Security Analysis and Portfolio Management: A Primer

Preface
Acknowledgements
Contents
About the Authors
List of Figures
List of Tables
1 Introduction to Investments
1.1  Background
1.2  A Broad Map of the Territory of Investments
1.2.1  Money
1.2.2  Sectors in an Economy
1.2.3  Real Assets and Financial Assets
1.2.4  Importance of Financial Assets
1.2.5  Financial Markets
1.2.5.1  Classification of Financial Markets
1.2.5.2  Functions of Financial Markets
1.2.5.3  Role of Financial Markets
1.2.6  Financial Assets
1.2.6.1  What is a Security?
1.2.6.2  Kinds of Securities
1.2.7  Who is an Investor?
1.2.8  What is an Investment?
1.3  Concept of Risk and Return
1.4  Basic Criteria/Factors/Attributes for Investments
1.5  What is Security Analysis and Portfolio Management?
1.5.1  What is a Portfolio?
1.6  Contemporary Trends in the Investment Environment
1.7  Conclusion
Tutorial: Foreign Direct Investment (FDI)
Market Size
Investments/Developments
Road Ahead: Indicative Interpretations/Discussion Points
Summary
1.8  Exercises
1.8.1  Objective (Quiz) Type Questions
1.8.2  Solved Numericals (Solved Questions)
Rate of Return
Risk
1.8.3  Unsolved Numericals (Unsolved Questions)
Rate of Return
1.8.4  Short Answer Questions
1.8.5  Discussion Questions (Points to Ponder)
1.8.6  Activity-Based Question/Tutorial
Additional Readings and References
2 Behavioural Finance
2.1  Introduction to Behavioural Finance
2.2  Efficient Market Hypothesis
2.3  Concept of Utility Maximization and Risk
2.4  The Behavioural Critique
2.4.1  Information Processing/Cognitive Errors
2.4.2  Behavioural Biases
2.5  Bubbles and Behavioural Economics
2.6  Equity Premium Puzzle and Myopic Loss Aversion (MLA)
2.7  Equity Premium Puzzle and Corporate Governance
2.8  Common Behavioural Errors in Investing
2.9  Behavioural Qualities for Successful Investing
2.10  Socially Responsible Investing
2.11  Conclusion
Summary
2.12  Exercises
2.12.1   Objective (Quiz) Type Questions
2.12.2  Short Answer Questions
2.12.3  Discussion Questions (Points to Ponder)
2.12.4  Activity-Based Question/Tutorial
Additional Readings and References
3 Concept of Risk and Return
3.1  Introduction to Risk and Return
3.2  Concept and Measurement of Return and Risk
3.2.1  Measuring Return
3.2.2  Measuring Risk
3.2.2.1  Probability Distribution and Risk and Return
3.2.2.2  Portfolio Risk
3.3  Conclusion
Summary
3.4  Exercises
3.4.1  Objective (Quiz) Type Questions
3.4.2  Solved Numericals (Solved Questions)
3.4.3  Unsolved Numericals (Unsolved Questions)
3.4.4  Short Answer Questions
3.4.5  Discussion Questions (Points to Ponder)
3.4.6  Activity-Based Question/Tutorial
Additional Readings and References
4 Fundamental Analysis
4.1  Introduction
4.2  Fundamental Analysis
4.2.1  Economy Analysis
4.2.1.1  Economic Features Which Impact Investments
4.2.1.2  Types of Information Sources
4.2.1.3  Indicators of Economic Situation
4.2.1.4  Economic Forecasting
4.2.2  Industry Analysis
4.2.2.1  Industry/Sector Classifications
Based on Size
Based on Ownership
Based on Nature of Product/Commodity
Based on Nature of Inputs/Raw Materials
Based on Lifecycle Stage
4.2.2.2  Key Factors to Be Examined
4.2.2.3  Industrial Legislation
Examples of Industry Analysis
4.2.2.4  Factors Affecting the Future Performance of the Industry
4.2.3  Company Analysis
4.2.3.1  Financial Analysis
4.2.3.2  Operational Analysis
Factual Disclosures by the Company
Estimating the Future Based on Current Operations
4.2.3.3  Efficiency Analysis
4.3  Classification of Companies’ Stock from an Investment Perspective
4.4  Examples of Different Aspects of Fundamental Analysis
4.5  Why Might Fundamental Analysis Fail to Work?
4.6  Conclusion
Summary
4.7  Exercises
4.7.1  Objective (Quiz) Type Questions
4.7.2  Short Answer Questions
4.7.3  Discussion Questions (Points to Ponder)
4.7.4  Activity Based Question/Tutorial
Additional Readings and References
5 Technical Analysis
5.1  Introduction
5.2  Technical Analysis
5.2.1  Economic Basis of Technical Analysis
5.2.2  Assumptions of Technical Analysis
5.2.3  Difference Between Fundamental and Technical Analysis
5.2.4  Market Trends/Phases Under Technical Analysis
5.3  Tools Deployed in/for Technical Analysis
5.3.1  Tools for Assessing Overall Market Movements
5.3.1.1  Dow Theory
5.3.1.2  Elliott Wave Principle
5.3.1.3  Kondratiev Wave Theory
5.3.1.4  Chaos Theory
5.3.1.5  Neural Networks and Genetic Algorithms
5.3.1.6  Breadth of Market Analysis
Advance/Decline Ratio
Short Interest Ratio Theory
Confidence Index
Odd Lot Ratio
Relative Strength Analysis (RSA)
5.3.2  Tools for Assessing Individual Stock’s Movements
5.3.2.1  Chart Analysis
Bar and Line Charts
Head and Shoulders (HS) Pattern
Inverse Head and Shoulders (IHS) Pattern
Pennant and Flag
Resistance and Support Levels
Triangle Formation
Point and Figure Charts (PFC)
5.3.2.2  Moving Average Analysis
5.3.2.3  Bollinger Band
5.3.2.4  Fibonacci Series
5.3.2.5  Spreads
5.3.2.6  Insider Transactions
5.4  Technical Indicators of the Witchcraft Variety
5.4.1  Super Bowl Indicator
5.4.2  Sunspots
5.5  Price Formation Process
5.6  Critiques of Technical Analysis
5.7  Conclusion
Summary
5.8  Exercises
5.8.1  Objective (Quiz) Type Questions
5.8.2  Short Answer Questions
5.8.3  Discussion Questions (Points to Ponder)
5.8.4  Activity-Based Question/Tutorial
Additional Readings and References
6 Bond and Equity: Valuation and Investment Strategies
6.1  Introduction
6.2  Bonds/Debt Instruments
6.2.1  Reasons for Issuing Debt
6.2.2  Features/Nomenclatures of a Debt Instrument
6.2.3  Concept of Time Value of Money
6.2.3.1  Compounding Technique
6.2.3.2  Discounting Technique
6.2.4  Bond Valuation
6.2.4.1  Current Yield
6.2.4.2  Holding Period Yield (HPY)
6.2.4.3  Yield on a Perpetual Bond
6.2.5  Risk in Debt Instruments
6.2.5.1  Unsystematic Risk in Bonds
6.2.5.2  Systematic Risk in Bonds
6.2.6  Factors Affecting Interest Rates
6.2.6.1  External Factors
6.2.6.2  Internal Factors
6.2.7  Effect of Interest Rate Changes on Bond Prices
6.2.8  Yield Curve (or Term Structure of Interest Rates)
6.2.8.1  Causes of Term Structure (Yield Curve)
6.2.8.2  Investment Strategy Related to Yield Curves
6.2.9  Bond Portfolio Management Strategies
6.2.9.1  Passive Strategy
6.2.9.2  Active Strategy
6.2.9.3  Core Plus Satellite Management
6.2.9.4  Horizon Matching
6.2.9.5  Classical Immunization Strategy
Duration
Properties of Macaulay’s Duration (MD)
6.2.9.6  Contingent Procedures (Structured Active Management)
6.2.9.7  Global Fixed Income Investment Strategy
6.3  Equity (Shares) Instruments
6.3.1  Equity Valuation
6.3.1.1  Capital Asset Pricing Model (CAPM)
6.3.1.2  Present Value Estimation
6.3.1.3  Dividend Discount Models
Zero Growth Models
Constant Growth Model
Variable Growth Model
6.3.1.4  Book Value Method
6.3.1.5  Liquidation Value Method
6.3.1.6  Price/Earnings (P/E) Multiple/Ratio
6.3.2  Equity Investment Strategies
6.3.2.1  Active Strategy
6.3.2.2  Passive Strategy
6.3.2.3  Difference Between Active and Passive Strategy
6.4  Difference Between Bond and Equity Valuation
6.5  Conclusion
Summary
6.6  Exercises
6.6.1  Objective (Quiz) Type Questions
6.6.2  Solved Numericals (Solved Questions)
6.6.3  Unsolved Numericals (Unsolved Questions)
6.6.4  Short Answer Questions
6.6.5  Discussion Questions (Points to Ponder)
6.6.6  Activity-Based Question/Tutorial
Additional Readings and References
7 Market Efficiency
7.1  Introduction
7.2  Efficient Market Hypothesis
7.3  Degrees of Market Efficiency
7.3.1  Strong Form Efficiency
7.3.2  Semi-strong Form Efficiency
7.3.3  Weak Form Efficiency
7.4  Stock Market Anomalies
7.4.1  Size Effect Anomaly
7.4.2  Calendar Anomaly
7.4.3  Value Effect Anomaly
7.4.4  Liquidity Effect Anomaly
7.4.5  Postearnings-Announcement Drift (PEAD) Anomaly
7.5  Critique of the Efficient Market Hypothesis
7.6  Merits of the Efficient Market Hypothesis
7.7  Normative Framework for Investors
7.8  Conclusion
Summary
7.9  Objective (Quiz) Type Questions
7.9.1  Short Answer Questions
7.9.2  Discussion Questions (Points to Ponder)
7.9.3  Activity-Based Question/Tutorial
Additional Readings and References
8 Diversification of Risk
8.1  Introduction
8.2  Markowitz’s Modern Portfolio Theory
8.2.1  Concept of Efficient Markets
8.2.2  Portfolio Construction Under Markowitz Portfolio Theory (MPT)
8.2.3  Critiques of Markowitz Portfolio Theory (MPT)
8.2.3.1  Short Selling
8.2.3.2  Borrowing and Lending or Leveraged Portfolios
8.3  Sharpe’s Single-Index Model and the Capital Asset Pricing Model (CAPM)
8.3.1  Sharpe’s Single-Index Model
8.3.2  Capital Asset Pricing Model (CAPM)
8.3.2.1  Expected Return–Beta Relationship Under CAPM
8.3.2.2  Assumptions of the CAPM
8.3.2.3  Unique Risk and Market Risk: Basis of Diversification
8.3.2.4  Market Portfolio Under CAPM
8.3.2.5  Security Market Line and Capital Market Line
8.3.2.6  Estimating Returns Through CAPM
8.3.2.7  Estimating Beta
Beta of a Portfolio
How Accurate Are Beta Estimates?
8.3.2.8  Constructing the Optimal Portfolio Under CAPM
8.3.2.9  Disadvantages/Limitations of CAPM
8.4  Advent of the Multi-factor Models
8.4.1  Two-Factor CAPM
8.4.2  Fama and French Three-Factor Model
8.4.3  Arbitrage Pricing Theory
8.4.3.1  The APT Return Generating Process
8.4.3.2  Risk Factors in APT
8.4.3.3  Challenges in APT
8.5  Normative Framework for Investors
8.6  Conclusion
Summary
8.7  Exercises
8.7.1  Objective (Quiz)-Type Questions
8.7.2  Solved Numericals (Solved Questions)
8.7.3  Unsolved Numericals (Unsolved Questions)
8.7.4  Short Answer Questions
8.7.5  Discussion Questions (Points to Ponder)
Additional Readings and References
9 Portfolio Management: Process and Evaluation
9.1  Introduction
9.2  Basic Aspects of a Portfolio
9.3  Underlying Principles in Portfolio Management
9.4  Portfolio Management Strategies
9.4.1  Active Portfolio Management Strategy
9.4.2  Passive Portfolio Management Strategy
9.5  Portfolio Management Process
9.5.1  Portfolio Planning Stage
9.5.1.1  Investor Conditions
Financial Situation of the Investor
Knowledge
Risk Tolerance
Operational Statement of Investment Objectives
9.5.1.2  Market Conditions
Short-Term Expectations
Long-Term Expectations
9.5.1.3  Investor Policies
Strategic Asset Allocation
z Current Asset Allocation
z Passive Rebalancing
Speculative Strategy
Tactical Asset Allocation
Security Selection
Internal/External Management
Statement of Investment Policy (SIP)
9.5.2  Portfolio Implementation Stage
9.5.2.1  Statement of Investment Policy (SIP)
9.5.2.2  Current Market Conditions
9.5.2.3  Rebalance Strategic Asset Allocation
Asset Classes
Sectors/Industries
9.5.2.4  Security Selection
9.5.3  Portfolio Monitoring Stage
9.5.3.1  Evaluation of Statement of Investment Policy (SIP)
9.5.3.2  Evaluation of Investment Performance
Types of Portfolios
Portfolio Performance Evaluation Measures
Sharpe’s Reward-to-Risk Ratio
Treynor’s Reward-to-Volatility Ratio
Jensen’s Differential Return Measure
Arbitrage Pricing Theory
Grinblatt and Titman’s Performance Change Measure (PCM)
9.6  Formula Plans
9.6.1  Constant Rupee Value Plan
9.6.2  Constant Ratio Plan
9.6.3  Variable Ratio Plan
9.6.4  Rupee Cost Averaging
9.7  Mutual Funds in India
9.8  Conclusion
Summary
9.9  Exercises
9.9.1  Objective (Quiz) Type Questions
9.9.2  Solved Numericals (Solved Questions)
9.9.3  Unsolved Numericals (Unsolved Questions)
9.9.4  Short Answer Questions
9.9.5  Discussion Questions (Points to Ponder)
9.9.6  Activity-Based Question/Tutorial
Additional Readings and References
10 Derivatives
10.1  Introduction
10.2  Forwards
10.3  Futures
10.3.1  Features of Futures
10.3.2  Hedging with Futures
10.3.3  Speculating with Futures
10.3.4  Examples of Financial Futures
10.3.5  Pricing the Future
10.3.5.1  Financial Futures
10.3.5.2  Commodity Futures
10.3.6  Benefits of Futures Contract
10.4  Options
10.4.1  Call Option
10.4.2  Put Option
10.4.3  Pay-Offs of Options
10.4.3.1  Buyer’s Position
Pay-Off of a Call Option
Pay-Off of a Put Option
10.4.3.2  Seller’s Position
Pay-Off of a Call Option
Pay-Off of a Put Option
10.4.4  Speculative Strategies Based on Options
10.5  Swaps
10.6  Advantages of Derivatives
10.7  Participants in the Derivatives Market
10.8  Risks in Derivatives Contracts
10.9  Conclusion
Summary
10.10  Exercises
10.10.1  Objective (Quiz) Type Questions
10.10.2  Solved Numericals (Solved Questions)
10.10.3  Unsolved Numericals (Unsolved Questions)
10.10.4  Short Answer Questions
10.10.5  Discussion Questions (Points to Ponder)
10.10.6  Activity-Based Question/Tutorial
Additional Readings and References
Index