Equity Research and Portfolio Management

Assignments - A
Question 1 i: Sweat equity is the best form of reward for those who
contribute to the growth of a company. Discuss.
Answer
Sweat Equity, as the name suggests, is the equity issued in lieu of
contribution in terms of time given, efforts made and services rendered by
the employees of the company. It is used to refer to a form of compensation
by businesses to their owners or employees. The term is sometimes used in
partnership agreements where one or more of the partners contribute no
financial capital. In the case of a business startup, employees might, upon
incorporation, receive stock or stock options in return for working for belowmarket salaries (or in some cases no salary at all).
The equity that is created in a company or some other asset as a direct
result of hard work by the owner(s)
The Companies Act provides for issue of sweat equity shares to employees
and/or directors of companies on favorable terms in recognition of their
work. Sweat equity makes employees part owners of the company and gives
them a share of profit earned.
Thus, it is the most suitable form of reward for those who contribute to the
growth of the company.
However, in India, as per SEBI and DCA regulations, sweat equity shares
can be issued only to employees or directors.

Question 1 ii: Why do investors add real estate in their portfolio?

Answer
The main aim of an investor, while deciding on a portfolio is to maximize
return and minimize risk of holding an asset. The total return comprises of
the periodic receipts plus change in price of the asset or capital appreciation.
The risk in investment is the chance that the realized return may be less
than the expected return.
In case of investment in real estate, the investor receives periodic receipts in
the form of rentals and the property generally appreciates over period of
time. Another reason to choose real estate in portfolio is its ability to serve
as an inflation hedge, since the owner can increase rentals during inflation.
Real estate also has the unique ability to reduce risk in the way properties
are leased. Portfolios that have followed a cash flow strategy and decided to
lock in rates in long-term leases have less risk exposure to market
movements, but they also have less inflation-hedging ability.
Question 1 iii: What are the steps taken by SEBI in the primary
market to protect investors?
Answer
SEBI has taken various steps and issued guidelines to protect the interest o
the investors in the primary market.
With the objective of boosting investor confidence in the primary market,
SEBI brought the concept of Anchor Investors. This allows an individual or
entity to subscribe up to 30% of the institutional share of an IPO, similar to
a pre-placement agreement. Since 50% of an IPO is typically reserved for
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institutional investors, this would mean up to 15% of the total offering could
be given to an anchor investor. This would thereby impute confidence to
the retail investors as they see a large investor taking a significant stake in
the IPO.
SEBI has recently introduced a new process applicable to retail individual
investors popularly referred to as ASBA (Application Supported by Blocked
amount) process. Under this process, the bid amount is blocked in the
investor account at the time of bidding. If and when an allotment is made,
his account will be debited and the money will be remitted to the company.
Therefore, the bid amount remains in his account earning interest during the
whole process period. Investors account will be debited only to the extent of
shares allotted, if any, and the remaining amount will be unblocked. There
will be no refund as such and therefore the investor will not encounter the
problems related to non-receipt of refund.
SEBI has increased the IPO card validity from 3 months to 1 year, so that
IPO Company can bring the IPO in the market at a right time (say in a bull
trend), This will provide better opportunity for the investors.
No listed company will be allowed to issue shares with superior voting rights.
There could also be no preferential issues with superior voting rights.
Question 2i: Discuss the dematerialisation and rematerialisation
processes in NSDL?
Answer
Dematerialization is the process of converting physical security holdings with
the depository into electronicform in which the share certificates are
shredded(i.e. its paper form is destroyed ) and a corresponding entry of the
number of shares (held in the certificates) is made in the account opened
with the DP(depository participant). The securities held in the demat form do
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not bear any distinguishing features like distinctive number, folio number
and so on. Once the scrip is dematerialized, it loses its identity in terms of
share certificate distinctive numbers and folio numbers.
Rematerialisation is a process by which a client can get his electronic
holdings converted back into physical holdings, that is, he can get back the
physical form of share certificates. To get the certificates back, he has to fill
up a Remat. Request Form and submit it to its DP, with whom he has an
account. The new certificates may not necessarily bear the same folio or
distinctive numbers as were previously existing. Rematerialisation is offered
for all those scrips which are eligible for demat in the depositories list of
securities available for dematerialization.
Question 2ii: Stock market indices are the barometers of the stock
market Discuss?
Answer
Stock market indices are the barometers of the stock market.
These help to recognize broad trend in the market. The investor can use the
indices to allocate the funds rationally among the stocks. Technical analysts
use the indices to predict the future of market.
The Dow Jones Industrial Average (DJIA), one of the most popular stock
market indices experienced a downfall in the early stages of 2004 which was
largely attributed to an increase in the Money Supply by the Federal Reserve
in the USA . The Technical Indicator Index (TII) studies incorporating the
Short Term Index and Intermediate Term Index from the period January to
May 2004 for the American equity markets showed largely negative or
bearish trends for both the indices as they closed at 3.50 and 48.48
respectively. Whereas the short-term index is a useful predictor of equity

markets over the short run, the intermediate term index serves as a warning
system for trend changes of considerable magnitude.

Question 2 iii: How can increasing short interest give a bullish

interpretation. Why?
Answer
A bull market is associated with increasing investor confidence, and
increased investing in anticipation of future price increases.
Short interest is the total number of shares of a particular stock that have
been sold short by investors but have not yet been covered or closed out.
This can be expressed as a number or as a percentage. When expressed as a
percentage short interest is the number of shorted shares divided by the
number of shares outstanding. For example, a stock with 1.5 million shares
sold short and 10 million shares outstanding has a short interest of 15%
(1.5 million/10 million = 15%).
Most stock exchanges track the short interest in each stock and issue reports
at month's end. These reports are great because, by showing what short
sellers are doing; they allow investors to gauge overall market sentiment
surrounding a particular stock. Or alternatively most exchanges provide an
online tool to calculate short interest for a particular security. For example
check out the Nasdaq's short interest calculator; it's very easy to use.
A large increase or decrease in a stock's short interest from the previous
month can be a very telling indicator of investor sentiment. Let's say that
Microsoft's (MSFT) short interest increased by 10% in one month. This
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means that there was a 10% increase in the amount of people who believe
the stock will decrease. Such a significant shift provides good cause for us to
find out more. We would need to check the current research and any recent
news reports to see what is happening with the company and why more
investors are selling its stock.

A high short-interest stock should be approached for buying with extreme

caution but not necessarily avoided at all cost. In fact, many investors use
short interest as a tool to determine the direction of the market. The
rationale is that if everyone is selling, then the stock is already at its low and
can only move up. Thus they feel that a high short-interest ratio is bullish because eventually there will be significant upward pressure on the stock's
price as short sellers cover their short positions (i.e. buy back the stocks
they borrowed to return to the lender).
Question 3i: Explain the utility of the economic analysis and state the economic
factors considered for this analysis.
Answer
Resources are scarce, while human wants and needs tend to be unlimited.
Economic analysis is the study of supply and demand, and the choices
(decisions) and incentives (pricing, taxes, etc.), so that scarce resources are
used efficiently.
The process of economic analysis involves identifying appropriate economic
indicators, collecting economic data, preparing or selecting an economic
forecast, interpreting the economic data, monitoring intervening forces and
using the economic analysis for decision making.
Decision makers use the results of an economic analysis for decision making.
Astute decision makers recognize that economic forces are uncontrollable
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and that current strategies may need to be adjusted to cope with or

overcome the economic changes. They approach with caution opportunities
and threats discovered as a result of economic scanning and analysis. They
pursue a proactive approach, however, knowing that an economic analysis
enables them to choose from alternative approaches , how to employ scarce
or uncommon resources and achieve objectives in the most efficient and cost
effective manner.
The economic factors considered for this analysis are unemployment rates,
personal income and expenditures, interest rates, business inventories,
gross product by industry, and numerous other economic indicators or
indices. Such measures of economic performance may be found in secondary
sources

such

as

business,

trade,

government,

and

general-interest

publications.

Question 3ii: What is meant by fundamental analysis? How does fundamental

analysis differ from technical analysis?

Answer
Fundamental analysis is the examination of the underlying forces that affect
the well being of the economy, industry groups, and companies. The term
simply refers to the analysis of the economic well-being of a financial entity
as opposed to only its price movements. As with most analysis, the goal is to
derive a forecast and profit from future price movements. It is performed on
historical and present data, but with the goal of making financial forecasts.
At the company level, fundamental analysis may involve examination of
financial data, management, business concept and competition. Also known
as quantitative analysis, this involves looking at revenue, expenses, assets,
liabilities and all the other financial aspects of a company. Fundamental
analysts look at this information to gain insight on a company's future
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performance At the industry level, there might be an examination of supply

and demand forces for the products offered. For the national economy,
fundamental analysis might focus on economic data to assess the present
and future growth of the economy. To forecast future stock prices,
fundamental analysis combines economic, industry, and company analysis to
derive a stock's current fair value and forecast future value. When talking
about stocks, fundamental analysis is a technique that attempts to
determine a securitys value by focusing on underlying factors that affect a
company's actual business and its future prospects.
Technical analysis, on the other hand, looks at the price movement of a
security and uses this data to predict its future price movements.
Fundamental analysis is different from technical analysis as a technical
analyst approaches a security from the charts, while a fundamental analyst
starts with the financial statements.
Question 3iii: What industry life cycle exhibits the status of the industry and
gives the clue to entry and exit for investors Elucidate.
Answer
There are typically five stages in the industry lifecycle. They are defined as:

i. Early Stages Phase - alternative product design and positioning,

establishing

ii.

the

Innovation

range

Phase

and

boundaries

Product

of

innovation

the

industry

declines,

itself.

process

innovation begins and a "dominant design" will arrive.

iii. Cost or Shakeout Phase - Companies settle on the "dominant
design"; economies of scale are achieved, forcing smaller players to be

acquired or exit altogether. Barriers to entry become very high, as

large-scale consolidation occurs.
iv. Maturity - Growth is no longer the main focus, market share
and cash flow become the primary goals of the companies left in the
space.
v. Decline - Revenues declining; the industry as a whole may be
supplanted by a new one.
Each stage shows the status of the industry and gives a clue for entry or exit
for investors.
Under the production and market introduction phases, revenues and
earnings are likely to be very low, which makes investments during these
phases more speculative in nature. Revenues and earnings are likely to be
low because there is little demand for the product, or the product is not
completed. Expenses are likely to be very large during these phases as a
company

or

industry

spends

lot

on

marketing

and

research.

Through the growth phase, revenues and margins are likely to be on the rise
due to an increase in demand for a product and the pricing power the firm
has due to a small number of competitors. Stock prices are likely to rise
during this phase.
During the maturity and stability phase, revenues and margins are likely to
decline due to lower sales demand and more competition. Stock prices are
likely to decline during these phases.
Answer 4i)
Expected return on portfolio is
=XL E(

) + XM E

) = 0.60*12 + 0.40*14

for95
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= 7.2 + 5.6
=12.8
=XL

+ XM E(

=0.60*18 + 0.40*12
=10.8 + 4.8
=15.60

.for96

Years

Return

L
( R1 )

1995
1997

12
18

M
Mean Dev.from

Squared

Mean

Dev

15

-3

14

13

15

12

13

18

Dev from Squared

Mean

Dev

-1

1
2

Variance of stock L = 18/2-1 = 18

Standard deviation of Stock L = 18 = 4.24
Variance of stock M = 2/2-1 = 2
Standard deviation of Stock M = 2 = 1.414

Answer 4( ii )
Covariance between stock L and M is
Cov( L, M ) =

( R2) Mean

=
10

Co-efficient of correlation between stock L and M is

Corr ( L, M ) =

=
Answer 4( iii ) Portfolio risk of a portfolio with 60% L and 40% M =

+2

+ 2*0.6*0.4*

*4.24*1.414

= 6.47 + 0.32 + 2.88

Answer 5
Stock Price =

Dividends(Div)
Expected Return(R) Growth Rate(G)

Or,
Stock Price =

Div
(R G)

2
(0.14 0.06)
At a growth rate of 6% infinitely
11

2
0.08

25Rs.

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Assignments B

Answer 1:
Present value of future cash flows for first four years including current year is

10 + 10/(1.14) + 10/

+ (10+(0.25*10))/(

(12.5+(0.25*12.5))/

= 10 + 8.77 +

7.69 + 8.44 + 15.625/1.688

= 10 + 8.77 + 7.69 + 8.44 + 9.25

= 44.15
5th Year = 405.76
Total = 449.91
Above amount is greater than initial outlay of 150, hence recommended to buy the
stock.

Answer 2:
In case of reorganization
PV of future cash flows is 16 + 16/1.18 +
= 16 + 13.56 + 11.49 + 97.38
= 138.43
In case of no reorganization
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PV of future cash flows is - 16 + 182.59

= 196.59
Hence, reorganization is better.

Answer 3:
Case A Total 25+21.19+17.95+15.22+429.82 = 509.18
Case B Something wrong in line highlighted in red i.e. Cash received from the
new investment is therefore, to reduce the dividend payments made in the 10% will also
be maintained because of other operations.
However if the question

intent is (assumption is at my end) that growth is 10% all

through year 5 plus all extra cash as dividend + year six is 15% growth resumes
Total = 25+23.3+21.73 + (20.25+1.22)+(18.88+11.86)+(17.60+17.92)+546.87 =
704.63
Hence investment in case B is much better.

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Case Study
Answer 4:
Here market return (proxy Nifty) is not given. Lets assume 15% correction
Average Beta Infosys = 0.0265
Expected return from Infosys = 5.15+15*.0265=5.55%

Average Beta Hamdard = 0.044

Expected return from Hamdard = 5.15+15*0.044=5.81%

So returns from Hamdard are marginally higher. However D/E ratio is also higher.
Since investor is conservative, Infosys is a world class company and provide IT solution
so as per current scenario Infosys is recommended.
Since corporate tax is there on both cases (assumption); it has no bearing on
investment decision.

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Assignment - C

Q1 b) Genuine investments involve calculated risks which are consistent with the
expected returns.
Q2 c) the preferred time horizon
Q3 a) Offers straight interest payments and is redeemed at par.
Q4 d) 50%
Q5 b) Purchase of gold and art objects
Q6 d) Cannot exceed 10% of the share capital plus free reserves.
Q7 b) 24%
Q8 d) both a & c
Q9 a) 1
Q10 d) Both b and c
Q11 c) Favourable investments
Q12 b) 1.75
Q13 b) 14%
Q14 c) Return on the security and return on the market
Q15 d) CML is a relationship between total risk and required return.
Q16 a) Default risk
Q17 a) Variability of the security's returns
Q18 d) All of the above
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Q19 c) Rise
Q20 d) Both a and c.
Q21 b) Expansion stage
Q22 b) Growth industries
Q23 c) Book value
Q24 b) Equity/Debt
Q25 a) Steel and Iron
Q26 a) High P/E ratios
Q27a) Cash cow
Q28d) None of the above
Q29 b) High dividend pay out ratios
Q30 d) Low value addition
Q31 d) Both a and c.
Q32 d) Both a and b.
Q33 c) MACD
Q34 a) 0.2
Q35 c) Contrarian opinion theory
Q36 a) Exponential moving average
Q37 d) Breadth of market indicators
Q38 d) Chart patterns tend to repeat themselves.
Q39 c) Rs. 300
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Q40 d) 100

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