money. Generally, investment
is the application of money for earning more money. Investment also means
savings or savings made through delayed consumption an investment is the
current commitment of dollars for a period of time in order to derive future
payments that will compensate the investor for the time the funds are
committed. The expected rate of inflation To keep the value of your money
from inflation: The money you have today will not have the same value
tomorrow. Yes, inflation decreases the value of money you have.
Long term high priority objectives-some investors look forward and invest
on the basis of objectives of long term needs. They want to achieve financial
independence in long period. For example investing for post retirement
period
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BIBLIOGRAPHY
http://www.investopedia.com/terms/p/portfoliomanagement.asp
http://www.sebi.gov.in/faq/faqpms.html
http://www.portfoliomanagement.in/portfolio-management-theory.html
http://epmlive.com/portfolio-management/essential-steps-to-building-a-
profitable-portfolio-process/
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