INVESTMENT AND CAPITAL MARKET:

Investment and Capital Market are corollary to each other. For efficient investment process, existence
of healthy capital market is a pre-requisite. Capital Market in India has witnessed growth and
structural changes, during the last two decades. The capital market of a country is the barometer of
that country’s economy and provides a mechanism for capital formation. The Indian economy is
growing at a fast pace due to the liberalization of the Indian economy and the 6 policies being adopted
by the Government of India. This raised the interest in the Indian capital market not only from
investors in India but also from the Foreign Institutional Investors. This also has resulted in the growth
of the stock exchange system in India. The capital market works as a mechanism to facilitate the
transfer of funds from the savers (investors) to the borrowers (issuers of securities). The transfer of
funds will be optimum if the capital market is efficient. The history of Indian capital markets spans
back 200 years, around the end of the 18th century. It was at this time that India was under the rule of
the East India Company. The capital market of India initially developed around Mumbai; with around
200 to 250 securities brokers participating in active trade during the second half of the 19th century.

SCOPE OF THE INDIAN FINANCIAL MARKET

The financial market in India at present is more advanced than many other sectors as it became
organized as early as the 19th century with the securities exchanges in Mumbai, Ahmedabad and
Kolkata. In the early 1960s, the number of securities exchanges in India became eight - including
Mumbai, Ahmedabad and Kolkata. Apart from these three exchanges, there was the Madras, Kanpur,
Delhi, Bangalore and Pune exchanges as well. Today there are 23 regional securities exchanges in
India. The Indian stock markets till date have remained stagnant due to the rigid economic controls. It
was only in 1991, after the liberalization process that the India securities market witnessed a flurry of
IPOs serially. The market saw many new companies spanning across different industry segments and
business began to flourish. The launch of the NSE (National Stock Exchange) and the OTCEI (Over the
Counter Exchange of India) in the mid 1990s helped in regulating a smooth and transparent form of
securities trading. The regulatory body for the Indian capital markets was the SEBI (Securities and
Exchange Board of India). The capital markets in India experienced turbulence after which the SEBI
came into prominence. The market loopholes had to be bridged by taking drastic measures.

FEATURES OF FINANCIAL MARKET IN INDIA:

 India Financial Indices - BSE 30 Index, various sector indexes, stock quotes, Sensex charts, bond
prices, foreign exchange, Rupee & Dollar Chart .

Indian Financial market news.

 Stock News - Bombay Stock Exchange, BSE Sensex 30 index, S&P CNX-Nifty, company information,
issues on market capitalization, corporate earning statements .

Fixed Income - Corporate Bond Prices, Corporate Debt details, Debt trading activities, Interest Rates,
Money Market, Government Securities, Public Sector Debt, External Debt Service.

Foreign Investment - Foreign Debt Database composed by BIS, IMF, OECD,& World Bank, Investments
in India & Abroad .

Global Equity Indexes - Dow Jones Global indexes, Morgan Stanley Equity Indexes.

 Currency Indexes - FX & Gold Chart Plotter, J. P. Morgan Currency Indexes

National and Global Market Relations

 Mutual Funds

 Insurance

 Loans

 Forex and Bullion

The capital market has two interdependent segments: the Primary Market and the Secondary Market.

PRIMARY MARKET OR NEW ISSUE MARKET:

Companies issue securities from time to time to raise funds in order to meet their financial
requirements for promotion, modernization, expansion, and diversification or for regular working
capital programmes. These securities are issued directly to the investors (both individual as well as
institutional) through the mechanism called primary market or new issue market. The primary market
refers to the set-up which helps the industry to raise funds by issuing different types of securities. The
primary market is that part of the capital markets that deals with the issue of new securities.
Companies, governments or public sector institutions can obtain funding through the sale of a new
stock or bond issue. This is typically done through a syndicate of securities dealers. The process of
selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an
initial public offering (IPO). Dealers earn a commission that is built into the price of the security
offering, though it can be found in the prospectus. Primary markets creates long term instruments
through which corporate entities borrow from capital market.

Features of primary markets are:

This is the market for new long term equity capital. The primary market is the market where the
securities are sold for the first time. Therefore it is also called the new issue market (NIM).

In a primary issue, the securities are issued by the company directly to investors

. The company receives the money and issues new security certificates to the investors

. Primary issues are used by companies for the purpose of setting up new business or for expanding
or modernizing the existing business.

The primary market performs the crucial function of facilitating capital formation in the economy.

The new issue market does not include certain other sources of new long term external finance, such
as loans from financial institutions. Borrowers in the new issue market may be raising capital for
converting private capital into public capital; this is known as "going public."

The financial assets sold can only be redeemed by the original holder.

Methods of issuing securities in the primary market:

Initial public offering An initial public offering (IPO) referred to simply as an "offering" or "flotation,"
is when a company (called the issuer) issues common stock or shares to the public for the first time.
An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is when an
unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or
both for the first time to the public. This paves way for listing and trading of the issuer's securities. The
sale of securities can be either through book building or through normal public issue.

Rights issue (for existing companies);

 A rights issue is an option that a company can opt for to raise capital under a secondary market
offering or seasoned equity offering of shares to raise money. The rights issue is a special form of shelf
offering or shelf registration. With the issued rights, existing shareholders have the privilege to buy a
specified number of new shares from the firm at a specified price within a specified time.[1] A rights
issue is in contrast to an initial public offering (primary market offering), where shares are issued to
the general public through market exchanges. Companies usually opt for a rights issue either when
having problems raising capital through traditional means or to avoid interest charges on loans.

Preferential issue. An issue of shares set aside for designated buyers, for example, the employees of
the issuing company.

Primary versus Secondary Markets: Primary markets are securities markets in which newly issued
securities are offered for sale to buyers. Secondary markets are securities markets in which existing
securities that have previously been issued are resold. The initial issuer raises funds only through the
primary market.

SECONDARY MARKET:

With primary issuances of securities or financial instruments, or the primary market, investors
purchase these securities directly from issuers such as corporations issuing shares in an IPO or private
placement, or directly from the federal government in the case of treasuries. After the initial issuance,
investors can purchase from other investors in the secondary market.

Meaning of Stock Exchange: Stock Exchanges are the organized securities markets regulating the
trading in shares, debentures and other securities in the interest of the investors.

Definition of Stock Exchanges: The Securities Contracts (Regulation) Act, 1956 defines a stock
exchange as "an association, organization or body of individuals, whether incorporate or not,
established for the purpose of assisting, regulating and controlling the business in buying, selling and
dealing in securities".
Functions of Stock Exchanges:

The role of a stock exchange in a capital market is as follows:-

(1) Ready and Continuous Market: The stock exchange provides a ready and continuous market for the
sale and purchase of securities.

(2) Bank Borrowing Facility: Securities listed on a stock exchange serve as a collateral security when an
investor needs funds from a bank.

(3) Promotes Capital Formation: Stock Exchanges promote capital formation as they encourage
investors to invest need funds from a bank.

(4) Safety and Fair Dealing: The Stock Exchange operates under rules and regulations framed by the
Central Government. The rules and regulations framed by the Central Government are in the interest
to ensure safety to the investors and whatever be their dealings, it should a fair one.

(5) Government Funding: Stock Exchanges helps the government to raise funds by selling shares and
debentures.

(6) Creation of Employment Opportunities: Stock Exchange creates a number of employment

opportunities to a number of brokers, sub brokers as they are the intermediaries through which shares
are being sold.

(7) Evaluation of Securities: Stock Exchanges helps to evaluate the worth of securities, as securities are
traded at a certain price on the stock market. Investors are able to determine the 11 real worth of
their holdings in the form of shares and debentures which are listed on the stock exchange.

(8) Industrial Development: The capital collected through shares and debentures can be put to
industrial use. With the capital, new industries can be started, existing ones can be expanded and
modernized and thereby enhancing the industrial development of a country.

(9) Clearing House of Securities: The Stock Exchanges acts as a clearing house of securities. It
facilitates easy and quick clearance of transactions of securities between the buyers and the sellers.

(10) Facilitates Flow of Capital: Stock Exchange facilitate the flow of capital to companies who have a
high potential to raise substantial funds.
Role of SEBI in monitoring the Stock Exchange

SEBI stands for Securities and Exchange Board of India. It was set up in April, 1988, as a strong need
was felt to protect the interest of the investors and to have a systematic and organized working of the
securities market. It started actually functioning when the SEBI Act was passed in 1992. The Act
empowered SEBI with necessary powers to regulate the activities connected with marketing of
securities and investment of Stock Exchanges, Portfolio Management, Stock Brokers, and Merchant
Banking etc.

Objectives of Securities & Exchange Board of India

There are three basic objectives of SEBI. They are as follows:-

(1) Towards Investors: To protect the interest of the investors.

(2) Towards Capital Issuers: It aims at creating a good market environment where capital issuers can
raise necessary funds.

(3) Towards Intermediaries: It wants to bring about professionalism among the brokers, stokers and
sub – brokers.

Powers and Functions of SEBI

(1) To protect investors Interest: SEBI is formed to protect the interest of the investors. It monitors
whether issuing companies, brokers, mutual funds are following the rules and regulations. It also gives
a hearing to the investor's complaints and grievances, if any, against the issuing companies brokers
etc.

(2) Regulating Working of Mutual Funds: SEBI regulates the working of mutual funds. It has laid down
certain rules and regulations that are needed to be followed. Failure to follow the regulations may
lead to cancellation of the registration of a mutual fund.

(3) Regulates Merchant Banking: SEBI has laid down certain regulations in respect of registration,
submission of half yearly results, code of conduct in respect of merchant banking, etc.
(4) Take over and Mergers: SEBI has issued guidelines to protect the interest of the investors in case of
take over and mergers.

(5) Restriction on Insider Trading: SEBI restricts insider trading activity. Its regulation states that, no
insider shall either on his own behalf or on behalf of any other person may deal in securities of a
company listed on any stock exchange on the basis of any unpublished price sensitive information.

(6) Regulates Stock Brokers Activities: SEBI has laid down the regulations in respect of brokers and
sub-brokers. Without being a registered member of SEBI, no broker or sub-broker can buy, sell or deal
in securities.

(7) Research and Publicity SEBI conducts survey and research in respect of investments and
opportunities. It also undertakes to publish two monthly bulletins called SEBI market review and SEBI
news letter.

(8) Guidelines on Capital Issues: SEBI has framed certain guidelines on capital issues which are
applicable to first public issue of new companies, first public issue by existing private held companies,
public issue by existing listed companies.

(9) Portfolio Management: SEBI has laid down certain regulations regarding portfolio management.
Without proper registration with SEBI, no person or institution can work as a portfolio manager.

(10) Other functions: There are some other functions also which are as follows:-

(i) It prevents unfair trade practices relating to the securities market.

(ii) It gives training to intermediaries in the securities market.

(iii) It promotes investor's education.

(iv) It conducts audits of the stock exchanges.

(v) It also conducts inquiries, and inspections

Online Stock Market Trading is an internet based stock trading facility. Investor can trade shares
through a website without any manual intervention from Stock Broker. In this case these Online Stock
Trading companies are stock broker for the investor . They are registered with one or more Stock
Exchanges. Mostly Online Trading Websites in India trades in BSE and NSE. There are two different
type of trading environments available for online equity trading.

Installable software based Stock Trading Terminals: These trading environment requires software to
be installed on investors computer. These software are provided by the stock broker. These softwares
require high speed internet connection. This kind of trading terminals are used by high volume intra
day equity traders.

Advantages:

 Orders directly send to stock exchanges rather then stock broker. This makes order execution
very fast.
 It provides almost each and every information which is required to a trader on a single screen
including stock market charts, live data, alerts, stock market news etc.

Disadvantages:

Location constrain - You cannot trade if you are not on the computer where you have

 installed trading terminal software. 14 It requires high speed internet connection.

 These trading terminals are not easily available for low volumn share traders

. Web (Internet) based trading application: These kind of trading environment doesn't require any
additional software installation. They are like other internet websites which investor can access from
around the world through normal internet connection. Below are few advantages and disadvantages
of Online Stock Market Trading .

Advantages of Online Stock Trading (Website based): Real time stock trading without calling or
visiting broker's office. Display real time market watch, historical datas, graphs etc. Investment in IPOs,
Mutual Funds and Bonds. Check the trading history; demat account balance and bank account balance
at any time. Provide online tools like market watch, graphs and recommendations to do analysis of
stocks. Place offline orders for buying or selling stocks. Set alert to inform you certain activity on the
stock through email or sms. Customer service through Email or Chat. Secure transactions.
Disadvantages of Online Stock Trading (Website based): Website performance - sometime the
website is too slow or not enough user friendly. Little long learning curve especially for people who
don’t know much about computer and internet. Brokerages are little high.

 SOME OF THE ONLINE STOCK MARKET TRADING WEBSITES:

1. ICICIDirect

2. Sharekhan

3. India bulls

4. 5Paisa

5. Motilal Oswal Securities

6. HDFC Securities

7. Reliance Money

8. IDBI Paisa Builder

9. Religare

10. Egoist

11. Networth Stock Broking

12. Kotak Securities

13. Standard Chartered-STCI Capital Markets Ltd

14. Angel Trade

15. HSBC Invest Direct

Things to do before opening Online Share Trading Account

1. Ask for Demo: Contact the broker who provide online trading service and ask him to give you a
demo of product.
2. Check if the broker trades in multiple stock exchanges. Usually most of the Online Trading Websites
trade in NSE and BSE in India.

3. Check the integration of Brokerage account, Demat account and Bank account.

4. Compare brokerages with other peer companies.

Standard document require to open an Online Trading Account

Proof of residence (Address proof)

o Driving license

o Voter's ID

o Passport

o Photo credit card

o Photo ration card

Investment

The money a person earns is partly spent and the rest saved for meeting future expenses. Instead of
keeping the savings idle he may like to use savings in order to get return on it in the future. This is
called Investment. The term investment refers to exchange of money wealth into some tangible
wealth. The money wealth here refers to the money (savings) which an investor has and the term
tangible wealth refers to the assets the investor acquires by sacrificing the money wealth. By investing,
an investor commits the present funds to one or more assets to be held for some time in expectation
of some future return in terms of interest or dividend and capital gain.“Investment may be defined as
an activity that commits funds in any financial/marketable or physical form in the present with an
expectation of receiving additional return in the future.” For example, a Bank deposit is a financial
asset, the purchase of gold is a physical asset and the purchase of bonds and shares is marketable
asset. “Investment is the commitment of current funds in anticipation of receiving larger inflow of
funds in future, the difference being the income”. An investor hopes to be compensated for (i)
forgoing present consumption, (ii) for the effects of inflation, and (iii) for taking a risk. Features: There
are three basic features common to all types of investment: 1. There is a commitment of present
funds. 2. There is an expectation of some return or benefits from such commitment in future, and 3.
There is always some risk involved in respect of return and the principal amount invested

OBJECTIVES OF INVESTMENT:

1. RETURN: Investors expect a good rate of return from their investments. Return from investment
may be in terms of revenue return or income (interest or dividend) and/or in terms of capital return
(capital gain i.e. difference between the selling price and the purchasing price). The net return is the
sum of revenue return and capital return. For example, an investor purchases a share (Face Value FV
Rs.10) for Rs.130. After one year, he receives a dividend of Rs.3 (i.e. 30% on FV of Rs.10) from the
company and sells it for Rs.138. His total return is Rs.11, i.e., Rs.3 + Rs.8. The normal rate of return is
Rs.11 divided by Rs.130 i.e., 8.46%. In the same case, if he is able to sell the share only for Rs.128, then
his net return is Re.1 (i.e., Rs.3 – Rs.2) only. The annual rate of return in this case is 0.77% (i.e., 1/130)
a) Expected Return: The expected return refers to the anticipated return for some future period. The
expected return is estimated on the basis of actual returns in the past periods. b) Realised Returns:
The realized return is the net actual return earned by the investor over the holding period.It refers to
the actual return over some past period.

2. RISK: Variation in return i.e., the chance that the actual return from an investment would differ
from its expected return is referred to as the risk. Measuring risk is important because minimizing risk
and maximizing return are interrelated objectives. There are two types of risk i.e. Systematic Risk and
Unsystematic Risk which is discussed in detail later in this chapter.

3. LIQUIDITY: Liquidity, with reference to investments, means that the investment is saleable or 4
convertible into cash without loss of money and without loss of time. Different types of investments
offer different type of liquidity. Most of financial assets provide a high degree of liquidity. Shares and
mutual fund units can be easily sold at the prevailing prices. An investor has to build a portfolio
containing a good proportion of investments which have relatively high degree of liquidity.Cash and
money market instruments are more liquid than the capital market instruments which in turn are
more liquid than the real estate investments. For ex, money deposited in savings a/c and fixed deposit
a/c in a bank is more liquid than the investment made in shares or debentures of a company.

4. SAFETY: An investor should take care that the amount of investment is safe. The safety of an
investment depends upon several factors such as the economic conditions, organization where
investment is made, earnings stability of that organization, etc. Guarantee or collateral available
against the investment should also be taken care of. For ex, Bonds issued by RBI are completely safe
investments as compared with the bonds of a private sector company. Like wise it is more safer to
invest in debenture than of preference shares of a company Accordingly, it is more safer to invest in
preference shares than of equity shares of a company, the reason being that in case of company
liquidation, order of payment is debenture holders, preference share holds and then equity share
holders.

5. TAX BENEFITS: Investments differ with respect to tax treatment of initial investment, return from
investment and redemption proceeds. For example, investment in Public Provident Fund (PPF) has tax
benefits in respect of all the three characteristics. Equity Shares entails exemption from taxability of
dividend income but the transactions of sale and purchase are subject to Securities Transaction Tax or
Tax on Capital gains. Sometimes, the tax treatment depends upon the type of the investor. The
performance of any investment decision should be measured by its after tax rate of 5 return. For
example, between 8.5% PPF and 8.5% Debentures, PPF should be preferred as it is exempt from tax
while debenture is subject to tax in the hands of the investors.

6. REGULARITY OF INCOME: The prime objective of making every investment is to earn a stable
return. If returns are not stable, then the investment is termed as risky. For example, return (i.e.
interest) from Savings a/c, Fixed deposit a/c, Bonds & Debentures are stable but the expected
dividends from equity share are not stable. The rate of dividend on equity shares may fluctuate
depending upon the earnings of the company.

CHARACTERISTICS OF INVESTMENT:

1. RETURN

2. RISK

3. SAFETY

4. LIQUIDITY

5. TIME HORIZON (Refer objectives of investment topic notes.

INVESTMENT & SPECULATION:

In speculation, there is an investment of funds with an expectation of some return in the form of
capital profit resulting from the price change and sale of investment. Speculation is relatively a short
term investment. The degree of uncertainty of future return is definitely higher in case of speculation
than in investment. In case of investment, the investor has an intention of keeping the investment for
some period whereas in speculation, the investor looks for an opportunity of making a profit and
“exitout” by selling the investment.

DIFFERENCES IN INVESTMENT & SPECULATION:

INVESTMENT ALTERNATIVES

One may invest in: Physical assets like real estate, gold/jewellery, commodities etc. and/or Financial
assets such as fixed deposits with banks, small saving instruments with post offices,
insurance/provident/pension fund etc. or Marketable assets - securities market related instruments
like shares, bonds, debentures, derivatives, mutual fund etc.

CLASSIFICATIONS OF INVESTMENT ACTIVITIES:

1. DIRECT INVESTING: Direct investing involves the buying and selling of securities by investors
themselves. The securities may be capital market securities such as shares, debentures or derivative
products, or money market instruments such as Treasury Bills, Commercial Bills, Commercial Papers,
Certificates of Deposits, or real assets such as land and building, house, etc or non-financial assets such
as gold, silver, art, antiques, etc.

2. INDIRECT INVESTING: Investors may not directly invest and manage the portfolio, rather they buy
the units of funds that hold various types of securities on behalf of the investors example, Mutual
funds, Public Provident fund (PPF), National Savings Scheme (NSS), National Savings Certificate (NSC),
and investment in Insurance Company schemes.

INVESTMENT PROCESS

Investment process of securities as follows:

1. Investment Policy: The government or the investor before proceeding into investment, formulates
the policy for the systematic functioning. The essential ingredients of the policy are the investible
funds, objectives and the knowledge about the investment alternatives and market.

a) Investible funds: The entire investment procedure revolves around the availability of investible
funds. The fund may be generated through savings or borrowings. If the funds are borrowed, the
investor has to be extra careful in the selection of investment alternatives. The return should be higher
than the interest he pays. Mutual funds invest their owner’s money in securities.

b) Objectives: The objectives are framed on the premises of the required rate of return, need for
regularity of income, risk perception and the need for liquidity. The risk taker’s objective is to earn
high rate of return in the form of capital appreciation, whereas the primary objective of the risk averse
(person not interested in taking risk) is the safety of the principal.
c) Knowledge: The knowledge about the investment alternatives and markets plays a key role in the
policy formulation. The investment alternatives range from security to real estate. The risk and return
associated with investment alternative differ from each other. Investment in equity is high yielding but
has more risk than in fixed income securities.

2. Security Analysis: After formulating the investment policy, the securities to be bought have to be
scrutinized through the market, industry and company analysis.

Market Analysis: The general economic scenario is reflected in the stock market. The growth in gross
domestic product and inflation are reflected in the stock prices. The recession in the economy results
in a bear market. The stock prices may be fluctuating in the short run but in the long run they move in
trends i.e. either upwards or downwards.

Industry Analysis: The industries that contribute to the output of the major segments of the economy
vary in their growth rates and their overall contribution to economic activity. Some industries grow
faster than the GDP and are expected to continue in their growth. For example, IT industry has higher
growth rate than the GDP in 1998. The economic significance and the growth potential of the industry
have to be analysed.

Company Analysis: The Company’s earnings, profitability, operating efficiency, capital structure and
management have to be analysed. These factors have direct bearing on the stock prices and the return
of the investors. Appreciation of the stock value is a function of the performance of the company.
Company with high product market share is able to create wealth to the investors in the form of the
capital appreciation.

3. Valuation: The valuation helps the investor to determine the return and risk expected from an
investment in the common stock.

Intrinsic Value: Intrinsic value is the present value of securities of all future cash inflows by using
simple discounting models.

Future Value: Future value of the securities could be estimated by using a simple statistical technique
like trend analysis. The analysis of the historical behaviour of the price enables the investor to predict
the future value.

Construction of Portfolio: A portfolio is a combination of securities. The portfolio is constructed in such

a manner to meet the investor’s goals and objectives.

Diversification: The main objective of diversification is the reduction of risk in the loss of capital and
income. A diversified portfolio is comparatively less risky than holding a single portfolio. Various types
of diversification are:

1) Debt – equity diversification

2) Industry diversification

3) Company diversification

Selection: Based on the diversification level, industry and company analyses the securities have to be
selected. Funds are allocated for the selected securities.

Evaluation: The portfolio has to be managed efficiently. The efficient management calls for evaluation
of the portfolio.

Appraisal: The return and risk performance of the security vary from time to time. The variability in
returns of the securities is measured and compared. The developments in the economy, industry and
relevant companies from which the stocks are bought have to be appraised. The appraisal warns the
loss and steps can be taken to avoid such losses.

Revision: Revision depends on the results of the appraisal. The low yielding securities with high risk
are replaced with high yielding securities with low risk factor. To keep the return at a particular level
necessitates the investor to revise the components of the portfolio periodically.

RISK Investors invest for anticipated future returns, but these returns can be rarely predicted. The
difference between the expected return and the realized return and latter may deviate from the 11
former. This deviation is defined as risk.

All investors generally prefer investment with higher returns, he has to pay the price in terms of
accepting higher risk too. Investors usually prefer less risky investments than riskier investments. The
government bonds are known as risk-free investments, while other investments are risky investments.
RISK Systematic Unsystematic Or Or Uncontrollable controllable

1. Market risk . Business risk

2. Interest rate risk . Financial risk

3. Purchasing power risk

SYSTEMATIC RISK

It affects the entire market. It indicates that the entire market is moving in particular direction. It
affects the economic, political, sociological changes. This risk is further subdivided into:

1. Market risk

2. Interest rate risk

3. Purchasing power risk.

1. Market risk: Jack Clark Francis defined market risk as “portion of total variability in return caused by
the alternating forces of bull and bear markets. When the security index moves upward for a
significant period of time, it is bull market and if the index declines from the peak to market low point
is called troughs i.e. bearish for significant period of time. The forces that affect the stock market are
tangible and intangible events. The tangible events such as earthquake, war, political uncertainty and
fall in the value of currency. Intangible events are related to market psychology. For example – In
1996, the political turmoil and recession in the economy resulted in the fall of share prices and the
small investors lost faith in market. There was a rush to sell the shares and stocks that were floated in
primary market were not received well.

2. Interest rate risk: It is the variation in single period rates of return caused by the fluctuations in the
market interest rate. Mostly it affects the price of the bonds, debentures and stocks. The fluctuations
in the interest rates are caused by the changes in the government monetary policy and changes in
treasury bills and the government bonds. Interest rates not only affect the security traders but also the
corporate bodies who carry their business with borrowed funds. The cost of borrowing would increase
and a heavy outflow of profit would take place in the form of interest to the capital borrowed. This
would lead to reduction in earnings per share and consequent fall in price of shares. EXAMPLE –In April
1996, most of the initial public offerings of many companies remained under subscribed, but IDBI &
IFC bonds were over subscribed. The assured rate of return attracted the investors from the stock
market to the bond market.

3. Purchasing power risk: Variations in returns are due to loss of purchasing power of currency.
Inflation is the reason behind the loss of purchasing power. The inflation may be, “demand-pull or
cost-push “. Demand pull inflation, the demand for goods and services are in excess of their supply.
The supply cannot be increased unless there is an expansion of labour force or machinery for
production. The equilibrium between demand and supply is attained at a higher price level. Cost-push
inflation, the rise in price is caused by the increase in the cost. The increase in cost of raw material,
labour, etc makes the cost of production high and ends in high price level. The working force tries to
make the corporate to share the increase in the cost of living by demanding higher wages. Hence,
Cost-push inflation has a spiraling effect on price level.

UNSYSTEMATIC RISK Unsystematic risk stems from managerial inefficiency, technological change in
production process, availability of raw materials, change in consumer preference and labour problems.
They have to be analysed by each and every firm separately. All these factors form Unsystematic risk.
They are 1. Business risk 2. Financial risk

1. BUISNESS RISK: It is caused by the operating environment of the business. It arises from the inability
of a firm to maintain its competitive edge and the growth or stability of the earnings. The variation in
the expected operating income indicates the business risk. It is concerned with difference between
revenue and earnings before interest and tax. It can be further divided into: Internal business risk
External business risk Internal business risk - it is associated with the operational efficiency of the
firm. The efficiency of operation is reflected on the company’s achievement of its goals and their
promises to its investors. The internal business risks are: Fluctuation in sales Research and
development Personal management Fixed cost Single product External business risk –It is the
result of operating conditions imposed on the firm by circumstances beyond its control. The external
business risk are, Social and regulatory factors Political risk Business cycle.

2. FINANCIAL RISK: It is the variability of the income to the equity capital due to the debt capital.
Financial risk is associated with the capital structure of the firm. Capital structure of firm consists of
equity bonds and borrowed funds. The interest payment affects the payments that are due to the
equity investors. The use of debt with the owned funds to increase the return to the shareholders is
known as financial leverage. The financial risk considers the difference between EBIT and EBT. The
business risk causes the variation between revenue and EBIT. The financial risk is an avoidable risk
because it is the management which has to decide how much has to be funded with equity capital and
borrowed capital.

BUY-SELL DECISION RULES FOR INVESTORS The intrinsic value working with the demand and supply
forces determine the price of security in market. The actual investment decision be made on the basic
of comparison of intrinsic value with the price. The rules are as follows,

BUY RULE: If the market price of a security is less than its value, it is an undervalued security and it
should be bought and held. Then, when price increases then it may be sold to make profit.

SELL RULE: If the market price of a security is more than its value, it is an overpriced and it should be
sold .Then, when price falls at later stage, it may be sold to make profit.

NO BUY-SELL: If the price is equal to its value then equilibrium exists. The security is correctly priced
and an investor may not make any profit from buying or selling

VALUATION OF SECURITIES

I. BOND YIELD Yield is a commonly used parameter in investment process. It is a common bench mark
for evaluating different investment instruments. It refers to the percentage rate of return on the
amount invested in buying one bond. Bond yield may or may not be same as the coupon rate. There
are various factors which it depends on,

1. Par value 2. Coupon rate 3. Maturity 4. Market price

PAR VALUE:

It is also called as face value or normal value. The par value of the bond is the principal amount of a
bond and is stated on the face of the bond security. The issue price may 16 be less than or more than
or equal to par value.
 COUPON RATE: It is the rate at which interest on par value of bond is payable as per payment
schedule. It represents a fixed annual monetary amount payable by borrower to lender. It may be paid
annually, semi-annually or even monthly. It is also called as Nominal Yield.

MATURITY: The maturity of bond refers to the period from date of issue, after the expiry of which the
redemption repayment will be made to the investor by the borrower firm. In India few firms have
issued unsecured bonds of maturity period 179 days. In International bank markets, the maturity
period will be 50 years or 100years. MARKET PRICE: An investor buys a bond from market, then the
return depends upon the price paid for the debt.

SECURITY ANALYSIS

FUNDAMENTAL ANALYSIS:

Fundamental analysis is the study of economic factors, industrial environment and the factors related
to the company. The earnings of the company, the growth rate and the risk exposure of the company
have a direct bearing on the price of the share. These factors in turn rely on the host of other factors
like economic development in which they function, the industry belongs to, and finally companies’
own performance. The fundamental school of thought appraised the intrinsic value of shares through
Economic Analysis Industry Analysis Company Analysis

ECONOMIC ANALYSIS: The state of the economy determines the growth of gross domestic product
and investment opportunities. An economy with favorable savings, investments, stable prices, balance
of payments, and infrastructure facilities provides a best environment for common stock investment. If
the company grows rapidly, the industry can also be expected to show rapidly growth and vice versa.
When the level of economic activity is low, stock prices are low, and when the level of economic
activity is high, stock prices are high reflecting the prosperous outlook for sales and profits of the
firms. The analysis of macro economic environment is essential to understand the behaviour of the
stock prices. The commonly analyzed macro economic factors are as follows:

Gross domestic product (GDP): GDP represents the aggregate value of goods and services produced
in the economy. It consists of personal consumption expenditure, gross private domestic investment
and government expenditure on goods & services and net export of goods & services. It indicates rate
of growth of economy. The estimate on GDP available on annual basis.

Business Cycle: Business cycles refer to cyclical movement in the economic activity in a country as a
whole. An economy marching towards prosperity passes through different phases, each known as a
component of a business cycle. These phases are: a. Depression: Demand level in the economy is very
low. Interest rates and Inflation rates are high. These affect profitability and dividend pay out and
reinvestment activities. b. Recovery: Demand level starts picking up. Fresh investment by corporate
firms shows increasing trend. c. Boom: After a consistent recovery for a number of years, the economy
starts showing signs of boom which is characterized by high level of economic activities such as
demand, production and profits. d. Recession: The boom period is generally not able to sustain for a
long period. It slows down and results in the recession.

3 Savings & investment:

The growth requires investment which in turn requires substantial amount of domestic savings. Stock
market is a channel through which the savings of investors are made available to the corporate bodies.
Savings are distributed over various assets like equity shares, deposits, mutual fund unit, real estate
and bullion. The saving and investment pattern of the public effect the stock to great extent.

Inflation:

The inflation is raise in price, where its rate increases, than the real rate of growth would be very little.
The demand is the consumer product industry is significantly affected. The industry which comes
under the government price control policy may lose the market. If the mild level of inflation, it is good
to the stock market but high rate of inflation is harmful to the stock market.

Interest rates: The interest rate affects the cost of financing to the firms. Higher interest rates
increase the cost of funds and lower interest rates reduce the cost of funds resulting in higher profit.
There are several reasons for change in interest rates such as monetary policy, fiscal policy, inflation
rate, etc,

Monetary Policy, Money supply and Liquidity: The liquidity in the economy depends upon the money
supply which is regulated by the monetary policy of the government. RBI regulate the money supply
and liquidity in the economy. Business firms require funds for expansion projects. The capacity to raise
funds from the market is affected by the liquidity position in the economy. The monetary policy is
designed with an objective to maintain a balance in liquidity position. Neither the excess liquidity nor
the shortage are desirable. The shortage of liquidity will tend to increase the interest rates while the
excess will result in inflation.

Budget: The budget draft provides an elaborate account of the government revenues and
expenditures. A deficit budget may lead to high rate of inflation and adversely affect the cost of
production. Surplus budget may result in deflation. Hence, balanced budget is highly favourable to the
stock market.

Tax structure: Every year in March, the business community eagerly awaits the government’s
announcement regarding the tax policy. Concessions and incentives given to the certain industry
encourage investment in particular industry. Tax relief given to savings encourages savings. The
minimum alternative tax (MAT) levied by finance minister in 1996 adversely affected the stock market.
Ten years of tax holiday for all industries to be set up in the northeast is provided in the 1999 budget.
The type of tax exemption has impact on the profitability of the industries.

Monsoon and agriculture: 4 Agriculture is directly and indirectly linked with the industries. For
example, sugar, cotton, textile and food processing industries depend upon agriculture for raw
material. Fertilizer and insectide industries are supplying inputs to agriculture. A good monsoon leads
to higher demand for input and results in bumper crop. This would lead to buoyancy in the stock
market. When the monsoon is bad, agricultural and hydro power production would suffer. They cast a
shadow on a share market.

Infrastructure facilities: Infrastructure facilities are essential for the growth of industrial and
agricultural sector. A wide network of communication system is a must for the growth of the economy.
Good infrastructure facilities affect the stock market favourably. The government are liberalized its
policy regarding the communication, transport and power sector.

Demographic factors: The Demographic data provides details about the population by age,
occupation, literacy and geographic location. This is needed to forecast the demand of customer
goods. The population by age indicates the availability of able work force.

Economic forecasting: To estimate the stock price changes, an analyst the macro economic
environment and the factor peculiar to industry concerned to it. The economic activities affect the
corporate profits, Investors, attitude and share prices.

Economic indicators: The economic indicators are factors that indicate the present status, progress
or slow down of the economy. They are capital investment, business profits, money supply, GNP,
interest rate, unemployment rate, etc. The economic indicators are grouped into leading, coincidental
and lagging indicators. The indicators are selected on the following criteria Economic significance,
Statistical adequacy, Timing, conformity.

Diffusion index: Diffusion index is a composite index or consensus index. The diffusion index consist
of leading, coincidental and lagging indicators. This type of index has been constructed by the National
Bureau of Economic Research in USA. But it is complex in nature to calculate and the irregular
movements that occur in individual indicators cannot be completely eliminated.

Econometric model building: For model building several economic variables are taken into
consideration. The assumptions underlying the analysis are specified. The relationship between the
independent and dependent variables is given mathematically. While using the model, the analyst has
to think clearly all inter-relationship between the variables. This model use simultaneous equations.

Other factors: a. Industrial growth rate 5 b. Fiscal policy of the Government c. Foreign exchange
reserves d. Growth of infrastructural facilities e. Global economic scenario and confidence f. Economic
and political stability.
INDUSTRY ANALYSIS An industry is a group of firms that have similar technological structure of
production and produce similar products. E.g.: food products, textiles, beverages and tobacco
products, etc. These industries can be classified on the business cycle i.e. classified according to their
relations to the different phases of the business cycle. They are classified into Growth industry
Cyclical industry Defensive industry Cyclical Growth industry

Growth industry: The growth industry has special features of high rate of earnings and growth in
expansion, independent of the business cycle. The expansion of the expansion of the industry mainly
depends upon the technological change.

Cyclical industry: The growth and the profitability of industry move along with the business cycle.
During the boom period they enjoy the growth and during depression they suffer set back.

Defensive industry: Defensive industry defies the movement of business cycle. The stock of defensive
industries can be held by the investor for income earning purpose. They expand and earn income in
the depression period too, under the government’s of production and are counter-cyclical in nature.

Cyclical Growth industry This is a new type of industry that is cyclical and at the same time growing.
The changes in technology and introduction of new models help the automobile industry to resume
their growth path. INDUSTRY LIFE CYCLE The life cycle of the industry is separated into four well
defined stages such as o Pioneering stage o Rapid growth stage o Maturity and stabilization stage o
Declining stage

SWOT ANALYSIS FOR THE INDUSTRY

Strength: Strength of the industry refers to its capacity and comparative advantage in the economy.
For example, the existing research and development facilities and greater dependence on allopathic
drugs are two elements of strength to the pharmaceutical industry in India.

Weakness: Weakness refers to the restrictions and inherent limitations in the industry, which keep
the industry away from meeting its target. For example, Lack of infrastructure facility, rail-road links,
etc., are weakness of the tourism industry in India.

Opportunities: Opportunities refers to the expectation of favourable situation for an industry. For
example, with increase in purchasing power with the people, demand for pharmaceutical industry will
increase and likewise, changing preference from gold to diamond jewellary has brought a lot of
opportunities for the diamond industry.

Threats: Threat refers to an unfavourable situation that has a potential to endanger the existence of
an industry. For example, after liberalization of import policy in India, import of Chinese goods has
threatened many industries in India, such as toys, novelties, etc.
COMPANY ANALYSIS

Effect of a business cycle on an individual company may be different from one industry to another.
Here, the main point is the relationship between revenues and expenses of the firm and the economic
and industry changes. The basic objective of company analysis is to identify better performing
companies in an industry .These companies would be identified for investment. The processes that
may be taken up to attain the objective are as follows: a. Analysis of management of the company to
evaluate its trust-worthiness, capacity and efficiency. b. Analyse the financial performance of the
company to forecast its future expected earnings. c. Evaluation of long-term vision and strategies of
company in terms of organizational strength and resources of company. d. Analysis of key success
factor for particular industry.

SOURCES OF INFORMATION: Information and data required for analysis of earnings of a firm are
primarily available in the annual financial statements of the firm. It include, Balance sheet or Position
statement Income statement or Profit & Loss account. Financial statement analysis (Ratio
analysis) Cash flow statement, the statement of sources and uses of cash and also Top level
management people in the company.

BALANCE SHEET (BS): It is the most significant and basic financial statement of any firm. It is prepared
by a firm to present a summary of financial position at a given point of time, usually at the end of
financial year. It shows the state of affairs of the firm at a point of time. In fact, the total assets must
be equal to the total claim against the firm and this can be stated as, Total assets =Total claim (Debt
+Share holders) =Liabilities +Share holders equity 9 The different items contained in BS can be grouped
into, 1. Assets 2. Liabilities 3. Shareholder’s funds. a.

ASSETS: An asset of the firm represents the investments made by the firm in order to generate
earnings. It can be classified into (a).Fixed Asset (b).Current assets.

FIXED ASSET – Those which are intended to be for a longer period .These are permanent in nature,
relatively less liquid and are not easily converted into cash in short run. Fixed asset include, plant &
machinery, furniture & fixtures, buildings, etc. The value of fixed asset is known as book value, which
may be different from market value or replacement cost of the assets. The amount of depreciation is
anon-cash expense and does not involve cash out flow. It is taken as an expense item and is included in
the cost of goods sold or indirect expense.

CURENT ASSET - It is the liquid asset of the firm and is convertible into cash within a period of one
year. It includes cash and bank balance, receivables, inventory (raw material, finished goods, etc),
prepaid expenses, loan, etc.

LIABILITIES: It is also called as debts. It is claimed by the outsiders against the assets of the firm. The
liabilities refer to the amount payable by the firm to the claim holders. The liabilities are classified into
long term and short term liabilities.
LONG TERM LIABILITIES: It is the debt incurred by the firm, which is not payable during the period of
next one year. It represents the long term borrowings of the firm.

CURRENT LIABILITITES: It is the debt which the firm expects to pay within a period of one year. It is
related to the current assets of the firm in the sense that current liabilities are paid out of the
realization of current assets.

SHAREHOLDERS EQUITY (SE): It represents the ownership interest in the firm and reflects the
obligations of the firm towards its owners. It the direct contribution of the shareholders to the
firm.The retained earnings on the other hand reflects the accumulated effect of the firms earnings. SE
is also called as net worth. The liabilities and the SE must be equal to the total assets of the firm.

II.INCOME STATEMENT OR PROFIT & LOSS ACCOUNT (IS): It shows the result of the operations of the
firm during a period. It gives detail sources of income and expenses; Income statement is a flow report
against the balance sheet which is a stock report or status report. It helps in understanding the
performance of the firm during the period under consideration. It can be grouped into three classes. (i)
Revenues (ii) Expenses & (iii) Net profit or loss

REVENUES- It is the inflow of resources\cash that arise because of operation of the firm. The revenue
arises from the sale of goods and services to the customer and other non-operating incomes. The firm
may also get revenue from the use of its economic resources elsewhere. E.g. – some of the 10 funds
might have been invested in some other firm. The income by way of interest or dividend is also a
revenue.

EXPENSES- The cost incurred in the earning the revenues is called the expenses. Expenses like, salaries,
general expenses, repairs, etc. It occurs when there is a decrease in assets or increase in liabilities

III.CASH FLOW STATEMENT AND FUND FLOW STATEMENT: The balance sheet and the income
statement are the two common financial statements and are also known as traditional financial
statements. It is essential to know the movement of cash during the period. It is a historical record of
where the cash came from and how was it used.

IV. FINANCIAL STATEMENT ANALYSIS: Financial statement analyses are ratio like: a.Profitability ratios
b. Liquidity ratios c.Solvency ratios

TECHNICAL ANALYSIS It is a process of identifying trend reversal at earlier stages to formulate the
buying and selling strategy. With the help of various indicators they analyse the relationship between
price& volume, supply & demand, etc. An investor who does this analysis is called technician.

ASSUMPTIONS:

1. The market value is determined by the interaction of supply and demand. 2. The market
discounts everything. The information regarding the issuing of bonus shares and right issues
may support the prices. These are some of the factors which cause shift in demand & supply
 and change in direction of trends. 3. The market always moves in trend, except for certain
minor deviations. The trend may either be increasing or decreasing. It may continue in same
manner or reverse. 4. In the rising market, many purchase shares in greater volume. When the
market moves down, people are interested in selling it. The market technicians assume that
past prices predict the future.

MARKET INDICATORS

Market indicators are a subset of technical indicators used to predict the direction of major
financial indexes or groups of securities. Most market indicators are created by analyzing the
number of companies that have reached new highs relative to the number that created new lows,
known as market breadth, since it shows where the overall trend is headed. Market Breadth
indicators compare the number of stocks moving in the same direction as a larger trend. For
example, the Advance-Decline Line looks at the number of advancing stocks versus the number of
declining stocks. Market Sentiment indicators compare price and volume to determine whether
investors are bullish or bearish on the overall market. For example, the Put Call Ratio looks at the
number of put options versus call options during a given period.

MOVING AVERAGES

Moving averages "smooth" price data by creating a single flowing line. The line represents the
average price over a period of time. Which moving average the trader decides to use is determined
by the time frame in which he or she trades. For investors and long-term trend followers, the 200-
day, 100-day and 50-day simple moving average are popular choices. There are several ways to
utilize the moving average. The first is to look at the angle of the moving average. If it is mostly
moving horizontally for an extended amount of time, then the price isn't trending, it is ranging. If
the moving average line is angled up, an uptrend is underway. Moving averages don't predict
though; they simply show what the price is doing, on average, over a period of time. Crossovers
are another way to utilize moving averages. By plotting a 200-day and 50-day moving average on
your chart, a buy signal occurs when the 50-day crosses above the 200-day. A sell signal occurs
when the 50-day drops below the 200-day. The time frames can be altered to suit your individual
trading time frame

When the price crosses above a moving average, it can also be used as a buy signal, and when the
price crosses below a moving average, it can be used as a sell signal. Since price is more volatile
than the moving average, this method is prone to more false signals, as the chart above shows.
Moving averages can also provide support or resistance to the price. The chart below shows a 100-
day moving average acting as support (i.e., price bounces off of it)
PORTFOLIO MANAGEMENT

“Never put all your eggs in one basket” is what is meant by diversification. Instead of investing all
funds in one asset, the funds be invested in a group of assets. Diversification helps in reducing the risk
of investing. Total risk of one investment is the sum of the impact of all the factors that might affect
the return from that investment. However, investors need not suffer risk inherent with individual
investments as it could be reduced by holding a diversity of investments. For example, return from a
single investment in a cold drink company is subject to weather conditions. This investment is a risky
investment. However, if a second investment can be made in an umbrella company, which is also
subject to weather changes, but in an opposite way, the return from the portfolio of two investments
will have a reduced risk-level. This process is known as diversification.

Portfolio is the combination of securities or diversified investment in securities.

Diversification may be Random or Efficient diversification.

In Random diversification, an investor may randomly select the portfolio without analyzing the risk
and return of the securities.

In Efficient diversification, an investor may construct a portfolio by carefully studying and analyzing the
risk and return of individual securities and also of its portfolio.

APPROACHES IN PORTFOLIO CONSTRUCTION: Traditional Approach & Modern Approach

1. STEPS IN TRADITIONAL APPROACH: Analysis of constraints: Analysing the constraints like, income
needs, liquidity, time horizon, safety, tax consideration and risk temperament of an investor.
Determination of objectives: The objective of the portfolio range from income to capital
appreciation. Investor has to decide upon the return which he gets from the portfolio like, current
income, growth in income, capital appreciation and so on. Selection of Portfolio: a) Selecting the type
of securities for investment i.e. Shares and Bonds or Bonds or Shares, b) Calculating the risk and
return of the securities and c) Diversifying the investment by selecting the securities combination and
its proportion of investment in that securities.
2. MODERN APPROACH: The traditional approach is a comprehensive job for the individual. In modern
approach, gives more attention on selecting the portfolio i.e. Markowitz Model as well as CAPM.
(These are discussed in Unit IV).

PORTFOLIO MANAGEMENT: Portfolio management may be defined as the process of construction,

maintenance, revision and evaluation of a portfolio. The objective of portfolio management is to build
a portfolio which gives a return commensurate with the risk preference of the investor. Portfolio
management specifically deals with security analysis, analysis and selection of portfolio, revision of
portfolio and evaluation of portfolio.

POINTS TO BE CONSIDERED:

Deciding the number and type of security in the portfolio.

 Deciding on the proportionate amount of investment in each security.

 Develop the various combinations of portfolio based on risk and return of portfolio.

 Select one combination using Markowitz Model or Capital Asset Pricing Model (CAPM).

 Evaluate the performance of the portfolio using Treynor’s, Sharpe’s or Jensen’s Model.

 Periodical revision of the portfolio in order to maximize the portfolio returns

PORTFOLIO SELECTION

Risk and return are two basic factors for construction of a portfolio. While constructing a portfolio, an
investor wants to maximize the return and to minimize the risk. The risk can be reduced by
diversification. A portfolio which has highest return and lowest risk is termed as an optimal portfolio.
The process of finding an optimal portfolio is known as the portfolio selection. If the investments can
be made with certainty of returns, then the returns from different investments would be the only
consideration for making portfolio. However, in case of uncertainty, decision regarding investments
cannot be made only on the basis of returns. Risk (uncertainty) should also be considered. The
following are the theoretical relationship between the risk and return and can be used to construct a
portfolio.

MARKOWITZ MODEL or PORTFOLIO THEORY

 CAPITAL ASSET PRICING MODEL

 MARKOWITZ MODEL or PORTFOLIO THEORY

In order to select the best portfolio, an investor can use the Markowitz Portfolio Model. 5 The
development of Portfolio theory is given by Harry Markowitz (HM) in1952 in Journal of Finance. He has
provided a conceptual framework and analytical tool for selection of an optimal portfolio. As the HM
Model is based on the expected returns (mean) and standard deviation (variance) of different
portfolios, this model is also called as Mean-Variance Model.

ASSUMPTIONS:

1. The investor should invest only in risky securities; this means no investment should be made in risk-
free securities.

2. The investor should use his own funds. Borrowed funds are not allowed for investments.

3. The decision of the investor regarding selection of the portfolio is made on the basis of expected
returns and risk of the portfolio

PORTFOLIO EVALUATION

Portfolio evaluation is the process of measuring and comparing the returns (actually) earned on a
portfolio with returns (estimates) for a benchmarks.

Evaluation factors:

1. Risk-return Trade-off: The performance evaluation should be based on risk and return not on either
of them. Risk without return and return without risk level are impossible to be interpreted. Investors
are risk-averse. But it does not mean that they are not ready to assume risk. They are ready to take
risk provided the return is commensurate. So, in the portfolio performance evaluation, risk-return
trade-off be taken care of.

2. Appropriate Market Index: The performance of one portfolio is benchmarked either against some
other portfolio (for comparative position) or against some market index.

3. Common Investment Time Horizon: Investment period horizon of the portfolio being evaluated and
the time horizon of the benchmark must be same. Suppose, a mutual fund scheme announces that it
has earned the highest return, it must be verified before accepting whether the highest return has
been earned during current year or during last 3 years or 5 years, etc.

4. Objectives or Constraints of Portfolio: The objectives for which the portfolio has been created has
to be evaluated.

Measures of Portfolio Performance: There are several measures for evaluation of portfolio
performance. They are

I. Return per unit of risk:

The return earned over and above the risk-free return is the risk-premium and is earned for bearing
risk. The risk-premium may be divided by risk factor to find out the reward per unit of risk undertaken.
This is also known as reward to risk ratio. There are two methods of measuring reward to risk ratio:

a) Sharpe Ratio (Reward to Variability Ratio) : The Sharpe Index measures the risk premium of the
portfolio relative to the total amount of risk in the portfolio. The larger the index value, the better the
portfolio has performed. RP – IRF Sharpe Ratio = ------------ σP

b) Treynor Ratio (Reward to Volatility Ratio): The Treynor Index measures the risk premium of the
portfolio related to the amount of systematic risk present in the portfolio. RP – IRF Treynor Ratio = ----
------- βP 19
II.Differential Return:

c) Jensen Ratio: Michel Jensen has developed another method for evaluation of performance of a
portfolio. This measure is based on differential returns. The Jensen’s Ratio is based on the difference
between the actual return of a portfolio and required return of a portfolio in view of the risk of the
portfolio. α Jensen’s Index = ----- β αP = RP - RS RP = Acutal Return on portfolio RS = Expected Return
on portfolio RS = IRF + (RM – IRF) β

PORTFOLIO REVISION

The care taken in the construction of portfolio should be extended to review and revision of the
portfolio. Volatility (fluctuation) that occur in the equity prices cause substantial gain/loss to the
investors. The investor should have competence and skill in the revision of portfolio. There are 3
important plans for revising the portfolio.

They are:

Constant rupee plan

Constant ratio plan

Variable ratio plan

1. Constant rupee plan: The constant rupee plan enables the shift of investment ftrom bonds to
stock and vice versa, by maintaining a constant amount invested in stock portion of portfolio. The
constant rupee plan starts from fixed amount of money invested in selected stocks and bonds.
When price of stocks increases, the investor sells sufficient amount of stock to return to the
original amount of investment in stock. By keeping the value of aggressive portfolio constant,
remainder (balance) is invested in the conservative portfolios. The plan force the investor to sell
when the price rise and purchase as price falls.

2 Variable Ratio Plan: Instead of maintaining a constant rupee amount in stock or constant ratio of
stock is to bonds, the variable ratio plan steadily lowers (by selling) the aggressive portion of the total
portfolio as stock price increases and steadily increases (by purchasing) the aggressive portion when
stock price falls and new ratio is adopted