MODULE - VII

PORTFOLIO  A grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closed-fund counterparts.  Portfolios are held directly by investors and/or managed by financial professionals.  Prudence suggests that investors should construct an investment portfolio in accordance with risk tolerance and investing objectives.  Think of an investment portfolio as a pie that is divided into into pieces of varying sizes representing a variety of asset classes and/or types of investments to accomplish an appropriate risk-return portfolio allocation.

 For example, a conservative investor might favor a portfolio with large cap value stocks, broad-based market index funds, investment-grade bonds and a position in liquid, high-grade cash equivalents.  In contrast, a risk loving investor might add some small cap growth stocks to an aggressive, large cap growth stock position, assume some high-yield bond exposure, and look to real estate, international, and alternative investment opportunities for his or her portfolio.

Portfolio Management  The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against. performance.  Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk.

Who is a Portfolio Manager?  Any person who pursuant to a contract or arrangement with a client, advises or directs or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise) the management or administration of a portfolio of securities or the funds of the client, as the case may be is a portfolio manager.

Difference between a discretionary portfolio manager and a non- discretionary portfolio manager  The discretionary portfolio manager individually and independently manages the funds of each client in accordance with the needs of the client in a manner which does not partake character of a Mutual Fund,  whereas the non-discretionary portfolio manager manages the funds in accordance with the directions of the client.

What is the procedure of obtaining registration as a portfolio manager from SEBI  One should register with the SEBI  An applicant for registration or renewal of registration as a portfolio manager is required to pay a non-refundable application fee of Rs.1,00,000/- (Rupees one lac only) by way of demand draft drawn in favour of ‘Securities and Exchange Board of India’, payable at Mumbai.  The fee has to be forwarded to the Treasury & Accounts Division at the below mentioned address.

PORTFOLIO MANAGEMENT THEORY

Harry M. Markowitz theory  Portfolio theory is an investment approach developed by University of Chicago economist Harry M. Markowitz ( ), who won a Nobel Prize in economics in  A Nobel prize winning economist who devised the modern portfolio theory in  Markowitz's theories emphasized the importance of portfolios, risk, the correlations between securities and diversification.  His work changed the way that people invested.

Highlights of markowitz model  He assumes market is efficient and all investors have information of the market.  It was his position that a portfolio's risk could be reduced and the expected rate of return could be improved if investments having dissimilar price movements were combined.  All investors have common goal of investment

 Investors base their decisions on the expected rate of return only  According to him a portfolio needs information in N(N+3)/2 Equation. I.e a portfolio of 100 securties would require 100(100+3)/2=5150  Investors have portfolio which are patient, aggressive and conservative

TYPES OF PORTFOLIO STRATEGIES:  A. Passive Portfolio Strategy  B. Active Portfolio Strategy

Passive Portfolio Strategy A strategy that involves minimal expectation input, and instead relies on diversification to match the performance of some market index. A passive strategy assumes that the marketplace will reflect all available information in the price paid for securities.

Active Portfolio Strategy A strategy that uses available information and forecasting techniques to seek a better performance than a portfolio that is simply diversified broadly.

TYPES OF PORTFOLIOS:  The Patient Portfolio  The Aggressive Portfolio  The Conservative Portfolio

The Patient Portfolio  This type invests in well-known stocks. Most pay dividends and are candidates to buy and hold for long periods... Perhaps forever!  The vast majority of the stocks in this portfolio represent classic growth companies, those that can be expected to deliver higher earnings on a regular basis regardless of economic conditions.

The Aggressive Portfolio  This portfolio invests in "expensive stocks" (in terms of such measurements as price-earnings ratios) that offer big rewards but also carry big risks.  This portfolio "collects" stocks of rapidly growing companies of all sizes, that over the next few years are expected to deliver rapid annual earnings growth.  Because many of these stocks are on the less- established side, this portfolio is the likeliest to experience big turnovers over time, as winners and losers become apparent.

The Conservative Portfolio  They choose stocks with an eye on yield, as well as earnings growth and a steady dividend history.

 Prior to Markowitz's theories, emphasis was placed on picking single high-yield stocks without any regard to their effects on portfolios as a whole. Markowitz's portfolio theory would be a large stepping stone towards the creation of the capital asset pricing model.  Portfolio theory allows investors to estimate both the expected risks and returns, as measured statistically, for their investment portfolios.

 Markowitz described how to combine assets into efficiently diversified portfolios. It was his position that a portfolio's risk could be reduced and the expected rate of return could be improved if investments having dissimilar price movements were combined.

 In other words, Markowitz explained how to best assemble a diversified portfolio and proved that such a portfolio would likely do well.

Sharpe’s Model  William Sharpe simplified the Markowitz method of diversification of portfolios.  Sharpe developed an index model reducing the data in a substantive manner referring a portfolio to Dow Jones industrial average index. In India it can be referred to Sensex or nifty.

 He assumed that the securities not only have individual relationship but they are related to each other through some indexes represented by business activity.  Sharpes model takes into consideration 3n+2 kinds of information.

Capital Asset Pricing Model - CAPM  A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.  The general idea behind CAPM is that investors need to be compensated in two ways: Time value of money and Risk.

 The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time.  The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk.  This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).

 The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium.  If this expected return does not meet or beat the required return, then the investment should not be undertaken.  The security market line plots the results of the CAPM for all different risks (betas).  Using the CAPM model and the following assumptions, we can compute the expected return of a stock: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2 and the expected market return over the period is 10%, the stock is expected to return 17% (3%+2(10%-3%)).

Expected Questions  Define Investment  What is Portfolio?  What is Speculation?  Differentiate between Speculation and Gambling.  What is arbitrage?  What is an index?  What is systematic risk  What is NAV  What is P/E of Share  Give the economic objective of investments.  What is discounting  What is compounding

 State the features of Markowitz model of portfolio theory  What is Gilt Edged securities  What is hybrid securities  What is Badla Transaction.  What is Auction market?  What is record date?  What is Bonus shares  What is intrinsic value of shares  What is FII and FDI?  What is Blue chip shares?  What is commercial papers  What is interest rate risk?  What is Gambling?  What is fundamental analysis  What is technical analysis

 What is EPS?  What is forward trading?  State the feature of william sharpe model.  What is Put and Call option?  How do you compute Rate of Return?  State the investment avenues?  State the regulatory funcations of stock exchange  What is SEBI  Define risk.  What is CAPM  What is ADR and GDR?  What is Growth shares  What is sweat equity?  What is certificate of deposits  What is capital Gain  State the securities eligible for tax rebate u/s 88

Section – B  Discuss the significance of savings and investments in an economy.  Define investment. Distinguish between investment from speculation and Gambling  What is portfolio? Discuss the Portfolio management process.  Discuss in detail the fixed income investment alternatives.  What are the factors influencing investment decisions?  What is systamtic risk? Discuss its effect on investment decisions?  Discuss the risk perception and attitude of indian investors  Discuss the profile of indian investors  State the characteristic features of financial instruments  Discuss the William sharpes model and its relevance in practical investment scenario.

 How risk and return of equity investment can be measured? Explain with examples.  Discuss the significance of beta in the portfolio.  Discuss the process involved in making investment decisions and highlight the factors to be considered in the decision process  How is a fundamental analysis useful to a prospective investor?  What is the meaning of company analysis? What financial statements in your opinion are helpful in understanding the company prospectus.  The three important elements of investment are risk, return and timing. Elaborate.  Find the present value of the bond when par value is Rs.100, coupon rate is 15% and current market price is Rs.90. The bond has a six year maturity value and has premium of 10%.

Section - c  Discuss in detail the systematic and unsystematic risk of a portfolio.  “Investment is an imperative element of capital formation” discuss  “Stock exchanges are economic barometers of the country” Discuss  Discuss in detail the influence of fundamental factors on the investments.  What is technical analysis? Explain its significance in securities transaction.  The three important elements of investment are risk, return and timing. Elaborate.  What is portfolio management? Discuss steps involved in portfolio building?  “No savings no investment” Justify.  What do you mean by financial assets? Expalin the different financial assets available in india for investment

 Explain the Role of SEBI in indian capital market  Discuss the role of Stock exchanges in india  What is IPO? Discuss the proceedure involved in the IPO.  Discuss the functions of stock exchange  Discuss the external factors influencing the investment decisions.  Define risk? Dicuss different measures of risk.  Discuss briefly the markowitz model.  Discuss briefly the willianm sharpes model.  What is CAPM? Discuss its importance in investment decions.