CHAPTER ONE

Introduction to Investment
Management
• Investment is the employment of funds with the aim of getting
return on it. (Financial or Other Products).
Two concepts of Investment:
1. Economic Investment: The concept of economic investment
means addition to the capital stock of the society.
• Thus, an investment, in economic terms, means an increase in
building, equipment, and inventory.
2. Financial Investment: This is an allocation of monetary
resources to assets that are expected to yield some gain or
return over a given period of time.
• It means an exchange of financial claims such as shares and
bonds, real estate, etc.
 INVESTMENT ALTERNATIVES
• Assets: Assets are things that people own. The two kinds of
assets are:
Assets

Real Assets Financial Assets

 Real Assets Financial Assets
• Can be used to produce • Don’t directly contribute
goods and services. to the productive
• Do not have a capacity of the economy
corresponding liabilities • A financial asset carries
associated with them.
a corresponding liability
• A separate liability may somewhere
be created to finance the
real asset, though.
 Difference Between Financial & Real Assets
• Divisibility: Financial assets are divisible, whereas
most physical assets are not.
• Marketability (or Liquidity)
• Holding Period: The planned holding period of
financial assets can be much shorter than the holding
period of most physical assets.
• Information Availability: Information about financial
assets is often more abundant and less costly to obtain,
than information about physical assets.
 Investment Vehicles (Alternatives)
The main types of financial investment vehicles
(alternatives) are:
• Short term investment vehicles; (Certificates of deposit,
Treasury bills, Commercial paper, Repurchase
agreements)
• Fixed-income securities; (Long-term debt securities –
Bond and Preferred stocks).
• Common stock;
• Other investment tools (Investment life insurance,
Pension funds, Hedge funds, Real estates)
 Investment Companies
• Investment companies are financial intermediaries that collect
funds from individual investors and invest those funds in a
potentially wide range of securities or other assets.
Functions of Investment companies
1. Diversification and divisibility: By pooling their money, investment companies
enable investors to hold fractional shares of many different securities.
2. Record keeping and administration
3. Professional management - have full time staffs of security analysts and
portfolio managers who attempt to achieve superior investment results for their
investors.
4. Lower transaction costs. Because they trade large blocks of securities,
investment companies can achieve substantial savings on brokerage fees and
commissions
 Major Characteristics of Investments
1. Return:  In fact, investments are made with the primary
objective of deriving a return in the form of Yield or Capital
Appreciation.
2. Safety:  certainty of return of capital without loss of money or
time.
3. Liquidity: An investment, which is easily saleable, or
marketable without loss of money & without loss of time is
said to possess liquidity.
4. Risk: Risk is inherent in any investment. The risk may relate
to: loss of capital, delay in repayment of capital, nonpayment
of interest, or variability of returns.
 Investment Risk Types
•Interest Rate Risk: Interest rate risk is the possibility that a fixed-rate debt
instrument will decline in value as a result of a rise in interest rates.
•Business Risk: the possibility that the issuer of a stock or a bond may go
bankrupt or be unable to pay the interest or principal in the case of bonds.
•Credit Risk: This refers to the possibility that a particular bond issuer will
not be able to make expected interest rate payments and/or principal
repayment.
•Taxability Risk: risk that a security that was issued with tax-exempt status
could potentially lose that status prior to maturity.
•Call Risk: possibility that a debt security will be called prior to maturity.
•Inflationary Risk: future inflation will cause the purchasing power of cash
flow from an investment to decline.
• Liquidity Risk: Liquidity risk refers to the possibility
that an investor may not be able to buy or sell an
investment as and when desired.
• Social/Political / legislative  Risk: Risk associated with
the possibility of nationalization, unfavorable
government action or social changes resulting in a loss
of value is called social or political risk.
• Currency/Exchange Rate Risk : Currency or exchange
rate risk is a form of risk that arises from the change in
price of one currency against another.
 Investment Management Process
1. Setting of investment policy.
• Availability of investible funds (savings or
borrowings)
• Objectives (max return or Hedge Risk)
• Knowledge (investment alternatives and markets)
• The investment horizon (short, long or
intermediate).
2. Analysis and evaluation of investment vehicles.
 Investment Management Process
3. Formation of diversified investment portfolio.
• Investment portfolio is the set of investment vehicles,
• Diversification forming the investor’s portfolio for
decreasing or limiting risk of investment.

•Debt and equity diversification

•Industry diversification
•Company diversification
 Investment Management Process
4. Portfolio revision - concerns the periodic revision of the three
previous stages. Currently held investor’s portfolio may no longer
be optimal and even contradict with the new settled investment
objectives
5. Measurement and evaluation of portfolio performance.
• Determining periodically how the portfolio performed, in
terms of not only the return earned, but also the risk of
the portfolio.
• For evaluation of portfolio performance appropriate
measures of return and risk and benchmarks are needed.
 CHAPTER TWO
Securities Market & Trading
2.1. Primary, Secondary and Third Markets
Financial market: is a market where financial assets are
traded /exchanged.
• Are not different from any other market.
• There are products and there are buyers and
sellers for these products.
• The ‘products’ in financial markets are financial
instruments or securities
• The sellers are called borrowers or issuers and the
buyers are called lenders.
 Cont.….

Financial markets have three essential functions-

• Determines the volume of credit available at a
macroeconomic level.
• They attract savers and borrowers.
• Set interest rate and security prices
 Functions of Financial Markets
• Saving function
• Wealth function: wealth is the sum of values of all individual assets
held at any moment in time.
• Liquidity function: providing a means of raising funds by converting
securities and other financial assets in to cash balance.
• Credit function: The financial markets furnish credit to finance
consumption and investment spending.
• Payment function: the financial system provides a mechanism for
making payments for purchase of goods and services.
• Risk protection function
• Policy function
• Separation of ownership and management
 Classification of Financial Markets
• Based on type financial claims: - Debt markets Vs Equity market.
• Based on maturity of financial claims: Money Market Vs Capital
Market
• Based on whether the financial claims are newly issued or
seasonal: Primary market Vs Secondary market
Third market - securities that are being traded over-the-
counter between broker-dealers and large institutional
investors.
Fourth market - trading differs from third market
trading in that there is no intermediary or broker
facilitating the trade.
 Cont.…
• Based on organizational structure:
Auction market- all financial assets are traded in the
centralized trading facility through bidding. Example
NBE treasury bills pronounce through TV for bidding.

Over- the- counter market- markets that do not

operate in a specific fixed location- rather transactions
occur via telephone, wire transfers, computer trading.
• Spot Vs Future Market
• Private Vs Public
 2.2. Foreign markets: Types of Foreign Exchange
Market
1. The Spot Market
The traders in the spot market are not exposed to the uncertainty of
the market.
2. Futures Market
The terms of the transaction are set in stone and cannot be altered.
3. Forward Market
Deals are similar to future market transactions. However, the terms
of the transactions and the terms agreed-upon can be negotiated and
altered as per the needs of the concerned parties.
The forward market has higher flexibility as compared to the futures
market.
 Cont.…
4.  Swap Market
When there is a simultaneous borrowing and lending of two
types of currencies between two investors, it is known as a
swap transaction.
5. Option Market
In the options market, the currency of exchange from one
denomination to the other is agreed upon by the investor at a
specific rate and on a specific date.
The investor has a right to convert the currency on a future
date but there is no obligation to do so.
2.3. Institutional Versus Private Investors
1. Institutional Investors
• A large group of investors or ‘Institutions’ invest in the
profitable securities market like real estate, stocks, and so
on.
• Manage large pools of investment contributed by small
investors
Some of the Institutional Investors are:
• Real Estate Investment Funds
• Mutual Funds
• Insurance Companies
• Banking Institutions
 Cont.…
2. Individual Investors
• Common people who invest in securities on an individual level.
• Individual investors have limited capital to invest and their
investments are for personal goals.
• Have to operate in the securities market through a registered
broker or a dealer.
• Individual investors do not affect the market momentum on a
large scale.
• The access to financial happenings is limited and hence,
individual investors are the laggards to gauge the market
sentiments.
 CHAPTER THREE

SECURITY ANALYSIS
 1. Market Analysis
Meaning of Security Market Analysis:
• The security market analysis refers to the analysis of
markets and securities traded there in terms of the risk-
return and other indicators of the market.
• As regards the risk-return factors, the expected return
varies with the risk attached to the instruments.
• Some instruments like government securities, Bonds are
least risky but have a cost in realization.
• The cost of conversion or realization of funds is zero in
the case of bank deposits.
 Valuation:
• The basic objective of market analysis is to know the
fair valuation of shares for buying and selling.
• The market comprises hundreds of securities whose
prices change from day-to-day and from time to time.
• The investors should have informa­tion of fair prices for
making their decisions of buying and selling.
• It is, therefore, necessary to make security valuation an
important part of market-analysis.
• As regards security valuation, the intrinsic value is the basis
on which overvaluation or undervaluation is judged.
• The intrinsic value is theoretically determined by the
expected net earnings flows over a number of years
discounted to the present time by a suitable discount rate.
• But in actual practice, this method is not followed due to
the practical difficulties of forecasting the future earnings
flows.
• Therefore, in practice, the P/E ratio is used to represent the
payback period of a share or multiplier relationship of the
price to its earnings per share.
Methods for Security Market Analysis:

The Methods of Valuation are:

(i) Discounted Value of Future Income Streams
or Dividends.
(ii) No. Of Years of Payback Period - (P/E Ratio).
(i) Discounted Value of Future Income Streams
Compounding:
Take 5% interest rate and capital of Br. 1.
Compounding:
• In one year, it becomes Br. (1 + 0.5) = 1.05
• In two years, it becomes Br. (1 + 0.5)2 = 1.1025
• In three years, it becomes Br. (1 + 0.5)3 = 1.1576
• This method is called compounding. The reverse of the
above is called discounting.
Discounting:
• If we receive Br. 116 at the end of three years, and if it is
discounted to the present day at 5%, it will be equal to Br.
100 at present.
• The present value of the principal of Br. 100 at the time of
maturity of 5 years at 8% return will be Br. 100/(1 + 0.08)5 =
Br. 68.
• The present value of Br. 100, ten years hence, will be 39 at a
discount rate of 10%.
• The above principle will apply to bond valuation and
debenture valuation.
 (ii) No. of Years of Payback Period:
For valuation of equity shares, the payback method is
used in the form of P/E ratio.
• Earning per share or dividend per share covers the price
paid for a share in, say 5 years.
• For example, earning is Br. 20 and the price Br. 100. P/E
Ratio is 5.
• Then the earnings multiplier is 5. The payback period is 5
years. The smaller is the period, the higher the return.
 Investment and Time Value of Money:
• Money today is more valuable than the same
tomorrow or a few days hence.
• This is because money has alternative uses and
opportunity costs.
• If it is invested, it would bring a return and better
the investment, the better is the return.
• To part with money is a risk which should be
rewarded by a return.
 Investment and Time Value of Money:
• The present value of a delayed pay off may be
found by multiplying the pay off by a discounting
factor, which is expressed as the reciprocal of 1
plus a rate of return.
• Thus the discounting factor = 1/1 + r

Where r is the rate of return that investor thinks

adequate for his parting with money. 
• Thus the present value (PV) = 1/1 + r x C, where C is the
expected cash flow or pay off in the period. If there are more
than one period, then-

Where C1 , C2 etc-are returns periods 1 and 2 etc. and r remains

as the same rate of return during all these periods.
• Thus any two investments can be compared in terms
of:
1. Actual rate of return above the risk-free return as
compared to return on other similar assets;
2. Pay-off period;
3. Net present value which is equal to the present
value of cash flows in future minus the actual
investment in the present period (NPV).
 Fundamental Analysis?
Fundamental analysis is the process of evaluating a security to make
forecasts about its future price.
For a stock, fundamental analysis typically includes reviewing many
elements related to stock prices, including:
•Performance of the overall industry
•Domestic political conditions
•Relevant trade agreements and external politics
•The company’s financial statements
•The company’s press releases
•News releases related to the company and its business
•Competitor analysis
Here are some examples of key company
performance statistics that are commonly used to
perform fundamental analysis on stocks:
•Earnings per share (EPS)
•Price-to-earnings (P/E) ratio
•Price-to-book (P/B) ratio
•Return on equity (ROE)
 Price-to-Earnings Ratio
• The price-to-earnings (P/E) ratio is used to evaluate companies
and determine if they are under or overvalued.
• The P/E ratio shows whether a share of stock pays
well compared to its price. 
• For example, imagine that the price per share is $30 and the
stock pays $2 earnings per share. The P/E ratio of the stock is
computed as follows:
30 / 2 = 15
• The lower the P/E ratio, the higher the earnings compared to the
stock price, and the more attractive the stock.
 Price-to-Book Ratio
•The price-to-book (P/B) ratio is a financial ratio that shows how much
the stock is worth compared to the book value of the company.
•It is computed by taking the price per share and dividing that by the
book value per share. 
•For example, if a company worth $10 million has 500,000 shares
outstanding, it will have a book value per share of:
$10,000,000 / 500,000 shares = $20 book value per share
•If its stock trades at $80 per share, then the P/B ratio is:
$80 / $20 = 4 P/B ratio
•If the P/B ratio is more than 1, this means the market’s consensus is
that the stock will grow at a faster pace than its book value suggests,
which is the reason why its price is higher than its book value.
•High P/B ratios are often seen in high growth stocks.
 Return on Equity (ROE)
• The return on equity is a measurement that
determines how efficient a company is when using its
shareholders’ equity. 
• You calculate the ROE by dividing the shareholders’ equity
by the company’s net income.
• If a company has generated $5 million this year and its
shareholder’s equity is $50 million, this means the ROE is:
$5,000,000 / $50,000,000 = 0.1 or 10%
 Return on Equity (ROE)
• The higher the ROE, the more efficient the company is.
• If a company generates a less than $5 million income this
year (say $2 million) with the same shareholders’ equity,
this means it is less efficient:
$2,000,000 / $50,000,000 = 0.04 or 4%
• Here, the company has a lower ROE given the same
shareholder’s equity, so it is less efficient in using its
shareholders’ equity to generate income.