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MBA 3 SEM SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT UNIT 1
UNIT: – 1
INTRODUCTION TO INVESTMENT
LECTURE No: -1
MEANING AND SIGNIFICANCE OF SAVING AND INVESTMENT
What Are Savings?
Savings refers to the money that a person has left over after they subtract out their consumer
spending from their disposable income over a given time period. Savings, therefore, represents
a net surplus of funds for an individual or household after all expenses and obligations have
been paid.
How to Calculate Your Savings Rate: -
One's savings rate is the percentage of disposable personal income that is kept rather than
spent on consumption or obligations.
Say that your net income is $25,000 a year after taxes (i.e., your disposable income) and over
the course of the year you also spend $24,000 in consumption, bills, and other expenditures.
Your total savings are $1,000. Dividing savings by disposable income yields a savings rate of 4%
= ($1,000 / $25,000 x 100).
Why is Savings Important?
Savings can be as simple as keeping aside money on a monthly basis or even investing small
amounts on a monthly basis. Savings can help in meeting financial commitments at a future
date, for example, to buy a house.
Savings can help you earn more money with investments. Even money kept idle in a
bank savings account earns interest annually.
Funds saved or set aside also enable an individual to stand against unforeseen emergencies.
Such emergencies can arise at any time to an individual due to any reason, such as the COVID-19
pandemic spread as well as the lockdown.
Dr. Pramod Gupta, Professor, MBA Department-MITRC 1

For example, Ms Z’s monthly pay-check is Rs.4,000. Her expenses include an Rs.1,000 on rent
payment, an Rs.400 car payment, an Rs.300 student loan payment, an Rs.100 credit
card payment, Rs.150 for groceries, Rs.50 for utilities, Rs.25 for her cell phone and Rs.75 for gas.
Since her monthly income is Rs.5,000 and her monthly expenses are Rs.2,100, Ms Z has Rs.1,900
leftover. If Z saves her excess income, she has money to live on while resolving her problems in
the case of an emergency.
Saving motives and saving habits
When it comes to the saving habits of households, there are often three distinct camps: the
regular savers, the irregular savers and those that do not save (the non-savers). Interestingly,
there is often a relationship between saving motives and saving habits*.
Importantly, saving motives can include things such as, for retirement, for children’s needs,
to buy a house or consumer durables (e.g., fridges, motor vehicles etc.), for holidays, for
emergencies and to have funds in reserve for necessities.
Here are some interesting findings regarding the relationship between saving motives and
saving habits:
• Someone that has a motive around saving for emergencies and/or retirement is more
likely to be a saver, whether regular or irregular.
• Someone with a high income and/or medium to long-term saving horizon is more
likely to be a saver, whether regular or irregular.
• Someone with a low-risk tolerance is more likely to be a non-saver.
Subjective Considerations:
(i) Foresight:
People save money as a provision against some unforeseen circumstances which might
arise in the future. A few other accumulate wealth for their dependents. All these
prudential considerations can be constituted under the heading foresight.
(ii) Social and political considerations:

Wealth gives power over other men in the economic sphere and also political and

social influence. The desire of prestige, power and respect in social sphere and political
life actuates human being to save.
(iii) Temperamental considerations:
There are a few persons who save neither for their families nor for their own use but
merely because they have acquired a short of mania for accumulation of wealth for its
own sake.
Objective Consideration:
(i) Security of life property:

If there is security of life and property in a country, the saving is encouraged.
(ii) Facilities for investment:

If facilities of profitable investment are available, then saving is stimulated.
(iii) Monetary stability:

Monetary stability also plays a very important part in the value of money, then saving is
discouraged and if the value of money is expected to rise, the saving is encouraged.
(iv) Saving and the rate of interest:
It is one the very important factors which exercises influences on the volume of saving.
If the rate of interest is high, it generally induces people to save more money and if it is
low, the saving is discouraged. However, there will of course be a few people who will
try to save more when the interest rate is low save Jess when the interest rate is high
just to provide for themselves a certain annual income for their old age of for their
dependents.
INVESTMENT
Investment has different meanings in finance and economics. Finance investment is putting
money into something with the expectation of gain that upon thorough analysis has a high
degree of security for the principal amount, as well as security of return, within an expected
period of time. In contrast putting money into something with an expectation of gain
without thorough analysis, without security of principal, and without security of return is
speculation or gambling. Investment is related to saving or deferring consumption.
Investment is involved in many areas of the economy, such as business management and
finance whether for households, firms, or governments.
OBJECTIVE OF INVESTMENT
Main objective of investment are:-

• Increasing the rate of return
• Reducing the risk
Other objective are also there like Safety , Liquidity and hedge against Inflation .
1. Return
Investor always expect a good rate of return from their investment.
Return = End period value – beginning period value + Dividend * 100 Beginning Period
Value
2. Risk
Risk of holding securities is related with the probability of actual return becoming less
than the Expected return.
3. Liquidity
If the portion of the investment could be converted into cash without much loss of time ,
it would help the investor meet the emergencies.
Stock are liquid only if they command good market by providing adequate return
through dividend and capital appreciation.
4. Hedge against inflation
Since there is inflation in almost all the Economy , rate of return should ensure a cover
against the inflation .
Return rate > rate of inflation , otherwise the investor would have loss in real term.
References:-
1. https://www.wisdomjobs.com/euniversity/securityanalysisandinvestmentmanagem
enttutorial356/investmentsmeaningtypesandcharacteristics11344.html
2. Security Analysis and Portfolio Management, Vikas Publishing House.

LECTURE NO:- 2
SAVING VS. INVESTING: WHAT'S THE DIFFERENCE?
Saving money and investing money are entirely different things, with different purposes and
different roles in your financial strategy. Saving money involves setting funds aside in safe, liquid
accounts. Investing involves buying an asset like stocks in hopes of earning a return. Make sure
you are clear on this fundamental concept before you begin your journey to building wealth and
finding financial independence.
Even with a great portfolio, you still risk losing everything if you don't appreciate the role of
savings. Learn how to find the right balance between saving money and investing money.

What's the Difference Between Saving and Investing?
SAVING INVESTING
Setting money aside in safe, liquid accounts Buying an asset that you anticipate will give
you a good rate of return
Includes checking accounts, savings accounts, Includes stocks, bonds, and real estate
and money market accounts
Saving money is the process of setting cash aside and parking it in extremely safe securities or
accounts. The money is also liquid, meaning cash can be accessed in a very short amount of
time. These types of accounts can include:
• Checking accounts
• Savings accounts
• United States Treasury bills
• Money market accounts
Above all, cash reserves must be there when you reach for them. They must be available to use
immediately with minimal delay, no matter what is happening around you. Many famous
wealthy investors advocate keeping a lot of cash on hand, even if it involves a major loss since
those funds aren't being invested or earning a higher rate of return.
ELEMENTS OF INVESTMENT
There are three factors that are considered as elements of investment.1
a) Reward (return);
b) Risk and return; and
c) Time

A. Reward
We have seen above that investment is made with the intention to gain profit. Thus,
investors, generally, may expand their fund to earn a return on it. The return is known
as reward from the investment, and it includes both current income and capital gains or
losses which arise by the increase or decrease of an investment.
B. Risk and Return
The second element of investment is risk and return. Risk may be defined as the chance
that the expected or prospective gains, or profit or return may not materialize. It also
includes the fact that the actual outcome of investment may be less than the expected
outcome. It is important to note that the greater the variability or dispersion in the
possible outcome, the greater the risk will be.
C. Time
Time is the third element of investment. It offers several different courses of action
Conditions change as time moves on and investors should re-e valuate expected return
for each investment.
Reference:-
1. Security Analysis and Portfolio Management, Vikas Publishing House

LECTURE NO: - 3
AVENUES OF INVESTMENT
INVESTMENT AVENUES
Are you searching for investment alternatives for parking idle funds? This article provides a
comprehensive list of such investment alternatives. Investment in any of the
alternatives depends on the needs and requirements of the investor. Corporates and
individuals have different needs. Before investing, these alternatives of investments need to
be analyzed in terms of their risk, return, term, convenience, liquidity etc.
EQUITY SHARES:
Equity investments represent ownership in a running company. By ownership, we mean

share in the profits and assets of the company but generally, there are no fixed returns. It is
considered as a risky investment but at the same time, depending upon situation, it is liquid
investments due to the presence of stock markets. There are equity shares for which there
is a regular trading, for those investments’ liquidity is more otherwise for stocks have less
movement, liquidity is not highly attractive. Equity shares of companies can be classified as
follows:
• Blue chip scrip
• Growth scrip
• Income scrip
• Cyclical scrip
• Speculative scrip
What are Blue Chip Stocks?

Blue Chip Stocks are shares of Blue chip companies that are well established and mature
companies. These companies have made their mark in their industry or sector. People often
consider them as pillars of the industry.
Features of Blue Chip Stocks

Blue chip stocks are large cap companies with a well-established business operation, growth and
history of consistent performance. These stocks have the history and potential to deliver
consistent returns over the long term.
Being financially resilient, blue chip companies have the potential to survive and thrive in the
turbulent economy.
Blue chip stocks are a better investment option for an investment horizon of minimum 7 years.
These stocks have the capability to provide a better rate of return in the long term while
avoiding short term volatility.
Such blue chip companies generate revenue from more than one business vertical or sector.
With such a diversification
The blue-chip companies in India include Reliance Industries Pvt Ltd, TATA Consultancy Services
Ltd, Hindustan Unilever Ltd, Infosys Ltd, Bharti Airtel Ltd, ITC Ltd, Asian Paints Ltd, Nestle India
Ltd, HCL Technologies Ltd.
1. What Is a Growth Stock?

A growth stock is any share in a company that is anticipated to grow at a rate significantly
above the average growth for the market. These stocks generally do not pay dividends. This
is because the issuers of growth stocks are usually companies that want to reinvest any
earnings, they accrue in order to accelerate growth in the short term. When investors invest
in growth stocks, they anticipate that they will earn money through capital gains when they
eventually sell their shares in the future.
2. What Is Scrip in the Stock Market?

A scrip issue, or bonus issue, is when a company creates new shares and awards them to
existing stockholders. This is different from a scrip dividend, where stockholders are given
the choice of receiving cash or shares.
3. What Is a Cyclical Stock?

A cyclical stock is a stock that's price is affected by macroeconomic or systematic changes in
the overall economy. Cyclical stocks are known for following the cycles of an economy
through expansion, peak, recession, and recovery. Most cyclical stocks involve companies
that sell consumer discretionary items that consumers buy more during a booming economy
but spend less on during a recession.
4. What Is a Speculative Stock?

A speculative stock is a stock that a trader uses to speculate. The fundamentals of the stock
do not show an apparent strength or sustainable business model, leading it to be viewed as
very risky and trade at a comparatively low price, although the trader is hopeful that this will
one day change. This may be a penny stock or an emerging market stock that the trader
expects to become much better known very soon.
DEBENTURES OR BONDS
Debentures or bonds are long-term investment options with a fixed stream of cash flows
depending on the quoted rate of interest. They are considered relatively less risky. An
amount of risk involved in debentures or bonds is dependent upon who the issuer is. For
example, if the issue is made by a government, the risk is assumed to be zero. However,
investment in long term debentures or bonds, there are risk in terms of interest rate risk
and price risk. Suppose, a person requires an amount to fund his child’s education after 5
years. He is investing in a debenture having maturity period of 8 years, with coupon
payment annually. In that case there is a risk of reinvesting coupon at a lower interest rate
from end of year 1 to end of year 5 and there is a price risk for increase in rate of interest at
the end of fifth year, in which price of security falls. In order to immunize risk, investment
can be made as per duration concept. Following alternatives are available under debentures
or bonds:
• Government securities
• Savings bonds
• Public Sector Units bonds
• Debentures of private sector companies
• Preference shares
MONEY MARKET INSTRUMENTS
Money market instruments are just like the debentures but the time period is very less. It is
generally less than 1 year. Corporate entities can utilize their idle working capital by
investing in money market instruments. Some of the money market instruments are
• Treasury Bills
• Commercial Paper
• Certificate of Deposits

MUTUAL FUNDS
Mutual funds are an easy and tension free way of investment and it automatically
diversifies the investments. A mutual fund is an investment only in debt or only in equity or
mix of debts and equity and ratio depending on the scheme. They provide with benefits
such as professional approach, benefits of scale and convenience. Further investing in
mutual fund will have advantage of getting professional management services, at a lower
cost, which otherwise was not possible at all. In case of open ended mutual fund scheme,
mutual fund is giving an assurance to investor that mutual fund will give support of
secondary market. There is an absolute transparency about investment performance to
investors. On real time basis, investors are informed about performance of investment. In
mutual funds also, we can select among the following types of portfolios:
• Equity Schemes
• Debt Schemes
• Balanced Schemes
• Sector Specific Schemes etc.
References:-
1. https://efinancemanagement.com/investmentdecisions/variousavenuesandinves
tmentsalternative

LECTURE NO:- 4
APPROACHES TO INVESTMENT ANALYSIS
1. The Fundamental Approach:
The Fundamental Approach is an attempt to identify overvalued and undervalued

securities. The assumption for undervalued stock is that the market will eventually
recognize its error and price will be driven up toward true value. Overvalued stocks are
identified so that they can be avoided, sold or sold short. The investor should select
stocks based on an economic analysis, industry analysis and company analysis.
Fundamental analysts have four variants:
(a) Present Value Analysis;
(b) Intrinsic Value Analysis;
(c) Regression Analysis; and
(d) Special Situation Analysis.
Some fundamental investors follow a ‘buy and hold’ policy by selecting quality stocks and
holding them for a relatively long period. Financial institutions usually follow the
fundamental approach.
Therefore, a fundamentalist does not look into the changeable prices but he determines the
price of the stock at which he is willing to invest and then measures the stock with his own
yardsticks with that of the market to find out if the stock is selling at the required price.
Fundamentalists are of the opinion that importance should be given to earnings, dividends
and asset values of firms. The basic ingredient of this school of thought is the reliance on
‘intrinsic’ value of stock. Also, according to them the price of a security is equal to the
discounted value of the continuous stream of the income from the security.
The prices alter or change due to change in expectations and availability of new
information. The price is dependent on expected returns and expected capitalization rates
corresponding to future time periods.
The fundamentalists who have contributed to this theory are John Burr Williams who gave a
full exposition to present value analysis in 1938. Benjamin Graham and David Dodd
popularized the intrinsic value approach in their widely known book ‘Security Analysis’.
Leader tested stock prices through regression analysis in 1933.
2. The Technical Approach:
The Technical Approach centre around plotting the price movement of the stock and
drawing inferences from the price movement in the market. The technicians believe that
stock market history will repeat itself. Charts of past prices, especially those which contain
predictive patterns can give signals towards the course of future prices. The emphasis is
laid on capital gains or price appreciation in the short run.
The technicians believe that the stock market activity is simultaneously making different
movements. Primarily it makes the long-term movement called the bull or bear market. The
secondary trend is usually for short-terms and may last from a week to several weeks or
months.
The secondary trend is a movement which works opposite the market’s primary movement,
i.e., a decline in a bull market or rally in a bear market. These are based on ‘Dow Theory’.
The third movement is the daily fluctuation which is ignored by the Dow Theory.
Technical analysis is based on the assumption that the value of a stock is dependent on
demand and supply factors. This theory discards the fundamentalist approach to intrinsic
value. Changes in the price movements represent shifts in supply and demand balance.
Supply and demand factors are influenced by rational forces and certain irrational factors
like guesses, hunches, moods and opinions. The technicians’ tools are expressed in the form
of charts which compare the price and volume relationships.
Technicians supplement the analysis made by the fundamentalists on stock prices. Thus,
technical analysis frequently confirms the findings based on fundamental analysis. The
technical analyst also believes that the price and volume analysis incorporates one factor
that is not explicitly incorporated in the fundamental approach and that is ‘the psychology
of the market’.
3. Efficient Market Theory:
The Efficient Market Theory is based on the efficiency of the capital markets. It believes
that market is efficient and the information about individual stocks is available in the
markets.
There is proper dissemination of information in the markets: this leads to continuous

information on price changes. Also the prices of stock between onetime and another are
independent of each other and so it is difficult for any investor to predict future prices.
Each investor has equal information about the stock market and prices of each
security. It is, therefore, assumed that no investor can continuously make profits on
stock prices. Therefore, securities will proved similar returns at the same risk level.
References:-
1. https://www.yourarticlelibrary.com/investment/top3approachestoinvestment/8
2352

LECTURE NO: - 5
RETURN AND RISK
MEANING AND TYPES OF RETURN
CONCEPT OF RISK AND RETURN
After investing money in a project, a firm wants to get some outcomes from the project.
The outcomes or the benefits that the investment generates are called returns. Wealth
maximization approach is based on the concept of future value of expected cash flows from
a prospective project.
So cash flows are nothing but the earnings generated by the project that we refer to as
returns. Since fixture is uncertain, so returns are associated with some degree of
uncertainty. In other words there will be some variability in generating cash flows, which
we call as risk. In this we discuss the concepts of risk and returns as well as the relationship
between them.
Concept of Return:
Return can be defined as the actual income from a project as well as appreciation in the
value of capital. Thus there are two components in return—the basic component or the
periodic cash flows from the investment, either in the form of interest or dividends; and the
change in the price of the asset, commonly called as the capital gain or loss.
The term yield is often used in connection to return, which refers to the income component
in relation to some price for the asset. The total return of an asset for the holding period
relates to all the cash flows received by an investor during any designated time period to
the amount of money invested in the asset.
What Is a Return?
A return, also known as a financial return, in its simplest terms, is the money made or lost
on an investment over some period of time.
A return can be expressed nominally as the change in dollar value of an investment over
time. A return can also be expressed as a percentage derived from the ratio of profit to
investment. Returns can also be presented as net results (after fees, taxes, and inflation) or
gross returns that do not account for anything but the price change.
“A positive return is the profit, or money made, on an investment or venture. Likewise, a

negative return represents a loss, or money lost on an investment or venture.”
Nominal Return
A nominal return is the net profit or loss of an investment expressed in nominal terms. It
can be calculated by figuring the change in value of the investment over a stated time
period plus any distributions minus any outlays. Distributions received by an investor
depend on the type of investment or venture but may include dividends, interest, rents,
rights, benefits or other cash-flows received by an investor. Outlays paid by an investor
depend on the type of investment or venture but may include taxes, costs, fees, or
expenditures paid by an investor to acquire, maintain and sell an investment.
Real Return
A real rate of return is adjusted for changes in prices due to inflation or other external
factors. This method expresses the nominal rate of return in real terms, which keeps
the purchasing power of a given level of capital constant over time. Adjusting the nominal
return to compensate for factors such as inflation allows you to determine how much of
your nominal return is real return. Knowing the real rate of return of an investment is very
important before investing your money. That’s because inflation can reduce the value as
time goes on, just as taxes also chip away at it.
Investors should also consider whether the risk involved with a certain investment is
something they can tolerate given the real rate of return. Expressing rates of return in real
values rather than nominal values, particularly during periods of high inflation, offers a
clearer picture of an investment's value.
Returns Ratios
Returns ratios are a subset of financial ratios that measure how effectively an investment is
being managed. They help to evaluate if the highest possible return is being generated on
an investment. In general, returns ratios compare the tools available to generate profit,
such as the investment in assets or equity, to net income, the actual profit generated.

Returns ratios make this comparison by dividing selected or total assets or equity into net
income. The result is a percentage of return per dollar invested that can be used to evaluate
the strength of the investment by comparing it to benchmarks like the returns ratios of
similar investments, companies, industries, or markets. For instance, return of capital (ROC)
means the recovery of the original investment.
Return on Investment (ROI)
A percentage return is a return expressed as a percentage. It is known as the Return on

Investment (ROI). ROI is the return per dollar invested. ROI is calculated by dividing the
dollar return by the dollar initial investment. This ratio is multiplied by 100 to get a
percentage. Assuming a $200 return on a $1,000 investment, the percentage return or ROI
= ($200 / $1,000) x 100 = 20%.
Return on Equity
Return on Equity (ROE) is a profitability ratio figured as net income divided by average
shareholder's equity that measures how much net income is generated per dollar of stock
investment. If a company makes $10,000 in net income for the year and the average equity
capital of the company over the same time period is $100,000, the ROE is 10%.
Return on Assets
Return on Assets (ROA) is a profitability ratio figured as net income divided by average total
assets that measures how much net profit is generated for each dollar invested in assets. It
determines financial leverage and whether enough is earned from asset use to cover the
cost of capital. Net income divided by average total assets equals ROA.
For example, if net income for the year is $10,000, and total average assets for the
company over the same time period is equal to $100,000, the ROA is $10,000 divided by
$100,000, or 10%.
IT IS MEASURED AS:
Total Return = Cash payments received + Price change in assets over the period /Purchase
price of the asset. In connection with return we use two terms—realized return and
expected or predicted return. Realized return is the return that was earned by the firm, so it

is historic. Expected or predicted return is the return the firm anticipates to earn from an
asset over some future period.
SOURCES OF RETURN
The return from the stock includes both current income and capital gain caused by the
appreciation of the price. The income and capital gain are expressed as a percentage of
money invested in the beginning. The historical returns are derived from the cash flow
received as well as the price changes that occur during the period of holding stock or any
asset. The income flow is the dividend he receives during the holding period.
The Anticipated Return:-
The historical term can be calculated by a direct method. The calculation of the anticipated
or expected return is different. The ex-ante or future returns are calculated with the help of
probability. Probability describes the likelihood occurrence of an event i.e. the likelihood of
getting a certain rate of return. The value of the probability ranges from 0 to +1. The value
never exceeds one.
Present value of return:-
The return occurs at the end of the period. If it is to be expressed at the beginning of the
holding period, it has to be given in terms of the present value.

Multiple year holding period:-
It is easy too calculate the present value of the stock of a year. If the holding period is more
than a year, a separate formula is applied to find out the present value of the share.
Constant growth model:-
In this model, the basic assumption is that dividends will grow at the same rate (g) into an
indefinite future.
This model is based on the assumption :

The firm’s dividend policy will be stable.
The firm will earn a stable return over the time.
This model is applicable when the analyst is able to predict all the three variables in the
equation namely (1)next year’s dividend, (2)the firms long term growth rate, and (3)the
required rate of returns of the investor. Once the three values are known to the analyst, the
theoretical value or the present value of the stock can be computed and compared with the
prevailing price.
References:-
1. https://nursejournal.org/askanurse/nonprofitvsforprofitnursingschools/

LECTURE NO: - 6
MEASUREMENT OF RETURN
MEASUREMENT OF RETURN
Financial market assets generate two different streams of return: income through cash
dividends or interest payments and capital growth through the price appreciation of the
asset. Headline stock market indices typically report on price appreciation only and do not
include the dividend income unless the index specifies it is a “total return” series. It is
important to be able to compute and compare different measures of return to properly
evaluate portfolio performance.
Holding Period Return
A holding period return is a return earned from holding an asset for a specified period of
time. The time period may be as short as a day or many years and is expressed as a total
return. This means we look at the return as a composite of the price appreciation and the
income stream.
Arithmetic or Mean Return
When we have assets for multiple holding periods, it is necessary to aggregate the returns
into one overall return. An arithmetic mean is a simple process of finding the average of the
holding period returns.
Geometric Mean Return
Computing a geometric mean follows a principle similar to the computation of compound

interest. The previous year’s returns are compounded to the beginning value of the
investment at the start of the new period in order to earn returns on your returns. A
geometric return provides a more accurate representation of the portfolio value growth
than an arithmetic return.
Money-weighted or Internal Rate of Return
Arithmetic and geometric returns do not take into account the money invested in a
portfolio in different time periods. A money-weighted return is similar in computation

methodology to an internal rate of return (IRR) or a yield to maturity. We examine the cash
flows from the perspective of the investor where amounts invested in the portfolio are seen
as cash outflows and amounts withdrawn from the portfolio by the investor are cash
inflows.
The IRR is the discount rate applied to determining the present value of the cash flows such
that the cumulative present value of all the cash flows is zero. The IRR provides the investor
with an accurate measure of what was actually earned on the money invested but does not
allow for easy comparison between individuals.
Annualized Return
If the period during which the return is earned is not exactly one year, we can annualize the
return to enable an easy comparative return. To annualize a return earned for a period
shorter than one year, the return must be compounded by the number of periods in the
year. A monthly return must be compounded 12 times, a weekly return 52 times and a daily
return 365 times.
Portfolio Return When a portfolio is made up of several assets, we may want to find the
aggregate return of the portfolio as a whole. In order to compute this, we weight the
returns of the underlying assets by the amounts allocated to them.
Other Major Return Measures
There are other measures of returns that need to be taken into account when evaluating
performance. These are as follows:
Gross and net return
A gross return is earned prior to the deduction of fees (management fees, custodial fees,
and other administrative expenses). A net return is the return post-deduction of fees.
Pre-tax and after-tax nominal returns
In general, returns are presented pre-tax and with no adjustment for the effects of inflation.
Tax considerations like capital gains tax and tax on interest or dividend income will need to
be deducted from the investment to determine post-tax returns.
Real returns

Returns are typically presented in nominal terms which consist of three components: the
real risk-free return as compensation for postponing consumption, inflation as
compensation for the loss of purchasing power and a risk premium. Real returns are useful
for comparing returns over different time periods as inflation rates vary over time.
Leverage returns
If an investor makes use of derivative instruments within a portfolio or borrows money to

invest, then leverage is introduced into the portfolio. The leverage amplifies the returns on
the investor’s capital, both upwards and downwards.
Reference:-

LECTURE NO:-7
RISK – MEANING AND TYPES OF RISK
CONCEPT OF RISK:-
A person making an investment expects to get some returns from the investment in the
future. However, as future is uncertain, the future expected returns too are uncertain. It is
the uncertainty associated with the returns from an investment that introduces a risk into a
project. The expected return is the uncertain future return that a firm expects to get from
its project. The realized return, on the contrary, is the certain return that a firm has actually
earned.
The realized return from the project may not correspond to the expected return. This
possibility of variation of the actual return from the expected return is termed as risk. Risk is
the variability in the expected return from a project. In other words, it is the degree of
deviation from expected return. Risk is associated with the possibility that realized returns
will be less than the returns that were expected. So, when realizations correspond to
expectations exactly, there would be no risk.
TYPES OF RISK:-
• Economic risks,
• Industry risks,
• Company risks,
• Asset class risks,
• Market risks.
Economic risks are risks that something will upset the economy as a whole. The economic
cycle may swing from expansion to recession, for example; inflation or deflation may
increase, unemployment may increase, or interest rates may fluctuate. These
macroeconomic factors affect everyone doing business in the economy. Most businesses
are cyclical, growing when the economy grows and contracting when the economy
contracts.
Consumers tend to spend more disposable income when they are more confident about
economic growth and the stability of their jobs and incomes. They tend to be more willing
and able to finance purchases with debt or with credit, expanding their ability to purchase
durable goods. So, demand for most goods and services increases as an economy expands,
and businesses expand too. An exception is businesses that are countercyclical. Their
growth accelerates when the economy is in a downturn and slows when the economy
expands. For example, low-priced fast food chains typically have increased sales in an
economic downturn because people substitute fast food for more expensive restaurant
meals as they worry more about losing their jobs and incomes.
Industry risks usually involve economic factors that affect an entire industry or
developments in technology that affect an industry’s markets. An example is the effect of a
sudden increase in the price of oil (a macroeconomic event) on the airline industry. Every
airline is affected by such an event, as an increase in the price of airplane fuel increases
airline costs and reduces profits. An industry such as real estate is vulnerable to changes in
interest rates. A rise in interest rates, for example, makes it harder for people to borrow
money to finance purchases, which depresses the value of real estate.
Company risk refers to the characteristics of specific businesses or firms that affect their
performance, making them more or less vulnerable to economic and industry risks. These
characteristics include how much debt financing the company uses, how well it creates
economies of scale, how efficient its inventory management is, how flexible its labor
relationships are, and so on.
The asset class that an investment belongs to can also bear on its performance and risk.
Investments (assets) are categorized in terms of the markets they trade in. Broadly defined,
asset classes include
• corporate stock or equities (shares in public corporations, domestic, or foreign);
• bonds or the public debts of corporation or governments;
• commodities or resources (e.g., oil, coffee, or gold);
• derivatives or contracts based on the performance of other underlying assets;
• real estate (both residential and commercial);

• Fine art and collectibles (e.g., stamps, coins, baseball cards, or vintage cars).
Within those broad categories, there are finer distinctions. For example, corporate stock is
classified as large cap, mid cap, or small cap, depending on the size of the corporation as
measured by its market capitalization (the aggregate value of its stock). Bonds are
distinguished as corporate or government and as short-term, intermediate-term, or long-
term, depending on the maturity date.
References:-
1. https://www.coursehero.com/file/14174306/Week5Homework/

LECTURE NO: - 8
SYSTEMATIC V/S NON-SYSTEMATIC RISKS
Elements of Risk:
Various components cause the variability in expected returns, which are known as elements
of risk. There are broadly two groups of elements classified as systematic risk and
unsystematic risk.
Systematic Risk:
Business organizations are part of society that is dynamic. Various changes occur in a
society like economic, political and social systems that have influence on the performance
of companies and thereby on their expected returns. These changes affect all organizations
to varying degrees. Hence the impact of these changes is system-wide and the portion of
total variability in returns caused by such across the board factors is referred to as
systematic risk. These risks are further subdivided into interest rate risk, market risk, and
purchasing power risk.
Unsystematic Risk:
The returns of a company may vary due to certain factors that affect only that company.
Examples of such factors are raw material scarcity, labour strike, management inefficiency,
etc. When the variability in returns occurs due to such firm-specific factors it is known as
unsystematic risk. This risk is unique or peculiar to a specific organization and affects it in
addition to the systematic risk. These risks are subdivided into business risk and financial
risk.
COMPARISON CHART
SYSTEMATIC RISK UNSYSTEMATIC RISK

BASIS FOR
COMPARISON

Meaning Systematic risk refers to the hazard Unsystematic risk refers to the
which is associated with the market risk associated with a particular
or market segment as a whole. security, company or industry.
Nature Uncontrollable Controllable
Factors External factors Internal factors
Affects Large number of securities in the Only particular company.

market.
Types Interest risk, market risk and Business risk and financial risk
MEASUREMENT OF RISK
A number of techniques have been suggested by economists to deal with risk in investment
appraisal.
Some of the popular techniques used for this purpose are as follows:1
1. Risk Adjusted Discount Rate Method:
This method calls for adjusting the discount rate to reflect the degree of the risk of the
project. The risk adjusted discount rate is based on the presumption that investors
expect a higher rate of return on risky projects as compared to less risky projects.
The rate requires determination of (i) risk free rates and (ii) risk premium rate. Risk free
rate is the rate at which the future cash inflows should be discounted. Risk premium rate
is the extra return expected by the investor over the normal rate.
The adjusted discount rate is a composite discount rate. It takes into account both time
and risk factors.

2. The Certainty Equivalent Approach:
According to this method, the estimated cash flows are reduced to a conservative level
by applying a correction factor termed as certainty equivalent coefficient. The correction
factor is the ratio of riskless cash flow to risky cash flow.
The certainty equivalent coefficient which reflects the management’s attitude towards
risk is Certainty Equivalent Coefficient = Riskless Cash Flow/Risky Cash Flow
3. Sensitivity Analysis:
The future is not certain and involves uncertainties and risk, the cost and benefits
projected over the lifetime of the project may turn out to be different. This deviation
has an important bearing on the selection of a project.
If the project can stand the test of changes in the future, affecting costs and benefits,
the project would qualify for selection. The technique to find out this strength of the
project is covered under the sensitivity analysis of the project. This analysis tries to
avoid over estimation or underestimation of the cost and benefits of the project.
In sensitivity analysis, we try to find out the critical elements which have a vital bearing
on the costs or benefits of the project. In investment decision, one has to consider as
many elements of uncertainty as possible on costs or benefits side and then arrive at
critical elements which effect the expected costs or benefits of the project.
Sensitivity analysis is a simulation technique in which key variables are changes and the
resulting change in the rate of return is observed. Some of the key variables are cost,
prices, project life, market share, etc.
Usually this analysis provides information about cash flows under the assumptions:
(i) Pessimistic,
(ii) Most likely, and
(iii) Optimistic.
It explains how sensitive the cash flows are under these three different situations. If the
difference is larger between the optimistic and pessimistic cash flows, the more risky is
the project.

4. Probability Theory Approach:
Yet another method for dealing with risks is to estimate the value for a result. Each value
of prospective result is assigned a probability. Here one has to see a range of possible
cash flows from the most optimistic to the most pessimistic for each pertinent year.
Probability means the likelihood of happening an event.
It may be objective or subjective. An objective probability is based on a large number of

observations under independent and identical conditions repeated over a period of
time. A subjective probability is based on personal judgement. In capital budgeting
decisions the probabilities are of a subjective type since they are based on a single
event.
Process of Assigning Probabilities:
Here let us see the process of assigning probabilities.

It is subject to certain rules and they are:
(i) List of events collectively expansive
(ii) Events must be mutually exclusive
(iii) The numerical probabilities must add up to 1.
Basic Probability Theorem:
We must see certain basic theorems relating to a probability theory.

These are as follows:
(i) The probability of an event is always a number between 0 and 1 inclusive. If an event is
sure to occur, its probability is by definition equal to 1. If it is certain that it will not occur its
probability is 0.
(ii) If ‘n’ events are equally likely and only one of them may happen, then the probability of
that event is 1/n.
(iii) If two events are mutually independent and the probabilities of one is PI while that of
other P2, the probability of the events occurring together is the product of P1, P2.
(iv) If the events are mutually exclusive and the probability of the one is PI while that of the
other is P2, the probability of either one or the other occurring is the sum P1+P2.
5. Standard Deviation:
Subjective judgment of the decision makers plays a crucial role in practice to resolve the
problem which may turn out to be imprecise or biased. There is no precise way to find
the probabilities of different outcomes. This limitation is overcome by adoption of
standard deviation approach.
The standard deviation is defined as the square root of the mean of the squared
deviations of all the items from the mean and it is usual to denote it by the small Greek
“Sigma”, σ. In the case of capital budgeting, this measure is used to compare the
variability of possible cash flows of different projects from their respective mean or
expected values.
Steps to be followed for calculating the S.D. of the possible cash flows:
(i) Compute the mean value of the possible cash flows.
(ii) Find out the deviation between the mean value and the possible cash flows.
(iii) Square the deviations.
(iv) Multiply the squared deviations by the assigned probabilities to get the weighted
squared deviations.
(v) The sum of the weighted squared deviations and their square root are calculated. The
result gives the S.D.
6. Coefficient of Variation:
Standard deviation is expressed in the units of the original distribution and is called
absolute measure of dispersion. Therefore, absolute measure must be reduced to a
form which is free from the original unit of measurement. This can be done by
expressing it in relation to the average from which variation is measured. This measure
of relative variation is obtained by dividing the absolute measure by that average and is
called a coefficient of variation.
The co-efficient of variation can be calculated as follows:
Coefficient of Variation = Standard Deviation/Expected (or Mean) Cash Flow = σ/Erf

7. Decision Tree Analysis:

The decision tree analysis is another technique which is helpful in tackling risky capital
investment proposals. A decision tree is a graphic display of various decision alternatives
and the sequence of events as if they were branches of a tree.
In constructing a tree diagram, it is a convention to use the symbol □ to indicate the

decision point and O denotes the situation of uncertainty or event. Branches coming out
of a decision point are nothing but representation of immediate mutually exclusive
alternative options open to the decision maker.
Branches emanating from the event point ‘O’ represent all possible situations. These
events are not fully under the control of the decision maker and may represent some
other factors. The basic advantage of a tree diagram is that another act subsequent to
the happening of each event may also be represented. The resulting pay-off for each act-
event combination may be indicated in the tree diagram at the outer end of each branch.
Construction of Decision Tree:
The construction of a decision tree requires definition of proposal, identification of

alternatives, graphing the decision tree, forecasting cash flows, and evaluating results.
This process can be undertaken in the following way:
(i) The first step in the construction of the decision tree is the definition of proposal. It
means what is exactly required under the proposal.
(ii) The second step in the decision tree is the identification of alternatives. Each proposal
will have at least two alternatives—accept or reject. In some cases, there may be more than
two alternatives too.
(iii) The third step is graphing the decision tree. Decision tree is a graphical method. It
visually helps the decision maker view his alternatives and outcomes.
Illustration of a Decision Tree Diagram:

(iv) The fourth step is forecasting cash flows. The forecasted cash flows regarding each
decision branch are also shown along with the branch. Probabilities are also assigned to
each cash flow. The probabilities of each event will be different.
(v) The fifth step in construction of a decision tree is evaluating results. The evaluation will
be based on manager’s own experience, consultation with others and information available
in this respect. On the basis of the expected value for each decision, the results are
analyzed. The firm may proceed with profitable alternative.
The pay-off for ultimate alternatives has been calculated by taking into account the
probabilities of the ultimate alternative as well as for the previous alternative and
multiplied by the expected pay-off of the first alternative without its probability. By
incorporating probabilities of various events in the decision tree, it is possible to
comprehend and trace probability of a decision leading to results desired.
What is significant about the decision tree approach is that it does several things for
decision makers. It is highly useful to a decision maker in multi-stage situations which
involve a series of decisions each dependent on the preceding one. It makes possible for
them to see at least the major alternatives open to them and that the subsequent decisions
may depend on events of the future.
Reference: -

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MBA 3 SEM SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT UNIT 1

MEANING AND SIGNIFICANCE OF SAVING AND INVESTMENT

What Are Savings?

How to Calculate Your Savings Rate: -

Why is Savings Important?

Dr. Pramod Gupta, Professor, MBA Department-MITRC 1

Saving motives and saving habits

(ii) Social and political considerations:

Dr. Pramod Gupta, Professor, MBA Department-MITRC 2

(i) Security of life property:

(ii) Facilities for investment:

(iii) Monetary stability:

Main objective of investment are:-

Dr. Pramod Gupta, Professor, MBA Department-MITRC 3

• Increasing the rate of return

• Reducing the risk

4. Hedge against inflation

Dr. Pramod Gupta, Professor, MBA Department-MITRC 4

SAVING VS. INVESTING: WHAT'S THE DIFFERENCE?

Dr. Pramod Gupta, Professor, MBA Department-MITRC 5

What's the Difference Between Saving and Investing?

There are three factors that are considered as elements of investment.1

b) Risk and return; and

Dr. Pramod Gupta, Professor, MBA Department-MITRC 6

B. Risk and Return

1. Security Analysis and Portfolio Management, Vikas Publishing House

Dr. Pramod Gupta, Professor, MBA Department-MITRC 7

Equity investments represent ownership in a running company. By ownership, we mean

• Blue chip scrip

What are Blue Chip Stocks?

Features of Blue Chip Stocks

1. What Is a Growth Stock?

2. What Is Scrip in the Stock Market?

3. What Is a Cyclical Stock?

4. What Is a Speculative Stock?

• Public Sector Units bonds

• Debentures of private sector companies

MONEY MARKET INSTRUMENTS

Dr. Pramod Gupta, Professor, MBA Department-MITRC 10

• Sector Specific Schemes etc.

Dr. Pramod Gupta, Professor, MBA Department-MITRC 11

APPROACHES TO INVESTMENT ANALYSIS

1. The Fundamental Approach:

The Fundamental Approach is an attempt to identify overvalued and undervalued

Fundamental analysts have four variants:

(a) Present Value Analysis;

(b) Intrinsic Value Analysis;

(c) Regression Analysis; and

(d) Special Situation Analysis.

2. The Technical Approach:

3. Efficient Market Theory:

There is proper dissemination of information in the markets: this leads to continuous

Dr. Pramod Gupta, Professor, MBA Department-MITRC 14

“A positive return is the profit, or money made, on an investment or venture. Likewise, a

Dr. Pramod Gupta, Professor, MBA Department-MITRC 16

Return on Investment (ROI)

A percentage return is a return expressed as a percentage. It is known as the Return on

Dr. Pramod Gupta, Professor, MBA Department-MITRC 17