Investment Analysis &

Portfolio Mgt
 Learning Objectives
• Investment Objectives
• Difference between speculation & investing
• Investment Alternatives
• Understanding the risk and return
 what is investments
In 1934, Graham and David Dodd

"An investment operation is one which, upon

thorough analysis promises safety of principal and
an adequate return. Operations not meeting these
requirements are speculative."
 INVESTMENT VS. SPECULATION

INVESTOR SPECULATOR

• PLANNING LONG SHORT

HORIZON
• RISK MODERATE HIGH
DISPOSITION
• RETURN MODEST HIGH
EXPECTATION
• BASIS FOR FUNDAMENTAL TECHNICAL
DECISIONS
• LEVERAGE NO HIGH
 Tools to Predict Equity Markets
Technical Analysis Fundamental Analysis

 Based on Graphs and Averages  Based on financial reports

Used for short term trading Ratios , earnings and assets
Price and Volume considered EIC approach
 Objectives of Investments
Primary Objectives

 Safety of capital -Risk Tolerance

 Regular Income
 Growth of capital

Secondary Objectives
 Tax Minimization
 Marketability / Liquidity
 INVESTMENT ALTERNATIVES

Money Market Instruments Real Estate

Forex
Fixed income securities

Bullion &
Equity Shares commodities

Non-marketable
Pooled
Financial Assets
Investments
Financial Derivatives
 High Risk Return Spectrum

Equity
Real Estate

Gold
Return potential

Debt Funds
PPF, NSC, KVP, PO Deposits, RBI Bonds

Liquid Funds
Savings Bank/ FD
Low

Low Risk High

Note:The above chart is for illustrative purpose only and is not marked to scale. The chart is based
on our perception of the risk and return potential of various investment avenues
 Call money market
• Is an integral part of the Indian money market where day-to-
day surplus funds (mostly of banks) are traded. The main
function of the call money market is to redistribute the pool
of day-to-day surplus funds of banks among other banks in
temporary deficit of funds The loans are of short-term
duration
• Money lent for one day is called ‘call money’;
• if it exceeds 1 day but is less than 15 days it is called ‘notice
money’.
• Money lent for more than 15 days is ‘term money’
• The borrowing is exclusively limited to banks, who are
temporarily short of funds.
 Money Market Instruments
Treasury Bills
 Sold by RBI on auctions basis every week in certain denominations say 91
days ,182 and 364
 Sold at discount and redeemed at par
 The rate of discount and the corresponding issue prices are determined at
each auction.
 When liquidity is tight in the economy, returns on Treasury Bills
sometimes become even higher than returns on bank deposits of similar
maturity.
 Any person in India including Individuals, Firms, Companies, Corporate
bodies, Trusts and Institutions can purchase Treasury Bills.
 Min Denomination 25000
 Treasury Bills are eligible securities for SLR purposes.
 Zero default risk as these are the liabilities of GOI
 Cash Management Bills (CMBs) Less Than 90 days
 Quiz on
• If investor requires 7% annualized Return on
treasury bill with face value of 25000 . What
should be fair price of his Bid
• 25000/1.07= 23364.49
Certificate of Deposit:
• It is a promissory note issued by a bank in form of a certificate
entitling the bearer to receive interest.
• The certificate bears the maturity date, the fixed rate of
interest and the value. It can be issued in any denomination.
They are stamped and transferred by endorsement.
• Its term generally ranges from three months to five years
and restricts the holders to withdraw funds on demand.
However, on payment of certain penalty the money can be
withdrawn on demand. T
• he returns on Certificate of Deposits are higher than T-Bills
because it assumes higher level of risk.
 Commercial Paper
 Debt instruments issued by corporations to meet their short-term financing needs.
 unsecured and have maturities ranging from 90 to 270
 the tangible net worth of the issuer as per the latest audited balance sheet, is not
less than Rs. 4 crore
 The aggregate amount of CP from an issuer shall be within the limit as approved
by its Board of Directors or the quantum indicated by the Credit Rating Agency for
the specified rating, whichever is lower.
 CP can be issued in denominations of Rs.5 lakh or multiples thereof.

Repos

• Short- term money market instrument;

• Transaction where one party agrees to sell a security to another party for
cash.
• The seller agrees to repurchase the security later.
Reliance Infrastructure 59-D
Commercial Paper P1+ 13.18
20/10/2014

Cox & Kings 91-D 10/11/2014 Commercial Paper P1+ 13.06

RHC Holdings Commercial Paper P1+ 10.54

Simplex Infrastructures 60-D

Commercial Paper P1+ 10.53
09/09/2014

Ballarpur Inds. Commercial Paper P1+ 10.43

Globe Capital Market Ltd. 56-

Commercial Paper P1+ 7.92
D 29/09/2014

Globe Capital Market Ltd. 59- 5.27

Commercial Paper P1+
D 17/10/2014
• Treasury bills are issued in minimum
denomination
– 2500
– 1000
– 25000
– 100000

• Commercial paper are issued in minimum

denomination
– 50000
– 500000
– 25000
 Bonds/Fixed Income securities
Traded thru Negotiated Dealing System
https://www.ccilindia.com/OMHome.aspx

Dated Government Securities

Long Maturity and statutory Compulsion
Coupon                                      : 7.49% paid on face value
Name of Issuer                           : Government of India
Date of Issue                              : April 16, 2007
Maturity                                     : April 16, 2017
Coupon Payment Dates              : Half-yearly (October 16 and April 16) every
Minimum Amount of issue/ sale   : Rs.10,000
State Development Loans (SDLs)
• SDLs issued by the State Governments qualify for SLR.
• They are also eligible as collaterals for borrowing through market repo as well as borrowing by eligible
entities from the RBI under the Liquidity Adjustment Facility (LAF).

3) nflation & Savings bonds

 Issued By RBI-
 5 to 10 Yrs-maturity
 cumulative & Non cumulative
 Wealth tax exempt
Tenure Yield to Maturity
1 6.84%
3 6.92%
5 7.08%
7 7.17%
10 7.18%
15 7.26%
20 8.33%
25 8.30%
29 8.13%
 Private sector Debentures

 Long term Capital requirement

 Appoint of trustee
 More than 18 Months need Credit Rating
 Secured against mortgage
 Coupon Rate
 Call Option
 Convertible clause
A debenture is a debt security issued by a corporation that is
not secured by specific assets, but rather by the general credit
of the corporation. Stated assets secure a corporate bond,
unlike a debenture, but in India these are used interchangeably.
 Turnover
Coupon YTM at
Symbol Series LTP % Chng High Low Volume
Rate LTP (%) (lacs)
IRFC N8 8.4 - 1,101.00 0.09 1,101.00 1,101.00 15,000 165.15
NHAI N2 8.3 8.4831 1,067.00 -0.74 1,074.99 1,065.10 7,757 83.12
MUTHOOTFIN N6 12.25 12.1525 1,004.20 0.06 1,007.00 1,002.00 8,093 81.28

SBIN N5 9.95 9.375 10,850.00 0.08 10,859.95 10,831.64 441 47.81

NHAI N1 8.2 8.6926 1,054.00 -0.41 1,062.00 1,054.00 3,758 39.7
ECLFINANCE N5 12 12.6049 1,009.50 0.05 1,010.98 1,008.51 3,291 33.23
NHAI N6 8.75 7.3122 1,170.00 -0.51 1,177.99 1,168.00 2,823 33.03
HUDCO N3 8.1 7.5327 1,075.00 -0.01 1,078.00 1,075.00 2,480 26.69
IRFC N2 8.1 7.4618 1,126.10 -0.35 1,130.00 1,123.00 2,204 24.82
NHBTF2014 N6 9.01 7.5486 6,035.00 0.05 6,040.00 6,026.00 364 21.98
IIFLFIN NA 12 12.0137 1,026.00 0 1,027.00 1,025.50 1,872 19.21
IIHFL N1 11.52 12.0716 1,000.50 -0.08 1,003.00 997 1,877 18.79
IIHFL N2 12 12.6227 1,008.50 0.08 1,011.88 1,005.00 1,618 16.31

SBIN N3 9.75 9.4792 10,575.00 0.18 10,590.00 10,566.14 95 10.04

SRTRANSFIN NL 11.6 10.0859 1,078.43 0.79 1,079.45 1,062.63 838 9
IIFLFIN N8 12 11.621 1,023.89 0.06 1,024.75 1,015.00 878 8.97
SRTRANSFIN Y9 10.15 10.069 1,021.90 -0.03 1,022.89 1,020.11 874 8.93
IIFLFIN N5 12.75 12.0693 1,048.60 -0.06 1,050.30 1,048.50 796 8.35
SRTRANSFIN NW 9.8 9.9307 1,042.00 0.68 1,042.00 1,035.01 777 8.08
L&TFINANCE N3 0 9.7577 1,615.00 0.35 1,615.00 1,609.00 479 7.73
HUDCO N2 8.2 7.4558 1,103.00 0.29 1,106.90 1,096.85 630 6.95
SHRIRAMCIT N8 10.75 10.4828 1,057.30 -0.25 1,060.00 1,055.60 640 6.78
NHBTF2023 N6 8.93 7.4896 5,839.99 0.19 5,840.00 5,830.00 116 6.77
IIFLFIN N4 11.9 - 1,061.00 0.02 1,062.00 1,060.95 496 5.26
 Shares

Equity shares
• Participation In Profit
• Indirect control over the Mgt
• Ownership of company

Preference shares
• Fixed Rate of dividend
• Cumulative dividend
• Redeemable
• Tax exempt
 Stock Market Classification Of Equity Shares

• Blue chip shares

-Financially strong co with impressive earning
• Growth shares
• Income shares
- Stable operations ,high dividend ratios and limited growth opportunities

• Cyclical shares
• defensive shares
• Speculative shares
 Pooled Investments

Pooled Investments

Mutual Funds Trusts Depositories Hedge Funds

Limited
Depository
Shares Units Partnership
Receipts
Interests

Investors
 Commodities
 Bullion
 Oil & oil seeds
 Spices
 Metal
 Fiber
 Pulses
 Cereals
 Energy
 Plantations
 Petrochemicals
 Weather
 Real Estate
• Residential Property
• Commercial Property
• Sub-urban Property
• Agricultural Land
 Ex Ante & Ex Post
Ex-ante - “ before the event” That is the
expected return of an investment portfolio.
one calculates the exante average rate of return
to gauge how much one may expect to make
from it.
Ex-post means actual returns, one calculates
the expost average rate of return after the
investment is complete to determine how
closely the investment matched estimate
 Expected Return
• The future is uncertain.
• Investors do not know with certainty whether the economy
will be growing rapidly or be in recession.
• Investors do not know what rate of return their investments
will yield.
• Therefore, they base their decisions on their expectations
concerning the future.
• The expected rate of return on a stock represents the mean
of a probability distribution of possible future returns on the
stock.

28
 Expected Return
State Probability Return On Return On
Stock A Stock B
1 20% 5% 50%
2 30% 10% 30%
3 30% 15% 10%
4 20% 20% -10%
• The state represents the state of the economy one period in the future i.e. state
1 could represent a recession and state 2 a growth economy.
• The probability reflects how likely it is that the state will occur. The sum of the
probabilities must equal 100%.
• The last two columns present the returns or outcomes for stocks A and B that
will occur in each of the four states.

29
 Expected Return
• Given a probability distribution of returns, the expected
return can be calculated using the following equation:
N

E[R] = (piRi)
i=1

• Where:
– E[R] = the expected return on the stock
– N = the number of states
– pi = the probability of state i
– Ri = the return on the stock in state i.

30
 Expected Return

• In this example, the expected return for stock A would

be calculated as follows:

E[R]A = .2(5%) + .3(10%) + .3(15%) + .2(20%) = 12.5%

• Now you try calculating the expected return for stock B!

31
 Expected Return

• Did you get 20%? If so, you are correct.

• If not, here is how to get the correct answer:

E[R]B = .2(50%) + .3(30%) + .3(10%) + .2(-10%) = 20%

• So we see that Stock B offers a higher expected return

than Stock A.
• However, that is only part of the story; we haven't
considered risk.
32
Ex Post
• calculate the CAGR for a portfolio from the
period from Jan 1, 2005 to Jan 1, 2008
• Initial investment value 10000
• Current Market value 19500
= (19,500 / 10,000)^(1 / 3)] – 1
• = (1.95 ^ 0.3333) – 1
• = 1.2493 – 1
• = 0.2493, or 24.93%.
 Portfolio Risk and Return
• For a portfolio consisting of two assets, the above equation
can be expressed as:
E[Rp] = w1E[R1] + w2E[R2]

• If we have an equally weighted portfolio of stock A and stock

B (50% in each stock), then the expected return of the
portfolio is:
E[Rp] = .50(.125) + .50(.20) = 16.25%

35
 Types of Risk
Systematic Risk - also known as “un diversifiable risk” or
“market risk,”
• Risk which affects the overall market, not just a particular
stock or industry. This type of risk is both unpredictable
and impossible to completely avoid.
• It cannot be mitigated through using the right asset
allocation strategy.

Unsystematic Risk - also known as “nonsystematic risk,”

"specific risk," "diversifiable risk" or "residual risk,“
• Company or industry-specific hazard that is inherent in
each investment.
• Can be reduced through diversification
• An example is news that affects a specific stock such as a
sudden strike by employees. Diversification is the only
way to protect yourself from unsystematic risk.
 Credit or Default Risk
• -Credit risk is the risk that a company or individual will
be unable to pay the contractual interest or principal
on its debt obligations.
• Government bonds have the least amount of default
risk and the lowest returns, while corporate bonds
tend to have the highest amount of default risk but
also higher interest rates.
• Bonds with a lower chance of default are considered to
be investment grade, while bonds with higher chances
are considered to be junk bonds.
• Moody S&P and CRISIL
 Price Risk /Market
• Market risk is caused due to changes in the market
variables, having an adverse impact on asset Price
• These variables may include unfavorable changes in the
interest rates, foreign exchange rates, equity prices and
commodity prices and so on.
 Sovereign/ Country risk
• Refers to the risk that a country won't be able to honor its
financial commitments.
• When a country defaults on its obligations, this can harm the
performance of all other financial instruments in that country
as well as other countries it has relations with.
• Country risk applies to stocks, bonds, mutual funds, options
and futures that are issued within a particular country.
• This type of risk is most often seen in emerging markets or
countries that have a severe deficit.
• Argentina and Spain
 Foreign-Exchange Risk
• When investing in assets in foreign countries ,currency
exchange rates can change the price of the asset as well.
Foreign-exchange risk applies to all financial instruments
that are in a currency other than your domestic currency.

• As an example, if you are a resident of America and invest

in some Canadian stock in Canadian dollars, even if the
share value appreciates, you may lose money if the
Canadian dollar depreciates in relation to the American
dollar.
 Liquidity Risk
• liquidity risk arises from situations in which a party interested in
trading an asset cannot do it because nobody in the market wants
to trade for that asset. Liquidity risk becomes particularly important
to parties who are about to hold or currently hold an asset, since it
affects their ability to trade.
• It is the risk that a given security or asset cannot be traded quickly
enough in the market to prevent a loss

“Amaranth Advisors lost roughly $6bn in the natural gas futures

market back in September 2006. Amaranth had a concentrated,
undiversified position in its natural gas strategy. The trader had
used leverage to build a very large position. Amaranth’s positions
were staggeringly large, representing around 10% of the global
market in natural gas future”
 Other Types of Risk
• Interest Rate Risk is the risk that an investment's value
will change as a result of a change in interest rates.
This risk affects the value of bonds more directly than
stocks.
• Political Risk represents the financial risk that a
country's government will suddenly change its policies.
This is a major reason why developing countries lack
foreign investment.
• Exposure risks include risks of bank’s exposure to a
single entity or a group of related entities, and risks of
banks’ exposure to a single entity related with the
bank.
 Other Types of Risk
• Operational risk is the risk caused by omissions in the
work of employees, inadequate internal procedures and
processes, inadequate management of information and
other systems, and unforeseeable external events.
• Legal risk is the risk of loss caused by penalties or
sanctions originating from court disputes due to breach
of contractual and legal obligations, and penalties and
sanctions pronounced by a regulatory body.
• Reputational risk is the risk of loss caused by a negative
impact on the market positioning of the bank.
 Measures of Risk
• Risk reflects the chance that the actual return on an
investment may be different than the expected return.
• One way to measure risk is to calculate the variance and
standard deviation of the distribution of returns.
• We will once again use a probability distribution in our
calculations.
• The distribution used earlier is provided again for ease of use.

44
 Statistical Measures of Risk
Variance
• Variance is a statistical measure used for
probability distribution. Variance is defined as
the measurement of the variability
(volatility) from mean or average.
• It can help investors determine the risk
involved in purchasing a specific security.
 

• A large variance is indicative of the fact that the numbers in

the set are far from the mean as well as from each other,
while a small variance indicates the opposite
• Variance is used by statisticians to interpret how individual
numbers relate to each other within a data set. The
drawback of variance is that it also gives much weight to
the numbers that are very far from the mean,
• i.e. the numbers that are outliers, and squaring such
numbers can lead to misinterpretation of the data as they
may skew the final result.
 Standard Deviation

• Standard Deviation is defined as the measure of deviation or

dispersion of a set of data from its mean. More the data is spread
apart, higher will be the deviation.
• Standard deviation is calculated as the square root of variance.
• An investor would use this statistical measure to calculate the
investment's volatility by applying standard deviation to the annual
rate of return of an investment.
• Standard deviation, also known as historical volatility, is a useful
tool to anticipate expected volatility.
• lower standard deviation is a sign of a stable stock, while a volatile
stock will have a high standard deviation. A large dispersion is a sign
of how much the return on the fund is deviating from the expected
normal returns.
 Coefficient of Variation (CV)

• Coefficient of Variation is a statistical

measure of the dispersion or deviation of
data points in a data series around the mean.
It basically represents the ratio of the
standard deviation to the mean. It is
calculated as follows:
• This ratio is useful to compare the degree of
variation from one data series to another,
even though the means might drastically differ
from each other.
• It is also useful to investors to determine the
volatility (risk) of a stock in comparison to the
expected return from that particular stock.
• the lower the ratio of coefficient of variation,
the better the risk-return trade off.
 Exercise 1
• A stock earns the following returns over a five year
period:
• R1 = 0.30,
• R2 = -0.20,
• R3 = -0.12,
• R4 = 0.38,
• R5 = 0.42,
• R6 = 0.36.
• What is the expected return and standard deviation of
returns for the stock
Expected Return
 Standard deviation
Deviation (Ri- Square of deviation (Ri-
Period Return in % Ri
R) R)2
1 30 11 121
2 -20 -39 1521
3 -12 -31 961
4 38 19 361
5 42 23 529
6 36 17 289
19 SUM= 3782
R=
 ABC XYZ ABC
XYZ

Jan 115 98
feb 129 101 12.2% 3.1%
Mar 138 105 7.0% 4.0%
Apr 126 108 -8.7% 2.9%
May 110 112 -12.7% 3.7%
Jun 132 114 20.0% 1.8%
Jul 140 116 6.1% 1.8%
Aug 165 118 17.9% 1.7%
Sep 174 121 5.5% 2.5%
Oct 150 125 -13.8% 3.3%
Nov 135 132 -10.0% 5.6%
Dec 162 130 20.0% -1.5%
Mean 3.9% 2.6%
Std Dev 13.2% 1.8%
 Portfolio Expected Return
• The Expected Return on a Portfolio of stock is
calculated as the weighted average of the
expected returns on the stocks which
comprise the portfolio.
• The weights are reflective of the proportion of
the portfolio invested in the stocks.
• E[Rp] =
 Portfolio Return

• The Expected Return on a Portfolio is computed as the weighted

average of the expected returns on the stocks which comprise the
portfolio.
• The weights reflect the proportion of the portfolio invested in the
stocks.
• This can be expressed as follows:
N

E[Rp] =  wiE[Ri]
i=1

• Where:
– E[Rp] = the expected return on the portfolio
– N = the number of stocks in the portfolio
– wi = the proportion of the portfolio invested in stock i
– E[Ri] = the expected return on stock i 58
 Portfolio Return
• For a portfolio consisting of two assets, the above equation
can be expressed as:
E[Rp] = w1E[R1] + w2E[R2]

• If equally weighted portfolio of stock A and stock B (50% in

each stock), expected return on
• Portfolio A =12.5%
• Portfolio B= 16.25%

• Calculate expected return of portfolio

59
• Answer
• then the expected return of the portfolio i
E[Rp] = .50(.125) + .50(.20) = 16.25%
 Portfolio Risk

– Covariance is a measure that combines the variance

of a stock’s returns with the tendency of those returns
to move up or down at the same time other stocks
move up or down.
– Since it is difficult to interpret the magnitude of the
covariance terms, a related statistic, the correlation
coefficient, is often used to measure the degree of co-
movement between two variables. The correlation
coefficient simply standardizes the covariance.
61
• 12 = the covariance between the returns on stocks 1 and 2,
• N = the number of states,
• pi = the probability of state i,
• R1i = the return on stock 1 in state i,
• E[R1] = the expected return on stock 1,
• R2i = the return on stock 2 in state i, and
• E[R2] = the expected return on stock 2.
 Covariance
• Covariance indicates how two variables are related. A positive covariance
means the variables are positively related, while a negative covariance means
the variables are inversely related. The formula for calculating covariance of
sample data is shown below.

• x = the independent variable

y = the dependent variable
n = number of data points in the sample
 = the mean of the independent variable x
 = the mean of the dependent variable y
Consider the table below, which describes the rate of economic growth (xi) and
the rate of return on the S&P 500 (yi
• The Correlation Coefficient between the returns on
two stocks is calculated as follows
:

• r12 = the correlation coefficient between the returns on

stocks 1 and 2,
• s12 = the covariance between the returns on stocks 1
and 2,
• s1 = the standard deviation on stock 1, and
• s2 = the standard deviation on stock 2.
 correlation coefficient
• If the correlation coefficient is one, the variables have a perfect positive correlation.
This means that if one variable moves a given amount, the second moves
proportionally in the same direction. A positive correlation coefficient less than
one indicates a less than perfect positive correlation, with the strength of the
correlation growing as the number approaches one.
• If correlation coefficient is zero, no relationship exists between the variables. If one
variable moves, you can make no predictions about the movement of the other
variable; they are uncorrelated.
• If correlation coefficient is –1, the variables are perfectly negatively correlated (or
inversely correlated) and move in opposition to each other. If one variable
increases, the other variable decreases proportionally. A negative correlation
coefficient greater than –1 indicates a less than perfect negative correlation, with
the strength of the correlation growing as the number approaches –1.
• COV(x,y) = 1.53
sx = 0.90
sy = 2.58
 Beta
• Beta measures a stock’s sensitivity to
overall market movements .A “coefficient
measuring a stock’s relative volatility”
• In practice, Beta is measured by comparing
changes in a stock price to changes in the
value of the index like NIFTY & Sensexc
over a given time period
• The Market index (Nifty ) has a beta of 1
 A Generic Example
• Stock XYZ has a beta of 2

• The S&P 500 index increases in value by 10%

• The price of XYZ is expected to increase 20%

over the same time period
 Beta can be Negative
• Stock XYZ has a beta of –2

• The S&P 500 index INCREASES in value by 10%

• The price of XYZ is expected to DECREASE 20%

over the same time period
• If the beta of XYZ is 1.5 …

• And the S&P increases in value by 10%

• The price of XYZ is expected to increase 15%

• A beta of 0 indicates that changes in the
market index cannot be used to predict
changes in the price of the stock

• The company’s stock price has no correlation

to movments in the market index
 How to Calculate Beta

Beta = Covariance(stock price, market index)

Variance(market index)

**When calculating, you must compare the

percent change in the stock price to the
percent change in the market index**
 How to Calculate the Beta
  Returns
  NIFTY (x) Rajesh Export (y)
April 4% 14%
May -1% 5%
June -9% -42%
July 9% -6%
August 2% 7%
September 2% 4%
Oct 10% 9%

β=
Y is the returns on your portfolio or stock - DEPENDENT VARIABLE
X is the market returns or index - INDEPENDENT VARIABLE
 =

  NIFTY (x) (y) xy x^2

April 4 14 56 16
May -1 5 -5 1
June -9 -42 378 81
July 9 -6 -54 81
August 2 7 14 4
September 2 4 8 4

Oct 10 9 90 100
287
 ∑ 17 -9 487

= 2.07093
Security Name Beta R2 Volatility (%)
ACC Ltd. 0.94 0.35 1.47
Idea Cellular Ltd. 0.74 0.11 1.94
IndusInd Bank Ltd. 1.08 0.41 1.92
Infosys Ltd. 0.61 0.12 2.03
I T C Ltd. 0.7 0.17 1.55
Kotak Mahindra Bank Ltd. 1 0.32 2.12
Larsen & Toubro Ltd. 1.22 0.53 1.85
Maruti Suzuki India Ltd. 0.88 0.42 1.82
NMDC Ltd. 0.63 0.11 1.92
NTPC Ltd. 0.86 0.27 1.85
Oil & Natural Gas Corporation Ltd. 1.06 0.27 3.14
Punjab National Bank 1.29 0.28 3.56
Power Grid Corporation of India
Ltd. 0.54 0.18 1.33
UltraTech Cement Ltd. 1.18 0.39 1.73
Vedanta Ltd. 1.52 0.28 4.88
Yes Bank Ltd. 1.57 0.48 3.43
Zee Entertainment Enterprises Ltd. 0.93 0.24 2.47
 Beta and Coefficient of Beta

• Beta measures the volatility or systematic risk of a security or a

portfolio in comparison to the market as a whole. In simple terms,
• Beta can be defined as the tendency of a security's returns to
respond to the movements in the market. It is also known as Beta
coefficient.
• Beta uses regression analysis in its calculation. If beta is equal to 1,
it indicates that the security's price will move along with the market
and a less than 1 beta states that the security will be less volatile
when compared to the market.

• However, a greater than 1 beta is indicative of more volatility in the

security's price than the market. For example, if the beta of a stock
is 1.4, theoretically it is 40% more volatile in comparison to the
market.
 Additional problem

• Probability Distribution:

State Probability Return On Return On

Stock A Stock B
1 20% 5% 50%
2 30% 10% 30%
3 30% 15% 10%
4 20% 20% -10%
• E[R]A = 12.5%
• E[R]B = 20%
84
 Measures of Risk
• Given an asset's expected return, its variance can be
calculated using the following equation:
N

Var(R) = 2 =  pi(Ri – E[R])2

i=1

• Where:
– N = the number of states
– pi = the probability of state i
– Ri = the return on the stock in state i
– E[R] = the expected return on the stock

85
 Measures of Risk
• The variance and standard deviation for stock A is calculated as
follows:

2A = .2(.05 -.125)2 + .3(.1 -.125)2 + .3(.15 -.125)2 + .2(.2 -.125)2 = .002625



• Now you try the variance and standard deviation for stock B!
• If you got .042 and 20.49% you are correct.

86
 Measures of Risk

• If you didn’t get the correct answer, here is how to get it:

2B = .2(.50 -.20)2 + .3(.30 -.20)2 + .3(.10 -.20)2 + .2(-.10 - .20)2 = .042



• Although Stock B offers a higher expected return than Stock A, it

also is riskier since its variance and standard deviation are greater
than Stock A's.
• This, however, is still only part of the picture because most
investors choose to hold securities as part of a diversified
portfolio.
87
Overview of Indian and world equity markets.
Primary Market

The Primary Market is that part of the Capital markets that deals
with the issuance of new securities. Companies, governments or
public sector institutions can obtain funding through the sale of a
new stock or bond issue.

Secondary Market

• The Secondary Market is the place where existing securities are

traded.
• It enables the Participants who hold Securities to adjust their
holdings in response to changes in their assessment of risk and
returns.
• It also provides the Investors the liquidity needs.
 Need For Capital

Banks & FI’s Primary Markets –IPO

(Equities)
Self Financing
(Loans, Debts)

General Public/Investors

Trading Member Broker

Secondary Market - NSE & BSE

(Listing of Shares In Stock Exchanges Like NSE and BSE)

Trading Member Broker

Buyer
 Intermediaries
Stock exchanges NSE & BSE
Brokers
 Registrars
Depositories and their participants
Securities and Exchange Board of India (SEBI)
 Derivatives

Financial Commodity
Derivatives Derivatives

Equity Real Foreign Debt

Derivatives Estate Exchange Derivatives

Interest GOI Sec

Index Stocks Rate Bonds
T-Bills
 What is Futures
• Agreement between two parties to exchange an
asset at a certain date in future at a certain price.

• Asset can be INDEX, Commodities ,Equities, Currency

• It is a standardized forward contract that is traded on
an exchange.
 Increase price &
Decrease in wheat price
Higher Production low supply

Forward Contract

If wheat
price increase
to 25 do you
think farmer
Contract Specification
will honor this
Quantity 10,000 Kgs contract ?
Price 15 Rs per Kg
Settlement 30-Dec
date
Place Punjab
Quality A Grade
 Stock Exchange
Collects Margins & Takes
Counter Party Risk

Buyer Seller
( Long Position) ( Short Position)
 Futures Terminology
• Spot price: The price at which an asset trades in the
cash market.
• Futures price: The price at which the futures contract
trades in the futures market.
• Contract maturity: The period over which a contract
trades. The maturity is 1, 2, 3 months in India.
• Expiry date: The last trading day of the contract.
• Contract size: The notional value of the contract
worked out as Futures Price multiplied by the volume
of units.
 Futures Terminology
• Initial margin: Upfront amount that must be deposited in the
margin account prior to trading.
• Marking-to-market: The process of Revaluing each investor's
positions generally at the end of each trading day and
computing the profit or loss on the positions accordingly.
• Maintaining margin :- If the balance in the margin account
falls below the maintenance margin, the investor receives a
margin call and is expected to top up the margin account to
the initial margin level before trading commences on the next
day.
• Open Interest –Total number of Outstanding Futures
positions in specific futures contract
• Basis: Future Price - Spot Price. In normal market basis is
positive.
PHYSICAL DELIVERY VS. CASH SETTLEMENT

• Futures contracts are either cash settled or

physically delivered.
• Futures contracts that are physically delivered
require the holder to either produce the
commodity or take delivery from the
exchange.
• Futures contracts that are cash settled are not
deliverable and a simple debit or credit is
issued when the contract expires
 Settlement/ Closing
  Lot Size Price Per Contract %
NIFTY 25 8635.85 21810 10%
ACC 250 1572.2 61738 16%
ARVIND 1000 286.75 48008 17%
ASHOKLEY 8000 70.95 101500 18%
CIPLA 500 711.6 55955 16%
COALINDIA 1000 365.75 57508 16%
COLPAL 125 2040.25 40042 16%
HDFCBANK 250 1056 41583 16%
ICICIBANK 1250 330.3 64894 16%
LT 250 1685.2 66218 16%
M&M 250 1207.75 47427 16%
M&MFIN 1000 265.75 41748 16%
MARUTI 125 3669.15 72131 16%
NHPC 10000 19.8 32000 16%
RELIANCE 250 858.05 33728 16%
RELINFRA 500 454.55 44559 20%
TATASTEEL 500 337.45 26536 16%
TCS 125 2596.45 50984 16%
Unitech 9000 19.4 51388 29%
ZEEl 1000 360.85 56763 16%
 Trade Demo
No of
Trade Date Trade Type Scrip Code Price
Lots
12-Nov 2015
Short HDFC Bank FUT NOV 15 3 1020 Market

HDFC Bank FUT NOV 15

18-Nov-2015 Long 2 1085 Market

HDFCBank FUT NOV 15 Final cash

26-Nov-2015 Long 1 960
settlement

Illustrated working for the same is provided in excel sheet

 Maturity of futures contracts
These contracts of different maturities are called near month (one month),
middle month (two months) and far month (three months) contracts. At
any point of time there will be three futures contracts available for
trading.
 Class Activity
• Calculate MTM and Initial & Span Margin to paid on
Buying future contract of Reliance Stock Futures at Rs
885 and lot size is 500 and span and In Margin charged
by exchange is 18%. What is Margin payable

Span & Initial Span & Initial MTM Gain or

Date Closing Price Margin Margin (Value) Loss
Day 1 870    
Day 2 890 19.5%   
Day 3 902 17.5%   
Day 4 896 18.5%   
Day 5 908  16.0%  
Day 6 Sold @ 916  15.5%  
Options
 What is Options
• Options are derivative contracts where the
Buyer (Holder) gets a right (but not obligation)
to buy or sell a specified quantity of the
underlying asset at an agreed price (strike
price) on or before the specified future date
(expiration date) based on the option type
Options
 Illustration -Options
 Foodworld offers Membership card for fee of Rs 1000
 Membership fee is not refundable
 Which entitles ( Right) the holder to buy 1000 kg onions at 30 per
Kg
 Membership card is valid for 30 days
 Membership card can be sold / transferred to another party by
holder
 So Options…
 Gives the buyer the right
 Not the obligation
 To buy or sell
 A specified underlying
 At a set price
 On or before a specified date
 Option Terminology
• Option Premium
– Price paid by the buyer to acquire the right
• Strike Price or Exercise Price
– Price at which the underlying may be
purchased
• Expiration Date
– Last date for exercising the option
• Exercise Date
– Date on which the option is actually exercised
 Types of Options based on Settlement

• American Option (options on stocks)

– can be exercised any time on or before the expiration
date

• European Option (options on index)

– can be exercised only on the expiration date (options
on index)
 Call Option

A call option gives the buyer, the right to buy

specified quantity of the underlying asset at the
set strike price on or before expiration date.

The seller (writer) however, has the obligation

to sell the underlying asset if the buyer of the
call option decides to exercise his option to buy.
Payoff for Buyer of Call option
Profit

6000
0
Nifty

60

Premium paid

Loss
long a call option of on 7th sep of HDFC Bank Ltd Sep Strike 880 by Paying
Premium of 6 Rs .Compute the Profit Market Price on 26th Sep is

Possibility Market Price Answer

Scenario 1 920 -6+40=34 

Scenario 2 900  -6+20=14

Scenario 3 875  -6+0=-6

Scenario 4 882 -6+2=-4 

 -6+0=-6
Scenario 5 825  
 -6+0=-6
Scenario 6 880  
 Question 1
If a Trader Purchases ITC call option of Rs 350 Strike Rate @ a Premium 14 Rs
Lot size 1000. Calculate his Profit or Loss. Draw Payoff Graph

Scenario 1 On the Expiry date the Closing Price of ITC may be Rs 385
Scenario 2 On the Expiry date the Closing Price of ITC may be Rs 334

Question 2
If a Trader RCOM Call OPTION of Rs 125 Strike price by paying a premium 6 Rs
& Lot size 2000. Calculate his Profit or Loss.

Scenario 1 On the Expiry date the Closing Price of Rcom may be Rs 142
Scenario 2 On the Expiry date the Closing Price of Rcom may be Rs 125
Scenario 3 On the Expiry date the Closing Price of Rcom may be Rs 130
Scenario 4 On the Expiry date the Closing Price of Rcom may be Rs 113
 Payoff for Seller of call option
Profit

Premium
Received

60
6000
0
Nifty

Loss
 Put Option
• A buyer of Put option has the right but not the
obligation to sell the underlying at the set
price by paying the premium upfront.

• He can exercise his option on or before expiry.

 Put Buyer v/s Seller
• Put Buyer
– Pays premium
– Has right to exercise resulting in a short position in the underlying
– Time works against buyer
– Risk limited, Reward unlimited

• Put Seller
– Collects premium
– Has obligation if assigned resulting in a long position in the underlying
– Time works in favor of seller
– Risk unlimited, Reward limited
Payoff for Buyer of Put Option
Profit

0 6000

Nifty
60

Premium paid

Loss
 Question 1
A trader Buys YES bank Put Option Strike rate of Rs 650 at Premium
Rs 14 Market Lot size 500. Calculate his Profit or Loss.

 Scenario 1 On the Expiry date the Closing Price of Yes may be Rs 685
 Scenario 2 On the Expiry date the Closing Price of Yes bank may be Rs584

Question 2

A trader Buys RCapital Put Option of Rs 450 Strike price by paying a

premium 6 Rs & Lot size 2000. Calculate his Profit or Loss

 Scenario 1 On the Expiry date the Closing Price of Rcap may be Rs 442
 Scenario 2 On the Expiry date the Closing Price of Rcom may be Rs 425
 Scenario 3 On the Expiry date the Closing Price of Rcom may be Rs 480
 Scenario 4 On the Expiry date the Closing Price of Rcom may be Rs 493
Payoff for Buyer of Put Option
Profit

584 636 650 685

Nifty
14

Premium paid

Loss
Payoff for the Writer of Put Option
Profit

Premium
received
60
6000
0
Nifty

Loss
 Activity
Underying Stock
Transaction Option Strike Premium
Company Name Expiry Date Lot Size Price on Expiry Profit
Type Type Price Paid
Date
ADANIENT 30-Jul-15 500 long CALL 80 3 89.9  
ADANIPORTS 30-Jul-15 1000 long CALL 330 4 318.7  
ADANIPOWER 30-Jul-15 4000 short CALL 20 3 28.65  
AJANTPHARM 30-Jul-15 250 short CALL 1700 23 1606.05  
ALBK 30-Jul-15 2000 long CALL 90 5 92.85  
AMARAJABAT 30-Jul-15 250 long CALL 830 17 855.8  
AMBUJACEM 30-Jul-15 1000 short CALL 300 23 241.7  
AMTEKAUTO 30-Jul-15 2000 short CALL 150 8 155.9  
ANDHRABANK 30-Jul-15 4000 long CALL 65 3 71.4  
APOLLOHOSP 30-Jul-15 250 long PUT 1300 7 1324.75  
APOLLOTYRE 30-Jul-15 2000 long PUT 190 4 176.45  
ARVIND 30-Jul-15 1000 short PUT 290 4 282.6  
ASIANPAINT 30-Jul-15 250 short PUT 750 30 799.5  
AUROPHARMA 30-Jul-15 250 short PUT 1400 65 1458.35  
AXISBANK 30-Jul-15 500 long PUT 550 25 581.1  
BAJAJ-AUTO 30-Jul-15 125 long PUT 2300 45 2479  
BAJFINANCE 30-Jul-15 125 short PUT 4500 165 5053.95  
BANKBARODA 30-Jul-15 2000 short PUT 150 17.5 156.8  
 Any option with intrinsic value is known as
“in-the-money.” An option without intrinsic
value is known as “out-of-the-money”. An
option with an exercise price equal to the
underlying security price is known as “at-the-
money”.

Market Scenario Call Option Put Option

Market price > Strike
price in-the-money out-of-the-money
Market price < Strike
price out-of-the-money in-the-money
Market price = Strike
price at-the-money at-the-money
 •Identify ITM/ATM/OTM

SL Strike Price Option Type Market Price ITM/ATM/OTM

1 40 CE 35  

2 150 CE 165  

3 350 PE 345  

4 125 PE 125  

5 2500 CE 2678  

6 170 PE 150  

7 50 CE 50  

8 200 PE 215  
 Components of Option Value
• Options Premium = Intrinsic value + Time Value.
• Intrinsic value = Intrinsic value is the value which you can get back if you exercise
the option.
• Time Value = The price (premium) of an option less its intrinsic value.

Satyam      

 Example Spot Price Rs. 223.7 26-Jun-02

Intrinsic
Satyam Jun Call Premium Value Time Value
Satyam 200 24 23.7 0.3
Satyam 220 5.5 3.7 1.8
Satyam 230 1.75 0 1.75
Satyam 240 0.5 0 0.5
Satyam 260 0.15 0 0.15
 Option Intrinsic Time Value
SL Strike Price Type Market Price Premium Value

1 50 CE 65 17

2 150 CE 135 4    

3 350 PE 345 10    

4 125 PE 125 4    

5 2500 CE 2678 180    

6 170 PE 150 32    

7 50 PE 42 11    

8 200 PE 215 6    
 Types of Options based on Settlement

• American Option (options on stocks)

– can be exercised any time on or before the
expiration date

• European Option (options on index)

– can be exercised only on the expiration date
(options on index)
 Why Black scholes option pricing
Model is used

• To determine the fair value of option premium

LTP-Ask BSOP Model
Equity CMP CE DEC 2013 CE DEC 2013

PTC India 62 4.5 3.72

135
 Determinants of the Fair Value of Option Premium

• Strike price
• Time until expiration
• Stock price
• Volatility
• Risk-free interest rate

136
 The Model


C  PoN ( d1 )  X / e RfT
N (d 2 )
where
 P  2 
ln 
 Rf  
T
 X   2 
d1 
 T
and
d 2  d1   T 137
 The Model (cont’d)
• Variable definitions:
Po= current stock price
X = option strike price
e = base of natural logarithms 2.7182818
Rf = riskless interest rate
T = time until option expiration
 = standard deviation (sigma) of returns on
the underlying security
ln = natural logarithm
N(d1) and
N(d2) = cumulative standard normal distribution
functions

138
 Strike Price
• The lower the striking price for a given stock,
the more the option should be worth
– Because a call option lets you buy at a
predetermined striking price

139
 Time Until Expiration
• The longer the time until expiration, the
more the option is worth
– The option premium increases for more distant
expirations for puts and calls

140
 Stock Price
• The higher the stock price, the more a given
call option is worth
– A call option holder benefits from a rise in the
stock price

141
 Volatility
• The greater the price volatility, the more the
option is worth
– The volatility estimate sigma cannot be directly
observed and must be estimated
– Volatility plays a major role in determining time
value

142
 Risk-Free Interest Rate
• The higher the risk-free interest rate, the
higher the option premium, everything else
being equal
– A higher “discount rate” means that the call
premium must rise for the put/call parity
equation to hold

143
 Assumptions of the Black-Scholes Model

• The stock pays no dividends during the

option’s life
• European exercise style
• Markets are efficient
• No transaction costs
• Interest rates remain constant
• Prices are lognormally distributed

144
 The Stock Pays no Dividends During the
Option’s Life
• If you apply the BSOPM to two securities,
one with no dividends and the other with a
dividend yield, the model will predict the
same call premium
– Robert Merton developed a simple extension to
the BSOPM to account for the payment of
dividends

145
 European Exercise Style
• A European option can only be exercised on
the expiration date
– American options are more valuable than
European options
– Few options are exercised early due to time value

146
 Markets Are Efficient
• The BSOPM assumes informational efficiency
– People cannot predict the direction of the market
or of an individual stock
– Put/call parity implies that you and everyone
else will agree on the option premium, regardless
of whether you are bullish or bearish

147
 No Transaction Costs
• There are no commissions and bid-ask
spreads
– Not true
– Causes slightly different actual option prices for
different market participants

148
 Interest Rates Remain Constant
• There is no real “riskfree” interest rate
– Often the 30-day T-bill rate is used
– Must look for ways to value options when the
parameters of the traditional BSOPM are
unknown or dynamic

149
 Prices Are Lognormally Distributed
• The logarithms of the underlying security
prices are normally distributed
– A reasonable assumption for most assets on
which options are available

150
 Intuition Into the Black-Scholes Model
(cont’d)
• The value of a call option is the difference
between the expected benefit from acquiring
the stock outright and paying the exercise
price on expiration day

151
 Calculating Black-Scholes Prices from
Historical Data
• To calculate the theoretical value of a call
option using the BSOPM, we need:
– The stock price
– The option striking price
– The time until expiration
– The riskless interest rate
– The volatility of the stock

152
Calculating Black-Scholes Prices from
Historical Data

Valuing a Microsoft Call Example

We would like to value a MSFT OCT 70 call in the year

2000. Microsoft closed at $70.75 on August 23 (58 days
before option expiration). Microsoft pays no dividends.

We need the interest rate and the stock volatility to value

the call.
153
Calculating Black-Scholes Prices from
Historical Data

Valuing a Microsoft Call Example (cont’d)

Consulting the “Money Rate” section of the Wall Street

Journal, we find a T-bill rate with about 58 days to maturity
to be 6.10%.

To determine the volatility of returns, we need to take the

logarithm of returns and determine their volatility. Assume
we find the annual standard deviation of MSFT returns to
be 0.5671.
154
 Calculating Black-Scholes Prices from Historical Data

Valuing a Microsoft Call Example (cont’d)

Using the BSOPM:

S  
2

ln    R  T
K  2 
d1 
 T
 70. 75   .56712

ln    .0610  0.1589
 70   2 
  .2032
.5671 .1589
155
156
157
Calculating Black-Scholes Prices from
Historical Data

Valuing a Microsoft Call Example (cont’d)

Using the BSOPM (cont’d):

d 2  d1   T
 .2032  .2261  .0229

158
Calculating Black-Scholes Prices from
Historical Data

Valuing a Microsoft Call Example (cont’d)

Using normal probability tables, we find:

N (.2032)  .5805
N (.0029)  .4909

159
Calculating Black-Scholes Prices from
Historical Data

Valuing a Microsoft Call Example (cont’d)

The value of the MSFT OCT 70 call is:

RT
C  SN (d1 )  ( X / e ) N (d 2 )
(.0610)(.1589)
 70.75(.5805)  70 / 2.708 (.4909)
 $7.04
160
161
Calculating Black-Scholes Prices from
Historical Data

Valuing a Microsoft Call Example (cont’d)

The call actually sold for $4.88.

The only thing that could be wrong in our calculation is the

volatility estimate. This is because we need the volatility
estimate over the option’s life, which we cannot observe.

162
 Using Black-Scholes to Solve for the Put
Premium
• Can combine the BSOPM with put/call parity:

 RT
P  Xe N (d 2 )  PoN (d1 )

163
 Problems Using the Black-Scholes Model

• Does not work well with options that are

deep-in-the-money or substantially out-of-
the-money
• Produces biased values for very low or very
high volatility stocks
– Increases as the time until expiration increases
• May yield unreasonable values when an
option has only a few days of life remaining

164
 Binomial Model
C = ∆S + B

Cu =Max (uS-E,0)
Cd =Max (dS-E,0)
u = upper price
d= Lower price

R is rate of interest
• A stock is currently selling for Rs.80. In a year’s
time it can rise by 50 percent or fall by 20
percent. The exercise price of a call option is
Rs.90.

• (i) What is the value of the call option if the

risk-free rate is 10 percent? Use the option-
equivalent method.
S0 = Rs.80 u = 1.5 d = 0.8
E = Rs.90 r = 0.10 R = 1.10
Cu =Max (uS-E,0) ((1.5*80)-90,0))=30
Cd =Max (dS-E,0) ((0.7*80) -90,0))=0
An equity share is currently selling for Rs 100. In
a year’s time it can rise by 30 percent or fall by
10 percent. The exercise price of call option on
this share is Rs.110.
•  
• (i) What is the value of the call option if the
risk – free rate is 7 percent ? Use the option –
equivalent method.