Master of Business Administration- MBA Semester 3 MF0010 Security Analysis and Portfolio Management- 4 Credits (Book ID: B1754)

Assignment Set -1 Q1. Describe the investment process. Answer: Any investor who sincerely works towards making the most of the current market trend will never underestimate the importance of having an investment strategy predefined before he starts investing. Nevertheless, importance of a well-defined and suitable investment strategy cannot be underestimated. An investment strategy defines how an investor should go about choosing securities to invest in. It is a basic guide for where to invest, when to invest and how much to invest. There are five important steps in an investment process which should not be neglected. They are: 1. Defining an Investment strategy/policy 2. Analyzing securities 3. Constructing a portfolio to minimize risk 4. Evaluating the performance of the portfolio, and 5. Revising the portfolio An investor cannot define his investment strategy unless he defines his investment objective and investment surplus to his disposal. Objective of 'making more money' is very vague. Of course everyone wants to make more money! Objectives have to be clearly defined in terms of risk and return. Understanding the relationship between risk and return will go a long way while building a portfolio that can provide optimum returns for the amount of risk an investor can take. The second step of analyzing securities enables the investor to distinguish between underpriced and overpriced stock. Return can be maximized by investing in stocks which are currently underpriced but have the potential to increase (remember buy low sell high).

Q2. Explain money market features and its compositions. Answer: The Indian money market is a market for short-term money and financial asset that are close substitutes for money, which are close substitute for money, with the short-term in the Indian context being for 1

year. The important feature of the money market instruments is that it is liquid and can be turned quickly at low cost. The money market is not a well-defined place where the business is transacted as in the case of capital markets where all business is transacted at a formal place, i.e. stock exchange. The money market is basically a telephone market and all the transactions are done through oral communication and are subsequently confirmed by written communication and exchange of relative instruments. Features of Money Market: 1. It is a collection of market for following instruments- Call money, notice money, repos, term money, treasury bills, commercial bills, certificate of deposits, commercial papers, inter-bank participation certificates, inter-corporate deposits, swaps etc 2. The sub markets have close inter- relationship & free movement of funds from one sub-market to another 3. A network of large number of participants exist which will add greater depth to the market. 4. Activities in the money market tend to concentrate in some centre, which serves a region or an area. The width of such area may vary depending upon the size and needs of the market itself. 5. The relationship that characterizes a money market is impersonal in character so that competition is relatively pure. 6. Price differentials for assets of similar type will tend to be eliminated by the interplay of demand & supply. 7. A certain degree of flexibility in the regulatory framework exists and there are constant endeavors for introducing a new instruments innovative dealing techniques. 8. It is a wholesale market & the volume of funds or financial assets traded are very large i.e. in crores of rupees. Composition and Structure of Money market Structure means support on the basis body will stand. So there are following components which support the whole money market. In the structure of money market, there are two components are included 1st Composition or component Financial institution There are two parts of financial institution in money market:a) organized sector In this sector there following dealer who deal short term loans in money market. I) RBI :- RBI means reserve bank of India. This is central bank of India. It is issue short term loan when any bank has any need of short term money. II) Commercial Banks:- In commercial banks, there are SBI , Nationalize bank , rural banks , private banks which deals in short term loans with each other , one bank can take or give short term loan to each other when they need or extra money , they want to invest in short term govt. security. III) Co-operative banks:- The co-operative banks are also take part in money market. In the top dealer in this market is state cooperative bank. In the district level central cooperative bank do dealing in short term loan. b) Unorganized Sector In this sector, indigenous banks, money lenders deal with each other or with organized sector. 2nd Composition or component Financial Instruments or papers 1) Call money market Call money market is the market which deals in short term loans. This loan can be given for one hour to one or two days .This call loans is given without any security. The borrower or loan taker will repay the loan at call. So this loan is also called call loan in this market. The rate of this loan is very high. II) Treasury bill Market

Treasury bills are the bill which is issued by central govt. This bill is sold by RBI on the behalf of Govt. There is dealing of treasury bills in treasury bill market. The main dealer of T.B is the UTI & LIC. This is 90 loan acceptance bills. This bill can be discounted from any other bank. III) Commercial bill market a) Promissory Notes: - In this bill, the loan taker give the promise to pay certain amount after certain period. b) Bill of exchange Under this bill firms can sell the good. In this bill, loan giver orders that his amount must be given to him or to his ordered person after certain period. This bill can also be discounted from bank. Q3. Discuss the factors affect industry analysis. Answer: Factors affecting industrial analysis are as follows: 1. Sensitivity to the business cycle Different industries respond differently to recessions and expansions. For example, while the heavy goods industries (i.e. steel manufacturers) will be severely affected in a recession, consumer goods (i.e. food & beverage firms) will probably be much less affected. During a severe inflationary period, regulated industries such as utilities will be severely hurt by their inability to pass along all price increases. Some industries perform better when the economy is booming, while others do so during times of economic declines. This is because the demand for the products of different industries differs at different times. For example, pharmaceuticals generally outperform the rest of the market during economic recessions, because people do not stop using medicine even during difficult economic times. Technology stocks, on the other hand, typically boom when the economy is expanding and interest rates are low. This allows young technological firms to borrow funds to expand and develop their operations, at low borrowing costs. Thus, an investors investment strategy may be determined depending on how each industry performs during varying economic cycles. During an economic upturn, investors may choose growth stocks, such as technology shares, as a suitable investment, while during economic decline; investors may focus on less volatile stocks that are well-established, such as banking. Therefore, fundamental analysis helps investors choose which industry is the most suitable to invest in, during a given economic period. Most industries can either be categorized as defensive or cyclical. Defensive industries are those that sell goods that people consume, irrespective of the state of the economy, such as food or pharmaceuticals. Their performance tends to be relatively steady in bad times, but earnings wont usually increase proportionately with an upswing in the economic cycle. Cyclical industries are those whose fortunes change with the rise and fall of the economy. The profitability of cyclical industries is closely tied to a particular economic cycle. For example, the profitability of consumer durables is dependent on the business cycle: they sell more in expansions and less in recessions. 2. Industry life cycle Most industries go through fairly well-defined life cycle stages that affect the growth of companies in that industry, competition climate, the types of profit margins, and overall stability of the market. The industry life cycle has a major effect on the earnings per share and rates of return offered by the industry. As a result, the ability to recognize the industry life cycle stage is a valuable asset for any investor. Many observers believe that industries evolve through at least three stages: the pioneering stage, the expansion stage, and the stabilization stage. The concept of an industry life cycle can apply to industries or product lines within industries. Each of the three stages is described briefly below: 1. Pioneering stage: During this stage, rapid growth in demand occurs. Although a number of companies within a growing industry fail at this stage as a result of strong competitive pressures, many experience rapid growth in sales and earnings, possibly at an increasing rate. Investor risk in an unproven company is high, but so are expected returns if the company succeeds. 2. Expansion stage: During this stage, the survivors from the pioneering stage are identifiable. The survivors continue to grow and prosper, but the rate of growth is more moderate than before. During the expansion stage, industries improve their products and sometimes lower their prices. The companies competing in an expanding industry are more stable and, consequently, attract considerable investment

capital. This is because investors are more willing to invest in these industries as they have proven their potential and reduced their risk of failure. Toward the later period of this stage, dividends often become payable, further enhancing the attractiveness of these companies to a number of investors. 3. Stabilization stage (or maturity stage): During this stage, growth begins to be moderate. Sales may still be increasing, but at a much slower rate than before. Products become more standardized and less innovative, the marketplace is full of competitors, and costs are stable rather than decreasing through efficiency moves. Industries at this stage continue to move along but without significant growth. Stagnation may occur for a considerable period of time. The three-part classification of industry life cycle described above helps investors to assess the growth potential of different companies in an industry. The pioneering stage may offer the highest potential returns, but it also poses the greatest risk. Investors interested primarily in capital gains should avoid the maturity stage. Companies at this stage may have relatively high dividend payouts, because they have fewer growth prospects. On the other hand, these companies often offer stability in earnings and dividend growth. It is the expansion stage that is probably of most interest to investors. Industries that have survived the pioneering stage often offer good opportunities, since the demand for their products and services is growing more rapidly than the economy as a whole. Growth is rapid but orderly, which is an appealing characteristic to the investors.

Q4. Differences between fundamental and technical analysis. Answer: The key difference between technical analysis and fundamental analysis are as follows. 1. Technical analysis mainly seeks to predict short-term price movements, whereas fundamental analysis tries to establish along term values. 2. The focus of technical analysis is mainly on internal market data, particularly price and volume data. The focus of fundamental analysis is on fundamental factors relating to the economy, the Industry and the firm. 3. Technical analysis appeals mostly to short term traders, whereas fundamental analysis appeals primarily to long term investor. 4. Technical analyst looks backward whereas fundamental analysis looks forward as well as backward. 5. Technical analyst thinks that stocks market behavior is 10% logical and 90% psychological whereas fundamental analyst thinks that the stocks market is 90% logical and 10% psychological.

Q5. Explain the implications of EMH for security analysis and portfolio management. Answer: The efficient market hypothesis (EMH) relates to informational efficiency and the fair pricing function as opposed to operational efficiency. The essence of the EMH is that so

many people watch the marketplace that few if any individuals can consistently make windfall profits by picking stocks better than the next person.There are three forms of the EMH. The weak form sa ys that past prices, or charts, are of no value in predicting future stock price performance. The semistrong form says that securityprices already fully reflect all relevant publicly available information. The strong form of the EMH includes private, inside information as well. Considerable empirical research supports the semistrong form; however, we know that insiders can make illegal profits. The random walk theory does not state that security prices move randomly. Rather it maintains that the news arrives randomly, and that in accordance with the EMH security prices rapidly adjust to this random arrival of news For Security Analysis: The efficient market debate plays an important role in the decision between active and passive investing. Active managers argue that less efficient markets provide the opportunity for skillful managers to outperform the market. However, it is important to realize that a majority of active managers in a given market will under perform the appropriate benchmark in the long run whether or not the markets are efficient. This is because active management is a zero-sum game in which the only way a participant can profit is for another less fortunate active participant to lose. However, when costs are added, even marginally successful active managers may under perform the market. By and large, the performance record of professionally managed funds does not support the claims that active managers can consistently beat the market. The empirical evidence is that investing in passively managed funds such as index fund has outperformed actively managed funds for the last several decades. Thus, it is difficult to beat the market consistently over time. If markets are efficient, then what is the role for investment professionals? Those who accept the EMH generally reason that the primary role of a portfolio manager consists of analyzing and investing appropriately based on an investor's tax considerations and risk profile. Optimal portfolios will vary according to factors such as age, tax bracket, risk aversion, and employment. The role of the portfolio manager in an efficient market is to tailor a portfolio to those needs, rather than to beat the market. For Portfolio management: The portfolio manager must choose a portfolio that is geared toward the time horizon and risk profile of the investor. The appropriate mixture of securities may vary according to the age, goals, tax bracket, employment, and risk aversion of the investor. Investors should follow a passive investment strategy, which makes no attempt to beat the market. This does not mean that there is no role for portfolio management. Returns can be optimized through diversification and asset allocation, and by minimization of investment costs and taxes. Public information cannot be used to earn abnormal returns (that is, returns above the normal level for that risk class). Therefore, the implication is that fundamental analysis is a waste of time and money and as long as market efficiency is maintained, the average investor should buy and hold a suitably diversified-portfolio. This would also avoid the costs of analysis and transaction.

Q6. What is Capital Asset Pricing Model(CAPM)? Write the assumptions of CAPM. Answer: The Capital Asset Pricing Model (CAPM) is a model to explain why capital assets are priced the way they are. The CAPM was based on the supposition that all investors employ Markowitz Portfolio Theory to find the

portfolios in the efficient set. Then, based on individual risk aversion, each of them invests in one of the portfolios in the efficient set. Note, that if this supposition is correct, the Market Portfolio would be efficient because it is the aggregate of all portfolios. Recall Property I - If we combine two or more portfolios on the minimum variance set, we get another portfolio on the minimum variance set. The capital asset pricing model (CAPM) helps us to calculate investment risk and what return on investment we should expect. Here we look at the formula behind the model, the evidence for and against the accuracy of CAPM, and what CAPM means to the average investor. So, in conclusion, the following line states the CAPM as: The CAPM is an equilibrium model that specifies the relationship between risk and required rate of return for assets held in well-diversified portfolios.

Assumptions of the CAPM Investors all think in terms of a single holding period. All investors have identical expectations. Investors can borrow or lend unlimited amounts at the risk-free rate. All assets are perfectly divisible. There are no taxes and no transactions costs. All investors are price takers that is, investors buying and selling wont influence stock prices. Quantities of all assets are given and fixed.