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1.1 Introduction
Financial investment is a process of paying out money now for the prospect
of getting back a bigger amount in the future. It means converting money
into an asset or a claim for a good financial return.
Investment can be made in the form of securities, and this type of
investment is the theme of our subject, Security Analysis and Portfolio
Management (SAPM). Investment can also be in non-security form.
SAPM deals with investment avenues in financial securities, evaluating a
security, ways to carry out fundamental and technical analysis of the
1.3.2 Portfolio
Portfolio is the combination of different classes of financial assets held by an
investor. A combination may include equity, debentures, warrants, money
market instruments etc.
An investor with a view to maximise return and minimise the risk builds a
portfolio of varied financial securities with different risk-return characteristics.
Portfolio analysis is an analysis of the risk-return characteristics of individual
securities in the portfolio, and the portfolio as a whole.
1.3.3 Security analysis
Security analysis involves the projection of future earnings, forecast of the
share price and estimate of the intrinsic value of a security. Intrinsic value is
derived from the forecast of future cash flows by way of dividend/interest
and terminal value (redemption value) of the security.
Security analysis at a fundamental level studies the strengths and
weaknesses of the asset, which backs the security, and evaluates the
risk/return ratio.
1.3.4 Portfolio management
Investopedia defines portfolio management as the art and science of
making decisions about investment mix and policy, matching investments to
objectives, asset allocation for individuals and institutions, and balancing
risk against performance. Portfolio management is all about strengths,
weaknesses, opportunities and threats in the choice of debt vs. equity,
domestic vs. international, growth vs. safety, and many other tradeoffs
encountered in the attempt to maximise return at a given appetite for risk.
Traditional portfolio theory aims at having a portfolio that matches the asset
preference of the investor. Modern portfolio theory focuses on maximisation
of return with minimum risk. It is the weighted average of return of individual
stocks. The risk appetite of the investor is definitely taken into account, but
continuous risk-return analysis is done to aim at optimising returns.
Portfolio analysis comprises of portfolio construction, selection of securities,
revision, evaluation and regular monitoring of the performance of the
portfolio.
Equity shares
Equity shares represent ownership capital. An equity shareholder enjoys
both ownership stake and residual interest in income and wealth. The issue
of equity shares could be in the form of initial public offer, rights issue,
bonus issue, preferential allotment and private placement.
Investors have a choice to select equity shares from a broad array of the
following types of equity instruments: blue chip company shares, growth
shares, income shares, cyclical shares and speculative shares.
Bonds/Debentures
Bonds represent long-term debt instruments. The issuer of a bond promises
to pay a stipulated amount (interest and principal) to the bondholder. Bond/
debenture is a contract between the issuer and the bondholder that
specifies details of the issue including par value of the bond, its coupon rate,
maturity period, maturity date, call/put options etc.
Internationally, a secured corporate debt instrument is called a corporate
bond while an unsecured corporate debt instrument is called a corporate
debenture. In India, corporate debt instrument is a debenture and it is
secured.
Central and State Governments issue government bonds. These bonds are
called gilt-edged securities. There are different types of bond straight
bonds, zero coupon bonds, floating rate bonds, bonds with embedded
options, commodity linked bonds etc. These are dealt in detail in the later
units.
Money market instruments
Debt instruments, which have a maturity of less than one year at the time of
issue, are called money market instruments. Important money market
instruments are:
Treasury bills.
Commercial paper.
Certificate of deposits.
Repurchase agreements Repos and Reverse Repos.
Mutual funds
Mutual funds are also known as indirect investments. It is an alternative
route of buying equity shares or fixed income securities through various
schemes floated by mutual funds companies. Three broad types of mutual
fund schemes are:
Equity schemes.
Debt schemes.
Balance schemes.
1.4.2 Non-security form of financial Investment
Non-security form of investments are neither transferable nor traded in any
organised financial market.
Activity:
Compare and contrast the market participants in the Securities market for
the years from 2010 -2012.
Hint: Prepare the list of market participants like stock exchanges with
equities trading, stock exchanges with debt market segment, stock
exchanges with Derivative trading, primary dealers, merchant bankers,
brokers, portfolio managers, mutual funds, underwriters etc
Self Assessment Questions:
8. __________ represent long-term debt instruments.
9. Fixed deposits mobilised by manufacturing companies are regulated
by ___________.
10. The investment period of PPF scheme is ________.
4. Portfolio revision
This step is the periodic revision of the portfolio using the three previous
steps. A portfolio might not be the optimal one forever and needs constant
modifications.
5. Portfolio performance evaluation
This step involves determining periodically how the portfolio has performed
over the review period (returns earned compared to targeted returns).
investors do not buy and sell assets day in and day out in order to beat the
market.
Rational approach towards investment choices
Smart investors unaffected by the daily, market fluctuations know the right
conditions under which they must dispose-off the investments. When the
investment is constantly making a loss, the investor sells it to avoid further
losses. Similarly, when the investments make unbelievable gains over a
period they know the trend cannot hold on forever. Therefore, they cash-in
by selling the asset. Such a rational approach enables successful investors
to safeguard their investments.
1.10 Summary
Financial investment is committing your funds to one or more assets that
you will hold over a future time period.
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 differs from gambling and speculation.
Investment involves risks. In order to minimise risk, an investor should
hold a well-balanced investment portfolio.
The investment procedure involves the following five steps:
o Set investment policy
o Perform security analysis
o Construct a portfolio
o Revise the portfolio
o Evaluate the performance of portfolio
Smart investors have a plan for investing and they stick to it. They invest
consistently and wait patiently for gains. They are not emotionally tied to
their investment positions.
1.11 Glossary
Fundamental analysis: A method used to evaluate the worth of a security
by studying the financial data of the issuer.
1.13 Answers
Self Assessment Questions
1. Financial assets
2. Underlying real asset
3. False
4. Risk and return
5. Weighted average
6. Portfolio
7. Risk-return characteristics
8. Bonds
9. Company Law Board
10. 15 years
11. Marketability
12. Terminal tax benefit
13. Risk
14. Speculation
15. Gambling
Privatisation was intended to pave the way for improved performance and
raising much-needed finance for growth. Demand for electricity always
exceeds supply and power generation required huge capital. The
management of AEC stated that their objective would be maximising return
to shareholders.
At the time of privatisation, a large private sector financial agency valued
AEC at Rs. 4,000 million. A public issue of ordinary shares of Rs. 10 plus a
premium of Rs. 20 per share was made, to raise Rs. 4,000 million. The
issue was oversubscribed and on the first day of trading the market price of
the share was Rs. 35.
AEC has been in operation for 3 years and select financial and operating
data is presented in the table below for the years 2006-09.
Table 1: Anandnagar Electricity Company: Key data for years ending 31 Mar
(Rs million)
2006 2007 2008 2009
Revenues 13,500 14,250 17,500 19,500
Operating profit 810 1,100 1,790 2,730
Taxes 160 200 300 400
Profit before depreciation & tax 900 960 1,030 1,190
Profit after tax 650 900 1,490 2,330
Dividends 200 320 600 900
Wages and salaries 3,000 3,000 2,700 2,600
Total assets 3,000 3,600 4,500 5,750
Capital expenditure 500 900 1,750 2,250
Debtors 6,000 3,200 3,000 3,600
Creditors 4,500 2,400 2,300 2,400
Directors emoluments 30 70 80 100
Number of employees 32,000 31,400 30,500 30,100
P/E Rat\o - 10.5 12.0 11.5
Consumer price index 100 102.7 105.8 107.4
Questions
1. What changes would you expect in the companys objectives after it
became private?
2. Has the company met its stated objectives? What other information do
you need to answer this question?
Sikkim Manipal University Page No.: 20
Security Analysis and Portfolio Management Unit 1
Hints:
1. Look at how AEC (a) has downsized its employee strength and outgo on
salaries (b) reduced balances of its debtors and creditors and improved
working capital management.
2. Calculate the market price and capitalisation using the P/E and see how
the shareholders have been benefited.
References:
V. K. Bhalla, Security Analysis and Portfolio Management, 2008,
Sultan chand Books.
Dr. V. A Avadhani, Security Analysis and Portfolio Management, 2011,
Himalaya Publishing House.
Preeti Singh; Security Analysis and Portfolio Management, 2011,
Himalaya Publishing House.
Puneethavathi & Pandian, Security Analysis and Portfolio Management,
Vikas Publishing House, Ninth edition.
Prasanna Chandra, Managing Investments, 2003. Tata mcgraw-Hill
Publishing Co. Ltd. New Delhi.
S. Kevin, Security Analysis And Portfolio Management PHI Learning
P. Ltd.
Fisher & Jordan: Security Analysis & Portfolio Management, Pearson
Education, New Delhi.