Introduction to SAPM What is a security? No, securities don't have anything to do with protecting your passwords or installing a hidden camera in your home. In the investing sense, securities are broadly defined as financial instruments that hold value and can be traded between parties. It consists of stocks, bonds, mutual funds, exchange-traded funds or other types of investments you can buy or sell. 1. Equity securities Equity securities generally refer to stocks, which are shares that you purchase in a company. When you buy an equity security, you own a piece of the company and have a stake in how the business performs. Stock performance moves up and down based on many factors, including how the economy is doing, how the business itself is doing, what’s happening in the world and other events you can’t really predict or control. There is risk involved with investing in stocks because they can be volatile. 2. Debt securities Debt securities, also called fixed-income securities, generally refer to bonds, and they are what they sound like: investments in debt. When you buy a debt security you’re essentially lending money to a company or government entity. In return, you get periodic fixed-interest payments (hence where the term “fixed income” comes from) and you can get your full loaned amount back on its maturity date. Bank fixed deposit and other sources of fixed income can also be considered debt securities. Although bonds are largely seen as safer investments than stocks, truth is they do come with risk — for example, the chance that the issuer of the bond could default, which means they may not be able to repay you. Also, if a bond's interest rate doesn't keep paceIntroduction to SAPM with the rate of inflation. Also good to know about bonds: Bond prices move in the opposite direction of interest rates, which means that when interest rates rise, bond prices typically fall, and vice versa. So what’s happening with interest rates will affect the value of your bonds. No investment strategy can guarantee a profit or protect against loss. All investing carries some risk, including loss of principal invested. Past performance is no guarantee of future results. 3. Mutual Funds There are a few different types of mutual funds, like: Equity Funds Debt funds Index funds Hybrid funds etc. Mutual funds offer instant diversification. Since your money can go towards many different types of securities at once, you won’t feel too much of a hit if you experience a loss in one security. 4. Exchange-Traded Funds (ETFs) ETFs are like mutual funds in that investors pool their money into a fund made up of many different securities, like stocks, bonds and other assets. ETFs are traded through the stock market like stocks, and you can buy and sell them throughout the day. What is security analysis? Security analysis refers to analyzing the value of securities like shares and other instruments to assess the business's total value, which will be useful for investors to make investment decisions as to buy sell or hold the securities. There are three methods toIntroduction to SAPM analyze the value of securities - fundamental, technical, and quantitative analysis. 1. Fundamental Analysis rere ene Analysis aaa \ Analysis OT | \ Analysis Dividend & %y ve Price . Share I ate 2. Technical Analysis This type of security analysis is a price forecasting technique that considers only historical prices, trading volumes, and industry trends to predict the security's future performance. It studies stock charts by applying various indicators (like MACD, Bollinger Bands etc.) assuming every fundamental input has been factored into the price.Introduction to SAPM 3. Quantitative Analysis This security analysis is a supporting methodology for both fundamental and technical analysis, which evaluates the stock’s historical performance through calculations of basic financial ratios e.g., Earnings Per Share (EPS), Return on Investments (ROI), or complex valuations like Discounted Cash Flows (DCF). What are objectives of security analysis? Objectives of security analysis is to select the most profitable investment such that it provides Capital appreciation, Regular Income, the Safety of Capital, Hedge against Inflation, and Liquidity. Ultimate goal of every investment is to maximize the returns and minimize the risk. Investment Objectives * Maximization of Returns * Minimization of Risk Investing in Stock Market aa Low Investing in Bond Market reeIntroduction to SAPM * Maximization of Returns Conflict in * Minimization of Risk ON Tsai NCTM) rae xe ta objectives NTT SLL ee] Conclusion = Conduct fundamental analysis to establish certain value ‘anchors.’ = Do technical analysis to assess the state of the market psychology. = Combine fundamental and technical analyses to determine which securities are worth buying, worth holding, and worth disposing off. Respect market prices and do not show excessive zeal in ‘beating the market.’ Accept the fact that the search for a higher level of return often necessitates the assumption of a higher level of risk. What is portfolio? Portfolio is a collection of a wide range of assets that are owned by an investor. The said collection of financial assets may consists of gold, stocks, bonds, funds, derivatives, property, cash equivalents, etc. It is outcome of the old proverb “Don’t keep all eggs in one basket”. It is always safe to diversify the investments. What Is Portfolio Management? Portfolio management is the art and science of selecting and overseeing a group of investments that meet the long-term financial objectives and risk tolerance of a client, a company, or an institution.Introduction to SAPM Some individuals do their own investment portfolio management. That requires a basic understanding of the key elements of portfolio building and maintenance that make for success, including asset allocation, diversification, and rebalancing. Professional licensed portfolio manager works on behalf of clients, while individuals may choose to build and manage their own portfolios. In either case, the portfolio manager's ultimate goal is to maximize the investments' expected return within an appropriate level of risk exposure. Portfolio management requires the ability to weigh strengths and weaknesses, opportunities and threats across the full spectrum of investments. The choices involve trade-offs, from debt versus equity to domestic versus international, and growth versus safety. What are the Key Elements of Portfolio Management? 1. Asset Allocation The key to effective portfolio management is the long-term mix of assets. Generally, that means stocks, bonds, and cash equivalents such as certificates of deposit. There are others, often referred to as alternative investments, such as real estate, commodities, derivatives, and crypto currency. Asset allocation is based on the understanding that different types of assets do not move in concert, and some are more volatile than others. A mix of assets provides balance and protects against risk. Investors with a more aggressive profile weight their portfolios toward more volatile investments such as growth stocks.Introduction to SAPM Investors with a conservative profile weight their portfolios toward stable investments such as bonds and blue-chip stocks. 2. Diversification The only certainty in investing is that it is impossible to consistently predict winners and losers. The prudent approach is to create a basket of investments that provides broad exposure within an asset class. Diversification involves spreading the risk and reward of individual securities within an asset class, or between asset classes. Because it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all of the sectors over time while reducing volatility at any given time. Real diversification is made across various classes of securities, sectors of the economy, and geographical regions. 3. Rebalancing Rebalancing is used to return a portfolio to its original target allocation at regular intervals, usually annually. This is done to reinstate the original asset mix when the movements of the markets force it out of kilter. For example, a portfolio that starts out with a 70% equity and 30% fixed-income allocation could, after an extended market rally, shift to an 80/20 allocation. The investor has made a good profit, but the portfolio now has more risk than the investor can tolerate.Introduction to SAPM Rebalancing generally involves selling high-priced securities and putting that money to work in lower-priced and out-of-favor securities. The annual exercise of rebalancing allows the investor to capture gains and expand the opportunity for growth in high-potential sectors while keeping the portfolio aligned with the original risk/return profile. Passive vs. Active Management Portfolio management may be either passive or active. Passive management is the set-it-and-forget-it long-term strategy. It may involve investing in one or more exchange-traded (ETF) index funds. This is commonly referred to as indexing or index investing. Those who build indexed portfolios may use modern portfolio theory (MPT) to help them optimize the mix. Active management involves attempting to beat the performance of an index by actively buying and selling individual stocks and other assets. Closed-end funds are generally actively managed. Active managers may use any of a wide range of quantitative or qualitative models to aid in their evaluations of potential investments.Introduction to SAPM PORTFOLIO MANAGEMENT PROCESS restment management (or portfolio management) is a complex activity which may be sken down into the following steps: 1. Specification of Investment Objectives and Constraints The typical objectives sought by investors are current income, capital appreciation, and safety of principal. The relative importance of these objectives should be specified. Further, the constraints arising from liquidity, time horizon, tax, and special circumstances must be identified. 2. Quantification of Capital Market Expectations To address the asset-mix question you need relatively long term estimates of returns and risks of various asset classes. Put differently, you have to quantify capital market expectations. 3. Choice of the Asset Mix |The most important decision in portfolio management is the asset mix decision. Very broadly, this is concerned with the proportions of ‘stocks’ and ‘bonds’ in the portfolio. The appropriate ‘stock-bond’ mix depends mainly on the risk tolerance and investment horizon of the investor. 4, Formulation of Portfolio Strategy Once a certain asset mix is chosen, an appropriate portfolio strategy has to be hammered out. Two broad choices are available: an active portfolio strategy or a passive portfolio strategy. An active portfolio strategy strives to earn superior risk-adjusted returns by resorting to market timing, or sector rotation, or security selection, or some combination of these. A passive portfolio strategy, on the other hand, involves holding a broadly diversified portfolio and maintaining a pre-determined level of risk exposure. 5. Selection of Securities Generally, investors pursue an active stance with respect to security selection. For stock selection, investors commonly go by fundamental analysis and/or technical analysis. The factors that are considered in selecting bonds (or fixed income instruments) are yield to maturity, credit rating, term to maturity, tax shelter, and liquidity 6. Portfolio Execution This is the phase of portfolio management which is concerned with implementing the portfolio plan by buying and/ or selling specified securities in given amounts. 7. Portfolio Revision The value of a portfolio as well as its composition - the relative proportions of stock and bond components ~ may change as stocks and bonds fluctuate. In response to such changes, periodic rebalancing of the portfolio is required. . Performance Evaluation ‘The performance of a portfolio should be evaluated periodically. The key dimensions of portfolio performance evaluation are risk and return and the key issue is whether the portfolio return is commensurate with its risk exposure. Such a review may provide useful feedback to improve the quality of the portfolio management process on a continuing basis.Introduction to SAPM Investment Setting © Criteria for Evaluation For evaluating an investment avenue, the following criteria are relevant. 1 Rate of return m Risk © Marketability 1 Tax shelter © ConvenienceIntroduction to SAPM Summary Evaluation of Various Investment Avenuesthese requirements are speculativ Introduction to SAPM Investor Behavior Analysis INVESTMENT VERSUS SPECULATION According to Benjamin Graham “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting differ from the speculator as follows: Planning horizon Risk disposition Return expectation Basis for decisions Investor An investor has a relatively longer planning horizon. His holding period is usually at least one year. An investor is normally not willing to assume more than moderate risk. Rarely does he knowingly assume high risk. An investor usually seeks a modest rate of return which is commensurate with the limited risk assumed by him. An investor attaches greater significance to fundamental factors and attempts a careful evaluation of the prospects of the firm. Typically an investor uses his own funds and eschews borrowed funds. Very broadly, the characteristics of an investor Speculator Aspeculator has a very short planning horizon. His holding period may be a few days to a few months. A speculator is ordinarily willing to assume high risk. A speculator looks for a high rate of return in exchange for the high risk borne by him. Aspeculator relies more on hearsay, technical charts, and market psychology. Aspeculator normally resorts to borrowings, which can be very substantial, to supplement his personal resources. Gambling Gambling is fundamentally different from speculation and investment in the following respects: ‘Compared to investment and speculation, the result of gambling is known more quickly. The outcome of a roll of dice or the turn of a card is known almost immediately. Rational people gamble for fun, not for income. Gambling does not involve a bet on an economic activity. It is based on risk that is created artificially. Gambling creates risk without providing any commensurate economic return.Introduction to SAPM COMMON ERRORS IN INVESTMENT MANAGEMENT Investors appear to be prone to the following errors in managing their investments: Inadequate comprehension of return and risk Vaguely formulated investment policy Naive extrapolation of the past Cursory decision making, Untimely entries and exits High costs Over-diversification and under-diversification Wrong attitude toward losses and profits Inadequate Comprehension of Return and Risk = What returns can one expect from different investments? What are the risks associated with these investments? Answers to these questions are crucial before you invest. Yet investors often have nebulous ideas about risk and return. Many investors have unrealistic and exaggerated expectations from investments, in particular from equity shares and convertible debentures. One often comes across investors who say that they hope to earn a return of 25 to 30 percent appropriate portfolio strategy has to be hammered out. Two broad choices are available: an active portfolio strategy or a passive portfolio strategy. An active portfolio strategy strives to earn superior risk-adjusted returns by resorting to market timing, or sector rotation, or security selection, or some combination of these. A passive portfolio strategy, on the other hand, involves holding a broadly diversified portfolio and maintaining a pre-determined level of risk exposure. per year with virtually no risk exposure or even double their investment in a year or so. They have apparently been misled by one or more of the following: (a) tall and unjustified claims made by people with vested interests; (b) exceptional performance of some portfolio they have seen or managed, which may be attributable mostly to fortuitous factors; and (c) promises made by tipsters, operators, and others. In most of the cases, such expectations reflect investor naivete and gullibility. By setting unrealistic goals, investors may do precisely the things that give poor results. They may churn their portfolios too frequently; they may buy dubious ‘stories’ from Dalal Street; they may pay huge premiums for speculative, fashionable stocks; they may discard sound companies because of temporary stagnation in earnings; they may try to outguess short-term market swings.Vaguely Formulated Investment Policy Often investors do not clearly spell out their risk disposition and investment policy. This tends to create confusion and impairs the quality of investment decisions. Ironically, conservative investors turn aggressive when the bull market is near its peak in the hope of reaping a bonanza; likewise, in the wake of sharp losses inflicted by a bear market, aggressive investors turn unduly cautious and overlook opportunities before them. Ragnar D. Naess put it this way: “The fear of losing capital when prices are low and declining, and the greed for more capital gains when prices are rising, are probably, more than any other factors, responsible for poor performance.”* If you know what your risk attitude is and why you are investing, you will lear how to invest well. A well articulated investment policy, adhered to consistently over a period of time, saves a great deal of disappointment. Naive Extrapolation of Past Investors generally believe in a simple extrapolation of past trends and events and do not effectively incorporate changes into expectations. People generally adhere to the course they are currently following, unmindful of the countervailing forces. The apparent comfort provided by extrapolating too far, however, is dangerous. As Peter Berntsein says: “Momentum causes things to run further and longer than we anticipate. The very familiarity of a force in motion reduces our ability to see when it is losing its momentum. Indeed, that is why extrapolating the present into the future so frequently turns out to be the genesis of an embarrassing, forecast.”" Cursory Decision Making Investment decision making is characterised by a great deal of cursoriness. Investors tend to: Base their decisions on tips and fads, rather than on thoughtful, quantified assessment of business. Cavalierly brush aside various kinds of investment risk (market risk, business risk, and interest rate risk) as greed overpowers them. Uncritically follow others because of the temptation to ride the bandwagon or lack of confidence in their own judgment. Untimely Entries and Exit Investors tend to follow an irrational start-and-stop approach to the market characterised by untimely entries (after a market advance has long been underway) and exits (after a long period of stagnation and decline). High Costs Investors trade excessively and spend a lot on investment management. A good proportion of investors indulge in day trading in the hope of making quick profits. However, more often than not the transaction costs wipe out whatever profits they may generate from frequent trading. Over-Diversification and Under-Diversification A number of individual portfolios are either over-diversified or under-diversified. Many individuals have portfolios consisting of thirty to sixty, or even more, different stocks. Managing such portfolios is an unwieldy task Perhaps as common as over-diversification is under-diversification. Many individuals do not apparently understand the principle of diversification and its benefit in terms of risk reduction. A number of individual portfolios seem to be highly under-diversified, carrying an avoidable risk exposure.Introduction to SAPM Wrong Attitude Towards Losses and Profits Typically, an investor has an aversion to admit his mistake and cut losses short. If the price falls, contrary to his expectation at the time of purchase, he somehow hopes that it will rebound and he can break even (he may even buy some more shares at the lower price in a bid to reduce his average price). Surprisingly, such a belief persists even when the prospects look dismal and there may be a greater possibility of a further decline. This perhaps arises out of a disinclination to admit mistakes. The pain of regret accompanying the realisation of losses is sought to be postponed. And if the price recovers due to favourable conditions, there is a tendency to dispose of the share when its price more or less equals the original purchase price, even though there may be a fair chance of further increases. The psychological relief experienced by an investor from recovering losses seems to motivate such behaviour. Put differently, the tendency is to let the losses run and cut profits short, rather than to cut the losses short and let the profits run. QUALITIES FOR SUCCESSFUL INVESTING Heis realistic. He is intelligent to the point of genius. Heis utterly dedicated to his craft. He is disciplined and patient. He isa loner. PReENS Qt Given below are the likely returns in case of shares of VCC Ltd. and LCC Lid. in the various economic conditions. Both the shares ste presently quoted at Rs. 100 per share. Economic Probability | Returns of | Returns of Conditions vec ud. | Lecita. High Growth 03 100 150 Low Growth o4 110 130 Stagnation o2 120 0 | Recession O41 140 Cy (2) Which of the two companies are risky investments? (2) Mr. Suresh has three options for investing Rs. 1000. @ Only inshares of VCC Ltd. Gi) Only in shares of LCC Ltd Which of the above options is the best? Why?Introduction to SAPM Q.2 The probability distribution of annual retums on a security are given below: Return on Security | Probability -0.35 0.04 -0.25 0.08 -0.15 0.14 - 0.05 0.17 0.05 0.26 0.15 0.18 0.25 0.09 0.35 0.04 Compute the expected return on the security. Q.3 Mr. Abraham has a portfolio of five stocks. The expected return and amount invested in each stock is given below: Stocks | Expected return | Amount invested A 0.14 10,000 B 0.08 20,000 c 0.15. 30,000 D 0.09 15,000 E 0.12 25,000 Portfolio value 1,090,000 Compute the expected return on Mr. Abraham's portfolio.Introduction to SAPM Your client is holding the following securities: Particulars of Securities Cost| Dividends/Interest| _ Market price 2 2 2 Equity Shares: Gold Ltd. 10,000 1,725 9,800 Silver Lid 15,000 1,000 16,200 Bronze Ltd. 14,000 700: 20,000 GOI Bonds 36,000 3,600 34,500 Calculate holding period return.