equity research 3

7/18/2019 Equity Research 3

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SECURITY ANALYSIS

AND

PORTFOLIO MANAGEMENT

DR N.N.SENGUPTA



NATURE OF INDIAN STOCK MARKET

Indian Stock Markets are one of the odest in Asia!

Its histor" dates #ack to near" $%% "ears a&o! The eariest records of sec'rit"

deain&s in India are (ea&re and o#sc're!

Indian stock (arkets ha)e not on" &ro*n +'st in n'(#er of e,chan&es- #'t aso in

n'(#er of isted co(.anies and in ca.ita of isted co(.anies! The re(arka#e

&ro*th after /012 can #e cear" seen- and this *as d'e to the fa)o'rin& &o)ern(ent

.oicies to*ards sec'rit" (arket ind'str"!

Tradin& in Indian stock e,chan&es are i(ited to isted sec'rities of .'#ic i(ited

co(.anies! The" are #road" di)ided into t*o cate&ories3

S.ecified Sec'rities 4for*ard ist5Non6S.ecified Sec'rities 4cash ist5!



T*o t".es of transactions can #e carried o't on the Indian stock e,chan&es3

Spot Delivery Transactions 7for dei)er" and .a"(ent *ithin the ti(e or on

the date sti.'ated *hen enterin& into the contract *hich sha not #e (ore

than /8 da"s foo*in& the date of the contract7 !

4#5 Forar! Transactions 7dei)er" and .a"(ent can #e e,tended #" f'rther

.eriod of /8 da"s each so that the o)era .eriod does not e,ceed 0% da"s

fro( the date of the contract7!

The nat're of tradin& on Indian Stock E,chan&es are that of a&e od

con)entiona st"e of face6to6face tradin& *ith #ids and offers #ein& (ade#" o.en o'tcr"! 9o*e)er- there is a &reat a(o'nt of effort to (oderni:e the

Indian stock e,chan&es in the )er" recent ti(es!



T"PES OF S#ARES

Shares in the co(.an" (a" #e si(iar i!e the" (a" carr" the sa(e ri&hts and

ia#iities and confer on their hoders the sa(e ri&hts- ia#iities and d'ties!

There are t*o t".es of shares 'nder Indian Co(.an" La* 36

/!E$UIT" S#ARES % That .art of the share ca.ita of the co(.an" *hich are

not .reference shares!

$!PREFERENCE S#ARES% Shares *hich f'fi the foo*in& $ conditions!

It carries Preferentia ri&hts in res.ect of Di)idend at fi,ed a(o'nt or at fi,ed

rate i!e! di)idend .a"a#e is .a"a#e on fi,ed fi&'re or .ercent and this di)idend

('st .aid #efore the hoders of the e;'it" shares can #e .aid di)idend!

It aso carries .referentia ri&ht in re&ard to .a"(ent of ca.ita on *indin& '. orother*ise! It (eans the a(o'nt .aid on .reference share ('st #e .aid #ack to

.reference sharehoders #efore an"thin& in .aid to the e;'it" sharehoders! In

other *ords- .reference share ca.ita has .riorit" #oth in re.a"(ent of di)idend

as *e as ca.ita!



T"PES OF PREFERENCE S#ARES

/!CUMU&ATI'E OR NON CUMU&ATI'E 3 A non6c'('ati)e .reference shares

&i)es ri&ht to fi,ed .ercenta&e di)idend of .rofit of each "ear! C'('ati)e

.reference shares ho*e)er &i)e the ri&ht to the .reference sharehoders tode(and the 'n.aid di)idend in an" "ear d'rin& the s'#se;'ent "ear or "ears *hen

the .rofits are a)aia#e for distri#'tion !

$!REDEEMA(&E OR NON REDEEMA(&E S#ARES3 Redee(a#e Preference

shares are .reference shares *hich ha)e to #e re.aid #" the co(.an" after the

ter( of *hich for *hich the .reference shares ha)e #een iss'ed!

Irredee(a#e Preference shares (eans .reference shares need not re.aid #" the

co(.an" e,ce.t on *indin& '. of the co(.an"! 9o*e)er- 'nder the Indian

Co(.anies Act- a co(.an" cannot iss'e irredee(a#e .reference shares!

<!PARTICIPATING OR NON PARTICIPATING PREFERENCE S#ARES 3

Partici.atin& Preference shares are entited to a .referentia di)idend at a fi,ed

rate *ith the ri&ht to .artici.ate f'rther in the .rofits either aon& *ith or after

.a"(ent of certain rate of di)idend on e;'it" shares! A non6.artici.atin& share is

one *hich does not s'ch ri&ht to .artici.ate in the .rofits of the co(.an" after the

di)idend and ca.ita ha)e #een .aid to the .reference sharehoders!



=ONDS AND MONEY MAR>ET SECURITIES

A sec'rit" is a f'n&i#e- ne&otia#e instr'(ent re.resentin& financia )a'e!

Sec'rities are #road" cate&ori:ed into de#t and e;'it" sec'rities! The co(.an"or other entit" iss'in& the sec'rit" is caed the iss'er!

Sec'rities (a" #e re.resented #" a certificate or- (ore t".ica"- #" an eectronic

#ook entr" interest! The" inc'de shares of cor.orate stock or ('t'a f'nds-

#onds iss'ed #" cor.orations or &o)ern(enta a&encies- stock o.tions or other

o.tions- i(ited .artnershi. 'nits- and )ario's other for(a in)est(ent

instr'(ents that are ne&otia#e and f'n&i#e!

A =ond is a de#t sec'rit"- in *hich the a'thorised iss'er o*es the hoders a de#t

and is o#i&ed to re.a" the .rinci.a and interest at a ater date- ter(ed (at'rit"!!

A #ond is si(." a oan- #'t in the for( of a sec'rit"- atho'&h ter(inoo&" 'sed

is rather different! The iss'er is e;'i)aent to the #orro*er- the #ond hoder to the

ender- and the co'.on to the interest! =onds ena#e the iss'er to finance on&6ter( in)est(ents *ith e,terna f'nds!



PRIMAR" AND SECONDAR" MARKET

Sec'rities &enera" ha)e t*o sta&es in their ifes.an!

The first sta&e is *hen the co(.an" initia" iss'es the sec'rit" direct" fro( its

treas'r" at a .redeter(ined offerin& .rice! This is a PRIMARY MAR>ET offerin&! It

is referred to as the initia .'#ic offerin& 4IPO5! In)est(ent deaers fre;'ent" #'"initia offerin&s on the .ri(ar" (arket and rese the sec'rities on the SECONDARY

MAR>ET!

In the .ri(ar" (arket- sec'rities are offered to .'#ic for s'#scri.tion for the

.'r.ose of raisin& ca.ita or f'nd! Secondar" (arket is an e;'it" tradin& a)en'e in

*hich aread" e,istin&?.re6 iss'ed sec'rities are traded a(on&st in)estors!

Secondar" (arket co'd #e either a'ction or deaer (arket! @hie stock e,chan&e

is the .art of an a'ction (arket- O)er6the6Co'nter 4OTC5 is a .art of the deaer

(arket



MAKERS OF T#E MARKET

A 7(arket (aker7 is a fir( or a .erson that stands read" to #'" and se a

.artic'ar stock on a re&'ar and contin'o's #asis at a .'#ic" ;'oted .rice!

Market (akers that stand read" to #'" and se stocks isted on an e,chan&e-s'ch as the Ne* York Stock E,chan&e- are caed 7third (arket (akers!7 Man"

OTC stocks ha)e (ore than one (arket6(aker!

Most stock e,chan&es o.erate on a (atched #ar&ain or order dri)en #asis! In

s'ch a s"ste( there are no desi&nated or officia (arket (akers #'t (arket

(akers ne)ertheess e,ist! @hen a #'"ers #id (eets a seers offer 4or )ice

)ersa5 the stock e,chan&es (atchin& s"ste( *i decide that a dea has #een

e,ec'ted!



NSE) NATIONA& STOCK E*C#ANGE

The Nationa Stock E,chan&e *as incor.orated in /00$ #" Ind'stria

De)eo.(ent =ank of India- Ind'stria Credit and In)est(ent Cor.oration ofIndia- Ind'stria Finance Cor.oration of India- a Ins'rance Cor.orations-

seected co((ercia #anks and others!

Tradin& at NSE can #e cassified 'nder t*o #road cate&ories3

4a5 @hoesae de#t (arket and

4#5 Ca.ita (arket!

@hoesae de#t (arket o.erations are si(iar to (one" (arket o.erations 6

instit'tions and cor.orate #odies enter into hi&h )a'e transactions in financia

instr'(ents s'ch as &o)ern(ent sec'rities- treas'r" #is- .'#ic sector 'nit

#onds- co((ercia .a.er- certificate of de.osit- etc!

There are t*o kinds of .a"ers in NSE3

4a5 tradin& (e(#ers and

4#5 .artici.ants!



Reco&ni:ed (e(#ers of NSE are caed TRADING MEM=ERS *ho trade on

#ehaf of the(se)es and their cients!

Partici.ants inc'de tradin& (e(#ers and ar&e .a"ers ike #anks *ho take

direct sette(ent res.onsi#iit"!

NSE #rin&s an inte&rated stock (arket tradin& net*ork across the nation!

In)estors can trade at the sa(e .rice fro( an"*here in the co'ntr" sinceinter6(arket o.erations are strea(ined co'.ed *ith the co'ntr"*ide access

to the sec'rities!

Ca.ita (arket #ein& one of the (a+or so'rce of on&6ter( finance for

ind'stria .ro+ects- India cannot afford to da(a&e the ca.ita (arket .ath! In

this re&ard NSE &ains )ita i(.ortance in the Indian ca.ita (arket s"ste(!



O'ER T#E COUNTER E*C#ANGE OF INDIA +OTCEI,

OTCEI 6 *as created in /00$ #" co'ntr"s .re(ier financia instit'tions 6 Unit Tr'stof India- Ind'stria Credit and In)est(ent Cor.oration of India- Ind'stria

De)eo.(ent =ank of India- S=I Ca.ita Markets- Ind'stria Finance Cor.oration of

India- Genera Ins'rance Cor.oration and its s'#sidiaries and Can=ank Financia

Ser)ices!

Tradin& at OTCEI is done o)er the centres s.read across the co'ntr"! Sec'rities

traded on the OTCEI are cassified into3

LISTED SECURITIES 6 The shares and de#ent'res of the co(.anies isted on the

OTC can #e #o'&ht or sod at an" OTC co'nter a o)er the co'ntr" and the"

sho'd not #e isted an"*here ese!

PERMITTED SECURITIES 6 Certain shares and de#ent'res isted on other

e,chan&es and 'nits of ('t'a f'nds are ao*ed to #e traded!

INITIATED DE=ENTURES 6 An" e;'it" hodin& ateast one akh de#ent'res of a

.artic'ar scri. can offer the( for tradin& on the OTC!



OTC has a 'ni;'e feat're of tradin& co(.ared to other traditiona e,chan&es!

That is- certificates of isted sec'rities and initiated de#ent'res are not traded atOTC!

AD'ANTAGES OF OTC E*C#ANGE NET-ORK%

OTCEI has *ide" dis.ersed tradin& (echanis( across the co'ntr" *hich

.ro)ides &reater i;'idit" and esser risk of inter(ediar" char&es!

Greater trans.arenc" and acc'rac" of .rices is o#tained d'e to the screen6

#ased scri.ess tradin&!

Faster sette(ent and transfer .rocess co(.ared to other e,chan&es!

In the case of an OTC iss'e 4ne* iss'e5- the aot(ent .roced're is co(.eted

in a (onth and tradin& co((ences after a (onth of the iss'e cos're- *hereas

it takes a on&er .eriod for the sa(e *ith res.ect to other e,chan&es!



INTERCONNECTED STOCK E*C#ANGES +ISE,

ISE endea)o'rs to consoidate the s(a- fra&(ented and ess i;'id (arkets into

a nationa6e)e- i;'id (arket #" 'sin& state6of6the6art infrastr'ct're and s'..ort

s"ste(s!The tradin&- sette(ent and f'nds transfer o.erations of ISE are co(.ete"

a'to(ated and state6of6the6art s"ste(s ha)e #een de.o"ed! The co(('nication

net*ork of ISE- *hich has connecti)it" *ith o)er 8%% tradin& (e(#ers and is

s.read across 8B cities!

FEATURES3 Skied and e,.erienced (an.o*er 3

ISE ha)e e,.erienced and .rofessiona staff- *ho ha)e *ide e,.erience in Stock

E,chan&es?Ca.ita (arket instit'tions!

Aressive pricin policy3

A&&ressi)e .ricin& .oic" for the )ario's .rod'cts and ser)ices offered #" it! Theai( is to .enetrate the retai (arket and stren&then the .osition- so that a *ide

)ariet" of .rod'cts and ser)ices ha)in& a..ea for the retai (arket can #e offered

'sin& a co((on distri#'tion channe!

'i/rant S0/si!iary Operations

ISS- the *ho"6o*ned s'#sidiar" of ISE- is one of the #i&&est E,chan&e



(OND 'A&UATION

It is the .rocess of deter(inin& the fair .rice of a #ond! As *ith an" sec'rit" or

ca.ita in)est(ent- the fair )a'e of a #ond is the .resent )a'e of the strea( ofcash fo*s it is e,.ected to &enerate!

(on!% @hen a co(.an" 4or &o)ern(ent5 #orro*s (one" fro( the .'#ic or

#anks 4#ondhoders5 and a&rees to .a" it #ack ater!

Par 'al0e% The a(o'nt of (one" that the co(.an" #orro*s!

Co0pon Pay1ents% This is ike interest! The co(.an" (akes re&'ar .a"(ents

to the #ondhoders- ike e)er" B (onths or e)er" "ear!

In!ent0re% A *ritten a&ree(ent #et*een the co(.an" and the #ond hoder! The"

tak a#o't ho* ('ch the co'.on .a"(ents *i #e- and *hen the (one" 4.ar)a'e5 *i #e .aid #ack to the #ondhoder!

Mat0rity Date% Date *hen the co(.an" .a"s the .ar )a'e #ack to the

#ondhoder!

Mar2et Interest Rate% This chan&es e)er"da"!



T3e present val0e 4 T3e present val0e 5 T3e present val0e

O6 a /on! o6 t3e co0pon o6 t3e par val0e

pay1ents +ti1e val0e o6 1oney,

+an ann0ity,

There are three t".es of D'ration that (a" #e cac'ated for a #ond and?or

.ortfoio3

Maca'a"s 4aso kno*n as Modified D'ration5

Effecti)e D'ration 4aso kno*n as O.tion6Ad+'sted D'ration5

D'ration6to6@orst!



Maca0lay7s +Mo!i6ie!, D0ration The a..ro,i(ate .ercenta&e chan&e in a

#onds .rice &i)en a / chan&e in its "ied6to6(at'rit" ! The Maca'a"sd'ration for('a is #ased on a .re6deter(ined set of .rinci.a and interest

cash fo*s co(.'ted to the #onds fina (at'rit" date and does not reco&ni:e

that those cash fo*s co'd #e affected #" chan&es in interest rates- inc'din&

the e,ercise of one or (ore e(#edded o.tions 4cas- .'ts- o.tiona

.re.a"(ents- foatin& rate co'.ons- inc'din& an" reset ca.s or foors- etc!5!

8. D0ration)to)-orst the a..ro,i(ate .ercenta&e chan&e in a #onds .rice

&i)en a / chan&e in its "ied6to6(at'rit" or its "ied6to6ca- *hiche)er is

o*er! D'ration6to6@orst is the sa(e as Maca'a"s d'ration e,ce.t the .re6

deter(ined set of .rinci.a and interest cash fo*s are #ased on either the

fina (at'rit" date- or a ca date *ithin the #onds ca sched'e- *hiche)er

*o'd res't in the o*est "ied to the in)estor i!e!- the Yied6to6@orst! 4Note

that for .'tta#e #onds- one *o'd 'se a d'ration6to6#est co(.'ted fro(

cash fo*s to the (at'rit" date or to the .'t date- *hiche)er res'ts in the

hi&hest "ied to the in)estor5!6



<! E66ective D0ration the a)era&e .ercenta&e chan&e in a #onds .rice-

#ased on '.*ard and do*n*ard .arae shifts in the 'nder"in& ter( str'ct're of

interest rates 4t".ica" the Treas'r" s.ot c'r)e5! =" deter(inin& *hat the #onds

.rice *o'd #e- &i)en hi&her?o*er interest rate en)iron(ents- the effecti)e

d'ration (eas're refects the increasin& or decreasin& ikeihood of an" o.tion

e,ercise- inc'din& cas- .'ts- chan&es in .re.a"(ent s.eeds for (ort&a&e6#acked sec'rities- and the hi&her .ro#a#iit" of enco'nterin& an" rate ca.s?foors

for sec'rities *ith ad+'sta#e co'.ons!



PORTFOLIO MANAGEMENT

De6inition%

H CREATION AND MANTAINANCE OF AN IN'ESTMENT.

H IT IS A COMP&E* PROCESS -#IC# TRIES TO MAKE IN'ESTMENT

ACTI'ITIES MORE RE-ARDING AND &ESS RISK"

H DEA&S -IT# SECURIT" ANA&"SIS9 PORTFO&IO ANA&"SIS9 PORFO&IO

SE&ECTION9 PORTFO&IO RE'ISION9 AND PORTFO&IO E'A&UATION.

In 6inance9 a port6olio is a collection o6 invest1ents 3el! /y an

instit0tion or an in!ivi!0al. #ol!in a port6olio is part o6 an invest1ent

an! ris2)li1itin stratey calle! !iversi6ication. (y onin several

assets9 certain types o6 ris2 +in partic0lar speci6ic ris2, can /e re!0ce!.T3e assets in t3e port6olio co0l! incl0!e stoc2s9 /on!s9 options9

arants9 ol! certi6icates9 real estate9 60t0res contracts9 pro!0ction

6acilities9 or any ot3er ite1 t3at is e:pecte! to retain its val0e.



INESTMENT

H It is an acti)it" that is en&a&ed #" .eo.e *hoha)e sa)in&s !

H In)est(ent in)o)es e(.o"(ent of f'nds *ith a

ai( of achie)in& additiona inco(e or &ro*th in)a'es!

H Critica .oint of in)est(ent is it in)o)es ti(efactor i!e! re*ard is associated *ith *aitin&!

H E,.ectation of ret'rn ia an essentia ee(ent ofin)est(ent!

H E,.ectation of ret'rns can #e hi&her or o*er



C#ARACTERISTICS

H RETURN

Invest1ent are 1a!e it3 a pri1ary o/;ective o6 !erivin a ret0rn

H RISK

Ris2 is !epen!ent 0pon 6olloin 6actors

&oner t3e 1at0rity perio!9 3i3er t3e ris2

&oer t3e cre!it ort3iness o6 t3e /orroer9 t3e 3i3er t3e is t3e ris2

Ris2 vary it3 t3e nat0re o6 invest1ent.

H SAFET"

Sa6ety i1plies t3e certainty o6 ret0rn o6 ret0rn on capital it3o0t t3e loss o6

1oney or ti1e.

H &I$UIDIT"

An invest1ent 3ic3 is easily salea/le or 1ar2eta/le it3o0t loss o6 1oney

an! it3o0t loss o6 ti1e is sai! to possess li<0i!ity.



CATEGORIES OF INESTMENT

H Fi,ed inco(e in)est(entH P'#ic e;'itiesH Rea ret'rn #ondsH Pri)ate e;'ities

='" o't

ent're ca.itaH Infrastr'ct're

Rate Settin&

Rate Settin& tied to ser)ice dei)er" e)es

Non6re&'ated assetsH Rea estateH A#so'te Ret'rn Strate&iesH Deri)ati)es



PORTFOLIO ANALYSIS

In order to find o't the efficienc" of .ortfoio i!e a .ortfoio is e)a'ated on" in

ter(s of e,.ected ret'rn and risk it #ears!

Th's this .rocess of deter(inin& the e,.ected ret'rn and risk of different

.ortfoios is a .ri(ar" ste. in .ortfoio (ana&e(ent - *hich is desi&nated as

.ortfoio ana"sis!



PORTFOLIO ANALYSIS EJPECTED RETURN

An in)estor - need to decide '.on on sec'rities ei&i#e for seection in the

.ortfoio! The ei&i#iit" of a sec'rit" is deter(ined on the #ases of ret'rns it can

&enerate!

These ret'rns are kno*n as e,.ected rate of ret'rns *hich is si(." *ei&hted

a)era&e of the ret'rn of the indi)id'a sec'rities hed in the .ortfoio!

The *ei&ht a..ied to each ret'rn is the fraction of the .ortfoio in)ested in thatsec'rit"

e!&! Consider a .ortfoio of t*o e;'it" shares P and K *ith e,.ected ret'rns of

/2 and $% .ercent!

If 8% .ercent of tota f'nds is in)ested in shares P and the re(ainin& B%

.ercent - in share K then the e,.ected .ortfoio ret'rn *i #e

4 %!8% /2 5 4 %!B% $% 5 /1 .ercent!

For('ae

r

∑=

=n

i

ii p r xr 1



PORTFOLIO ANALYSIS RIS>

The )ariance or standard de)iation of an indi)id'a sec'rit" (eas'res theriskiness of a sec'rit" !

Risk of a .ortfoio of sec'rities is cac'ated on the #ases of riskiness of each

sec'rit" *ithin the conte,t of the o)era .ortfoio ! This de.ends on their

interacti)e risk i!e! ho* the ret'rns of a sec'rit" (o)e *ith the ret'rns of

other sec'rities in the .ortfoio and contri#'tes to the o)era risk of the.ortfoio!

COARIANCE is a statistica too 'sed to indicate interacti)e risk of a sec'rit"

reati)e to others in a .ortfoio of sec'rities!

The co)ariance is a (eas're of ho* ret'rns of t*o sec'rities (o)e to&ether!

If the ret'rns of t*o sec'rities (o)e in the sa(e direction consistent" theco)ariance is .ositi)e! If the ret'rns of the t*o sec'rities (o)e in the

o..osite direction consistent" the co)ariance *o'd #e ne&ati)e!



N

R R x R R

Cov

m

i

y y x

xy

∑=

−−

= 1

]][[

*here

xyCov

co)ariance #et*een , and "

x R

ret'rn of sec'rit" ,

y R

ret'rn of sec'rit" "

x R

e,.ected or (ean ret'rn of sec'rit" ,

y R

e,.ected or (ean ret'rn of sec'rit" "

N n'(#er of o#ser)ations



PORTFOLIO ANALYSIS 6

DIERSIFICATION

The .rocess of co(#in& sec'rities into a .ortfoio is kno*n as di)ersification!

Di)ersification ai(s at red'cin& the tota risk *itho't sacrificin& .ortfoio ret'rn!

To 'nderstand the (echanis( and .o*er of di)ersification- it is necessar" to

consider the i(.act of co)ariance or correation on .ortfoio risk (ore cose"!

@e sha e,a(ine three cases 3

/! @hen sec'rit" ret'rns are .erfect" .ositi)e correated

$! @hen sec'rit" ret'rns are .erfect" ne&ati)e" correated and

<! @hen sec'rit" ret'rns are not correated!



PORTFOLIO ANALYSIS

MAR>O@IT MODEL

The .ro.er &oa of .ortfoio constr'ction *o'd #e to &enerate a .ortfoio that

.ro)ides the hi&hest ret'rn and o*est risk! Method of seectin& s'ch a o.ti(a

.ortfoio is kno*n as MARKOWITZ MODEL ( HM MODEL).

I t ana"ses the )ario's .ossi#e .ortfoio of a &i)en n'(#er of sec'rities and

he.s in seection of the #est or (ost efficient one! 9M (ode sho*s ho* an

in)estor can red'ce the risk i!e the standard de)iation of the .ortfoio ret'rns #"choosin& those sec'rities that do not (o)e e,act" to&ether!

It is aso kno* as Mean6 de)iation (ode !

Assumptions:

H an investor is /asically ris2 averse an! t3e ris2 o6 a port6olio is esti1ate!on t3e /asis o6 varia/ility o6 ret0rns.

H t3e !ecision o6 t3e investor rear!in selection o6 port6olio is 1a!e on

t3e /assis o6 ret0rns an! ris2 o6 t3e port6olio.

H an investor atte1pts to et 1a:i101 ret0rn 6ro1 1ini101 ris2 .



CAPITA& ASSET PRICING

MODE&

CAPM atte(.ts to (eas're the risk of a sec'rit" in the .ortfoio sense! It

considers the re;'ired rate of ret'rn of a sec'rit" on the #asis of itscontri#'tion to tota .ortfoio risk!

The core idea of CAPM is that on" 'ndi)ersifia#e risk is ree)ant to the

deter(ination of e,.ected ret'rn on an" asset!

MOTI'ATION FOR PARTIONING OF RISK 3

The tota risk of a .ortfoio is di)ided into s"ste(atic and 'ns"ste(atic

risk! The atter is ei(inated #" (ore and (ore di)ersification! On the

other hand s"ste(atic risk is one *hich cannot #e ei(inated and is

correated *ith that of (arket .ortfoio! A .ortfoio is efficient is there is no 'ns"ste(atic risk! Therefore on" effect

the sec'rit" has on the .ortfoio risk is thro'&h its s"ste(atic risk!



Formulae: e,.ected ret'rn .rice of ti(e .rice of risk a(o'nt of risk

RS IRF4RM IRF5 β*here-

RS The e,.ected ret'rn fro( a sec'rit" asset!

IRF The risk6free interest rate!

RM The e,.ected ret'rn on (arket .ortfoio!β The #eta factor- a (eas're of s"ste(atic risk of the

sec'rit"?asset!



S"STEMATIC RISK3

It is the .art of tota risk *hich cannot #e ei(inated #" di)ersification! This risk

arises #eca'se e)er" sec'rit" has a #'it in tendenc" to (o)e in ine *ith the

f'ct'ations in the (arket! It is aso kno*n as non6di)ersifia#e risk- or (arket

risk!

It is (eas'red in ter(s of Q factor!

UNS"STEMATIC RISK3

It is the .art of the risk *hich can #e ei(inated #" di)ersification! This risk

re.resents the f'ct'ations in ret'rns d'e to the factors s.ecific to the .artic'ar

fir( on" and not the (arket as a *hoe!



CAPM sho*s that the e,.ected ret'rn for a .artic'ar sec'rit"

de.ends '.on three thin&s 3

/! The .'re ti(e )a'e of (one"

$! The re*ard for #earin& the s"ste(atic risk

<! The a(o'nt of s"ste(atic risk



SING&E INDE* MODE&

Sinle in!e: 1o!e o)erco(es the diffic'ties associated *ith M9 (ode !

Under"in& feat're of sin&e6inde, (ode is that a stocks are affected #" (o)e(ents in

stock (arket! Cas'a .rice of share .rice re)eas that *hen the (arket (o)es '. -

.rices of (ost of the shares &oes '. and )ice )ersa! This s'&&ests that one reason

*h" sec'rit" ret'rns (i&ht #e co6reated and ther is co6(o)e(ent #et*een sec'rities is

#eca'se of a co((on res.onse to (arket chan&es

The co6(o)e(ent of stocks *ith a (arket inde, (a" #e st'died *ith the he. of a

si(.e inear re&ression e;'ation

Ri αI βI R( ei

@hereαI is the co(.onent of sec'rit"s ret'rn that is inde.endent of the (arket .erfor(ance!

Ri is the rate of ret'rn on the (arket inde,

β is the constant that (eas're the e,.ected chan&e in Ri &i)en a chan&e in R(

ei is the error ter( re.resentin& the rando( or resid'a ret'rn



S9ARPE INDEJ MODEL

This is aso caed Rear! to "aria#ilit$ Ratio . In this ratio the risk is

(eas'red in ter(s of standard de)iation! The ratio is

In the a#o)e ratio- σ. is the standard de)iation of the .ortfoio and sho*s

tota risk of the .ortfoio! The Shar.e Inde, (eas'res the risk .re(i'( of

the .ortfoio reati)e to the tota a(o'nt of risk in the .ortfoio! This inde,

(eas'res the so.e of the risk6 ret'rn ine! The Shar.e Inde, he.s

s'((ari:in& the risk and the ret'rn of a .ortfoio in a sin&e (eas're that

cate&ori:es the .erfor(ance on a risk6ad+'sted #asis! The ar&er the inde,

)a'e- the #etter the .ortfoio has .erfor(ed!

P

RF P I R

oSharpeRati σ

−=



PORTFOLIO =ETA

factor is 'sed to (eas're the s"ste(atic risk! The #eta can #e )ie*ed

as an inde, of the de&ree of the res.onsi)eness of the sec'rit" ret'rns

*ith the (arket ret'rn! The #eta coefficient is the reati)e (eas're of

sensiti)it" of an assets ret'rns to chan&e in the ret'rn on the (arket

.ortfoio!

The #eta coefficient is cac'ated #" reatin& the ret'rns of a sec'rit"

*ith the ret'rns for the (arket!

SM

M

S

M

SM M S

M

CORCOR M S COV

×===

σ

σ

σ

σ σ

σ β

22

),(



*here

CO 4S-M5 Co)ariance #et*een the ret'rn of sec'rit"- S-

and the ret'rn on the (arket .ortfoio- M!

ariance of the ret'rn of (arket .ortfoio- M!

σS Standard de)iation of the sec'rit"- S!

σM Standard de)iation of the (arket .ortfoio- M!

CORSM Correation #et*een the ret'rn of the sec'rit" an the (arket

.ortfoio

2

M σ



=eta o6 a port6olio

Under the risk and ret'rn ana"sis of a .ortfoio it has #een disc'ssed that

the )ariance of a .ortfoio can #e fo'nd *ith the he. of standard de)iation

of each of the sec'rit" and the correation coefficient of the .ortfoio!

9o*e)er in case of CAPM - the risk is (eas'red in ter(s of Q ! The Q of a

.ortfoio is the *ei&hted a)era&e of the Q of indi)id'a sec'rities in the

.ortfoio! So -

∑= ii p w β β



The choice of the #est .ortfoio is in)o)es t*o se.arate decision

/! Deter(ination of the efficient set of .ortfoios and -

$! Seectin& - o't of this efficient set - the one *hich is the #est for the in)estor!

EFFI%IE&T FRO&TIER:

T'e #o'ndar" AGE9 is caed the efficient frontier !

Portfoios to the ri&ht of this of efficient frontier are not

efficient #eca'se for a &i)en rate of ret'rn - there *o'd #e

&reater risk!!

Portfoio at o*er e)e that this efficient frontier are aso not

&ood eno'&h #eca'se for a &i)en e)e of risk - the rate of

ret'rn *o'd #e o*er!

Therefore- a .ortfoios "in& on the #o'ndar" AGE9 i!e! the

efficient frontier are caed eiient portolio !

The efficient frontier is sa(e for a in)estors #eca'se of the

ass'(.tion that a in)estors are risk a)erse and *ant

(a,i('( ret'rn at o*est risk!

Dia&ra(3



A

G

LE

9

RETURN

RIS>



RIS> AND RETURN

E)er" in)est(ent is characteri:ed #" risk and ret'rn!

A .erson (akin& an in)est(ent e,.ects to &et so(e ret'rn for( the in)est(ent fro( the

f't're #'t as the f't're is 'ncertain so as the f't're e,.ected ret'rn

T3ere are to types o6 ret0rns

E*pete! return

Reali+e! return

E,.ected ret'rn is the 'ncertain f't're ret'rn that an in)estor e,.ects to &enerate

fro( his in)est(ent!

Reai:ed ret'rn is the certain ret'rn that the in)estor has act'a" o#tain fro( his

in)est(ent at the end of the hodin& .eriod

The in)estor (akes the in)est(ent decision #ased on the e,.ected ret'rn fro( the

in)est(ent



Ris2De6inition

Risk is the .otentia for )aria#iit" in ret'rns

An in)est(ent *hose ret'rns are fair" sta#e is considered as o*

risk in)est(ent *hereas an in)est(ent *hose ret'rns f'ct'atessi&nificant" is considered to #e hi&h risk in)est(ent

Ele1ents o6 ris2

The essence of risk in an in)est(ent in the )ariation in its ret'rns

This )ariation in ret'rns is ca'sed #" a n'(#er of factors

Total ris, - s$stemati uns$stemati



Factors 3ic3 pro!0ce variation ret0rns

Syste1atic ris2 the i(.act of econo(ic- .oitica- and socia

chan&es is s"ste( *ide and that .ortion of tota )aria#iit" in sec'rit"

ret'rns ca'sed are caed s"ste(atic risk

Interest rate ris2 it is a t".e of s"ste(atic risk that .artic'ar" affects

de#t- de#t sec'rities ike #onds- and de#ent'res

Mar2et ris2 it is a t".e of s"ste(atic risk that affects sharesP'rchasin& .o*er risk6 it is aso a t".e of s"ste(atic risk it refers to the

)ariation in in)estor ret'rn ca'sed #" infation!

Unsyste1atic ris26 the ret'rn fro( sec'rities (a" so(eti(e )ar"

#eca'se of certain factors affectin& on" that co(.an" iss'in& that

sec'rities

T$pes / #usiness ris,

inanial ris,



FUNDAMENTA& ANA&"SIS

F'nda(enta ana"sis is a o&ica and s"ste(atic a..roach to esti(ate the f't're

di)idend and share .rices!

F0n!a1ental analysis involves t3ree steps

HEcono(ic ana"sis

HInd'str" ana"sis

HCo(.an" ana"sis



Econo1ic analysis

The .erfor(ance of a co(.an" de.ends '.on - the .erfor(ance of the econo(" ! If thecono(" is #oo(in& the inco(e rises and the de(and for &ood increases! The ind'str

tends to #e .ros.ero's!

'aria/les in t3e econo1y 3ic3 a66ects t3e per6or1ance o6 t3e co1pany

HGro*th rate of nationa inco(e

HInfation

HInterest rate

HGo)ern(ent re)en'e- e,.endit're and deficits

HE,chan&e rates

HInfrastr'ct're

HMonsoon

HEcono(ic and .oitica sta#iit"



In!0stry analysis

An ind'str" is &enera" descri#ed as a ho(o&eneo's &ro'. of co(.anies

An ind'str" is a &ro'. of fir(s .rod'cin& reasona#" si(iar .rod'cts *hich ser)ethe sa(e needs of a co((on set of #'"ers! Traditiona" ind'str" are cassified

on the #asis of .rod'cts ike ce(ent ind'str" - cotton ind'str"!! Etc!!

In!0stry c3aracteristics

The ke" characteristics that sho'd #e consider #" the ana"sts are

H De(and s'.." &a.

HCo(.etiti)e conditions in the ind'str"

HPer(anence

HLa#or conditions

H Attit'de of &o)ern(ent

HS'.." of ra* (ateria

HCost str'ct're



Co1pany analysis

It is the fina sta&e of f'nda(enta ana"sis

It deas *ith the esti(ation of risk and ret'rn of indi)id'a shares Infor(ation

re&ardin& co(.anies can #e #road" cassified into t*o &ro'.s

Internal it consists of data and e)ents (ade .'#ic #" co(.anies

concernin& there o.erations! It inc'des ann'a re.ort- .'#ic and P)tstate(ent etc!!

E:ternal6 these are &enerated inde.endent" o'tside the co(.an"! These

are .re.ared #" in)est(ent ser)ices and the financia .a"ers

FINANCIA& ANA&"SIS



FINANCIA& ANA&"SIS

The financia state(ents of a co(.an" can #e 'sed to e)a'ate the financia

.erfor(ance of the co(.an"! Financia ratios are the (ost e,tensi)e" 'sed

for the .'r.ose!

Different ratios (eas're different as.ects of a co(.an"s .erfor(ance or heath!

Fo'r &ro'. of ratios are 'sed to ana":e the .erfor(ance of a co(.an"!

>. &i<0i!ity ratios these (eas're the co(.an" a#iit" to f'fi its stor( ter(

o#i&ations and refects its short ter( i;'idit"!

a5 c'rrent ratio

#5 acid test ratio 4 ;'ick ratio 5

$! leverae ratios these ratios are kno*n as ca.ita str'ct're ratios! The"

(eas're the co(.an"s a#iit" to (eet its on& ter( de#t o#i&ation! The"

thro* i&ht on the on& ter( so)enc" of a co(.an"!a5 de#t6 e;'it" ratio

#5 tota de#t ratio

c5 .ro.rietar" ratio

d5 interest co)era&e ratio



Profita#iit" ratio6 the .rofita#iit" of a co(.an" can #e (eas'red #" these

ratios! These ratios are cac'ated #" reatin& the .rofit either to saes or

to in)est(ent - or to the e;'it" shares!

There are three t".es of .rofita#iit" ratios

/! Profita#iit" reated to saes

a5 &ro*th .rofit ratio

#5 o.eratin& .rofit ratio

c5 net .rofit ratio

d5 ad(inistrati)e e,.enses ratio

e5 sein& e,.enses ratio!

$! Profita#iit" reated to in)est(ent

a5 ret'rn on assets

#5 ret'rn on ca.ita e(.o"ed

c5 ret'rn on e;'it"



Pro6ita/ility relate! to e<0ity s3ares

a5 Earnin& .er share

#5 earnin& "ied

c5 Di)idend "ied

d5 Di)idend .a"o't

e5 Price earnin& ratio

Earnin poer

a5 Ret'rn on in)est(ent

Activity or e66iciency ratio

a5 C'rrent assets t'rno)er#5 Fi,ed assets t'rno)er

c5 tota asset t'rno)er

d5 In)entor" t'rno)er



S#ARE 'A&UATION

Te in)est(ent decision of the financia ana"st to #'" or se share is

#ased on a co(.arison #et*een the intrinsic )a'e of the share and the

c'rrent (arket .rice

If

Market .rice intrinsic )a'e- s'ch a share sho'd #e #o'&htMarket .rice intrinsic )a'e - s'ch a share sho'd #e sod

Market .rice of a share and its intrinsic )a'e are th's t*o #asic in.'t

essentia for in)est(ent decision

The intrinsic )a'e is esti(ated thro'&h the .rocess of share )a'ation



S3are val0ation 1o!el

The )a'ation (ode 'sed to esti(ate the intrinsic )a'e of share is the

.resent )a'e (ode !

The intrinsic )a'e of a share is the .resent )a'e of a f't're a(o'nt to

#e recei)ed in res.ect to o*nershi. of that share- co(.'ted at an

a..ro.riate disco'nt rate

The (a+or recei.ts that co(e fro( o*nershi. of a share are

Ann'a di)idend

Saes .roceed of the share at the end of hodin& .eriod

These are disco'nted to find there .resent )a'e takin& into consideration

the risk in)o)ed and other in)est(ent o..ort'nit"



S3are val0ation 1o!els

/! One "ear hodin& .eriod here a in)estor intends to .'rchase a

share no* - hod it for one "ear and se it off at the end of one

"ear!

$! M'ti.e "ear hodin& .eriod6 an in)estor (a" hod a share for a

certain n'(#er of "ears and se it off at the end of his hodin&

.eriod!

<! Constant &ro*th (ode

equity research 3

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