Security Analysis & Portfolio Management

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Introduction
Handsome returns have been reaped in many ways;

unfortunately most of them cannot be replicated consistently rewarded by exceptional returns

Investment; however smartly made, cannot always be

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Objective of an investor
Maximization of return Minimization of risk Hedge against inflation (if the investment cannot earn as

much as the rise in price level, the real rate of return will be negative)

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Investment versus speculation

Investmenthorizon Short time Long time horizon speculation Moderate disposition High risk risk

disposition
Modest return High return

expectation expectations Bases decision on Bases decision on fundamental factors technical factors Less levered Highly levered

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Investment Process
Traditional approach: compare intrinsic value with

market price

Modern approach: emphasis on risk and return in

addition to above

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Investment alternatives
Non-marketable Financial Assets Equity shares Bonds Money market instruments Mutual funds Life insurance Real estate Precious objects Financial derivatives
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Criteria for Evaluation of Investment

Rate of return Risk Marketability Tax shelter Convenience

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Financial Markets
Market for creation and exchange of financial assets Functions of financial markets - facilitate price discovery - Provide liquidity - Reduce cost of transacting

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Security Analysis
The entire process of estimating return and risk for individual securities is known as security analysis

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Portfolio Management
Securities having risk return characteristics of their own, in

combination, make up a portfolio

Portfolio analysis: understanding the interactive effects of

combining the securities

Portfolio selection: Entails choosing the one best portfolio to

suit the risk-return preferences of the investor

Portfolio management: evaluating and revising the portfolio

in terms of stated investor objectives

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Portfolio Management

Literature supports the efficient markets paradigm

On a well-developed securities exchange, asset prices accurately reflect the tradeoff between relative risk and potential returns of a security

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Efforts to identify undervalued and overvalued securities are fruitless Free lunches are difficult to find

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Portfolio Management (contd)

Market efficiency and portfolio management

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A properly constructed portfolio achieves a given level of expected return with the least possible risk

Portfolio managers have a duty to create the best possible collection of investments for each customers unique needs and circumstances

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Purpose of Portfolio Management

Portfolio management primarily involves reducing risk rather than increasing return

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Consider two $10,000 investments:

1) 2)

Earns 10% per year for each of ten years (low risk) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk)

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Low Risk vs. High Risk Investments

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Low Risk vs. High Risk Investments (contd)

1) Earns 10% per year for each of ten years (low risk)

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Terminal value is $25,937

2) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk)

Terminal value is $23,642

The lower the dispersion of returns, the greater the terminal value of equal investments
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Portfolio Management Process

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Set Portfolio Objectives

Choose appropriate Asset mix

Evaluate Performance

Protect the Portfolio When Appropriate

Formulate an Investment Strategy

Have a Game Plan for Portfolio Revision

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Common Errors in Investment Management

Inadequate comprehension of return and risk Vaguely formulated investment policy Nave extrapolation of past Untimely entries and exit Over/under diversification Wrong approach towards losses and profits

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Recap of the session

Introduction Investment objectives Investment versus speculation Investment process Investment alternatives Criteria for evaluating investments Financial markets Security analysis and portfolio management Common errors in Investment Management
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