MF0010–

Q.1 Frame the investment process for a person of your age group.
Answer: It is rare to find investors investing their entire savings in a single security. Instead, they tend to invest in a group of securities. Such a group of securities is called a portfolio. Most financial experts stress that in order to minimize risk; an investor should hold a well-balanced investment portfolio. The investment process describes how an investor must go about making. Decisions with regard to what securities to invest in while constructing a portfolio, how extensive the investment should be, and when the investment should be made. This is a procedure involving the following five steps: • Set investment policy • Perform security analysis • Construct a portfolio • Revise the portfolio • Evaluate the performance of portfolio

1. Setting Investment Policy This initial step determines the investor‘s objectives and the amount of his investable wealth. Since there is a positive relationship between risk and return, the investment objectives should be stated in terms of both risk and return. This step concludes with the asset allocation decision: identification of the potential categories of financial assets for consideration in the portfolio that the investor is going to construct. Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds and cash. The asset allocation that works best for an investor at any given point in his life depends largely on his time horizon and his ability to tolerate risk.

Time Horizon – The time horizon is the expected number of months, years, or decades that an investor will be investing his money to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable with a riskier or more volatile investment because he can ride out the slow economic cycles and the inevitable ups and downs of the markets. By contrast, an investor who is saving for his teen-aged daughter‘s college education would be less likely to take a large risk because he has a shorter time horizon.

identified in the asset allocation decision. how does an investor select which securities to purchase.‖ While setting the investment policy. is more likely to risk losing money in order to get better results. by holding all or a representative sample of the securities in the index or asset class. Active Management is the process of managing investment portfolios by attempting to time the market and/or select „undervalued? stocks to buy and „overvalued? stocks to sell. Passive Management is the process of managing investment portfolios by trying to match the performance of an index (such as a stock market index) or asset class of securities as closely as possible. it focuses on the „basics? of the business. Security analysis involves examining a number of individual securities within the broad categories of financial assets identified in the previous step. Technical analysis is a method used to evaluate the worth of a security by studying market statistics. technical analysis disregards an issuer‘s financial statements. An aggressive investor. investigation and analysis. based upon research. In other words. it relies upon market trends to ascertain investor sentiment to predict how a security will perform. Fundamental analysis is a method used to evaluate the worth of a security by studying the financial data of the issuer. This portfolio management style does not use market timing or stock selection strategies. 2. management. passive management). Performing Security Analysis This step is the security selection decision: Within each asset type. Unlike fundamental analysis. One purpose of this exercise is to identify those securities that currently appear to be mispriced. Security analysis is done either using Fundamental or Technical analysis (both have been discussed in subsequent units). the investor also selects the portfolio management style (active vs. Portfolio Construction . or one with a low-risk tolerance. The conservative investors keep a ―bird in the hand. and position in its industry. Instead. A conservative investor. or one with a high-risk tolerance.Risk Tolerance – Risk tolerance is an investor‘s ability and willingness to lose some or all of his original investment in exchange for greater potential returns. assets and liabilities. 3. It scrutinizes the issuer‘s income and expenses.‖ while aggressive investors seek ―two in the bush. tends to favour investments that will preserve his or her original investment.

2001 BSE launched DOLLEX-30. 1986. Selectivity refers to security analysis and focuses on price movements of individual securities. timing and diversification issues are addressed. Here selectivity.733 billion (US$660 billion) (42. The Bombay Stock Exchange SENSEX (acronym of Sensitive Index) more commonly referred to as SENSEX or BSE 30 is a free-float market capitalization-weighted index of 30 well-established and financially sound companies listed on Bombay Stock Exchange. and its base year as 1978-79. risks incurred). the market capitalisation of SENSEX was about 29. a dollar-linked version of SENSEX. Portfolio performance evaluation This step involves determining periodically how the portfolio has performed over some time period (returns earned vs. 4. Q.34% of market capitalization of BSE). the SENSEX is regarded as the pulse of the domestic stock markets in India. The base value of the SENSEX is taken as 100 on April 1. Portfolio Revision This step is the repetition of the three previous steps. 5.2 From the website of BSE India. It is made of 30 stocks representing a sample of large. as objectives might change and previously held portfolio might not be the optimal one. explain how the BSE Sensex is calculated. are representative of various industrial sectors of the Indian economy. as well as determining the proportion of the investor‘s wealth to put into each one. On 25 July. liquid and representative companies. The 30 component companies which are some of the largest and most actively traded stocks.690 billion (US$348 billion). As of 21 April 2011. Answer: SENSEX: Sensex is the stock market index for BSE. .This step identifies those specific assets in which to invest. The following table summarizes how the portfolio is constructed for an active and a passive investor. while its free-float market capitalization was 15. It was first compiled in 1986. Published since January 1. Diversification aims at constructing a portfolio in such a way that the investor‘s risk is minimized. 1979. The base year of SENSEX is 1978-79 and the base value is 100. Timing involves forecasting of price movement of stocks relative to price movements of fixed income securities (such as bonds).

77 500410 ACC 500103 BHEL Capital Goods 0. replacement of scrips. 2003. Free float factor represent the percentage of shares that are readily available for trading. The index has increased by over ten times from June 1990 to the present. However this was shifted to the free float method with effect from September 1.90 500180 HDFC Bank Diversified 5.35 532454 Bharti Airtel Telecom 532868 DLF Universal Limited Housing related 0. such as those held by promoters.08 . or shares that are readily available for trading.50 1. which translates to roughly 9% per annum after compensating for inflation.03 0. does not include restricted stocks. The calculation of SENSEX involves dividing the free float market capitalization of 30 companies in the index by a number called index divisor.75 500440 Hindalco Industries Ltd. Factor Housing Related Weight in Index(%) 0. Metal.02 1. the level of index at any point of time reflects the free float market value of 30 component stocks relative to a base period. Instead of using a company‘s outstanding shares it uses its float. therefore.21 5. As per free float capitalization methodology.26 0.The divisor is the only link to original base period value of the SENSEX.43 1. 2010.7 500696 Hindustan Lever Limited FMCG 0.35 3 1. etc.25 500300 Grasim Industries 500010 HDFC Finance 0.5 0. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is multiplied by a free float factor to determine the free float market capitalization. The free-float method.75 Finance 0. Using information from April 1979 onwards.Metal Products & Mining 0. Transport Equipments 0. It keeps the index comparable over time and is the adjustment point for all index adjustments arising out of corporate actions. The index is calculated based on a free float capitalization method—a variation of the market capitalisation method. Globally. Following is the list of the component companies of SENSEX as on Feb 26. Code Name Sector Adj.The Bombay Stock Exchange (BSE) regularly reviews and modifies its composition to be sure it reflects current market conditions. Free float factor is also referred as adjustment factor. government and strategic investors. the free float market capitalization is regarded as the industry best practice.50 2. Initially.55 3.85 500182 Hero Honda Motors Ltd.6% per annum. the index was calculated based on the ‗full market capitalization‘ method. the long-run rate of return on the BSE SENSEX works out to be 18.

85 1.15 2.55 Power 0.70 2.88 507685 Wipro Information Technology0.85 500875 ITC Limited FMCG 0.71 1.86 10.70 1.63 Metal.15 500304? NIIT Information Technology0.99 532532 Jaiprakash Associates 500510 Larsen & Toubro Housing Related Capital Goods 0.61 0. Metal Products. Metal Products & Mining 1.71 Information Technology0.50 1.61 Transport Equipments 0.532174 ICICI Bank Finance 1.25 500520 Mahindra & Mahindra Limited Transport Equipments 0.92 Oil & Gas 500390 Reliance Infrastructure Power 0.55 6.20 3.94 0.26 500209 Infosys Information Technology0.70 4.45 2.50 532541? NIIT Technologies 2.19 4.03 1.87 Telecom 0.20 .45 Metal.39 524715 Sun Pharmaceutical Industries Healthcare 532540 Tata Consultancy Services 500570 Tata Motors 500400 Tata Power 500470 Tata Steel Information Technology0.03 2.35 12.00 7.75 532500 Maruti Suzuki Transport Equipments 0. and Mining 0.03 532555 NTPC Power 0.15 0.40 1.90 0.66 3.03 0.65 500112 State Bank of India 500900 Sterlite Industries Finance 0.25 1.57 500312 ONGC Oil & Gas 532712 Reliance Communications 500325 Reliance Industries 0.