Capital Market and Portfolio Management

June 2023 Examination

Ans 1.

Introduction

The term "investing" refers to the practise of allocating capital to various assets with the
expectation of a return. Money market accounts, certificates of deposit, stocks, and other assets
are all acceptable forms of long-term investment.

When purchasing assets, individuals consider their wants, passions, and goals. These guarantee
that our funds are being invested correctly and that any profits will be safe from loss. When
determining an appropriate investment ratio, many things must be considered.

To maximise returns, which are gains over and above the value of the original investment,
prudent investors focus their capital on a limited number of well selected assets or project
assignments. It makes investments of time and money with the expectation of a return on such
investments.

You may invest in anything from coins to start a business to real estate with the intention of
renting it out or selling it for a profit.

The risk of losing money on an investment is higher than on a savings account since you are
using the money for anything rather than putting it away. Unlike investing, which is best for
riding out short-term market fluctuations, speculating puts money to work continuously.

Concepts and applications

Discussing about the factors that we must keep in mind while investing in Financial assets-

a)Return on funding- Return on investment, or ROI, is the profit earned by an investor as a

consequence of a decrease in investment costs.
 • It might come via interest, dividends, or even just an increase in value.

• When calculating ROI, it's important to use the real net income after taxes.

• The net amount after taxes should be more than inflation.

• There is often a negative correlation between risk and ROI.

b)Risk- Losing money due to random circumstances is called "chance."

• The potential for loss increases in tandem with the rate of return.

• For example, the potential reward from investing in stocks is greater than that from a DF,
but the danger is higher.

Investment period/ investment term- The financing period might be based on the distance
(duration) of the investment, which influences the ROI.

c)The funding can be short-term.

• Short-term investments should be held for little more than a year, whereas long-term
investments need at least that much time to grow a profit.

• Investments with a longer time horizon often generate higher returns.

• The duration of one's investment is a matter of personal preference.

d) Liquidity- Since coins may be used to purchase almost anything, they are called a liquid
asset. The term "liquidity" is used to describe the ease with which a financial asset may be turned
into cash.

• The emergency fund should be easily accessible in case of withdrawal.

• Real estate is less liquid than a savings account because it takes longer to sell.

• Because of the enormous number of buyers and sellers on the stock market, many
equities are considered very liquid.

e)Taxation and Tax Implications: Taxes are mandatory payments made to the government.

• Investments are taxed in a broad variety of ways.

• Tax rates vary depending on the kind of asset.

• Gains taxes are something investors should consider since it might significantly impact
results.
The purchase and creation of capital is now most typically associated with the use of financial
instruments, and so the word "financing" has taken on this connotation. The money is then used
to finance expansion or new income streams for these organisations.

The following investments are the most widely held notwithstanding the immensity of the
financial landscape: When a consumer buys shares in a firm, he or she effectively becomes a
shareholder. Investors that possess stock in a corporation are referred to as "stockholders." They
stand to gain if the business does well, both in terms of the value of their shares and the
dividends paid out of the firm's earnings. the Bonds Corporate, governmental, and municipal
bonds are all examples of debt obligations. When we acquire a bond, we take ownership of the
debt owed by the issuing corporation and are thus entitled to interest payments and the face value
of the bond upon its maturity.

f) Budget- An investment banker oversees a financial plan that may be used to buy stocks,
commodities, preferred shares, and other financial instruments. Exchange-traded funds (ETFs)
and change-traded funds (CTFs) are the two most popular investment vehicles. ETFs, or
exchange-traded funds, are similar to stocks in that they trade on stock exchanges and experience
daily price fluctuations. Traditionally, mutual funds have been valued at the conclusion of the
trading day rather than during periodic adjustments. In the case of ETFs and mutual funds,
investors may choose between active management by fund managers and passive monitoring of
benchmarks like the Nifty 50 and Sense indexes.

g) Make a financial road plan for yourself.

If you have never made a financial plan before, it is strongly recommended that you do so before
making any investment decisions.

The first step in prudent investing is establishing your goals and your tolerance for risk.
Investments carry with them no assurance of a return. However, if you are well-versed in the
facts of investing and saving, and maintain a prudent strategy, you should eventually achieve
financial stability and success.

h) Create and maintain an emergency fund.

If anything unexpected were to happen, like unemployment, most astute investors would be able
to absorb the expenses. Some people save up enough money to last them for up to six months in
case they ever need it.

Conclusion
When you need to purchase veggies, how do you go about doing so? You choose the ones that
are now in season, so you go to the market. The same dangers apply to your financial
investments. When making a financial commitment, you shouldn't only rely on what others say;
instead, you should do your own research on the developers involved.

If you're just starting out in the financial world, it's extremely important to listen to expert
guidance. You are in the best position to assess your needs and risk tolerance and make prudent
portfolio changes. Choosing investments is just the first step in building wealth. You need to
keep an eye on your investments' performance over time to see whether they are helping you
reach your objectives in the market.

The notion that a career in investment is a good one is common. learning a skill that requires
practice and dedication. It's a time-consuming technique that benefits from repetition.

Ans 2.

Introduction

Investing in anything new demands careful consideration. The estimated rate of return is a major
factor in making a choice.

The end result of an investment is usually evaluated in terms of interest or a gain in percentage.
You may learn more about how various measures of return are computed and how they are used
to assess your investment or portfolio by reading the literature for different products as well as
brochures, websites, calculators, and more.

Investment returns are typically calculated by contrasting the initial outlay (the outflow) with the
subsequent income (the inflow) from an asset. Investing cash inflows may come from a variety
of sources, including interest payments on fixed-income securities, dividends on equities assets,
and capital gains or losses from a rise or decline in the value of the investment. Dividends and
capital gains are the two main ways in which mutual funds compensate their shareholders. Funds
or Standard return measurements are used to assess the performance of an investment, even
though returns may take numerous forms.

Concepts and applications

To find which Stock will give Maximum return Investor will invest in those stocks is below
explained:
It is critical for every investor to understand what kind of return they may expect from any
particular investment. Therefore, it is the responsibility of the investor to assess the profitability
of the asset. The success of an investment may be evaluated in several ways. Below are examples
of potential evaluation criteria.

Return on Investment (ROI): It's a standard method for estimating a project's financial return.
The projected return takes into account all cash flows generated by an asset. Investing profits,
dividends, interest, and principal repayment are all potential sources of cash flow. Here is the
formula for calculating return on investment:

ROI = (Net Returns from investment original cost of investment− Original amount
invested)× 100

Risk Premium: It is used to calculate the potential return on an investment. A "risk premium"
describes the higher profits an investor receives from purchasing shares of a quickly developing
firm as opposed to those of a more stable corporation. A startup, for instance, may need a high
risk premium from investors due to its limited resources and the possibility of market failure. As
a result, if the business succeeds, the investors will get large returns on their investment.
However, failure is less likely to befall a huge corporation whose brand is well recognized. Due
to the general perception that investing in large corporations is risk-free, GE has a relatively low
risk premium.

Expected Return: It's a weighted average of all feasible ROIs. Expected return is used to predict
a portfolio's worth in the future and as a comparison point for actual returns.

The formula for calculating expected return is

E[R]=Sigma (R*P)

Benchmark Portfolios: Investors often use this metric to assess the performance of their
holdings. Investment returns are estimated by comparing multiple portfolios to a benchmark,
often an index. Take XYZ, a portfolio management firm, for example. They measure their
success against the Russell 2000. When XYZ's portfolio achieves an annual return of 8.6% and
the benchmark return is 8%, XYZ is said to have outperformed the benchmark.

.Some of the most commonly used benchmarks are:

 Standard & Poor’s 500: This is the standard against which the performance of large-cap
stocks is measured.

 Russell 2000: It is a measure of the performance of small-cap stocks.

 Europe, Australia and Far East Index (EAFE): This is used as a standard against which
returns on international stock investments may be measured.

Holding Period Return: It's the profit made by investing one's money. This metric may be used
to evaluate the success of investments across very short time periods. However, the duration of
an investment has a substantial impact on the volatility of its return. Stock returns will be more
volatile in the near term.

However, as time invested in a stock increases, its volatility does as well. Return over the
holding time may be computed using the following formula:

Holding Period Return =Income + (End of Period Value – Initial Value) / Initial Value

Excess Returns: A positive alpha is the amount of return on a stock or portfolio that an investor
receives above and above what was anticipated based on the stock's or portfolio's beta. To put it
another way, if an investor anticipates a 12% return on his portfolio next year, it may end up
yielding 15%. In this case, the portfolio would have an excess return of 3% (15% minus 12%).

Conclusion:

while a result of your newfound knowledge of these metrics, you should keep a few things in
mind while you evaluate investments. First and foremost, the product categories being compared
must be same (the same goes for the time period and the unit of measurement). The potential for
future profit is another factor to think about. Despite their significance, returns are seldom the
deciding factor. A person's risk appetite, investment goals, risk tolerance, liquidity demands, and
the balance between short-term and long-term investment goals should all be taken into account.
You may be able to become a successful investor if you have a firm grasp of all these
considerations, in addition to returns.

Ans 3a.

Introduction

As was implied in the preceding question, there is an art to selecting shares to invest in given the
sheer number of firms trading on the stock exchange. There are many companies to choose from,
with share prices ranging from pennies to billions. If a shareholder is forced to relocate due to the
company's lack of success, they may sell their shares for very little money.

Another kind of stock is "blue chip" stocks. Companies having a blue chip status have a
significant presence in their industry. These companies have been around for a while and
consistently bring in a lot of cash.

Before putting money into anything, investors should assess their risk appetite and financial
resources.

Concepts and applications

Mr. A should bear in mind the following methods while investing for better riskmeasuring-

Beta: Systemic risk is quantified by the beta coefficient, sometimes known as simply beta. The
beta of an asset or portfolio reflects its volatility relative to the market as a whole. Beta is
calculated via a regression analysis. The beta of a stock is a measure of its volatility relative to
the market as a whole. The value of beta might be more than 1, but yet less than 1. The beta of
the market is defined as 1. Any asset with a beta value greater than 1 is more volatile and has a
larger potential return than the market as a whole. This regulation applies to all forms of financial
instruments, including stocks.

Alpha: To what extent may stock price fluctuations (alpha) be explained by elements unique to
the underlying asset? Alpha is a metric used to evaluate a company's or a portfolio's "risk-
adjusted" performance. The alpha metric considers an asset's volatility (sometimes called price
risk) and its performance compared to a benchmark index. The term "alpha" is used to describe a
stock's or a portfolio's outperformance relative to a benchmark index.

Alpha = Portfolio Return – Benchmark Portfolio Return

Here, Benchmark Return (CAPM) = Risk-Free Rate of Return + Beta (Return of Market –
Risk-Free Rate of Return)

Benchmark Return (CAPM) = Rf + β (Rm – Rf)And

Alpha, α = Rp – [Rf + (Rm – Rf) β]

Where,

Rp = Portfolio Return – Benchmark Return

Alpha 1.0 stocks have gained 1% more than the market average. A comparable alpha of -1.0
would mean that the stock would underperform the market by 1%.

Sharpe Ratio: It is a sophisticated metric for gauging the unpredictability of a company or a

portfolio. The potential profit grows in proportion to the Sharpe ratio. The Sharpe ratio is a
common measure of performance in the stock market that takes risk into account. An
investment's risk premium is its return above and above the portfolio's or stock's standard
deviation.

It is calculated using the formula mentioned below:

Sharpe Ratio = (total return - risk free rate of return) / standard deviation of portfolio

a)Warding off investment risk- then there is no chance of loss on our investments. Sometimes
we give up some of our potential to return in exchange for more security. We may or may not
have used a passbook from Fatherland Savings Bank. We thought our money was secure in an
FDIC-insured savings account. We can still maintain up to Rs. 250,000 in an FDIC-insured
savings account. However, we must be prepared to fork out a nominal interest charge. Our rupees
may lose all value as a result of inflation. To increase our financial rewards, we're prepared to
increase our risk tolerance.

b) Coping with investment risk- Given our present investing options, we are unable to make
adjustments to mitigate loss. By wisely using the loans and financing options at our disposal, we
may be able to save money on charges and levies.

Conclusion

Overall, it's clear that having a strategy or plan is crucial to effective risk management and
reduction. Examine avoidance, transfer, and management strategies for investment risk
reduction. Recall how we worked with a financial genius to tailor a green investing strategy to
our specific goals, needs, and comfort levels. Finally, despite difficulties and upheaval, we must
think about and stick to our strategy.

Ans 3b.

Introduction

Ad agencies listed on US exchanges are a popular investment target for equity-focused mutual
funds. The success of the firm, which is impacted by traditional microeconomic variables, is the
foundation of its value.

Why is mutual fund investment risky?

Investors lose money when their portfolio's Net Asset Value (NAV) falls below their cost basis,
which is calculated by taking the total market value of the investor's holdings in all of the
schemes and dividing that number by the number of units in the portfolio's liability allocation.

Concepts and applications

The risk associated with mutual funds are-

a) Volatility risk- Many equity-focused mutual funds seek for publicly traded advertising
businesses in the United States. The firm's worth is based on how successful it has been in the
past, which is affected by more standard microeconomic factors.

b) Liquidity risk, alternatively, the possibility that selling an investment may result in a loss for
the investor. If the security's seller can't find a buyer, this outcome is also possible. During the
lock-in period, mutual funds like ELSS are susceptible to liquidity risk. Nothing may be done at
all during the locked-in period. Exchange-traded funds (ETFs) are another investment option that
might be impacted by liquidity risk.

Like stocks, exchange-traded funds (ETFs) may be bought and sold on the stock market. If there
are no buyers, you may be unable to redeem your assets when you really need them. The easiest
way to avoid this is to have a diverse portfolio and choose your funds carefully.

For example- Motilal finance restricts the options available to investors in a firm while they wait
for their money due to a protracted lock period. In addition, the need for more buyers in the stock
market might make it difficult to redeem assets at a time judged appropriate with the aid of
dealers.

c) Interest risk- Interest rate risk, the physical embodiment of fluctuating discretionary
expenditure, haunts mutual fund investors over the long term. It results from the fact that, as the
end of their financing period approaches, investors may be exposed to financial hazards.

That is to say, the repayment terms of the debt instrument will shift in accordance with any
changes to the interest rate. If the price of a connected activity goes up, for instance, the value of
the bond will decrease.

d. Concentration Risk

One popular definition of concentration is the act of focusing one's whole attention on
something. Spending a lot of money on a single strategy almost never pays off. You stand to win
a lot, but you may lose a lot as well. Diversifying one's holdings is the greatest method to
mitigate this danger. Putting all of one's confidence on a single venture is a dangerous game to
play. The volatility of a diversified portfolio is lower.

Conclusion

As a result, there will always be some mystery around joint finances. However, prudent investors
may mitigate these consequences and prevent their funds from drying up by using innovative
financing strategies.