portfolio management’

Study of Portfolio Management

Profile and Historical Background of the‘Shrishma Portfolio & Investment services Ltd.’

Address: 1/D Priya Apt., Opp. Old civil court, Nanpura, Surat.

Shrishma Portfolio & Investment Services Ltd. is an Investment

Company registered under Companies Act 1956 since 1995. It provides a

proper solution to the investors regarding any investment related queries.

The company has all modern communication facilities, infrastructure.

The main objective of the company is to help the investors in

managing their investment portfolio. The other objective is to provide

best service and guideline to the clients for their suitable investment

avenue, so they get maximum gain with safety for their future. Generally,

people is not aware about different safe and gainful investment avenue, if

they invest their money in any investment avenue there are chances to

incur a loss and could not get the proper return from it.

Shri Satish joshi is a Director of the company. He has more than

twenty five year's wide experience in Capital Market, Financial Service

Sector, and Equity Research.

During his college life in 1976-77 he started applying in equity

issues. A small beginning of Rs. 500/- of the year 1976-77 has reached to

lacks of Rs. investment. He has done M.Sc. (1st class) in 1982 from S. P.

University, Post graduate in computer science (1st class) in 1982-83. He

joined PRL (Physical Research Laboratory) as computer scientist. The

habit of doing research and analysis has given advantage in equity

research. He spend two year in C.F.A and recently passed exam of

Association of Mutual Fund Industries (AMFI) for validity of his mutual

fund activities. He has spent several years in fundamental analysis. Then

PProf. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.

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he started writing regular articles in various news papers and magazines.

He is appearing on T.V. channels for his investment advice. He has been

respected by thousand of investors and has earned reputation as one of

most successful equity research analyst.

He is a regular student of Yoga classes and meditation. His nature

of helping everybody has proved beneficial to the society.

He believes in and respects GOD. He loves challenge and struggle

for excellence. His primary objective of advice is "no investors of him

should lose".

He is equally efficient in technical analysis. He has attended

several seminars on technical analysis. He is a professional advisor to

many Charted Accountants, engineers, advocates and managers.


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Saving:

Saving are excess of income over expenditure for any economic

unit. Thus,

S = Y – E

Where, S is saving,

Y is income and

E is expenditure.

Secondly, excess funds or surplus in profits or capital gains are

also available for investment. Thus,

S = W1 – W2

Where, W1 is wealth in period 2,

W2 is wealth in period 1,

So, the difference between them is capital gains or losses.

Thirdly, investment is also made by many companies and

individuals by borrowing, from others. Thus the Corporate Sector and

Government Sector are always net borrows, as they invest more than their

savings. Thus,

S = B – L

Where, B is borrowings

L is landings

Savings can be negative or positive

Why Saving:

Saving is abstaining from present consumption for a future use.

Saving are sometimes autonomous coming from households as a matter

of habit. But bulk of the savings come for specific objectives, like interest

income, future needs, contingencies, precautionary purposes, or growth in

future wealth, leading to rise in the standard of living etc.


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Saving and Investment:

Investors are savers but all savers cannot be good investors, as

investment is a science and an art. Savings are sometimes autonomous

and sometimes induced by the incentives like fiscal concessions or

income or capital appreciation. The number of investors is about 50

million out of population of more than one billion in India. Savers come

from all classes except in the case of the population who are below the

poverty line. The growths of urbanization and literacy have activated the

cult of investment. More recently, since the eighties the investment

activity has become more popular with the change in the Government

Polices towards liberalization and financial deregulation. The process of

liberalization and privatization was accelerated by the Government policy

changes towards a market oriented economy, through economic and

financial reforms stated in July 1991.

What is investment?

“Investment may be defined as the purchase by an individual or

institutional investor of a financial or real asset that produces a return

proportional to the risk assumed over some future investment period.”

- F. Amling

“Investment defined as commitment of funds made in the

expectation of some positive rate of return. If the investment is properly

undertaken, the return will commensurate with the risk the investor

assumes.”

- Fisher & Jordan

Investment refers to acquisition of some assets. It also means the

conversion of money into claims on money and use of funds for

productive income earnings assets. In essence, it means the use of funds

for productive purpose, for securing some objectives like, income,


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appreciation of capital or capital gains, or for further production of goods

and services with the objective of securing yield

Financial and Economic Meaning of Investment:

Financial investment involves of funds in various assets, such as

stock, Bond, Real Estate, Mortgages etc. Investment is the employment of

funds with the aim of achieving additional income or growth in value. It

involves the commitment of resources which have been saved or put

away from current consumption in the hope some benefits will accrue in

future. Investment involves long term commitment of funds and waiting

for a reward in the future.

From the point of view people who invest their finds, they are the

supplier of ‘Capital’ and in their view investment is a commitment of a

person’s funds to derive future income in the form of interest, dividend,

rent, premiums, pension benefits or the appreciation of the value of their

principle capital. To the financial investor it is not important whether

money is invested for a productive use or for the purchase of secondhand

instruments such as existing shares and stocks listed on the stock

exchange. Most investments are considered to be transfers of financial

assets from one person to another.

Economic investment means the net additions to the capital stock

of the society which consists of goods and services that are used in the

production of other goods and services. Addition to the capital stock

means an increase in building, plants, equipment and inventories over the

amount of goods and services that existed.

The financial and economic meanings are related to each other

because investment is a part of the savings of individuals which flow into


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SaverInvestor

FINANICAL ASSETS: cash Bank DepositsP.F.; L.I.C schemePension scheme Post office certificates

PHYSICAL ASSETS: House, Land, Building, FlatsGold, Silver and Other MetalsConsumer Durables

MARKETABLE ASSETS: Shares, BondsGovernment securitiesMutual FundUTI units etc.

Stock & Capital Markets

New Issues Stock Market


the capital market either directly or through institutions, divided in ‘new’

and secondhand capital financing. Investors as ‘suppliers’ and investors

as ‘users’ of long-term funds find a meeting place in the market.

So from above we know the term investment. The savers become

the investors in the following term and invest in unique assets:

Becomes

Source: Investment Management By.V.A. Avadhani, Himalaya Publishing, Page 45.

Need of investment:


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Investments are both important and useful in the context of present

day conditions. The following points have made investment decision

increasingly important.

1. Planning for retirement

2. Interest rate

3. High rate of inflation

4. Increase rate of taxation

5. Income

6. Investment channels

1. Planning for retirement:

A tremendous increase in working population, proper plans for life

span and longevity have ensured the need for investment decisions.

Investment decision have becomes significant as working people retire

between the age 55 and 60. The life expectancy has increased due to

improved living conditions, medical facilities etc. The earnings from

employment should, therefore, be calculated in such a manner that a

portion should be put away as savings. Saving from the from the current

earning must be invested in a proper way so that principal and income

thereon will be adequate to meet expenditure on them after their

retirement.

2. Interest rate:

The level of interest rates is another factor for a sound investment

plan. Interest rates may vary between one investments to other risky and

non- risky investments. They may also differ due to different benefit

schemes offered by the investments. These aspects must be considered

before actually allocating any amount. A high rate of interest may not be

the only factor favouring the outlet for investment. The investor has to


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include in his portfolio several kinds on investments. Stability of interest

is as important as receiving a high rate of interest.

3. High rate of inflation:

In the conditions of inflation, the prices will rise and purchasing

power of rupee will decline. On account of this, capital is eroded every

year to the extent of rise in the inflation. The return on any investment

should be regarded as positive, when such return compensates the effect

of inflation. For maintaining purchasing power stability, investors should

carefully plan and invest their funds by making analysis.

a. The rate of expected return and inflation rate.

b. The possibilities of expected gain or loss on their investment.

c. The limitation imposed by personal and family considerations.

4. Increase rate of taxation:

Taxation is one of the crucial factors in a person’s savings. Tax

planning is an essential part of over all investment planning. If the

investment or disinvestment in securities in made without considering the

various provisions of the tax laws, the investor may find that most of his

profits have been eroded by the payment of taxes. Proper planning could

lead to a substantial increase in the amount of tax to be paid. On the other

hand, good tax planning and investing in tax savings schemes not only

reduces the tax payable by the investor but also helps him to save taxes

on other incomes. Various tax incentives offered by the government and

relevant provisions of the Income Tax Act, the Wealth Tax Act, are

important to an investor in planning investments.

5. Income:


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Income is also a factor in making a sound investment decision. The

general increase in employment opportunities which gave rise to income

level and avenues for investment, have lead to the ability and willingness

of working population to save and invest such savings.

6. Investment Channels:

The growth and development of the country leading to greater

economic activity has led to the introduction of a vast array of

investments. Apart from putting aside savings in savings banks where

interest is low, investors have the choice of a variety of instruments. The

question to reason out is which is the most suitable channel? Which

media will give a balanced growth and stability of return? The investor in

his choice of investment will have to try and achieve a proper mix

between high rate of return and stability of return to reap the benefits of

both. Some of the instruments available are corporate stock, provident

fund, life insurance, fixed deposits in corporate sector, Unit Trust

Schemes and so on.


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What Is Portfolio:

A portfolio is a collection of securities. Since it is rarely desirable to

invest the entire funds of an individual or an institution in a single

security, it is essential that every security be viewed in a portfolio

context.

A set or combination of securities held by investor. A portfolio

comprising of different types of securities and assets.

As the investors acquire different sets of assets of financial nature,

such as gold, silver, real estate, buildings, insurance policies, post office

certificates, NSC etc., they are making a provision for future. The risk of

each of such investments is to be understood before hand. Normally the

average householder keeps most of his income in cash or bank deposits

and assumes that they are safe and least risky. Little does he realize that

they also carry a risk with them – the fear of loss or actual loss or theft

and loss of real value of these assets through the rise price or inflation in

the economy? Cash carries no interest or income and bank deposits carry

a nominal rate of 4% on savings deposits, no interest on current account

and a maximum of 9% on term deposits of one year. The liquidity on

fixed deposits is poor as one has to wait for the period to maturity or take

loan on such amount but at a loss of income due to penal rate. Generally

risk averters invest only in banks, Post office and UTI and Mutual funds.

Gold, silver real estate and chit funds are the other avenues of investment

for average Householder, of middle and lower income groups. If the

investor desired to have a real rate of return which is substantially higher

than the inflation rate he has to invest in relatively more risky areas of

investment like shares and debenture of companies or bonds of

Government and semi-Government agencies or deposits with companies


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and firms. Investment in Chit funds, Company deposits, and in private

limited companies has a highest risk. But the basic principle is that the

higher the risk, the higher is the return and the investor should have a

clear perception of the elements of risk and return when he makes

investments. Risk Return analysis is thus essential for the investment and

portfolio management.

Why Portfolio:

You will recall that expected return from individual securities

carries some degree of risk. Risk was defined as the standard deviation

around the expected return. In effect we equated a security’s risk with the

variability of its return. More dispersion or variability about a security’s

expected return meant the security was riskier than one with less

dispersion.

The simple fact that securities carry differing degrees of expected

risk leads most investors to the notion of holding more than one security

at a time, in an attempt to spread risks by not putting all their eggs into

one basket. Diversification of one’s holdings is intended to reduce risk in

an economy in which every asset’s returns are subject to some degree of

uncertainty. Even the value of cash suffers from the inroads of inflation.

Most investors hope that if they hold several assets, even if one goes bad,

the others will provide some protection from an extreme loss.

Portfolio Management:

The portfolio management is growing rapidly serving broad array

of investors – both individual and institutional – with investment

portfolio ranging in asset size from few thousands to crores of rupees.

Despite growing importance, the subject of portfolio and investment

management is new in the country and is largely misunderstood. In most


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cases, portfolio management has been practiced as a investment

management counseling in which the investor has been advised to seek

assets that would grow in value and / or provide income.

Portfolio management is concerned with efficient management of

investment in the securities. An investment is defined as the current

commitment of funds for a period of time in order to derive a future flow

of funds that will compensate the investing unit:

- For the time the

funds are committed.

- For the expected

rate of inflation, and

- For the uncertainty

involved in the future flow of funds.

The portfolio management deals with the process of selection of

securities from the number of opportunities available with different

expected returns and carrying different levels of risk and the selection of

securities is made with a view to provide the investors the maximum

yield for a given level of risk or ensure minimize risk for a given level of

return.

Investors invest his funds in a portfolio expecting to get a good

return consistent with the risk that he has to bear. The return realized

from the portfolio has to be measured and the performance of the

portfolio has to be evaluated.

It is evident that rational investment activity involves creation of an

investment portfolio. Portfolio management comprises all the processes

involved in the creation and maintenance of an investment portfolio. It

deals specially with security analysis, portfolio analysis, portfolio

selection, portfolio revision and portfolio evaluation. Portfolio

management makes use of analytical techniques of analysis and


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conceptual theories regarding rational allocation of funds. Portfolio

management is a complex process, which tries to make investment

activity more rewarding and less risky.

Definition of Portfolio Management:

It is a process of encompassing many activities of investment in

assets and securities. The portfolio management includes the planning,

supervision, timing, rationalism and conservatism in the selection of

securities to meet investor’s objectives. It is the process of selecting a list

of securities that will provide the investor with a maximum yield constant

with the risk he wishes to assume.

Application to portfolio Management:

Portfolio Management involves time element and time horizon.

The present value of future return/cash flows by discounting is useful for

share valuation and bond valuation. The investment strategy in portfolio

construction should have a time horizon, say 3 to 5 year; to produce the

desired results of say 20-30% return per annum.

Besides portfolio management should also take into account tax

benefits and investment incentives. As the returns are taken by investors

net of tax payments, and there is always an element of inflation, returns

net of taxation and inflation are more relevant to tax paying investors.

These are called net real rates of returns, which should be more than other

returns. They should encompass risk free return plus a reasonable risk

premium, depending upon the risk taken, on the instruments/assets

invested.


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Objective of Portfolio Management:-

The objective of portfolio management is to invest in securities is

securities in such a way that one maximizes one’s returns and minimizes

risks in order to achieve one’s investment objective.

A good portfolio should have multiple objectives and achieve a sound

balance among them. Any one objective should not be given undue

importance at the cost of others. Presented below are some important

objectives of portfolio management.

1. Stable Current Return: -

Once investment safety is guaranteed, the portfolio should yield a

steady current income. The current returns should at least match the

opportunity cost of the funds of the investor. What we are referring to

here current income by way of interest of dividends, not capital gains.

2. Marketability: -

A good portfolio consists of investment, which can be marketed

without difficulty. If there are too many unlisted or inactive shares in

your portfolio, you will face problems in encasing them, and switching

from one investment to another. It is desirable to invest in companies

listed on major stock exchanges, which are actively traded.

3. Tax Planning: -

Since taxation is an important variable in total planning, a good

portfolio should enable its owner to enjoy a favorable tax shelter. The

portfolio should be developed considering not only income tax, but


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capital gains tax, and gift tax, as well. What a good portfolio aims at is

tax planning, not tax evasion or tax avoidance.

4. Appreciation in the value of capital:

A good portfolio should appreciate in value in order to protect the

investor from any erosion in purchasing power due to inflation. In other

words, a balanced portfolio must consist of certain investments, which

tend to appreciate in real value after adjusting for inflation.

5. Liquidity:

The portfolio should ensure that there are enough funds available at

short notice to take care of the investor’s liquidity requirements. It is

desirable to keep a line of credit from a bank for use in case it becomes

necessary to participate in right issues, or for any other personal needs.

6. Safety of the investment:

The first important objective of a portfolio, no matter who owns it,

is to ensure that the investment is absolutely safe. Other considerations

like income, growth, etc., only come into the picture after the safety of

your investment is ensured.

Investment safety or minimization of risks is one of the important

objectives of portfolio management. There are many types of risks, which

are associated with investment in equity stocks, including super stocks.

Bear in mind that there is no such thing as a zero risk investment. More

over, relatively low risk investment give correspondingly lower returns.

You can try and minimize the overall risk or bring it to an acceptable level

by developing a balanced and efficient portfolio. A good portfolio of

growth stocks satisfies the entire objectives outline above.


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Scope of Portfolio Management:-

Portfolio management is a continuous process. It is a dynamic

activity. The following are the basic operations of a portfolio

management.

a) Monitoring the performance of portfolio by incorporating the latest

market conditions.

b) Identification of the investor’s objective, constraints and

preferences.

c) Making an evaluation of portfolio income (comparison with targets

and achievement).

d) Making revision in the portfolio.

e) Implementation of the strategies in tune with investment

objectives.

Approaches of Portfolio Management:-

Different investors follow different approaches when they deal

with investments. Four basic approaches are illustrated below, but there

could be numerous variations.

i) The Holy-Cow Approach:

These investors typically buy but never sell. He treats his scrips

like holy cows, which are never to be sold for slaughter. If you can

consistently find and then confine yourself to buying only prized bulls,

this holy cow approaches may pay well in the long run.

ii) The Pig-Farmer Approach:


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The pig-farmer on the other hand, knows that pigs are meant for

slaughter. Similarly, an investor adopting this approach buys and sells

shares as fast as pigs are growth and slaughtered. Pigs become pork and

equity hard cash.

iii) The Rice-Miller Approach:

The rice miller buys paddy feverishly in the market during the

season, then mills, hoards and sells the rice slowly over an extended

period depending on price movements. His success lies in his shills in

buying and selling, and his financial capacity to hold stocks. Similarly, an

investor following this approach grabs the share at the right price, takes a

position, holds on to it, and liquidates slowly.

iv) The Woolen-Trader Approach:

The woolen-trader buys woolen ever a period of time but sells

them quickly during the season. Hid success also lies in his skill in

buying and selling, and his ability to hold stocks. An investor following

this strategy over a period of time but sells quickly, and quits.

SEBI Guidelines to Portfolio Management:-

SEBI has issued detailed guidelines for portfolio management

services. The guidelines have been made to protect the interest of

investors. The salient features of these guidelines are given here under;

1) The nature of portfolio management services shall be investment

consultant.

2) The portfolio manager shall not guarantee any return ti his clients.

3) Client’s funds will be kept in separate bank account.

4) The portfolio manager shall acts as trustee of client’s funds.

5) The portfolio manager can invest in money or capital market.


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6) Purchase and sale of securities will be at prevailing market price.

Different Phases of Portfolio Management:

Portfolio management is a process encompassing many activities

aimed at optimizing the investment of one’s funds. Main five phases can

be identified in this management process:

a. Security Analysis

b. Portfolio Analysis

c. Portfolio Selection

d. Portfolio Revision

e. Portfolio Evaluation

f. Portfolio Construction

(A) SECURITY ANALYSIS:-

The different types of securities are available to an investor for

investment. In stock exchange of the country the shares of 7000

companies are listed. Traditionally, the securities were classified into

ownership such as equity shares, preference share, and debt as a

debenture bonds etc. Recently companies to raise funds for their projects

are issuing a number of new securities with innovative feature.

Convertible debenture, discount bonds, Zero coupon bonds, Flexi bond,

floating rate bond, etc. are some of these new securities. From these huge

group of securities the investors has to choose those securities, which he

considers worthwhile to be included in his investment portfolio. So for

this detailed security analysis is most important.

The aim of the security analysis is to find out intrinsic value of a

security. The basic value is also called as the real value of a security is the

true economic worth of a financial asset. The real value of the security


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indicates whether the present market price is over priced or under priced

in order to make a right investment decision. The actual price of the

security is considered to be a function of a set of anticipated capitalization

rate. Price changes, as anticipation risk and return change, which in turn

change as a result of latest information.

Security analysis refers to analyzing the securities from the point of

view of the scrip prices, return and risks. The analysis will help in

understanding the behaviour of security prices in the market for

investment decision making. If it is an analysis of securities and referred

to as a macro analysis of the behaviour of the market. Security analysis

entails in arriving at investment decisions after collection and analysis of

the requisite relevant information. To find out basic value of a security

“the potential price of that security and the future stream of cash flows

are to be forecast and then discounted back to the present value.” The

basic value of the security is to be compared with the current market price

and a decision may be taken for buying or selling the security. If the basic

value is lower than the market price, then the security is in the over

bought position, hence it is to be sold. On the other hand, if the basic

value is higher than the market price the security’s worth is not fully

recognized by the market and it is in under bought position, hence it is to

be purchased to gain profit in the future.

There are mainly three alternative approaches to security analysis,

namely fundamental analysis, technical analysis and efficient market

theory.

The fundamental analysis allows for selection of securities of

different sectors of the economy that appear to offer profitable

opportunities. The security analysis will help to establish what type of

investment should be undertaken among various alternatives i.e. real

estate, bonds, debentures, equity shares, fixed deposit, gold, jewellery etc.


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Neither all industries grow at same rate nor do all companies. The growth

rates of a company depend basically on its ability to satisfy human desires

through production of goods or performance is important to analyze

nation economy. It is very important to predict the course of national

economy because economic activity substantially affects corporate

profits, investors’ attitudes, expectations and ultimately security price.

According to this approach, the share price of a company is

determined by these fundamental factors. The fundamental works out the

compares this intrinsic value of a security based on its fundamental; them

compares this intrinsic value, the share is said to be overpriced and vice

versa. The mispricing security provides an opportunity to the investor to

those securities, which are under priced and sell those securities, which

are overpriced. It is believed that the market will correct notable cases of

mispricing in future. The prices of undervalued shares will increase and

those of overvalued will decline.

Fundamental analysis helps to identify fundamentally strong

companies whose shares are worthy to be included in the investor’s

portfolio.

The second alternative of security analysis is technical analysis.

The technical analysis is the study of market action for the purpose of

forecasting future price trends. The term market action includes the three

principal sources of information available to the technician – price, value,

and interest. Technical Analysis can be frequently used to supplement the

fundamental analysis. It discards the fundamental approach to intrinsic

value. Changes in price movements represent shifts in supply and demand

position. Technical Analysis is useful in timing a buy or sells order. The

technical analysis does not claim 100% of success in predictions. It helps

to improve the knowledge of the probability of price behaviour and

provides for investment. The current market price is compared with the


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future predicted price to determine the extent of mispricing. Technical

analysis is an approach, which concentrates on price movements and

ignores the fundamentals of the shares.

A more recent approach to security analysis is the efficient

market hypothesis/theory. According to this school of thought, the

financial market is efficient in pricing securities. The efficient market

hypothesis holds that market prices instantaneously and fully reflect all

relevant available information. It means that the market prices of

securities will always equal its intrinsic value. As a result, fundamental

analysis, which tries to identify undervalued or overvalued securities, is

said to be a useless exercise.

Efficient market hypothesis is direct repudiation of both

fundamental analysis and technical analysis. An investor can’t

consistently earn abnormal return by undertaking fundamental analysis or

technical analysis. According to efficient market hypothesis it is possible

for an investor to earn normal return by randomly choosing securities of a

given risk level.

(B) PORTFOLIO ANALYSIS:-

The main aim of portfolio analysis is to give a caution direction to

the risk and return of an investor on portfolio. Individual securities have

risk return characteristics of their own. Therefore, portfolio analysis

indicates the future risk and return in holding of different individual

instruments. The portfolio analysis has been highly successful in tracing

the efficient portfolio. Portfolio analysis considers the determination of

future risk and return in holding various blends of individual securities.

An investor can sometime reduce portfolio risk by adding another

security with greater individual risk than any other security in the

portfolio. Portfolio analysis is mainly depending on Risk and Return of


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the portfolio. The expected return of a portfolio should depend on the

expected return of each of the security contained in the portfolio. The

amount invested in each security is most important. The portfolio’s

expected holding period value relative is simply a weighted average of

the expected value relative of its component securities. Using current

market value as weights, the expected return of a portfolio is simply a

weighted average of the expected return of the securities comprising that

portfolio. The weights are equal to the proportion of total funds invested

in each security.

Tradition security analyses recognize the key importance of risk

and return to the investor. However, direct recognition of risk and return

in portfolio analysis seems very much a “seat-of-the-pants” process in the

traditional approaches, which rely heavily upon intuition and insight. The

result of these rather subjective approaches to portfolio analysis has, no

doubt, been highly successfully in many instances. The problem is that

the methods employed do not readily lend themselves to analysis by

others.

Most traditional method recognizes return as some dividend receipt

and price appreciations aver a forward period. But the return for

individual securities is not always over the same common holding period

nor are he rates of return necessarily time adjusted. An analyst may well

estimate future earnings and P/E to derive future price. He will surely

estimate the dividend. But he may not discount the value to determine the

acceptability of the return in relation to the investor’s requirements.

A portfolio is a group of securities held together as investment.

Investments invest their funds in a portfolio of securities rather than in a

single security because they are risk averse. By constructing a portfolio,

investors attempt to spread risk by not putting all their eggs into one


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basket. Thus diversification of one’s holding is intended to reduce risk in

investment.

Most investor thus tends to invest in a group of securities rather

than a single security. Such a group of securities held together as an

investment is what is known as a portfolio. The process of creating such a

portfolio is called diversification. It is an attempt to spread and minimize

the risk in investment. This is sought to be achieved by holding different

types of securities across different industry groups.

(C) PORTFOLIO SELECTION: -

Portfolio analysis provides the input for the next phase in portfolio

management, which is portfolio selection. The proper goal of portfolio

construction is to generate a portfolio that provides the highest returns at

a given level of risk. A portfolio having this characteristic is known as an

efficient portfolio. The inputs from portfolio analysis can be used to

identify the set of efficient portfolios. From this set of efficient portfolios

the optimum portfolio has to be selected for investment. Harry Markowitz

portfolio theory provides both the conceptual framework and analytical

tools for determining the optimal portfolio in a disciplined and objective

way.

(D) PORTFOLIO REVISION: -

Once the portfolio is constructed, it undergoes changes due to

changes in market prices and reassessment of companies. Portfolio

revision means alteration of the composition of debt/equity instruments,

shifting from the one industry to another industry, changing from one

company to another company. Any portfolio requires monitoring and

revision. Portfolios activities will depend on daily basis keeping in view

the market opportunities. Portfolio revision uses some theoretical tools


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like security analysis that already discuss before this, Markowitz model,

Risk-Return evaluation.

Portfolio revision involves changing the existing mix of securities.

This may be effected either by changing the securities currently included

in the portfolio or by altering the proportion of fund invested in the

securities. New securities may be added to the portfolio or some of the

existing securities may be removed from the portfolio. Portfolio revision

thus, leads to purchasing and sales of securities. The objective of

portfolio revision is the same as the objective of portfolio selection, i.e

maximizing the return for a given level of risk or minimizing the risk foa

given level of return. The ultimate aim of portfolio revision is

maximization of returns and minimizing of risk.

Having constructed the optimal portfolio, the investor has to

constantly monitor the portfolio to ensure that it continues to be optimal.

As the economy and financial markets are dynamic, changes take place

almost daily. As time passes, securities, which were once attractive, may

cease to be so. New securities with promises of high returns and low risk

may emerge. The investor now has to revise his portfolio in the light of

the development in the market. This revision leads to purchase of some

new securities and sale of some of the existing securities from the

portfolio. The mixture of security and its proportion in the portfolio

changes as a result of the revision.

Portfolio revision may also be necessitated some investor related

changes such as availability of additional funds, changes in risk attitude

need of cash for other alternative use etc.

Whatever be the reason for portfolio revision, it has to be done

scientifically and objectively so as to ensure the optimality of the revised

portfolio. Portfolio revision is not a casual process to be carried out

without much care. In fact, in the entire process of portfolio management


24


portfolio revision is as important as portfolio analysis and selection. In

portfolio management, the maximum emphasis is placed on portfolio

analysis and selection which leads to the construction of the optimal

portfolio. Very little discussion is seen on portfolio revision which is as

important as portfolio analysis and selection.

Portfolio revision involving purchase and sale of securities gives

rise to certain problem which acts as constraints in portfolio revision,

from those constraints some may be as following:

1. Statutory Stipulations:

Investment companies and mutual funds manage the largest

portfolios in every country. These institutional investors are

normally governed by certain statutory stipulations regarding their

investment activity. These stipulations often act as constraints in

timely portfolio revision.

2. Transaction cost:

Buying and selling of securities involve transaction costs such as

commission and brokerage. Frequent buying and selling of

securities for portfolio revision may push up transaction cost

thereby reducing the gains from portfolio revision. Hence, the

transaction costs involved in portfolio revision may act as a

constraint to timely revision of portfolio.

3. Intrinsic difficulty:

Portfolio revision is a difficult and time-consuming exercise. The

methodology to be followed for portfolio revision is also not

clearly established. Different approaches may be adopted for the

purpose. The difficulty of carrying out portfolio revision it self may

act as a restriction to portfolio revision.


25


4. Taxes:

Tax is payable on the capital gains arising from sale of securities.

Usually, long term capital gains are taxed at a lower than short-

term capital gains. To qualify as long-term capital gain, a security

must be held by an investor for a period not less than 12 months

before sale. Frequent sales of securities in the course of periodic

portfolio revision of adjustment will result in short-term capital

gains which would be taxed at a higher rate compared to long-term

capital gains. The higher tax on short-term capital gains may act as

a constraint to frequent portfolios.

(F) PORTFOLIO PERFORMANCE EVALUATION:-

Portfolio evaluating refers to the evaluation of the performance of

the portfolio. It is essentially the process of comparing the return earned

on a portfolio with the return earned on one or more other portfolio or on

a benchmark portfolio. Portfolio evaluation essentially comprises of two

functions, performance measurement and performance evaluation.

Performance measurement is an accounting function which measures the

return earned on a portfolio during the holding period or investment

period. Performance evaluation , on the other hand, address such issues as

whether the performance was superior or inferior, whether the

performance was due to skill or luck etc.

The ability of the investor depends upon the absorption of latest

developments which occurred in the market. The ability of expectations if

any, we must able to cope up with the wind immediately. Investment

analysts continuously monitor and evaluate the result of the portfolio

performance. The expert portfolio constructer shall show superior

performance over the market and other factors. The performance also


26


depends upon the timing of investments and superior investment analysts

capabilities for selection. The evolution of portfolio always followed by

revision and reconstruction. The investor will have to assess the extent to

which the objectives are achieved. For evaluation of portfolio, the

investor shall keep in mind the secured average returns, average or below

average as compared to the market situation. Selection of proper

securities is the first requirement. The evaluation of a portfolio

performance can be made based on the following methods:

a) Sharpe’s Measure

b) Treynor’s Measure

c) Jensen’s Measure

(a) Sharpe’ Measure:

The objective of modern portfolio theory is maximization of

return or minimization of risk. In this context the research studies have

tried to evolve a composite index to measure risk based return. The credit

for evaluating the systematic, unsystematic and residual risk goes to

sharpe, Treynor and Jensen. Sharpe measure total risk by calculating

standard deviation. The method adopted by Sharpe is to rank all

portfolios on the basis of evaluation measure. Reward is in the numerator

as risk premium. Total risk is in the denominator as standard deviation of

its return. We will get a measure of portfolio’s total risk and variability of

return in relation to the risk premium. The measure of a portfolio can be

done by the following formula:

Rt – Rf SI =

σf

Where, SI = Sharpe’s Index


27


Rt = Average return on portfolioRf = Risk free return σf = Standard deviation of the portfolio return.

For instance:

Which portfolio perform better performance from following two

portfolio, by using Sharpe’s model

Portfolio Average return Standard deviation Risk free rate

A 50% 10% 24%

B 60% 18% 24%

Performance can be finding out by the following formula:

For Portfolio A: Rt – Rf SI =

σf Rt = 50Rf = 24σf = 0.10

0.50 – 0.24 SI = = 0.26 / 0.10

0.10 = 2.6 Portfolio A

For Portfolio B: Rt – Rf SI =

σf

0.60 – 0.24 SI = = 0.36 / 0.18 0.18

= 2, Portfolio B

Conclusion: According to the calculated “portfolio A” has better

performance than portfolio B

(b) Treynor’s Measure:


28


The Treynor’s measure related a portfolio’s excess return to non-

diversifiable or systematic risk. The Treynor’s measure employs beta.

The Treynor based his formula on the concept of characteristic line. It is

the risk measure of standard deviation, namely the total risk of the

portfolio is replaced by beta. The equation can be presented as follow:

Rn - RfTn =

βm Where, Tn = Treynor’s measure of performance

Rn = Return on the portfolio

Rf = Risk free rate of return

βm = Beta of the portfolio ( A measure of systematic risk)

For instance: Which securities perform better performance from following two portfolios, by

using Treynor’s method

Portfolio Return βm Risk free rate

X 44% 0.12% 22%

Z 52% 2.40% 22%

For portfolio X: Rn - RfTn =

βm

Rn = 0.44 Rf = 0.22 βm = 0.12

0.44 – 0.22 0.22Tn = = = 0.092

2.40 2.40

For portfolio Y: 0.52 - 0.22 0.30Tn = = = 0.125

2.4 2.40

Conclusion: Portfolio Y is better than X because Tnx < Tny

(c) Jensen’s Measure:


29


Jensen attempts to construct a measure of absolute performance on

a risk adjusted basis. This measure is based on CAPM model. It measures

the portfolio manager’s predictive ability to achieve higher return than

expected for the accepted riskiness. The ability to earn returns through

successful prediction of security prices on a standard measurement. The

Jensen measure of the performance of portfolio can be calculated by

applying the following formula:

Rp = Rf + (RMI – Rf) x β

Where, Rp = Return on portfolio

RMI = Return on market index

Rf = Risk free rate of return

For instance: From the following data, the portfolio performance can be

measure according to Jensens model as follow:

Portfolio Estimated Return on portfolio Portfolio Beta

I 40% 1.5

II 34% 1.1

III 46% 1.8

Market Index: 36% 1.03

Risk free rate of return: 20%

Market Beta =1.00

For portfolio –I:

RMI = 40%, Rf = 20%, β = 3

Rp = 20 + (40 – 20) x 1.5

= 50%

For portfolio – II:

RMI = 34%, Rf = 20%, β = 1.1

Rp = 20 + (34 – 20) x 1.1 = 35.4%

For portfolio – III:


30


RMI = 46%, Rf = 20%, β = 1.8

Rp = 20 + (46 – 20) x 1.8

=66.8%

The measure of performance = Actual – estimated

I = 50% - 40% = 10%

II = 35.4% - 34% = 1.4%

III = 66.8% - 46% = 20.8%

Here, the portfolio III is better perform then other two

(G) PORTFOLIO CONSTRUCTION:-

Portfolio construction refers to the allocation of funds among a

variety of financial assets open for investment. Portfolio theory concerns

itself with the principles governing such allocation. The objective of the

theory is to elaborate the principles in which the risk can be minimized

subject to desired level of return on the portfolio or maximize the return,

subject to the constraint of a tolerate level of risk.

Thus, the basic objective of portfolio management is to maximize

yield and minimize risk. The other ancillary objectives are as per the

needs of investors, namely:6

Safety of the investment

Stable current Returns

Appreciation in the value of capital

Marketability and Liquidity

Minimizing of tax liability.

In pursuit of these objectives, the portfolio manager has to set out

all the various alternative investment along with their projected return and

risk and choose investment with safety the requirement of the individual

investor and cater to his preferences. The manager has to keep a list of

such investment avenues along with return-risk profile, tax implications,


31


yield and other return such as convertible options, bonus, rights etc. A

ready reckoned giving out the analysis of the risk involved in each

investment and the corresponding return should be kept.

The portfolio construction, as referred to earlier, be made on the

basis of the investment strategy, set out for each investor. Through choice

of asset classis, instrument of investment and the specific scripts, save of

bond or equity of different risk and return characteristics, the choice of

tax characteristics, risk level and other feature of investment, are decided

upon.

Portfolio Investment Process:-

The ultimate aim of the portfolio manager is to reduce the risk and

increase the return to the investor in order to reach the investment

objectives of an investor. The manager must be aware of the investment

process. The process of portfolio management involves many logical

steps like portfolio planning, portfolio implementation and monitoring.

The portfolio investment process applies to different situation. Portfolio is

owned by different individuals and organizations with different

requirements. Investors should buy when prices are very low and sell

when prices rise to levels higher that their normal fluctuation.

The process used to manage a security portfolio is conceptually the

same as that used in any managerial decision. One should (1) Panning, (2)

Implement the plan; and (3) Monitor the result. This portfolio investment

process is displayed schematically as follow:


32


The Portfolio Investment Process

Applying the different steps for portfolio investment process can be

complex and opinions are divided for maximization of wealth to the

investor. Many differences exist between present investment theory and

empirical result and which have often contradictory result the following

some basic principles should be applied to all portfolio decisions.

1. The quantum of risk to be acceptable.

2. The profits will vary along with variability of risk.

3. Individual securities affect the aggregate portfolio.

4. Portfolio should provide a sound liquidity position.

5. Diversification of a portfolio may decrease the risk level.

6. Portfolio should be tailored to the needs of investors.

7. Follow the passive investment strategy or an activity

speculative strategy.


33

Planning:Investor’s situation Market ConditionSpeculative policiesStrategic asset allocation

Monitoring:Evaluate Statement of Investment PolicyEvaluate Investment Performance

Implementation:Rebalance Strategic Asset AllocationTactical Asset AllocationSecurity Selection


Portfolio investment process is an important step to meet the needs

and convenience of investors. The portfolio investment process involves

the following steps:

1. Planning of portfolio

2. Implementation of portfolio plan.

3. Monitoring the performance of portfolio.

1) PLANNING OF PORTFOLIO:

Planning is the most important element in a proper portfolio

management. The success of the portfolio management will depend upon

the careful planning. While making the plan, due consideration will be

given to the investor’s financial capability and current capital market

situation. After taking into consideration a set of investment and

speculative policies will be prepared in the written form. It is called as

statement of investment policy. The document must contain (1) The

portfolio objective (2) Applicable strategies (3) Investment and

speculative constraints. The planning document must clearly define the

asset allocation. It means an optimal combination of various assets in an

efficient market. The portfolio manager must keep in mind about the

difference between basic pure investment portfolio and actual portfolio

returns. The statement of investment policy may contain these elements.

The portfolio planning comprises the following situation for its better

performance:

(A) Investor Conditions: -

The first question which must be answered is this – “What is the

purpose of the security portfolio?” While this question might seem


34


obvious, it is too often overlooked, giving way instead to the excitement

of selecting the securities which are to be held. Understanding the

purpose for trading in financial securities will help to: (1) define the

expected portfolio liquidation, (2) aid in determining an acceptable level

or risk, and (3) indicate whether future consumption (liability needs) are

to be paid in nominal or real money, etc. For example: a 60 year old

woman with small to moderate saving probably (1) has a short investment

horizon, (2) can accept little investment risk, and (3) needs protection

against short term inflation. In contrast, a young couple investing couple

investing for retirement in 30 years has (1) a very long investment

horizon, (2) an ability to accept moderate to large investment risk because

they can diversify over time, and (3) a need for protection against long-

term inflation. This suggests that the 60 year old woman should invest

solely in low-default risk money market securities. The young couple

could invest in many other asset classes for diversification and accept

greater investment risks. In short, knowing the eventual purpose of the

portfolio investment makes it possible to begin sketching out appropriate

investment / speculative policies.

(B) Market Condition: -

The portfolio owner must known the latest developments in the

market. He may be in a position to assess the potential of future return on

various capital market instruments. The investors’ expectation may be

two types, long term expectations and short term expectations. The most

important investment decision in portfolio construction is asset allocation.

Asset allocation means the investment in different financial instruments

at a percentage in portfolio. Some investment strategies are static. The

portfolio requires changes according to investor’s needs and knowledge.

A continues changes in portfolio leads to higher operating cost. Generally


35


the potential volatility of equity and debt market is 2 to 3 years. The

another type of rebalancing strategy focuses on the level of prices of a

given financial asset.

(C) Speculative Policies:

The portfolio owner may accept the speculative strategies in order

to reach his goals of earning to maximum extant. If no speculative

strategies are used the management of the portfolio is relatively easy.

Speculative strategies may be categorized as asset allocation timing

decision or security selection decision. Small investors can do by

purchasing mutual funds which are indexed to a stock. Organization with

large capital can employ investment management firms to make their

speculative trading decisions.

(D) Strategic Asset Allocation:-

The most important investment decision which the owner of a

portfolio must make is the portfolio’s asset allocation. Asset allocation

refers to the percentage invested in various security classes. Security

classes are simply the type of securities: (1) Money Market Investment,

(2) Fixed Income obligations; (3) Equity Shares, (4) Real Estate

Investment, (5) International securities.

Strategic asset allocation represents the asset allocation which

would be optimal for the investor if all security prices trade at their long-

term equilibrium values that is, if the markets are efficiency priced.

2) IMPLEMENTATION:-

In the implementation stage, three decisions to be made, if the

percentage holdings of various assets classes are currently different from

the desired holdings as in the SIP, the portfolio should be rebalances to


36


the desired SAA (Strategic Asset Allocation). If the statement of

investment policy requires a pure investment strategy, this is the only

thing, which is done in the implementation stage. However, many

portfolio owners engage in speculative transaction in the belief that such

transactions will generate excess risk-adjusted returns. Such speculative

transactions are usually classified as “timing” or “selection” decisions.

Timing decisions over or under weight various assets classes, industries,

or economic sectors from the strategic asset allocation. Such timing

decision deal with securities within a given asset class, industry group, or

economic sector and attempt to determine which securities should be

over or under-weighted.

(A) Tactical Asset Allocation:-

If one believes that the price levels of certain asset classes,

industry, or economic sectors are temporarily too high or too low, actual

portfolio holdings should depart from the asset mix called for in the

strategic asset allocation. Such timing decision is preferred to as tactical

asset allocation. As noted, TAA decisions could be made across

aggregate asset classes, industry classifications (steel, food), or various

broad economic sectors (basic manufacturing, interest-sensitive,

consumer durables).

Traditionally, most tactical assets allocation has involved timing

across aggregate asset classes. For example, if equity prices are believes

to be too high, one would reduce the portfolio’s equity allocation and

increase allocation to, say, risk-free securities. If one is indeed successful

at tactical asset allocation, the abnormal returns, which would be earned,

are certainly entering.

(B) Security Selection:-


37


The second type of active speculation involves the selection of

securities within a given assets class, industry, or economic sector. The

strategic asset allocation policy would call for broad diversification

through an indexed holding of virtually all securities in the asset in the

class. For example, if the total market value of HPS Corporation share

currently represents 1% of all issued equity capital, than 1% of the

investor’s portfolio allocated to equity would be held in HPS corporation

shares. The only reason to overweight or underweight particular securities

in the strategic asset allocation would be to off set risks the investors’

faces in other assets and liabilities outside the marketable security

portfolio. Security selection, however, actively overweight and

underweight holding of particular securities in the belief that they are

temporarily mispriced.

(3) PORTFOLIO MONITORING: -

Portfolio monitoring is a continuous and on going assessment of

present portfolio and the portfolio manger shall incorporate the latest

development which occurred in capital market. The portfolio manager

should take into consideration of investor’s preferences, capital market

condition and expectations. Monitoring the portfolio is up-grading

activity in asset composition to take the advantage of economic, industry

and market conditions. The market conditions are depending upon the

Government policy. Any change in Government policy would reflect the

stock market, which in turn affects the portfolio. The continues revision

of a portfolio depends upon the following factors:

i. Change in Government policy.

ii. Shifting from one industry to other


38


iii. Shifting from one company scrip to another company scrip.

iv. Shifting from one financial instrument to another.

v. The half yearly / yearly results of the corporate sector

Risk reduction is an important factor in portfolio. It will be

achieved by a diversification of the portfolio, changes in market prices

may have necessitated in asset composition. The composition has to be

changed to maximize the returns to reach the goals of investor.


39


RISK & RETURN IN PORTFOLIO

Return:-

` The typical objective of investment is to make current income from

the investment in the form of dividends and interest income. Suitable

securities are those whose prices are relatively stable but still pay

reasonable dividends or interest, such as blue chip companies. The

investment should earn reasonable and expected return on the


40


investments. Before the selection of investment the investor should keep

in mind that certain investment like, Bank deposits, Public deposits,

Debenture, Bonds, etc. will carry fixed rate of return payable periodically.

On investments made in shares of companies, the periodical payments are

not assured but it may ensure higher returns from fixed income securities.

But these instruments carry higher risk than fixed income instruments.

Risk:-

The Webster’s New Collegiate Dictionary definition of risk

includes the following meanings: “……. Possibility of loss or injury …..

the degree or probability of such loss”. This conforms to the connotations

put on the term by most investors. Professional often speaks of

“downside risk” and “upside potential”. The idea is straightforward

enough: Risk has to do with bad outcomes, potential with good ones.

In considering economic and political factors, investors commonly

identify five kinds of hazards to which their investments are exposed. The

following tables show components of risk:

(A) SYSTEMATIC RISK:

1. Market Risk

2. Interest Rate Risk

3. Purchasing power Risk

(B) UNSYSTEMATIC RISK:

1. Business Risk

2. Financial Risk

(A) SYSTEMATIC RISK:


41


Systematic risk refers to the portion of total variability in return

caused by factors affecting the prices of all securities. Economic, Political

and Sociological charges are sources of systematic risk. Their effect is to

cause prices of nearly all individual common stocks or security to move

together in the same manner. For example; if the Economy is moving

toward a recession & corporate profits shift downward, stock prices may

decline across a broad front. Nearly all stocks listed on the BSE / NSE

move in the same direction as the BSE / NSE index.

Systematic risk is also called non-diversified risk. If is

unavoidable. In short, the variability in a securities total return in directly

associated with the overall movements in the general market or Economy

is called systematic risk. Systematic risk covers market risk, Interest rate

risk & Purchasing power risk

1. Market Risk:

Market risk is referred to as stock / security variability due to

changes in investor’s reaction towards tangible & intangible events is the

chief cause affecting market risk. The first set that is the tangible events,

has a ‘real basis but the intangible events are based on psychological

basis.

Here, Real Events, comprising of political, social or Economic

reason. Intangible Events are related to psychology of investors or say

emotional intangibility of investors. The initial decline or rise in market

price will create an emotional instability of investors and cause a fear of

loss or create an undue confidence, relating possibility of profit. The

reaction to loss will reduce selling & purchasing prices down & the

reaction to gain will bring in the activity of active buying of securities.

2. Interest Rate Risk:


42


The price of all securities rise or fall depending on the change in

interest rate, Interest rate risk is the difference between the Expected

interest rates & the current market interest rate. The markets will have

different interest rate fluctuations, according to market situation, supply

and demand position of cash or credit. The degree of interest rate risk is

related to the length of time to maturity of the security. If the maturity

period is long, the market value of the security may fluctuate widely.

Further, the market activity & investor perceptions change with the

change in the interest rates & interest rates also depend upon the nature of

instruments such as bonds, debentures, loans and maturity period, credit

worthiness of the security issues.

3. Purchasing Power Risk:

Purchasing power risk is also known as inflation risk. This risks

arises out of change in the prices of goods & services & technically it

covers both inflation & deflation period. Purchasing power risk is more

relevant in case of fixed income securities; shares are regarded as hedge

against inflation. There is always a chance that the purchasing power of

invested money will decline or the real return will decline due to

inflation.

The behaviour of purchasing power risk can in some way be

compared to interest rate risk. They have a systematic influence on the

prices of both stocks & bonds. If the consumer price index in a country

shows a constant increase of 4% & suddenly jump to 5% in the next.

Year, the required rate of return will have to be adjusted with upward

revision. Such a change in process will affect government securities,

corporate bonds & common stocks.

(B) UNSYSTEMATIC RISK:-


43


The risk arises out of the uncertainty surrounding a particular firm

or industry due to factors like labour Strike, Consumer preference &

management policies are called Unsystematic risk. These uncertainties

directly affect the financing & operating environment of the firm.

Unsystematic risk is also called “Diversifiable risk”. It is avoidable.

Unsystematic risk can be minimized or Eliminated through diversification

of security holding. Unsystematic risk covers Business risk and Financial

risk

1. Business Risk:

Business risk arises due to the uncertainty of return which depend

upon the nature of business. It relates to the variability of the business,

sales, income, expenses & profits. It depends upon the market conditions

for the product mix, input supplies, strength of the competitor etc. The

business risk may be classified into two kind viz. internal risk and

External risk.

Internal risk is related to the operating efficiency of the firm. This

is manageable by the firm. Interest Business risk loads to fall in revenue

& profit of the companies.

External risk refers to the policies of government or strategic of

competitors or unforeseen situation in market. This risk may not be

controlled & corrected by the firm.

2. Financial Risk:

Financial risk is associated with the way in which a company

finances its activities. Generally, financial risk is related to capital

structure of a firm. The presence of borrowed money or debt in capital

structure creates fixed payments in the form of interest that must be

sustained by the firm. The presence of these interest commitments – fixed


44


interest payments due to debt or fixed dividend payments on preference

share – causes the amount of retained earning availability for equity share

dividends to be more variable than if no interest payments were required.

Financial risk is avoidable risk to the extent that management has the

freedom to decline to borrow or not to borrow funds. A firm with no debt

financing has no financial risk. One positive point for using debt

instruments is that it provides a low cost source of funds to a company at

the same time providing financial leverage for the equity shareholders &

as long as the earning of company are higher than cost of borrowed funds,

the earning per share of equity share are increased.

Risk - Return Relationship:-

The entire scenario of security analysis is built on two concepts of

security: Return and risk. The risk and return constitute the framework for

taking investment decision. Return from equity comprises dividend and

capital appreciation. To earn return on investment, that is, to earn

dividend and to get capital appreciation, investment has to be made for

some period which in turn implies passage of time. Dealing with the

return to be achieved requires estimated of the return on investment over

the time period. Risk denotes deviation of actual return from the

estimated return. This deviation of actual return from expected return

may be on either side – both above and below the expected return.

However, investors are more concerned with the downside risk.

The risk in holding security deviation of return deviation of

dividend and capital appreciation from the expected return may arise due

to internal and external forces. That part of the risk which is internal that

in unique and related to the firm and industry is called ‘unsystematic


45


risk’. That part of the risk which is external and which affects all

securities and is broad in its effect is called ‘systematic risk’.

The fact that investors do not hold a single security which they

consider most profitable is enough to say that they are not only interested

in the maximization of return, but also minimization of risks. The

unsystematic risk is eliminated through holding more diversified

securities. Systematic risk is also known as non-diversifiable risk as this

can not be eliminated through more securities and is also called ‘market

risk’. Therefore, diversification leads to risk reduction but only to the

minimum level of market risk.

The investors increase their required return as perceived

uncertainty increases. The rate of return differs substantially among

alternative investments, and because the required return on specific

investments change over time, the factors that influence the required rate

of return must be considered.

Following chart-A represent the relationship between risk and

return. The slop of the market line indicates the return per unit of risk

required by all investors highly risk-averse investors would have a steeper

line, and Yields on apparently similar may differ. Difference in price, and

therefore yield, reflect the market’s assessment of the issuing company’s

standing and of the risk elements in the particular stocks. A high yield in

relation to the market in general shows an above average risk element.

This is shown in the Char-B

Chart-A: RELATIONSHIP BETWEEN RISK AND RETURN

Rate of Return Low Average High


46


Risk Risk Risk Market Line

Slop indicates required return per unit of risk

Risk free return

Risk

Chart-B: RISK RETURN RELATIONSHIP: DIFFERENT STOCKS

Rate of Market Line Return Risk Premium Ordinary shares Preference shares

Subordinate loan stockUnsecured loan

Debenture with floating charge Mortgage loan

Government (i.e. risk free) stock

Degree of risk

Source: Financial Management, By Ravi M. Kishore, Page No: 1145-46

Given the composite market line prevailing at a point of time,

investors would select investments that are consistent with their risk

preference. Some will consider low risk investments, while others prefer

high risk investments.

The construction of a best portfolio will depend upon a careful

security analysis. The portfolio management always thinks about the

return and rewards of different financial assets which are fully involved

with systematic and unsystematic risk. The portfolio management is

mainly concentrated on the stock behaviour in the market. Selection of a

particular scrip or financial asset is the responsibility of a security analyst.


47


But the portfolio manager’s obligation is to know best returns to the

portfolio owner with a combination of different kinds of financial assets.

Portfolio analysis indicates the determination of future risk and return in

holding a different set of individual securities. The portfolio analysis

contains the important elements as presented below;

1. Return on portfolio

2. Risk of a portfolio

Return on Portfolio:-

The portfolio value is highly influenced by return of individual

securities. Each security in a portfolio contributes return in the proportion

of its investment is security. Thus, the portfolio value may increase and

the targeted goals can be achieved. The return on portfolio is the

weighted average of the expected returns, from each security with a

proportionate weight of the different securities in the total investment.

The return on portfolio depends upon the selection of financial asset

which was made according to the investor’s perception. The efficiency of

a portfolio is highly influenced by a number of factors, i.e. investor’s

objective, investor’s risk presumption, safety of investment, capital

appreciation, liquidity of financial asset, hedging, time horizon set out by

investor, constraints regarding diversification by the investor etc.

The data of the following table reveals the calculation of 4 portfolio’s return and risk

Security

Proportion of funds

invested in each

security (Weights)

Expected

return on

each security

Contribution of

each security to

return

A 35% 13% 4.55

B 30% 185 5.40

C 20% 23% 4.60

D 15% 15% 2.25


48


100% 16.8%

The above portfolio yield 16.8% return on an average of 4 kinds of

securities.

The portfolio risk can be calculated by using the measure such as

standard deviation and variance. These can be calculated by applying the

following formula;

Standard deviation = √ ∑(x-x1)

Variance = ∑(x-x1) 2 = ∑x2

x = is the expected return on security ‘A’

x1= is the mean or the weighted average return on the security ‘A’

so, the co-efficient of variance = σ x 100 x1

The following table will explain the calculation of standard deviation for a

given portfolio.

Security Return Probability

1 7% 0.30

2 11% 0.55

3 15% 0.15

Solution:

(1)Return

(2)Probability

(3)

Weighted Return(2 x 3)

Return deviation

from mean

Weighted deviations squared

1 7% 0.30 0.021 - 0.033 0.001

2 11% 0.55 0.060 0.007 0.001

3 15% 0.15 0.022 0.047 0.002


49


- - 1.00 0.103 - 0.004

Average expected return 0.103 or 10.3 (mean)

The return deviation can be obtained as follows:

For security 1 = (0.07 – 0.103) = -0.033

For security 2 = (0.11 – 0.103) = 0.007

For security 3 = (0.15 – 0.103) = 0.047

σ2 = 0.004

σ = √ σ2 =√ 0.004

σ = 0.063 0r 6.3%

The co-efficient of variance = σ x 100 x1 = 6.3 / 10.3

= 61%

Risk on Portfolio:-

Risk is the most important element in portfolio management. Risk

is reflected in the variability of the returns from Zero to infinity. The risk

on a portfolio is different from the risk on individual securities. The

expected return of a portfolio depends on the probability of the returns

and their weighted contribution to the risk. This is the essence of risk.

Risk means, the probability of various possible bad outcomes from a

constructed portfolio. The measurement of risk in portfolio involves

(a) Finding of average absolute deviation.

(b) Standard deviation.

These elements can be explained with following illustrations:

The probability of each of the return of a portfolio is given below. Calculate the absolute

deviations for the given portfolio.

Event Return Probability


50


1 0.20 -10

2 0.25 22

3 0.30 27

4 0.25 12

Estimation of absolute deviation:-

Event

(1)

Return

(2)

Probability

(3)

Absolute

return

(2x3)=(4)

Probability

deviation

(5)

(X)Absolute

deviation

(5x2)=(6)

1 0.20 -10 -2.0 -24.6 4.92

2 0.25 22 +5.5 7.4 1.85

3 0.30 27 +8.1 12.4 3.72

4 40.25 12 +3.0 -2.6 0.65

Total +14.6 11.14%

Probability deviation can be calculated as follows ;

-10 - 14.6 = -24.6

22 - 14.6 = +7.4

27 - 14.6 = +12.4

12 - 14.6 = -2.6

The measure of absolute deviation is 11.14 %


51


Different Type of Investment in India and

Risk – Return Associated With It:-

1) Life Insurance Policy:-

In India the life insurance corporation offers different types of

policies tailor made to suit the varied age group in society. The Whole

Life Policies, Limited – Payment Life Policy, Convertible Whole Life

Assurance Policy, Endowment Assurance Policy, Jeevan Mitra, The

Special Endowment Plan with Profits, Jeevan Saathi, The New Money

Back Plan, Marriage Endowment, Children’s Differed Endowment

Assurance Policy, Jeevan Dhara have gained immense popularity among

all classes of people. In LIC there is some scheme have eligible for

exemption from tax under section 80C of the Income Tax Act, 1961. Risk

associated with Insurance Corporation is as follow:


52


High

RIS ModerateK

Low

Low Moderate High

RETURN

2) Bank Deposits:-

Commercial Bank has been extending deposits facilities to the

public and has been the Indian investor’s greatest investment opportunity.

The various schemes offered by commercial Banks are in the categories

of saving accounts. Fixed Deposits, recurring deposits, monthly re-

payment plan, cash certificates, children’s deposits schemes and

retirement plans. The saving account offers an interest rate of 4% per

annum. One fixed deposits the banks give a rate of 6.5% per annum.

High


53


RIS ModerateK

Low

Low Moderate High

RETURN

3) Provident Funds:-

Many employers offer recognized provident Fund schemes for the

benefit of their employees. In general employees are obliged to contribute

a minimum of 8.33% of their salary every month to the PPF, however,

they may in certain cases contribute up to a maximum of 30% of their

salary, Whatever, may be the employee’s contribution, the employer’s

contribution is generally restricted to 8.33% only. Employees own

contribution can be claimed as a deduction form his total income under

section 80C of income Tax Act. The interest on Provident Funds is now

10 % per annum. The prime benefit of the provident fund is the facility of

loan up to 755 of the sum contributed.

High


54


RIS ModerateK

Low

Low Moderate High

RETURN

The SBI and its subsidiaries operate the public provident funds

schemes. It is a 15 year scheme. A minimum sum of Rs. 100/- has to be

deposited every year in this fund; the maximum amount which can be

deposited in this fund, is Rs.20,000/- in one year. The rate of interest on

the PPF is 12% per annum. The PPF scheme offers both income Tax and

Wealth Tax benefits. The deposits made every year qualify for deduction

under section 80C and the interest is completely tax free, in addition,

loans can also be taken after one year from the close of the year in which

the account was opened.

4) Equity Shares: -

The investment in equity share has a number of positive aspect

associated with it. These are Capital Appreciation as a hedge against

inflation, bonus shares, Right shares, voting rights, marketability, annual

dividends and fringe benefits etc. Income tax and wealth tax benefits are

also available to investment in equity share, 50% of the contribution

made by investors in shares of new companies qualifies for deduction

under section 80CC. No deduction is available in under section 80CCA

with effect from 1993-94 except rebate of Section 88.


55


High

RIS ModerateK

Low

Low Moderate High

RETURN

5) Government Bonds:-

The government bond, there is two categories of these bonds,

namely, tax-free and taxable. The tax-free bonds are 9 to 10% bonds

issued for Rs.1000; interest compounded half-yearly and payable half-

yearly. They have a maturity period of 7 to 10 years with the facility for

buy-back sometimes provided to small investors up to certain limits. The

taxable bonds yield 13% or above, compounded half-yearly and payable

half-yearly. They have normally a face value of Rs.1000/- and have buy-

back facilities similar to taxable bonds. Income from these bonds is tax

exempt up to Rs.12, 000/- under section 80L.

High


56


RIS ModerateK

Low

Low Moderate High

RETURN

6) Fixed Deposits with Companies:-

Fixed Deposits are invited from the public by different private

sector companies. Their major selling point is the high rates of interest,

which they offer. Some of these companies offer even up to 16% return

per annum on deposits; the risk element is high in fixed deposits since

they are absolutely unsecured. In addition, there are no tax benefits, An

example, may be cited of a well known company. Orkay Silk Mills, The

Company delayed the payment of quarterly interest by two months and

the matured amount has not been returned to the depositors.

High


57


RIS ModerateK

Low

Low Moderate High

RETURN

7) Debentures:-

A debenture is just a loan bond. Debenture holders are lenders but

not owners of the company. They don’t enjoy any voting rights. Usually

Debentures are of the face value of Rs.100/- each. They carry a fixed rate

of interest. The ruling rate in the market for debentures is 10% to 14%.

There are no income tax or wealth tax benefits for an investment in

Debenture.

High

RIS ModerateK


58

Low Moderate High


Low

RETURN


59


DIVERSIFICATION

Risk Reduce through Diversification:-

The process of combining securities in a portfolio is known as

diversification. The aim of diversification is to reduce total risk without

sacrificing portfolio return. To understand the mechanism and power of

diversification, it is necessary to consider the impact of covariance or

correlation on portfolio risk more closely. We shall examine three cases:

(1) when security returns are perfectly positively correlated, (2) when

security returns are perfectly negatively correlated and (3) when security

returns are not correlated.

Diversification means, investment of funds in more than one risky

asset with the basic objective of risk reduction. The lay man can make

good returns on his investment by making use of technique of

diversification.


60


Main three forms of diversification:-

1. Simple Diversification,

2. Over Diversification,

3. Efficient Diversification.

(1) Simple Diversification:

It involves a random selection of portfolio construction. The

common man could make better returns by making a random

diversification of investments. It is the process of altering the mix ratio of

different components of a portfolio. The simple diversification can reduce

unsystematic risk. The research studies on portfolio found that 10 to 15

securities in a portfolio will bring sufficient amount of returns. Further,

this concept reveals that the prediction should be based on a scientific

method.

(2) Over Diversification: -

Investors have the freedom to choose many investment alternatives

to achieve the desired profit on his portfolio. However, the investor shall

have a great knowledge regarding a large number of financial assets

spreading different sectors, industries, companies. The investors also

more careful about the liquidity of each investment, return, tax liability,

the performance of the company etc. Investors find problems to handle

the large number of investments. It involves more transaction cost and

more money will be spent in managing over diversification. If any

investor involves in over diversification, there may be a chance either to

get higher return or exposure to more risk. All the problems involved in

this process may result in inadequate return on the portfolio.


61


(3) Efficient Diversification:-

Efficient diversification means a combination of low risk involved

securities and high risk instruments. The combination will only be

finalized after considering the expected return from an individual security

and it does inter relationship with other components in a portfolio. The

securities shall have to be evaluated and thus diversification to be

restricted to some extent. Efficient diversification assures the better return

at an accepted level of risk.

Importance of Diversification:-

If you invest in a single security, your return will depend solely on

that security; if that security flops, your entire return will be severely

affected. Clearly, held by itself, the single security is highly risky.

If you add nine other unrelated securities to that single security

portfolio, the possible outcome changes—if that security flops, your

entire return won't be as badly hurt. By diversifying your investments,

you have substantially reduced the risk of the single security. However,

that security's return will be the same whether held in isolation or in a

portfolio.

Diversification substantially reduces your risk with little impact on

potential returns. The key involves investing in categories or securities

that are dissimilar: Their returns are affected by different factors and they

face different kinds of risks.

Diversification should occur at all levels of investing.

Diversification among the major asset categories—stocks, fixed-income


62


and money market investments—can help reduce market risk, inflation

risk and liquidity risk, since these categories are affected by different

market and economic factors.

Diversification within the major asset categories—for instance,

among the various kinds of stocks (international or domestic, for

instance) or fixed-income products—can help further reduce market and

inflation risk.

And as shown in the 10-security portfolio, diversification among

individual securities helps reduce business risk.

Diversification process:-

The process of diversification has various phases involving

investment into various classes of assets like equity, preference shares,

money market instruments like commercial paper, inter-corporate

investments, deposits etc. Within each class of assets, there is further

possibility of diversification into various industries, different companies

etc. The proportion of funds invested into various classes of assets,

instruments, industries and companies would depend upon the objectives

of investor, under portfolio management and his asset preferences,

income and asset requirements. The subject is further elaborated in

another chapter.

A portfolio with the objective of regular income would invest a

proportion of funds in bonds, debentures and fixed deposits. For such

investment, duration of the life of the bond/debenture, quality of the asset

as judged by the credit rating and the expected yield are the relevant

variables.


63


Bond market is not well developed in India but debentures, partly

or fully convertible into equity are in good demand both from individuals

and mutual funds. The portfolio manager has to use his analytical power

and discretion to choose the right debentures with the required duration,

yield and quality. The duration and immunization of expected inflows of

funds to the required quantum of funds have to be well planned by the

portfolio manager. Research and high degree of analytical power in

investment management and bond portfolio management are necessary.

The bond investment are thus equally challenging as equities

investment and more so in respect of money market instruments. All

these facts bring out clearly the needed analytical powers and expertise of

portfolio manager.

Naïve Diversification:-

Portfolios may be diversified in a naïve manner, without really

applying the principles of Markowitz diversification, which is discussed

at length in the next paragraph. Naïve diversification, where securities are

selected on a random basis only reduces the risk of a portfolio to a limited

extent. When the securities included in such a portfolio number around

ten to twelve, the portfolio risk decreases to the level of the systematic

risk in the market. It may also be noted that beyond fifteen shares, there is

no decrease in the total risk of a portfolio.

Before discussing the Markowitz diversification, what the

researches of investors and investment analysts have found is to be set out

briefly. Firstly, they found that putting all eggs in one basket is bad and

most risky. Secondly, there should be adequate diversification of

investment into various securities as that will spread the risk and reduce

it; if the numbers of them say 10 to 15 it is adequate to enjoy the


64


economies of time, scale of operations and expertise utilized by the

investors in his analysis.

Portfolio With Number of Securities:-

The benefits from diversification increase, as more and more

securities with less than perfectly positively correlated returns are

included in the portfolio. As the number of securities added to a portfolio

increases, the standard deviation of the portfolio becomes smaller and

smaller. Hence an investor can make the portfolio risk arbitrarily small by

including a large number of securities with negative or zero correlation in

the portfolio.

But in reality, no securities show negative or even zero correlation.

Typically, securities show some positive correlation, which is above zero

but less than the perfectly positive value (+1). As a result, diversification

(that is , adding securities to a portfolio) results in some reduction in total

portfolio risk but not in complete elimination of risk. Moreover, the

effects of diversification are exhausted fairly rapidly. That is, most of the

reduction in portfolio standard deviation occurs by the time the portfolio

size increases to 25 or 30 securities. Adding securities beyond this size

brings about only marginal reduction in portfolio standard deviation.

Adding securities to a portfolio reduces risk because securities are

not perfectly positively correlated. But the effects of diversification are

exhausted rapidly because the securities are still positively correlated to

each other though not perfectly correlated. Had they been negatively

correlated, the portfolio risk would have continued to decline as portfolio

size increased. Thus, in practice, the benefits of diversification are

limited.

The total risk of an individual security comprises two components;

the market related risk called systematic risk and the unique risk of that


65


particular security called unsystematic risk. By combining securities into

a portfolio the unsystematic risk specific to different securities is

cancelled out. Consequently the risk of the portfolio as a whole is reduced

as the size of the portfolio increases. Ultimately when the size of the

portfolio reaches a certain limit, it will contain only the systematic risk of

securities included in the portfolio. The systematic risk, however, cannot

be eliminated. Thus a fairly large portfolio has only systematic risk and

has relatively little unsystematic risk. That is why there is no gain in

adding securities to a portfolio beyond a certain portfolio size.

International Diversification:-

The benefits of diversification are well perceived by portfolio

managers, that many in developed countries started investing in foreign

bonds, stocks and other instruments. They found that can extend

diversification principle to foreign stocks, bonds etc, to improve returns

for a given risk by adopting proper techniques of diversification.

Need of International Diversification:-

The size and character of international Equity and bond markets are

widely varying that it will increase the scope for larger investment

and larger diversification.

The returns in local currencies of some foreign countries are higher

than in domestic markets. Thus, for example in Singapore, Malaysia,

Taiwan and India the returns in local currencies are higher than in U

S economy.

The economic trends, business conditions and local profitability and

earnings ratio differ widely among countries that the EPS in some


66


developing countries is higher and give opportunity for better

diversification and higher returns, through international investments.

International investment is advantageous due to larger investment

avenues now open in the first place and secondly due to the

imperfect correlation among the international investment markets.

The total risk of a portfolio including the international investment

will be lower than with only domestic investment. The degree of

volatility, and all risk measures, indicates that these risks vary among

the countries and in different degrees and the possibility of

covariance, or high correlation will be low.

The frontier of efficiency portfolio can be widened, by inclusion of

foreign investment in a portfolio. Thus many international portfolio

managers prefer to invest in India and so will be the case of India n

portfolio managers, if they can diversify into international investment.

There are some directions however, which will increase risk in such

investment.


67



68


ANALYSIS OF PORTFOLIO

We have seen in chapter no 4 about the risk and return, it is clearly

shown that when the risk is high, return is also high and when risk is low,

return is also low. In the portfolio management risk and return of

investment is most important. If management of investment is done well

then it is possible to get high return with low risk. This is proved in the

following examples of different mutual fund, it compared with portfolio

of retire bank officer. Professional fund management is done in the

portfolio of mutual fund.


69


LICMF BALANCE FUND COMPARED WITH INVESTED

PORTFOLIO OF A PERSON WHO IS BANK OFFICER:

. In this scheme the portfolio is hybrid. The fund size as on

31/01/2004 of Rs.1303.35 lakhs, this fund invested in the following

manner in different equity and debt with good portfolio.

(Figure in Lakhs)

Equity portfolio Debt Portfolio

Holdings Investment Holdings InvestmentACC 102.14 IFCI 150.00Satyam Computer 101.79 Reliance Industry 121.08Reliance Industries 89.41 Ashok Leyland FInance 98.71SBI 77.45Polaris software 63.77DR. Reddy’s Lab 55.98ITC 51.13Hindustan Lever 47.19IPCL 44.70TISCO 38.42ONGC 36.93ZEE Tele Films 34.46Bharti Tele-venture 33.71GACL 28.86


70


NALCO 28.32Hero Honda 22.61TATA Power 11.25GAIL 11.02Ranbaxy Laboratories 9.94Total Equity 889.08 Total Debt 369.79Money Market Instruments Investment 44.48

Annualized returns of this fund on the basis of fact sheet for last 1st

year of 35.01% and last 3 years average 13.28%. Now last years’ returns

i.e. 35.01% it would be compared with the bank officer’s portfolio who

has invested in following way:

One customer who is bank officer and his portfolio

Security Expected

Return

Proportion of

Security

Equity share 20 % 60 %

Debenture 20 % 20 %


71


Bond 8 % 20 %

Return Profile

Portfolio Expected Return

= R1 X1 + R2 X2 + R3 X3

= (0.60 x 20) + (0.20 x 20) + (0.20 x 8)

= 12 + 4 + 1.6

= 17.6 %

Risk Profile

Security ProportionCredit *

Risk

Market *

Risk

Interest *

Rate Risk

Liquidity

Risk *

Equity

Shares

60 % Medium –

Higher

Medium –

Higher

Low-

Medium

Medium

– High

Debenture 20 % Low –

Medium

Low –

Medium

Medium –

High

Low -

Medium

Bond

Fund

20 % Low-

Medium

Low–

Medium

Medium-

high

Low–

Medium

58. 33 % Portfolio Risk Profile: Lower to Medium Risk

Interpretation: -

So, LICMF Balance Fund portfolio gave the double return than the

bank officer’s portfolio because there fund has invested in number of

good companies, so diversified portfolio give good return.


72


(* For risk categories see in annexure no 1)

PORTFOLIO OF LICMF EQUITY FUND COMPARED WITH

PORTFOLIO OF RETIRED COLLEGE PROFESSOR

.

Total fund of this scheme was invested in equity. The fund size as

on 31/01/2004 of Rs.6861.79 lakhs, this fund invested in the following

manner in different equity with good portfolio.

(Figure in Lakhs)

Equity portfolio

Holdings Investment Holdings InvestmentSatyam Computer 416.34 Tata Power 262.57Maruti Udyog 367.71 Reliance Industries 251.82Infosys Technology 348.70 SBI 250.24ITC 347.27 Larsen & Toubro 174.83ONGC 347.17 Hindustan Lever 169.88Renbaxy Laboratories 327.97 Dr Reddy’s Lab 167.93Concor 325.41 HDFC 129.96ACC 306.42 GAIL 125.60Grasim Industries 277.91 ICICI Bank 118.10GACL 274.09 NALCO 110.30BHEL 273.11 Bharti Tele - Venture 107.88Bajaj Auto 264.26 Zee Telefilms 101.47TISCO 101.11

FUND SIZE ( AS ON 31/01/2004) 6861.79


73


Annualized returns of this fund on the basis of fact sheet for last 1st

year of 97.23% and last 3 years average 13.00%. Now last years’ returns

i.e. 97.23% it would be compared with the portfolio return of retired

college professor invested in following way:

Security Expected

Return

Proportion of

Security


74


Post Deposit 12 % 40 %

Bond Fund 08 % 25 %

Company Fixed Deposit 10 % 35%

Return Profile

Portfolio Expected Return = R1 X1 + R2 X2 + R3 X3

= (0.40 x 12) + (0.25 x 8) + (0.35 x 10)

= 4.8 + 2 + 3.5

= 10.30%

Risk Profile

Security Allocation Credit

Risk

Market

Risk

Interest

Rate Risk

Liquidity

Risk

Post Deposit 40 % Low–

Medium

Low–

Medium

Low–

Medium

Medium-

high

Bond Fund 25 % Medium-

high

Medium-

high

Low–

Medium

Medium-

high

Company

Fixed Deposit

35 % Medium-

high

Medium-

high

Medium-

high

Low–

Medium

58.33% Portfolio Risk Profile: Medium to High Risk

Portfolio Risk Profile

Post deposit: The risk profile of post office deposit is lower to

medium because in credit risk, market risk, interest rate risk, it getting

lower to medium risk. In liquidity risk the risk is medium to high because


75


before maturity of it if deposit is drawn up the interest rate getting cut

down.

Bond fund: The risk profile of bond fund is medium to high

because in credit risk, market risk, and liquidity risk it getting the

medium to high-risk profile. Interest rate risk is lower to medium because

it will get the prevailing market interest rate at any time.

Company fixed deposit: The risk profile of company fixed deposit

is medium to high because company is also giving the high return on

deposits.

Equity Share: The risk profile of equity share is medium to high

because in it’s very important credit risk and market risk getting medium to

high risk for equity shares.

Interpretation:

So, LICMF equity Fund portfolio gave the very return than the

college professor’s portfolio because there fund has invested in number of

good companies, so diversified portfolio gives good return


76


The Case study of Two Person’s portfolio, who is Lecturer of

college and Share Broker. One has two investment avenues in his

portfolio and other has three securities in his portfolio. So we

check out risk and return of both people as follow:

Lecturer of college who has two securities in his portfolio:

Security Expected * Return

Proportion of * Security

First Year:Mutual fund 12 % 50 %Share market 8 % 50%

Second Year:Mutual fund 20 % 50 %Share market 16 % 50%

Return on Portfolio:

Rp = R1X1 + R2X2

Where: Rp = Expected return to portfolio

R1 = Average Expected return of security one

R2 = Average Expected return of security second.

X1 = Proportion of security one

X2 = Proportion of security second.

Rp = [(12+20) / 2] x (0.50) + [(8 + 16) / 2] x (0.50)

= 8 + 6


77


= 14 %

( * All the data are assumed data )

Risk on Portfolio:

For the calculation of risk we considered the formula of Markowitz

model it is as follow

6p = X1

2 Ø12 + X2

2 Ø22 + 2X1X2 r12 Ø1 Ø2

Where,

6p = Risk of portfolio

X1 = Proportion of security 1


Ø1 = Standard deviation of security 1


r12 = Co-efficient of correlation between security 1 & 2

Standard deviation for Mutual Fund:

Year Return X x – x (x – x)2 1 12 16 – 4 162 20 16 4 16

Total 32 0 32

X = ∑X = 32 = 16 N 2

Ø1 = ∑ ( X – X ) 2 N

= 32 = 16 = 4 2

Standard deviation for share market:


78



Total 24 0 32

X = ∑X = 24 = 12 N 2

Ø2 = ∑ (X 2 – X2) 2 N

= 32 = 16 = 4 2

cov12 = ½ [(R1 – R1) + (R2 – R2)]

Where,

Cov12 = Co-variance between security one and second

R1 = Return on security one

R2 = Return on security second.

R2 & R1 = Expected return

Cov12 = ½ [(12 – 14) (8 – 14) + (20 – 14) (16 – 14)]

= ½ [(-2) (- 6) + (6) (2)]

= ½ [(12 + 12)]

= ½ [24]

= 12

r12 = Cov12 = 12 Ø1 Ø2 4 x 4


79


R12= 0.75

6p = X12 Ø1

2 + X22 Ø2

2 + 2X1X2 r12 Ø1 Ø2

= [(0.50) 2 (4) 2] + [(0.50) 2 (4) 2] + 2(0.50) (0.50) (0.75) (4) (4)

= 4 + 4 + 6

= 16

Risk = 3.74 %

Share Broker who has three securities in his portfolio:

Security Expected Return

Proportion of Security

First Year:Mutual fund 12 % 40%Share market 8 % 40%Debt Security 13% 20%

Second Year:Mutual fund 20 % 40 %Share market 16 % 40%Debt Security 10% 20%

o Return of Portfolio:

Rp = R1X1 + R2X2 + R3X3

= [(12 + 20)/2] x (0.40) + [(8+16)/2] x (0.40) + [(14+10)/2] x (0.20)


80


= 6.4 + 4.8 + 2.4

= 13.6%

o Risk on Portfolio:

Standard deviation for Mutual Fund:


Total 32 0 32

X = ∑X = 32 = 16 N 2

Ø1 = ∑ ( X – X ) 2 N

= 32 = 16 = 4 2

Standard deviation for share market:


Total 24 0 32

X = ∑X = 24 = 12 N 2

Ø2 = ∑ (X 2 – X2) 2 N


81


= 32 = 16 = 4 2

Standard deviation for Debt Security:


Total 24 0 8

X = ∑X = 24 = 12 N 2

Ø3 = ∑ (X 3 – X3) 2 N

= 8 = 4 = 2 2

Covariance between security 1 and 2

cov12 = ½ [(R1 – R1) + (R2 – R2)]

Cov12 = ½ [(12 – 13.6) (20 – 13.6) + (8 – 13.6) (16 – 13.6)]

= ½ [(-1.6) (6.4) + (- 5.6) (2.4)]

= ½ [(–10.24 – 13.44)]

= ½ [- 23.68]

= – 11.84


cov23 = ½ [(R2– R2) + (R3 – R3)]

Cov23= ½ [(8 – 13.6) (14 – 13.6)] + [(16 – 13.6) (10 – 13.6)]


82


= ½ [(-5.6) (0.40) + (2.4) (- 3.6)]

= ½ [(–2.24 – 8.64)]

= ½ [- 10.88]

= – 5.44


Cov13 = ½ [(R1– R1) + (R3 – R3)]

Cov13= ½ [(12 – 13.6) (14 – 13.6)] + [(20 – 13.6) (10 – 13.6)]

= ½ [(- 1.6) (0.40) + (6.4) (- 3.6)]

= ½ [(– 0.64 – 23.04)]

= ½ [- 23.68]

= – 11.84

Co-efficient of correlation between security 1 and 2

r12 = Cov12 = - 11.84 Ø1 Ø2 4 x 4

r12 = - 0.74

Co-efficient of correlation between security 2and 3

r23 = Cov23 = - 5.44 Ø2 Ø3 4 x 2

r23 = - 0.68

Co-efficient of correlation between security 1and 3

r23 = Cov13 = - 11.84 Ø1 Ø3 4 x 2

r23 = - 1.48


83


6p = X12 Ø1

2 + X22 Ø2

2 + X32 Ø3

2 + 2X1X2 r12 Ø1 Ø2 + 2X2X3 r23 Ø2 Ø3

+ 2X1X3 r13 Ø1Ø3

Where,

6p = Risk of portfolio










= [(0.40) 2 (4) 2] + [(0.40) 2 (4) 2] + [(0.20) 2 (4) 2] + 2(0.40) (0.40) (- 0.74) (4) (4) + 2(0.40) (0.20) (- 0.68) (4) (2)+ 2(0.40) (0.20) (- 1.48) (4) (2)

= 2.56 + 2.56 + 0.64 + (- 3.79) + (- 0.87) + (- 1.89)

= - 0.79


84


Risk = - 0.88

NOW, RETURN AND RISK OF BOTH PERSON AS FOLLOW :

Person Risk Return

Lecturer of college 3.74% 14%

Share Broker - 0.88% 13.6%

Interpretation:

We can see two different portfolios of two persons i.e. Lecturer and

Share broker. We calculate the risk and return on it. So lecturer has two

securities and share broker has three securities in his portfolio. The

investment avenue of the lecturer has high risk and high return. The

investment avenue of the share broker has low risk and it get low return

in compared to lecturer because of he has low risk.


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So from above comparison we can find that when risk is high then

return also high, when risk is low then return low. Also find that

diversified portfolio give good return with low risk.


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CONCLUSION

It is important to understand that equity shares are not

recommended for all investors. If you are past sixty, and dependent on

your savings for a living, I would strongly advise you not to buy and hold

equity shares only but also in other securities which gives a regular

income in periodic intervals. The stock markets are by nature volatile and

unpredictable. Prudence, in such cases, demands that one should never

put one’s nest egg in the stock market at such a late stage in life. On the

other hand, if you are young and resilient enough to take risks, the stock

market can be quite interesting and rewarding. But remember these Ten

Commandments and follow them with religious favour:

1. Do not speculate.

2. Do not invest in new issues.

3. Do not put all your eggs in one basket.

4. Limit the number of scrips in your portfolio.

5. Invest for the long term.

6. Invest in real value.

7. Invest in sunrise industries.

8. Disinvest before a company becomes a sunset industry.

9. Do not marry your stocks.

10. Set a limit to your greed.

Investing in portfolio of carefully selected stocks with an

excellent track record can be quite safe in the long run. If you are

below fifty, you can build a fortune with an equity stock are even

better than gold.


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FINDINGS

Investment in Mutual funds schemes specializes in the business of

investment management, and therefore professional management for


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carrying out their activities. Professional management ensures that

the best investment avenues are tapped with the aid of comprehensive

information and detailed research. It also ensures that expenses are

kept under tight control and market opportunities are fully utilized.

An investor who opts for direct equity investing loses out on these

benefits.

Portfolio management reduces risk & increases return. Portfolio

management renders the services to satisfy the asset preference of

investors.

Risk and return has direct relationship with each other, it was proved

in comparative case study, like in portfolio of lecturer has two

security and its risk and return 3.74% and 14% respectively and share

broker has three security in his portfolio and its risk and return

-0.88 % and 13.6% respectively. So here we seen easily that when

risk is high then return also high, when risk reduces then return also

reduces.

Saving is invests in different investment avenue then it will be safe

for person and give beneficial return and reduce the changes of

losses.

A portfolio includes not only equity shares, but all other major

categories of investments, like houses or flats, bank accounts,

company deposits and debentures, mutual funds, gold and silver, etc.

So investment in these categories also reduced risk and increases

your return with safety.

SUGGESTION

A portfolio includes not only equity shares, but all other major

categories of investments, like houses or flats, bank accounts, company


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deposits and debentures, mutual funds, gold and silver, etc. You may also

notice that a certain risk-profile is assumed for each investor. If your

actual risk profile is different from the ones assumed due to reasons like

family background, inheritance, etc. you should modify your investment

strategy.

The main point to be emphasized is that the appropriate portfolio

for “a single, highly placed 50-year old executives, living in own flat,

with no kids,” would not be the same as that for “ a single-income couple,

aged 45 with two college-going children”. The investment strategies

discussed cover a range of investors and families with varying incomes,

responsibilities and financial goals. Select the investment strategy that

best approximates your situation and adapt it to your specific needs.

Age(Years)

Single Couple with double income Couple with single income

Unmarried No kids With two kids

No kid With two kids

25-35 The most eligible bachelor

The 5-star honeymooners

The sweet home family

The budget honeymooners

The model family

36-45 The high flying single

The evergreen couple

The hard workers

The happy pair The sharing caring family

46-60 The confirmed bachelor

The graying couple

The empire builders

The made-for-each other

couple

The budget family

60+ The most blessed person

Retired couple with some family responsibilities

Retired couple with no family responsibilities

The ever-responsible couple The liberated souls

Risk categories of different individual profiles

A. The aggressive risk category


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The most eligible bachelor

The 5-star honeymooners

The sweet home family

The budget honeymooners

The model family

The high flying single

B. The medium risk category

The ever green couple

The hard workers

The happy pair

The sharing-caring family

The confirmed bachelor

The graying couple

The empire builders

The made for each other couple

C. The conservative risk category

The budget family

The most blessed person

The ever responsible couple

The liberated souls

There are certain investments, which every investor ought to make,

though their relative priority changes with age as given below

Young Middle aged Senior Retired

25-35 35-45 45-60 60+


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PRIORITY LEVELS

Life insurance High Medium Low Nil

Medical insurance Low Medium High High

House / flats Low High High High

Tax oriented savings

schemes

Low High High Low

Also, savings bank accounts have to be maintained by all of

us for meeting ongoing liquidity needs.

Gold and silver may be acquired only to satisfy some

essential family needs like marriage, festivals, and other special

occasions.


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ANNEXURE -1

CREDIT RISK

In simple terms this risk means that the issuer of a debenture/bond or a

money market instrument may default on interest payment or even in

paying back the principal amount on maturity. Even where no default


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occurs, the price of a security may go down because the credit rating of an

issuer goes down. It must, however, be noted that where the scheme has

invested in government securities, there is no credit risk to that extent.

All the above factors may not only affect the prices of securities but also

the time taken by the fund or redemption of units, which could be

significant in the event of receipt of a very large number of redemption

requests or very large value redemption requests. The liquidity of the

assets may be affected by other factors such as civil strife. In view of this,

redemption may be limited or suspended after approval from the boards of

directors of the AMC and the trustee, under certain circumstances.

Should the scheme be permitted to invest in offshore securities,

such investment run currency risk in addition to other risks faced by

investments? Investments made in US dollar or any other foreign

currency denominated securities may lose in value if the Indian rupee

appreciates with respect to the foreign currency or gain in value if the

Indian if the Indian rupee depreciates.

INTEREST-RATE RISK

Interest rate fluctuation is a common phenomenon with its

consequent impact on investment values and yields. Interest rate risk

refers to the risk of the change in value of your investment as a result of

movement in interest rates. Suppose you have invested in a security

yielding 8% p.a. for 3 years. One year down the line, interest rate have

moved and a similar security can be issued only at 9%. Due to the lower

yield, the value of your security gets reduced. The current value of a

security is calculated by using the market rate as the discount rate for the

security’s expected cash flows.


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Fixed income securities such as bonds, debentures and money

market instruments run price-risk or interest rate risk. Generally, when

interest rates rise, prices of existing fixed income securities fall and when

interest rates drop, such prices increase. The extent of fall or rise in the

prices is a function of the existing coupon, days to maturity and the

increase or decrease in the level of interest rates. The new level of interest

rates is determined by the rates at which government and other entities

raise new money and/or the price levels at which the market is already

dealing in existing securities. The price risk is minimal in the case of

floating rate or rating sensitized instruments or inflation linked bonds.

The price risk does exist if the investment is made under a redo

agreement.

MARKET RISK

Market risk is the risk of movement in security prices due to

factors that affect the market as a whole, rather than particular companies

or industries. Natural disasters (and certain man-made ones, like war) can

be one such factor. The most important of these factors is the phase the

markets are going through. Stock markets and alternating bullish and

bearish periods. There are several theories that partially explain why

these bull and bear markets keep alternating. Bearish stock markets

usually precede economic recessions. Bearish bond markets result

generally from high market interest rates, which in turn, are pushed by

high rates of inflation. Bullish stock markets are witnessed during

economic recovery and boom periods. Bullish bond markets result from

low interest rates and low rates of inflation. Thus, experts believe that

good economic forecasting is the key to anticipating changes in the stock

and bond markets. You need to find answers to the following questions:


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When is the economic recession going to end and recovery start?

When is the boom going to peek and recession start?

What will be the rate of inflation next year?

What will be the interest rate next year?

These questions are easy to ask. But experience indicates that it is

quite difficult to find even reasonably approximate answers. No two

economists seem to agree on the answers to these questions.

LIQUIDITY RISK

Money has only a limited value if it is not readily available to you

as and when you need it. The ready availability of money is called

liquidity in financial jargon. An investment should not only be safe and

profitable, but also fairly liquid. Liquidity of an investment can be

measured in terms of the speed and ease with which it can be converted

into cash, whenever you need it. An asset is said to be liquid if it can be

converted into cash quickly, and with little loss in value. Liquidity risk

refers to the possibility of the investor not being able to realize its value

when required. This may either happen due to the fact that the security

cannot be sold in the market or prematurely terminated, or because the

resultant loss in value may be unrealistically high.

Current and savings accounts in a bank, national savings

certificates, actively traded equity shares and debentures, etc. are fairly

liquid investments. In the case of a bank fixed deposit, you can raise

loans up to 75% to 90% of the value of the deposit; to that extent, it is a

liquid investment. Now days there are savings deposits available that

automatically sweep-in any amount exceeding a pre-set limit to a fixed


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deposit; any part of the excess that is needed to be withdrawn is

automatically swept back into the savings accounts. This provides an

excellent blend of liquidity with returns. Some of the banks have

attractive loan schemes against security of approved investments, like

selected company shares, debentures, national saving certificates, units,

etc. Such schemes add to the liquidity of investments. Some banks also

offer buy-back schemes for the non-convertible portion of partly

convertible debentures of some companies. Similarly, most companies

offering fixed deposits provide an opportunity for premature termination

under certain circumstances.


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ANNEXURE -2

BIBLIOGRAPHY

Investment Management

- V. A. Avadhani



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- V. K. Bhalla


- Preeti Singh


- V. Gangadhar

- G. Ramesh Babu.

Financial Management

- Ravi M. Kishore.


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ANNEXURE - 3


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portfolio management’

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