UNIT6

INVESTMENT MANAGEMENT
 Investment management

Investment management refers to the handling

of financial assets and other investment not
only buying and selling them. Management
includes devising a short- or long-term strategy
for acquiring and disposing of portfolio
holdings.
It can also include banking, budgeting, and tax
services and duties, as well.
 Meaning Contd---
 The term ‘investment’ or ‘investing’ is closely related to concepts in
economics, finance, and business management. Investment refers to
the active redirection of monetary resources and assets towards
profit generation and future benefits, rather than consuming them as
they are generated.
 Investment management is the process of professionally managing
the various financial securities and assets belonging to an investor,
for the purpose of earning maximum benefits.
 Over the past few years, the investment management industry has
grown considerably, managing trillions of dollars annually across
the globe.
What Is Investment Planning?
 Investment planning is the process of matching your financial goals and
objectives with your financial resources. Investment planning is a core
component of financial planning. It is impossible to have one without
the other.
 Investment planning is a process that begins when you are clear on your
financial goals and objectives. Our Financial Planning process is
designed to help you get clear on how to match your financial resources
to your financial objectives.
 Identify your Financial Goals : These goals can be buying a house,
planning for kid’s higher education etc., You can sort them as High, Medium
and Low priority goals.
 Analyze how much risk you can afford : You’re the best judge for
yourself to decide on how much risk you can take on your investments.
There are certain psychometric tests which can be used to measure your risk
taking capacity. The risk profiles can be Aggressive, Medium and
Conservative.
 Identify time frame for your goals : You can divide the goals based
on the duration as Short, Medium and Long term goals.
 Identify financial products : Now based on the above points, identify
the financial products which match your requirements.
 OBJECTIVES OF INVESTMENT

 The primary objectives taken into consideration by investors

include capital appreciation, safety of principle and current

income. The main aspect affecting the objectives is risk. Some

investors are risk takers unlike others who try to reduce risk.
Categories of Investments
 ASSET ALLOCATION

Asset allocation is the implementation of

an investment strategy that attempts to
balance risk versus reward by adjusting
the percentage of each asset in an
investment portfolio according to the
investor's risk tolerance, goals and
investment time frame.
1. Risk vs. Return
The risk-return tradeoff is at the core of what asset allocation is all about. It's easy for everyone to say that
they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and
derivatives) isn't the answer.
2. Don't Rely Solely on Financial Software or Planner Sheets
Financial-planning software and survey sheets designed by financial advisors or investment firms can be
beneficial, but never rely solely on software or some pre-determined plan. For example, one old rule of
thumb that some advisors use to determine the proportion a person should allocate to stocks is to subtract the
person's age from 100. In other words, if you're 35, you should put 65% of your money into stocks and the
remaining 35% into bonds, real estate, and cash. More recent advice has shifted to 110 or even 120 minus
your age.
3. Determine Your Long- and Short-Term Goals
We all have our goals. Whether you aspire to build a fat retirement fund, own a yacht or vacation home, pay
for your child's education or simply save for a new car, you should consider it in your asset-allocation plan.
All these goals need to be considered when determining the right mix.
4. Time Is Your Best Friend
 The U.S. Department of Labor has said that for every ten years you delay saving for retirement (or some
other long-term goal), you will have to save three times as much each month to catch up.
 Having time not only allows you to take advantage of compounding and the time value of money, but it
also means you can put more of your portfolio into higher risk/return investments, namely stocks. A
couple of bad years in the stock market will likely show up as nothing more than an insignificant blip 30
years from now.
5. Just Do It!
 Once you've determined the right mix of stocks, bonds, and other investments, it's time to implement it.
The first step is to find out how your current portfolio breaks down.
 It's fairly straightforward to see the percentage of assets in stocks versus bonds, but don't forget to
categorize what type of stocks you own (small, mid or large cap). You should also categorize your
bonds according to their maturity (short, mid or long-term).
 Investing in stocks
 1. Decide how you want to invest in stocks
 2. Open an investing account
 3. Know the difference between stocks and stock mutual funds
 4. Set a budget for your stock investment
 5. Start investing
 STOCK EVALUATION
 Every investor who wants to beat the market must master the skill of stock
valuation. Essentially, stock valuation is a method of determining the
intrinsic value (or theoretical value) of a stock. The importance of valuing stocks
evolves from the fact that the intrinsic value of a stock is not attached to its
current price. By knowing a stock’s intrinsic value, an investor may determine
whether the stock is over- or under-valued at its current market price. Stock
valuation is usually divided into two groups:
 Absolute Valuation: This approach mainly focuses on finding out the intrinsic
value of a stock.
 Dividend Discount model
 Discounted Cash Flow model
 Relative Valuation
 .
What is a Portfolio ?
 A portfolio refers to a collection of investment tools such as stocks, shares,
mutual funds, bonds, cash and so on depending on the investor’s income,
budget and convenient time frame.

Following are the three types of Portfolio:

 Market Portfolio
 Zero Investment Portfolio
 Defensive Portfolio
What is Portfolio Management ?
 The art of selecting the right investment policy for the individuals in terms
of minimum risk and maximum return is called as portfolio management.
 Portfolio management refers to managing an individual’s investments in the
form of bonds, shares, cash, mutual funds etc so that he earns the maximum
profits within the stipulated time frame.
 Portfolio management refers to managing money of an individual under the
expert guidance of portfolio managers.
 In a layman’s language, the art of managing an individual’s investment is
called as portfolio management.
Types of Portfolio Management

Portfolio Management is further of the following types:

 Active Portfolio Management: As the name suggests, in an active portfolio
management service, the portfolio managers are actively involved in buying
and selling of securities to ensure maximum profits to individuals.
 Passive Portfolio Management: In a passive portfolio management, the
portfolio manager deals with a fixed portfolio designed to match the current
market scenario.
 Discretionary Portfolio management services: In Discretionary portfolio
management services, an individual authorizes a portfolio manager to take care
of his financial needs on his behalf. The individual issues money to the portfolio
manager who in turn takes care of all his investment needs, paper work,
documentation, filing and so on. In discretionary portfolio management, the
portfolio manager has full rights to take decisions on his client’s behalf.
 Non-Discretionary Portfolio management services: In non discretionary
portfolio management services, the portfolio manager can merely advise the
client what is good and bad for him but the client reserves full right to take his
own decisions.
 Contd---
 1) Public Provident Fund (PPF): This is a popular investment avenue in
India as it is considered safe. However, it comes with rules attached.
a) It offers tax benefit under Section 80C of Income Tax Act. Interest
earned until maturity are also exempt from tax (yes it’s tax-free).
b) It has a lock-in period of 15 years, which means there is no liquidity.
c) Post maturity of 15 years, it can be extended in blocks of five years
for any number of times.
d) Interest paid on PPF is reviewed by Government frequently. July-
Sept 2019 rate of interest is 7.9% compounded annually.
e) Some loans are issued with PPF balance as guarantee.
 2) Bank Fixed Deposits (FD): According to me, this is most misunderstood
investment avenue. In FD, we lock our funds for a stipulated time, get minimal
interest paid on we also pay tax on interest earned.
a) The duration of FD ranges from 7 days to 10 years (even more in some cases).
One can choose any time range according to their choice. Interest rate varies
according to tenure.
b) FDs offer premature withdrawal options but with penalty. One should make a
note of this with their bank at the time of opening the account.
c) FDs are insured by Deposit Insurance and Credit Guarantee Corporation
(DICGC) rules. Under this, only up to Rs 1 lakh (principal plus interest) is
insured per person per bank.
d) Interest rates vary from 5% to 7% for tenures 1 to 10 Yrs. Senior Citizens get extra
0.5%
e) Bank FDs offer cumulative and non-cumulative options. In the cumulative
option, the interest is re-invested and payable on maturity whereas, in the non-
cumulative option, interest is payable periodically (monthly, quarterly or annually
depending on the bank).
f) Interest is added to your income and taxed as per your income tax slabs. Interest
is subject to tax deducted at source (TDS)
 3) Real Estate: This is another popular investment. There is two way of seeing
this. If one is buying the first house in which he/she wants to stay, then it has to
be bought in the beginning of one’s career (assuming it is bought availing home
loan). In this manner it is easy to absorb the EMI (equated monthly instalments)
as there are many working years till retirement. If the same is done 15 years later,
then the EMI will be a burden. Having said this let’s check the following:
a) Home Loan is a long goal with repayment of loan ranging from 15 to 20 years.
b) Rental income of home is around 2-3% and interest on EMI is between 8-9%.
This is not a great investment if one is looking to earn income from rent.
c) This investment is very illiquid i.e. buying/selling is time consuming. Cash flows
are not immediate.
d) Capital appreciation on a home is not always positive. Many people hold on to
property assuming that it will give a great appreciation. However, if you consider
inflation rate it may not be very impressive. Also, the capital gains (profit from
sale of property) have to be dealt in specific manner as per Income Tax Act.
Details in this case vary from case to case and Chartered Accountant will be
better person to guide you on this.
 4) Gold: One can buy gold in various forms- physical, paper or
digital. Physical form is jewels, the paper form is gold bonds and
digital form is gold ETF (explained in point 6).
a) Gold bought for personal use is individual choice. However,
gold bought for investments can be in any of the above
mentioned forms.
b) Gold is often used to offset the risk associated with other
investment options. For example, when equity, bond or real
estate are in downward trend gold acts as a hedge. In short, the
value of gold is same globally. Therefore, it is sometimes used to
offset the risks associated with equity or bond markets.
c) Gold has not given the best return when one considers tenure
of 20 years or more. It is recommended to have a limited
investments exposure in gold.
 5) Mutual Funds: There are several types of Mutual Funds. Equity Mutual Funds, Debt Mutual
Funds and Balanced Funds.
a) Equity mutual funds are those schemes that invest at least 65% of the corpus in stocks of
Indian companies. These are volatile as most part of the investment is in equity stocks which are
subject to market risks.
b) Debt mutual funds are considered less volatile as compared to equity; however, there is
always a risk in terms of interest rate. Most of these funds invest in debt funds like government
securities, corporate bonds, treasury bills etc.
c) Balanced funds have a balance mix of equity and debt. This to some extent cuts the volatility
and balances the return as well.
d) Most of these funds are managed professionally by fund houses. There are policies and
documents where one can see the profile of fund managers and where the funds are invested.
e) For a long-term investor, the most suitable investment would be in equity based mutual
funds. For investments above 5 years equity is the only area where there is maximum return.
f) For those who have no expertise in stock markets or for those who do not have time to analyze
the markets and invest periodically the best way to invest in equity is through mutual funds.
 6) Exchange Traded Funds (ETF): ETFs are many in number. However, the
preferred investment is in Index ETFs. These are just like mutual funds, but the
returns are based on performance of an index. For example: Nifty Bees are ETFs
where the return on investment is based on performance of Nifty50 index.
Similarly, Gold Bees are investments where the return is as per price movement
on Gold.
a) ETFs are cost-efficient. Mutual funds are embedded with cost which we do not
see in our statements. Most of the funds charge 2.5 to 3% on your investments to
manage your funds. However, in ETFs the cost is minimal, as little as 0.5% or less.
b) ETFs are managed digitally and most of them can be invested through DMAT
account. There is no need to deposit a cheque or fill a form or visit a branch. It is
easilymanageable.
c) All investment details are available online. These are more transparent and less
risk.
d) With the ease of management, this is the most liquid investment option just like
Equity. In case of emergency, one can withdraw cash within minutes.
e) Index funds like Nifty Bees have given a return of 15 % to 20% in past 3 years,
which are far superior than fixed deposits. Gold ETF has given returns of 9% to
10% in the past 3 years.
 7) Direct Equity: Investors who understand stock markets and are willing to take risks on
their own can directly invest in Equity stocks of several listed companies and create their
own portfolio.
a) Direct equity investments are considered risky as they are subject to price fluctuation on
stocks (volatility). This could lead to a capital loss in case the stock picks are not efficient.
One needs to devote time to learn and understand how stock market works, before
investing their hard-earned money.
b) Market knowledge is a must as tips can be a costly mistake.
c) There are domestic and global market conditions influencing stock prices. One needs to
be diligent and disciplined while investing in equity directly. If this is difficult to manage
then one can choose to invest through mutual funds.
d) This is one of the BEST investments one could make in the long run. No other
investment beats inflation as equity does. The value of Rs. 100 today is not the same as that
was 10 years. Today we get far fewer items with the same amount. This is the effect of
inflation.
e) Some stocks have given more than 100% return in the past 5 to 10 years. It takes a lot of
patience and practice to get such returns but for those who put in efforts it’s an ocean of
opportunities.
f) WEALTH is created only by investing in equities over a long period of time which is
over 10+ years.
 8) Bonds: Investors can choose to invest in bonds issued by government of India.
a) The government issues several bonds with different interest rates and maturity
periodically.
b) Bonds can be issues in material or dematerialised form. Material form is when a
certificate of holding is issued as a proof of investment with all the details. The
dematerialised form is digital, and amount is sent to account directly.
c) Return on bonds is limited. If the investment is made in 7 years 8% bond, then the return
is only 8% and not more.
d) This is considered less risky as compared to equity, however, there is interest rate risk
associated.
 You can use, most of the above-mentioned options to create a balanced investment
portfolio. The younger you are, the higher should be your risk-taking ability and the
older you are lower should be the risk in investments. The general rule is to invest 100-X
(X here is your age) in equity. Example: If you are 30 years of age, then 70% (100-30=70)
should be the investment exposure in equity.
 Question on future Return
 Adit is thinking of buying some stocks in XYZ Co. After
Reviewing financial report, it is estimated the future dividends
and price behaviour were as follows:
 Expected Annual Dividend 2018-19 Rs.2.15 per share

 E xpected Market price of the stock 2019 Rs.95 per share

Assume at present stock is selling @Rs. 60 per share. What is the

Capital Gain?
Amount of Capital Gain= Expected Future Price- Current Price
95-60= Rs. 35 Per Share
 What is Yield to Maturity?
Yield to Maturity (YTM) – otherwise referred to as redemption or
book yield – is the speculative rate of return or interest rate of a
fixed-rate security, such as a bond. The YTM is based on the belief
or understanding that an investor purchases the security at the
current market price and holds it until the security has matured
(reached its full value), and that all interest and coupon payments
are made in a timely fashion
Formula for Calculating Yield to Maturity
 Expansion for the formula
 Where:
• CI – Average Annual current Income (Amount that you expect to receive annually
from dividends, interest, or Rent)
• FV – Face Value of the security/future price of the Investment
• PV – Present value/price of the security/Current price of the investment
• t – How many years it takes the security to reach maturity
  
 The formula’s purpose is to determine the yield of a bond (or other fixed-asset
security) according to its most recent market price. The YTM calculation is structured
to show – based on compounding – the effective yield a security should have once it
reaches maturity. It is different from simple yield, which determines the yield a
security should have upon maturity, but is based on dividends and not compounded
Interest.
 Problem No 1
 Assume that there is a bond on the market priced at Rs. 850 and
that the bond comes with a face value of Rs. 1,000 (a fairly
common face value for bonds). On this bond, yearly coupons are
Rs. 150. The coupon rate for the bond is 15% and the bond will
reach maturity in 7 years.
Solution to problem No 1
 Problem No 2
 Average Current Income from Dividend of Rs. 156.95,current
stock price of Rs.4380, future stock price of Rs.6935 and an
Investment period (N) of three years (You expect to hold the
stock from the beginning of 2017 through the end of 2019.
Calculate the expected approximate yield.

 Solution???
 Problem No 3
 The price of a bond is Rs. 920 with a face value of Rs. 1000 which
is the face value of many bonds. Assume that the annual
coupons are Rs. 100, which is a 10% coupon rate, and that there
are 10 years remaining until maturity Calculate YTM.
 PROBLEMS IN RISK AND RETURN
1. From the following Information about certain equity stock, Calculate the
expected rate of return of Mr.Aneesh
 Price at the beginning of the year Rs.120

 Dividend Paid at the end of the year Rs. 4.80

 Price at the end of the year Rs. 138

Formula for calculating Rate of Return on the stock

RoR= Actual Income+ Ending price – Beginning Price

--------------------------------------------------------------
Beginning Price
 Solution to problem No 1
 Rate of return= Rs. 4.80+ (Rs138- Rs.120)
----------------------------------- = Rs.22.80
Rs .120 -------------
Rs.120
= 0.19 or 19% Rate of return on Stock
 Alternative method
It is sometimes helpful to split the rate of return in to two components:

1. 1. Current Yield = Annual Income

---------------------

Beginning Price

2. Capital gain Yield= Ending price- Beginning Price

----------------------------------------

Beginning Price

Therefore rate of return is equal to Current yield + Capital Gains Yield

 Problem No 2
The rate of return of 19 percent in the previous problem No 1 may be take into
calculation for 1. Current Yield 2. Capital gain Yield and 3. Rate of return on stock
1. Calculation of Current Yield

Current Yield= Annual Income/ Beginning Price

Rs.4.80/Rs 120 = 0.04 or 4%
2. Calculation of capital Gain yield
Capital gain Yield= Ending price – Beginning Price/ Beginning price
Rs.138-Rs.120/ Rs. 120 = O.15 or 15%
3. Calculation of Rate Of Return
Rate of return = Current Yield + capital gain Yield
4%+ 15%= 19 %
Calculation of Average/Accounting Rate of Return

The rate of return on an investment that is calculated by taking the

total cash inflow over the life of the investment and dividing it by
the number of years in the life of the investment.
FORMULA FOR CALCULATING ARR ON
INVESTMENT
 Formula contd---
Where:
• Average Annual Profit = Total profit over Investment Period / Number of Years

• Average Investment = (Book Value at Year 1 + Book Value at End of Useful Life) / 2

or Opening Investment +Closing Investment/2

 
Components of ARR
 If the ARR is equal to 5%, this means that the project is expected to earn five cents for
every Rupee invested per year.
 In terms of decision making, if the ARR is equal to or greater than the
required rate of return, the project is acceptable because the company will earn at least
the required rate of return.
 If the ARR is less than the required rate of return, the project should be rejected.
Therefore, the higher the ARR, the more profitable the investment.
 PROBLEM ON ARR

XYZ Company is looking to invest in some new machinery to

replace its current malfunctioning one. The new machine, which
costs Rs. 420,000, would increase annual revenue by Rs.200,000 and
annual expenses by Rs. 50,000. The machine is estimated to have a
useful life of 12 years and zero salvage value.
 Solution to Problem
Step 1: Calculate Average Annual Profit
Inflows, Years 1-12
(200,000*12) Rs. 24,00,000
Less: Annual Expenses
(50,000*12) Rs. 600,000
Less: Depreciation - Rs. 4,20,000
Total Profit Rs. 1,380,000
Average Annual Profit
(1,380,000/12) Rs. 115,000
Step 2: Calculate Average Investment
Average Investment
(Rs. 420,000 + Rs. 0)/2 = Rs. 210,000
Step 3: Use ARR Formula
 ARR = Rs. 115,000/Rs. 210,000 = 54.76%
 Therefore, this means that for every Rupee invested, the investment will return a profit of about
54.76 cents.
 Problem No 2

XYZ Company is considering investing in a project that requires an

initial investment of Rs. 100,000 for some machinery. There will be

net inflows of Rs. 20,000 for the first two years, Rs. 10,000 in years

three and four, and Rs. 30,000 in year five. Finally, the machine has

a salvage value of Rs. 25,000.

Step 1: Calculate Average Annual Profit
Inflows, Years 1 & 2
(20,000*2) $40,000

Inflows, Years 3 & 4

(10,000*2) $20,000

Inflow, Year 5 $30,000

Less: Depreciation
(100,000-25,000) -$75,000
Total Profit $15,000

Average Annual Profit

(15,000/5) $3,000

 Step 2: Calculate Average Investment

Average Investment
($100,000 + $25,000) / 2 = $62,500

 Step 3: Use ARR Formula

ARR = $3,000/$62,500 = 4.8%