Nature and Scope of Investment Decisions

Part I : The Investment Environment
C1 Nature and Scope of Investment Decisions
Chapter 1
Nature and Scope of

Investment Decisions
Copyright © 2008, Sudhindra Bhat
1– 1 Excel Books
SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT Sudhindra Bhat
Definition of Investment
 Investment involves making of a sacrifice in the

present with the hope of deriving future benefits.
 Investment has many meanings and facets.
 The two most important features of an investment are

current sacrifice and future benefit.
1– 2 Excel Books
Why Invest?
 We invest in order to improve our future welfare.
 Funds to be invested come from assets already owned,
borrowed money, and savings or foregone consumption.
 By foregoing consumption today and investing the savings, we
expect to enhance our future consumption possibilities.
 Anticipated future consumption may be by other family
members, such as education funds for children or by ourselves,
possibly in retirement when we are less able to work and
produce for our daily needs.
1– 3 Excel Books
Nature of Investment Decisions

 Investment decisions are premised on an important
assumption that investors are rational and hence prefer
certainty.
 They are risk averse which implies that they would be

unwilling to take risk just for the sake of risk.
 Investors are more often concerned with “RISK” and

“RETURN”.
 The basic investment decision would be a trade-off between

risk and return.
1– 4 Excel Books
The Investment Process

A typical investment decision undergoes a five step
procedure which, in turn, forms the basis of the
investment process. These steps are:
1. Determine the investment objectives and policy.
2. Undertake security analysis.
3. Construct a portfolio.
4. Review the portfolio.
5. Evaluate the performance of the portfolio.

1– 5 Excel Books
1. INVESTMENT OBJECTIVES AND POLICY:
The investor will have to work out his objectives first and then
evolve a policy with the amount of investible wealth on his hand.
Hence, the objectives of an investor must be defined in terms of
risk and return.
The next step in formulating the investment policy of an investor

would be the identification of categories of financial assets
he/she would be interested in.
1– 6 Excel Books
2. SECURITY ANALYSIS:
This step would consist of examining the risk-return
characteristics of individual securities or groups of securities
identified under step one.
The aim here is to know if it is worthwhile to acquire these

securities for the portfolio. And there are two broad
approaches to finding out the ‘mispriced status’ of individual
securities.
One approach is known as ‘technical analysis’. The second

approach is known as ‘fundamental approach’.
1– 7 Excel Books
3. PORTFOLIO CONSTRUCTION:
This consists of identifying the specific securities in which to

invest and determining the proportion of the investor’s wealth to
be invested in each.
Portfolio construction address itself to three major problems

via., selectivity, timing, and diversification.
The related questions would be: which specific

shares/debentures to buy, when to buy, and how best to
combine them in such a way which minimize the overall risk for
a given level of expected return. Cont….
1– 8 Excel Books
4. PORTFOLIO REVISION:
As time passes, the investor would discover that securities that

once were very attractive have ceased to be so.
Also, new securities with promises of high returns and relatively

low risk have emerged. In view of such developments it would
be necessary for him to review the portfolio.
He would liquidate the unattractive securities and acquire the

new one from the market. In a way, he repeats the first three
steps of the investment process.
1– 9 Excel Books
5. PORTFOLIO PERFORMANCE EVALUATION:

A rational investor would constantly examine his chosen
portfolio both for average return and risk. Measures, for doing
so, must be developed.
Also, the calculated risk-return positions must be compared
with certain yardsticks or norms.
This step in the investment process, thus, acquires
considerable significance since the tasks involved are
quantitative measurement of actual risk and return their
evaluation against objective norms.
1– 10 Excel Books
The Investment Environment
Investment decisions to buy/sell securities taken by individuals and
institutions are carried through a set of rules and regulations.
There are markets — money and capital — which function subject to
such rules and established procedures and are, in turn, regulated by
legally constituted authority.
Then there are securities or financial instruments, which are the objects
of purchase and sale. Finally, the mechanism which transfers from one
owner to another comprises of a host of intermediaries. All these
elements comprise the investment environment. Investors have to be fully
aware of this environment for making optimal investment decisions.
The three elements of the investment environment viz., instruments,
institutions and markets are of PRIME IMPORTANCE.
1– 11 Excel Books
Financial Intermediaries
Financial intermediaries perform the intermediation function i.e., they bring
the users of funds and the suppliers of funds together.
Many of them issue financial assets.
1– 12 Excel Books
Investment versus speculation

Basis of Difference Investment Speculation
Planning Horizon An Investor has a relatively A Speculator has very
longer planning horizon short planning horizon.
Holding Period Normally 1 year or more Few days to few months
Psychological attitude Cautious and conservative Daring and careless

of participants
Return Expectations Moderate Very High
Quantity of risk Small Large
Stability of income Very stable Uncertain and variable
Basis of decisions Fundamental Analysis and Technical Analysis and

careful evaluation of Market Psychology
prospects of firm.
Source of income Earnings of enterprise Change in market price
1– 13 Excel Books
Investment versus Gambling speculation

Speculation typically lasts longer than gambles but are briefer than
investments. A speculation usually involves the purchase of a salable asset in
hopes of making a quick profit from an increase in the price of the asset which
is expected to occur within a few weeks or months. Those involved in
speculations are reluctant to refer to this activity as speculation because they
dislike the connotations of the word; they prefer to refer to speculations as
investment activities.
 A gamble is usually a very short-term investment in a game of chance.
 The holding period for most gambles can be measured in seconds.
 That is, the result of so-called investments is quickly resolved by the roll of
the dice or the turn of a card.
 Such activities have planning horizons that are far too brief to do the
research that should precede any investment activity.
Cont….
 Rational people gamble for FUN and not for an INCOME. Copyright © 2008, Sudhindra Bhat
1– 14 Excel Books
• GAMBLING V/S SPECULATION:
Speculation is not the same as gambling and the two should never be
confused. The difference between speculation and gambling is that in
gambling, artificial and unnecessary risks are created whereas in
speculation the risks already exist and the question is simple – who
shall bear them? Gambling is a far cry from the carefully planned
research and scientific procedure which underlies the best speculative
practice. The gambler plays rumors, tips, guesses and other unreliable
intuitions which should not play any but a negative role in the trained
speculator’s process. Speculation is a reasoned anticipation of future
conditions. It does not rely upon gossip or labels. It attempts to
organise the relevant knowledge as a support for judgments. It is as
legitimate and moral as any other form of risk-taking business activity.
1– 15 Excel Books
Investment Attributes/Factors influencing selection of

investment
For evaluation of investment avenue, the following attributes are relevant:
1. Returns
2. Capital Appreciation
 Conservation
• Aggressive growth
• Speculation
 Form of return
• Periodic cash receipts
• Capital gain
3. Safety and security of funds
 Risk
 Liquidity
 Tax considerations
 Conceal ability
1– 16 Excel Books
Investment Alternatives
Equity
Preference shares
Debentures
Bonds or fixed income securities
 Government securities
 Savings bonds
 Private sector debentures
 PSU bonds
 Preference shares
Money market instruments
 Treasury bills
 Certificates of deposits
 Commercial paper Cont….
 Repos Copyright © 2008, Sudhindra Bhat
1– 17 Excel Books
Non-marketable financial assets

 Bank deposits
 Post office time deposits (POTD)
 Monthly income scheme of the post office (MISPO)
 Kisan Vikas Patra (KVP)
 National savings certificate
 Company deposits
 Employees provident fund scheme
 Public provident fund scheme
Cont….
1– 18 Excel Books
Real estate
 Residential House
 Sources of Housing Finance
 Features of Housing Loans
 Guidelines for Buying a Flat
 Commercial Property
 Agricultural Land
 Suburban Land
 Time Share in a Holiday Resort
Cont….
1– 19 Excel Books
Precious objects
 Gold and Silver
 Precious Stones
 Art Objects
Insurance policies
 Endowment Assurance
 Money Back Plan
 Whole Life Assurance
 Unit Linked Plan
 Term Assurance
 Annuity Plans
1– 20 Excel Books
Investments and Innovation

Technology
 Advancements in computing power and Internet technology
 More complete and timely information delivery
Globalization
 Domestic firms compete in global markets
 Broad variety of Financial Instruments
 Leads to diversification of risk
 Globalization continues and offers more opportunities
 Securitization continues to develop
 Derivatives continue to develop
 Strong economic growth
 Integration of investments and corporate finance
1– 21 Excel Books
Types of Investor
 Measured Investor
 Reluctant Investor
 Competitive Investor
 Unprepared Investor
1– 22 Excel Books
C1
Chapter Ends…
1– 23 1– 23 Excel Books

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Part I : The Investment Environment

C1 Nature and Scope of Investment Decisions

Nature and Scope of

 Investment involves making of a sacrifice in the

 Investment has many meanings and facets.

 The two most important features of an investment are

Copyright © 2008, Sudhindra Bhat

Nature of Investment Decisions

 They are risk averse which implies that they would be

 Investors are more often concerned with “RISK” and

 The basic investment decision would be a trade-off between

Copyright © 2008, Sudhindra Bhat

The Investment Process

1. Determine the investment objectives and policy.

2. Undertake security analysis.

4. Review the portfolio.

5. Evaluate the performance of the portfolio.

1. INVESTMENT OBJECTIVES AND POLICY:

The next step in formulating the investment policy of an investor

Copyright © 2008, Sudhindra Bhat

The aim here is to know if it is worthwhile to acquire these

One approach is known as ‘technical analysis’. The second

Copyright © 2008, Sudhindra Bhat

This consists of identifying the specific securities in which to

Portfolio construction address itself to three major problems

The related questions would be: which specific

Copyright © 2008, Sudhindra Bhat

As time passes, the investor would discover that securities that

Also, new securities with promises of high returns and relatively

He would liquidate the unattractive securities and acquire the

Copyright © 2008, Sudhindra Bhat

5. PORTFOLIO PERFORMANCE EVALUATION:

Copyright © 2008, Sudhindra Bhat

Many of them issue financial assets.

Copyright © 2008, Sudhindra Bhat

Investment versus speculation

Psychological attitude Cautious and conservative Daring and careless

Quantity of risk Small Large

Stability of income Very stable Uncertain and variable

Basis of decisions Fundamental Analysis and Technical Analysis and

Investment versus Gambling speculation

• GAMBLING V/S SPECULATION:

Investment Attributes/Factors influencing selection of

Non-marketable financial assets

Copyright © 2008, Sudhindra Bhat

Copyright © 2008, Sudhindra Bhat

Copyright © 2008, Sudhindra Bhat

Investments and Innovation

Copyright © 2008, Sudhindra Bhat

Copyright © 2008, Sudhindra Bhat

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