SAPM BCU M1 Security Analysis and Portfolio Management

SAPM
MODULE-1
INTRODUTION TO SECURITIES
For Bangalore City University
By Deepak N C
Mob- 6363238970

INTRODUCTION
An investment is an asset or item acquired with the
goal of generating income or appreciation.
Appreciation refers to an increase in the value of an
asset over time. When an Individual purchases a good
as an investment, the intent is not to consume the
good but rather to use it in the future to create wealth.

Investment be broadly categorized
 Fixed income- bonds, FD
 Variable- equity, real estate , gold
In the Financial sense an investment can refer
to any mechanism used for generating future
income. This includes the purchase of bonds,
stocks, or real estate property, among other
examples. Additionally, purchasing a property
that can be used to produce goods can be
considered an investment.

 In the Economic sense an investment is an asset
or item acquired with the goal of generating
income or appreciation. Appreciation refers to an
increase in the value of an asset over time. When
an individual purchases a good as an investment,
the intent is not to consume the good but rather to
use it in the future to create wealth.
 Investment also includes money committed into a
new business venture or for expanding an
existing business or purchase of interest or share
in a business or investment of an asset in a
business. The purpose of investment is to make
your money work for you or let your money
grow.

There is always an element of risk associated with
an investment. Risk is the likelihood of securing
the return of the amount invested. The risk is low
in cases such as investments in government
securities. The risk is high in case of investment in
stocks, new business ventures, business
expansion, and so on.

Characteristics / Nature of investment
 Returns
 Risk
 Safety
 Liquidity
 Capital growth
 Stability of income
 Tax shelter
 Marketability- transferability or saleability

Why Investment are important
 Longer life expectancy
 Taxation
 Interest rates
 Inflation
 Income

Factors favourable for investment
 Legal safeguards
 A stable currency
 Existence of financial institutions & services
 Form of business organization
 Choice of investment
 Risk free vs risky investments

Objectives of investment
Primary investment objectives
 Safety
 Capital gain
 Income
Secondary investment objectives
 Tax minimization
 Marketability/liquidity
 Liquidity
 Tax savings

Importance of investment
 Transaction motive
 Precautionary
 Speculative
 To meet unexpected expenditure in life
 Savings act as an inducement for investment
 Makes a felling of rationality
 Children education
 Achieve a feeling of self reliance
 Security of the family

Concept of investment avenue
 Stocks
 Bonds
 Mutual funs
 ETF
 Real estate
 Commodities
 Crypto currencies
 FD
 Government securities
 Options and futures
 Peer to peer lending
 Retirement accounts

Features of investment avenues
 Future earnings will be secure
 Security
 Liquidity value
 The financial ramifications
 Equilibrium
 Legality

Types or avenues of investment
 Corporate securities
 Deposits in banks and non baking companies
 UTI and other mutual fund scheme
 Post office deposits and certificates
 Life insurance polices
 Provident fund scheme
 Government and semi government securrites

Investment philosophies
 Value investing
 Fundamentals investing
 Growth investing
 Socially responsible investing
 Technical investing

Various investment strategies
 No strategy
 Active vs passive
 Momentum trading
 Buy and hold
 Long short strategy
 Indexing
 Pair trading
 Value vs growth
 Dividend growth investing
 Contrarian investment

Investment v/s Speculation
Basis of comparison Investment speculation
Meaning Hope of getting return Hope of substantial profit
Basis of decision fundamental factor technical charts , market psychology
Time horizon Long term short term
Risk involved moderate risk high risk
Intend to profit changes in values changes in prices
Expected rate of return modest rate of return high rate of return
funds his own funds borrowed funds
income stable uncertain and erratic
behavior of participants conservative , cautious daring and careless

Investment v/s Gambling
 Purpose
 Risk and return
 Skill and knowledge
 Time horizon
 Asset ownership
 Regulation and legality

Gambling v/s Speculation
 Objective
 Risk and reward
 Time horizon
 Knowledge and analysis
 Regulation and legality

Arbitration v/s Hedging
 Arbitration- refers to a legal processes where
disputes b/w 2 or more parties are resolved by an
impartial third party
 Hedging-refers to risk management strategy used
to minimize or offset potential loss or adverse
price movements in an investment or portfolio

Types of investors
 Cautious investors
 Emotional investors
 Technical investors
 Busy investors
 Casual investors
 Informed investors
 Passive investors
 Active investors

Factors to be considered for investment
 Investment goals
 Risk tolerance
 Time horizon
 Asset allocation
 Investment research
 Investment strategy
 Market conditions
 Cost and fees
 Diversification
 Exit strategy

Investment policy
Is a written document that outlines the guidelines
objectives and procedures for managing
investment portfolio.
 Objectives
 Risk tolerance
 Asset allocation
 Investment guidelines
 Performance benchmark

 Investment strategies
 Due diligence process
 Monitoring and reporting
 Roles and responsibilities
 Review and evaluation

Types of investment policy
 Aggressive
 Conservative
 Balanced
 Income oriented
 Value based
 Growth oriented
 Social responsible investment
 Sector specific investment

Advantages of investment policy
 Clear objectives and guidelines
 Consistency and discipline
 Risk management
 Long term focus
 Accountability and transparency
 Reduced behavioural biases
 Flexibility and adaptability
 Professionalism and governance

Disadvantages of investment policy
 Rigidity
 Lack of flexibility
 Overemphasis on past performance
 Limited individual considerations
 Complexity and maintenance
 Behavioural constraints
 Unforeseen events or black swan events

RISK
Is a probability or threat of damage injury, liability
or loss, or any negative occurrence.
Nature of risk
 General economic conditions
 Industry factors
 Company factors

Types of risk
 Financial risk
 Static and dynamic risk
 Fundamental and particular risk
 Pure and speculative risk
 Exchange rate risk
 Business risk
 Liquidity risk
 Country risk
 Market risk
 Credit risk
 Operational risk

Techniques of measuring risk
 Sensitivity analysis
 Scenario analysis
 Break even analysis
 Hillier model
 Simulation analysis
 Decision tree analysis
 Corporate risk analysis
 Selection of project under risk
 Practical risk analysis

 Diversification of risk
 Risk adjusted discount rate approach- estimation
of the present value of cash for high risk
investment
 Under CAPM or CAPITAL ASSET PRICING
MODEL- Risk premium=
(market rate of return-risk free rate)x beta of the
project.

Common risk analysis in practice
 Conservative estimation of revenues
 Safety margin in cost figures
 Flexible investment yardsticks
 Acceptable overall certainty index
 Judgement on three point estimates- A=the best
case estimate, M= the most likely estimate , B=
the worst-case estimate

Financial risk
 Credit risk
 Currency risk
 Country risk
 Political risk
 Economic risk
 Liquidity risk

Risk appetite
 Objective and goals
 Risk tolerance
 Financial capacity
 Time horizon
 Regulatory and compliance requirement
 Market conditions and economic outlook

Benefit of understanding risk appetite
 Risk management
 Goal alignment
 Investment strategy
 Decision making consistency
 Stakeholder communications

Types of risk appetite
 Aggressive risk
 Moderate risk appetite
 Conservative
 Risk-averse appetite
 Risk seeking appetite

Types of risk in investment
 Market risk
 Credit risk
 Liquidity risk
 Inflation risk
 Interest rate risk
 Currency risk
 Political and regulatory risk
 Operational risk
 Concentration risk
 Event risk

Source of risk
 Environmental and social risk
 Economic risk
 Political risk
 Regulatory risk
 Technology risk

Approaches to risk measurement
 Probability based
 Volatility Measures
 Scenario Analysis
 Stress testing
 Risk indicators

 Standard deviation - statistical measure that
qualifies the dispersion or variability of a set of
values
 Covariance -measures the extent to which two
variables move together
 BETA-measure of systematic risk
 Correlation- measures the strength and
direction of the linear relation b/w 2 variables

STANDARD DEVIATION, COVARIANCE, BETA, CORRELATION
The statistical measures (standard deviation,
covariance, beta, and correlation) are commonly
used in financial and investment analysis to
assess risk, evaluate the relationship between
investments, and construct portfolios that align
with an investor's risk tolerance and objectives.

Standard Deviation:
Standard deviation is a statistical measure that
quantifies the dispersion or variability of a set of
values. In the context of risk measurement, it is
commonly used to assess the volatility or risk
associated with an investment or portfolio. A
higher standard deviation indicates a greater
degree of variability and, therefore, higher
potential risk.

Covariance:
Covariance measures the extent to which two
variables move together. In the context of risk
measurement, covariance is used to assess the
relationship between the returns of two different
investments. A positive covariance suggests that
the returns of the two. investments tend to move
in the same direction, while a negative
covariance indicates that the returns move in
opposite directions. Covariance alone does not
provide a standardized measure of risk.

Beta:
Beta is a measure of systematic risk or the
sensitivity of an investment's returns to the overall
market movements. It compares the price volatility
of an investment to that of the broader market. A
beta of 1 indicates that the investment tends to
move in line with the market, while a beta greater
than 1 suggests higher volatility than the market,
and a beta less than 1 indicates lower volatility.
Beta is commonly used in the Capital Asset Pricing
Model (CAPM) to estimate the expected return of
an investment based on its level of risk.

Correlation:
Correlation measures the strength and direction of the
linear relationship between two variables. In the
context of risk measurement, correlation is used to
assess the relationship between the returns of two
investments. A correlation coefficient ranges from -1
to 1. A value of 1 indicates a perfect positive
correlation (both investments move in the same
direction), a value of -1 indicates a perfect negative
correlation (investments move in opposite directions),
and a value of 0 indicates no correlation (no linear
relationship between the investments' returns)

PRACTICAL PROBLEMS ON STANDARD DEVIATION
Most investors do not hold stocks in isolation.
Instead, they choose to hold a portfolio of several
stocks. When this is the case, a portion of an
individual stock's risk can be eliminated, Le.,
diversified away.
Portfolio Expected Return
The Expected Return on a Portfolio is
computed as the weighted average of the
expected returns on the stocks which comprise
the portfolio. The weights reflect the proportion
of the portfolio invested in the stocks. This can be
expressed as follows:

Portfolio Expected Return
 E[Rp]= n wiE[R_i]
∑
 Where
 E[Rp]= the expected return on the portfolio,
 N= the number of stocks in the portfolio,
 wi= the proportion of the portfolio invested in
stock i, and
 E[Ri]= the expected return on stock i.
For a portfolio consisting of two assets, the above
equation can be expressed as
E[Rp]=w1E[R1]+[1-w1)E[R2]

Portfolio Variance and Standard Deviation
The variance/standard deviation of a
portfolio reflects not only the variance/standard
deviation of the stocks that make up the portfolio
but also how the returns on the stocks which
comprise the portfolio vary together. Two
measures of how the returns on a pair of stocks
vary together are the covariance and the
correlation co-efficient.

LEGAL FRAMEWORK AND REGULATORY COVER FOR
INVESTMENT IN INDIA
 Investment in India is governed by a legal framework and regulatory system that aims to promote
transparency, protect investors' rights, and facilitate ease of doing business. Here are some key
components of the legal framework and regulatory cover for investment in India.
 1. Foreign Exchange Management Act (FEMA)

FEMA is a crucial legislation that governs foreign exchange transactions and regulates cross-border
investments in India. It provides guidelines for foreign direct investment (FDI), external commercial
borrowing, foreign portfolio investment, and repatriation of funds. The Reserve Bank of India (RBI)
is the regulatory authority responsible for enforcing FEMA regulations.
 2. Securities and Exchange Board of India (SEBI)
 SEBI is the regulatory body for the securities market in India. It formulates rules and regulations to
protect the interests of investors, promote fair and transparent trading practices, and regulate
entities such as stock exchanges, brokers, and market intermediaries. SEBI regulates various
investment vehicles, including mutual funds, venture capital funds, and alternative investment
funds.
 3. Companies Act, 2013
 The Companies Act governs the incorporation, operation, and governance of companies in India. It
lays down provisions related to shareholders' rights, corporate governance, disclosure requirements,
and investor protection. The Act provides a legal framework for investments in Indian companies
and ensures transparency and accountability in corporate affairs.

 4. Insolvency and Bankruptcy Code (IBC)
 The IBC is a comprehensive legislation that addresses insolvency and
bankruptcy proceedings in India. It provides a time-bound and creditor-
friendly mechanism for the resolution of distressed companies. The IBC
aims to enhance the ease of doing business and protect the interests of
investors by ensuring a streamlined process for resolving insolvency-
related issues
 5. Competition Act, 2002
 The Competition Act promotes fair competition and prevents anti-
competitive practices in India. It prohibits anti-competitive agreements,
abuse of dominant market position, and regulates mergers and acquisitions
that may have an adverse impact on competition. The Act aims to create a
level playing field for investors and protect consumer interests.
 6. Taxation Laws
 India has a comprehensive taxation system that includes direct and
indirect taxes. The Income Tax Act governs the taxation of individuals,
businesses, and foreign investors in India. The Goods and Services Tax
(GST) is a unified indirect tax that replaced multiple taxes at the national
and state levels. Understanding the tax implications and complying with
tax obligations is essential for investors in India.

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