investments & risk
TRANSCRIPT
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Investments Scenario
Risk and Return
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Introduction
Investment Decisions
Favourable Factors
Modes of Investment
Investment Programme
Process of Investment
Risk and Returns
Overview
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Investment is defined asthe employment of funds,with the aim of achievingadditional income or some
growth in its value.
Investment involves the
commitment of resources.
Savings is primary source of
investments, via sacrifices
made in current consumption
Element of hope that benefits
will accrue in the future.
Economic definition Invt. is theallocation of monetary resources
to assets that are expected to
yield some gain or positive returns
over a given period of time.
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Importance of Investment decisions LongerLife Expectancy Savings, by themselves do not
increase wealth. Higher pay scales, tough life-styles, early
retirements and longer life spans necessitate investments.
Inflation rising inflation (excess of 12%) erodes savings.
Investments must be in avenues that earn higher than the rateof inflation.
Interest Rates interest rates play an important role in
investments. Stability of interest and its relation to risk should
be considered prior to investments.
Taxation consideration must be given to investments
directed towards reducing tax liability.
Income higher income more savings better investment
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Favourable Factors
Higher Investments needsfavourable environment forits proper functioning andgrowth. Influencing factors:
Social, Economic, Political.
a. Legal safeguards: a stablegovt. ensures adequate legal
protection, thus encouraging
savings and investments.
b. Stable currency: organized
monetary system, sound plans
and policies. Keeping inflation
in check, stable price levels.
c. Financial Inst.: better mobility
to savings, conversion into
productive invt. Manage risk,
liquidity, provide marketability.
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Modes of Investments
Fixed Principle Investment: Savings A/c, Fixed Deposit
NSC, Govt. Bonds
Variable Principle Investment:
Equity & Preference shares
Convertible debentures
Non-security Investments:
Real Estate, Commodities
Business ventures
Art, antiques, valuables
Indirect Investments:
Provident / Pension fund
Insurance
Mutual Funds, UTI
Saver
Investor
Shares, bonds,
Govt. security
Cash
Bank
deposits
P.F, LIC,NSC,
Post off.
Land,
flats
Gold,
silver
Consumer
durables
Capital Market
New issues Stock market
Marketable assets
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Investment Programme
# Safety ofPrincipal safety of principal amount is the primaryconcern. Thus, industry & economic trends must be reviewed.
Investments should be in diverse spheres to reduce risk.
# Liquidity minimum liquidity is important for emergency
situations. Thus, investments in highly liquid assets is essential
# Income Stability regularity of income at a consistent rate is
necessary in any investment pattern. Adequacy of income after
taxes should be the main consideration.
# Capital appreciation a high capital growth is required for
maintenance of purchasing power, i.e. counter inflation effect
# Legality all investments must be legal. All applicable laws
must be studied, e.g. minors, trust, shares, insurance etc.
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Investment Steps
InvestmentAnalysis
InvestmentAnalysis
InvestmentPolicy
InvestmentPolicy
SecuritiesValuationSecuritiesValuation
PortfolioConstruction
PortfolioConstruction
Present worth
Future benefit
Value comparison
Combine results
Basic principles
Satisfy needs Invest timing
Diversified Set objectives
Future needs
Preferences
Prepare Policy
Industry review
Security analysis
Trend study
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Investments in capital markets are in various types of financialinstruments, which are claims on money. These are known assecurities in the market language.
Security Analysis & Portfolio Mgt.
Security as per Securities Contracts (Regulation) Act, 1956, a
security includes shares, scrips, stocks, bonds, debentures orany other marketable securities of like nature, derivatives, unitsof MF, govt. securities, and rights / interests in such securities.
Security Analysis involves projection of future dividends or
earnings flow, forecast of the share price in future & estimatingthe intrinsic value of a security, based on the above estimations.
Security Analysis involves fundamental analysis of security,risk-return analysis, safety of funds & projection of future returns
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Portfolio - a combination of various securities, with differentrisk-return characteristics constitutes a portfolio of an investor.
Security Analysis & Portfolio Mgt.
Portfolio Management portfolio mgt. involves analysis of therisk return characteristics of individual securities in a portfolio,and changes that may take place in combination with othersecurities, due to interaction among themselves and impact ofeach one of them on others.
Portfolio Management is the investment of funds in suchcombination of different securities in which the total risk of theportfolio is minimized, while expecting maximum return from it.
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Risk and uncertainty are anintegral part of investments.
Risk refers to the variability of
outcome from the expected.
In order to analysis risk, one
should identify risk and must be
able to measure risk.
Risk should not be avoided, butit must be managed.
Understanding and measuring
risk is fundamental to the whole
investment process.
Risk
To have a higher return, an
investor must accept the fact
that he will face greater risks
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Systematic Risk
Associated with the market
Non-diversifiable risk, uncontrollable risk
Depends on economic, sociological, political, legal factors
E.g. economy growth, Govt. stability, inflation, interest rate
Unsystematic Risk
Related to the company, its unique features
Diversifiable and controllable risk
Depends on the internal aspect of a business
E.g. new product launch, new competitor, labour strike,
shortage of raw material etc.
Risk classification
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Unsystematic Risk divided into Business risk & Financial risk
Business risk is the variation from the pre-defined operating
level of a company. E.g. if expected EBIT is 15% and actuals
are 10% or 18%, it would be said that business risk is high.
Internal business risk may be due to the conservative nature of
the management. External business risk include cyclical
variations (age-wise & seasonal), changes in monetary policy.
Low fixed expenses, cost cutting help reduce business risks.
Financial risk depends on capital structure of the company, i.e.the debt-equity ratio / degree of financial leverage.
Large debt component increases the risk of uncertain returns to
shareholders, and thus increases risk.
Earnings must always be higher than cost of borrowings.
Risk classification (contd.)
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Risk Measurement
Beta ()
Measure of non-diversifiable risk of a stock of a portfolio
Beta measures the relationship of the portfolio risk with respect
to the market risk / deviations.
Beta of a portfolio is the weighted average of the betas of thesecurities that constitute the portfolio.
Beta = 1 indicates average risk, i.e. portfolio returns are similar
to market returns. Beta > 1 indicates high risk, i.e. portfolio
returns are more riskier than market returns. Beta < 1 indicateslow risk, i.e. portfolio returns are less riskier than market returns.
It is an key evaluation tool of risk measurement for investors.
Beta = Systematic risk of asset portfolio
Risk of market portfolio
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Risk Measurement
Alpha ()
Alpha is a risk-adjusted measure of the active return on an
investment. It is a measure of assessing active performance of
the return in excess of a benchmark index.
Alpha measures the stocks diversifiable risk and its averagereturn independent of the markets return.
Thus, alpha judges the efficiency of investment manager to
create wealth in all types of market conditions.
It favours active investment strategy against passive (anybodycan earn in a rising market i.e. market trends)
If alpha is gives a positive value, it is a healthy sign since it
indicates value creation (in the economic sense)
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Risk Measurement
Correlation Coefficient (r)
Correlation coefficient between two securities measures the
relationship between two securities in a portfolio.
Correlation coefficient of + 1.0 indicates a direct relationship
between two stocks, and 1.0 implies inverse relationship. R=0,implies no correlation between the securities.
Also known as Rho
Standard Deviation ()
Standard Deviation is the degree of spread / range, away fromthe expected returns.
Greater the standard deviation of returns, higher is the risk in
the investment
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Risk Measurement Coefficient ofVariation ()
Coefficient of Variation is a relative measure of risk.
CV is useful for comparing projects with the same standard
deviation but different returns or same returns but different
standard deviations.
Higher the CV implies higher is the relative risk.
Co-efficient of Variation (CV) = Std. deviation
Expected return
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The major purpose of investment
is an expected return.
Returns includes dividends, rent,
interest, capital appreciation etc.
The most important feature of
financial assets are the size and
variability of their future returns.
As returns on investment fluctuate,
various techniques are used to
measure it.
Returns
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Normal Returns = Cash income
Amount invested
Current Yield on Bonds = Annual coupon
Purchase price
Yield to Maturity Bonds = Coupon + (Maturity Par value) / Period
(Maturity + Par value) / 2
Return on stocks = Dividend + (current price purchase price)
Purchase price
Returns Measurement