iapm i introduction

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Investment Analysis & Portfolio Management I

Introduction

Contents:Investment Introduction

Economic Investment Vs Financial Investment

Investment Vs speculation

Investment Vs Gambling

Investment Process

Investment Avenues

Approaches to Investment Decision MakingCommon Errors In Investment Management

Qualities for Successful Investing

Measures of Return & Risk


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nves men Investment is the employment of funds on assets with aim of

earning income or capital appreciation. Investment is puttingmoney into something with the expectation of profit. Morespecifically, investment is the commitment of money or capital tothe purchase of financial instruments or other assets so as to gainprofitable returns in the form of interest, income (dividends), orappreciation (capital gains) of the value of the instrument. It is

related to saving or deferring consumption.Investment is involved in many areas of the economy, such

as business management and finance no matter for households,firms, or governments. An investment involves the choice by an

individual or an organization, such as a pension fund, after someanalysis or thought, to place or lend money in a vehicle,instrument or asset, such as property, commodity, stock, bond,financial derivatives (e.g. futures or options), or the foreign asset

denominated in foreign currency, that has certain level of riskand provides the possibility of generating returns over a period of


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ECONOMIC INVESTMENT AND FINANCIAL INVESTMENT

When a person invests his funds for the acquisition of somephysical assets, say a building or equipment, such types of

investments are called economic investments. Economicinvestment can be defined as the investment that contributes to thenet additions to the capital stock of society. Capital stock refers tothe goods and service that are used in the production of othergoods and services. Hence, in short, it can be said that economicinvestments help create physical assets directly.

When a person invests his funds for the acquisition of somefinancial assets like shares, debentures, insurance policies, mutualfund units etc, and such investments are known as financial

investments. Financial investments also help in creating physicalassets, but indirectly. Hence, economic investment and financialinvestment are inter-related. Increase in financial investment leadsto increase in capital stock. When an investor invests in a financial

asset, he indirectly invests in an underlying physical asset, since thefinancial investments are ultimately used in creation of physical


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INVETMENT V/s SPECULATION

Both investment and speculation are somewhat interrelated. It is said that

speculation requires investment and investments are to some extent

speculative. Speculation is the purchase or sale of anything in the hope of

profit from anticipated changes in price. Both investment and speculationaim at realizing income and capital appreciation. Yet, differences exist in

terms of expectation, risk and period of time.

Investment Speculation

The investor invest for longterm gain purpose

The investor holds securitiesfor long period.

Risk is less as compare tospeculation

The rate of return is less ascompare to speculation

The investor invest for shortterm gain purpose

The investor hold securities veryshort period say 1 or 2 days

Risk is high Rate of return is more

It involve buying and selling ofsecurities


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GAMBLING

As against investment and speculation, gambling is

unplanned. A gamble is usually a very short terminvestment in a game or chance. It is an act of creatingartificial and unnecessary risks for expected increasedreturn. Gambling is undertaken just for trill and

excitement. There is no risk and return trade off in thegambling and the negative outcomes are expected. Butin the investment there is an analysis of risk and return.

In short, gambling involves acceptance of

extraordinary risks even without a thorough knowledgeabout them for pecuniary gains. Horse racing, playingcards, lottery etc., are some typical examples ofgambling.


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INVESTMENT PROCESS

The investment process involves a series of activities leading to

the purchase of securities or other investment alternatives. The

investment process can be divided into the following stages.

INVESTMENTPOLICY

ANALYSIS PORTFOLIOCONSTRUCTION

VALUATIONPORTFOLIO

EVALUATION

Investablefund

ObjectivesKnowledge

MarketIndustry

Company

Intrinsic value

Future value

Diversification

Selection &

Allocation

AppraisalRevision


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VARIOUS AVENUES (or)

DIFFERENT ALTERNATIVES FOR INVESTMENT

Investment in any of the alternatives depends on the needs andrequirements of the investor. Corporate and individuals havedifferent needs. Before investing, these alternatives of investmentsneed to be analyzed in terms of their risk, return, term, convenience,liquidity etc.

Equity Shares:

Equity investments represent ownership in a running company. Byownership, we mean share in the profits and assets of the companybut generally, there are no fixed returns. It is considered as a risky

investment but at the same time, they are most liquid investmentsdue to presence of stock markets.


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Debentures or Bonds:

Debentures or bonds are long term investmentoptions with a fixed stream of cash flows depending on thequoted rate of interest. They are considered relatively lessrisky. Amount of risk involved in debentures or bonds isdependent upon who the issuer is. For example, if theissuer is government, the risk is assumed to be zero.Following alternatives are available under debentures orbonds:

Government securities Savings bonds

Public Sector Units bonds

Debentures of private sector companies

Preference shares


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Money Market Instruments:

Money market instruments are just like thedebentures but the time period is very less. It isgenerally less than 1 year. Corporate entities can utilizetheir idle working capital by investing in money

market instruments. Some of the money marketinstruments are

Treasury Bills

Commercial Paper

Certificate of Deposits


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Mutual Funds:

Mutual funds are an easy and tension free way of

investment and it automatically diversifies theinvestments. Mutual fund is an investment mix ofdebts and equity and ratio depending on the scheme.They provide with benefits such as professional

approach, benefits of scale and convenience. Inmutual funds also, we can select among the followingtypes of portfolios:

Equity Schemes

Debt Schemes

Balanced Schemes

Sector Specific Schemes etc.


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Life Insurance:

Life insurances are one of the important parts of

investment portfolios. Life insurance is an investmentfor security of life. The main objective of otherinvestment avenues is to earn return but the primaryobjective of life insurance is to secure our families

against unfortunate event of our death. It is popular inindividuals. Other kinds of general insurances areuseful for corporate. There are different types ofinsurances which are as follows:

Endowment Insurance Policy

Money Back Policy

Whole Life Policy

Term Insurance Policy


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Real Estate:

Every investor has some part of their portfolioinvested in real assets. Almost every individual andcorporate investor invests in residential and officebuildings respectively. Apart from these, othersinclude:

Agricultural Land

Semi-Urban Land

Commercial Property

Raw House Farm House etc


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Precious Objects:

Precious objects include gold, silver and other

precious stones like diamond. Some artistic peopleinvest in art objects like paintings, ancient coins etc.

Financial Derivatives:

Derivatives means indirect investments in the

assets. Derivatives market is growing at a tremendousspeed. The important benefit of investing throughderivatives is that it leverages the investment, managesthe risk and helps in doing speculation. Derivativesinclude: Forwards

Futures

Options

Swaps etc


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Non Marketable Securities:

Non marketable securities are those securitieswhich cannot be liquidated in the financial markets.Such securities include:

Bank Deposits

Post Office Deposits Company Deposits

Provident Fund Deposits


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APPROACHES TO INVESTMENT DECISION MAKING:

There are four approaches for investment decisionmaking

Fundamental Approach

Psychological Approach

Academic Approach

Electric Approach


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COMMON ERRORS IN INVESTMENT MANAGEMENT

Inadequate comprehension of return and riskVaguely formulated investment policy

Nave extrapolation of the past

Cursory decision making

Untimely entries and exits

High costs

Over diversification and under diversification

Wrong attitude towards losses and profits


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QUALITIES FOR SUCCESSFUL INVESTING

The game of investment, as any other game, requirescertain qualities and virtues on the part of theinvestors, to be successful in the long run.

Contrary thinking

Patience

Composure

Flexibility and openness

Decisiveness


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MEASURES OF RETURN AND RISK

Investment decisions are influenced by various motives.Most investors, however, are largely guided by thepecuniary motive of earning a return on their investment.For earning returns investors have to almost invariablybear some risk. In general, risk and return go hand inhand. These are the two sides of investment coin.

Investment decisions, therefore, involve a trade offbetween risk and return. Since risk and return are central

to investment decisions, we must clearly understand whatrisk and return are and how they should be measured.


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Return:

Return is the primary motivating force that drivesinvestment. It represents the reward forundertaking investment. Since the game if

investing is about returns (after allowing for risk),measuring of realized (historical) returns isnecessary to assess how well the investmentmanager has done. In addition, historical returns

are often used as an important input inestablishing future returns.


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The return of an investment consists of two components.

Current return: Current return is measured as theperiodic income in relation to the beginning price of theinvestment. Ex: Dividend or interest.

Capital return: The return which is reflected on theprice change called the capital return. It is simply the

price appreciation or deprecation divided by thebeginning price of the asset. For assets like equity stocks,the capital return predominates.

Thus, the total return is defined as,

Total return = Current return + Capital return

Note: The current return can be zero or positive, whereasthe capital return can be negative, zero or positive.


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RISK

Any investor, before investing his investable wealth in thestock, analyses the risk associated with the particularstock. The actual return he receives from a stock may varyfrom his expected return and the risk is expected in terms

of variability of return.

The dictionary meaning of risk is the possibility of loss orinjury. In risk, the probable outcomes of all possibleevents are listed. Once the events are listed subjectively,the derived probabilities can be assigned to the entirepossible events.


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Risk consists of two components:

Systematic risk: it is caused by the factors external to theparticular company and uncontrollable by the company.The systematic risk affects the entire market.

Ex: - stock market volatility, economic conditions,

political situations and sociological changes. Unsystematic risk: It is unique and peculiar to a firm or

an industry. Unsystematic risk stems from managerialinefficiency, technological change in the production

process, availability of raw material, changes in theconsumer preference and labour problems.


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iapm i introduction

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