Professional Documents
Culture Documents
Portfolio Mgt
Learning Objectives
Investment Objectives
Difference between speculation &
investing
Investment Alternatives
Understanding the risk and return
what is investments
In 1934, Graham and David Dodd
"An investment operation is one which,
upon thorough analysis promises safety
of principal and an adequate return.
Operations not meeting these
requirements are speculative."
Fundamental Analysis
Objectives of Investments
Primary Objectives
Safety of capital -Risk Tolerance
Regular Income
Growth of capital
Secondary Objectives
Tax Minimization
Marketability / Liquidity
INVESTMENT ALTERNATIVES
High
Return potential
Real Estate
Gold
Debt Funds
PPF, NSC, KVP, PO Deposits, RBI Bonds
Liquid Funds
Low
Savings Bank/ FD
Low
Risk
Note:The above chart is for illustrative purpose only and is not marked to scale. The chart is based
on our perception of the risk and return potential of various investment avenues
High
Quiz on
If investor requires 7% annualized
Return on treasury bill with face
value of 25000 . What should be fair
price of his Bid
25000/1.07= 23364.49
Certificate of Deposit:
It is a promissory note issued by a bank in form of
a certificate entitling the bearer to receive interest.
The certificate bears the maturity date, the fixed
rate of interest and the value. It can be issued in
any denomination. They are stamped and
transferred by endorsement.
Its term generally ranges from three months to
five years and restricts the holders to withdraw
funds on demand. However, on payment of certain
penalty the money can be withdrawn on demand. T
he returns on Certificate of Deposits are higher
than T-Bills because it assumes higher level of risk.
Commercial Paper
Repos
Reliance Infrastructure
59-D 20/10/2014
Commercial
Paper
P1+
13.18
Commercial
Paper
P1+
13.06
RHC Holdings
Commercial
Paper
P1+
10.54
P1+
10.53
Ballarpur Inds.
Commercial
Paper
P1+
10.43
Commercial
Paper
P1+
7.92
Commercial
Paper
P1+
5.27
2500
1000
25000
100000
Bonds/Fixed Income
securities
Traded thru Negotiated Dealing System
https://www.ccilindia.com/OMHome.aspx
Dated Government Securities
Long Maturity and statutory Compulsion
Coupon
: 7.49% paid on face value
Name of Issuer : Government of India
Date of Issue : April 16, 2007
Maturity : April 16, 2017
Coupon Payment Dates : Half-yearly (October 16 and April 16) every
Minimum Amount of issue/ sale : Rs.10,000
State Development Loans (SDLs)
They are also eligible as collaterals for borrowing through market repo as well as
borrowing by eligible entities from the RBI under the Liquidity Adjustment Facility
(LAF).
3)
Tenure
Yield to Maturity
6.84%
6.92%
7.08%
7.17%
10
7.18%
15
7.26%
20
8.33%
25
8.30%
29
8.13%
Symbol
Series
IRFC
N8
NHAI
N2
MUTHOOTFIN
N6
SBIN
N5
NHAI
N1
ECLFINANCE
N5
NHAI
N6
HUDCO
N3
IRFC
N2
NHBTF2014
N6
IIFLFIN
NA
IIHFL
N1
IIHFL
N2
Coupon YTM at
Rate LTP (%)
LTP
1,101.0
8.4
0
1,067.0
8.3
8.4831
0
1,004.2
12.25 12.1525
0
10,850.
9.95
9.375
00
1,054.0
8.2
8.6926
0
1,009.5
12
12.6049
0
1,170.0
8.75 7.3122
0
1,075.0
8.1
7.5327
0
1,126.1
8.1
7.4618
0
6,035.0
9.01 7.5486
0
1,026.0
12
12.0137
0
1,000.5
11.52 12.0716
0
1,008.5
12
12.6227
0
% Chng
High
Low
Volume
Turnove
r
(lacs)
0.09
-0.74
0.06
0.08
-0.41
0.05
-0.51
-0.01
-0.35
0.05
0
-0.08
0.08
1,101.0
0
1,074.9
9
1,007.0
0
10,859.
95
1,062.0
0
1,010.9
8
1,177.9
9
1,078.0
0
1,130.0
0
6,040.0
0
1,027.0
0
1,003.0
0
1,011.8
8
1,101.0
0
1,065.1
0
1,002.0
0
10,831.
64
1,054.0
0
1,008.5
1
1,168.0
0
1,075.0
0
1,123.0
0
6,026.0
0
1,025.5
0
15,000 165.15
7,757
83.12
8,093
81.28
441
47.81
3,758
39.7
3,291
33.23
2,823
33.03
2,480
26.69
2,204
24.82
364
21.98
1,872
19.21
997
1,877
1,005.0
0
1,618
18.79
16.31
Shares
Equity shares
Participation In Profit
Indirect control over the Mgt
Ownership of company
Preference shares
Fixed Rate of dividend
Cumulative dividend
Redeemable
Tax exempt
Growth shares
Income shares
- Stable operations ,high dividend ratios and limited growth
opportunities
Cyclical shares
defensive shares
Speculative shares
Pooled Investments
Pooled Investments
Mutual Funds
Shares
Trusts
Units
Depositories
Depository
Receipts
Investors
Hedge Funds
Limited
Partnership
Interests
Commodities
Bullion
Oil & oil seeds
Spices
Metal
Fiber
Pulses
Cereals
Energy
Plantations
Petrochemicals
Weather
Real Estate
Residential Property
Commercial Property
Sub-urban Property
Agricultural Land
Expected Return
The future is uncertain.
Investors do not know with certainty whether the
economy will be growing rapidly or be in
recession.
Investors do not know what rate of return their
investments will yield.
Therefore, they base their decisions on their
expectations concerning the future.
The expected rate of return on a stock
represents the mean of a probability distribution
of possible future returns on the stock.
28
Expected Return
State
Probability
Return On
Return On
Stock A
Stock B
1
20%
5%
50%
2
30%
10%
30%
3
30%
15%
10%
4
20%
20%
-10%
The state represents the state of the economy one period in the
future i.e. state 1 could represent a recession and state 2 a
growth economy.
The probability reflects how likely it is that the state will occur.
The sum of the probabilities must equal 100%.
The last two columns present the returns or outcomes for stocks
A and B that will occur in each of the four states.
29
Expected Return
Given a probability distribution of returns, the
expected return can be calculated using the
following equation:
N
E[R] = (piRi)
i=1
Where:
E[R] = the expected return on the stock
N = the number of states
pi = the probability of state i
Ri = the return on the stock in state i.
30
Expected Return
In this example, the expected return for
stock A would be calculated as follows:
E[R]A = .2(5%) + .3(10%) + .3(15%) + .2(20%) =
12.5%
Expected Return
Did you get 20%? If so, you are correct.
If not, here is how to get the correct answer:
E[R]B = .2(50%) + .3(30%) + .3(10%) + .2(-10%) = 20%
Ex Post
35
Types of Risk
Systematic Risk - also known as un diversifiable
risk or market risk,
Risk which affects the overall market, not just a
particular stock or industry. This type of risk is both
unpredictable and impossible to completely avoid.
It cannot be mitigated through using the right asset
allocation strategy.
Unsystematic Risk - also known as nonsystematic
risk, "specific risk," "diversifiable risk" or "residual
risk,
Company or industry-specific hazard that is inherent
in each investment.
Can be reduced through diversification
An example is news that affects a specific stock
such as a sudden strike by employees.
Diversification is the only way to protect yourself
from unsystematic risk.
Foreign-Exchange Risk
When investing in assets in foreign countries
,currency exchange rates can change the price
of the asset as well. Foreign-exchange risk
applies to all financial instruments that are in a
currency other than your domestic currency.
As an example, if you are a resident of America
and invest in some Canadian stock in Canadian
dollars, even if the share value appreciates, you
may lose money if the Canadian dollar
depreciates in relation to the American dollar.
Liquidity Risk
liquidity risk arises from situations in which a party
interested in trading an asset cannot do it because
nobody in the market wants to trade for that asset.
Liquidity risk becomes particularly important to parties
who are about to hold or currently hold an asset, since it
affects their ability to trade.
It is the risk that a given security or asset cannot be
traded quickly enough in the market to prevent a loss
Amaranth Advisors lost roughly $6bn in the natural gas
futures market back in September 2006. Amaranth had
a concentrated, undiversified position in its natural gas
strategy. The trader had used leverage to build a very
large position. Amaranths positions were staggeringly
large, representing around 10% of the global market in
natural gas future
Measures of Risk
Risk reflects the chance that the actual return on
an investment may be different than the
expected return.
One way to measure risk is to calculate the
variance and standard deviation of the
distribution of returns.
We will once again use a probability distribution
in our calculations.
The distribution used earlier is provided again for
ease of use.
44
Exercise
1
A stock earns the following returns over a
five year period:
R1 = 0.30,
R2 = -0.20,
R3 = -0.12,
R4 = 0.38,
R5 = 0.42,
R6 = 0.36.
Expected Return
Standard deviation
Period
Return in % Ri
1
2
3
4
5
6
30
-20
-12
38
42
36
Deviation (RiR)
11
-39
-31
19
23
17
19
SUM=
R=
Price
XYZ
ABC
Price
Jan
115
98
feb
129
101
12.2%
3.1%
Mar
138
105
7.0%
4.0%
Apr
126
108
-8.7%
2.9%
May
110
112
-12.7%
3.7%
Jun
132
114
20.0%
1.8%
Jul
140
116
6.1%
1.8%
Aug
165
118
17.9%
1.7%
Sep
174
121
5.5%
2.5%
Oct
150
125
-13.8%
3.3%
Nov
135
132
-10.0%
5.6%
Dec
162
130
20.0%
-1.5%
Mean
3.9%
2.6%
Std Dev
13.2%
1.8%
Portfolio 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:
N
E[Rp] = wiE[Ri]
i=1
Where:
49
Portfolio Return
For a portfolio consisting of two assets, the above
equation can be expressed as:
E[Rp] = w1E[R1] + w2E[R2]
If equally weighted portfolio of stock A and stock
B (50% in each stock), expected return on
Portfolio A =12.5%
Portfolio B= 16.25%
Calculate expected return of portfolio
50
Answer
then the expected return of the
portfolio i
E[Rp] = .50(.125) + .50(.20) =
16.25%
Portfolio Risk
Covariance
Covariance indicates how two variables are related. A positive
covariance means the variables are positively related, while a
negative covariance means the variables are inversely related. The
formula for calculating covariance of sample data is shown below.
correlation coefficient
correlation coefficient
COV(x,y) = 1.53
sx= 0.90
sy= 2.58
Beta
Beta measures a stocks sensitivity to
overall market movements .A
coefficient measuring a stocks relative
volatility
In practice, Beta is measured by
comparing changes in a stock price to
changes in the value of the index like
NIFTY & Sensexc over a given time
period
The Market index (Nifty ) has a
beta of 1
A Generic Example
Stock XYZ has a beta of 2
The S&P 500 index increases in value
by 10%
The price of XYZ is expected to
increase 20% over the same time
period
April
May
June
July
August
September
Oct
NIFTY (x)
4%
-1%
-9%
9%
2%
2%
10%
Returns
Rajesh Export (y)
14%
5%
-42%
-6%
7%
4%
9%
=
Y is the returns on your portfolio or stock - DEPENDENT VARIABLE
X is the market returns or index - INDEPENDENT VARIABLE
NIFTY (x)
April
4
May
-1
June
-9
July
9
August
2
Septembe
r
2
Oct
10
17
(y)
14
5
-42
-6
7
xy
56
-5
378
-54
14
x^2
16
1
81
81
4
4
9
8
90
4
100
287
-9
487
2.07093
Security Name
ACC Ltd.
Idea Cellular Ltd.
IndusInd Bank Ltd.
Infosys Ltd.
I T C Ltd.
Kotak Mahindra Bank Ltd.
Larsen & Toubro Ltd.
Maruti Suzuki India Ltd.
NMDC Ltd.
NTPC Ltd.
Oil & Natural Gas
Corporation Ltd.
Punjab National Bank
Power Grid Corporation of
India Ltd.
UltraTech Cement Ltd.
Vedanta Ltd.
Yes Bank Ltd.
Zee Entertainment
Enterprises Ltd.
Beta
0.94
0.74
1.08
0.61
0.7
1
1.22
0.88
0.63
0.86
R2
0.35
0.11
0.41
0.12
0.17
0.32
0.53
0.42
0.11
0.27
Volatility (%)
1.47
1.94
1.92
2.03
1.55
2.12
1.85
1.82
1.92
1.85
1.06
1.29
0.27
0.28
3.14
3.56
0.54
1.18
1.52
1.57
0.18
0.39
0.28
0.48
1.33
1.73
4.88
3.43
0.93
0.24
2.47
What is INDEX
Indices -An Index is used to give information about the price
movements of products in the financial, commodities or any
other markets.
Barometer of ECONOMY
Stock market indexes are meant to capture the overall
behavior of equity markets.
A stock market index is created by selecting a group of stocks
that are representative of the whole market or a specified
sector or segment of the market. An Index is calculated with
reference to a base period and a base index value.
Constituen
t
securities
Benefits of Index
They provide a historical comparison of returns on
money invested in the stock market against other
forms of investments such as gold or debt.
They can be used as a standard against which to
compare the performance of an equity fund.
It is a lead indicator of the performance of the
overall economy or a sector of the economy
Stock indexes reflect highly up to date information
Modern financial applications such as Index Funds,
Index Futures, Index Options play an important
role in financial investments and risk management
Nifty 50
Date
Adjusted
Total Market Base Market
cap (In Cr) Cap (In Cr) Index Value
31-May-16 2985846.62
365908.1
30-Jun-16
365908.1
3032557.43
Date
Adjusted
Total Market Base Market
cap (In Cr) Cap (In Cr) Index Value
31-May-16 2985846.62
365908.1
8160.1
30-Jun-16
365908.1
8179.95
3032557.43
ADDITIONAL EXAMPLES
Where:
SD(RA)SD(RB)
Where:
A,B=the correlation coefficient between the returns on stocks
A and B
A,B=the covariance between the returns on stocks A and B,
A=the standard deviation on stock A, and
B=the standard deviation on stock B
86
88
= .0128 = 1.28%
the
the
the
the
the
the
90
Statistical Measures of
Risk
Variance
Variance is a statistical measure used
for probability distribution. Variance
is defined as the measurement of
the variability (volatility) from
mean or average.
It can help investors determine the
risk involved in purchasing a specific
security.
Standard Deviation
Standard Deviation is defined as the measure of deviation
or dispersion of a set of data from its mean. More the
data is spread apart, higher will be the deviation.
Standard deviation is calculated as the square root
of variance.
An investor would use this statistical measure to calculate
the investment's volatility by applying standard deviation
to the annual rate of return of an investment.
Standard deviation, also known as historical volatility, is a
useful tool to anticipate expected volatility.
lower standard deviation is a sign of a stable stock, while
a volatile stock will have a high standard deviation. A
large dispersion is a sign of how much the return on the
fund is deviating from the expected normal returns.
Portfolio Expected
Return
The Expected Return on a Portfolio
of stock is calculated as the
weighted average of the expected
returns on the stocks which
comprise the portfolio.
The weights are reflective of the
proportion of the portfolio invested in
the stocks.
E[Rp] =
12
2,
N = the number of states,
pi = the probability of state i,
R1i = the return on stock 1 in state i,
E[R1] = the expected return on stock 1,
R2i = the return on stock 2 in state i, and
E[R2] = the expected return on stock 2.
Additional problem
Probability Distribution:
State
1
2
3
4
Probability
20%
30%
30%
20%
E[R]A = 12.5%
E[R]B = 20%
Return On
Stock A
5%
10%
15%
20%
Return On
Stock B
50%
30%
10%
-10%
101
Measures of Risk
Given an asset's expected return, its variance can
be calculated using the following equation:
N
Where:
N = the number of states
pi = the probability of state i
Ri = the return on the stock in state i
E[R] = the expected return on the stock
102
Measures of Risk
The variance and standard deviation for stock A is
calculated as follows:
2A = .2(.05 -.125)2 + .3(.1 -.125)2 + .3(.15 -.125)2 + .2(.2 -.125)2 = .
002625
Measures of Risk
If you didnt get the correct answer, here is how to get
it:
2B = .2(.50 -.20)2 + .3(.30 -.20)2 + .3(.10 -.20)2 + .2(-.10 - .20)2
= .042