Ans 1 Investment Decision Process

The process of investment includes following steps :-

1. Setting up the Investment Policy : The first step is setting up the investment policy for the
investor. The investment policy is based on investment goals or objectives, investible funds, tax
status and investment horizons. Different investment objectives of an investor may be capital
appreciation, regular income, tax benefits etc. The investment objectives are framed as per the risk
return preferences of the investors. Every investor has a different risk appetite or risk profile which is
an essential ingredient in investment policy. The investment objective is also related to the period of
investment or investment horizon. Investment policy sets the broad framework for investment
decision making by an individual investor.

2. Building up an inventory of securities : This step involves building up a list of all available
securities wherein an investor may make his investment. Depending upon investment objectives and
investment horizon, the securities may be filtered. For example, if an investor’s objective is to
receive regular income at low risk, then equity shares which do not pay regular dividends may not be
included in the list of securities where an investor may invest.

3. Performing Security Analysis : Once an inventory or list of available securities has been made, the
next step is to analyze these securities primarily with respect to risk and return characteristics. This is
known as security analysis. The main idea in security analysis is to estimate the expected return and
risk of individual securities. This may also help investors in detecting undervalued or overvalued
securities and timing of buy or sell decision. There are various approaches of security valuation -
Fundamental analysis, Technical analysis and Efficient Market Hypothesis (EMH).

4. Constructing portfolios, portfolio analysis and portfolio selection : A portfolio is a combination of

two or more securities in which an investor may prefer to hold investments rather than in all the
securities available for investment. Therefore, after security analysis, the next step is to construct all
feasible portfolios or portfolio opportunity set and selecting optimal portfolio for the concerned
investor. Portfolio opportunity set is also termed as Investment opportunity Set. It must be noted
that there may be many feasible portfolios by combining various securities in different proportions,
but all of them may not be efficient. An Efficient portfolio is one which provides maximum return for
a given level of risk or which has minimum risk for a given level of return. Such efficient portfolios
may also be large in numbers. Hence in order to select the optimal or best portfolio for the investor,
one needs to consider risk return preferences of the investor.

5. Portfolio Revision : The fifth step in investment decision process is portfolio revision. It consists of
the repetition of the previous four steps in the light of changes in investment environment.
Moreover the investment objectives of the investor may also change overtime and hence there is a
need to revise the originally selected portfolio periodically. Due to changes in security prices, the
originally built portfolio may not remain optimal and hence the investor needs to revise it or build up
a new portfolio. Changes in security prices may also make certain securities attractive, which were
not selected earlier due to higher prices or may make certain securities already include in the
portfolio, unattractive. All this calls for periodic revision of the portfolio.

6. Portfolio performance Evaluation and Management : The last step in the investment process is to
evaluate the performance of the portfolio. It implies determining periodically whether the portfolio
has performed better than the benchmark portfolio or other similar portfolios or not. Portfolio
performance evaluation may be done using absolute return as well as various risk adjusted return
measures such as Sharpe ratio, Treynor’s ratio or Jensen’s alpha. Sharpe ratio is calculated by
dividing excess return (i.e. risk premium) by the total risk of the portfolio. It is a measure of excess
return per unit of risk. The higher this ratio the better is the performance of the portfolio.

Ans 2

Year Share Price Returns (%)

2007 100 _

2008 125 25 ( 125-100/100 *100)

2009 118 -5.6 (118-125/125*100)

2010 130 10.16 (130-118/118*100)

2011 120 -7.6 (120-130/130*100)

2012 140 16.66 ( 140-120/120*100)

Total 38.62

(i) Average Return ( based on arithmetic mean) = 38.62/5 = 7.72%

(ii) Average Return ( based on geometric mean)

= [ (1+R1) (1+R2) (1+R3) (1+R4) (1+R5) ]^1/5 – 1

= [ (1+25) (1-5.6) (1+10.16) (1-7.6) (1+16.66) ] ^1/5 – 1

= [ 26*(-4.6)*11.16*(-6.6)*17.66 ]^1/5 -1

= [ 155571.3192 ]^1/5 -1

= 10.92 – 1

= 9.92 %

Ans 3 Yes, I agree Ratio Analysis is important for evaluating the financial performance of the
company because it helps the investor to understand the financial performance of the company
through its financial statements. Ratio analysis are mainly used by external analysts to determine
various aspects of a business such as profitability, liquidity and solvency. Through these one can
evaluate the financial performance of the company. Financial ratios are tools used to assess financial
performance through balance sheet , cash flow statement , income statement etc. Ratio can be
classified as liquidity ratio, activity ratio , leverage ratio , profitability ratio , valuation ratio. These
ratios helps in evaluating financial performance of the company. Ratios helps in identifying the areas
of a business that requires more attention and it helps to study and understand the riskiness of the
firm’s operations.