Dr. Shuchita - SAPM Upto Unit IV (SAPM G 2)

Security Analysis & Portfolio Management
Trimester: IV (Finance Specialization)
By: Dr. Shuchita Singh
shuchitas81@gmail.com
Text Book:
Chandra, P. ( 5th Edition , 2017)
Investment Analysis and Portfolio
Management,
Tata McGraw-Hill
Other resources:
www.equitymaster.com
www.valueresearchonline.com
www.moneycontrol.com
Unit-1
 Investment Attributes
 Investment Alternatives (An Overview)
 Investment versus Speculation
 Financial Markets
 Security Analysis
 Portfolio Management Process
 Approaches to Investment Decision Making
 Common Errors in Investment Management
 Qualities for Successful Investing
 Three Approaches to Succeed as an Investor
Investment Attributes
 Return: Expected benefits of today’s secrifice
 Risk: Uncertainty in the probability of returns
 Security analysis: estimating risk and return of individual securities
 Information
 Liquidity
 Tax shelter
 Convenience
Investment Alternatives
Government Saving Bonds or Money Market

Deposits
Schemes Debentures Instruments
(Financial Asset)
(Financial Asset) (Financial Asset) (Financial Asset)
Mutual Fund Insurance Retirement

Equity Shares
Schemes Products Products
(Financial Asset)
(Financial Asset) (Financial Asset) (Financial Asset)
Precious
Real Estate REITs PMS
Objects
(Real Asset) (Financial Asset) (Financial Asset)
(Real Asset)
www.moneycontrol.com
Investment versus Speculation
Criteria Investment Speculation

Example:
Example: RIL
Vodafone Idea
Horizon Long Short
Risk Calculated, hence Moderate High
Expected Return Moderate High
Fundamental Analysis, long Positional and Technical,

Technique
term performance Short term Performance
Consistency of Return Higher Lower
Sentiment Growth Greed

Financial Markets
On the Basis of • Debt

Security • Equity
On the Basis of • Primary Market

Transaction • Secondary Market
On the Basis of • Cash Segment

Delivery • Derivatives Segment
Qualities for Successful Investing
 Contemporary Thinking by following trendy
Investing using Fintech, real time
information and applying latest tools for
analysis
 Patience
 Composure
Warren Buffett known for Value Investing Flexibility and openness
Types of Investors
On the Basis of
On the Basis of Risk On the basis of
Portfolio
Preference Investment Horizon
Management
• Risk Averse • Value based • Traditional
• Risk Neutral Investing • Modern
• Risk Taker • Growth based
Investing
Chapter 2
INVESTMENT
ALTERNATIVES
Non Marketable Financial Assets
Money Market Instruments
Bonds and Fixed Income Securities
Equity Shares
Mutual Funds
Financial Derivatives
Life Insurance
Real Estate
Precious Objects
Equity, Linked Saving Schemes (ELSS)
Peter Lynch’s classification of Stocks
 The Sluggards : RIL, Maruti, WIPRO (Value Stocks)
 The Stalwarts : ITC
 The Fast Growers : Bajaj FinServ (During COVID 19)
 The Cyclicals : Telecom, Pharma Stocks (during COVID 19)
 The Turnarounds : PVR
 The Asset Plays : NTPC, ONGC
Let’s See…..
Chart of each of the above category Stock (www.equitymaster.com)
Security Analysis: Traditional vs Modern Approach
Traditional Modern
Analysis of Macro
Intrinsic Value> Market economic Factors
Value= BUY
Fundamental Analysis
Intrinsic Value<
Market Value= Technical Analysis
SELL
Sentiments and Inside Information
Tools used: EPS, P/E Ratio, Real Time

Information Analysis, sophisticated tools like
Algo are used
Portfolio Management Process
Specification of investment objectives and Constraints
Quantification of Capital Market Expectations

Investment policy and
strategy
Asset Allocation (selection of securities, which are best fit for
individual)
Formulation of Portfolio Strategy
Selection of Securities
Portfolio Execution Investment

implementation and
Portfolio Revision review
Portfolio Evaluation
Common Errors In Investment Management
• Inadequate comprehension of return and risk

• Not able to follow Life-cycle hypothesis
• Simultaneous Switching
• Misplaced love for cheap stocks
• Over-diversification and Under-diversification
• Buying shares of familiar companies (Biased Behavior for Domestic Stocks)
• Wrong attitude toward losses and profits (Buy at uptrend and sell in panic
• Tendency to speculate
• Following Herd
Time for a quick quiz……………
https://forms.gle/HhMdysthwk7cL9xZA
Mutual Funds
By By Investment
Others
Constitution Objective
Equity Traded Funds
Open Ended (Equity)

Equity Based schemes high
return, high risk (100%)
Way
ETF, exchange, yes
Debt Based schemes (100%),

Close Ended/ ELSS (80 C), 3 years, capital
long/short, G-sec, Gilt, money Fund of Funds
gain (LT/ST) (Equity)
market
Hybrid Schemes / balanced

schemes/ Monthly Incone
scheme/ income plan (60:40, e:d, International Funds
visa versa, debt oriented,
equityoriented
Thematic/ Sector Funds
Non Marketable Financial Assets
Non Marketable
Financial Assets
Government Saving Bonds
Savings Accounts
Money Market Deposit Accounts

Non-Negotiable Certificate of
Deposits
 Government-issued debt instruments

 RBI Bonds, War Bonds, Sovereign Bonds, Gold Bonds, Rural Electrification Certificates, National
Housing Bond
 not transferable, though Nominee can be appointed
 Non Negotiable CD like, Life insurance investments, bank accounts, company deposits, provident
fund deposits, NSC
 Traded through OTC transactions
 Highly illiquid, high & Guaranteed Return, High Safety, Tax Benefits
 Must be part of Portfolio for retirement Planning
Money Market Instruments
• Maturity up to 14,91, 182,364 days
Treasury Bills • Issued by RBI to banks and trusts with minimum investment of 25,000/-
• Issued at discount to face value
• Private and unsecured Debt paper issued by Corporates

• Commercial Paper • Purchased by Mutual Funds, Pension Funds, Insurance Companies
• Fixed Maturity Period

• Certificate of Deposit • Higher Interest than savings Deposits
• Surplus Money lent by banks
• Call Money Market • Mutual Funds, Insurance companies and banks trade
• Maintain CRR
• Short Term, Collateral Backed, Interest Bearing Loans

Repos • It is a derivative of money market
• Collateralized Borrowing • Multi Party obligation between a borrower and a lender

• Mutual Funds, Pension Funds, Insurance Companies participate
and Lending Obligations
Bonds and Fixed Income Securities
 On the basis of Issuer: Government bonds, Corporate Bonds, State Development Bonds
 On the basis of Convertibility: Convertible Bonds and Non-Convertible Bonds
 Zero Coupon Bonds and Income Bonds
 Secured and Unsecured Bonds (Debentures)
Equity Shares
 Common Stocks and Preferred Stocks
 Common Stocks offer ownership in firm, through voting rights, pay dividends and capital gains, no
maturity
 Stock Splits, Stock Dividends, Right Issues are some other benefits
 Preferred Stocks are hybrid of Stock and Bond. They earn interest
Insurance Products
Health
Life Travel
Home Auto
Fire/Burglary
Real Estate and Precious Objects
For the bulk of the investors, the most important asset in their portfolio is a
residential house. In addition to a residential house, the more affluent
investors are likely to be interested in the following types of real estate.
 Semi-urban land
 A second house
 Commercial property
 Agricultural land
 Time share in a holiday resort
 Gold and Silver
 Precious Stones
 Art Objects
Financial Derivatives
A derivative is an instruments whose value depends on the value of some underlying asset.
 Futures A futures contract is an agreement between two parties to exchange an asset for cash at a
predetermined future date for a price that is specified today.
 Options An option gives its owner the right to buy or sell an underlying asset on or before a given
date at a predetermined price.
 Forward A forward contract is a private and customizable agreement that settles at the end of the
agreement and is traded over-the-counter
 Swaps: Mumbai Inter bank Offered rate (MIBOR) and London Inter bank Offered Rate (LIBOR),
OTC, Interest rate Swaps, Currency Swaps, Commodity Swaps, Credit Default Swaps. Used for risk
hedging and exploring new markets and products
Unit-2
Securities Market
Outline
 Public Issue
 Secondary Equity Market
 Reforms in Stock Markets
 Trading and Settlement
 Type of Orders
 Corporate Debt Market
 Retail Debt Market
Financial Markets and Participants
Outline
 Indian Economy and Financial Markets

 Structure of the Securities Market
• Participants in the Securities Market
• Primary Equity Market
• Secondary Equity Market (Stock Market)
• SEBI’s Regulation
• Stock Market Abroad
Structure of Securities market
Securities
Market
Equity
Debt Market
Market
Government
Secondary Primary Corporate Money
Securities
Market Market Debt Market Market
Market
Initial Public Offer-Process
 Offer of New securities is made to new investors/existing investors
 Initial Public Offer (IPO) and Follow on Public Offer (FPO)
 Approval of the board of directors
 Approval of shareholder
 Appointment of the lead manager
 Due diligence by the lead manager
 Appointment of other intermediaries like co-managers, Trustees, advisors, underwriters,
bankers, brokers, and registrars
 Preparation of the draft/red herring prospectus
 Filing of the draft prospectus with SEBI
 Application for listing in stock exchanges
Initial Public Offer-Process
 Filing of the prospectus (after any modifications suggested by SEBI) with the Registrar of
Companies
 Promotion of the issue
 Printing and distribution of applications
 Statutory announcement
 Collection of applications by Registrar
 Processing of applications by Registrar
 Determination of the liability of underwriters
 Finalization of allotment
 Giving of demat credit (or dispatch of share certificates) and refund orders
 Listing of the issue
Book Building Issue-Procedure
Book Running Lead Manager (BRLM) and syndicate members appoint the intermediaries registered with SEBI who eligible to
act as underwriters.
Syndicate members are appointed by the BRLM. The book building process is undertaken basically to determine investor
appetite for a share at a particular price.
It is undertaken before making a public offer and it helps determine the issue price and the number of shares to be issued.
Process of price discovery-
weighted average
Hired Investment determining the Invite investors to arrive at the
bank price range to submit bids final price/cut off
price
Dig Deeper……
Applications Supported by Blocked Amount (ASBA)
Facility required in Book Building Process

Supported by SCSB (Self-Certified Syndicate Banks)
Amount mentioned in application money get blocked
Listing of Securities
Regulated by SEBI
Shares, debentures, Mutual Fund, commodities can be listed on exchange like NSE, BSE, MCX
Minimum capital shall be INR 5 Crore for listing of share of a registered company
File an Application Compliance of

Listing approval Voluntary/ Non-
on Exchange, in Exchange by laws
and Allotment of Voluntary
accordance with in accordance with
ISIN Delisting
SEBI SCRA
Dig Deeper….
• Right Issue: A rights issue involves selling securities in the primary market by issuing rights to
existing shareholders on a pro rata basis. ( RIL right issue of nearly INR 53,000 Cr. with share ratio
1:15 at 1257 per share)
• Private Placement: A private placement is a sale of either stocks, bonds or securities to

a private investor. (mannapuram Finance, JSW Steel, Piramal Board are some deals in 2020.
https://economictimes.indiatimes.com/topic/private-placement
Comparison
Criteria Right Issue Private Placement
Offered to Existing Investors New investors
Instrument Equity Equity/Debt
Effect on Share Price Falls No Effect
Traded in Secondary Markets Primary Markets
Role of SEBI- Dig Deeper…..
Securities Contracts (Regulations) Act 1956
SEBI was created as administrative body of MoF in 1989
1992 SEBI took charge of all regulations of SCRA in 1992, through SEBI
Act
SEBI’S principal tasks are:

Regulate business on Stock Exchange
Register and regulate Intermarries
Prohibit fraudulent Activities
Promote Investor’s Education
Regulate merger and acquisition process
Role of SEBI : Topic of presentation for group
2 on 3.9.2020 (take reference from two case studies provided)
Regulatory Intermediaries
Regulates and Approves by- Regulations for Merchant
laws of Stock Exchanges Bankers
Inspect books of Accounting Regulations for Registrar
Licencing of Brokers and Sub

Listing of Companies
Brokers
Role of SEBI- Dig Deeper…..
Some Initiatives:
 Freedom of Designing and Pricing Instruments
 Ban on Badla System in 1993
 Introduction of Screen Based System in 1996
 Electronic Transfer in 1996 till 2019 NSDL and CDSl, T+5
 Risk Management by Limit to exposure, Margin on VAR, Circuit, KYC
 Rolling System 2001
 Introduction of derivatives 2001
 Agreement with Exchange for better Corporate Governance
 Change in management Structure of Exchange
 Regulation on Intermediaries
 Regulation o Mutual Funds through AMFI in1995
 Regulation of Foreign portfolio through Foreign Exchange Management (Transfer or Issue of Security by a Person
Resident Outside India) Regulations, 2017
 Development of Code for takeover in 1992 shuchitas81@gmail.com
Latest and scope on SEBI- Dig Deeper.
 Introduction of Margin Trading with Pledge of Shares

 Provide line of Credit to brokers
 T+0 settlement
 To check Skewed Distribution of Turnover
 Home work : ISIN which have been maximum traded
on NSE in last week.
Participants
Regulator Stock Depository Broker Mutual Funds

SEBI (1992) Exchanges NSDL (1996) Icici Direct Trusts
MCA NSE (1994) CDSL(1999) Motilal Oswal Custodians
AMFI (1995) BSE (1995) IIFL Bankers
IRDA (1999)
Participants on NSE and BSE
Regulators and Investors in

Issuer of Securities Intermediaries
Securities
• SEBI • Corporate • Clearing Corporation
• Exchange itself (Pension Funds, (NSCCL/ICCL)
• Depositories
• Companies Mutual Funds..) (NSDL/CDSL)
• Retail • Banks
• Brokers ( Stock Broker,
Forex Broker, Full Broker,
Discount Broker)
Dig Deeper in Secondary Markets
Trading and Settlement
• Investor Buys/Sells on Exchange, Day • Trade Details from

N Exchange to
NSCCL, Day N
NSCC
NSE
L
Banks Depository
• Pay out/in, from/to Banks, Day • Notification to Clearing Members,

Day N+1
N+2 • Transfer to/from DEMAT account,
Day T+2
Stock Exchanges in India
 Presently 5 Operating exchanges, Namely BSE, NSE, CSE,
 BSE (1875): SENSEX evolved in 1986, offers Depository services through
CDSL, 5700 listed securities, now ODIN (Open dealer integrated
Network)earlier BOLT, jobbers were operational
 NSE (1994): National Exchange for Automated Trading (NEAT), offers
Depository services through NSDL, NIFTY 50 is the most popular
benchmark, 1700 securities
 ODIN: Owned by Financial technologies, ODIN (NSE,BSE, MCX, NCDEX)
 CSE (1908)
 MSE (till 2019)
 India INX (2017), subsidiary of BSE
 NSE IFSC (2016), subsidiary of NSE, 8:00-5:00 and 5:30-11:00
Some Terms
 Bulk Deal: if share under transaction are more than .5% of total equity Shares.
 Block Deal: before regular trading, in range of either 5 lakh shares or min. 5 cr. Value
 SBS: BOLT, ODIN, NEAT and many more….
Types of Orders
 Market Order : Trade takes place at as order is released in market partial
prevailing Price, for purchase (lowest ask execution is possible.
price), for sell (highest bid price)  Opposite of IOC is GTC (good till cancel).
 Limit Order : Trade takes place at a specified
 Best Price
price, or lower price (purchase), higher (Sell)
 Active Orders
 Stop Loss Order : Setting the threshold price,
for sale/purchase, will get triggered if market  Passive Orders
price falls/exceeds, below/above the set price  Limit Order Book
 Trailing Stop Loss Orders : when stop loss  Circuit Breakers
limit keeps changing with change in market
price, for sell (moves upward), for buy (moves
downward)
 Day Order : Valid for a specific day, cancelled
there after, can be executed partially. Likewise
there are week orders and month orders
 Immediate or Cancel Order : executed as soon
Some other Terms
 Buying on margin or Margin Trading
 Short Sell
 Algorithmic Trading/ Black Box trading
 Round Lots
 Odd Lots
 Sensex, 100 as base value, base year as 1978-79
 Nifty, 1000 as base value, base year as 1995
Do You Know??
Stock Market Indices Around The World
 Dow Jones: Stock market index that measures the stock performance of 30 large companies
listed on stock exchanges in the United States
 S & P 500 : 500 large companies listed on stock exchanges in the United States.
 Nikkei 225: Stock market index for the Tokyo Stock Exchange
 FTSE 100 (The Financial Times Stock Exchange Group) : Share index of the 100 companies
listed on the London Stock Exchange with the highest market capitalisation.
 KOPSI (The Korea Composite Stock Price Index ): Representative stock market index of
South Korea
Stock Market- Pre and Post Reforms
 Reforms after Harshad Mehta scam

 Capital Gain tax being taxable: Long term capital gains accrued
from selling equity shares and equity-oriented mutual funds are
exempt from tax for maximum up to Rs 1 lakh in a financial year.
The gains in excess of Rs 1 lakh are chargeable at the rate of flat 10
percent.
 STT: .1% (delivery Based), .025% (Intraday)
 Policy of investment by FII and FPI: <=20% of total issued capital
by FII, <= 10% for FPI
Indian Economy and Financial Markets
 3 Trillion Dollar Economy
 NSE total Market Capitalization 2 Trillion Dollar
 Size of Mutual Fund Industry is nearly INR 24 Trillion or nearly .3 Trillion Dollar
What Deloitte Says…..
Government Securities Market
Secondary Market
· As soon as they are issued G-secs are deemed to be listed and eligible for trading.
· The NSE has a wholesale Debt Market (WDM) for high value debt transactions.
· Two kinds of trades occur on the WDM : Repo trades and Non-repo trades.
· Despite the WDM, the wholesale market in G-secs is by and large a telephone market. After a deal is
done, it is reported on the Negotiated Dealing System (NDS) of NSE
Government Securities Market
Primary Market
· The issue of G-secs or Treasury securities is done by the Reserve Bank of India (RBI) which serves as the
merchant banker to the central and state governments.
· The RBI announces the auction of G-secs through a press notification and invites bids from prospective
investors.
· Two systems of treasury auctions are widely used all over the world: (a) French auction. (b) Dutch
auction
· In a French auction (or discriminatory price auction), successful bidders pay the actual price (yield)
they bid for
· In a Dutch auction successful bidders pay a uniform price which is usually the cut off price (yield)
· DVP (Delivery vs Payment ) system prevails to mitigate risk
Participants
Banks, Mutual funds, Pension Funds, PF, Primary and Satellite Dealers
Instruments in Debt Market
Corporate Bonds
Corporate bonds may be issued publicity or placed privately. Over 90 percent of corporate bonds are presently privately
placed.
Public Issue
Public issue of corporate bonds is done on a fixed price basis through an offer document (prospectus) which specifies the
coupon, tenor, security and other terms. According to SEBI guidelines, all publicity issued bonds have to be secured,
credit-rated, and compulsorily listed. Further, it is mandatory to appoint a debentures trustees, create debenture
redemption reserve, and create a charge on the assets of the company
Private Placement
Private placement is mostly done through a book built issue to institutional investors. Details of the issuer and the bond
are provided in the placement document(information memorandum)
Corporate Bonds are traded on the equity segment of the National Stock Exchange (NSE) and the BSE-F segment of the
Bombay Stock Exchange (BSE). The NSE also has a segment called the Wholesale Debt Market (WDM) to trade
bonds. However, the real secondary market for corporate bonds is an over-the-counter (OTC) market.
All corporate bonds are settled in dematerialized form at the equity market depositories.
Instruments in Debt Market
Money market is the market for short-term debt funds. It comprises of the call and notice money market, repo market,
and the market for debt instruments such as treasury bills that have an original maturity of less than one year.
The money market does not exist in a specific physical location or follow a single set of rules or post a single set of prices.
Rather, it represents a web of borrowers and lenders, linked by telephones and computers, dealing with short-term debt
funds.
Call and Notice Money Market : Lending and borrowing of funds between banks and entities like Primary Dealers.
Borrowing/Lending for 1 day is call, whereas for 2-14 days is notice.
Repo Market : The party which lends securities (or borrows cash) is said to be doing the repo and the party which lends
cash (or borrows securities) is said to be doing a reverse repo.
Treasury Bills: Short-term debt instruments of the central government, issued from 14days to 364 days. Treasury bills are
issued at a discount and redeemed at par.
Let’s Take Quiz 2……….
https://forms.gle/RTQ1p6k4wLpVz5gh7
https://forms.gle/JJznDVyBrHDwG9tcA
https://forms.gle/fDQh55f5SGDAzNqy7
Unit III
RISK AND RETURN
Two Sides of the Investment Coin
 Return: Return is the primary motivating force that drives investment.
The return of an investment consists of two components:
Current return (Dividend and Interest)
Capital return (Change in Price, Appreciation/Depreciation)
 Risk : Risk refers to the possibility that the actual outcome of an

investment will deviate from its expected outcome.
The three major sources of risk are : business risk, interest rate risk, and market risk.
 Modern portfolio theory looks at risk from a different perspective. It divides total risk as
follows.
Total Risk = Unique Risk (controllable/Unsystematic) + Market Risk (uncontrollable/ systematic)
Measuring Historical Return
 Total Return
R = C + (PE - PB)/PB
 Arithmetic Mean : ∑ R/n, R=Return
 Geometric Mean : ((1+R1) (1+R2)…… (1+Rn)1/n )-1, where R=Return Relative, R=1+% Return
 Difference between Arithmetic Return and Geometric Return is Variability of Distribution.
1+Geometric Mean 2
≃ 1+Arithmetic Mean 2
- Standard Deviation 2
 Blume’s Formula:
R(T) = (T-1/N-1)* GA + (N-T/N-1)* AA
T= year duration for which forecast to be done
N= past Years for which data is given
Forecasting the Future on the Basis of the Past
To illustrate, suppose that from 20 years of data on annual returns, you find that the geometric and arithmetic
average returns are 12 percent and 15 percent respectively. You want to forecast 1 – year, 5 – year, and 10 – year
average return forecasts. According to the Blume formula, the average return forecasts are as follows:

1–1 20 – 1
R(1) = X 12% + X 15% = 15%
20 – 1 20 - 1

5–1 20 – 5
R(5) = X 12% + X 15% = 14.37%
20 – 1 20 - 1

10 – 1 20 – 10
R(10) = X 12% + X 15% = 13.58%
20 – 1 20 - 1

20 – 1 20 – 20
R(20) = X 12% + X 15% = 12%
20 – 1 20 - 1

Risk
 Variance(σ^2): Square of Standard Deviation (σ)
(σ^2) = (∑(Ri-R)^2)/(n-1))
Ri=Return, R =Arithmetic Return
 Ex post Facto : Historical Return and Risk (refer excel)
 Ex Ante : expected Return and Risk
 Probability : Likelihood of occurrence of an event
 Expected Rate of Return = E(R) = ∑Ripi (refer excel)
 Variance of return = σ^2 = ∑pi (Ri-(E (R ))^2 (refer excel)
 Std. Deviation = square root of variance
Risk, Dig Deeper……
 Total Risk = Unique Risk (controllable/Unsystematic/ diversifiable) + Market Risk (uncontrollable/ systematic/ Non Diversifiable)
 β, calculates Non Diversifiable/Systematic Risk through β coefficient
 More responsiveness towards the market, a security is, higher is the β
 To calculate β, below equation is used:
Rs = Rf + s (RM – Rf)
Where,
Rs = Estimated Return on Stock
Rf = Risk free return
RM = Return on the Market Index
s = Sensitivity of Stock towards Market
Refer Excel, chart drawn is SML, The Security Market Line
Using Beta to Estimate Return
 Capital Asset pricing Model (CAPM) is used to check the impact of a security on
Risk and Return of a portfolio. The relationship between risk and return is called
Risk-Return Trade off.
 Mathematical Expression is through CAPM
Suppose, (refer excel)
 Graphical Expression is through SML (The Security Market Line)
Beta Return of Security
1 12
1.2 13.6
1.5 16
The Characteristic Regression Line (CRL)
 Simple Linear Regression Model of representing SML, estimates the diversifiable

and un diversifiable risk of a security against the market index return.
s = n∑XY-(∑X)(∑Y)/n∑X^2-(∑X)^2 (refer Excel)

Rf = Y bar- s X Bar
Beta ∆Rs wrt ∆Rm

1 ∆Rs = ∆Rm
<1 ∆Rs < ∆Rm
>1 ∆Rs > ∆Rm
negative ∆Rs negative correlation ∆Rm
Equity Valuation
 Dividend Discount Model,
 Earning Multiplier Approach,
 CAPM Model
 Dividend Discount Model:
“Value of equity is equal to the present value of expected dividends + present value of Sales price
expected when equity is sold.”
Assumption: Dividends are Paid Annually

First Dividend is paid after one year
Dividend Discount Model contd.
 Single Period Valuation Model
P0 = {D1/(1+r)}+ {P1/(1+r)}
where P0= Present Price, D1=Expected Dividend, P1= Expected Price after one year, r- rate of return
 If P0 is expected to grow at rate of g, then,
P0 = {D1/(1+r)}+ {P0(1+g)/(1+r)}
or
P0=D1/(r-g)
or
r= (D1/ P0)+g
 Multi Period Valuation Model P0 = Current return + Capital Return
{D1/(1+r1)^1}+{D2/(1+r2)^2}……infinite
Or
∑Dt/(1+r)^t,
now we need to add capital return also, so
P0= {∑Dt/(1+r)^t}+ Pn/(1+r)^n
Also
P0= {∑Dt/(1+r)^t}+ {Dn+1/(1+r)^1}+….
Finally
P0= ∑ Dt/(1+r)^t
Subject to Assumptions
 Dividend per share is constant/ Zero Growth Model
 Dividend per share grows at a constant rate per year
 Extraordinary, then normal
 Above Normal, Decline, normal
Subject to Assumptions
 Dividend per share is constant, Zero Growth model: P0 =D/r
 Dividend per share grows at a constant rate per year (Gordon Model): P0= D1/(r-g)
 Extraordinary (finite period), then normal (infinite period) / (Two stage Model):
P0= D1{ 1-(1+g1/1+r)^n/r-g1}+(d1(1+g1)^n-1(1+g2)/r-g2)(1/(1+r)^n}
 Above Normal (ga), Decline for 2H years exactly upto half, normal and constant afterwards(gn)
H Model:
P0= {D0(1+gn)/ r-gn}+{D0H(ga-gn)/r-gn}
Earnings Multiplier Approach
P0=E1*(P0/E1)
Determinants of P/E Ratio are:
* Dividend Payout Ratio, (1-b), where b stands for ploughback ratio

**Required rate of Return (r) and P/E, has inverse relationship
The expected growth rate, ROE*b
Above determinants are derived through DDM, which is P0=d1/r-g
D1 can also be written as E1(1-b)
So P0= E1(1-b)/r-(ROE*b),
or
P0/E1=(1-b)/r-(ROE*b)
* In case, ROE>r, an increase in b, then P/E will increase

In Case, ROE<r, an decrease in b, will lead to decrease in P/E
In case ROE=r, no effect on b and P/E
Earnings Multiplier Approach
*** Higher the Return, higher the Risk and low the P/E
**** Higher the Liquidity, higher the P/E
Three popular rule of Thumb are as below:

 PEG= 1 , stock is fairly valued
PEG> 1, stock is overvalued
PEG<1, stock is undervalued
 Lower the corporate lending, earnings tend to increase
 P/E tends to be inverse of real rate of return
Discuss case of Alpha Company, in Excel
Bond Valuation
 Return from Bonds are in form of Coupons and Maturity Value
 Risks associated with Bonds are Interest Rate Risk, Default risk, Marketability and callability Risk
 Interest Rate Risk, value of bond is inverse of market interest rate
 Bond Return = (Price Gain + Coupon Amount)/ purchase price
 Current Yield = Annual Coupon Payment/Current market Price
 Yield to Maturity (YTM) = yield is the required rate by investor, if bond is held till maturity. It gives the
discounted value of future cashflows
 Assumptions for YTM: no default, coupon payments are reinvested, bond is hold till maturity
 Zero Coupon Bonds/Deep Discount Bonds: coupon payments are zero, issued at discount and
redeemed at face value.
YTM= Coupon1/(1+y)1+Coupon2/(1+y)2+………
Y=(C+(premium or discount/ years to maturity))/(P0+Face Value)/2
NPV= Coupon/ (1+y)^t + (Pm/1+y)t

Bond Value Theorems
All bond theorems are based on below equations:
Y=(C+(premium or discount/ years to maturity))/(P0+Face Value)/2
YTM= Coupon1/(1+y)1+Coupon2/(1+y)2+………
Theorem 1: As market price increases, yield reduces (Y=1/P0)
Theorem 2: if Y is constant, lower the maturity, higher the discount (d=1/t)
Theorem 3: if Y is constant, discount will decrease with increasing rate
Theorem 4: rise in bond price when yield declines is More the fall in price when
yield increases
Theorem 5: change in price is lesser, for a change in yield, if coupon is higher

Bonds, Dig Deeper
Convexity
 Though bond’s price and yield is inversely proportionate (Theorem 1), but relationship is not linear (Theorem 4).
 The relationship is convex in nature.
Yield Curve
Relationship between term/ time or years to maturity and yield is called Yield Curve
Probable reasons are:
Hicks & Lutz
Expectation Theory: long term rates > short term rates (rising Yield Curve), in expectation of higher
interest rates, or visa versa
Liquidity preference Theory: On long term bonds issuer pay premium
Segmentation Theory (Modigilani): YC a function of demand ans Supply
Duration in Bonds
 Duration in Bonds mean time structure in bonds and interest Rate Risk.
 One way to calculate is YTM (Years to Maturity) or Asset Time: which is the time for which investor has to wait
to get principal after maturity of bond.
 Other way is to measure the average time until all coupons and principal is covered. This Duration is called
Macaulay’s Duration. Duration is weighted average time to maturity. Where weight is present value of each
time period.
D = ∑ (Pv(Ct)/P0)*t
Where, D=Duration
P0= Sum of Present Value of Cash Flow
Pv(Ct) = present Value of the Cash Flow
T= Number of Years
Interpretation:
 Larger the Coupon, Shorter the Duration, less volatile the Bond
 Larger the Maturity, Longer the Duration, more volatile the Bond
 Larger the YTM, Shorter the Duration, less volatile the Bond
 In Zero Coupon Bond, Maturity and duration are same.
Immunization
 A technique through which the stream of cash flow can be almost certain.
 In the Immunization Process, Coupon rate can be reinvested in the bond, so that it can offer higher interest rate.
This is said as Immunization Process
 The bond portfolio duration is weightage average of the durations of individual bond in portfolio.
 So, the equation is:
Investment Outflow = (X1* Duration of Bond1)+(X2* Duration of Bond2)
 Assumptions here are:

Changes in Interest Rate Occurs before start of Coupon Rates
Bonds have same yield
Shift in interest Rate effect the bonds equally
There is no Call Risk and Default Risk.
(Numerical in extra Class) (through solved numerical Images)
Unit IV
Security Analysis
 Outline
 Economic Analysis Fundamental Analysis /
 Industry Analysis E-I-C Analysis /
Top Down Analysis
 Company Analysis
 Technical Analysis
 Random walk Theory
 Efficient market Hypothesis
Economic Analysis
 Researches prove that half of variation in price of stock is due to Economic Factors
 This variation is defined as “Systematic Risk”
 Economic Analysis starts with study of Global Economy, as it bring many opportunities and
threats as well
 Economic Activity affects Corporate Mindset, Investors attitude and expectations
 Hence, Identifying right time to invest is important
 Broad Economic Variables are National income, Fund allocation to different Sector, Policies of
Central Government, Saving and Investment Pattern, Inflation, Interest Rate, Government
Deficit
 Techniques for Economic Analysis are, surveys, key economic Indicators and Various Indexes
 Hence, Market and Indexes are related to overall economic Performance
 Future prospects of economy also decides the development in some industries. Like a digital or
paperless economy will provide scope to IT industry to flourish
Macro Economic analysis
• Fiscal Policies (Expansionary and Contractionary):
Demand
• taxation and
• spending by center
• Monetary policies:
Side Policies • Interest Rates, Liquidity, Reserve Requirements (CRR

& SLR)
• Privatization, De regulation,
Supply Side •
•
Public Sector Investment,
Vocational training, Housing Supply
Policies • Health facilities
GDP Analysis
Calendar Actual Previous Consensus Forecast

2019-11-29 4.5% 5% 4.7% 4.7%
2020-01-31 6.1% 7% 5%
2020-02-28 4.7% 5.1% 4.7% 4.6%
2020-05-29 3.1% 4.1% 2.1% 1.9%
Change of 11%
2020-08-31 3.1%
-8%
2020-11-30 2.3%
Employment Rate, Wages and Disposable Income
India’s Inflation (CPI) and India’s Industrial Productivity
India’s Foreign Reserve and Trade Deficit
Calendar Actual Previous

2020-06-19 $507.6B $501.7B
2020-06-26 $505.57B $507.6B
2020-07-03 $506.8B $505.57B
2020-07-10 $513.3B $506.8B
2020-07-17 $513.3B
Corporate Tax Rate and Interest Rate
Macro Economic Factors
Growth Rate of GDP
(2.9 Trillion Dollar) Savings and Investments
Industry Growth Rate Inflation
Expected to grow at -8% Irregular, though
-18% presently Nearly 6% CPI
(Aug 2020) increasing
Monsoon &Agriculture
Interest Rate Govt. Budget and Deficit Tax Structure
Fall in GDP from
Nearly 4% Trade Deficit -3 Billion $ 25% Corporate Tax
Agriculture
Demography Sentiments
Balance of Payment Logistics
Reduced rate of BCI
$513 Billion Foreign Badly Effected, huge
employment, increased
reserve investment Ease of Doing Business
Disposable Income
Source: https://tradingeconomics.com/india
A Flow Diagram Of Stock Price Determination
EXOGENOUS VARIABLES ENDOGENOUS VARIABLES
Corporate
tax rate tx
Changes in
government Expected
spending Δ Changes in Nominal Real corporate
G total spending corporate corporate earnings
ΔY earnings E earnings E* E*e
Changes in
nominal
money Δ M Changes in
real output Stock
Changes in ΔX Interest price SP
Potential price level Δ P rate R
output Y*
Changes in
real money Δ
M*
Source : Michael W.Keran, “Expectations, Money, and the Stock Market, “Review
Jan. 1971
Sensitivity to the Business Cycle
The sensitivity of a
Sensitive Industry Defensive
Industries Cyclical firm’s earnings to the
Automobile Industry Industry business cycle is
vary in their FMCD
determined by three
sensitivity to FMCG Tobacco factors:
BFSI Firm’s sales to
the business Education Industry business conditions,
Oil & Petroleum
cycle. Construction the operating
leverage,
Financial leverage.
Study of the Structure and Characteristics of an Industry
 Structure of the Industry and Nature of Competition

 Nature and Prospects of Demand
 Cost, Efficiency, and Profitability
 Technology and Research
Industry Life Cycle Analysis and Investment
 Pioneering Stage
 Rapid growth Stage
 Shake out Stage
 Maturity Stage
 Decline Stage
Profit Potential of Industries: Porter Model
Word Of Caution For Investor
As, INDUSTRY FACTORS Effect Stock Prices From15 To 20 PERCENT
Display caution Respond quickly

during the pioneering and expand your Moderate your Sensibly disinvest
stage—this stage has commitments investment during when signals of
an appeal primarily during the rapid the maturity stage. decline are evident.
for speculators. growth stage.
Company Analysis
 Company Factors effect stock prices from 30 to 35 Percent
 Strategy analysis seeks to explore the economics of a firm and identify its profit drivers so that the
subsequent financial analysis reflects business realities.
 Corporate Strategy the way in which it exploits synergies across its business portfolio.
 Competitive Strategy
Cost Leadership Strategy (Wal-Mart, RIL)
Product Differentiation Strategy ( Rolex, Mercedes)
Cost-cum-differentiation advantage Differentiation advantage

Relative
Differentiation Low cost advantage Stuck-in-the
Position
Middle
Relative Cost Position

Company Analysis
• The institutional framework for

Financial Reporting
• Accrual System, IND AS, Well
Audited
• Sources of noise and bias in
Accounting Accounting
• Dissemination of financial
Analysis Information, Different
Depreciation and Stock valuation
• Differences between Good and Bad
Accounting Quality.
Earning Multiplier Approach : Expected EPS and Reasonable
P/E
Risk (Beta) and Valuation (P/E and PBV
Ratio)
Sustainable Growth Rate = Retention ratio

x Return on equity
Earnings (EPS, BPS,

DPS, D/P Ratio)
Intrinsic
Value
Identifying Value Anchor and value Range
Value Anchor = Projected EPS x Appropriate PE ratio

Identify Value Range
• PBV-ROE Matrix
• Growth-Duration Matrix
Tools for Judging • Expectations Risk Index
Undervaluation or • Quality at Reasonable
Overvaluation Price (VRE)
• PEG: Growth at a
Reasonable Price
PBV-ROE Matrix and Growth Duration Matrix
Quality at a Reasonable Price
 Expectations Risk Index (ERI)
Developed by Al Rappaport, the ERI reflects the risk in realizing the expectations embedded in
the current market price
Proportion of stock price depending on expected future growth * Ratio of expected future growth
to recent growth (Acceleration ratio)
In general, the lower (higher) the ERI, the greater (smaller) the chance of achieving expectations
and the higher (lower) the expected return for investors.
 The VRE is defined as the return on equity (ROE) percentage divided by the PE(price-earning)
ratio.
A stock is considered overvalued if the VRE is less than 1.
A stock is worthy of being considered for investment, if the VRE is greater than 1.
A stock represents a very attractive investment proposition if the VRE > 2
A stock represents an extremely attractive investment proposition if the VRE > 3
Quality at a Reasonable Price
 PE-to-growth ratio or PEG ratio is simply the PE ratio divided by the expected EPS growth rate (in
percent).
A PEG of 1 or more suggests that the stock is fully valued.
A PEG of less than 1 implies that the stock is worthy of being considered for investment.
A PEG of less than 0.5 means that the stock possibly is a very attractive investment proposition.
A PEG of less than 0.33 suggests that the stock is an unusually attractive investment proposition.
Obstacles for a Research Analyst

 Inadequacies or incorrectness of data
 Future uncertainties
 Irrational market behavior
Technical analysis
 Assumptions: Price is a reflection of demand and supply, market moves in trends, markets discounts
everything, History repeats itself
 Dow Theory says: no individual can effect markets, market discounts everything, Dow theory is not
infallible
 Trends: Trends shows direction of market. Primary (tide) Intermediate (wave), short term (ripple)
trend.
Support and Resistance Level and Technical Indicators
 Price level below which price fall is prevented due to demand of stock (Support Level)
 Price level above which price rise is prevented due to supply of stock (Resistance Level)
 Major Indicators are:

Volume of Trade: High Volume expects Bull Run and visa versa, large rise or fall in price will lead to large volume
Breadth of Market: used to study advances ((no. of shares whose price have rose) and declines (no. of shares whose
price have fallen) from previous day’s price. Difference of Advances and decline is defined as breadth. Higher the
breadth, indicates bull run. If a/d=<.5, indicates bear run, if a/d=>1.25, indicates bull run
Moving Average as Market indicator
 As market rise and fall is not smooth, so we need to smooth the data to know the trend. Moving
Average is used for it. 10-30 days for short term, 50-125 days for medium term and above 200 days
for long term trend.
RSI and Charts as Market indicator
 Relative strength index (RSI) uses oscillators (movement of share price across a reference point)
 Developed by Wels Wilder.
 RSI= 100-(100/(1+RS)), RS= Average price gain per Day/ Average loss Per day
 RSI> 70 is sell, RSI<30, Buy
Charts
Flags
Pennants Wedges
• Evening Star
Pattern
• Engulfing pattern
Cup and Handle Head and Shoulder
Random Walk Theory
and
Efficient market Hypothesis
Strong form
Semi Strong Form
Weak Form
Unit V
 Portfolio Management: Equity portfolio selection and
revision.
 Capital asset pricing model - arbitrage pricing theory -
models of Markowitz and Sharpe.
 Equity portfolio management strategies (Passive
management strategies (Buy and hold, indexing),
 Active management. Portfolio revision strategies.
 Life Cycle Hypothesis and Asset Allocation.
Portfolio Construction: Traditional Approach
Analysis of Constraints: Income Needs, Liquidity, Safety, Time
Horizon, tax Consideration, Temperament
Determination of Objectives: Current Return and Capital Return
Selection of Portfolio: Asset Mix as per Objective, Form of income,

Safety of Principal
Assessment of Risk and Return
Diversification: On the Basis of I&C, assign weightage
Modern Approach-Markowitz Model
 For a given expected Return, reducing portfolio variance using covariance of securities
 Simple Diversification reduces unsystematic risk/Controllable Risk
 Simple Diversification reduces risk up to a level
 Markowitz Model is answer to minimize Systematic Risk

Modern Approach-Markowitz Model
 Assumptions: For a given risk, higher return is preferred and for a given return, lower risk is preferred
 Concept:
 Cov of X12 =1/N∑(R1-R)(R2-R) or ½{(11-14)(20-14)+(17-14)(8-14)}= -18

 r= Co X12/ σ1 σ2= -18/(3*6)= -1
 σ1 σ2= Standard Deviation of security 1 and 2
Risk and return with different Correlation
Efficient Frontier:
Sharpe Index Model and CAPM
 Assumption: Return of Security is linearly related to Market Index. (no fundamental factor)
 Single Index model: Ri=rfr+β*Rm+error term
 Sharpe’s optimal portfolio is it’s excess return and Beta ratio = (Ri-Rm)/βi
 CAPM Theory:
 Assumptions: Perfectly Competitive Market
Decisions are on the basis of return, Std. deviation and Co variance
Investors have homogenous expectations
Lending and Borrowing is possible
Assets are infinitely Divisible
No transaction Cost and No Personal Income Tax
Unlimited Sales Allowed
CAPM contd.
 Rp= Rf*Xf+Rm(1-Xf), where Rp= Portfolio Return, Rf=Risk free return, Rm= Return on Risky Assets,
Xf and (1-Xf) are weights
Variance of portfolio
E (Rp)= Rf+(Rm-Rf/σm)*σp E (Rp)= Rf+(Rm-Rf/σm)*σp
APT
Portfolio evaluation: Sharpe, trenor’s and
jensons alpha
Portfolio revision

Dr. Shuchita - SAPM Upto Unit IV (SAPM G 2)

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Security Analysis & Portfolio Management

Trimester: IV (Finance Specialization)

By: Dr. Shuchita Singh

 Return: Expected benefits of today’s secrifice

 Risk: Uncertainty in the probability of returns

 Security analysis: estimating risk and return of individual securities

Government Saving Bonds or Money Market

Mutual Fund Insurance Retirement

Criteria Investment Speculation

Risk Calculated, hence Moderate High

Expected Return Moderate High

Fundamental Analysis, long Positional and Technical,

Consistency of Return Higher Lower

Sentiment Growth Greed

On the Basis of • Debt

On the Basis of • Primary Market

On the Basis of • Cash Segment

Investing using Fintech, real time

information and applying latest tools for

Warren Buffett known for Value Investing Flexibility and openness

Chart of each of the above category Stock (www.equitymaster.com)

Sentiments and Inside Information

Tools used: EPS, P/E Ratio, Real Time

Quantification of Capital Market Expectations

Formulation of Portfolio Strategy

Portfolio Execution Investment

• Inadequate comprehension of return and risk

Equity Traded Funds

Open Ended (Equity)

Debt Based schemes (100%),

Hybrid Schemes / balanced

Thematic/ Sector Funds

Money Market Deposit Accounts

 Government-issued debt instruments

• Private and unsecured Debt paper issued by Corporates

• Fixed Maturity Period

• Surplus Money lent by banks

• Short Term, Collateral Backed, Interest Bearing Loans

• Collateralized Borrowing • Multi Party obligation between a borrower and a lender

 Indian Economy and Financial Markets

Facility required in Book Building Process

File an Application Compliance of

• Private Placement: A private placement is a sale of either stocks, bonds or securities to

SEBI was created as administrative body of MoF in 1989

SEBI’S principal tasks are:

Inspect books of Accounting Regulations for Registrar

Licencing of Brokers and Sub

 Introduction of Margin Trading with Pledge of Shares

Regulator Stock Depository Broker Mutual Funds

Regulators and Investors in

Trading and Settlement

• Investor Buys/Sells on Exchange, Day • Trade Details from

• Pay out/in, from/to Banks, Day • Notification to Clearing Members,

listed on stock exchanges in the United States

 KOPSI (The Korea Composite Stock Price Index ): Representative stock market index of

 Reforms after Harshad Mehta scam

 Risk : Risk refers to the possibility that the actual outcome of an

 Difference between Arithmetic Return and Geometric Return is Variability of Distribution.

Refer Excel, chart drawn is SML, The Security Market Line

Beta Return of Security

 Simple Linear Regression Model of representing SML, estimates the diversifiable

s = n∑XY-(∑X)(∑Y)/n∑X^2-(∑X)^2 (refer Excel)