South Eastern University of Sri Lanka

Programme: Final Year BBA , Semester –I, 2023

Course: FIM- 41063 Investment Analysis and

Portfolio Management

Topic: Investment Analysis

Lecturer: Dr. S.Safeena M.G Hassan Ph.D (UJA), M.Sc (SJP),
BBA (Hons.) (Col) and (EUSL)
Senior Lecturer
Department of Management
Faculty of Management and Commerce
Handout No: 01
What is an investment?

 Investment may be defined as a commitment of

funds made in the expectation of some positive
rate of return (Kevin,2004).
 Investment is the current commitments 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
 Expected rate of inflation
 Un certainly of the future payments (Brown,2007)
Who can be investor?

 Individual
 Government
 Pension fund
 corporation
Types of investment

 Financial assets
 Real assets
Financial Assets
 Investing in a securities
 It is a financial claim in a assets
 It can be divided in to five groups
1. Direct equity claim: ordinary shares,
warrants
2. Indirect equity claims: Unit trust
3. Credit Claims: Treasury bills , commercial
papers, debentures
4. Preference shares
5. Commodity futures
Operations Management - S.Safeena Mg Hassan 5
Real Assets

 Investing in a physical things;

1. Real estate: Land Building
2. Precious metals: Gold, Silver
3. Precious Stones: Diamonds, Rubbies,
Sapphires
4. Collectibles: Art, Antiques, Stamps, coins
5. Others: Cows, goat (animals)

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Characteristics of investment

 Return
 Risk
 Safety
 Liquidity
Differentiate Financial Assets and
Real Assets
 High flexible
 Diversifiable
 High Risk
 More Return and more liquidity

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Return
 The return from an investment is the realizable
future cash flow during a given period of time.
 Different types of investments promise different
rate of return.
 Returns depend upon the nature of the
investments, maturity period and host of the
factors.
 The return maybe received in the form of yields
plus capital appreciation.
 Capital appreciation: The difference between the
sale price and the purchase price.
 Yields: The dividend or interest received from the
investment.
1. Holding period return (HPR)

Ending value of investment

HPR= ------------------------------------
Beginning value of investment

 HPR > 1, Investor’s wealth will be increased.

 HPR < 1, Investor’s wealth will be declined
 HPR = 0, Investor’s lost their money
Holding period Yield (HPY)

Converting an HPR to an annual percentage

rate is to derive a percentage return, this is
referred to Holding period yield.
HPY =HPR -1

Annual Holding period Return(AHPR)

AHPR =(HPR)1/n
 Example-1:

 Suppose you bought a share of Red skin stock on

January 1, 2022 at a price of Rs.300 per share. A
year later you want to evaluate this investment.
After consulting an investment Company, you find
that the current price of Red skin shares is
Rs. 450.00. If you were paid Rs 4.00 Per share in
dividend Calculate the Total return?

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Annual Holding Period Return

 Annual HPR = HPR 1/n

where n = number of years investment is held

Annual Holding Period Yield

 Annual HPY = Annual HPR - 1
 Exapmple-2

1.Consider an investment that cost Rs. 450 and is

worth Rs. 600 after being held two years: What is
the annual holding period yield?
2. Consider an investment that cost Rs. 500 and is
worth Rs. 400 after being held one years: What is
the holding period yield?
3. Consider an investment of Rs. 100 held for only six
month that earned a return of RS 12; What is the
annual holding period yield?

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Mean Historical Return.

 Arithmetic Mean (AM) = ∑HPY/n

 Geometric mean(GM) = (πHPR) 1/n -1
 Example -3

 Considering the following data calculate the

arithmetic mean and Geometric mean.
Year Beginning value(RS) Ending Value(RS)
1 1000 1250
2 1250 1500
3 1500 1600

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 AM provides a good indication of the expected rate
return for an investment during of an individual
year, it is biased upward if you are attempting to
measure an asset’s long term performance.
GM is considered a superior measure of the long
term mean rate of return because it indicates the
compound annual rate of return based on the
ending value of the investment versus its
beginning value.

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 Example

 Consider a security that increases in price from

Rs.500 to Rs. 1000 during the first year and drops
back to Rs 500 during the second year. What is the
AM, GM.?

18
Year Beginning value(RS) Ending Value(RS)
1 500 1000
2 1000 500

Operations Management - S.Safeena Mg Hassan 19

Expected Rates of Return
 Risk is uncertainty that an investment
will earn its expected rate of return
 Probability is the likelihood of an
outcome
Expected return
 The expected return is the weighted average of all
the possible returns, where the weighted reflect
the possibilities of each possible return.

 ER = ∑(out come x probability)

 ER = (R1 Prob1 +R2 Prob2 +----------+ Rn Probn )

R1 = 1st possible out come

Prob1= Probability associated with the 1stpossible

outcome
Expected Rates of Return
1.6
Expected Return  E(R i )
n

 ( Probabilit y of Return)  (Possible

i 1
Return)

[(P 1 )(R 1 )  (P 2 )(R 2 )  ....  (P n R n )

n

 (P )(R
i 1
i i )
 Expected Return
 The expected rate of return [E (R)] is the sum of the product of each
outcome (return) and its associated probability:

Rates of Returns Under Various Economic Conditions

Returns and Probabilities

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 Stock A has the following possible return the
coming year What is the Expected return of stock
A?

Economic status Boom Average Recession Depression

Return 24% 19% 12% 04%

Probability 0.20 .25 .35 .20

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 Risk
 It is relate to Loss of capital delay in repayment of capital,
nonpayment of interest or variability of returns.
 Risk is inherent in any investment.
 Risk refers to the uncertainly of outcome and thereby,
dispersion of probability distributions of outcomes.
 Some investments like government bond and bank deposits
are almost risk less.
 Most popular measure of risk is the variance or standard
deviation of the probability distribution of possible return.
 SD or variance provides a measure of the total risk associated
with a security.
 Total risk = systematic risk + unsystematic risk
Risk depends on the following
section;
 The longer the maturity Period, the larger is
the risk,
 Lower the credit worthiness of the
borrower, the higher is the risk
 Risk varies with the nature of investment
ex: Common share carries higher risk
compare with debentures and bonds.

Operations Management - S.Safeena Mg Hassan 26

Systematic risk
 Environmental factors such as economic,
political, and social factors have an influence
on the performance of companies.
 The impact of these changes is system-wide
and that portion of total variability in security
returns caused by such system wide factors is
referred to as systematic risk.
 Systematic risk cannot be eliminated and it is
uncontrollable.

Operations Management - S.Safeena Mg Hassan 27

 This risk is further subdivided into;
 Interest rate risk
 Market risk: it refers to the variation in
returns caused by the volatility of the stock
market.
 Purchasing power risk: it refers to the
variation in investors return caused by
inflation.

Operations Management - S.Safeena Mg Hassan 28

Unsystematic risk

It is controllable risk which can arise firm’s

specific factors such as operating environment
of the company and the financial pattern
adopted by the company.
There are two types of unsystematic risk.
Business risk and Financial risk.

Operations Management - S.Safeena Mg Hassan 29

Formula for Calculation of risk (SD): Method -1


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Problem
Consider the following returns over the last 5
years for stocks X and Y Compute the SD of
the possible outcome of stocks X and Y.
Returns
Year Stock X Stock Y
1 15% 18%
2 14% 12%
3 -06% 10%
4 10% -08%
5 12% 07%
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Problem
Considering the following data of Stock A and
stock B . Select the best stock for the investment.
Return rate of Possibility for the Return rate of
Stock A% return of stock A Stock B%
&B

5 0.2 -5
8 0.4 5
10 0.3 15
15 0.1 30
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 Method -II


33
Coefficient of Variation

Operations Management - S.Safeena Mg Hassan 34

 Problem
Following table shows the returns over the last 5
years for stock A and B
Return Rate
Year Stock – A Stock – B
1 15 18
2 04 05
3 09 10
4 08 12
5 09 05
 What is the risk rate for each stock
 What is the Coefficient of variation for each stock? According to
this measure which stock is preferable, give reasons.
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Thank you

Acknowledgement:
Keith C. Brown