Chapter 3 Security Analysis

SECURITY ANALYSIS
Fundamental Analysis
Fundamental analysis is a method for determining a security's intrinsic value, such as the value of a stock or
bond, by examining its underlying economic and financial elements.
● The "intrinsic value of the share" is the present value of future dividends computed by discounting the
cash flows at an appropriate discount rate.
The present value of the future dividends can be calculated by discounting the cash flows at an appropriate
discount rate and is known as the 'intrinsic value of the share'. The intrinsic value of a share, according to a
fundamental analyst, depicts the true value of a share. A share that is priced below the intrinsic value must be
bought, while a share quoting above the intrinsic value must be sold.
● Fundamental analysis' principal goal is to identify whether an investment is overvalued or undervalued
by the market. If a security is undervalued, the analyst may advise purchasing it; if it is overvalued, the
analyst may advise selling it.

Dividend Growth Model and the PE Multiple

Financial analysts tend to relate price to earnings via the P/E multiples (the ratio between the market price and
earnings per share).
● If a company is assumed to pay out a fraction b of its earnings as dividends on an average (i.e. the
Dividend Payout Ratio = b), D(1) may be expressed as b E(1), where E(1) is the earning per share (EPS)
of the company at the end of the first period.

Key Variables that an investor must monitor in order to carry out his Fundamental Analysis
OR Factors affecting Economic Analysis
OR Various Techniques used in Economic Analysis
OR Factors affecting Industrial Analysis

ECONOMIC ANALYSIS
Macro- economic factors e. g. historical performance of the
economy in the past/ present and expectations in future, growth of different sectors of the economy in future
with signs of stagnation/degradation at present to be assessed while analyzing the overall economy. Trends in
peoples’ income and expenditure reflect the growth of a particular industry/company in future. Consumption
affects corporate profits, dividends and share prices in the market.
Factors Affecting Economic Analysis:
● Growth Rates of National Income and Related Measures: The difference between the nominal growth
rate given by GDP and the 'real' growth rate after inflation is crucial. The predicted economic growth
rate would provide a guide to the prospects for the industrial sector, and thus to the returns investors
might expect from stock investments.
● Growth Rates of Industrial Sector: This can be further divided into growth rates of different industries
or groups of industries. The rates of growth in particular industries are estimated based on the
expected demand for their products.
● Inflation: Inflation is measured in terms of either wholesale prices (the Wholesale Price Index or WPI)
or retail prices (Consumer Price Index or CPI). The demand in some industries, particularly the
consumer products industries, is significantly influenced by the inflation rate.
● Monsoon: Because of the strong forward and backward linkages, monsoon is of great concern to
investors in the stock market too.
Techniques used in Economic Analysis
Anticipatory Surveys:
They help investors to form an opinion about the future state of the economy.
In spite of valuable inputs available through this method, it has certain drawbacks:
(i) Survey results do not guarantee that intentions surveyed would materialize.
(ii)They are not regarded as forecasts per se, as there can be a consensus approach by the investor for
exercising his opinion.
Continuous monitoring of this practice is called for to make this technique popular.
Barometer/Indicator Approach:
Various indicators are used to find out how the economy shall perform in the future. The indicators have been
classified as under:

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(i) Leading Indicators: They lead the economic activity in terms of their outcome. They relate to the time
series data of the variables that reach high/low points in advance of economic activity.
(ii) Roughly Coincidental Indicators: They reach their peaks and troughs at approximately the same in the
economy.
(iii) Lagging Indicators: They are time series data of variables that lag behind in their consequences vis-a- vis
the economy. They reach their turning points after the economy has reached its own already.
Economic Model Building Approach:
A precise and clear association between dependent and independent variables is determined using this
approach. In practise, GNP model construction or sectoral analysis is carried out using a national accounting
framework.
The steps used are as follows:
(i) Hypothesize total economic demand by measuring total income (GNP) based on political stability, rate of
inflation, changes in economic levels.
(ii) Forecasting the GNP by estimating levels of various components viz. consumption expenditure, gross
private domestic investment, government purchases of goods/services, net exports.
(iii) After forecasting individual components of GNP, add them up to obtain the forecasted GNP.
(iv) Comparison is made of total GNP thus arrived at with that from an independent agency for the forecast of
GNP and then the overall forecast is tested for consistency.
This is carried out for ensuring that both the total forecast and the component wise forecast fit together in a
reasonable manner.

INDUSTRY ANALYSIS:
An assessment has to be made regarding all the conditions and factors relating to demand of the particular
product, cost structure of the industry and other economic and Government constraints on the same.
Since a company's core profitability is determined by the economic prospects of the industry to which it
belongs, an assessment of the industry's prospects is required.
Factors Affecting Industry Analysis
● Product Life-Cycle: An industry's profitability is often high in the early and growing stages, middling but
consistent in the maturity stage, and rapidly decreasing in the final stage of growth.
● Demand Supply Gap: Excess supply affects industry profitability due to lower unit price realisation, but
insufficient supply tends to boost profitability due to greater unit price realisation.
● Barriers to Entry: Any industry with a high profit margin would attract new investment. Potential
industry entrants, on the other hand, face a variety of entrance challenges. Some of these challenges
are inherent in the product and manufacturing technology, while others are established by current
industry firms.
● Government Attitude: The attitude of the government towards an industry is a crucial determinant of
its prospects.
● State of Competition in the Industry: Firms with leadership capability and the nature of competition
among them in foreign and domestic markets, type of products manufactured, demand prospects type
of industry the firm is placed viz. growth, cyclical, defensive, or decline
● Cost Conditions and Profitability: The price of a share depends on its return, which in turn depends on
profitability of the firm. Profitability depends on the state of competition in the industry, cost control
measures adopted by its units and growth in demand for its products.
Factors to be considered are:
1) Cost allocation among various heads e.g. raw material, labors and overheads and their
controllability.
2) Product price.
3) Production capacity in terms of installation, idle and operating.
4) Level of capital expenditure required for maintenance / increase in productive efficiency.
● Technology and Research: Technology is subject to change very fast leading to obsolescence.
Industries which update themselves have a competitive advantage over others in terms of quality, price
etc. Things to be probed in this regard are:
1) Nature and type of technology used.
2) Expected changes in technology for new products leading to increase in sales.
3) Relationship of capital expenditure and sales over time. More capital expenditure means
increase in sales.
4) Money spent in research and development.
5) Assessment of industry in terms of sales and profitability in short, immediate and long run.

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TECHNIQUES USED IN INDUSTRY ANALYSIS

Regression Analysis:
Investor diagnoses the factors determining the demand for output of the industry through product demand
analysis. Factors to be considered are GNP, disposable income, per capita consumption / income, price
elasticity of demand. For identifying factors affecting demand, statistical techniques like regression analysis
and correlation are used.
Input – Output Analysis:
It reflects the flow of goods and services through the economy, intermediate steps in production process as
goods proceed from raw material stage through final consumption. This is carried out to detect changing
patterns/trends indicating growth/decline of industries.

COMPANY ANALYSIS:
Economic and industry framework provides the investor with proper background against which shares of a
particular company are purchased. This requires careful examination of the company's quantitative and
qualitative fundamentals.
● Net Worth and Book Value
● Sources and Uses of Funds
● Cross-Sectional and Time Series Analysis
● Size and Ranking
● Growth Record
● Financial Analysis
● Competitive Advantage
● Quality of Management
● Corporate Governance
● Regulation
● Location and labour management relations
● Pattern of Existing stock holding
● Marketability of the shares

Techniques used in Company Analysis

Correlation & Regression Analysis:
Simple regression is used when inter relationship covers two variables. For more than two variables, multiple
regression analysis is followed. Here the inter relationship between variables belonging to economy, industry
and company are found out. The key benefit of such a study is determining the anticipated values as well as
assessing the accuracy of the estimations.
Trend Analysis:
The relationship of one variable is tested over time using regression analysis. It gives an insight to the
historical behaviour of the variable.
Decision Tree Analysis:
Information relating to the probability of occurrence of the forecasted value is considered useful. A range of
values of the variable with probabilities of occurrence of each value is taken up. The limitations are reduced
through decision tree analysis and use of simulation techniques.

Short note on Technical Analysis.

Technical analysis is a method of determining he future price of the stock using charts to identify the patterns
and trends. The technical analyst is concerned with a company's or an industry's fundamental strength or
weakness; he monitors investor and pricing behaviour.
The two basic questions that he seeks to answer are:
● Is there a discernible trend in the prices?
● If there is, then are there indications that the trend would reverse?
Assumptions
● The market value of stock depends on the supply and demand for a security.
● The supply and demand are actually governed by several factors which can be rational or irrational. For
instance, recent initiatives taken by the Government to reduce the Non- Performing Assets (NPA)
burden of banks may result in the demand for banking stocks.
● Stock prices generally move in trends which continue for a substantial period of time. Therefore, if
there is a bull market going on, there is every possibility that there will soon be a substantial correction
which will provide an opportunity to the investors to buy shares at that time.

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● Technical analysis relies upon chart analysis which shows the past trends in stock prices rather than
the information in the financial statements like balance sheet or profit and loss account.

Principles of Technical Analysis

The Market Discounts Everything - Most technical analysts believe that a company's share price covers
everything, including its fundamentals.
Price Movements in Trends - Stock prices are more likely to continue a previous trend than to change
direction.
History tends to repeat itself - Technical analysis analyses subsequent market movements using chart
patterns to understand trends.

Theories of Technical Analysis OR Explain The Dow Theory OR Explain Random Walk Theory
Charles Dow invented The Dow Theory, a fundamental concept in technical analysis used to understand the
stock market. The Dow Theory is based on the analysis of the Dow Jones Industrial Average (DJIA), which is
one of the oldest and most widely followed stock market indices. According to the Dow Theory, the DJIA
reflects the overall health of the stock market and can be used to predict its future direction.
The market's movements can be divided into three categories, all of which are active at the same time:
primary movement, secondary movement, and daily fluctuations.
● The primary movement is the main trend of the market, which lasts from one year to 36 months or
longer. This trend is commonly called bear or bull market.
● The secondary movement of the market is shorter in duration than the primary movement, and is
opposite in direction. It lasts from two weeks to a month or more.
● The daily fluctuations are the narrow movements from day-to-day.
Thus, the Dow Theory’s purpose is to determine where the market is and where is it going, although not how
far or high
Charles Dow proposed that the primary uptrend would have three moves up,
● The first one being caused by accumulation of shares by the far-sighted, knowledgeable investors,
● The second move would be caused by the arrival of the first reports of good earnings by corporations,
and the last move up would be caused by widespread report of financial well being of corporations.
● The third stage would also see rampant speculation in the market.
● Towards the end of the third stage, the far-sighted investors, realizing that the high earnings levels may
not be sustained, would start selling, starting the first move down of a downtrend, and as the
non-sustainability of high earnings is confirmed, the second move down would be initiated and then the
third move down would result from distress selling in the market.

Overall, the Dow Theory is a useful framework for understanding the stock market and predicting its future
direction. However, like any investment strategy, it requires careful analysis and consideration of multiple
factors

Explain Elliot Wave Theory

Elliot Wave Theory is a technical analysis approach used to forecast market trends based on human behaviour
patterns in financial markets.
● Elliot discovered that the markets exhibited certain recurring patterns or waves.
● Waves are categorised into two types: Impulse waves and Corrective waves.
1) Impulse/Motive waves (Basic Waves) are comprised of up of five smaller waves that move in the
direction of the overall trend and are labelled 1, 2, 3, 4, and 5.
2) Corrective waves (Reaction Waves) are comprised of up of three smaller waves labelled A, B, and C
that move in the opposite direction of the trend.

Explain Random Walk Theory

Random Walk Theory is a financial theory that suggests that stock prices and other financial market variables
move in an unpredictable and random manner. Future stock prices, according to this hypothesis, cannot be
anticipated based on past stock prices because they are not influenced by any past information.
● The theory argues that stock prices follow a random walk, with each step being independent of the
previous stages.
● In other words, based on the history of previous price changes, the direction and amount of the
forthcoming price shift cannot be forecast.

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The supporters of this theory put out a simple argument. It follows that:
(a) Prices of shares in stock market can never be predicted.
(b) The reason is that the price trends are not the result of any underlying factors, but that they represent a
statistical expression of past data.
(c) There may be periodical ups or downs in share prices, but no connection can be established between two
successive peaks (high price of stocks) and troughs (low price of stocks )

CHARTS USED FOR TECHNICAL ANALYSIS

i.Bar Chart:
A bar chart illustrates the open, high, low, and closing prices of a financial asset in the form of vertical bars for
each time period. The top and bottom of the bar show the high and low values, while the open and closing
prices are represented by horizontal lines within the bar. It can be used to analyse price volatility.
ii.Line Chart:
Line charts are the most basic sort of chart used in technical analysis. It's made by graphing the closing prices
of a stock or other financial instrument over time and connecting them with a straight line. It is excellent for
determining trends and levels of support/resistance.
iii.Japanese Candlestick Chart:
A candlestick chart is similar to a bar chart in that it displays more visual information about price movement. It
is made by graphing the open, high, low, and closing prices of a financial instrument in the shape of
candlesticks for each period. The opening and closing prices are represented by the body of the candlestick,
while the high and low prices are represented by the wicks or shadows.
iv.Point and Figure Chart:
A point and figure chart is a type of chart used to determine stock price movements. It is developed by
graphing only a stock's significant price moves while omitting smaller fluctuations. The chart is made up of
columns of Xs and Os, which reflect upward and downward price changes.
Point and Figure Chart Price Period
30 1 24
29 2 26
28 X 3 27
27 X 4 26
26 X 5 28
25 X O 6 27
24 X O 7 26
23 O 8 25
22 9 26
10 23

Explain Various Market Indicators [MTP Oct 20, RTP Nov 20]
Some of the most commonly used market indicators:
1. Breadth Index:
It is an index that includes all traded securities. It is calculated by dividing the market's net advances or
declines by the number of issues traded. The movement of the Dow Jones Averages is either supported or
contradicted by the breadth index. If it supports the movement of the Dow Jones Averages, it is a sign of
technical strength; if it does not, it is a sign of technical weakness, indicating that the market will move in the
opposite direction of the Dow Jones Averages. The Dow Theory and the movement of the Dow Jones
Averages are supplemented by the breadth index.

2.Volume of Transaction:
The number of shares traded in the market can provide useful information about how the market will act in the
near future. A rising index/price with rising volume would indicate buy behaviour because the situation shows
unsatisfied market demand. Similarly, a declining market with increased volume indicates a bear market, and
prices are likely to decline further. A rising market with decreasing volume denotes a bull market, whereas a
falling market with declining volume denotes a bear market. Thus, the volume concept is best used with
another market indicator, such as the Dow Theory.

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3.Confidence Index:
It is meant to demonstrate how eager investors are to take a risk in the market. It is the proportion of
high-quality bond yields to low-quality bond yields. Market analysts utilise it as a means of trading or timing
the buying and selling of stock, as well as a forecasting device to determine market turning points. A rising
confidence index is predicted to be followed by a rising stock market, while a falling index is likely to be
followed by a decline in stock prices. A drop in the confidence index indicates that low-grade bond yields are
rising or dropping faster than high-grade yields.

4.Relative Strength Analysis:

According to the relative strength concept, some securities' values increase relatively faster in a bull market
and decrease more slowly in a bear market than other securities, implying that some securities demonstrate
relative strength. Investors will receive higher returns by investing in securities that have previously showed
relative strength because a security's relative strength tends to remain unchanged over time. Security relative
to its industry and security relative to the overall market can also be utilised to determine relative strength in a
security or an industry.

5.Odd Lot Theory:

This theory is a contrary - opinion theory. It assumes that the average person is usually wrong and that a wise
course of action is to pursue strategies contrary to popular opinion. The odd-lot theory is used primarily to
predict tops in bull markets, but also to predict reversals in individual securities

Short note on Support and Resistance Levels?

● When the index/price goes down from a peak, the peak becomes the resistance level.
● When the index/price rebounds after reaching a trough subsequently, the lowest value reached
becomes the support level.
Every time the price respects the support Every time the price respects the resistance
line and/or big volumes are traded at the line and/or big volumes are traded at that
support level, the support level becomes level, the resistance level becomes stronger.
stronger.

Explain Interpreting Price Patterns

OR What are the numerous price patterns documented by Technical Analysis.
Channel:
A series of uniformly changing tops and bottoms gives rise to a channel formation. A downward sloping
channel indicates falling prices, whereas an upward sloping channel indicates rising prices.
Wedge:
It is Formed when the tops (resistance levels) and bottoms (support levels) change in opposite direction or
when they change in the same direction at different rates over time.
Head and Shoulders:
It is a distorted drawing of a human form, with a large lump (for head) in the middle of two smaller humps (for
shoulders). This is possibly the most essential pattern for indicating a price trend reversal. The pattern's
neckline is made by joining points where the head and shoulder meet.
● Head and Shoulder Top Pattern: The Head and Shoulders top pattern is a technical chart pattern used
in the analysis of stock prices to help identify potential trend reversals. It is typically seen as a bearish
signal and is formed by three consecutive peaks, with the middle peak (the head) being higher than the
other two (the shoulders). It is signal to sell.
● Inverse Head and Shoulder Pattern: It is the opposite of the Head and Shoulders pattern and is
typically seen as a bullish signal. It is signal to purchase.
● Triangle or Coil Formation: It represents a pattern of uncertainty and is difficult to predict which way
the price will break out.
● Flags and Pennants Form: This form signifies a phase after which the previous price trend is likely to
continue.
● Double Top Form: This form represents a bearish development, signals that price is expected to fall.
● Double Bottom Form: This form represents bullish development signalling price is expected to rise.
● Gap: A gap is the difference between the opening price on a trading day and the closing price of the
previous trading day.

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The decision using Data Analysis.

a) Moving Averages –
Moving Averages is one of the more popular methods of data analysis for decision making. Moving averages
are regularly plotted with prices to make buy and sell decisions. Technical analysts utilise moving average
research to spot trends.
● 200 days moving average of daily prices or a 30-week moving of weekly price for identifying a
long-term trend.
● 60 days moving average of daily price to identify an intermediate term trend.
● 10 days moving average of daily price to detect a short-term trend.
Buy and Sell Signals provided by Moving Average Analysis.
Buy Signal Sell Signal
Stock price line rise through the moving Stock price line falls through moving
average line when graph of the moving average line when graph of the moving
average line is flattering out. average line is flattering out
Stock price line falls below moving average Stock price line rises above moving
line which is rising. average line which is falling
Stock price line which is above moving Stock price line which is slow moving
average line falls but begins to rise again average line rises but begins to fall again
before reaching the moving average line before reaching the moving average line.

b) Exponential Moving Average –

Unlike the AMA, which assigns equal weight of 1/n to each of the prices used for computing the average, the
Exponential Moving Average (EMA) assigns decreasing weights, with the highest weight being assigned to the
latest price. The weight decrease exponentially, according to a scheme specified by the exponential smoothing
constant, also known as the exponent, a.
EMAt = aPt + (1-a)(EMAt-1)
Where, a (exponent) 2n+1
Pt = Price of today
EMAt-1 = Previous Day’s EMA
Or
EMAt = (Closing Price of the day – EMA of Previous Day) X Exponent + Previous Day EMA
n = Number of days for which average is to be calculated

Describe the concept of Evaluation of Technical Analysis

Technical Analysis has several supporters as well several critics.
1. Technical analysis evaluation includes assessing the efficiency of technical analysis in predicting future
price movements and investment decision making.
2. Technical analysis helps in recognising this transition early on and hence provides insight into future price
movements.
3. Price movement tends to continue more or less in same direction till the information is fully assimilated in
the stock price.

Detractors of technical analysis feel it is an ineffective effort, and they present their arguments as follows:
● Most technical analysts unable to offer a convincing explanation for their tools employed
● Empirical evidence in support of random walk hypothesis cast its shadow over the useful ness of
technical analysis.
● Up trend and down trend signalled by technical analysis may already have taken place.
● Technical analysis must be self-defeating proposition.

Differences between Fundamental Analysis and Technical Analysis.

Basis Fundamental Analysis Technical Analysis
Meaning Fundamental analysis is the practise Technical analysis is a method of
of analysing securities in order to predicting the future price of a stock
determine the stock's intrinsic value. by utilising charts to discover
patterns and trends.
Relevant for Long term investment Short term investment

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Function Investing Trading

Objective To identify the intrinsic value of the To identify the right time to enter or
stock. exit the market
Decision making Decisions are made based on the Decisions are based on market
available information and statistics. trends and stock prices.
Focuses on Both Past and Present Data Past Data only
Form of data Economic reports, news events and chart Analysis
industry statistics.
Future prices Predicted on the basis of the Predictions based on charts and
company's previous and present indications
performance and profitability
Types Of Trader Long term position traders Swing trader and short term day
trader.
Method Prospects are calculated by Forecasts future prices and their
examining macroeconomic elements directions based solely on historical
such as the country's GDP, inflation market data and information such as
rate, interest rate, and growth rate, as price movements, volume, Open
well as microeconomic factors such Interest, and so on.
as sales, profitability, solvency, assets
and liabilities, and cash position.

Explain the Efficient Market Theory (Efficient Market Hypothesis)

According to this theory, no investor can consistently outperform the market since every company is priced
appropriately based on available information. And because stocks are always exchanged at their fair value on
stock exchanges, it is difficult for investors to either buy inexpensive equities or sell them for inflated prices.
Search for Theory
The randomness of stock price was caused by an efficient market, which led to the following points of view:
● Information is freely and instantaneously available to all market participants.
● Keen competition among the market participants more or less ensures that market will reflect intrinsic
values. This means that they will fully impound all available information.
● Price change only response to new information that is unrelated to previous information and therefore
unpredictable
Misconception about Efficient Market Theory
Efficient Market Theory implies that market prices factor in all available information and as such it is not
possible for any investor to earn consistent long term returns from market operations.
● Although prices change, they cannot accurately reflect fair value because the future is uncertain.
● Inability of institutional portfolio managers to achieve superior investment performance implies that
they lack competence in an efficient market. It is not possible to achieve superior investment
performance since market efficiency exists due to portfolio managers doing this job well in a
competitive setting.
● The random movement of stock prices suggests that stock market is irrational.

Explain the different levels or form of Market Efficiency.

i. Weak form Efficiency - Price reflect all information found in the record of past prices and volumes.
ii.Semi – strong Efficiency – Price reflects not only all information found in the record of past prices and
volumes but also all other publicly available information.
iii.Strong form Efficiency - Price reflect all available information public as well as private.

Empirical Evidence on Weak form of Efficient Market Theory

● Serial Correlation Test - Price change in one period has to be correlated with price change in some
other period. Price changes are considered to be serially independent. These studies were carried on
short term trends viz. daily, weekly, fortnightly and monthly and not in long term trends in stock prices
as in such cases. Stock prices tend to move upwards.
● Run Test - Given a series of stock price changes each price change is designated + if it represents an
increase and – if it represents a decrease. The resulting series may be -,+, - , -, - , +, +. A run occurs
when there is no difference between the sign of two changes. When the sign of change differs, the run
ends and new run begins

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● Filter Rules Test - If the price of stock increases by at least N% buy and hold it until its price decreases
by at least N% from a subsequent high. When the price decreases at least N% or more, sell it. If the
behaviour of stock price changes is random, filter rules should not apply in such a buy and hold
strategy.
Empirical Evidence on Semi Strong Efficient Market Theory
There have been empirically verified studies that indicate the following inefficiencies and anomalies:
● Stock price adjust gradually not rapidly to announcements of unanticipated changes in quarterly
earnings. •Small firms’ portfolio seemed to outperform large firms’ portfolio.
● Low price earning multiple stock tend to outperform large price earning multiple stock.
● Monday’s return is lower than return for the other days of the week.
Empirical Evidence on Strong form of Efficient Market Theory
● The researcher examined the profits made by specific groups, such as business insiders, stock
exchange professionals, and mutual fund managers who have access to internal information (not
publicly available) or have more resources or expertise to intensely assess information in the public
domain.
● Mutual Fund managers do not on an average earn a superior rate of return. No scientific evidence has
been formulated to indicate that investment performance of professionally managed portfolios as a
group has been any better than that of randomly selected portfolios.

Mention various challenges to the Efficient Market Theory

● Information Adequacy - Information is neither openly available nor swiftly conveyed to all stock market
participants. Many companies are making a concerted effort to spread misinformation.
● Limited information processing capabilities - Human information processing capabilities are sharply
limited.
● Irrational Behaviour - It is generally believed that investors’ rationality will ensure a close
correspondence between market prices and intrinsic values. The market seems to function largely on
hit or miss tactics rather than on the basis of informed beliefs about the long term prospects of
individual enterprises.
● Monopolistic Influence - A market is regarded as highly competitive. No single buyer or seller is
supposed to have undue influence over prices. In practice, powerful institutions and big operators wield
grate influence over the market. The monopolistic power enjoyed by them diminishes the
competitiveness of the market.

Describe the role of Financial Market in Economic Development

The role of various forms of financial markets in economic development has been examined below.
1. Capital Market: Long-term debt and equity funds are traded in this market. Industries that require huge
amounts of capital may use the capital market. As a result, the capital market provides much-needed
liquidity to the economy, boosting GDP significantly.
2. Money Market: The money market is where short-term funds are transacted. In basic terms, this
market trades all financial assets or products that can be easily transformed into money. Borrowers'
short-term cash needs can be easily satisfied using funds given through the money market.
3. Foreign Exchange Market: Foreign cash produced through FDI in India can be used to alleviate poverty
and for other constructive uses.
4. Derivative Market: The derivative market is a financial market for derivatives derived from other assets.
as all derivatives transactions take place in the future, it provides individuals with better opportunities
because an individual who wants to short (sell) some stock for a long time can only do so in futures or
options. The biggest benefit of this is that it provides an investor or trader with numerous options to
execute all types of strategies.

Modified Duration is a proxy not an accurate measure of change in price of a Bond due to change
interest rate. Discuss
● Although Modified Duration is a measure of volatility or change in a bond's price as a result of a change
in yield or interest rates.It assumes a linear relationship between the Modified Duration and the bond's
proice, although it is not an accurate measure due to convexity.
● As a result, the relationship between interest rate changes and bond value is nonlinear, i.e. a convex
curve to the origin, as illustrated below.

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The preceding diagram clearly shows that the real effect of interest rate changes on bond prices differs from
the projected linear relationship.

In an efficient market, technical analysis may not work perfectly. However, with imperfections,
inefficiencies and irrationalities, which characterises the real world, technical analysis may be
helpful. Critically analyse the statement [Suggested Nov 2020]
This assertion is correct.
Arguments for Technical Analysis
a. Under influence of crowd psychology trend persists for some time. Technical analysis helps in the early
identification of these tendencies, helping in decision making.
b. The shift in demand and supply is gradual rather than abrupt. Technical analysis helps in recognising this
transition early enough.
c. Over time, the market observes and absorbs essential information about the company. Hence Price
movements tend to be in the same direction until the information is fully incorporated in the stock price.
Arguments against Technical Analysis
a. Technical are unable to provide a persuasive explanation for the tools they use.
b. Empirical findings supporting the random walk theory threw a shade over it.
c. Trends have already occurred by the time technical analysis signals them.

Explain how cash flow -based approach of valuation is different from Income based approach and
also explain briefly the steps involved in this approach. [RTP May 2021]
● The cash flows approach considers the amount of free cash available in future periods and discounts it
properly to fit the flow's risk.
● If the present value obtained after applying the discount rate is greater than the current cost of
investing
● Enterprise valuation is appealing to both stakeholders and externally interested parties.
● It makes an attempt to address the issue of over-reliance on past data.
● There are five phases to performing DCF-based evaluation:
1. Obtaining the Free Cash Flows
2. Future cash flow forecasting
3. Calculating the discount rate using the cost of capital
4. Determining the enterprise's Terminal Value (TV)
5. Calculating the present values of the free cash flows and the Tv, and interpreting the results

Equity Research Overview:

● Finance and investment field focusing on evaluating a company's financial performance for stock
decisions.
● Guides investors on buying, selling, or holding equity shares.
Purpose:
● Aids decision-making for stock transactions.
● Essential in determining swap/exchange ratios in mergers and acquisitions.
Key Players:
● Conducted by Equity Research Analysts.
Evolution:
● Started as paper-based; now relies on efficient online tools.
Analyst's Role:
● Analyzes financial data to recommend stock actions.
Tech Impact:
● Internet tools have streamlined and accelerated equity research.
Accessibility:
● Online resources make equity research more accessible.
M&A Application:
● Crucial in deciding swap/exchange ratios in mergers and acquisitions.

Some of the Equity Research tool available on internet are as follows:

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 Chapter 3 Security Analysis

S. No. Name Founde Website

d
1 Bloomberg 1981 https://www.bloomberg.com/professional/solution/bloomberg- terminal/
Terminal
2 Benzinga Pro 2010 https://pro.benzinga.com
3 Refinitiv EIKON 2010 https://www.refinitiv.com
4 MarketXLS 2015 https://marketxls.com
5 Stockopedia 2010 https://www.stockopedia.com

6 Koyfin 2016 https://www.koyfin.com

7 Finbox.io 2014 https://finbox.com
8 GuruFocus 2004 https://www.gurufocus.com
9 Business Quant2014 https://businessquant.com
10 Ycharts 2009 https://get.ycharts.com

Question 1-
Closing values of NSE Nifty from 6th to 17th day of the month of January of the year 2020 were as follows:
Days Date Day Sensex
1 6 THU 14522
2 7 FRI 14925
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 15222
6 11 TUE 16000
7 12 WED 16400
8 13 THU 17000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 18000
Calculate Exponential Moving Average (EMA) of Sensex during the above period. The previous day exponential
moving average of Sensex can be assumed as 15,000. The value of exponent for 31 days EMA is 0.062.
Give detailed analysis on the basis of your calculations.

Question 2-
The closing value of a Stock Market Index for the month of October, 2007 is given below:
Date Closing Index Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140

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 Chapter 3 Security Analysis

31.10.07 3260
You are required to test the weak form of efficient market hypothesis by applying the run test at 5% and 10%
level of significance.

Following values can be used:

Value of t at 5% is 2.101 at 18 degrees of freedom
Value of t at 10% is 1.734 at 18 degrees of freedom.

CA Nitin Guru | www.edu91.org 3.12