Professional Documents
Culture Documents
Preface 2
11.Conclusion 36
12.Bibliography 37
1
Executive Summary
Investing is both Arts and Science. Every Individual has their own specific
financial need and expectation based on their risk taking capabilities,
whereas some needs and expectation are universal. Therefore, we find that
the scenario of the Stock Market is changing day by day hours by hours and
minute by minute. The evaluation of financial planning has been increased
through decades, which can be best seen in customers. Now a day’s
investments have become very important part of income saving.
In order to keep the Investor safe from market fluctuation and make them
profitable, Portfolio Management Services (PMS) is fast gaining Investment
Option for the High Net worth Individual (HNI). There is growing
competition between brokerage firms in post reform India. For investor it is
always difficult to decide which brokerage firm to choose.
At the time of investing money everyone look for the Risk factor involve in
the Investment option.
The first of the two most consequential take-home messages that we want to
convey is that good portfolio management practice is not a matter of
establishing a discussion culture, but one of implementing sound, data
driven, and transparent decision processes. The second message is that, even
as seen in the light of the previous insight, portfolios and their constituent
projects are ultimately managed by people, not by functions. Objections to
portfolio management, or attempts to push it in a certain direction,
frequently arise from less rational elements in the personalities of the acting
people, even if they are driven by the best intentions. A good portfolio
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manager will be aware of this and make use of these human features instead
of attempting their suppression.
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Introduction to
Portfolio Management
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As the economic and financial environment keeps changing, the risk-return
characteristics of individual securities as well as portfolios also change. This
calls for periodic review and revision of investment portfolios of investors.
The total variability in returns of a security represents the total risk of that
security. Systematic and Unsystematic Risk are the two components of total
risk. Thus,
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When variability of returns occurs because of company issuing factors such
as raw material scarcity, labour strike, management inefficiency, it is known
as Unsystematic Risk.
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PORTFOLIO CONSTRUCTION
1. Setting objectives:
The first step in building a portfolio is to determine the main objectives of
the fund given the constraints (i.e. tax and liquidity requirements) that may
apply. Each investor has different objectives, time horizons and attitude
towards risk. Pension funds have long-term obligations and, as a result,
invest for the long term. Their objective may be to maximize total returns in
excess of the inflation rate. A charity might wish to generate the highest
level of income whilst maintaining the value of its capital received from
bequests. An individual may have certain liabilities and wish to match them
at a future date. Assessing a client’s risk tolerance can be difficult. The
concepts of efficient portfolios and diversification must also be considered
when setting up the investment objectives.
2. Defining Policy:
Once the objectives have been set, a suitable investment policy must be
established. The standard procedure is for the money manager to ask clients
to select their preferred mix of assets, for example equities and bonds, to
provide an idea of the normal mix desired. Clients are then asked to specify
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limits or maximum and minimum amounts they will allow to be invested in
the different assets available. The main asset classes are cash, equities,
gilts/bonds and other debt instruments, derivatives, property and overseas
assets. Alternative investments, such as private equity, are also growing in
popularity, and will be discussed in a later chapter. Attaining the optimal
asset mix over time is one of the key factors of successful investing.
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4. Asset selections:
Once the strategy is decided, the fund manager must select individual assets
in which to invest. Usually a systematic procedure known as an investment
process is established, which sets guidelines or criteria for asset selection.
Active strategies require that the fund managers apply analytical skills and
judgment for asset selection in order to identify undervalued assets and to try
to generate superior performance.
5. Performance assessments:
In order to assess the success of the fund manager, the performance of the
fund is periodically measured against a pre-agreed benchmark – perhaps a
suitable stock exchange index or against a group of similar portfolios (peer
group comparison). The portfolio construction process is continuously
iterative, reflecting changes internally and externally. For example, expected
movements in exchange rates may make overseas investment more
attractive, leading to changes in asset allocation. Or, if many large-scale
investors simultaneously decide to switch from passive to more active
strategies, pressure will be put on the fund managers to offer more active
funds. Poor performance of a fund may lead to modifications in individual
asset holdings or, as an extreme measure; the manager of the fund may be
changed altogether.
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Steps to Stock Selection Process
Types of assets
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Cash and cash instruments
Cash can be invested over any desired period, to generate interest income, in
a range of highly liquid or easily redeemable instruments, from simple bank
deposits, negotiable certificates of deposits, commercial paper (short term
corporate debt) and Treasury bills (short term government debt) to money
market funds, which actively manage cash resources across a range of
domestic and foreign markets. Cash is normally held over the short term
pending use elsewhere (perhaps for paying claims by a non-life insurance
company or for paying pensions), but may be held over the longer term as
well. Returns on cash are driven by the general demand for funds in an
economy, interest rates, and the expected rate of inflation. A portfolio will
normally maintain at least a small proportion of its funds in cash in order to
take advantage of buying opportunities.
Bonds
Bonds are debt instruments on which the issuer (the borrower) agrees to
make interest payments at periodic intervals over the life of the bond – this
can be for two to thirty years or, sometimes, in perpetuity. Interest payments
can be fixed or variable, the latter being linked to prevailing levels of
interest rates. Bond markets are international and have grown rapidly over
recent years. The bond markets are highly liquid, with many issuers of
similar standing, including governments (sovereigns) and state-guaranteed
organizations. Corporate bonds are bonds that are issued by companies. To
assist investors and to help in the efficient pricing of bond issues, many bond
issues are given ratings by specialist agencies such as Standard & Poor’s and
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Moody’s. The highest investment grade is AAA, going all the way down to
D, which is graded as in default. Depending on expected movements in
future interest rates, the capital values of bonds fluctuate daily, providing
investors with the potential for capital gains or losses.
Future interest rates are driven by the likely demand/ supply of money in an
economy, future inflation rates, political events and interest rates elsewhere
in world markets. Investors with short-term horizons and liquidity
requirements may choose to invest in bonds because of their relatively
higher return than cash and their prospects for possible capital appreciation.
Long Term investors, such as pension funds, may acquire bonds for the
higher income and may hold them until redemption – for perhaps seven or
fifteen years. Because of the greater risk, long bonds (over ten years to
maturity) tend to be more volatile in price than medium- and short-term
bonds, and have a higher yield.
Equities
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event of firm failure, preference shareholders are paid before ordinary
shareholders. Returns from investing in equities are generated in the form of
dividend income and capital gain arising from the ultimate sale of the shares.
The level of dividends may vary from year to year, reflecting the changing
profitability of a company. Similarly, the market price of a share will change
from day to day to reflect all relevant available information. Although not
guaranteed, equity prices generally rise over time, reflecting general
economic growth, and have been found over the long term to generate
growing levels of income in excess of the rate of inflation. Granted, there
may be periods of time, even years, when equity prices trend downwards –
usually during recessionary times. The overall long-term prospect, however,
for capital appreciation makes equities an attractive investment proposition
for major institutional investors.
Derivatives
Derivative instruments are financial assets that are derived from existing
primary assets as opposed to being issued by a company or government
entity.
The two most popular derivatives are futures and options. The extent to
which a fund may incorporate derivatives products in the fund will be
specified in the fund rules and, depending on the type of fund established for
the client and depending on the client, may not be allowable at all.
A futures contract is an agreement in the form of a standardized contract
between two counterparties to exchange an asset at a fixed price and date in
the future. The underlying asset of the futures contract can be a commodity
or a financial security. Each contract specifies the type and amount of the
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asset to be exchanged, and where it is to be delivered (usually one of a few
approved locations for that particular asset). Futures contracts can be set up
for the delivery of cocoa, steel, oil or coffee. Likewise, financial futures
contracts can specify the delivery of foreign currency or a range of
government bonds. The buyer of a futures contract takes a ‘long position’,
and will make a profit if the value of the contract rises after the purchase.
The seller of the futures contract takes a ‘short position’ and will, in turn,
make a profit if the price of the futures contract falls. When the futures
contract expires, the seller of the contract is required to deliver the
underlying asset to the buyer of the contract. Regarding financial futures
contracts, however, in the vast majority of cases no physical delivery of the
underlying asset takes place as many contracts are cash settled or closed out
with the offsetting position before the expiry date.
An option contract is an agreement that gives the owner the right, but not
obligation, to buy or sell (depending on the type of option) a certain asset for
a specified period of time. A call option gives the holder the right to buy the
asset. A put option gives the holder the right to sell the asset. European
options can be exercised only on the options’ expiry date. US options can be
exercised at any time before the contract’s maturity date. Option contracts
on stocks or stock indices are particularly popular. Buying an option
involves paying a premium; selling an option involves receiving the
premium. Options have the potential for large gains or losses, and are
considered to be high-risk instruments. Sometimes, however, option
contracts are used to reduce risk. For example, fund managers can use a call
option to reduce risk when they own an asset. Only very specific funds are
allowed to hold options.
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Property
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PHASES OF PORTFOLIO MANAGEMENT
1. Security Analysis
2. Portfolio Analysis
3. Portfolio Selection
4. Portfolio Revision
5. Portfolio Evaluation
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SECURITY ANALYSIS
Each share is assumed to have an economic worth based on its present and
future earning capacity. This is called its intrinsic value or fundamental
value. The investor can then compare the intrinsic value of the share with the
prevailing market price to arrive at an investment decision. If the market
price of the share is lower than its intrinsic value, the investor would decide
to buy the share as it is underpriced. The price of such a share is expected to
move up in the future to match with its intrinsic value.
On the contrary, when the market price of a share is higher than its intrinsic
value, it is perceived to be overpriced. The market price of such a share is
expected to come down in future and hence, the investor would decide to
sell such a share.
The fundamental approach calls upon the investor to make his buy or sell
decision on the basis of a detailed analysis of the information about the
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company, the industry to which the company belongs, and the economy in
which it is established. Thus, a fundamental makes use of EIC (Economy,
Industry, and Company) framework of analysis.
1. Economy Analysis
2. Industry Analysis
3. Company Analysis
FORECASTING TECHNIQUES
Economic forecasting may be carried out for short term periods (up to three
years), intermediate term periods (three to five years) and long-term periods
(more than five years). Some of the techniques of short term economic
forecasting are discussed below:
Anticipatory Surveys
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of their intentions can provide valuable input to short term economic
forecasting.
To find out how the economy is likely to perform in the future various kinds
of indicators such as time series data of certain economic variables are
studied to economic forecasting.
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A number of key characteristics that should be considered by the analyst.
These features broadly relate to the operational and structural aspects of the
industry. They have a bearing on the prospects of the industry. Some of
these are discussed below:
Labour conditions
Attitude of Government
The government may encourage the growth of certain industries and can
assist such industries through favourable legislation or vice-versa. In India,
this has been the experience of alcoholic drinks and cigarette industries.
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Company analysis is the final stage of fundamental analysis. In
company analysis, the analyst tries to forecast the future earnings of the
company because there is strong evidence that earnings have a direct and
powerful effect upon share prices. The level, trend and stability of earnings
of a company, however, depend upon a number of factors concerning the
operations of the company.
Financial Statements
Liquidity Ratios
These measure the company’s ability to fulfil its short term obligations and
reflect its short term financial strength or liquidity.
1. Current ratio = Current Assets
Current Liabilities
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3. Leverage Ratios
4. Profitability Ratios
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Technical analysis believes that share price are determined by the demand
and supply forces operating in the market. A technical analyst therefore
concentrates on the movement of share prices. He claims that by examining
past share price movement future share prices can be accurately predicted.
Thus, technical analysis is really a study of past or historical price and
volume movements so as to predict the future stock price behavior.
Bar Chart
It is perhaps the most popular chart used by technical analysts. In this chart,
the highest price, the lowest price and the closing price of each day are
plotted on a day-to-day basis.
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Date High Price (Rs.) Low Price (Rs.) Close Price (Rs.)
1 346.5 335 340.5
2 355 340 354.1
3 359.4 354 356.2
4 357.8 348 350.6
5 353.75 345.15 349.9
6 355.6 346 350.75
7 353.35 349.15 352.05
365
360
355
P 350
R
I 345
High Price (Rs.)
C 340 Low Price (Rs.)
E
335 Close Price (Rs.)
S
330
325
320
1 2 3 4 5 6 7 8
DAYS
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PORTFOLIO ANALYSIS
Let’s consider a portfolio of two equity shares P and Q with expected return
of 15% and 20% resp. if 40% of the available total funds is invested in share
P and the rest in Q, then the expected portfolio return will be:
RISK OF A PORTFOLIO
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securities in the portfolio and contribute to the overall risk of the
portfolio.
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PORTFOLIO SELECTION
The feasible set of portfolios in which the investor can possibly invest, is
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Efficient Set of Portfolios
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PORTFOLIO REVISION
The need for portfolio revision may arise because of some investor
related factors also. These factors may be listed as:
1. Transaction Cost
Buying and selling of securities involve transaction costs such as
commission and brokerage. Frequent buying and selling may push up
transaction costs thereby reducing the gains from portfolio revision.
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2. Taxes
Frequent sales of securities of periodic portfolio revision will result in
short term capital gains which would be taxed at a higher rate
compared to long term capital gains.
3. Statutory Stipulations
The largest portfolios in every country are managed by investment
companies and mutual funds. These institutional investors are
governed by certain statutory stipulations regarding their investment
activity.
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PORTFOLIO EVALUATION
Portfolio Evaluation is the last step in the process of portfolio
management. It is the stage where we examine to what the extent the
objectives has been achieved. Through portfolio evaluation the
investor tries to find out how well the portfolio has performed.
Without portfolio evaluation, portfolio management would be
incomplete.
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Two methods of measuring the reward per unit of risk have been proposed
by William Sharpe and Jack Treynor in their pioneering work on evaluation
of portfolio performance.
Sharpe Ratio
It is the ratio of the reward or risk premium to the variability of return or risk
as measured by the standard deviation of return. The formula for
calculating Sharpe Ratio may be stated as:
Treynor Ratio
It is the ratio of the reward or risk premium to the variability of return or risk
as measured by beta of portfolio.
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Fund Return (%) Standard Deviation (%) Beta
A 12 18 .7
Z 19 25 1.3
M (Market Index) 15 20 1.0
SR =
A = 12 – 7 /18 = .277
Z = 19 – 7 /25 = .48
M = 15 – 7 /20 = .40
TR =
A = 12 – 7 /.7 = 7.14
Z = 19 – 7 / 1.3 = 9.23
M = 15 – 7 / 1.0 = 8.00
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Conclusion
The point is that different types of investors, with different goals, resources
and aptitudes require very different types of investments. If you've put
together your portfolio rationally, it will reflect your circumstances.
The purpose of this workshop is to drive home the lesson that in creating and
managing a portfolio, do so rationally. Think about your objectives and how
different asset classes meet them, think about risk and how to reduce it,
think about diversification and the level you are comfortable with, and think
about your weaknesses and strengths and how to work within them.
Investing with a high degree of self-awareness will not only bring you the
best results but also preserve your peace of mind in what can be a fraught
theatre of nerves.
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Bibliography
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