Handout: Module 1: Security Analysis and Portfolio Management

References: Prasanna Chandra, “Investment analysis and portfolio management”, Mc Graw Hill
Education, “ISBN-13:978-1-25-900599-2
Punithavathy Pandian, “Security Analysis and portfolio Management, Vikas, Publishing housing
PVT LTD, “ISBN:978-93259-6308-5.
Note: Handouts are given to help the students to use the textbook and to emphasize important
points. They may not contain enough information to pass an assessment/exam.  When studying
for assessments/exams you must use the textbook and the handouts.  Do not rely on the handouts
only
Learning objectives: conceptual understanding of the elements appropriate process in securities
and in developing skill of analysis selection of appropriate security for investment.

Content: Investment- meaning, nature, objectives and scope; investment, speculation and
gambling; investment plan; avenues of investment- marketable and non-marketable securities;
development of debt and stock market in India; stock trading mechanism; stock exchanges in
India- demutualization and corporatization- stock indices- meaning, types and methods of
developing stock indices-BSE & NSE Stock indices; Financial regulation- meaning and
importance; role of SEBI as a market regulator.

Investment

Why invest?
We invest in order to improve our future welfare. Funds to be invested come from assets already
owned, borrowed money, and saving or foregone consumption. By foregoing consumption today
and investing the saving, we expect to enhance our future consumption possibilities.
How Do we invest:
If we are making investment decision today that will directly affect our future wealth, it would
make sense that we utilize a plan guide our decision.
Financial planning is the process of meeting your life goals through the proper management of
your finances. Life goals can include buying a home, saving for your child’s education planning
for retirement.
Meaning:
In its broadest sense, an investment is a sacrifice of current money or other resource for
future benefits. (Prasanna Chandra)
Investment in the employment of funds on assets with aim of earning income or capital
appreciation. Investment has two attributes, namely, time and risk. In the process of investment,
the present consumption is sacrificed to get a return in the future.
Financial investment is the allocation of money to assets that are expected to yield some
gains over a period of time. (Punithavathy Pandian)

An investment is a commitment of funds made in the expectation of some positive rate of

return. (Donald. E. Fischer)
Nature of investment:

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 You have understood that an individual investor ‘postpones current consumption only in
response to a rate of return which must be suitability adjusted for inflation and risk. The basic
postulate, in fact, unfolds the nature of investment decision. Let us explain as follows.
Cash has an opportunity cost and when you decide to invest it, you are deprived of this
opportunity to earn a return on that cash. Also, when the general price level rises the purchasing
power of cash. This explain the reason why individual require a real rate of return’ on their
investment. Now within the large body of investors, some buy government securities or deposit
their money in bank accounts that are adequately secured. In contrast, some others prefer to buy,
hold, and sell equity shares even when they know that they get exposed to the risk of losing their
money mush more than those investing in government securities.
The risk factor gets fully manifested in the purchase and sale of financial assets, especially
equity shares. It is common knowledge that some investors lose even when the securities market
boom. So there lies the risk.

Investment objectives:
The investor will have to work out his objectives first and then evolve a policy with the
amount of investible wealth at his command. An investor might say that his objectives is to have
‘large money’. You will agree that this would be a wrong way of stating the objective. You
would recall that the pursuit of ‘large money’ is not possible without the risk of ‘large losses’.
Hence, the objective of an investor must be defined is terms of risk and return.
Scope of Investment Management:
The business of investment has several facets, the employment of professional fund
managers, research (of individual assets and asset classes), dealing, settlement, marketing,
internal auditing, and the preparation of reports for clients. The largest financial fund managers
are firms that exhibit all the complexity their size demands. Apart from the people who bring in
the money (marketers) and the people who direct investment (the fund managers), there are
compliance staff (to ensure accord with legislative and regulatory constraints), internal auditors
of various kinds (to examine internal systems and controls), financial controllers (to account for
the institutions' own money and costs), computer experts, and "back office" employees (to track
and record transactions and fund valuations for up to thousands of clients per institution).
Speculation:
Speculation is about taking up the business risk in the hope of achieving short-term gain.
Speculation essentially involves buying and selling activities with expectation a profit from price
fluctuations.
A speculation usually involves the purchase of salable assets in hope of making a quick profit
from an increase in the price of the assets which is expected to occur within a few weeks or
months.
Gamble:
Gamble is usually a very short-term investment in a game of chance. The holding period for
most gambles can be measured in seconds.

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 GAMBLING AND INVESTMENT

A gamble is usually a very short-term investment in a game or chance. Gambling is different

from speculation and investment. The time horizon involved in gambling is shorter than
speculation and investment. The results are determined by the roll of dice or the turn of a card.
Secondly, people gamble as a way to entertain themselves, earning incomes would be the
secondary factor. Thirdly, the risk in gambling is different from the risk of the investment.
Gambling employs artificial risks whereas commercial risks are present in the investment
activity. There is no risk and return trade off in the gambling and the negative outcomes are
expected. But in the investment, there is an analysis of risk and return. Positive returns are 5
expected by the investors. Finally, the financial analysis does not reduce the risk proportion
involved in the gambling.
Investment plan:
Investment planning has the ‘rate of return’ ingredient at its core, thus making the approach a
little narrow. Investment planning means commit of funds on one or more assets over a period.
The investment planning process involves several steps such as the following:
o Setting investment goals.
o Understanding the risk appetite.
o Designing an investment portfolio.
o Evaluating the market and investment avenues.
Investment planning helps to:
o Identify the financial goals of the investor.
o Derive the maximum benefit from investment.
o Choose the right investment options.
o Decide upon the optional investment strategy.
o Maintain a balance between risk and returns.
It is possible to arrive at an optimal combination of risk and return to suit the requirement of an
investor through prudent planning.

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Aspects of investment planning:
Investment planning mainly involves the following aspects:
o Identification of financial needs and goals
o Choice of investment options
o Investment approaches
Identification of financial needs and goals:
Sound investment planning requires a clear understanding of financial needs and goals. A good
investment for long-term retirement plan may be a suitable investment for higher education
expenses of children. Financial needs or goal determines the tenure of the investment horizon.
All investment needs and goals are classified into short-term (less than 1 year), medium-term
( more than 1 year) and long-term ( more than 5 years).
Choice of investment options:
To a large extent, the choice of the right investment option depends upon financial goals. For
example, if the investment vehicle that has a three-years lock-in period. Similarly, if he wants to
invest for his daughter’s marriage after 10 years, he cannot invest in one- year bonds for the next
10 years. A 10-year bond may, in this case, match his goa. Thus, the right investment is a
balance of three things:
 Liquidity
 Risk
 Return
Investment approaches:
The investor’s ability to tolerate his investment strategy. The ability to manage risks depends
largely on the level of income and responsibility, knowledge about investment, age, etc. higher
risk, higher is the possibility of earning a fair return. Many people adopt the following
approaches:
o A conservative approach concentrates on secured debenture, bonds etc. and has limited
risk.
o A moderate approach focusses on investing a mutual funds, bonds and selected a
fundamentally strong companies’ equity, shares etc.
o Investors take major risks on investment to have high (above-average) returns. They like
speculative equity shares and follows the market movements.

Avenues of investment:
There are a large number of investment avenue for savers in India. Some of them are
marketable and liquid while others are non-marketable. Some of them are highly risky while
some others are almost riskless. The investor has to choose proper avenue from among them
depending on his preference, needs and ability to assume risk.
The investment avenue can be broadly categorized under the following heads:
1. Corporate securities
2. Deposits in banks and non-banking companies
3. UTI and other mutual funds schemes
4. Post office deposits and certificates
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 5. Life insurance policies
6. Provident funds schemes
7. Government and semi government securities.
Let us discus briefly the important investment avenues available to servers in India.

Corporate securities:
Corporate securities are the securities issued by joint stock companies in the private sector.
These include equity shares, preference shares and debentures.
Equity shares have variable dividend and hence belong to the high risk- high return
category, while preference shares and debentures have fixed return with lower risk.

Deposit:
Among the non-corporate investment, the most popular are deposits with banks such as
saving accounts and fixed deposits have low interest rates whereas fixed deposits have high
interest rate varying with the period of maturity. Interest is payable quarterly or half-yearly.
Fixed deposits may also be recurring deposit wherein saving are deposited at regular interval.
Fixed deposit in non-banking financial companies (NBFCs) in another investment avenue
open to serves. NBFCs include leasing companies, hire purchase companies, investment
companies, chit funds, etc. Deposit in NBFCs carry higher returns with higher risk compared to
bank deposits.

UTI and Other mutual funds schemes:

Mutual funds offer various investment schemes to investor. UTI is the oldest and the largest
mutual funds in the country. Unit scheme 1964, Unit Linked insurance Plan 1971, Master Share,
Master Equity Plans, Mastergain, etc.

Post office Deposit and certificates:

The investment avenues provided by post offices are generally non-marketable. Moreover, the
major investment in the post office enjoy tax concessions also. Post office accept saving deposit
as well as fixed deposits from the public. There is also a recurring deposit scheme which is an
instrument of regular monthly savings.
Six-year National Saving Certificate (NSC) are issued by post offices to investors. The interest
on the amount invested in compounded half yearly and is payable along with principle at the
time of maturity which is six years from the date if issue.
Indra Vikas Patra and kissan Vikas Patra are saving certificates issued by post office.

Life Insurances Policies:

The life insurance Corporation (LIC) offers many investment schemes to investors. These
schemes have additional facility of life insurance cover. Some of the schemes of LIC are whole
life policies, Convertible Whole life Assurance Policies, Endowment Assurance Policies, Jeven
Saathi, Money Back Plan, Jeevan Dhara, Marriage Endowment Plan etc.

Provident Funds Schemes:

Provident funds schemes are compulsory deposit schemes applicable to employees in the
public and private sectors. There are three kinds of provident funds applicable to different sector
of employment namely statutory provident funds, Recognized provident fund and Unrecognized
provident funds.

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 In addition to these, there is a voluntary provident funds scheme which is open to any investor
whether employed or not. This is known as the public provident funds (PPF). Any member of the
public can join the scheme which is operated by post offices and Stat Bank of India.

Government and Sami Government Securities:

The government and Sami-government bodies like the public sector undertaking borrow
money from the public through the issue of government securities and public sector bonds. These
are less risky avenues of investment because of the credibility of the government and
government undertaking.

Investment Process
The investment process involves a series of activities leading to the purchase of securities or
other investment alternatives. The investment process can be divided into five stages:
1) Framing of the investment policy.
2) Investment analysis.
3) Valuation.
4) Portfolio construction.
5) Portfolio evolution.

Framing of the investment policy:

For systematic functioning, the government or investor, formulate the investment policy before
proceeding to invest. The essential ingredient of the policy are investible funds, objectives and
knowledge about investment alternative and the market.
a) Investible funds: The investment revolves around the availability of investible funds.
Funds may be generated through saving or borrowing. If the funds are borrowed, the
investor has to be extra careful in the selection on investment alternative. He must make
sure that the returns are higher than the interest he pays. Mutual funds invest their
stockholder’s money in securities.
b) Objectives: The objectives are framed on the premises of the required rate of return, need
for regular income, risk perception and the need for liquidity. The risk taker’s objectives
is to earn a high rate of return in the form of capital appreciation, whereas the primary
objective of the risk-averse is the safety of principal.
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 c) Knowledge: knowledge about investment alternatives and markets plays a key role in
policy formulation. Investment alternatives range from security to real estate. The risk
and return associated with investment alternatives differ from each other. Investment in
equity is high-yielding but faces more risk than fixed income securities. Tax sheltered
schemes offer tax benefits on the investors.

Security analysis:
Securities to be bought are scrutinized through market, industry and company analysis after the
formation of investment policy.
a) Market analysis: The stock market mirrors the general economics scenario. The growth
in gross domestic product and inflation is reflected in stock prices. Recession in the
economy resulted in a bear market. Stock prices may fluctuate in the short-run but in the
long-run, they move in trends. i.e., either upwards or downwards. The investor can fix his
entry and exit points through technical analysis.
b) Industry analysis: Industries that contribute to the output of major segment of the
economy vary in their growth rate’s overall contribution to economic activity. Some
industries growth faster than the GDP and are expected to continue in their growth. For
example, the information technology industry has experienced a higher growth rate than
the GDP in 1998. The economic significance and the growth potential of the industry
have to be analyzed.
c) Company analysis: The purpose of company analysis is to help the investors make better
decisions. The company’s earnings, profitability operating efficiency, capital structure
and management have to be screened. These factors have a direct bearing on stock prices
and investor’s return. The appreciation of stock value is a function of the performance of
the company. A company with a high product market share is able to create wealth for
investor in the form of capital appreciation.
Valuation:
Valuation help the investor determine the return and risk expected from an investment in
common stock. The intrinsic value of the share is measured through the book value of the share
and price earning ratio. Simple discounting models also can be adapted to value the shares. Stock
market analysis have developed many advanced models to value shares. The real worth of the
share is compared with the market price, and investment decision are then made.
Future Value: The future value of securities. It is constructed in a manner so as to meet the
investor’s goals and objectives. The investor should decide how best to reach the goals with the
securities available. The investor tries to attain maximum return with minimum risk. Towards
this end, he diversifies his portfolio and allocates funds among the securities.

Construction of a portfolio:
A portfolio is a combination of securities. It is constructed in a manner so as to meet the
investor’s goals and objectives. The investor should decide how best to reach the goals with the
securities available. The investor tries to attain maximum return with minimum risk. Towards
this end, he diversifies his portfolio and allocates funds among the securities.

Diversification:
The main objectives of diversification are the reduction of risk in the form of loss of capital and
income. A diversified portfolio is comparatively less risky than holding a single portfolio.
Several modes are available to diversify a portfolio.
Debt and equity diversification: Debt instrument provide assured return with limited capital
appreciation. Common stocks provide income and capital gain but with flavor of uncertainty.
Both debt instruments and equity are combined to complement each other.
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Industry diversification: Industries; growth and their reaction to government policies differ from
each other. Banking industry shares may provide regular returns but with limited capital
appreciation. Information technology stocks yield higher return and capital appreciation, but
their growth potential in the post-global crises years was unpredictable. Thus, industry
diversification. Thus, industry diversification is needed, and reduce the risk.
Company diversification: Securities from different companies are purchased to reduce the risk.
Technical analysis suggest that investor buy securities based on price movement. Fundamental
analysis suggests the selection of financially sound and investor-friendly companies.
Selection: Securities have to be selected based on the level of diversification, industry and
company analyses funds are allocated for selected securities. Selection of securities and the
allocation of funds seal the construction of portfolio.

Evaluation:
A portfolio has to be managed efficiently. Efficient management calls for evaluation of the
portfolio. This process consists of portfolio appraisal reversion.
Appraisal: The return and risk performance of security varies from time to time. The variability
in returns of securities is measured and compared. Development in the economy, industry and
relevant companies from which stock are bought have to be appraised. The appraisal warns of
the loss and steps can be taken to avoid such losses.
Revision: It depends on the result of the appraisal. Low-yielding securities with high risk are
replaced with high-yielding securities with low risk factor. The investor periodically revise the
components of the portfolio to keep the return at a level.
Marketable and non-marketable securities
Security:
Various types of security are traded in the market. Securities broadly represent evidence to
property right. A Security provides a claim on an assets and ant future cash flows the asset may
generate. We commonly think of securities as shares and bonds. According to securities contract
regulation Act1956, securities include shares, scripts, stocks, bonds, debenture and other
marketable products like securities of incorporated companies, other body corporate ore the
government.
Or
“Security” is a broad term for a non-tangible asset with value that is derived from the work of
someone else, according to The Street financial learning site. Securities are financial instruments
that have monetary value and often represent ownership or a creditor relationship. There are
three primary categories of securities: debt, equity, and a hybrid of both debt and equity.

One significant difference among securities is whether they are marketable or non-marketable.
Many investors choose both marketable and non-marketable investments to diversify their
portfolios, according to Napkin Finance.

What Is Marketable vs. Non-Marketable?

A marketable item is positioned to be bought or sold easily through a marketplace. Marketable
securities are financial instruments that are available on exchanges or markets. Features of
marketable securities include ownership that is easily transferred and values that are subject to
market pricing. Marketable securities represent the amount of capital that the issuer can access.
These securities are considered to be liquid because they mature quickly and are easily
converted into cash. Marketable securities carry a higher risk than non-marketable securities.

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Non-marketable securities are not bought or sold on markets and are more difficult to
obtain as a result. A non-marketable security is not exposed to the influences of market
fluctuations, which makes it less prone to volatility due to market conditions. Some
non-marketable securities may be restricted, and they are regarded as long-term
investments. Non-marketable securities are considered to be illiquid because they are
not easily transferred to new ownership and are not easily converted into cash. The risk
associated with non-marketable securities is low.

What Is a Marketable Security?

Marketable securities are primarily unrestricted, short-term financial assets issued through
companies seeking to raise capital. Most securities are considered marketable and can be
purchased through a secondary market. Marketable securities are easily bought, sold or traded.
They tend to be liquid because they can be sold rather easily compared to other assets.
Marketable securities include stocks, bonds, mutual funds and certificates of deposit (CD).
Marketable securities represent either debt or equity. Stocks are an example of equity, while
bonds represent debt.
Governments issue debt securities that are marketable in the form of Treasury bills, according to
the Corporate Finance Institute. Marketable securities have a short maturity period of usually less
than a year. For accounting purposes, the issuer identifies these securities in one of three
classifications for marketable securities: available for sale, held for trade and held to maturity.
Bonds are a type of marketable security that are often held to maturity.

What Are Non-Marketable Securities?

Most often, non-marketable securities examples are specific types of Treasury bonds. U.S.
savings bonds, rural electrification certificates, state and local government series securities, and
government account series bonds are non-marketable. These are also examples of debt securities.
Non-marketable securities are often issued at a discount and are expected to mature over time
into their face value. In some cases, non-marketable securities, such as savings bonds, are non-
transferable or restricted. Non-marketable securities are often issued at a discount because they
are not as easily obtained as marketable securities.

The primary reason for issuing a security with non-marketable status is to ensure stable
ownership of these securities. The gain for investors of non-marketable securities is the
difference between the purchase price and the value at maturity. They are considered long-term
investments because maturity takes longer than a year, unlike marketable securities. Non-
marketable securities can be purchased directly from the issuer or bought over the counter.

Development of debt and stock market in India

Stock trading mechanism

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 Stock exchanges in India

Demutualization and corporatization

Stock indices

Financial regulation

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