FT-405-F : INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT

Section A

1. Explain the term Investment and types of Investment. Briefly describe any five characteristics of
Investment.

Investment

An investment is an asset or item acquired with the goal of generating income or appreciation. Appreciation
refers to an increase in the value of an asset over time. When an individual purchases a good as an
investment, the intent is not to consume the good but rather to use it in the future to create wealth. An
investment always concerns the outlay of some asset today—time, money, or effort—in hopes of a greater
payoff in the future than what was originally put in.

For example, an investor may purchase a monetary asset now with the idea that the asset will provide income
in the future or will later be sold at a higher price for a profit.

6 types of investments

Stocks

A stock is an investment in a specific company. When you purchase a stock, you’re buying a share — a
small piece — of that company’s earnings and assets.

Bonds

A bond is a loan you make to a company or government. When you purchase a bond, you’re allowing the
bond issuer to borrow your money and pay you back with interest.

Mutual funds

If the idea of picking and choosing individual bonds and stocks isn’t your bag, you’re not alone. In fact,
there’s an investment designed just for people like you: the mutual fund.

Index funds

An index fund is a type of mutual fund that passively tracks an index, rather than paying a manager to pick
and choose investments.

Exchange-traded funds

ETFs are a type of index fund: They track a benchmark index and aim to mirror that index’s performance.

Options

An option is a contract to buy or sell a stock at a set price, by a set date.

five characteristics of Investment.

• All investments are characterized by the expectation of a return. In fact, investments are made with the
primary objective of deriving a return.

• Risk is inherent in any investment. The risk may relate to loss of capital, delay in repayment of capital,
nonpayment of interest, or variability of returns.

• An investment, which is easily saleable, or marketable without loss of money & without loss of time is said
to possess liquidity.

• It is another feature of investment that they are marketable. It means buying and selling or transferability of
securities in the market.

• The safety of an investment implies the certainty of return of capital without loss of money or time.
2. What do you mean by Technical Analysis ? How is Technical Analysis different from Fundamental
Analysis ? Explain.

Technical Analysis

Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities
by analyzing statistical trends gathered from trading activity, such as price movement and volume.

Unlike fundamental analysis, which attempts to evaluate a security's value based on business results such as
sales and earnings, technical analysis focuses on the study of price and volume. Technical analysis tools are
used to scrutinize the ways supply and demand for a security will affect changes in price, volume and
implied volatility. Technical analysis is often used to generate short-term trading signals from various
charting tools, but can also help improve the evaluation of a security's strength or weakness relative to the
broader market or one of its sectors. This information helps analysts improve there overall valuation
estimate.

Technical Analysis different from Fundamental Analysis

Fundamental Analysis examines all of the factors that impact the price of a company’s stock. These factors
include the recent news financial statements, management structure, industry, and more. The goal is to
determine the intrinsic value of the firm and ascertain if the asset is over or under-priced. Most often used by
investors looking for longer-term positions.

Technical analysis employs price charts, patterns, indicators, and trends to forecast an asset’s price action in
the near to distant future. Traders partake in this type of analysis mostly, as it provides a good read on the
current price action.

Stock prices constantly change throughout trading sessions, making understanding the coming price action a
key to profits. Traders use both types of analysis to find trends and predict price movements for an asset in
the future.

3. Discuss the Bond Evaluation. Justify the reasons for the best methods of Bond Evaluation.

Bond Valuation

Bond valuation is a technique for determining the theoretical fair value of a particular bond. Bond valuation
includes calculating the present value of a bond's future interest payments, also known as its cash flow, and
the bond's value upon maturity, also known as its face value or par value.

Because a bond's par value and interest payments are fixed, an investor uses bond valuation to determine
what rate of return is required for a bond investment to be worthwhile.

Bond valuation is a way to determine the theoretical fair value (or par value) of a particular bond.

It involves calculating the present value of a bond's expected future coupon payments, or cash flow, and the
bond's value upon maturity, or face value.

As a bond's par value and interest payments are set, bond valuation helps investors figure out what rate of
return would make a bond investment worth the cost.

Best methods of Bond Evaluation

• There are different methods and techniques used in the bond valuation process. We can value a bond using: a
market discount rate, spot rates and forward rates, binomial interest rate trees, or matrix pricing.

• The ‘market discount rate’ method is the simplest one. It assumes using only one discount rate.

• In the case of bond valuation based on spot rates, each of the bond’s cash flows will be discounted by a
different spot rate applicable to the given cash flow.

• Similarly, we use a whole set of forward rates (instead of one discount rate) to discount bond cash flows
when we want to use forward rates to value bonds.
 • The bond valuation method that applies binomial interest rate trees assumes that interest rates are volatile.

• We use binomial interest rate trees to value bonds with embedded options mainly.

4. Explain any three of the following with examples:

(a) Portfolio Investment Process.

he 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 portfolio 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.

Portfolio investment process is an important step to meet the needs and convenience of investors. The
portfolio investment process involves the following steps:

• Planning of portfolio.

• Implementation of portfolio plan.

• Monitoring the performance of portfolio.

(b) Markowitz Model.

In finance, the Markowitz model ─ put forward by Harry Markowitz in 1952 ─ is a portfolio optimization
model; it assists in the selection of the most efficient portfolio by analyzing various possible portfolios of the
given securities. Here, by choosing securities that do not 'move' exactly together, the HM model shows
investors how to reduce their risk. The HM model is also called mean-variance model due to the fact that it is
based on expected returns (mean) and the standard deviation (variance) of the various portfolios. It is
foundational to Modern portfolio theory.

Harry M. Markowitz is credited with introducing new concepts of risk mea-surement and their application to
the selection of portfolios. He started with the idea of risk aversion of average investors and their desire to
maximise the expected return with the least risk.

(c) Capital Asset Pricing Model.

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected
return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities
and generating expected returns for assets given the risk of those assets and cost of capital.

Investors expect to be compensated for risk and the time value of money. The risk-free rate in the CAPM
formula accounts for the time value of money. The other components of the CAPM formula account for the
investor taking on additional risk.