Portfolio Management - Revised by Me

Study Material
BAFI3200-Protfolio Management
Chapter 1- Introduction to Investment
BAFI3200-Protfolio Management Page |1

Topics Covered:
1. Meaning of investment
2. Definition of Investment
3. Investment objectives
4. Risk and Return
5. Investment decision process
6. Types of Investments
7. Bond Valuation
The income that a person receives may be used for purchasing goods and services that
he currently requires or it may be saved for purchasing goods and services that
he may require in the future .In other words, income can be what is spent for
current consumption. savings are generated when a person or organization abstain
from present consumption for a future use .The person saving a part of his
income tries to find a temporary repository for his savings until they are
required to finance his future expenditure .this result in investment.
Meaning of investment
Investment is an activity that is engaged in by people who have savings, i.e.
investments are made from savings, or in other words, people invest their savings .But
all savers are not investor’s .investment is an activity which is different from
saving.
It may mean many things to many persons. If one person has advanced some money to
another, he may consider his loan as an investment. He expect to get back the money
along with interest at a future date .another person may have purchased on
kilogram of gold for the purpose of price appreciation and may consider it as an
investment.
In all these cases it can be seen that investment involves employment of funds with the
main aim of achieving additional income or growth in the values. The essential quality
of an investment is that it involves something for reward. Investment involves
the commitment of resources which have been saved in the hope that some
benefits will accrue in future.
Thus investment may be defined as “a commitment of funds made in the expectation of

some positive rate of return.
Definition of Investment
F. Amling defines investment as “purchase of financial assets that produces a yield that
is proportionate to the risk assumed over some future investment period.”
According to sharpe, ”investment is sacrifice of certain present value for some

uncertain future values”
Gambling

Gambling is taking a chance. There is nothing scientific about it. Out of the various
options or choices or alternatives available to the investor, he/she does not take a
decision based on his or her rational thinking or logical reasoning. He /she takes a
decision based on luck.
Speculation
Speculation is the practice of engaging in risky financial transactions in an attempt to
profit from short or medium term fluctuations in the market value of a tradable
good such as a buying, holding, selling and short selling of stocks, bonds,
commodities, currencies, real estate collectibles, derivatives or any valuable financial
instrument.
Types of Speculators
The prominent among them are hulls, bears, stag and lame duck.
1. Bull
A trader who expects a rise in prices of securities is known as a bull. He, therefore, takes
a long position with respect to securities. He engages in long buy anticipating a rise in
prices of securities. The bulls will be able to make profit only if the prices rise as
anticipated; otherwise they will suffer losses.
2. Bear
A bear is a pessimist who expects a decline in the prices of securities. He, therefore,
takes a ‘short position’ on securities by engaging in short sales. He attempts to cover up
his short position by buying the securities at lower prices when prices decline. He may
engage in a bear raid so as to bring down the prices of securities. Spreading unfavorable
rumors about companies with the intention of creating a decline in their share prices is
known as a bear raid. The bear will suffer a loss if the prices of securities rise after he
takes a short position on securities. When there is a general decline in prices of
securities in the stock market, the market is said to be bearish.
3. Lame Duck
A lame duck is a bear who has made a short sale but is unable to meet his commitment
to deliver the securities sold by him on account of rise in prices of securities subsequent
to the short sale. He is said to be struggling like a lame duck.
4. Stag
A stag is a trader who applies for shares in the new issues market just like a genuine
investor. A stag is an optimist like the bull and expects a rise in the prices of securities
that he has applied for. He anticipates that when the new shares are listed in the stock
exchange for trading, they would be quoted at a premium, that is, above their issue
price.
Sl.no Investment Speculation

1 Investment is all about value creation Speculation is concerned about price
movement.

2 Investment is has lower risk but need Speculation is challenging, has higher
more capital to generate more value risk but requires less capital.
while
3 Investment is about getting what Speculation is about trying to get
market offers more by doing more in believing that
speculator can beat the market.
4 Investment is over long term speculation is of shorter term
5 Investment is about simplicity Speculation is about complexity
Investment objectives
Investment is made because it serves some objective for an investor. Depending on the
life stage and risk appetite of the investor, there are Five main objectives of investment:
safety, growth, income, Tax exemptions and Liquidity.
1. Return
Investors buy or sell financial instruments in order to earn return on them. The return
on investment is the reward to the investors. The return includes both current income
and capital gain or losses, which arises by the increase or decrease of the security price.
2. Liquidity
Liquidity is also important factor to be considered while making an investment.
Liquidity refers to the ability of an investment to be converted into cash as and when
required. The investor wants his money back any time. Therefore, the investment
should provide liquidity to the investor.
3. Safety
While no investment option is completely safe, there are products that are preferred by
investors who are risk averse. Some individuals invest with an objective of keeping
their money safe, irrespective of the rate of return they receive on their capital. Such
near safe products include fixed deposits, savings accounts, government bonds, etc.
4. Growth
While safety is an important objective for many investors, a majority of them invests to
receive capital gains, which means that they want the invested amount to grow.There
are several options in the market that offer this benefit. These include stocks, mutual
funds, gold, property, commodities, etc.
5. Tax Saving
The investors should get the benefit of tax exemption from the investments. There are
certain investments which provide tax exemption to the investor. The tax saving
investments increases the return on investment. Therefore, the investors should also

think of saving income tax and invest money in order to maximize the return on
investment.
Concept of Return and Risk
When you invest you expect to earn a certain rate of return. When you invest you also
take risks. Such risks include the possibility that the expected return may not actually
materialize. The expected return should be commensurate with risk taken. For
instance, if you take more risk, you would expect to earn more return. Put differently, if
you want to earn more return you should be willing to take more risk. Now where
should you invest and how much return should you look for? Should you invest in
only one investment or should you invest in a basket of investments (portfolio of
investments). What should be return from that portfolio? The capital asset pricing
model, which won for Harry Morkowitz and William Sharpe the Nobel Prize provides
the framework for figuring out the required rate of return on an investment. Here we
proceed to explain this with a series of notions (concepts).
Concept of Return:
When you invest in a stock, you would like to know the rate of return that you would
be able to earn from that stock in future. The major objective of an investment is to earn
and maximize the return. Return on investment may be because of income, capital
appreciation or a positive hedge against inflation. Income is either interest on bonds or
debenture, dividend on equity, etc. Historical returns often are used as a starting point
in estimating expected returns and uncertainly of returns (risk).
There are several ways in which return can be computed, each of which would lead to
different result. Various methods such as Arithmetic Mean, Holding Period Return,
Annualized Holding Period Return, and Compounded Annual Rate of Growth are used
in computation of Return on a security.
Arithmetic Mean: The return from these securities can be considered as the simple
average of annual rates of return. Such simple average return is also known as
Arithmetic Mean.
n
∑ Ri
Ŕi= i=0
N
Example -1: Consider the annual rate of returns of the following two securities, T
and H, captured for previous five years.
Returns (%)
Years 1 2 3 4 5

T Security 18 22 20 17 23
H Security 15 20 30 25 20
In the above example, returns (arithmetic means) from the T & H securities are:
∑ Rt
Ŕt = i=0
N
(18+22+20+17+ 23)
Ŕt = =20 %
5
(15+20+30+25+20)
Ŕh = =22 %
5
Holding Period Return (HPR):
Holding period return is the total return received from holding an asset over a period of
time, generally expressed as a percentage. Holding period return is calculated on the
basis of total returns from the asset (income plus changes in value). It is particularly
useful for comparing returns between investments held for different periods of time.
Holding Period Return = Income + (End of Period Value – Initial Value) / Initial Value
Returns for regular time periods such as quarters or years can be converted to a holding
period return through the following formula:
(1 + HPR) = (1 + r1) x (1 + r2) x (1 + r3) x (1 + r4) – where r1, r2, r3 and r4 are periodic
returns.
Thus, HPR = [(1 + r1) x (1 + r2) x (1 + r3) x (1 + r4)] – 1
Annualized Holding Period Return:

We can convert the holding period return to annual return. Mathematically,
Annualized Holding Return =
{[(Income + (End of Period Value – Initial Value)] / Initial Value+ 1} 1/t – 1, where t = number of
years.
1
Or t
¿ ( HPR+1 ) −1
Example -2: On 1/6/2015 Ali brought a share of a co. for OR 140 per share from
market. The co. paid dividend of OR. 8 per share, later Ali sold the share at OR. 160
on 1/6/2016. What is Holding Period Rate of Return?

The rate of return= 8+ (160-140)/140 = 20percent
Example -3: What is the HPR for an investor, who bought a stock a year ago at OR 50
and received OR 5 in dividends over the year, if the stock is now trading at OR 60?
HPR = [5 + (60 – 50)] / 50 = 30%
Example-4: Which investment performed better: Mutual Fund X, which was held for
three years and appreciated from OR 100 to OR 150, providing OR 5 in distributions,
or Mutual Fund B, which went from OR 200 to OR 320 and generated OR 10
in distributions over four years?
HPR for Fund X = [5 + (150 – 100)] / 100 = 55%
HPR for Fund B = [10 + (320 – 200)] / 200 = 65%
Note: Fund B had the higher HPR, but it was held for four years, as opposed to the
three years for which Fund X was held. Since the time periods are different, this
requires annualized HPR to be calculated, as shown below.
Calculation of annualized HPR:
Annualized HPR for Fund X = (0.55 + 1)1/3 – 1 = 15.73%
Annualized HPR for Fund B = (0.65 + 1)1/4 – 1 = 13.34%
Thus, despite having the lower HPR, Fund X was the superior investment.
Example- 5: Your stock had the following returns in the four quarters of a given
year: +8%, -5%, +6%, +4%. How did it compare against the benchmark index, which
had total returns of 12% over the year?
HPR for your stock portfolio = [(1 + 0.08) x (1 – 0.05) x (1 + 0.06) x (1 + 0.04)] – 1 = 13.1%
Your stock therefore outperformed the index by more than a percentage point (12%).
(However, the risk of the portfolio should also be compared to that of the index to
evaluate if the added return was generated by taking significantly higher risk.)
Compound Annual Rate of Growth (CARG):

We can also compute CARG in built in the Holding period return. This involves
computing the IRR (internal rate of return). For instance, if OR 100 were to grow to OR
247 in 5 years what would be the IRR? In this example, it would be approximately 20%.
Evaluating Returns from Listed Securities:
In case of listed shares “dividends” is one form of returns. There can be second form of
return namely “capital appreciation”. For instance, between the date of purchase of

listed share and say a year later, the market price may undergo a change. It can be
either more than the purchase price (capital appreciation) or it can be less than the
purchase price (capital depreciation). Hence, into addition to dividends, capital gains
or losses are also to be considered a part of total returns from listed securities.
Mathematically, return on listed securities can be computed as follows:
( P1−P 0) + D1
Ri=
P0
Ri=Return on Listed Security i

P1=Market price at end of the period
P0=Market price at the beginning of the period
D 1=Dividends declared ∧paid during year
Example -6: The dividends per share and market price per share of ABC SAOG during
the last few years are listed below. Compute the annual return and expected return.
Per Share in OR
Years Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Dividend 1.75 1.75 2.5 3.2 3.8 4.5
Market Price 30 20 28 42 50 80
Calculation of Return on Stock ABC:
Market Price Capital Appreciation Return

Years Dividend
P0 P1 (P1-P0) {(P1-P0)+D1}/P0
1 1.75 30 20 -10 -0.275
2 2.5 20 28 8 0.525
3 3.2 28 42 14 0.614
4 3.8 42 50 8 0.281
5 4.5 50 80 30 0.690
Total Return 1.835
Average Annual Return on Stock 36.7%
= (Total Returns /Number of years) (1.835/5)*100
= (1.835/5 years) = 0.367 * 100 = 36.7%
Expected Rate of Return
Expected return is used as a synonym for the average of a set of returns in investing,
expected return more often refers to future returns than historical returns. We had

earlier indicated that the arithmetic mean was an appropriate measure of return. The
arithmetic mean need not necessarily be simple average with equal weights given to
past rates of return. If probabilities of occurrence can be assigned, then the expected
return would be weighted average return with probabilities being the assigned weights.
Mathematically, expected rate of return can be express as
n
E Ŕt =∑ ( P∗R t ) ∨¿
i=1
n
E Ŕt =∑ ( P Rt )
i=1
E Ŕt =Expected rate of return on t stock

P=assigned probabilities
Rt =Returns ont stock
Example -7: An investor estimates that return on shares in two different companies
under three different scenarios is likely to be as follows:
Scenario
Probabilities Return
(Chances) X SAOG Y SAOG
1 0.25 36% 22%
2 0.50 25% 16%
3 0.25 12% 14%
What will be the expected rate of return if he invested all his funds in security X
alone or in Y alone? Which is the preferred security?
Expected Rate of Return on Security X and Security Y:

n
E Ŕt =∑ ( P Rt )
i=1
E Ŕ x =( 0.25 ) ( 36 ) + ( 0.50 ) ( 25 ) + ( 0.25 ) ( 12 )=24.5 %
E Ŕ y = ( 0.25 )( 22 ) + ( 0.50 )( 16 ) + ( 0.25 )( 14 )=17 %
Security X gives a higher return than security Y and would hence be preferred.
Concept of Risk
The dictionary meaning of risk is the possibility of loss or injury; risk the possibility of
not getting the expected return. The difference between expected return and actual
return is called the risk in investment. Investment situation may be high risk, medium
and low risk investment;
The risk of an investment depends on the following factors:
1. The longer the maturity period, the larger is the risk.

2. The lower the credit worthiness of the borrower, the higher is the risk.
3. The risk varies with the nature of investment. Investments in ownership
securities like equity shares carry higher risk compared to investments in debt
instruments like debentures and bonds.
Example:-
Buying government securities low risk
Buying shares of an existing Profit making company Medium risk
Buying shares of a new company High risk
Types of risks:
Total Risk=Systematic Risk +Unsystematic Risk
Systematic risk:
The systematic risk is caused by factors external to the particular company and
uncontrollable by the company. The systematic risk affects the market as a whole.
Changes in security’s total return are directly related with overall movements in general
market or economic conditions. It cannot be controlled by an investor.
Types of systematic risk

1. Market risk: A market risk that portion of total variability of return caused by
alternating forces of bull and bear market. When market goes up shares prices will
rise.
2. Inflationary risk: It is also known as purchasing power risk. Inflationary risk is the
chance that the value of an asset or income will be eroded as inflation shrinks the
value of a country’s currency.
3. Interest rate risk: It is the variability in return caused by the changes in level of
interest rates. As interest rate goes up. Market price of existing fixed income
securities falls and vice versa.
Unsystematic risk:
Unsystematic risk emerges due to internal and controllable factors like labour strikes,
management decisions, scarcity of raw materials etc. In case of unsystematic risk, the
factors are specific, unique and related to the particular industry or company.
Types of Unsystematic risk
BAFI3200-Protfolio Management P a g e | 10
Business risk
It is the variability in incomes of the firm and expected dividends. Business risk is
associated with a particular security.
Management risk
Errors made in the managerial decision making will affect the investors who have
invested in that particular company.
Credit risk
This is refers to the possibility that a particular bond issuer will not be able to make
expected interest rate payments and or principle repayments. The higher credit risk, the
higher the interest rate on the bond.
Liquidity risk
Liquidity risk refers to the possibility that an investor may not be able to buy or sell an
investment as and when desired or in sufficient quantities because opportunities are
limited.
Computation of Risk:
Risk reflects the chance that the actual return on an investment may be very different
than the expected return. One way to measure risk is to calculate the variance and
standard deviation of the distribution of returns.
Standard deviation is the deviation from arithmetic mean and is a measure of total risk.
The investment with the lower standard deviation carries the lesser risk. In portfolio
management, we would be computing the variation of returns (express in %), the
resultant standard deviation is also in percentage. Mathematically, Standard deviation
for expected returns is expressed as
n
σ t= √∑
i=1
P( Rt −E Ŕt )2
σ t=Standard Deviation of stock t ( risk of stock t )
P=assigned probabilities
Rt =Returns ont stock
E Ŕt =Expected rate of return on t stock
Steps in computing standard deviation:
1. Compute expected return using the below mentioned formula:
n
E Ŕt =∑ ( P Rt )
i=1
2. Take the deviation of each possible return form the expected return
¿( R t−E Ŕt )
3. Square the deviations
¿( R t−E Ŕt )2
4. Multiply with respective probabilities with the squared deviations and summate
the result to get variance.
n
Variance=∑ P(Rt −E Ŕt )2
i=1
5. Standard deviation is the square rood of variance
σ t=√ Variance
In other way,
n
σ t= √∑
i=1
P( Rt −E Ŕt )2
Example -8: From the following possible outcomes associated with investing in X
Ltd, compute the risk of this investment.
Possible outcome Probability

40% return 0.25
17% return 0.50
Loss of 6% 0.25
Computation of Expected Return and Risk on Stock of X Ltd
Possible Probability Returns E Ŕ x =¿ ( Rt −E Ŕt )

( Rt −E Ŕt )2 P(Rt −E Ŕt )2
Outcome P (Rx) ( P∗Rx ) E Ŕt =17
1 0.25 40 10 23 529 132.25
2 0.50 17 8.5 0 0 0
3 0.25 (6) (1.50) (23) 529 132.50
2
17 ∑ P(R t−E Ŕ t ) 264.50
E Ŕ x
Standard Deviation
n
σ t= √∑
i=1
P( Rt −E Ŕt )2= √ 264.50 = 16.26%
Note: All other things remaining the same, the security with the lower risk should
be selected.
Example – 9: Suppose the standard deviation of returns of PAL Ltd is 16.26% and that
of Hyundai Ltd is 30.40%, while their returns are identical, which will you prefer?
PAL Ltd has lower standard deviation. Hence it is less risky and will therefore be preferred.
Problems:
1. An investor purchased a share for OMR. 84. At the end of the first year the share
price is OMR. 96 and the company declared a dividend of OMR.2 per share. Find the
holding period yield of the investor.
2. Alpha Ltd share price on June 30 th 2008 is OMR 1800 and the price on June 30 th 2007
was OMR. 1620. The dividend paid at the end of the year was OMR 60 per share.
What is the holding period return?
3. Mr. Ikram wants to evaluate the rate of return on his corporate stock. Price of the
stock at the beginning of the year was OMR 50 and at the end of the year is OMR 62.
Income received for the year is OMR 6. Calculate the rate of return on the stock.
4. The dividends per share and market price per share of ABC SAOG during the last
few years are listed below. Compute the annual return and expected return.
Per Share in OR
Years Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Dividend 1.25 1.25 2.25 3.25 3.7 5.4
Market Price 40 30 28 34 45 48
5. Ohms LLC is considering rate of return on two assets A&B. the assets A and B’s
details are in table find the rate of return on both assets.
Asset Cash Inflow Market price Market price
(Income) at beginning of the period at end of the period
A 10,000 2,000,000 2,500,000
B 50,000 1,000,000 960,000
6. The forecast of returns for securities A and B are laid out below.
Scenarios
Probability 0.05 0.25 0.40 0.25 0.05
Returns on Security A (%) 15 20 25 30 35
Returns on Security B (%) 8 18 26 34 44
Required:
(i) Expected rate of return of each security
(ii) Standard deviation for each security
(iii) Comment with reasons as to which of the two securities has more upside
potential (return) and downside higher risk.
Types of Investments
1. Bank deposits
It is the simplest investment avenue open for the investors. He has to open an account
and deposit the money. Traditionally the banks offered current account, Saving account
and fixed deposits account.
2. Life insurance
Life insurance is a contract for payment of a sum of money to the person assured on the
happening of event insured against. Usually the contract provides for the payment of
an amount on the date of maturity or at a specified date or if unfortunate death occurs.
3. Mutual fund
Investing directly in equity shares, and debt instruments may be difficult task for a
large number of customers because they want to know more about the company,
promoter, prospects, competition for the product etc.in such a case, investor can go for
investing in financial assets indirectly through mutual fund. A mutual fund is a trust
that pools the savings of a number of investors who share a common financial goal.
4. Real estate
The real estate market offers a high return to the investors. The word real estate means
land and buildings. Real estate investments cannot be enchased quickly. Liquidity is a
problem. Real estate investment involves high transaction cost.
5. Gold
Off all the precious metals gold is the most popular as an investment. Investors
generally buy gold as a hedge against economic, political, social fiat currency crisis.
6. DEBENTURES/BONDS
A Bond is a loan given by the buyer to the issuer of the instrument. Companies,
financial institutions, or even the government can issue bonds. Over and above the
scheduled interest payments as and when applicable, the holder of a bond is entitled to
receive the par value of the instrument at the specified maturity date.
7. EQU ITY SHARE

Equity, also called shares or scrips, is the basic building blocks of a company. A
company’s ownership is determined on the basis of its shareholding. Shares are, by far,
the most glamorous financial instruments for investment for the simple reason that,
over the long term, they offer the highest returns. Predictably, they’re also the riskiest
investment option.
VALUATION OF FINANCIAL INSTRUMENTS:
BOND VALUATION:
Bonds are long-term debt securities that are issued by Corporations and Government
entities. Purchasers of Bond receive periodic interest payments (coupons) until maturity
at which time they receive the face value of the bond and the last coupon payment.
Bonds pay interest (coupons) yearly or semi-annually.
Coupon Rate: Coupon rate is the rate at which periodic coupon or interest payments
are made. It is expressed as a percentage of bond’s face value.
Coupon payments: Coupon payments represent the periodic interest payments from
the bond issuer to the bondholders.
Maturity Date: Maturity date represents the date on which the bond matures, i.e., the
date on which the face value is repaid. The last coupon payment is also paid on the
maturity date.
Call Date: For bonds which are callable, i.e. bonds which can be redeemed by the
issuer prior to maturity, the call date represents the date at which the bond can be
called.
Call Price: The amount of money the issuer has to pay to a callable bond is the call
price.
Yield to Call: The rate of return that an investor would earn if he bought a callable
bond at its current market price, and held it until the call date, given that the bond was
called on the call date.
Yield to Maturity: The rate of return that sets the present value of the promised bond
payments equal t the current market price of the bond.
Intrinsic Value of Bond (Bond Price)
Intrinsic value of Bond is the present value of the future interest payments and the
maturity proceeds arising from the Bond. The appropriate discount rate used to
ascertain the intrinsic value is the interest rate that investors could earn on bond with
similar characteristics.
1 1 MV
P=CPN x
i(1−
( 1+i ) )
N
+
(1+i)
N
Where: P = Bond Price or Intrinsic Value of Bond

CPN =Coupon amount∨interest amount
i=Interet rate∨Co upon Rate∨ yield ¿ maturity
M V =Maturity Value of t h e Bond issued
N=No of Coupon payments∨interest payments
If the Intrinsic Value > Market Price = Bond is undervalued = Buy the bond
If the Intrinsic value < Market Price = Bond is overvalued = Sell the bond
If the Intrinsic value = Market Price = Bond is correctly priced = Hold the bond
Example – 1:
What is the price of two-year, 10% coupon bond (annual coupon payments) with a
face value of $1,000 and a required rate of 12%?
1 1 MV
P=CPN x
i(1−
( 1+i ) )
N
+
(1+i)
N
1 1 1000
P=100 x
0.12
1−
( )
+
( 1+0.12 ) (1+0.12)2
2
P=966.35
Example -2:
What is the price of two-year, 10% coupon bond (semi-annual coupon payments)
with a face value of $1,000 and a required rate of 12%?
1 1 MV
P=CPN x
i (
1−
( 1+i ) N)+
(1+i)
N
1 1 1000
P=100 x
0.12
1−
(( 1+0.12 ) 4)+
(1+ 0.12)
4
P=939.25
Example -3:
A bond has a $1,000 face value, 20 years to maturity, an 8 percent coupon rate(annual
coupon payments), and a yield of 9 percent. What’s the price?
1 1 MV
P=CPN x
i (
1−
( 1+i ) N)+
(1+i) N
1 1 1000
P=80 x
0.09(1−
( 1+0.09 ) )
20
+
(1+ 0.09)
20
P=¿908.71
Bond Yield
Yield is a method of evaluating the returns of a financial instrument. Bond yield is the
percentage rate of return on the amount invested by the investor. Bond yield may be
current yield, yield to maturity, yield to call and holding period return.
Current yield
Current yield is the relationship of the coupon interest rate with the present market
price of a bond. It is calculated as a ratio of coupon rate to market price multiplied by
100
CPN
Current Yield= x 100
Current Market Price
Example -4:
The face value of a 12% bond is OMR 100. What the current yield if an investor buys
the bond from the market for (i) OMR 80, (ii) OMR 100 and (iii) OMR 120?
CPN
12
if the market price isOMR 80 , thenthe Current Yield= x 100=15 %
80
12
if the market price isOMR 100 , thenthe Current Yield= x 100=12%
100
12
if the market price isOMR 120 , thenthe Current Yield= x 100=10 %
120
Example -5: What is the current yield of 10 years, 12% coupon bond with a par value
of OMR 1000 and current market price is OMR. 950
CPN
120
Current Yield= x 100=12.63 %
950
Example -6: An investor buys 20 years bond at OMR. 800 and its carries OMR.100
worth of coupons per year and its par value is OMR 1000. How much is the current
yield?
CPN
100
Current Yield= x 100=12.5%
800
Yield to Maturity (YTM)
Yield to Maturity (YTM) is the measure of a bond’s rate of return that considers both the
interest (coupon) and any maturity value.
It is rate of return that an investor would earn if the bond is bought at its current market
price and held till maturity. It is bond’s internal rate of return, i.e. its represents the
discount rate which equates the discounted value of a bond’s future cash flows to its
current market price. The yield is expressed as an annual percentage of the amount of
face value.
By using trial and error, YTM can be calculated as follows:
YTM =LR+ ( difference between a∧b

difference between b∧c )
( HR−LR )
Where, YTM is Yield to maturity

LR = Lower Rate of return (lower discount rate)
HR = Higher rate of return (higher discount rate)
a = Issues price of the bond
b= Price of the Bond at Lower Rate (LR)
c= Price of the Bond at Higher Rate (HR)
Illustration
1. A bond of OMR 5000 bearing coupon rate of 10% and redeemable in 10 years at is
being redeemed at OMR 5300. Find the YTM of the bond.
Calculation of Bond Price at discount rate of 10% (assumed by trial and error)
1 1 MV
P=CPN x
i(1−
( 1+i ) )
N
+
(1+i)
N
1 1 5300
P=500 x
0.10 (
1−
( 1+0.10 )10 )
+
(1+0.10)10
P=¿5116.244
Calculation of Bond price at discount rate of 20% (Assumed by trial and error)
1 1 MV
P=CPN x
i(1−
( 1+i ) )
N
+
(1+i)
N
1 1 5300
P=500 x
0.20 (
1−
( 1+0.20 )10 )
+
(1+0.20)10
=P=2952.21
Computation of YTM:
difference between a∧b

YTM =LR+ ( differrence between b∧c )
( HR−LR )
LR = Lower Rate of return (lower discount rate) = 10%
HR = Higher rate of return (higher discount rate) = 20%
a = Issues price of the bond = 5000
b= Price of the Bond at Lower Rate (LR) = 5116.244
c= Price of the Bond at Higher Rate (HR) = 2952.21
116.244
YTM =10+ ( 2164.034 ) ( 20−10 )
YTM =10.53 %
2. A bond has a par value of OMR 1000. It has a coupon rate of 9%. It matures after 8
years. Its current market price is OMR 800. What is the yield to maturity of the bond?
Yield to Call
The Yield-to-Call is the rate of return that would be earned if an investor bought a
callable bond at its current market price and held it until the call date (given that the
bond was called on the call date). A Callable Bond is one that can be redeemed before
its call date.
It is calculated similarly to YTM, however, callable value and callable period is

considered while computing for YTC.
Illustration
1. Calculate yield to call when the following information of the bond is given
Market price OMR 110 Maturity date 31/12/2011
Face value OMR 100 Callable on 31/12/2008
Coupon rate 11% Interest payable annually
Date of purchase1/1/2006 Maturity/Callable value of the bond OMR

108
2. An investor has the following information of a bond
Face value is OMR 1000

Coupon rate is 10%
Time to maturity is 10 Years
Market price is OMR 1250
Callable in 5 years is OMR 1200
Find out:- 1) Yield to maturity
2) Yield to call
3. An investor wants you to evaluate the following bond
Face value is OMR 100

Coupon value is 12%
Maturity period is 3 years
1) The investor wants a yield of 15%. What is the maximum price that he should pay for
it?
If the bond is selling for OMR 95, what would be the yield?
4. You have been appointed as an investment consultant and investment analyst by

“Barclays investment consultant” a financial intelligence company dealing with retail
investors. Your job description includes the analysis of the equity and debt securities to
determine the effectiveness of the investment and recommend the effective investment
option. One of your customers has invested OMR 2000 in 10% bond purchased on
1/1/2006 which is having maturity on 31/12/2015, the bond also having the market
price of OMR 2550. If the bond is called up on 31/12/2011 the price of the bond is 3200.
Find out:
i. Yield to call
ii. Yield to maturity
iii. Should the share be sold by an investor
TEST YOUR UNDERSTANDING

1. Define the term Investment and speculation.
2. Comment on the risks involved in investment
3. Discuss about the role of speculators in the investment environment.
4. What is the meaning of investment?
5. An investor wants to invest some of his surplus money in the securities. Discuss
in details the various steps that are involved in his investment decision making
process
6. Distinguish between Investment and speculation
7. Differentiate between Systematic and Unsystematic risk.
8. How do you select securities for investment?
Reference
1. Sudhindra Bhat, Security Analysis And Portfolio Management, Excel Books
2. Fischer And Jordan; Security Analysis And Portfolio Management; Prentice-
Hall,pearson
3. Punithavathy Pandian, SECURITY ANALYSIS AND PORTFOLIO
MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001.
Chapter 2 Financial Markets

Topics Covered:
1. Meaning of Financial Markets
2. Functions of Financial Markets
3. Classification of Financial Markets
(a) Debt market
(b) Equity market
(c) Money market
(d) Capital Market
(e) Secondary Market
(f) Organized markets
(g) Unorganized markets
Financial market is a place or a system where financial assets or instruments are

created and exchanged by market participants. Financial markets play a significant
role in performing the resource management in an economy through various
financial assets namely equity, debt, currency and other quasi instruments. Financial
markets facilitate the price discovery and provide liquidity of financial assets. Financial
market performs the crucial role of capital creation that is acting as a bridge
between providers of finance and the seekers of finance.
Meaning
“Financial markets are the centers or arrangements that provide facilities for
buying and selling of financial claims and services”.
Functions of Financial Markets:
The main functions of financial markets are outlined as below:
1. To facilitate creation and allocation of credit and liquidity.
2. To serve as intermediaries for mobilisation of savings.
3. To help in the process of balanced economic growth.
4. To provide financial convenience.
5. To provide information and facilitate transactions at low cost.
6. To cater to the various credits needs of the business organisations.
Classification of Financial Markets:
There are different ways of classifying financial markets. There are mainly five ways
of classifying financial markets.
1. Classification on the basis of the type of financial claim:
Debt market: This is the financial market for fixed claims like debt instruments.
Equity market: This is the financial market for residual claims, i.e., equity instruments.
2. Classification on the basis of maturity of claims:
Money market: A market where short term funds are borrowed and lend is called
money market. It deals in short term monetary assets with a maturity period of
one year or less. Liquid funds as well as highly liquid securities are traded in
the money market.
According to Crowther, “Money market is a collective name given to various firms and
institutions that deal in the various grades of near money”.
The following are the characteristics of money market:
1. It is a market for short term financial assets that are close substitutes of
money.
2. It is basically an over the phone market.
3. It is a wholesale market for short term debt instruments.
4. It is not a single market but a collection of markets for several instruments.
5. It facilitates effective implementation of monetary policy of a central bank of a

country.
6. Transactions are made without the help of brokers.
Functions of Money Market
Money market per forms the following functions:
1. Facilitating adjustment of liquidity position of commercial banks, business

undertakings and other non -banking financial institutions.
2. Enabling the central bank to influence and regulate liquidity in the economy
through its intervention in the market.
3. Providing a reasonable access to users of short term funds to meet their

requirements quickly at reasonable costs.
4. Providing short term funds to govt. institutions.
5. Enabling businessmen to invest their temporary surplus funds for short period.
6. Facilitating flow of funds to the most important uses.

Structure of Money Market
Money market consists of a number of sub markets.
I. Call Money Market
Call money is required mostly by banks. Commercial banks borrow money without
collateral from other banks to maintain a minimum cash balance known as cash reserve
ratio (CRR).
2. Commercial Bill Market
Commercial bill market is another segment of money market. It is a market in which

commercial bills (short term) are bought and sold. Commercial bills are important
instruments.
3. Treasury Bills Market
Treasury bill market is a market which deals in treasury bills. In this market,
treasury bills are bought and sold. Treasury bill is an important instrument of
short term borrowing by the Govt. These are the promissory notes or a kind of finance
bill issued by the Govt.
4. Acceptance Market
Acceptance Market is another component of money market. It is a market for banker’s

acceptance. The acceptance arises on account of both home and foreign trade.
Capital market: Capital market is the market for long term funds. This market
deals in the long term claims, securities and stocks with a maturity period of
more than one year. It is the market from where productive capital is raised and made
available for industrial purposes.
According toW.H. Husband and J.C. Dockerbay, “the capital market is used to
designate activities in long term credit, which is characterized mainly by securities of
investment type”.
Characteristics of Capital Market
1. It is a vehicle through which capital flows from the investors to borrowers.
2. It generally deals with long term securities.
3. All operations in the new issues and existing securities occur in the capital
market.
4. It deals in many types of financial instruments. These include equity shares,
preference shares, debentures, bonds, etc.
5. It functions through a number of intermediaries such as banks, merchant

bankers, brokers, underwriters, mutual funds etc.
The functions of an efficient capital market are as follows:
1. Mobilise long term savings for financing long term investments.
2. Provide risk capital in the form of equity or quasi- equity to entrepreneurs.
3. Provide liquidity with a mechanism enabling the investor to sell financial

assets.
4. Improve the efficiency of capital allocation through a competitive pricing

mechanism.
5. Disseminate information efficiently for enabling participants to develop an informed

opinion about investment, disinvestment, reinvestment etc.
6. Enable quick valuation of instruments–both equity and debt.
Distinguish between Money Market and Capital Market
Money market Capital market
Short term funds Long term funds
Instruments are: bills, CPs, T-bills, CDs Shares, debentures, bonds etc., Are main
etc., instruments in capital market
Huge face value for single instrument Small face value of securities
Central and coml. banks are major Development banks, investment
players institutions are major players
No formal place for transactions Formal place, stock exchanges

Usually no role for brokers Brokers playing a vital role
3. Classification on the basis of seasoning of claim:
Primary market: Primary markets are those markets which deal in the new securities.
Therefore, they are also known as new issue markets. These are markets where
securities are issued for the first time. In other words, these are the markets for the
securities issued directly by the companies. The primary markets mobilize savings and
supply fresh or additional capital to business units.
The main function of a primary market can be divided into three service
functions. They are: origination, underwriting and distribution
1. Origination: Origination refers to the work of investigation, analysis and processing

of new project proposals. Origination begins before an issue is actually floated in the
market. The function of origination is done by merchant bankers who may be
commercial banks, all India financialinstitutions or private firms.
2. Underwriting: When a company issues shares to the public it is not sure that
the whole shares will be subscribed by the public. It is a contract between a
company and an underwriter (individual or firm of individuals) by which he agrees to
undertake that part of shares or debentures which has not been subscribed by the
public. The firms or persons who are engaged in underwriting are called underwriters.
3. Distribution: This is the function of sale of securities to ultimate investors. This

service is performed by brokers and agents. They maintain a direct and regular contact
with the ultimate investors.
Secondary market: Secondary markets are those markets which deal in existing
securities. Existing securities are those securities that have already been issued
and are already outstanding. Secondary market consists of stock exchanges.
Meaning of Secondary Market
Secondary market is a market for old issues. It deals with the buying and selling
existing securities i.e. securities already issued. In other words, securities already
issued in the primary market are traded in the secondary market. Secondary
market is also known as stock market.
According to Pyle, “Security exchanges are market places where securities that
have been listed thereon may be bought and sold for either investment or
speculation”.
Characteristics of a Stock Exchange
1. It is an organized capital market.
2. It may be incorporated or non-incorporated body (association or body of

individuals).
3. It is an open market for the purchase and sale of securities.
4. Only listed securities can be dealt on a stock exchange.
5. It works under established rules and regulations.
6. The securities are bought and sold either for investment or for speculative purpose.
Functions of Stock Exchange
1. Ensures liquidity to capital: The stock exchange provides a place where shares and
stocks are converted into cash.
2. Continuous market for securities: It provides a continuous and ready market for
buying and selling securities. It provides a ready market for those who wish to buy and
sell securities
3. Mobilisation of savings: It helps in mobilizing savings and surplus funds of

individuals, firms and other institutions. It directs the flow of capital in the most
profitable channel.
4. Capital formation: The stock exchange publishes the correct prices of various
securities. Thus the people will invest in those securities which yield higher
returns. It promotes the habit of saving and investment among the public.
5. Evaluation of securities: The prices at which transactions take place are recorded
and made public in the forms of market quotations. From the price quotations, the
investors can evaluate the worth of their holdings.
6. Economic developments: It promotes industrial growth and economic

development of the country by encouraging industrial investments.
4. Classification on the basis of structure or arrangements: On this basis, financial

markets can be classified into organized markets and unorganized markets.
Organized markets: These are financial markets in which financial transactions take
place within the well-established exchanges or in the systematic and orderly structure.
Unorganized markets: These are financial markets in which financial transactions

take place outside the well established exchange or without systematic and
orderly structure or arrangements.
5. Classification on the basis of timing of delivery: On this basis, financial

markets may be classified into cash/spot market and forward / future market.
Cash / Spot market: This is the market where the buying and selling of
commodities happens or stocks are sold for cash and delivered immediately after the
purchase or sale of commodities or securities.
Forward/Future market: This is the market where participants buy and sell
stocks/commodities, contracts and the delivery of commodities or securities occurs at a
pre-determined time in future.
6. Other types of financial market: Apart from the above, there are some other
types of financial markets. They are foreign exchange market and derivatives market.
Foreign exchange market: Foreign exchange market is simply defined as a market in

which one country’s currency is traded for another country’s currency. It is a market for
the purchase and sale of foreign currencies.
Derivatives market: The derivatives are most modern financial instruments in hedging
risk. The individuals and firms who wish to avoid or reduce risk can deal with the
others who are willing to accept the risk for a price. A common place where
such transactions take place is called the derivative market.

1. What are the various operations carried out in secondary market?
2. What are the various components of Capital market?
3. What are the various components of Money market?
4. Elaborate the role of financial markets.
5. What are the general features of Money Market?
Reference
Hall,pearson
Chapter 3 Fundamental Security Analysis
Topics Covered:
1. Fundamental Security Analysis
2. Economy Analysis
3. Industry Analysis
4. Company analysis
Fundamental Security Analysis
The intrinsic value of an equity share depends on a multitude of factors. The earnings of
the company, the growth rate and the risk exposure of the company have a direct
bearing on the price of the share. These factors in turn rely on the host of other factors
like economic environment in which they function, the industry they belong to, and
finally companies own performance.
Fundamental analysis thus involves three steps:
1. Economy Analysis
2. Industry Analysis
3. Company analysis
Economy Analysis
The performance of a company depends on the performance of the economy. If the

economy is booming, incomes rise, demand for goods increases, and hence the
industries and companies in general tend to the prosperous. On the other hand, if the
economy is in recession, the performance of companies will be generally bad.
Investors are concerned with those variables in the economy which affect the
performance of the company in which they intend to invest. A study of these economic
variables would give an idea about future corporate earnings and the payment of
dividends and interest part of his fundamental analysis.
Factors to be considered in Economy Analysis
1. Growth Rates of National Income

The rate of growth of the national economy is an important variable to be considered by
an investor. GNP (gross national product), NNP (net national product) and GDP (gross
domestic product) are the different measures of the total income or total economic
output of the country as a whole.
2. Inflation
Inflation prevailing in the economy has considerable impact on the performance of
companies. Higher rates of inflation upset business plans, lead to cost escalation and
result in a squeeze on profit margins.
3. Interest Rates
Interest rates determine the cost and availability of credit for companies operating in an
economy. A low interest rate stimulates investment by making credit available easily
and cheaply.
4. Exchange Rates
The performance and profitability of industries and companies that are major importers
or exporters are considerably affected by the exchange rates of the rupee against major
currencies of the world. A depreciation of the rupee improves the competitive position
of Indian products in foreign markets, thereby stimulating exports.
5. Infrastructure
The development of an economy depends very much on the infrastructure available.
Industry needs electricity for its manufacturing activities, roads and railways to
transport raw materials and finished goods, communication channels to keep in touch
with suppliers and customers.
Industry Analysis
An industry is a group of firms that have similar technological structure of production
and produce similar products. For the convenience of the investors, the broad
classification of the industry is given in financial dailies and magazines. Companies are
distinctly classified to give a clear picture about their manufacturing process and
products.
Factors to be Considered Industry Analysis
1. Growth of the Industry

The historical performance of the industry in terms of growth and profitability should
be analysed. Industry wise growth is published periodically by the Centre for
Monitoring Indian Economy. The past variability in return and growth in reaction to
macro economic factors provide an insight into the future.
2. Cost Structure and Profitability

The cost structure, that is the fixed and variable cost, affects the cost of production and
profitability of the firm. In the case of oil and natural gas industry and iron and steel
industry the fixed cost portion is high and the gestation period is also lengthy. Higher
the fixed cost component, greater sales volume is required to reach the firm’s breakeven
point.
3. Nature of the Product
The products produced by the industries are demanded by the consumers and other
industries. If industrial goods like pig iron, iron sheet and coils are produced, the
demand for them depends on the construction industry. Likewise, textile machine tools
industry produces tools for the textile industry and the entire demand depends upon
the health ofthe textile industry.
4. Nature of the Competition

Nature of competition is an essential factor that determines the demand for the
particular product, its profitability and the price of the concerned company scrips. The
supply may arise from indigenous producers and multinationals. In the case of
detergents, it is produced by indigenous manufactures and distributed locally at a
competitive price.
5. Government Policy
The government policies affect the very nerve of the industry and the effects differ from
industry to industry. Tax subsidies and tax holidays are provided for export oriented
products. Government regulates the size of the production and the pricing of certain
products.
6. Labor
The analysis of labor scenario in a particular industry is of great importance. The
number of trade unions and their operating mode has impact on the labour
productivity and modernization of the industry.
Company Analysis
In the company analysis the investor assimilates the several bits of information related
to the company and evaluates the present and future values of the stock. The risk and
return associated with the purchase of the stock is analyzed to take better investment
decisions. The valuation process depends upon the investors’ ability to elicit
information from the relationship and inter-relationship among the company related
variables.
The investor should be aware that income of the company may vary due to the
following reasons.
➢ Change in sales
➢ Change in costs
➢ Depreciation method adopted
➢ Depletion of resources in the case of oil, mining, forest products, gas etc.
➢ Inventory accounting method
➢ Replacement cost of inventories
➢ Wages, salaries and fringe benefits
➢ Income taxes and other taxes.
Factors Share value

 Competitive edge Earnings  Historic price of stock
 Capital structure  P/E ratio
 Management  Economic condition
 Operating efficiency  Stock market condition
 Financial performance
Future price Present price
Factors to be Considered Company Analysis
1. The Market Share

The market share of the annual sales helps to determine a company’s relative
competitive position within the industry. If the market share is high, the company
would be able to meet the terms of sales. While analyzing the market share, the size of
the company also should be considered because the smaller companies may find it
difficult to survive in the future. The leading companies of today’s market will continue
to lead at least in the near future.
2. Growth of Sales
The company may be a leading company, but if the growth in sales in comparatively
lower than another company, it indicates the possibility of the company losing the
leadership. The rapid growth in sales would keep the shareholder in a better position
than one with the stagnant growth rate. The company of large size with inadequate
growth in sales will not be preferred by the investors.
3. Stability of Sales
If a firm has stable sales revenue, other things being remaining constant, will have more
stable earning and wide variations in capacity utilization, financial planning and
dividend. Periodically all the financial newspapers provide information about the
market share of different companies in an industry.
4. Sales Forecast
The Company may be in a superior position commanding more sales both in monetary
terms and physical terms but the investor should have an idea whether it will continue
in future or not.
5. Capital Structure
The equity holders’ return can be increased manifold with the help of financial leverage,
i.e., using debt financing along with equity financing. The effect of financial leverage is
measured by computing leverage ratios. The debt ratio indicates the position of the long
term and short term debts in the company finance. The debt may be in the form of
debentures and term loans from financial institutions.
6. Management
Good and capable management generates profit to the investors. The management of
the firm should efficiently plan, organize, actuate and control the activities of the
company. The basic objective of management is to attain the stated objectives of
company are achieved, investors will have a profit.
Test Your Understanding

1. What is meant by fundamental analysis?
2. What is meant by Economy Analysis?
3. What is meant by Industry Analysis
4. What is meant by Company analysis
5. Do you think that knowing the current status of economy is useful in analyzing
stock market movements? If so, explain.
6. Explain the utility of the economic analysis and state the economic factors
considered for this analysis.
7. How is the competitive position of a company within an industry determined?
8. How does management of a company affect its stock prices?
Reference
1. Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND
PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009
2. Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI,
Delhi, 2011
Chapter-4 Portfolio management

Topics Covered:
1. Introduction and Meaning
2. Objectives of Portfolio Management
3. Phases of Portfolio Management
4. Return and Risk on Portfolio
5. Measures of Portfolio Performance
6. Graded illustrations
Introduction and Meaning
Most investors thus tend to invest in a group of securities rather than a single security.
Such a group of securities held together as an investment is what is known as a
portfolio.
Portfolio is a group of financial assets such as shares, stocks, bonds, debt instruments,
mutual funds, cash equivalents, etc. A portfolio is planned to stabilize the risk of non-
performance of various pools of investment.
Thus, Portfolio Management refers to the selection of securities and their continuous
shifting in the Portfolio for optimizing the return and maximizing the wealth of an
investor.
Portfolio Management (PM) guides the investor in a method of selecting the best
available securities that will provide the expected rate of return for any given degree of
risk and also to mitigate (reduce) the risks.
For example, Consider Mr. John has $100,000 and wants to invest his money in the
financial market other than real estate investments. Here, the rational objective of the
investor (Mr. John) is to earn a considerable rate of return with less possible risk.
Factors affecting investment decisions in Portfolio Management
1. Types of Securities: What type of securities be chosen? Bonds, Preference shares,

Equity Shares, Government Securities etc.,
2. Proportion of Investment: What should be proportion of investment in fixed

interest securities (Bonds) and dividend bearing securities?
3. Identification of Industry: In case investments are to be made in shares or bonds of

companies, which particular industry shows potential of growth?
4. Identification of Company: After identifying industries which high growth

potential, selection of the Company, in which shares or securities investments are to be
made?
5. Objectives of Portfolio: If the portfolio is to have a safe and steady returns, then
securities which low-risk would be selected. In case of portfolios which are floated for
high returns, then risk investments which carry a very high rate of return will be
selected.
6. Timings of purchase: At what price the price share is acquired for the Portfolio,
depends entirely on the timing decision. If a person wishes to make any gains, he
should buy when the shares are selling at a low price and sell when they are at a high
price.
Phases of Portfolio Management

Portfolio management is a process and broadly it involves following five phases and
each phase is an integral part of the whole process and the success of portfolio
management depends upon the efficiency in carrying out each of these phases.
1. Security Analysis:
Security analysis constitutes the initial phase of the portfolio formation process and
consists in examining the risk-return characteristics of individual securities and also the
correlation among them. A simple strategy in securities investment is to buy
underpriced securities and sell overpriced securities
2. Portfolio Analysis:
Once the securities for investment have been identified, the next step is to combine
these to form a suitable portfolio. Each such portfolio has its own specific risk and
return characteristics which are not just the aggregates of the characteristics of the
individual securities constituting it. The return and risk of each portfolio can be
computed mathematically based on the risk-return profiles for the constituent securities
and the pair-wise correlations among them.
3. Portfolio Selection:
The goal of a rational investor is to identify the Efficient Portfolios out of the whole set
of Feasible Portfolios mentioned above and then to zero in on the Optimal Portfolio
suiting his risk appetite. An Efficient Portfolio has the highest return among all Feasible
Portfolios having identical Risk and has the lowest Risk among all Feasible Portfolios
having identical Return.
4. Portfolio Revision:
Once an optimal portfolio has been constructed, it becomes necessary for the investor to
constantly monitor the portfolio to ensure that it does not lose it optimality. Since the
economy and financial markets are dynamic in nature, changes take place in these
variables almost on a daily basis and securities which were once attractive may cease to
be so with the passage of time. New securities with expectations of high returns and
low risk may emerge.
5. Portfolio Evaluation:
This process is concerned with assessing the performance of the portfolio over a
selected period of time in terms of return and risk and it involves quantitative
measurement of actual return realized and the risk borne by the portfolio over the
period of investment. The objective of constructing a portfolio and revising it
periodically is to maintain its optimal risk return characteristics.
Notion of Portfolio
Term portfolio means a basket or a combination of securities. Thus if you invest Soft
drink securities and Coffee business, you are creating a portfolio of businesses.
Similarly, if you invest Raysut Cement Company and Bank Muscat you are building a
portfolio of stocks. How does one compute the return and risk of a portfolio?
Return on Portfolio( R p ¿:
The return on portfolio is the weighted average return of the securities constituting the
portfolio with the value of investment being the assigned weight.
R p =∑ W∗E( Ŕt )
R p =Return on Portfolio
W =Weight∨Proportion of Investment ∈stocks∨ percentage of investment
E ( Ŕt )=Expected rate of stock t ( single stock )
Steps in computing Expected Rate of Return on Portfolio:
1. Compute Expected Rate of Return on single stock using the following formula:
n
E Ŕt =∑ ( P Rt )
i=1
2. Compute Expected Rate of Return on Portfolio using the following formula:
R p =∑ W∗E( Ŕt )
Example-1: From the following data, compute the expected rate of return on
portfolio.
Seasons Probability Return on Soft drink Return on Coffee

Summer 0.5 20% 10%
Winter 0.5 10% 20%
Assume that investment is made in the proportion of 80:20.
Step -1: Expected Rate of Return on Soft drink and Coffee:

n
E Ŕt =∑ ( P Rt )
i=1
E Ŕs =( 0.5 ) ( 20 ) + ( 0.5 ) ( 10 )=15 %
E Ŕc =( 0.5 )( 10 ) + ( 0.5 )( 20 ) =15 %

Step -2: Expected Rate of Return on Portfolio:
R p =∑ W∗E( Ŕt )
Ws = Weight of investment in soft drink is given as 80% = 0.80
Wc = Weight of investment in coffee is given as 20% = 0.20
Therefore, Expected Rate of Return on Portfolio:
R p =( W s ) ( E Ŕ s ) + ( W c ) ( E Ŕ c )
R p =( 0.8 ) (15 )+ ( 0.2 )( 15 ) =12+ 3=15 %
Example -2: What is return on a portfolio consisting of five securities earning returns
as shown in table?
Security % of share in the Returns (%)

portfolio
A 15 22
B 17 24
C 25 8
D 32 13
E 11 43
In the above question, expected returns on single stocks are already given.
Therefore, Return on Portfolio is calculated as follows:
R p =( W a ) ( E Ŕa ) + ( W b ) ( E Ŕ b ) +(W c ) ( E Ŕc ) + ( W d ) ( E Ŕd ) + ( W e ) ( E Ŕe )
R p =( 0.15 ) (22 ) + ( 0.17 )( 24 ) + ( 0.25 ) ( 8 ) + ( 0.32 ) ( 13 ) + ( 0.11 ) ( 43 ) =18.27 %
Computation of Expected Rate of Return based on CAPM

(Capital Asset Pricing Model):
CAPM explains the relationship between the Expected Return, Systematic Risk (Non-
diversifiable Risk) and the valuation of securities. CAPM is based on premise that the
diversifiable risk of a security is eliminated when more and more securities are added
to the portfolio. All securities do not have same level of systematic risk and therefore,
the required rate of return goes with level of systematic risk. It considers the required
rate of return of a security on basis of its systematic risk contribution to the total risk.
Systematic risk can be measured by Beta (β ¿ ,which is function of the following:
 Total risk associated with the Market Return

 Total risk associated with the individual securities return
 Correlation between the two
Formula for computing Expected Rate of Return on Portfolio under CAPM is
E ( R p ) =Rf + {β p∗( R m−R f ) }
E ( R p ) =Expected rate of return on Portfolio
R f =Risk free rate
β p=Beta of Portfolio∨Systematic risk of Portfolio
Rm =Return on Market Portfolio
Example -3: If the risk free rate of interest is 10%, and expected return on market
portfolio is 15%, ascertain expected return on the portfolio if portfolio beta is 0.20
using CAPM.
E ( R p ) =Rf + {β p∗( R m−R f ) }

E ( R p ) =10+ { ( 0.20 )∗( 15−10 ) }=10+1=11%
Example -4: Beta of the security 0.8, Rate of return on market portfolio 15% and Risk
free interest 7%. Find out the expected rate of return of the security. And find out the
Beta of the portfolio which has an expected return of 20%.
E ( R p ) =Rf + {β p∗( R m−R f ) }

E ( R p ) =7+ {( 0.8 )∗( 15−7 ) }=7 +6.4=13.4 %
Calculation of Beta of a Security:
20=7+ { ( β )∗( 15−7 ) }

20=7+ β 8
so , 20−7=β 8
20−7 13
Therefore , β= = =1.625
8 8
Concept of Beta ( β ):
Beta is measure of Non-diversifiable risk. Beta of a stock measures the sensitivity of
stock with reference to broad market index. The broad based index for instance, in
Oman, could be MSM 30 index. Beta measures systematic risk i.e. that which affects the
market as a whole and hence cannot be eliminated through diversification. Beta is the
factor of Standard deviation of security or portfolio ( σ t ¿; Standard deviation of the
Market (σ m) and Correlation between security and market ( ρtm ) .
Thus, Beta is equals to
( σ t∗ρtm)
β=
σm
Where,
β=Beta of Portfolio
σ t=Standard Deviation of stock t returns
σ m=Standard Deviation of market returns
ρtm=Coefficient of correlation between stock returns∧market returns
Alternatively, Beta is equal to
(Covariance )tm
β= 2
(ρm )
Example-5: Return on LKG Ltd’s shares has a standard deviation of 22%, as against
the standard deviation of the market at 12%. The correlation between market and
stock is 0.7. Compute the Beta value, Systematic Risk and Unsystematic risk.
( σ t∗ρtm)
β=
σm
(22∗0.7)
β= =1.28
12
Beta value is 1.28
Systematic risk = (Total risk of market)* (beta) = (12)*(1.28) = 15.36%
Unsystematic risk = Total risk of the stock – systematic risk = 22% - 15.36% = 6.64%
Covariance (Cov(ts) ¿ :
The return from each security is not static. The returns vary. In other words, each of
securities is variable in itself. A possible return in one security can accompany by a
positive, neutral, or adverse return in another.
The Covariance between two securities may be positive, negative or zero. A positive
value for covariance indicates that the returns on two securities tend to go together. A
negative value for covariance indicates that the returns on two securities bear a
tendency to offset each other. A zero value for covariance would simply that there no
distinct relationship between the movements in returns in respect of two securities.
Mathematically, Covariance can be expressed as
COV ts =∑ P(R t−E Ŕ t )( R s−E Ŕ s)
Correlation Coefficient ( ρts ¿:

Correlation coefficient is a measure of closeness of the relationship between two
securities returns and is bounded by the values +1 and -1.
Correlation (ρ ¿ supplements and upgrades the Covariance values in order to help

comparison with corresponding values for other pairs of securities constituting the
portfolio. Correlation coefficient ranges between (-) 1 to (+) 1.
Portfolio risk will be maximum when two components of portfolio stand perfectly
positively correlated (+) 1; and will be minimum when the same rate perfectly
negatively correlated (-) 1.
Mathematically, Correlation Coefficient can be expressed as
COV ts
ρts =
(σ t )(σ s)
Risk on Portfolio (σ p):
The risk of a portfolio is measured using the standard deviation of the portfolio.
However, the standard deviation of the portfolio will not be simply the weighted
average of the standard deviation of the two assets. We also need to consider the
covariance/correlation between the assets. The covariance reflects the co-movement of
the returns of the two assets. Unless the two assets are perfectly correlated, the
covariance will have the impact of reduction in the overall risk of the portfolio.
The portfolio standard deviation can be calculated as follows:
Using Correlation Coefficient:
2 2 2 2
√
σ p= ( σ t ) ( wt ) + ( σ s) ( ws ) +(2)( ρts )(w t )(w s)( σ t )(σ s)
Using Covariance:
2 2 2 2
√
σ p= ( σ t ) ( wt ) + ( σ s) ( ws ) +(2)(COV ts )(w t )(w s)
where , σ p =Risk on Portfolio
σ t=Risk on stock t
σ s=Risk on stock s
w t=Proportion of investment ∈stock t ( weight)
w s=Proporation ofinvetment ∈stock s (weight )
ρts =Correlation coefficient between stocks t∧s
COV ts =Coverarnce between stocks t∧s
Example-6: Security A and B have standard deviations of 6% and 8%. If we invest

40% in A and 60% in B what would be portfolio risk? Assume that correlation is
(i) +1 (ii) -1 (iii) +0.4 (iv) 0
What conclusions can be drawn?
Example -7: C and D are two securities in a portfolio. Coefficient of correlation is

+0.5. Compute expected rate of return on portfolio and risk on portfolio from the
following information about weight, return and risk. Also calculate Covariance
between C and D.
Security Proportion of investment Return (%) Standard Deviation (%)

Security C 60% 12% 10%
Security D 40% 18% 15%
Example -8: The return from security Z can be provided in different time periods:
Time Period-2016 Return Probability

January 0.25 0.1
February 0.15 0.5
March 0.10 0.3
April 0.05 0.2
What would be the average expected risk and return of the security?
Example-9: The Return on two securities X and Y are given below. Compute expected
return on portfolio and risk on portfolio, assume that the correlation coefficient is
+0.2.
Probability Proportion of Return on security ‘X’ Return on security ‘Y’

Investment
.5 40% 5% 1%
.4 40% 4% 3%
.1 20% 0% 3%
Example-10: An investor has to choose from two securities. The following are their
rates of return and probabilities.
Security Q Security P
Return % Probability Return% Probability
20 0.1 13 0.1
16 0.4 16 0.2
10 0.3 22 0.3
3 0.2 25 0.4
Which is better Security?
Example – 11: Mr. Joshi has a portfolio of securities. These are as follows
Amounts 600,000 900,000 1,200,000 1,500,000 1,800,000

Return 7% 12% 19% 10% 2%
Find out expected return on portfolio.
Example-12: Mr. Ahmed invests OMR 1,000,000 in 5 securities. He is interested in

finding out his return.
Securities Investment Return

Security A 300,000 15%
Security B 200,000 14%
Security X 250,000 9%
Security Y 150,000 12%
Security P 100,000 18%
Example -13: Suppose you have invested in three stocks: A, B and C. you expect that
returns on the stock depends on the following two states of the economy, with the
probabilities to happen given below.
State of the Probability of Return on Return on Return on

economy state stock A stock B stock C
occurrence
Boom 0.70 7% 15% 33%
Bust 0.30 3% 3% -6%
1. What is the expected return of an equally weighted portfolio of these three

stocks?
2. What is the expected return of a portfolio invested 20% each in A and B and
60% in C
Treynor Measure of Portfolio Performance:
Jack L. Treynor was the first to provide investors with a composite measure of portfolio
performance that also included risk. Treynor's objective was to find a performance
measure that could apply to all investors, regardless of their personal risk preferences.
Treynor introduced the concept of the security market line, which defines the
relationship between portfolio returns and market rates of returns, whereby the slope of
the line measures the relative volatility between the portfolio and the market (as
represented by beta). The beta coefficient is simply the volatility measure of a stock
portfolio to the market itself. The greater the line's slope, the better the risk-return
tradeoff.
The Treynor measure, also known as the reward-to-volatility ratio, can be easily defined
as:
= (Portfolio Return – Risk-Free Rate) / Beta
(E Ŕ p −R f )
T p=
β
Example -14: Assume you are evaluating three distinct portfolio managers with the
following 10-year results:
Managers Average Annual Return Beta

Manager A 10% 0.90
Manager B 14% 1.03
Manager C 15% 1.20
Evaluate Treynor value for each manager and give comment on which management
demonstrate the better outcome. Assume that risk free rate is 5%.
Sharpe Ratio Measure of Portfolio Performance:
The Sharpe ratio is almost identical to the Treynor measure, except that the risk
measure is the standard deviation of the portfolio instead of considering only the
systematic risk, as represented by beta. Conceived by Bill Sharpe, this measure closely
follows his work on the capital asset pricing model (CAPM) and by extension uses total
risk to compare portfolios to the capital market line.
The Sharpe ratio can be easily defined as:
= (Portfolio Return – Risk-Free Rate) / Standard Deviation
( E Ŕ p−R f )
S p=
σ
Example -15: Assume you are evaluating three distinct portfolio managers with the
following 10-year results:
Managers Average Annual Portfolio Standard Deviation

Return
Manager A 14% 0.11
Manager B 17% 0.20
Manager C 19% 0.27
Evaluate Sharp ratio for each manager and give comment on which management
demonstrate the better outcome. Assume that risk free rate is 5%.
Jensen Measure of Portfolio Performance:
The Jensen measure is also based on CAPM. Named after its creator, Michael C. Jensen,
the Jensen measure calculates the excess return that a portfolio generates over its
expected returns. This measure of return is also known as alpha (α ¿. The Jensen ratio
measures how much of the portfolio's rate of return is attributable to the manager's
ability to deliver above-average returns, adjusted for market risk. The higher the ratio,
the better the risk-adjusted returns. A portfolio with a consistently positive excess
return will have a positive alpha, while a portfolio with a consistently negative excess
return will have a negative alpha.
The formula is broken down as follows:
( J p ) =E Ŕ p−¿ ¿
Example – 16: Assume a risk-free rate of 5% and a market return of 10%, what is the
alpha for the following funds? Which manager did best?
Managers Average Annual Return Beta

Manager D 11% 0.90
Manager E 15% 1.10
Manager F 15% 1.20
Example-17: The policy committee of syntax financial recently used reports from
various security analyses to develop input for single index model. Output derived
from single model considered full efficient portfolio.
Portfolio Expected return (%) Standard deviation (%)

1 8 3
2 10 6
3 13 8
4 17 13
5 20 18
1. If prevailing risk free rate is 6%, which portfolio is best one
2. Assume that the policy committees would take to earn an expected return of
10% with the standard deviation of 4% is this possible
3. If standard deviation of 12% were acceptable, what would be the expected
portfolio return?
Example -18: Compare the following two portfolios on the basis of Sharp ratio and
Treynor ratio and offer your comments
Portfolio Return from the Standard deviation Beta

portfolio
A 10% 15 0.85
B 20% 25 1.65
Market portfolio 15% 18 1.00
Interest free rate of return is 8%
Example -19: Compare the following two portfolios on the basis of Sharp ratio and
Treynor ratio and offer your comments
Portfolio Return from the Standard deviation Beta

portfolio
A 10% 15 0.40
B 20% 25 3.00
Market portfolio 15% 18 1.00
Interest free rate of return is 8%

1. What do you mean by portfolio management? What are the elements of portfolio
management?
2. Explain the concepts of risk and return in the context of portfolio.
3. Explain with the suitable example, the return of two security portfolio.
4. The expected return of a portfolio is equal to the weighted average of the
expected returns of the components of portfolio. Why not then the portfolio risk
is equal to the weighted average of their risk?
5. How a salaried person can make the investment portfolio?
6. The return from security A can be provided in different time periods:
Time Period-2016 Return Probability

Aug 0.3 0.1
Sep 0.2 0.4
Oct 0.1 0.5
Nov 0 0.3
What would be the average expected risk and return of the security?
7. Beta of the security 0.8, Rate of return on market portfolio 15% and Risk free
interest 7%. Find out the expected rate of return of the security. And find out the
Beta of the security which has an expected return of 20%.
8. If a fund has a return of 12% and a standard deviation of 15%, and if the risk free
rate is 2%, then what is its Sharpe ratio?
9. If a portfolio has return of 12% and a beta of 1.4 and if the risk free rate is 12%,
then what is its Treynor ratio?
10. The rate of return and risk for three growth oriented firms were calculated over
the most recent 5 years and are listed below
Growth firm Return Risk
M 15% 16%
N 13% 18%
O 12% 11%
11. Rank each firm by Sharpe index of portfolio performance if the risk free rate is
7%.
12. From the data given below compute treynors portfolio measure for the following
firms and rank them
Growth firm Return Risk Beta Risk free rate
M 15% 16% 1.15 7%
N 13% 18% 1.25 7%
O 12% 11% 0.90 7%
13. Consider the following information for 3 mutual funds A, B,C and Market index.
Particulars Mean return in% Standard deviation Beta
%
A 12 18 1.1
B 10 15 0.9
C 13 20 1.2
Market Index 11 17 1.0
The mean risk free rate was 6%. Calculate the TREYNOR and Sharpe Measure for the 3
Mutual funds and Market index
Reference
Hall,pearson
3. Punithavathy Pandian, SECURITY ANALYSIS AND PORTFOLIO
MANAGEMENT,
4. Vikas Publications Pvt. Ltd, New Delhi. 2001.
Chapter 5 Investment alternatives
Topics Covered:
1. Derivatives
2. Participants in Derivative Markets
3. Financial Derivatives
4. Features of Financial Derivatives
5. Basic Financial Derivatives
Derivatives
Derivatives are financial instruments whose value depends on the value of some
underlying assets. Such assets could be tangible such as wheat, cotton, real estate or
financial instruments like equity, or it could be intangible such as interest rates or index.
“Derivative” includes
1. Security derived from a debt instrument, share, loan whether secured or unsecured,
risk instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices of underlying
securities.
Participants in Derivative Markets

The participants in the derivative markets can be broadly classified in three depending
upon their motives. These are:
1. Hedgers
2. Speculators
3. Arbitrageurs
Hedgers
Hedgers are those who enter into a derivative contract with the objective of covering
risk. Farmer growing wheat faces uncertainty about the price of his produce at the time
of the harvest. Similarly, a flour mill needing wheat also faces uncertainty of price of
input. Both the farmer and the flour mill can enter into a forward contract, where the
farmer agrees to sell his produce when harvested at predetermined price to the flour
mill. The farmer apprehends price fall while the flour mill fears price rise. Both the
parties face price risk.
Speculators
Speculators are those who enter into a derivative contract to make profit by assuming
risk. They have an independent view of future price behavior of the underlying asset
and take appropriate position in derivatives with the intention of making profit later.
Arbitrageurs
It would seem that hedgers and speculators would complete the market. Not really so
because we assume that different markets are efficient by themselves and they operate
in tandem.
Financial Derivatives
The term financial derivative relates with a variety of financial instruments which
include stocks, bonds, treasury bills, interest rate, foreign currencies and other hybrid
securities. Financial derivatives include futures, forwards, options, swaps, etc.
Features of Financial Derivatives

1. A derivative instrument relates to the future contract between two parties.
2. The derivative instruments have the value which derived from the values of other
underlying assets, such as agricultural commodities, metals, financial assets, intangible
assets, etc.
3. The derivatives contracts can be undertaken directly between the two parties or
through the particular exchange like financial futures contracts.
4. Derivatives are mostly secondary market instruments and have little usefulness in
mobilizing fresh capital by the corporate world
Basic Financial Derivatives

Forward Contracts
“A forward contract is an agreement entered today under which one party agrees to
buy and the other agrees to sell an asset on a specified future date at an agreed price”.
A forward contract is a simple customized contract between two parties to buy or sell
an asset at a certain time in the future for a certain price. Forward contracts are traded
in the over-the-counter market, usually between two financial institutions or between a
financial institution and its client.
Futures Contracts
“A future contract is a standardized contract between two parties where one of the
parties commits to sell and the other commits to buy, a specified quantity of a
specified asset at an agreed price on a given date in the future”.
Futures contracts are normally traded on an exchange which sets the certain
standardized norms for trading in the futures contracts.
Options Contracts
“An option is a contract between two parties under which the buyer of the option
buys the right and not the obligation to buy or sell, a standardized quantity of
underlying asset at or before a predetermined date at price, which is decided in
advance”.
Options can be divided into two types: calls and puts. A call option gives the holder the
right to buy an asset at a specified date for a specified price whereas in put option, the
holder gets the right to sell an asset at the specified price and time.
Warrants and Convertibles

Warrants and convertibles are other important categories of financial derivatives, which
are frequently traded in the market. Warrant is just like an option contract where the
holder has the right to buy shares of a specified company at a certain price during the
given time period. In other words, the holder of a warrant instrument has the right to
purchase a specific number of shares at a fixed price in a fixed period from an issuing
company.
Convertibles are hybrid securities which combine the basic attributes of fixed interest
and variable return securities. Most popular among these are convertible bonds,
convertible debentures and convertible preference shares. These are also called equity
derivative securities.
SWAP Contracts
Swaps have become popular derivative instruments in recent years all over the world.
A swap is an agreement between two counter parties to exchange cash flows in the
future.
Forward exchange Rate: Rate that is currently paid for the delivery of a currency at
some future date. In the forward market, currencies are traded for future delivery.
Forward rates (for example, 30-days, 90-days or 180-days forward rates) for few
currencies are quoted in forex market. Most banks will, however, quote currency’s
forward rates to the traders.
Forward premium or discount
The forward rate may be at premium or discount. Forward rate premium or discount
may be shown in terms of percentage.
Forward premium or discount for spot rate can be calculated by using the following
formula:
Forward Premium or Discount = [(forward rate –Spot rate) / Spot rate] x [360 / N]
N = No. of days for which forward rate is quoted
The resulting value is measured in terms of percentage and termed as premium if it is

positive. If the resulting percentage is negative, it is a forward discount.
Example -1: If the spot exchange rate between INR and USD is 50.10 and the one
month forward is 50.375. Find out Forward Premium or Discount.
( forward rate−spot rate ) 360

Forward Premium∨Discount= [ spot rate ][ ]
∗
N
( 50.375−50.10 ) 360
Forward Premium∨Discount= [ 50.10 ][ ]
∗
30
=6.58 %
There is forward premium at 6.58%
Example -2: Given the following forward rate is GBP 1.030/$ and spot rate is GBP
1.0200/$. Find the forward premium or discount for 3 months.
( forward rate−spot rate ) 360

Forward Premium∨Discount= [ spot rate ][ ]
∗
N
( 1.030−1.0200 ) 360
Forward Premium∨Discount= [ 1.0200 ][ ]
∗
90
=3.92%
There is forward premium at 3.92%
3. Exercise: An investor buys JP Morgan futures at OMR 3500 in the market lot of 100
futures. On the settlement date, the JP Morgan futures at OMR 3600. Find out his
profit or loss for one lot of futures. What would be his position, if the JP Mogan
share is OMR 3450 on the settlement date?
4. Exercise: An investor Buying a futures contracts for OMR 2,80,000 (Lot size 50
futures). On the settlement date, the Futures closes at 5512. Find out his profit or loss,
if he pays OMR 1000 as brokerage. What would be position, if he has sold the futures
contracts?
5. Exercise: An investor buys 500 shares of Al Rawabi Company at OMR 210 per
shares in the cash market. In order to hedge, he sells 300 futures of Al Rawabi
Company at OMR 195 each. Next day, the share price and futures decline by 5% and
3% respectively. He closes his position next day by counter transactions. Find out his
profit or losses

1. What are derivatives? Who are the participants of derivatives market?
2. What are the underlying assets?
3. What are the different types of financial derivatives?
4. How futures contracts can be priced under the different situations?
5. What do you mean by forward premium and forward discount?
Reference
Hall,pearson
Chapter 6 Muscat Securities Market (MSM)

Topics Covered:
1. Muscat Securities Market
2. Market classification
3. Market sectors
4. MSM-30 index
5. Capital market authority Oman
6. CMA’s Role
Muscat Securities Market

The Muscat Securities Market is the only stock exchange in Oman. It was established by
the Royal Decree (53/88) issued on 21 st June 1988 to regulate and control the Omani
securities market and to participate, effectively, with other organisations for setting up
the infrastructure of the Sultanate’s financial sector.
After ten years of continuous growth there was a need for a better functioning of the
Market. Thus MSM has been restructured by two Royal Decrees (80/98) and (82/98).
The Royal Decree (80/98) dated November 9, 1998 which promulgated the new Capital
Market Law provides for the establishment of two separate entities, an exchange,
Muscat Securities Market (MSM) where all listed securities shall be traded and the
Capital Market Authority (CMA) – the regulatory. The exchange is a governmental
entity, financially and administratively independent from the regulatory but subject to
its supervision. Thus the securities industry in Oman was well established to enhance
investors’ confidence by developing and improving all the processes appertaining to
the stock exchange.
As a continuing process in the development of the securities market, the MSM has
developed its regulations to provide information and financial data relating to the
performance of the Market and all listed companies directly to investors through a
highly advanced electronic trading system. This will not only ensure transparency of
dealings which is considered to be one of the main principles of fair trading, but will
encourage investors to take the right investment decisions at the right time.
The Market had developed its existing system of clearance and settlement by
introducing a new mechanism for ensuring stable dealings in securities as well as
providing a better environment attracting foreign investment into Oman. The former
settlement mechanism was involving only three parties in the clearance and settlement,
MSM, Muscat Depository and Registration of Securities Co. (M.D.R.C) and the brokers.
The newly introduced settlement formula is through a Settlement Bank (Central Bank)
with Settlement Guarantee Fund (SGF).
Market classification:
Regular market has strict listing requirements. For listing on this market, companies
must have a solid record of profitability.
The parallel market has relatively less requirements and is therefore easier of companies
to list on, especially the newly established ones.
Third market consists of companies that are facing financial difficulties.
Market sectors
MSM listed companies are from three sectors: banking and investment, insurance and
service industry
MSM-30 index
Muscat Securities Market Index has been established in 1992 and the base date was June
1990. A number of companies included in the index sample, has changed overtime to
reach currently 30 companies the most liquid in the market.
The main objectives of the MSM 30 are to represent the prices movement of the listed
shares objectively and to be a benchmark for individual and institutional investors
which guide them through their investment processes. To achieve these objectives, the
MSM 30 has the following features:
1. Freely available shares for trading are included.
2. A 10% capping (CAP) is set to ensure wider representation of smaller companies in
the index.
3. The free float and capping revised (re-set) on quarterly basis.
Capital market authority Oman
CMA was established by Royal Decree 80/98 issued on 9 November 1998, and

commenced it’s duties on 9 January 1999.
CMA’s Role
1. Regulatory role:
CMA regulates regulations required to develop the capital market and insurance
sectors. The core business of the CMA is to supervise the Capital Market and Insurance
Sectors in the Sultanate. CMA assumes the following duties and responsibilities:
1) Regulating, licensing and monitoring the issuance of securities
2) Supervising:
• Muscat Securities Market.

• Muscat Clearing and Depository Company.
• Public shareholding companies, and
• Audit firms accredited to audit the accounts of the companies regulated by
CMA.
3) Licensing and supervising:
•Companies operating in the field of securities.

•Investment funds.
•Credit rating agencies.
•Insurance companies.
•Insurance brokers, and
•Agents of insurance companies.
4) Constantly reviewing of legislation governing the two sectors , and developing them
in accordance with the best international practices and work requirements.
5) Enforcing laws under its jurisdiction.
2. Supervision role:
CMA supervises and monitors institutions regulated by CMA to upgrade the efficiency
and the level of capital market and insurance sectors in general, and to protect investors
and policyholders in particular.
3. Awareness role:
CMA is keen to upgrade the efficiency of investors and policyholders and to achieve
this, CMA spreads awareness in matters related to investment and rights of investors.
Moreover, CMA enhances awareness of directors and management, establishes saving
concept and investment, enhances awareness of the public on the importance of capital
markets and dealing therein and enhances awareness on insurance for all the segments
of the community.
4. Legislative Role
The legislative role of CMA is represented in regulating regulations for the capital
market and insurance sectors.
The legislative frame of CMA witnessed in the last period remarkable developments as
a response for the requirements of the stages it has been through and for being in line
with the developments regionally and internationally. In this frame, the Sultanate
presided in a number of fields especially those related to disclosure, Corporate
Governance and the development of legal frame of the capital market as mentioned in a
number of reports issued by international and regional institutions.

1. What do you mean by MSM 30 Index?
2. Write a short note on Market classification of MSM?
3. What ids the main role of the MSM?
4. What are the objectives of the MSM 30 Index?
5. Explain the CMA role in Oman?
Reference
https://www.cma.gov.om
www.msm.gov.om

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Study Material

Chapter 1- Introduction to Investment

BAFI3200-Protfolio Management Page |1

Thus investment may be defined as “a commitment of funds made in the expectation of

According to sharpe, ”investment is sacrifice of certain present value for some

BAFI3200-Protfolio Management Page |2

Sl.no Investment Speculation

BAFI3200-Protfolio Management Page |3

BAFI3200-Protfolio Management Page |4

Concept of Return and Risk

BAFI3200-Protfolio Management Page |5

Holding Period Return (HPR):

Thus, HPR = [(1 + r1) x (1 + r2) x (1 + r3) x (1 + r4)] – 1

Annualized Holding Period Return:

Annualized Holding Return =

BAFI3200-Protfolio Management Page |6

HPR = [5 + (60 – 50)] / 50 = 30%

HPR for Fund X = [5 + (150 – 100)] / 100 = 55%

HPR for Fund B = [10 + (320 – 200)] / 200 = 65%

Calculation of annualized HPR:

Annualized HPR for Fund X = (0.55 + 1)1/3 – 1 = 15.73%

Annualized HPR for Fund B = (0.65 + 1)1/4 – 1 = 13.34%

Compound Annual Rate of Growth (CARG):

BAFI3200-Protfolio Management Page |7

Ri=Return on Listed Security i

Calculation of Return on Stock ABC:

Market Price Capital Appreciation Return

Expected Rate of Return

BAFI3200-Protfolio Management Page |8

E Ŕt =Expected rate of return on t stock

Expected Rate of Return on Security X and Security Y:

E Ŕ x =( 0.25 ) ( 36 ) + ( 0.50 ) ( 25 ) + ( 0.25 ) ( 12 )=24.5 %

E Ŕ y = ( 0.25 )( 22 ) + ( 0.50 )( 16 ) + ( 0.25 )( 14 )=17 %

1. The longer the maturity period, the larger is the risk.

Types of systematic risk

Types of Unsystematic risk

Possible outcome Probability

Possible Probability Returns E Ŕ x =¿ ( Rt −E Ŕt )

7. EQU ITY SHARE

VALUATION OF FINANCIAL INSTRUMENTS:

Intrinsic Value of Bond (Bond Price)

Where: P = Bond Price or Intrinsic Value of Bond

Yield to Maturity (YTM)

By using trial and error, YTM can be calculated as follows:

YTM =LR+ ( difference between a∧b

Where, YTM is Yield to maturity

difference between a∧b

LR = Lower Rate of return (lower discount rate) = 10%

It is calculated similarly to YTM, however, callable value and callable period is

Market price OMR 110 Maturity date 31/12/2011

Face value OMR 100 Callable on 31/12/2008

Coupon rate 11% Interest payable annually

Date of purchase1/1/2006 Maturity/Callable value of the bond OMR

2. An investor has the following information of a bond

Face value is OMR 1000

3. An investor wants you to evaluate the following bond

Face value is OMR 100

4. You have been appointed as an investment consultant and investment analyst by

TEST YOUR UNDERSTANDING

Chapter 2 Financial Markets

Financial market is a place or a system where financial assets or instruments are

Functions of Financial Markets:

The main functions of financial markets are outlined as below: