INVESTMENT

PLANNING

Module 4 : Workbook

The Indian Institute of Financial Planning

 Contents

Copyright: IIFP

1st Edition : September 2008

The course material is exclusively designed and published for the use of the Students of the IIFP. It is
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Price: Not for Sale

Printed in INDIA

Publication: September 2008

The Indian Institute of Financial Planning

Contents

FOREWORD

Welcome to IIFP-
Power Your Growth…..

We thank you for choosing the IIFP as your preferred education provider for CFP
certification program. We are one of the leading education providers for CFP
certification program and we are basically a No Frills-Pure Education institute
imparting high quality financial planning education in India.

IIFP has been promoted by Kush Education Society which has been formed and
backed by eminent industrialists and educationists of India. Kush Education Society
was formed in the year 2001 and it also runs the prestigious Delhi Public School
(DPS), Varanasi.

We are constantly engaged in research and development of new study tools which
can help our students to crack this highly professional CFP certification program in
the first attempt itself and in light of this we feel pleasure in presenting before you
first edition of our Work book, Module 4 (Investment Planning).

We hope that this tool will help you in your studies and we assure you that we will
always be there to help and guide you.

Wishing you Good Luck….

Faculty and Content Team, IIFP

The Indian Institute of Financial Planning

Contents

Index
Page No.

1. List of Important Formulas 1 - 10

2. Types of Risk and General Economics 11 - 16

3. Measuring Risk 17 - 38

4. Measuring Return 39 - 56

5. CAPM 57 - 62

6. Risk Adjusted Return 63 - 68

7. Fixed Income Securities 69 - 82

8. Equity Valuation 83 - 98

9. Forward and Futures 99 - 106

10. Options 107 - 132

11. Real Estate and Other Investments 133 - 138

12. Mutual Funds 139 - 142

13. Other Fixed Income Instruments and SSI 143 - 146

14. Asset Allocation Strategies 147 - 152

15. Financial Statement Analysis 153 - 172

16. Regulations 173 - 177

The Indian Institute of Financial Planning

 Chapter 1

List of Important Formulas

 Chapter 1 : List of Important Formulas

Chapter 1

List of Important Formulas

Measuring Risk

1. Range = Highest Value – Lowest Value

2. Variance= P1[r1-E(r)]2+ P2[r2-E(r)]2+ P3[r3-E(r)]2 + ... +Pn(rn–E(r)]2
where,
r1,r2,r3,...,rn = Observed Returns
E(r) = Expected return
P1,P2,P3,......, Pn = Probability
3. Standard Deviation = Variance
Standard Deviation
4. Coefficient of variation = X 100
Mean

C o v im
5. B e ta (β i m ) =
σ2m
Where,
Covim = Co-variance between market return and security ‘i’ return
σ 2m = Variance of market return

6. Covariance of two securities

n

∑
i =1
(xi - x ) (yi - y )

n-1
Where,
xi = Return on Security ‘i’
yi = Return on security ‘i’
x = Mean of return on Security ‘x’
y = Mean of return on Security ‘y’
n = Number of observations

7. Cov12 = r12 * σ 1 * σ 2

Where,
Cov12 = Co – variance between return on asset ‘1’ & asset ‘2’
r12 = Coefficient of correlation between two securities
σ1 = Standard Deviation of asset ‘1’ return
σ2 = Standard Deviation of asset ’2’ return

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Investment Planning (Workbook)

8. Co-efficient of correlation of security ‘i’ return with security k return

Covik
r =
σi * σ k

Where,
Covik = Co – variance Between asset ‘i’ & asset ‘k’
σ i = Standard Deviation of asset ‘i’ return
σ m = Standard Deviation of asset ’k’ return

Return
1. Cumulative Wealth Index (CWIn) = WI0 (1+R1) (1+R2) ........ (1+Rn)
CWIn = Cumulative wealth index at the end of n years
WI0 = The begning index value which is typically one rupee
Ri = Total return for year i (i = 1, .......n)

2. Arithmetic Return = R1 + R2 + R3 + ........... + Rn

n
n

= ∑R
i =1
i

n
Where,
R1, R2, R3, ..... R4 = Returns for the different periods
n = Number of periods
n

∑R
i =1
i = Summation of the returns for the period

3. Holding Period Return = [(Ending Price – Beginning Price + Cash Dividend) /Beginning Price] x 100.

4. Geometic Mean (G.M.) = { ( 1+ TR1) ( 1+ TR2)….(1+ TRn)]1/n -1} x 100

TRi = Total return for period i, where i = (1, 2, 3...... n)
n = Total holding period

5. CAGR (Compounded Annual Growth Rate)

{[ BeginningV
EndingV alue
alue
] 1/n
-1 } x100
6. Real rate of Return = { [ 11 ++ ei ] - 1 } x 1 0 0
i = Interest Rate
e = Inflation Rate

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 Chapter 1 : List of Important Formulas

7. Post Tax Return = Return * (1 – Tax Rate)

8. Expected return : E(R) = ∑R P

i=1
i i

Where,
E(R) = Expected return from the stock
Ri = Return form the stock
Pi = Probability associated with the possible outcome
n = Number of possible states of the world

9. Treynor Measure = (Return on portfolio - risk free return) / beta of portfolio

r p – rf
Ti =
ß

Where,
Ti =
Treynor Index
rp = Return on Portfolio Risk
rf = Risk Free Return
ß = Beta of Portfolio

10. Sharpe Measure = (Return on portfolio - risk free return)/ standard deviation of portfolio
rp – rf
Si =
σp

Where,
si = Sharpe Performance Index
rp = Return on Portfolio
rf = Risk Free Return
s p= Standard Deviation of Portfolio

11. Jensen Measure (ALPHA) = Portfolio return – [Risk free rate + (market return- risk free rate) *
portfolio beta]
Jensen Measure = Rp – [Rf + (Rm – R f)* ß p ]

Where,
Rp = Portfolio Return
Rf = Risk free rate
R = Market Return
ßp = Portfolio Beta

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Investment Planning (Workbook)

Portfolio Investment

1. Portfolio variance: = [Standard Deviation of Portfolio]2

2. For a two asset portfolio:

Portfolio return:
E ( R p ) = w A E ( R A ) + (1 − w A )E ( RB ) = w A E ( R A ) + wB E ( R B )

Where,
E(RP) = Expected return of the portfolio
wA = Weight of security A
wB = Weight of security B
E(RA) = Expected return of the security A
E(RB) = Expected return of the security B

3. Variance of Portfolio Returns= W12s12 + W22s22 + 2 W 1W2 Cov12

Where co – variance is given
W1 = Weight of security 1
W2 = Weight of security 2
s1 = Standard deviation of security 1
s2 = Standard deviation of security 2
Cov12 = Covariance between return on security 1 & 2

4. Variance of Portfolio Returns = W12 s12 + W22s22 + 2 W1W2 r12 s1 s 2

Where correlation is given
r12 = coefficient of correlation between security 1 & 2

5. For a three asset portfolio, the variance is:

w2Aσ2A +w2Bσ2B + w2CσC2 + 2wAwBrABσAσB +2wAwCrACσAσC +2wBwCrBCσBσC
Where,
rAB = Coefficient of correlation between security A and B
rBC = Coefficient of correlation between security B and C
rAC = Coefficient of correlation between security A and C
wA = Weight of security A
wB = Weight of security B
wC = Weight of security C
σA = Standard deviation of security A
σB = Standard deviation of security B
σC = Standard deviation of security C

4 The Indian Institute of Financial Planning