Investment is the employment of funds or assets with the aim of earning income or capital

appreciation. Investment has two attributes namely time and risk. In the process of investment,
the present consumption sacrificed to get a return in the future. The sacrifice i.e. done to is
certain but the return in future may be uncertain. This attribute of investment indicates the risk
factor.

Speculation:-

Speculation is about taking a business risk with a hope to achieve short-term gain. It mainly
involves buying and selling activities with the expectation of making profits from price
fluctuations. The speculators are more interested in market action and its price movement. He
is more interested in getting an abnormal return. The speculator’s investments are made for
short term.

BOD Investor Speculator

Time Plans for a longer time horizon, this Plans for a very short period, holding
horizon holding period may be form 1 year to period varies from few days to months.
few years.
Risk Assume moderate risk, likes to have Willing to undertake high risk, like to
return moderate rate of return associated have high returns for assuming high risk.
with limited risk.
Decision Considers fundamental factors and Considers inside information here says
evaluates the performance of the and market behavior.
company regularly.
Funds Uses his own funds and avoids Uses borrowed funds to supplement to
borrowed funds. his personal resources..
Gambling: - an investment

A gamble is usually a very short-term investment in a game of chance. Gambling is different

from speculation and investment. This is because the time frame involved in gambling is
shorter. Another reason is individuals also gamble for entertainment purposes. Thirdly, the risk
taken in gambling is different from that of an investment or speculation. Gambling employs
artificial whereas commercial risks are present for investment activity.

Risk-return tradeoff is absent in gambling and negative outcomes can be expected.

Investment objectives:-

The main objectives of investment are increasing the rate of return and reducing the inherent
risk.
There may be some other objective as well:

i. Return: Investors expects good return from their investments. Return is defined as the
total income the investors receives during the holding period expressed as a percentage
of the purchasing price at the beginning of the holding period.
End period value−Start period value+ Dividen d
Return= { Start period value }
∗100

Rate of return is mention annually or semi annually to help in comparison of different

investment options.
E.g. A share is purchased at ₹50 in 2020. It is sold at ₹60 in 2021. Dividend yield is ₹5.
What is the rate of return?
60−50+5
Ans:- Return= { 50 } ∗100=30

ii. Risk: Risk holding securities are related with the probability of actual return becoming
less than the expected return. An investment whose rate of return varies widely from
period to period is risky than whose return does not change much.
iii. Liquidity: Marketability of the investment provides liquidity to it. Stocks are liquid only if
they command considerable market by providing adequate return to dividends and
capital appreciation.
iv. Hedge against impletion: Since every economy has some impletion therefore the rate of
return should ensure a cover against it. The rate of return should be higher and the rate
of impletion, otherwise the investor will have loss in real terms. The return earned
should assure the safety of the principle amount, regular flow of income and a hedge
against impletion.
v. Safety: The selective investment option should be under the legal and regulatory
framework.
The investment process

Construction of a portfolio:

A portfolio is a combination of securities. It is constructed in such a manner to meet the

investor’s goals and objectives. The investor tries to attend maximum return with minimum
risk.

i. Diversification: The main objective of diversification is reduction of risk in the loss of

capital and income. A diversified portfolio is comparatively less risky than holding
single assets. There are several ways to diversify the portfolio:-
 Debt and equity diversification: - Debt instruments provide a short return with
limited capital appreciation. Common stock provides income and capital gain
but has some uncertainty both debt and equity instruments are combined to
complement each other.
 Industry diversification: - Industries growth and their reaction to government
policy differ from each other. Different industries may react in completely
different way to a particular event. Therefore, industry diversification is
needed and it reduces the risk.
 Company diversification: - Securities from different companies are purchased
to reduce the risk of investing in any single company. Technical analyst
suggests that investors should buy securities based on price movement.
Fundamental analyst suggest that the selection of the financially sound and
investor friendly companies could be done before the investment is made.

Risk and Return:

Return on a single asset: -

X ltd. is a large company with several 100 of shareholders. An investor bought 100 shares of
the company at the beginning of the year at the market price of ₹225. The par value of each
share is ₹10. What is the total amount of investment?

Total amount of dividend enjoyed by investor= 100shares × 2.5/shares= ₹250

Now the price of the shares at the end of the year= ₹267.50

Therefore the capital gained or loss at the end of the year= (Selling price-Buying price) × No.
of shares.

Therefore, the total rate of investment is individual × Capital investment= 100×225=22500

Cash flow at the end of the year= Dividends × Value of sold shares

= 250+ (267.50×100) =27000

Cash flow at the end of the year= Dividend + Value of sold share =250+26750=27000

Value of sold share= 267.50×100= 26750

The dividend is also equal to the initial investment of ₹22500+total return of ₹4500

Now the calculation of % returns can be done as follows: - (Return/total investment) ×100 =>
(4500/22500) ×100=20%

The rate of return consists of the dividend yield and the capital gain yield.

Rate of return of a share held for 1year is as follows:-

Rate of return= Dividend yield + Capital gain yield D1

R1=Return in year 1

DIV1=Dividend received in year 1

P1=Price of share at the end of the year

P0=Price of shares at the beginning of the year

D1 V 1 ( P 1−P 0 ) D 1V 1+ ( P 1−P 0 )
R1= + =
P0 P0 P0

If the share of price is ₹225 and at end ₹200

Capital loss=( 200−225 ) × 100=−25000

∴ The total return=−2500+200=−2250

2.50
R 1= + ¿)×100=0.011-0.111=-0.10011
225

2.50 ( 267.50−225 )
R1= + =0.0111+ 0.1888=0.1999=19.99 % 20 %
225 225

Average rate of return= It is the sum of various period rate of return dividend by the number of
period

Dividend= It is the sum total of various rate of return divided by the no. of periods. The simple
arithmetic average is another particular to which rate of return can be calculated.\

Risk management:

X invests ₹1 today in a company’s share for 5years. The rates of return are 18%, 9%, 0%, 10%,
and 14%. What is the worth of shares?

Since X holds the shares for 5years, therefore, the worth of the investment can be calculated
assuming that the dividends of the previous years are reinvested in these shares. Therefore, the
investment worth after 5years= (1+0.18) × (1+0.09) × (1+0.0) × (1-0.10) × (1+0.14) =1.3196

The rupees investment has grown to 1.3196 at the end of 5years.

Therefore, total return is 1.31-1=0.31

Year Dividend/Share(₹ Dividend Yield Share Price Capital gain Return (S+5)
) (DIV/Pt-1) (P) (Pt-Pt-1)
(DIV)
2000 3.50 - 206.35 - -
2001 5.00 2.42 223.65 8.38 10.81
2002 5.50 2.46 181.75 -18.73 -16.28
2003 5.50 3.03 204.70 12.63 15.65
 2004 5.00 2.44 143.50 -22.90 -27.45
2005 5.00 3.48 197.25 37.46 40.94
2006 6.00 3.04 216.55 9.78 12.83
2007 9.00 4.16 213.90 -1.22 2.93
2009 7.50 3.51 237.50 11.03 14.54
2010 6.50 2.74 238.70 0.51 3.24
2011 6.50 2.72 284.60 19.23 21.95
2012 7.50 2.64 409.90 44.03 48.66
Average 6.27 2.97 232.00 8.47 11.44
In the given table, the returns show a wide fluctuation from -27.45 to 46.94. The fluctuations
are costs due to volatility of share price. The variability of the rate of return may be defined as
the extent of deviations or dispersions of individual rates of return from the average rate of
return.

Variability of return=n-n’ (Return – Average return) (Dispersion formula)

There are two measures of dispersion= Variance and Standard deviation.

Standard deviation is the square root of variance.

n
1
Standard Deviation= √V=Ϭ=√ (Ϭ) 2=√ ∑ (R1−R)2
n−1 t−1

R1= Individual on return

R= Mean average return

The 10 annual rates of return for the company are calculated of given.

The average rate of return=11.44

∴The standard deviation can be calculated through the above formula.

Standard Deviation=
1
√ 10−1
∑ ( 10.81−11.44 )2 + (−16.68−11.44 )2+ ( 15.65−11.44 )2+ (−27.45−11.44 )2 + ( 40.94−11.44 )2 + ( 12.83−11.4

√ 0.1 ∑ 0.3969+ 790.7344+17.241+1512.4321+ 870.25+1.9321+72.4201+ 9.61+ 67.24+110.4601+1240.4484 ¿

¿

√(0.1¿× 4693.6482)=√ 469.36482=21.6648291015 ¿

The annual rate of return of the company shows a high degree of variability. They deviate on an
average by above 21.66 from the average of rate of return 11.44%
Expected return of risk: - Incorporation the probability estimate. The outcome of actual returns
may depend upon the economic conditions the performance of the company and other factors.
For e.g. X ltd., provide share of M.P. 261.25. Today the company pays depend of 2.50/share.
Following are the sceneries.

Economic conditions Share price Dividend

R1 High growth 305.50 4.00
R2 Expansion 285.50 3.25
R3 Stagnation 261.25 2.50
R4 Decline 243.60 2.00
∴The possible outcome of return can be calculated as follows:-

4+(305.50−261.25) 48.25
R1= = =0.1846 ×100=18.46 %
261.25 261.25

3.25+(285.50−261.25) 27.5
R2= = =0.105 ×100=10.53 %
261.25 261.25

2+(243.50−261.25) −15.75
R4= = =−0.06028 ×100=−6.028 %
261.25 261.25

2.50+ ( 261.25−261.25 )
R3= =0.00956× 100=0. .956 %
261.25

Expected rate of return= the expected rate of return [E(R)] is the sum of the product of each
outcome or return of its associated probability.

Expected rate of return= Rate of return and scenario 1 × Probability of scenario 1