Unit -1

Introduction to
Investment Management
ABHISHEK PRAKAH
 List the things you
can buy with money.
 What Is
Investment?
1- The action or process of investing money
for profit.

2- Investment is the process of investing your

money in an asset with the objective to grow
your money in a stipulated time period.

3- An investment is an asset or item acquired to generate income or gain

appreciation. Appreciation is the increase in the value of an asset over
time. It requires the outlay of a resource today, like time, effort, and
money for a greater payoff in the future, generating a profit.
Two attributes of investment -

Risk

Time
 Is speculation the same as investing?
Speculation is the act of investing in opportunities with
a high risk of loss, but also with the potential for
significant financial gain in a short time frame.
 What is gambling?
Gambling involves taking a risk on an unclear outcome
or event by risking something of value (usually money)
with the intent of trying to win an item of higher value.
 Objectives of Investment.

Maximize returns
Minimize risk
Hedge against inflation
Safety
Capital gains
Tax planning
Liquidity
Minimize tax
 Investment Avenues
1- Securities
Equity

Based on Market cap - Total outstanding shares X Market price per

share
Blue chip shares
Growth shares
Income shares
Defensive shares
Cyclical shares
Speculative shares.
 Hybrid securities
Convertible Bonds
Preference shares - Redeemable and irredeemable
Perpetual Bonds - Bonds with no maturity date that pay regular interest
indefinitely.
Derivatives

Options, Futures, forwards, etc.

Currencies
Commodities
 Debt

Government debt instruments Corporate debt instruments

Treasury bills - Short-term securities Corporate bonds

Government bonds - Long-term Commercial papers - Short-term
securities with fixed or floating unsecured promissory notes
interest rates. Debentures - Long-term,
Sovereign gold bonds unsecured bonds backed by the
Municipal bonds - fund public issuing company’s
projects. creditworthiness.
 2- deposits

Banks Non-Banking financials

institutes.
Fixed deposits
Savings account Fixed deposits
Recurring ac MF’s
i-wish (goal based savings)
 3- Postal schemes
Public provident fund
Sukanya Samriddhi Yojana (SSY)
Senior Citizen Savings Scheme (SCSS)
National Savings Certificate (NSC)
Post Office Monthly Income Scheme (POMIS)
Kisan Vikas Patra (KVP)
Post Office Time Deposit Account (TD)
Recurring Deposit (RD)
4- Insurance

Term Insurance
Endowment Plans
Unit Linked Insurance Plans (ULIPs)
Money-Back Plans
Pension/Retirement Plans
Child insurance plan
Group insurance
5- Real Estate (REIT’s)
6- Gold/Silver
7 - Digital Assets
8- Collectibles and tangible assets
9- Green bonds
10- Mutual funds

¨Equity Fund
¨Growth Fund
¨Income Fund
¨Balanced Fund
¨Index Fund
¨Debt Fund
 Hedging

A hedge is an investment that is selected to reduce the potential for loss in other investments
because its price tends to move in the opposite direction. This strategy works as a kind of
insurance policy, offsetting any steep losses in other investments.
 Class activity

Find out 10 factors influencing investments.

 Measurning Returns
1- Historic Returns - The historical return of a financial asset, such as a bond,
stock, security, index, or fund, is its past rate of return and performance. The
historical data is commonly used in financial analysis to project future returns or
determine what variables may impact future returns and the extent to which the
variables may influence returns.

Total return = Income received + Price Change

100
Purchase Price
1- Suppose that you purchased 1 shares of XYZ stock for Rs.50 per share five years ago.
Recently, you sold the stock for Rs100. In addition, the company paid a dividend each
year of Rs1.00 per share.What is your HR? (110%)

2- The data below provides the historical performance of the S&P 500 index.

December 31, 2016: 2,105

December 31, 2017: 2,540

Calculate HR. (20.7%)

 Calculation of average Historical returns.

The data below provides the average historical returns of an index over a 5-year period.

December 31, 2015: 28%

December 31, 2016: 18.7%
December 31, 2017: 19.9%
December 31, 2018: 23.1%
December 31, 2019: 29.7%

Calculate the Average HR. (23.9%)

 Find Arithmetic & Geometric mean

Year Value %Return

AM = 0.08
0 10,000 -
GM = 0.01
1 12,000 20%
2 7,000 -42%
3 11,000 57%
4 10,400 -5%
 Expected Return

¨Most investments carry risk

¨Likelihood of possible returns vary
¨To calculate expected returns – consider probability
¨Suppose Investment A has probable returns as follows:

¤In the boom market conditions, Investment A earned 12%.

¤In the recent market slump, it earned only 4%.
¤If we project a 60% probability of renewed boom and a 40%
probability of bust
¤Calculate Expected Return
Period Probability Rate of Return

1 0.30 16

2 0.50 11

3 0.20 6
 Measurement of Risk

Historical Risk
Risk is the variation in return.
Standard Deviation - It measures the dispersion of data points around the
mean. It is a statical tool used to measure Risk/Volatility.
Variance is the average squared deviations from the mean.
 R = Athematic mean return
¨Variance Ri = Return in period i

n = number of periods

¨Standard Deviation
Period 1 2 3 4 5 6

Return 15 12 20 -10 14 9
Period 1 2 3 4 5

Return 25 16 22 20 40
Year Return

1 0.07 ¨Calculate:
¤Arithmetic Mean
2 0.03
¤Geometric Mean
3 -0.09 ¤Variance
¤Standard Deviation
4 0.06

5 0.10
 Expected risk

The expected return in investment analysis and portfolio management is

the average return an investor anticipates earning from an investment,
considering all possible outcomes and their associated probabilities. It is a
probabilistic measure that helps investors evaluate the potential
performance of an asset or portfolio under varying market conditions.

By assigning probabilities to different possible returns, the expected

return provides a single value that summarizes the weighted average of
these outcomes, helping investors make informed decisions.
 R(E)- Expected return
¨Variance Ri - Possible return
Pi - Probability of that return
occurring

¨Standard Deviation
 Rate
of return

State Probability Bharath Oriental

of the Economy of Occurance Foods Shipping

BOOM 0.3 16 40

NORMAL 0.5 11 10

RECESSION 0.2 6 -20

Probability Share A Share B

0.1 30% 26%

0.2 28% 13%

0.3 34% 48%

0.2 32% 11%

0.2 31% 57%

Period Infosys TCS

30-Apr-13 2,234 1,376

30-May-13 2,408 1,500

30-Jun-13 2,493 1,518

30-Jul-13 2.967 1,815

30-Aug-13 3,100 2,023

30-Sep-13 3,015 1,927

Date Open High Low Close

01-Jan-13 274 303 268.8 301.04

01-Jan-14 260.61 264.92 221.16 223.91

01-Jan-15 502 604 488.25 499.3

01-Jan-16 450 452.7 366.65 408.15

01-Jan-17 451 491.65 424.6 465.9

 How to buy unlisted stocks?

An unlisted share is any security or financial instrument that’s available for trade on
over-the-counter markets and is also known as over-the-counter (OTC) securities.

Investing in Start-ups and Intermediaries

Buying ESOPs Directly from Employees
Buying Stocks Directly from Promoters

Unlistedzone
Sharescart
 Investment Strategies

Active investing
Passive investing
Growth Investing
Value investing
Momentum investing ( Rely on technical analysis)
Downward averaging.
Unit -2
Fundamental
analysis
Fundamental analysis - is a method used to evaluate the intrinsic value of an asset, typically a
stock, by analyzing related economic, financial, and qualitative factors. The goal of fundamental
analysis is to determine whether an asset is undervalued or overvalued relative to its current
market price.
 Key Elements of fundaments analysis
Quantitative analysis - P/L, Balance sheet, P/E ratio, D/E ratio, etc.
Qualitative analysis - Business model, management quality, competitive
advantage, industry analysis, etc.
Macroeconomic factors - GDP, inflation, interest rates, etc.
Market trends and external influences - political stability, news,
technology advancements, etc.
 ECONOMY

INDUSTRY

COMPANY

•E-I-C Framework/Top Down Approach

 ECONOMIC ANALYSIS

Macro-Economic factors

1- Inflation - 5.48 as of nov 2024.

2- GDP - India's GDP growth rate for 2023 was
7.58%, and the estimated growth rate for 2024 is
7.0%.
3- Savings and investments.
4- Interest rates - Current repo rate in India?
Central Bank of India: 6.50%

DCB Bank: 7.40%

Federal Bank: 7.10%

HDFC Bank: 7.00%

Axis Bank: 6.70% for one year and 7.10% for three years

Bandhan Bank: 8.05% for one year and 7.25% for three years

Bank of Baroda: 6.85% for one year and 7.15% for three years
 CIA - 1

1- Create an investment plan that gives you maximum benefit.

2- Your group has been allocated 40L for this investment decision.
3- Give appropriate reasons for you to allocate money to investment avenues.
4- Give real-time data to support your allocation decisions.
5- A minimum of 5 investment avenues has to be decided.
6- Support your answer in line with the character you have picked.
7- 5 members or less in a group.
8- Create a PPT for the same.
9- Presentation time - 5 minutes for each team.
10- Maximum creativity and maximum returns creation will result in maximum marks.
 CIA - 1

Perform a top-down analysis of your preferred country and stock.

Provide valid points for you to choose the country.

Provide an analysis of the industry you have picked.
Provide an analysis of the stock.
What returns can you expect from that particular stock?
Make a PPT, max 5 slides.
5-Budget and fiscal deficit -
https://energy.economictimes.indiatimes.com/news/renewable/b
udget-2024-25-and-the-future-of-energy-transition-in-
india/112030823

6- Tax structure
7- Balance of payments
8- Foreign Direct Investments(FDI)
9- Foreign Institutional investments (FII)
10- International Economic Conditions
11- Business Cycle and Investor Psychology
12- Monsoon and Agriculture
13- Infrastructure
14- Demographic Factors
Department for Promotion of Industry
and Internal Trade (DPIIT)
Moneycontrol.com
 Economic forecasting
Economic forecasting is the process of predicting future economic conditions
based on the analysis of historical and current data, trends, and economic
models. It helps governments, businesses, and individuals make informed
decisions by anticipating changes in the economy.

Anticipatory survey - India Vs China, FDI, INR, etc.

Barometric or Indicator Approach to Forecast Economic Growth

Leading indicators - Building permits, new business orders, consumer

confidence index, etc.
Coincident indicators - Industrial production, retail sales, etc
Lagging indicators - Unemployment rate, corporate profits,etc.
 Econometric model building - Econometric model building involves using
statistical techniques and economic theory to develop mathematical models
that describe relationships between various economic factors.

Opportunistic model building - refers to an adaptive, flexible approach to

creating forecasting models by taking advantage of available data and
situational insights rather than relying on rigid theoretical frameworks.

Data-Driven Approach
Flexible Model Selection
Iterative Process
Hybrid Techniques
 INDUSTRY ANALYSIS

¨Analysis of the performance, problems and prospects of the industry

¨Industry: group of firms having similar technological structure of production

and produce similar products
Industry life cycle
 Key Industry Analysis Factors

Economic Indicators and GDP Contribution.

Government Policies and Regulatory Environment - Make in India, Production
Linked Incentive (PIL).
Sector Performance and Market Trends - Automobiles.
Demand and Supply Analysis - Renewable energy.
Global Market Influence and Trade Dynamics.
Competitive Landscape and Market Structure - Flipkart, BBQ nation.
Technological Advancements and Innovations - Fintech, Slice, OneCard, etc.
Consumer Behavior and Demographics - Luxury products.
Environmental, Social, and Governance (ESG) Factors.
Sector-Specific Risks
Analytical Tools
 Company analysis

Qualitative factors Quantitative Factors

¨Business Model ¨Earnings

¨Management ¨Competitive Edge
¨Corporate Governance ¨Financial Leverage
¨Organisational Culture ¨Operational Leverage
¨Production Efficiency
 Mode of analysis

¨Financial Statements

Balance Sheet
Statement of Profit and Loss
Cash Flow Statement
Ratio analysis
Comparative financial statements
Trend analysis
Unit - 3
Technical
Analysis
Technical analysis is a method of evaluating statistical trends
in trading activity, typically involving price movement and
volume. It is used to identify trading and investment
opportunities.

Unlike fundamental analysis, which attempts to evaluate a

security's value based on financial information such as sales
and earnings, technical analysis focuses on price and volume
to draw conclusions about future price movements.
 Introduction

¨Process of identifying trend reversals at an early stage to

formulate buying/selling strategies
¨Used as a supplement to fundamental analysis
¨Supply and demand patterns reflected in price and volume of
trading
¨Examination of these patterns can help predict future price
movements
¨Price fluctuations reflect logical and emotional forces
Assumptions

¨Interaction of demand and supply determine market value of the

security
¨The market always moves in a trend
¨History repeats itself in the stock market
1. Intraday Short Selling is Allowed (MIS – Margin Intraday Square Off)
2. No Carry Forward of Short Positions in Cash Market
3. How to Short Stocks for a Longer Time? (Using Futures & Options)
4. Why Does SEBI Restrict Short Selling for Retail Traders?
Prevent Market Manipulation
Reduce Risk of Settlement Failures
Protect Retail Traders
The Dow Theory is a technical analysis theory that aims to explain and
predict the behavior of the stock market by looking at price movements
and trends. It is based on the work of Charles Dow, the founder of The Wall
Street Journal and co-founder of Dow Jones & Company.

1. The Market Discounts Everything.

2. There Are Three Types of Trends

Primary Trend (Long-term Trend): This is the major market direction,
which can last from several months to several years. The primary trend
is either bullish (upward) or bearish (downward). The primary trend
typically moves in cycles, with a rising phase and a falling phase.
Secondary Trend (Intermediate Trend): These are shorter-term
movements that move against the primary trend. They can last from a
few weeks to a few months. For example, if the primary trend is
upward, a secondary trend might be a short-term decline.

Minor Trend (Short-term Trend): These are small movements within the
secondary trend and usually last only a few days to weeks. They are
often seen as noise within the bigger trends.
3. The Market Moves in Trends

Dow's theory posits that the stock market moves in predictable trends. There are three
phases to each trend:
Accumulation: This phase occurs when informed investors or market professionals
start to buy or sell based on their knowledge, but the general public is unaware of
the shift.
Public Participation: In this phase, the broader market begins to recognize the
trend, and the public starts jumping in. This is when most people get involved and is
typically characterized by strong price movement.
Distribution: In the final phase, the informed investors begin to sell, anticipating a
reversal of the trend. However, by this time, the public might still be buying,
unaware that the trend is changing.
4- Indices Must Confirm Each Other
5- Volume Confirms the Trend
6 - A Trend Remains Until a Clear Reversal Occurs.

Practical Application of Dow Theory

Investors use Dow Theory to identify trends and avoid trading
against the market’s direction.
It helps in timing entry and exit points by understanding
market phases.
Modern technical analysis builds upon Dow Theory with
indicators like moving averages, RSI, and Fibonacci
retracements.
Support and Resistance are key concepts in technical analysis used to
identify potential price levels where an asset may experience a pause or
reversal in its trend. These levels help traders make informed decisions
about buying and selling.
What is Support?

Support is a price level where a downtrend is expected to pause or reverse

due to a concentration of buying interest. It acts like a floor that prevents
the price from falling further.

✅ Why Does Support Form?

Buyers enter the market, believing the price is undervalued.
Psychological price levels (e.g., round numbers like $50, $100).
Historical buying zones where the price previously bounced back.
🔍 Example:
If a stock consistently drops to $100 and then rebounds, $100 becomes a
support level.
What is Resistance?
Resistance is a price level where an uptrend is expected to pause or
reverse due to a concentration of selling interest. It acts like a ceiling that
prevents the price from rising further.

✅ Why Does Resistance Form?

Sellers believe the price is overvalued.
Profit-taking at previous highs.
Psychological levels and historical price ceilings.
🔍 Example:
If a stock rises to $150 multiple times but fails to go higher, $150 becomes
a resistance level.
Elliott Wave Theory is a form of technical analysis that suggests stock
prices move in repetitive wave patterns driven by investor psychology. It
was developed by Ralph Nelson Elliott in the 1930s and is still widely used
today to predict market trends.

Markets Move in Waves

Prices do not move in a straight line but in a series of waves, reflecting

crowd psychology (optimism and pessimism).

There are two main types of waves:

Impulse Waves (Motive Waves) – Move in the direction of the
trend.
Corrective Waves – Move against the trend.
The 5-3 Wave Structure

A full market cycle consists of eight waves:

Five waves (1-2-3-4-5) in the direction of the main trend (Impulse

Phase).

Three waves (A-B-C) in the opposite direction (Corrective Phase).

 Types of charts
Line Charts
Bar Charts
 Candlestick Chart

$90

$80

$70

$60

$50

$40

$30

$20

$10

$0
March April
heikin-ashi candle
Point and Figure Chart – Focuses on price movement
without considering time.
 Chart Patterns
Chart patterns are formations created by price movements on a chart. They
help traders predict future price movements based on historical behavior.
Patterns are divided into three main categories: reversal, continuation, and
bilateral patterns.
 Common types of chart patterns:

Reversal Patterns
These indicate a possible change in trend direction.
1. Head and Shoulders – Signals a reversal from an uptrend to a downtrend.
2. Inverse Head and Shoulders – Indicates a reversal from a downtrend to an uptrend.
3. Double Top – A bearish reversal pattern forming after two peaks at the same level.
4. Double Bottom – A bullish reversal pattern forming after two troughs at the same
level.
5. Triple Top and Triple Bottom – Similar to double patterns but with three peaks or
troughs.
Continuation Patterns

These suggest that the current trend will continue.

6. Flags – Small rectangular consolidation that slants against the trend.
7. Pennants – Small symmetrical triangles that form after a strong move.
8. Rectangles – Horizontal consolidation between two parallel support and resistance
levels.
9. Cup and Handle – A bullish continuation pattern where the price forms a "U" shape
followed by a small pullback.
Bilateral Patterns

These indicate potential movement in either direction.

10. Symmetrical Triangle – A pattern with converging trendlines that can break out in
either direction.
11. Ascending Triangle – Typically a bullish pattern with a flat resistance level and rising
support.
12. Descending Triangle – Generally a bearish pattern with a flat support level and
declining resistance.
 CIA 2
Individual Assignment
Prepare a PPT about Chart Patterns and Candle stick patterns - Reversal,
Continuation and Bilateral Patterns.
12 Slides / 12 patterns minimum.
Identify a stock or index which is forming a particular pattern.
Viva on the same (2 minutes).
Deadline - 3rd march.
Technical indicators
1. Trend Indicators (Directional Indicators)

These indicators help identify the direction and strength of a market trend.
Moving Averages (MA) – Simple Moving Average (SMA), Exponential Moving Average
(EMA)
Moving Average Convergence Divergence (MACD)
Average Directional Index (ADX)
Parabolic SAR

2. Momentum Indicators (Strength of Price Movement)

These indicators measure the speed and magnitude of price movements.

Relative Strength Index (RSI)
Stochastic Oscillator
Commodity Channel Index (CCI)
Rate of Change (ROC)
Technical indicators are pattern-based signals produced by the price,
volume, and/or open interest of a security or contract used by traders who
follow technical analysis.

By analyzing historical data, technical analysts use indicators to predict

future price movements. Examples of common technical indicators
include the Relative Strength Index (RSI), Money Flow Index (MFI),
stochastics, moving average convergence divergence (MACD), and
Bollinger Bands®.
 Simple Moving Average (SMA)
A simple moving average (SMA) calculates the average price of an asset,
usually using closing prices, during a specified period of days.

Exponential Moving Average (EMA)

EMA gives a higher weighting to recent prices, while the SMA assigns an
equal weighting to all values.
 Price Rate of Change (ROC) Indicator

The price rate of change (ROC) is a momentum-based technical indicator that

measures the percentage change in price between the current price and the
price a certain number of periods ago. The ROC indicator is plotted against
zero, with the indicator moving upwards into positive territory if price
changes are to the upside, and moving into negative territory if price changes
are to the downside.

The indicator can be used to spot divergences, overbought and oversold

conditions, and centerline crossovers.

ROC = Today’s closing price - Closing price n periods ago x 100

Closing price n periods ago
 Relative Strength Index (RSI)

The relative strength index (RSI) is a momentum indicator used in technical analysis. RSI
measures the speed and magnitude of a security's recent price changes to detect
overbought or oversold conditions in the price of that security.

In addition to identifying overbought and oversold securities, the RSI can also indicate
securities that may be primed for a trend reversal or a corrective pullback in price. It
can signal when to buy and sell. Traditionally, an RSI reading of 70 or above indicates an
overbought condition. A reading of 30 or below indicates an oversold condition.

The RSI is one of the most popular technical indicators, and it is generally available on
most trading platforms offered by online stock brokers.
 Bollinger Bands
Bollinger Bands, a popular tool among investors and traders, helps gauge
the volatility of stocks and other securities to determine if they are over-
or undervalued.

The center line is the stock price's 20-day simple moving average (SMA).
The upper and lower bands are set at a certain number of standard
deviations, usually two, above and below the middle line.

The bands widen when a stock's price becomes more volatile and contract
when it is more stable. Many traders see stocks as overbought as their
price nears the upper band and oversold as they approach the lower band,
signaling an opportune time to trade.
 MACD Indicator

Moving average convergence/divergence (MACD) is a technical indicator to

help investors identify price trends, measure trend momentum, and identify
entry points for buying or selling. Moving average convergence/divergence
(MACD) is a trend-following momentum indicator that shows the relationship
between two exponential moving averages (EMAs) of a security’s price.

Traders use the MACD’s histogram to identify peaks of bullish or bearish

momentum, and to generate overbought/oversold trade signals.
 Efficient market hypothesis
Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis (EMH), developed by Eugene Fama (1970),
suggests that financial markets are "informationally efficient", meaning that
all available information is already reflected in stock prices. This implies that
investors cannot consistently achieve higher-than-average returns by using
past information, technical analysis, or fundamental analysis.

The EMH argues for a passive investing strategy, rather than an active one, in
which investors buy and hold a low-cost portfolio over the long term to
achieve the best returns.
Forms of EMH
Weak Form Efficiency - Stock prices reflect all past market information
Semi-Strong Form Efficiency - Stock prices reflect all publicly available
information
Strong Form Efficiency - Stock prices reflect all information, both public
and private

Implications of EMH:

Active portfolio management (trying to beat the market) is ineffective.

Passive investment strategies (index funds) are preferred.
Investors should diversify to reduce risk instead of trying to time the
market.
 Random Walk Theory
The Random Walk Theory, proposed by Burton Malkiel (1973), states that
stock price movements are completely random and unpredictable. It
supports the weak form of EMH, arguing that past price patterns cannot
predict future movements.
Key Assumptions:

Future stock prices are not influenced by past prices.

No predictable trends exist in the market.
Short-term price movements are like a random sequence (similar to flipping a coin).

Implications of Random Walk Theory:

Technical analysis is useless because price patterns do not repeat.

Stock prices reflect all past information, making it impossible to predict future
movements.
Investors should adopt passive investment strategies, such as index funds.
Unit - 4
PORTFOLIO
MANAGEMENT
 Class activity
What is Portfolio management process.
Portfolio Management Process
 Modern Portfolio Theory (MPT)
The modern portfolio theory (MPT) is a practical method for selecting investments in
order to maximize their overall returns within an acceptable level of risk. This
mathematical framework is used to build a portfolio of investments that maximize the
amount of expected return for the collective given level of risk.

American economist Harry Markowitz pioneered this theory in his paper "Portfolio
Selection," which was published in the Journal of Finance in 1952.He was later awarded
a Nobel Prize for his work on modern portfolio theory.

A key component of the MPT theory is diversification. Most investments are either high
risk and high return or low risk and low return. Markowitz argued that investors could
achieve their best results by choosing an optimal mix of the two based on an
assessment of their individual tolerance to risk.
Key Points
The modern portfolio theory (MPT) is a method that can be used by risk-averse
investors to construct diversified portfolios that maximize their returns
without unacceptable levels of risk.
The modern portfolio theory argues that any given investment's risk and return
characteristics should not be viewed alone but should be evaluated by how it
affects the overall portfolio's risk and return.
Based on statistical measures such as variance and correlation coefficient, a
single investment's performance is less important than how it impacts the
entire portfolio.
The MPT assumes that investors are risk-averse, meaning they prefer a less
risky portfolio to a riskier one for a given level of return.
Criticism of the MPT

The most serious criticism of the MPT is that it evaluates portfolios based on
variance rather than downside risk.

That is, two portfolios that have the same level of variance and returns are
considered equally desirable under modern portfolio theory. One portfolio may have
that variance because of frequent small losses. Another could have that variance
because of rare but spectacular declines. Most investors would prefer frequent small
losses, which would be easier to endure.

The post-modern portfolio theory (PMPT) attempts to improve modern portfolio

theory by minimizing downside risk instead of variance.
 Portfolio Return

Where:

Rp = Portfolio Return
Rx = Return/ Expected return on security x
Ry = Return/ Expected return on security y
wx = proportion of total portfolio invested in security x / weight of x in the portfolio
wy = proportion of total portfolio invested in security y / weight of y in the portfolio
Portfolio Risk

Correlation
coefficient (r)
of Security 1 and 2
Correlation Coefficient
 Return X
Period Return Y (%)
(%)
1 40 28
2 20 30
3 14 30
4 35 40
5 23 25
6 30 14
7 41 36

Either invest Rs.70,00,000 in stock X and Rs. 30,00,000 in stock

Y or invest 30,00,000 in stock
X and Rs 70,00,000 in stock Y. Evaluate both portfolio options
 Return A
Period Return B (%)
(%)

1 12 10

2 10 15

3 20 30

4 15 20

5 -5 14

6 10 -10

7 -8 -14
Portfolio Stock A Stock B Returns Port. Risk
A 75 25
B 66.66 33.33
C 50 50
 Return on asset Return on asset
Period Prob
A B

1 0.1 5 0

2 0.3 10 8

3 0.5 15 18

4 0.1 20 26

Find out the portfolio risk and return if the funds are split equally between asset A
and B
 Security A Security B

E(R) 12% 20%

σ 20% 40%

rab -0.20
Portfolio Proportion of A Proportion of B

1 (A) 100% 0%

2 90% 10%

3 75.90% 24.10%

4 50% 50%

5 25% 75%

6 (B) 0% 100%
 Particulars SEC A SEC B

Returns 15% 20%

SD 0.5 0.3
Correlation Coefficient -0.6 -
1 - The weights of the securities with the objective of
minimizing the risk.
 Sharpe’s single index model.
Sharpe’s Single Index Model (SIM) is a method used in portfolio management to simplify
the process of selecting stocks and constructing an optimal portfolio. It assumes that
the return on a stock is influenced primarily by the overall market performance rather
than multiple economic factors.

This model was developed by William F. Sharpe, who also introduced the Sharpe Ratio
for risk-adjusted return measurement. SIM is particularly useful for portfolio selection
and risk assessment because it breaks down stock returns into systematic risk (market-
related risk) and unsystematic risk (stock-specific risk).
The return of a stock (Ri) is expressed using the following equation:

Ri = αi + βiRm + ei Where:

Ri​= Return of stock i

αi= Alpha (α), the stock-specific return component that is independent of the market
βi = Beta (β), a measure of the stock’s sensitivity to the market movements
(systematic risk)
Rm= Return of the overall market index
ei = Error term, which represents the unsystematic risk (company-specific or
industry-specific risk)
The total risk (σi2) of an individual stock in SIM is given by:
 Beta (β) – Measure of Market Sensitivity
Beta (β) is a measure of systematic risk, meaning it tells us how much a stock’s price
moves in response to changes in the market.
Interpretation of Beta:

β>1 → The stock is more volatile than the market. If the market increases by 1%, the
stock may increase by more than 1%.

β<1 → The stock is less volatile than the market. If the market increases by 1%, the
stock may increase by less than 1%.

β=1 → The stock moves in line with the market.

 Alpha (α) – Measure of Excess Return

Alpha (α) represents the portion of a stock’s return that is not explained by the market
movements. It is the stock’s excess return compared to what would be expected based
on its beta.

Where:

Ri​= Actual return of the stock

Rm​= Market return
βi​= Beta of the stock
Interpretation of Alpha:

α>0 (Positive Alpha) → The stock has outperformed the market. It has earned a
return higher than expected based on its beta.
α<0 (Negative Alpha) → The stock has underperformed the market. It has earned a
return lower than expected based on its beta.
α=0 → The stock has performed as expected given its beta.
Calculate alpha and
beta value for ABC
1- Calculate the alpha and beta
values for RB.
Market returns = 16.4%
Standard deviation of market = 14%
Calculate Portfolio Risk and Return using SIM.
 Capital Asset Pricing Model

The Capital Asset Pricing Model (CAPM) is a fundamental model in Investment

Analysis and Portfolio Management used to determine the expected return of an
asset based on its risk. It helps investors understand the relationship between
risk and return, particularly in the context of diversified portfolios.
Key Assumptions:

1. Investors are rational and seek to maximize returns.

2. Markets are efficient, meaning all information is reflected in prices.
3. No transaction costs or taxes.
4. Investors can borrow and lend at the risk-free rate.
5. A single-period investment horizon.

Interpretation:

If an asset has a high beta (beta β), it is more volatile than the market and has higher
expected returns.
A low beta means lower volatility and lower expected returns.
The CAPM helps determine if an asset is overvalued or undervalued compared to its
risk.
Undervalued Asset:

If Actual Return > CAPM Expected Return, the asset is undervalued.

This means the asset is providing a higher return than justified by its risk, making it
an attractive buy opportunity.

Overvalued Asset:

If Actual Return < CAPM Expected Return, the asset is overvalued.

This means the asset is offering a lower return than its risk justifies, making it
unattractive.
 Securities market line
The Securities Market Line (SML) is a graphical representation of the Capital Asset
Pricing Model (CAPM). It shows the relationship between an asset’s systematic risk (beta
β) and its expected return.
Key Interpretations of SML:

Assets on the SML:

These assets are fairly valued according to CAPM.
Their expected return is appropriate for their risk level.

Assets Above the SML (Undervalued):

These assets offer higher actual returns than expected based on their risk.
Investors should buy because they are providing a better return for the risk
taken.
Assets Below the SML (Overvalued):

These assets offer lower actual returns than expected for their risk.
Investors should sell or avoid them.
Calculate if the assets are overvalued or undervalued according to CAPM model,
 Capital Market Line

The capital market line (CML) represents portfolios that optimally combine
risk and return. It is a theoretical concept that represents all the portfolios
that optimally combine the risk-free rate of return and the market portfolio of
risky assets. Under the capital asset pricing model (CAPM), all investors will
choose a position on the capital market line, in equilibrium, by borrowing or
lending at the risk-free rate, since this maximizes return for a given level of
risk.
Portfolio
evaluation
and
revision
Unit 5
 What is portfolio evaluation

Portfolio evaluation is an essential aspect of investment analysis. It involves

assessing the quality of investment approaches and determining changes to
improve investment results.

A portfolio combines investment products, including bonds, shares,

securities, and mutual funds. Experienced portfolio managers customise this
combination based on the client’s risk tolerance to create a long-term return
portfolio.
Why should an investor do a periodic portfolio review?

To maintain optimal asset allocation mix

To accommodate changes in personal circumstances
To take advantage of market movements
For tax purposes
To replace underperforming securities
 Types of portfolio evaluation
Sharpe’s Ratio

In 1966, William F. Sharpe developed the Sharpe ratio as a tool to evaluate the risk-
adjusted return that considers both the standard deviation of the portfolio’s returns
and the risk involved in achieving that return.

Sharpe ratio = (RP – RF) / σP

where,
RP – Portfolio Return
RF – Risk-free rate of return
σP – Standard deviation of the portfolio’s returns
A higher Sharpe ratio reflects a higher risk-adjusted return.

A well-diversified portfolio will have a lower standard deviation and a higher Sharpe
ratio than a concentrated portfolio with the same return. It also assumes that
investors are risk-averse and prefer lower risk and higher return.
 Portfoli
Portfoli o Rf (%) σp
o Return(
%)

A 8.79 5 8.29

B 13.47 5 19.82
Treynor’s Measure

The Treynor measure, first introduced by Jack L. Treynor, is a performance metric that
assesses the risk-adjusted return of an investment portfolio by evaluating the
portfolio’s return per unit of systematic and assumes that the portfolio has already
eliminated unsystematic risk.

Treynor’s measure = (RP – RF) / ß

where,
RP – Portfolio Return
RF – Risk-free rate of return
ß – Beta coefficient.

A higher measure indicates better portfolio performance.

 Portfoli
Portfoli o Rf (%) βp
o Return(
%)

A 8.79 5 0.499

B 13.47 5 1.2493
Jensen’s measure

Based on the Capital Asset Pricing Model (CAPM), the Jensen measure measures how
much return a portfolio generates above the expected return from the market. The
excess return generated by the portfolio is also known as alpha.

Jensen’s α = Rp – E(Rp)
E(Rp) = RF + (ß) * (RM – RF)
where,
RP – Portfolio Return
RF – Risk-free rate of return
RM – Market rate of return
ß – Beta coefficient

A consistently positive alpha indicates that the portfolio is performing above average,
while a negative alpha signals that the portfolio is underperforming.
The measure calculates risk premiums in beta, representing systematic risk.
 Portfolio
Portfolio average SD Beta
returns

A 20% 0.30 1.25

B 15% 0.31 0.39

C 18% 0.26 1.10

Nifty 50 13% 0.20 1

The risk free rate is 5%, you are required to compare three portfolios on performance
using Sharpes, Treynors and Jensons measure and comment
 Portfolio Revision

The art of changing the mix of securities in a portfolio is called as portfolio

revision.

The process of addition of more assets in an existing portfolio or changing the

ratio of funds invested is called as portfolio revision.

The sale and purchase of assets in an existing portfolio over a certain period
of time to maximize returns and minimize risk is called as Portfolio revision.
Need for portfolio revision

¨Availability of additional funds

¨Change in risk tolerance
¨Change in investment objective
¨Need to liquidate

Constrains of portfolio revision

¨Transaction costs –
brokerage/commission
¨Taxes – capital gains
¨Statutory stipulations
¨Intrinsic difficulty
Portfolio Revision Strategies

1. Active Revision Strategy

Active Revision Strategy involves frequent changes in an existing portfolio

over a certain period of time for maximum returns and minimum risks.
Active Revision Strategy helps a portfolio manager to sell and purchase
securities on a regular basis for portfolio revision.

2. Passive Revision Strategy

Passive Revision Strategy involves rare changes in portfolio only under

certain predetermined rules. These predefined rules are known as formula
plans.
According to passive revision strategy a portfolio manager can bring
changes in the portfolio as per the formula plans only.
Formula Plans
Formula Plans are certain predefined rules and regulations deciding when and
how much assets an individual can purchase or sell for portfolio revision.
Securities can be purchased and sold only when there are changes or
fluctuations in the financial market.

Formula plans help an investor to make the best possible use of

fluctuations in the financial market. One can purchase shares when the
prices are less and sell off when market prices are higher.
With the help of Formula plans an investor can divide his funds into
aggressive and defensive portfolio and easily transfer funds from one
portfolio to other.
¨Types of formula plans

¤Constant Rupee Value Plan

¤Constant Ratio Plan
¤Dollar Cost Averaging