Investment Analysis

and
Portfolio Management
Investment and Portfolio Management.do
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Chapter One

Introduction to
Investments
Brainstorming
Questions
What is
Finance?
Financial system?
Investment?
Return vs Earning?
Risk?
Risk return tradeoff?
 Meaning of Finance
The term finance should be understood in
two perspectives - finance as a resource and
finance as a discipline.
Finance, as a resource, refers to monetary
means of financing assets of an entity.
Finance as a discipline or subject of study,
describes how economic entities manage
the flows of money through an organization.
Study how people make decisions
about the collection and allocation of
resources in organizations.
Therefore, it is important for all
organizations.
 Scope Of Finance as a
Discipline
The academic discipline of
finance includes the following
specialized main areas:
Public Finance
Institutional Finance
International Finance
Securities And Investment
Analysis
Financial Management
 A) Securities And Investment
Analysis
It deals with financial assets such as
stocks and bonds.
What are the potential risks and
rewards associated with investing in
financial assets?
What is the best mixture of the
different types of financial assets to
hold?
It covers mainly measurement
of risk and return on
investment in securities
b) Financial Institutions
Financial institutions are
basically businesses that deal
primarily in financial matters.
For example, a commercial loan officer
at a bank would evaluate whether a
particular business has a strong
enough financial position to warrant
extending a loan.
At an insurance company, an analyst
would decide whether a particular risk
was suitable for insuring and what the
premium should be.
C) International Finance
International finance studies economic
transactions among nations, corporations
and individually internationally.
It is concerned with flows of money across
international boundaries.
Employees are expected to be familiar with
such international topics as exchange
rates and political risk.

D) Public
Finance
 E) Business Finance/FM
Guttmann and Douglas:-
business finance can be broadly
defined as the activity concerned
with the planning, raising,
controlling and administering the
funds used in the business.
Thus, it studies financial
problems in individual firms,
seeks low-cost funds and
seeks profitable business
activities. 10
 What is Investments?
Investments refers to sacrifice/
surrendering of current resources
in anticipation of a future benefit
Investment involves
commitment of certain current
cash flow in anticipation of an
uncertain future cash flows
Investment involves employment
of own funds or borrowed funds
on a real or financial asset for a
certain period of time in
anticipation of a return in future
 Financial System
Thefinancial system consists of the
money market and capital
market.
Afinancial system is
asystemthat allows the
exchange of funds between
lenders, investors, and borrowers.
Financial systemsoperate at
national, global, and firm-specific
levels.
It
Security Market
allow corporations and
governments to raise funds
and also to execute their
buying and selling orders.
In Security markets funds are
channeled from those who buy
securities to those who
issue/sell securities.
Security market determines
the prices of assets traded and
provides a liquidity
Security markets can be
Primary as:
classified market: where corporations
can raise capital and where newly issued
securities are sold
Secondary market: where previously
issued securities are traded among
investors
Based on term of financial assets
traded, security markets can be
classified as:
Money market - only short-term
financial instruments are traded.
Capital market - in which only long-
term financial instruments are traded.
Does Capital market affect
Economy?
A well-developed stock/capital

market can foster economic

growth in the long run.
A well-functioning stock markets
can promote economic
development by fuelling the
engine of growth through faster
capital accumulation, and by
tuning it through better resource
allocation.
 The current understanding of economic
growth is largely based on the neoclassical
growth model developed by Robert Solow
(1956).
In the this model, capital
accumulation (physical and human
capital) is a major factor contributing
to economic growth.
Productivity growth measured as an
increase in output per worker results
from increases in the amount of capital
accumulation (Fagerberg 1994).
Economic growth and income
inequality
Rapid economic growth is often essential
for achieving a reduction in absolute
poverty.
As growth may be associated with increased
income inequality, it does not automatically
address the whole poverty problem.
The traditional economic development
literature considered highly unequal income
and wealth distribution as a necessary
condition for continued and rapid economic
growth (X=Income Inequality has a Positive
effect on economic growth @1% significance
level).
Contd.

The basic economic argument to

justify large income inequalities
was that high incomes (personal
and corporate) were a necessary
condition for higher savings,
which in turn were needed for
investment and economic growth
(Todaro, 1994).
 The New political economy
literature
Itlinks greater inequality
to lower future growth
paths, and considers it an
impediment to poverty-
reducing growth when
inequality increases
(Nissanke and Thorbecke, 2004).
(X=Income Inequality has a negative effect
on growth @1% significance level)
 Contd.

High inequality, manifested in a large

proportion of population having poor health,
nutrition, and education, is also likely to
impact on overall labor productivity and to
cause slower economic growth (Todaro,
1994).
Raising income levels of the poor, on the
other hand, stimulates demand for domestic
products and increases employment and
production.
More equitable distribution of income may
also act as a material and psychological
incentive to widespread public participation
in the development process (Ibid), whereas
inequality may cause political and economic
instability.
Summary
In general, the impacts of inequality on
growth and of growth on inequality
depend very much on national
characteristics and initial levels of poverty
and inequality, but especially on the
nature of the development process how
growth is achieved, who participates, which
sectors are given priority.
Taiwan and South Korea have been able to
combine economic growth and industrialization
with decreased inequality.
However, in Thailand, for instance, rapid growth
was accompanied by increased income inequality
(e.g. Sarntisart, 2000).
 WHAT DO YOU KNOW ABOUT INVESTMENTS?
When a person has more money than he requires
for current consumption, he would be coined as a
potential investor.
The investor who is having extra cash could
invest it in securities or in any other assets like
gold or real estate or could simply deposit it in
his bank account.
The companies that have extra income may like
to invest their money in the extension of the
existing firm or undertake new venture.
For most of our lives we will be earning and
spending money.
Our current money does not exactly balance our
consumption desires .
Why do individuals
invest?
To achieve a higher level
of consumption in the
future by forgoing
consumption today
To improve their welfare
in the future
Investments help us
achieve tradeoff between
current consumption and
future consumption
INVESTMENT Vs
SPECULATION
Investments are carefully thought out
which involves calculated risk
decisions
whereas
speculation on the other hand is based on
rumors and hearsay.
An investor has a relatively longer time horizon
compare to that of a speculator.
An investor is generally risk averse whereas a
speculator is generally risk prone.
An investors expected return is consistent with
the underlying risk of the investment whereas
risk assumed by a speculator and his anticipated
return is disproportionate.

Investor expects regular income in the

form of dividend whereas Speculator looks
for Capital appreciation.
 INVESTMENT Vs
Gambling is defined as an act of
GAMBLING
betting on an uncertain outcome.
The outcome of gambling is largely a
matter of luck.
The risk that gamblers assume is
highly disproportionate to that of their
expected return.
Gamblers show a sign of addiction and fun
loving.
Results of gambling are known in quick
time.
Theresults of gambling are random in
nature and it is not correlated with an
past events.
Nature and Scope of Investment
Decision
The primary objective of any
Investment is to increase the rate
of return and to reduce the risk.
Higher the Risk, Higher is the
Expected Return.
Investor prefers among securities
which yield higher return for the
same risk or lower risk for the same
return.
Investors should also consider
Liquidity and Hedge against
Inflation
 Types of Investment
Broadly, investment can be
made in to two forms
I)Real investments: generally
involve some kind of
tangible asset, such as land,
machinery, factories, etc.
II) Financial investments:
involve contracts in paper
or electronic form such as
stocks, bonds, et
 contd..
Financial asset determines the
means by which individuals hold
their claims on real assets.
Real assets appear only on the
asset side of the balance sheet
where as Financial assets appear
both on asset side and liability side
of Balance Sheet.
When we aggregate overall Balance
Sheet, Financial asset will cancel
out leaving only the sum of real
assets as net wealth of
aggregate economy.
 Direct and Indirect
Direct
investment
investing: realized using financial
markets
investors buy and sell financial assets and
manage individual investment portfolio
themselves.
Indirect investing: involves financial
intermediaries
investors buy and sell financial instruments of
financial intermediaries (financial institutions)
which invested large pools of funds and hold
portfolios.
The risk for investor is related more with the
credibility of chosen institution. For example
through Investment companies
 Investment companies
A corporation or trust engaged in the
business of investing the pooled capital
of investors in financial securities.
Are business entities, both privately
and publicly owned, that manage, sell,
and market funds to the public.
They typically offer investors a variety
of funds and investment services
including
portfolio management, recordkeeping,
custodial, legal, accounting and tax
management services.
 Investment companies
With an investment company:
you gain access to a wider
range of investments
your investment is managed
by an expert fund manager
you make an investment
that includes a share of all
those assets
 Investment alternatives
There are various investment
alternatives
Short term investment vehicles: such
as Certificates of deposit, Treasury bills,
Commercial paper
Fixed income securities: such as
Preference shares and Debentures.
Common stock;
Speculative investment vehicles; such
as Options; Futures; forward contracts and
swaps
Real estate
Gold, Precious and Aesthetic articles.
 Investment attributes
When considering investments,
investors usually consider the
following attributes
Expected Return : benefit from the
investment
Risk: the possibility that the realized return
will be different than the expected return
Marketability: the feasibility of converting
of the asset into cash quickly and without
affecting its price significantly
Tax benefit: the tax saving from the
investment
Convenience : ability to buy or sell portion
of investment when needed (divisibility)
Investment Constraints
Liquidity
Age
Need for regular
income
Risk Tolerance
Tax liability
INVESTMENT DECISION
PROCESS
An organized view of the
investment process
involves analyzing the basic
nature of
investment decisions and
organizing the
activities in the decision process.
traditionally it is divided into a
two-step process:
security analysis and
portfolio management.
 SECURITY ANALYSIS
Involves the analysis and valuation
of individual security.
The valuation of securities
require:
Understanding the characteristics
of the various securities and the
factors that affect them
Knowledge of valuation model to
estimate the price of securities
Valuation is a function of
expected return and risk.
 PORTFOLIO MANAGEMENT
Portfolio management involves initial portfolio
construction, revision and the evaluation of
portfolio performance.
After securities have been evaluated, a portfolio
should be selected.
the smart investor must consider how and when to
revise it.
Portfolio Management strategies:
A passive investment strategy: involves
determining the desired investment proportions
and assets in a portfolio and maintaining these
proportions and assets, making few changes.
Active investment strategy: involves specific
decisions to change the investment proportions
chosen, or the assets in a particular category
frequently.
 .
Contd
A typical investment
decision undergoes a five-
step procedure:
1.Determine the investment
objectives and policy
2.Undertake Security analysis
3.Construct a portfolio
4.Review a portfolio
5.Evaluate the performance
of the portfolio
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