Anda di halaman 1dari 99

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

1
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

 Saving:
2
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.
 Saving and Investment:

3
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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,

4
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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

5
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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:
FINANICAL ASSETS:
cash
Bank Deposits
P.F.; L.I.C scheme
Pension scheme
Post office certificates

Becomes PHYSICAL ASSETS:


House, Land, Building, Flats
Saver Investor
Gold, Silver and Other Metals
Consumer Durables

MARKETABLE ASSETS:
Shares, Bonds
Government securities
Mutual Fund
UTI units etc.

Stock & Capital Markets

New Issues Stock Market

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

 Need of investment:
6
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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

7
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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:
8
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

9
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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

10
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
11
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
12
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

13
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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

14
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

15
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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:


16
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.
17
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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


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.

18
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
19
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.
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
20
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
21
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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.

22
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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,

23
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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.
24
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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:

25
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

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.

26
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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

27
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
Rt = Average return on portfolio
Rf = 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 = 50
Rf = 24
σf = 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
28
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

= 2, Portfolio B

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


performance than portfolio B
(b) Treynor’s Measure:
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 - Rf
Tn =
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 - Rf
Tn =
βm
Rn = 0.44 Rf = 0.22 βm = 0.12
0.44 – 0.22 0.22
Tn = = = 0.092
2.40 2.40

For portfolio Y: 0.52 - 0.22 0.30


29
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

Tn = = = 0.125
2.4 2.40
Conclusion: Portfolio Y is better than X because Tnx < Tny
(c) Jensen’s Measure:
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%
30
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

For portfolio – III:


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

31
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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, 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
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

The Portfolio Investment Process

Planning:
Investor’s situation
Market Condition
Speculative policies
Strategic asset allocation

Implementation:
Rebalance Strategic Asset Allocation
Tactical Asset Allocation
Security Selection

Monitoring:
Evaluate Statement of Investment Policy
Evaluate Investment Performance

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.
33
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

7. Follow the passive investment strategy or an activity


speculative strategy.
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: -

34
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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


purpose of the security portfolio?” While this question might seem
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
35
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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


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

36
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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

37
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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


are certainly entering.

(B) Security Selection:-


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

38
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

RISK & RETURN IN PORTFOLIO

 Return:-
40
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

` 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
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

41
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

(B) UNSYSTEMATIC RISK:


1. Business Risk
2. Financial Risk

(A) SYSTEMATIC RISK:


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
42
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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:


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.
43
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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:-


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:
44
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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.

45
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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

46
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

Rate of
Return Low Average High
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 stock
Unsecured 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

47
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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. 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
Proportion of funds Expected Contribution of
Security invested in each return on each security to
security (Weights) each security return
48
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

A 35% 13% 4.55


B 30% 185 5.40
C 20% 23% 4.60
D 15% 15% 2.25
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:
Weighted Return Weighted
Return Probability
(1) Return deviation deviations
(2) (3)
(2 x 3) from mean squared
1 7% 0.30 0.021 - 0.033 0.001
2 11% 0.55 0.060 0.007 0.001
49
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

3 15% 0.15 0.022 0.047 0.002


- - 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.
50
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

Event Return Probability


1 0.20 -10
2 0.25 22
3 0.30 27
4 0.25 12
Estimation of absolute deviation:-
Event Return Probability Absolute Probability (X)Absolute
return deviation deviation
(1) (2) (3) (2x3)=(4) (5) (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
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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:

High

52
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

R
I
S Moderate
K

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
R
I
S Moderate
K

53
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
R
I
S Moderate
K

54
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

High
R
I
55
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

S Moderate
K

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
R
I
S Moderate
K

56
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
R
I
S Moderate
K

57
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
R
I
S Moderate
K

Low

Low Moderate High


58
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

RETURN

59
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

 Main three forms of diversification:-

1. Simple Diversification,
2. Over Diversification,
3. Efficient Diversification.

60
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

(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.

(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

61
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
62
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.
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

63
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
64
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
65
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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.

66
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

68
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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 Investment
ACC 102.14 IFCI 150.00
Satyam Computer 101.79 Reliance Industry 121.08
Reliance Industries 89.41 Ashok Leyland FInance 98.71
SBI 77.45
Polaris software 63.77
DR. Reddy’s Lab 55.98
ITC 51.13
Hindustan Lever 47.19
IPCL 44.70
TISCO 38.42
ONGC 36.93
ZEE Tele Films 34.46
Bharti Tele-venture 33.71
GACL 28.86
NALCO 28.32
Hero Honda 22.61
TATA Power 11.25
GAIL 11.02
Ranbaxy Laboratories 9.94
Total Equity 889.08 Total Debt 369.79
Money Market Instruments Investment 44.48

70
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

Portfolio of Balance Fund

Money Mkt.
3.41%

Debt
28.37% Equity
Debt
Money Mkt.

Equity
68.21%

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 Proportion of
Return Security
Equity share 20 % 60 %
Debenture 20 % 20 %
Bond 8 % 20 %

71
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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
Credit * Market * Interest * Liquidity
Security Proportion
Risk Risk Rate Risk Risk *
Equity 60 % Medium – Medium – Low- Medium
Shares Higher Higher Medium – High
Debenture 20 % Low – Low – Medium – Low -
Medium Medium High Medium
Bond 20 % Low- Low– Medium- Low–
Fund Medium Medium high 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.

(* For risk categories see in annexure no 1)

72
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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

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

73
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

PORTFOLIO
13.65% 11.68%

7.54%

15.58%
8.10%

2.17%
8.20%

20.34% 12.92%

Auto FMCG Pharma


Banking Money Mkt. & Others Infrastructure
Telecom IT & Media Oil and Gas

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 Proportion of


Return Security
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)
74
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

= 4.8 + 2 + 3.5
= 10.30%
 Risk Profile

Security Allocation Credit Market Interest Liquidity


Risk Risk Rate Risk Risk
Post Deposit 40 % Low– Low– Low– Medium-
Medium Medium Medium high
Bond Fund 25 % Medium- Medium- Low– Medium-
high high Medium high
Company 35 % Medium- Medium- Medium- Low–
Fixed Deposit high high high 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
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.

75
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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

 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:
76
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 Lecturer of college who has two securities in his portfolio:

Security Expected * Proportion of *


Return 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
= 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 = X12 Ø12 + X22 Ø22 + 2X1X2 r12 Ø1 Ø2


77
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

Where,
6p = Risk of portfolio
X1 = Proportion of security 1
X2 = Proportion of security 2
Ø1 = Standard deviation of security 1
Ø2 = Standard deviation of security 2
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 16
2 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:

Year Return X x–x (x – x)2


1 8 12 –4 16
2 16 12 4 16
Total 24 0 32

X = ∑X = 24 = 12
N 2

Ø2 = ∑(X2 – X2)2
N
78
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

= 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 4x4

R12= 0.75

6p = X12 Ø12 + X22 Ø22 + 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
79
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

= 16

Risk = 3.74 %

 Share Broker who has three securities in his portfolio:

Security Expected Proportion of


Return 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)
= 6.4 + 4.8 + 2.4
= 13.6%

o Risk on Portfolio:

 Standard deviation for Mutual Fund:

80
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

Year Return X x–x (x – x)2


1 12 16 –4 16
2 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:

Year Return X x–x (x – x)2


1 8 12 –4 16
2 16 12 4 16
Total 24 0 32

X = ∑X = 24 = 12
N 2

Ø2 = ∑(X2 – X2)2
N

= 32 = 16 =4
2

 Standard deviation for Debt Security:

Year Return X x–x (x – x)2


81
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

1 14 12 –2 4
2 10 12 2 4
Total 24 0 8

X = ∑X = 24 = 12
N 2

Ø3 = ∑(X3 – 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

 Covariance between security 2 and 3

cov23 = ½ [(R2– R2) + (R3 – R3)]

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


= ½ [(-5.6) (0.40) + (2.4) (- 3.6)]
= ½ [(–2.24 – 8.64)]
= ½ [- 10.88]
= – 5.44

 Covariance between security 1 and 3

Cov13 = ½ [(R1– R1) + (R3 – R3)]


82
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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 4x4

r12 = - 0.74

 Co-efficient of correlation between security 2and 3

r23 = Cov23 = - 5.44


Ø2 Ø3 4x2

r23 = - 0.68

 Co-efficient of correlation between security 1and 3

r23 = Cov13 = - 11.84


Ø1 Ø3 4x2

r23 = - 1.48

83
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

6p = X12 Ø12 + X22 Ø22 + X32 Ø32 + 2X1X2 r12 Ø1 Ø2 + 2X2X3 r23 Ø2 Ø3
+ 2X1X3 r13 Ø1Ø3
Where,
6p = Risk of portfolio
X1 = Proportion of security 1
X2 = Proportion of security 2
X3 = Proportion of security 3
Ø1 = Standard deviation of security 1
Ø2 = Standard deviation of security 2
Ø3 = Standard deviation of security 3
r12 = Co-efficient of correlation between security 1 & 2
r23 = Co-efficient of correlation between security 2 & 3
r13 = Co-efficient of correlation between security 1 & 3

= [(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

Risk = - 0.88

84
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 NOW, RETURN AND RISK OF BOTH PERSON AS


FOLLOW:

Person Risk Return


Lecturer of college 3.74% 14%
Share Broker - 0.88% 13.6%

15.00% 14% 13.60%

10.00%

5.00% 3.74%

- 0.88%
0.00%
Lecturer of college Share Broker
-5.00%

Risk Retrun

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.
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.

85
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
86
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

87
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

FINDINGS
 Investment in Mutual funds schemes specializes in the
business of investment management, and therefore professional
management for 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.

88
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 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
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.

89
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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 Single Couple with double income Couple with single
(Years) income
Unmarried No kids With two No kid With
kids two
kids
25-35 The most The 5-star The sweet The budget The
eligible honeymooners home honeymooners model
bachelor family family
36-45 The high The evergreen The hard The happy pair The
flying single couple workers sharing
caring
family
46-60 The The graying The The made-for- The
confirmed couple empire each other budget
bachelor builders couple family
60+ The most Retired couple with some Retired couple with no
blessed family responsibilities family responsibilities
person
The ever-responsible couple The liberated souls

 Risk categories of different individual profiles

A. The aggressive risk category

∗ The most eligible bachelor


∗ The 5-star honeymooners
∗ The sweet home family
∗ The budget honeymooners
90
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

∗ 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+
PRIORITY LEVELS

Life insurance High Medium Low Nil


Medical insurance Low Medium High High
House / flats Low High High High
Tax oriented savings Low High High Low
91
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

schemes

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.

92
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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

93
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

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
94
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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:

∗ 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?

95
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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
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
96
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

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.

ANNEXURE -2

97
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

BIBLIOGRAPHY
 Investment Management
- V. A. Avadhani

 Investment Management
- V. K. Bhalla

 Investment Management
- Preeti Singh

 Investment Management
- V. Gangadhar
- G. Ramesh Babu.

98
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.
Study of Portfolio Management

 Financial
Management
- Ravi M. Kishore.

ANNEXURE - 3
99
P
Prof. V. B. Shah Institute of Management & R. V. Patel College of Commerce, Amroli.