Security Analysis & Portfolio Management

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 Handsome returns have been reaped in many ways;

unfortunately most of them cannot be replicated consistently rewarded by exceptional returns

Investment; however smartly made, cannot always be


Objective of an investor
 Maximization of return  Minimization of risk  Hedge against inflation (if the investment cannot earn as

much as the rise in price level, the ‘real’ rate of return will be negative)


Investment versus speculation
Investmenthorizon Short time Long time horizon speculation Moderate disposition High risk risk

Modest return High return

expectation expectations Bases decision on Bases decision on fundamental factors technical factors Less levered Highly levered


Investment Process
Traditional approach: compare intrinsic value with

market price

Modern approach: emphasis on risk and return in

addition to above


Investment alternatives
Non-marketable Financial Assets Equity shares Bonds Money market instruments Mutual funds Life insurance Real estate Precious objects Financial derivatives

Criteria for Evaluation of Investment
Rate of return Risk Marketability Tax shelter Convenience


Financial Markets
Market for creation and exchange of financial assets Functions of financial markets - facilitate price discovery - Provide liquidity - Reduce cost of transacting


Security Analysis
“ The entire process of estimating return and risk for individual securities is known as security analysis”


Portfolio Management
 Securities having risk return characteristics of their own, in

combination, make up a portfolio

 Portfolio analysis: understanding the interactive effects of

combining the securities

 Portfolio selection: Entails choosing the one best portfolio to

suit the risk-return preferences of the investor
 Portfolio management: evaluating and revising the portfolio

in terms of stated investor objectives


Portfolio Management

Literature supports the efficient markets paradigm
On a well-developed securities exchange, asset prices accurately reflect the tradeoff between relative risk and potential returns of a security

11 11

Efforts to identify undervalued and overvalued securities are fruitless Free lunches are difficult to find


Portfolio Management (cont’d)

Market efficiency and portfolio management

12 12

A properly constructed portfolio achieves a given level of expected return with the least possible risk

Portfolio managers have a duty to create the best possible collection of investments for each customer’s unique needs and circumstances


Purpose of Portfolio Management

Portfolio management primarily involves reducing risk rather than increasing return

13 13

Consider two $10,000 investments:
1) 2)

Earns 10% per year for each of ten years (low risk) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk)


Low Risk vs. High Risk Investments
14 14


Low Risk vs. High Risk Investments (cont’d)
1) Earns 10% per year for each of ten years (low risk)

15 15

Terminal value is $25,937

2) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk)

Terminal value is $23,642


The lower the dispersion of returns, the greater the terminal value of equal investments

Portfolio Management Process
16 16
Set Portfolio Objectives

Choose appropriate Asset mix

Evaluate Performance

Protect the Portfolio When Appropriate

Formulate an Investment Strategy

Have a Game Plan for Portfolio Revision


Common Errors in Investment Management
Inadequate comprehension of return and risk Vaguely formulated investment policy Naïve extrapolation of past Untimely entries and exit Over/under diversification Wrong approach towards losses and profits


Recap of the session
Introduction Investment objectives Investment versus speculation Investment process Investment alternatives Criteria for evaluating investments Financial markets Security analysis and portfolio management Common errors in Investment Management

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