Security Analysis and Portfolio Management CBCFB6T12A

Syllabus topics (RTMNU)

• Investment: Meaning, Objectives and Process
• Investment Alternatives (Financial vs Non-Financial Assets)
• Risk and Return: Types of Risk (Systematic & Unsystematic)
• Measurement of Risk (Variance, Standard Deviation, Beta)
• Time Value of Money (Present Value & Future Value concepts)

Investment: Meaning, Objectives and Process

Investment means putting money today into an asset (shares, bonds, gold, property etc.) with the hope of getting a return in future in the form of income (interest, dividend, rent) and/or capital appreciation.

Investment vs speculation vs gambling: An investor takes moderate risk for a reasonable long-term return after analysis; a speculator takes high risk for quick short-term gains from price changes; gambling is based on pure chance.

Objectives of investment:

1. Return: Earn regular income and capital growth.
2. Safety of capital: Protect the principal amount.
3. Liquidity: Ability to convert into cash quickly.
4. Hedge against inflation: Return should be higher than inflation.
5. Tax saving: e.g. ELSS, PPF (check latest tax rules).
6. Meeting future goals: Education, house, retirement.

Investment process (steps):

1. Investment policy: Decide the amount, objectives, risk tolerance and time horizon.
2. Security analysis: Study securities through fundamental and technical analysis to find mispriced ones.
3. Valuation: Find the intrinsic (true) value and compare with market price.
4. Portfolio construction: Choose the mix of assets (diversification).
5. Portfolio evaluation and revision: Measure performance and change the portfolio when needed.

Investment Alternatives (Financial vs Non-Financial Assets)

Financial assets may be fixed income (bonds, FDs – safer, lower return) or variable income (equity shares – riskier, higher expected return). Sovereign Gold Bonds and Gold ETFs combine both worlds.

Risk and Return: Types of Risk (Systematic & Unsystematic)

Return is the gain from an investment. Holding period return = (Income + Closing price − Opening price) ÷ Opening price × 100. Risk is the chance that the actual return will differ from the expected return. Higher risk usually means higher expected return.

Total risk = Systematic risk + Unsystematic risk.

Measurement of Risk (Variance, Standard Deviation, Beta)

1. Expected return E(R) = Σ (Probability × Return).
2. Variance σ² = Σ P × (R − E(R))² – average squared deviation from expected return.
3. Standard deviation σ = √Variance – measures total risk; higher σ means more risk.
4. Beta (β) = Covariance of stock with market ÷ Variance of market. It measures systematic risk: β = 1 moves with the market; β > 1 aggressive (e.g. 1.5 moves 15% when market moves 10%); β < 1 defensive (e.g. FMCG shares).

Illustration 1: Share X has these returns: Boom (probability 0.3) 25%, Normal (0.5) 12%, Recession (0.2) −5%.

Expected return = 12.5%; Variance = 108.25; Standard deviation = √108.25 = 10.40%.

Illustration 2 (Beta): Covariance of share Y with Nifty = 60; variance of Nifty = 40. β = 60 ÷ 40 = 1.5. Y is an aggressive share: if Nifty rises 10%, Y is expected to rise about 15%.

Time Value of Money (Present Value & Future Value Concepts)

Time value of money means ₹1 today is worth more than ₹1 in future, because money today can be invested to earn interest, and because of inflation and risk.

1. Future Value (compounding): FV = PV × (1 + r)ⁿ.
2. Present Value (discounting): PV = FV ÷ (1 + r)ⁿ.
3. Annuity: A series of equal payments (like SIP or EMI); its PV/FV is found with annuity tables.

Illustration 3: ₹10,000 invested at 8% p.a. compounded yearly for 3 years: FV = 10,000 × (1.08)³ = 10,000 × 1.259712 = ₹12,597.12.

Illustration 4: PV of ₹50,000 receivable after 5 years at 10%: PV = 50,000 ÷ (1.10)⁵ = 50,000 ÷ 1.61051 = ₹31,046.07.

Likely exam questions

1. (Long, 8/16 marks) Explain the meaning, objectives and process of investment. Compare financial and non-financial investment alternatives.
2. (Long, 8/16 marks) Distinguish between systematic and unsystematic risk. Explain how risk is measured using variance, standard deviation and beta.
3. (Short, 4 marks) Distinguish between investment and speculation.
4. (Short, 4 marks) What is beta? How is it interpreted?
5. (Short, 4 marks) Explain the concept of time value of money with present and future value.

Syllabus topics (RTMNU)

• Economic Analysis (GDP, Inflation, Interest Rates, Fiscal & Monetary Policy)
• Industry Analysis (Porter’s Five Forces Model)
• Company Analysis: Financial Statement Analysis
• Ratio Analysis (Profitability, Liquidity, Solvency, Efficiency)
• Earnings Per Share (EPS)
• P/E Ratio
• Dividend Discount Model (DDM)

Fundamental Analysis – Meaning

Fundamental analysis is the study of the economy, the industry and the company to find the intrinsic value of a share. If intrinsic value > market price, the share is undervalued (buy); if lower, it is overvalued (sell). It follows the E-I-C framework: Economy → Industry → Company (top-down approach).

Economic Analysis (GDP, Inflation, Interest Rates, Fiscal & Monetary Policy)

1. GDP growth: Higher GDP growth means more demand, higher company profits and rising share prices. Investors watch quarterly GDP data.
2. Inflation: Moderate inflation is normal; high inflation raises costs, reduces real returns and leads RBI to raise interest rates – bad for shares.
3. Interest rates: When interest rates (repo rate) fall, borrowing becomes cheaper, profits rise and share prices usually rise; bond prices also rise. Higher rates have the opposite effect.
4. Fiscal policy (government taxes and spending, the Union Budget): Tax cuts and infrastructure spending help sectors like cement, steel, capital goods; high fiscal deficit may raise interest rates.
5. Monetary policy (RBI's repo rate, CRR, liquidity): Easy money supports markets; tight money cools them.
6. Other factors: monsoon (rural demand), exchange rate, balance of payments, political stability, global conditions, FPI flows.

Industry Analysis (Porter's Five Forces Model)

Industry analysis studies the attractiveness of an industry – its life cycle stage (pioneering, expansion, maturity, decline), government policy, demand, and competition. Michael Porter's Five Forces Model explains the competition that decides industry profitability:

1. Threat of new entrants: Low if entry barriers are high (huge capital, licences, brand). E.g. telecom has few players.
2. Bargaining power of suppliers: High if there are few suppliers of key inputs; reduces industry profits.
3. Bargaining power of buyers: High if buyers are few and big, or products are standard (e.g. auto component makers selling to car companies).
4. Threat of substitutes: E.g. UPI vs cards, OTT vs cinema halls.
5. Rivalry among existing firms: Many competitors, price wars, low growth → lower profits (e.g. airlines).

Company Analysis: Financial Statement Analysis

Company analysis studies the company's management, competitive position, products and especially its financial statements – Balance Sheet, Statement of Profit and Loss and Cash Flow Statement. Tools: comparative statements, common-size statements, trend analysis, ratio analysis and cash flow analysis. Non-financial factors: quality and honesty of management, corporate governance, brand, market share, technology.

Ratio Analysis (Profitability, Liquidity, Solvency, Efficiency)

Earnings Per Share (EPS) and P/E Ratio

1. EPS = (Profit after tax − Preference dividend) ÷ Number of equity shares. It shows profit earned per equity share.
2. P/E ratio = Market price per share ÷ EPS. It shows how many rupees investors pay for ₹1 of earnings. A high P/E means high growth expected (or overvaluation); low P/E may mean undervaluation or low growth.
3. Value of share = EPS × Normal (industry) P/E.

Illustration 1: PAT ₹50 lakh, preference dividend ₹5 lakh, equity shares 9 lakh, market price ₹75.
EPS = (50,00,000 − 5,00,000) ÷ 9,00,000 = ₹5.
P/E = 75 ÷ 5 = 15 times. If the industry P/E is 18, intrinsic value = 5 × 18 = ₹90 > ₹75, so the share looks undervalued.

Dividend Discount Model (DDM)

The DDM says the intrinsic value of a share is the present value of all future dividends, discounted at the investor's required rate of return (k).

1. Zero growth: P₀ = D ÷ k.
2. Constant growth (Gordon model): P₀ = D₁ ÷ (k − g), where D₁ = D₀ × (1 + g) and k > g.
3. Multi-stage growth: Different growth rates for different periods.

Illustration 2: Last dividend D₀ = ₹4, growth g = 6%, required return k = 14%.
D₁ = 4 × 1.06 = ₹4.24; P₀ = 4.24 ÷ (0.14 − 0.06) = 4.24 ÷ 0.08 = ₹53. If the market price is ₹45, buy; if ₹60, the share is overvalued.

Limitations: Not useful for companies paying no dividend; very sensitive to k and g; assumes constant growth.

Likely exam questions

1. (Long, 8/16 marks) What is fundamental analysis? Explain economic analysis with reference to GDP, inflation, interest rates and fiscal and monetary policy.
2. (Long, 8/16 marks) Explain Porter's Five Forces Model of industry analysis. Describe the role of ratio analysis in company analysis.
3. (Short, 4 marks) Explain EPS and P/E ratio with an example.
4. (Short, 4 marks) A company paid a dividend of ₹4 last year; growth is 6% and required return is 14%. Find the value of the share using the Gordon model.
5. (Short, 4 marks) State any four ratios used in company analysis with formulas.

Syllabus topics (RTMNU)

• Dow Theory
• Trends and Trend Reversals
• Support and Resistance Levels
• Chart Patterns (Head & Shoulders, Double Top/Bottom)
• Moving Averages
• Oscillators (RSI – Conceptual Introduction)

Technical Analysis – Meaning

Technical analysis is the study of past share prices and trading volumes, mainly through charts, to predict future price movements and decide the right time to buy or sell.

Basic assumptions:

1. Market price reflects all information ("market discounts everything").
2. Prices move in trends, and a trend continues until it reverses.
3. History repeats itself – investor psychology creates repeating patterns.
4. Market value is decided only by demand and supply.

Dow Theory

Developed from the writings of Charles H. Dow (founder of the Wall Street Journal and the Dow Jones index). It is the base of modern technical analysis.

1. Three movements:
   • Primary trend – the main long-term trend lasting a year or more: bull (rising) or bear (falling) market. Like the tide of the sea.
   • Secondary reaction – corrections against the primary trend, lasting weeks to a few months, often retracing one-third to two-thirds of the earlier move. Like waves.
   • Minor (daily) movements – day-to-day fluctuations, not important. Like ripples.
2. Phases of a bull market: accumulation (informed investors buy), public participation (prices rise fast), distribution/excess (speculation, smart money sells). A bear market has the reverse phases.
3. Confirmation: Two averages (originally industrial and transport) must confirm each other.
4. Volume confirms the trend: Volume rises in the direction of the main trend.
5. A trend remains in force until a clear reversal signal appears.

Limitations: Signals come late; no clear way to separate secondary reaction from reversal; not useful for selecting individual shares.

Trends and Trend Reversals

A trend is the general direction of prices.

1. Uptrend: Series of higher highs and higher lows. A trend line is drawn joining the rising lows.
2. Downtrend: Series of lower highs and lower lows; trend line joins falling highs.
3. Sideways (horizontal) trend: Prices move in a narrow range.

A trend reversal is a change in direction – e.g. an uptrend changing to a downtrend. Signs: price breaks the trend line with high volume, failure to make a new high, reversal chart patterns (head and shoulders, double top), moving average crossovers.

Support and Resistance Levels

1. Support: A price level where buying (demand) is strong enough to stop a fall. Prices "bounce" from it. E.g. a share repeatedly stops falling near ₹500.
2. Resistance: A price level where selling (supply) stops a rise. E.g. the same share fails to cross ₹600 again and again.
3. Role reversal: When resistance is broken with good volume (a breakout), it often becomes the new support; a broken support becomes resistance.
4. Traders buy near support and sell near resistance, and use stop-loss just below support.

Chart Patterns (Head & Shoulders, Double Top/Bottom)

1. Head and Shoulders (top): A bearish reversal pattern after an uptrend. Three peaks – left shoulder, a higher head, right shoulder (about the same height as the left). The line joining the two lows is the neckline. When price breaks below the neckline, a fall is expected. Target = height from head to neckline, measured down from the breakout point.
2. Inverse Head and Shoulders: Bullish reversal at the end of a downtrend.
3. Double Top ("M" pattern): Price rises to a level twice and fails to cross it; a fall below the low between them confirms a bearish reversal.
4. Double Bottom ("W" pattern): Price falls to a support twice and rises; a breakout above the middle peak confirms a bullish reversal.

Moving Averages

A moving average (MA) is the average of closing prices over a fixed number of recent days, recalculated every day. It smooths out daily ups and downs and shows the trend.

1. Simple Moving Average (SMA): Plain average of the last n closing prices.
2. Exponential Moving Average (EMA): Gives more weight to recent prices, so it reacts faster.
3. Common periods: 20-day (short term), 50-day, 200-day (long term).
4. Signals: Price crossing above the MA = buy; below = sell. When the 50-day MA crosses above the 200-day MA it is called a golden cross (bullish); crossing below is a death cross (bearish).

Illustration: Closing prices for 5 days: ₹100, 102, 104, 103, 106. 5-day SMA = 515 ÷ 5 = ₹103. Price ₹106 is above the SMA, which shows a short-term uptrend.

Oscillators (RSI – Conceptual Introduction)

An oscillator is an indicator that moves up and down between fixed limits and shows whether a share is overbought or oversold. Useful in sideways markets.

The Relative Strength Index (RSI), developed by J. Welles Wilder, compares average gains with average losses over a period (usually 14 days):

1. RSI moves between 0 and 100.
2. Above 70 = overbought (price may fall); below 30 = oversold (price may rise).
3. Divergence: If price makes a new high but RSI does not, the uptrend is weakening.

Example: Average gain ₹1.20, average loss ₹0.80 → RS = 1.5 → RSI = 100 − 100/2.5 = 60 (neutral zone).

Likely exam questions

1. (Long, 8/16 marks) What is technical analysis? Explain the Dow Theory and its limitations.
2. (Long, 8/16 marks) Explain support and resistance levels and the chart patterns Head & Shoulders and Double Top/Bottom.
3. (Short, 4 marks) Distinguish between fundamental and technical analysis.
4. (Short, 4 marks) What are moving averages? How are they used?
5. (Short, 4 marks) Write a note on RSI.

Syllabus topics (RTMNU)

• Meaning and Objectives of Portfolio Management
• Factors Affecting Financial Portfolio
• Asset Allocation and Diversification
• Active vs Passive Portfolio Management
• Portfolio Revision Strategies

Meaning and Objectives of Portfolio Management

A portfolio is a combination (basket) of different investments held by an investor – shares, bonds, mutual funds, gold, deposits etc. Portfolio management is the art and science of selecting the right mix of investments, and managing it over time, to get the best return for a given level of risk.

In India, professional Portfolio Managers are regulated by the SEBI (Portfolio Managers) Regulations, 2020; the minimum investment in a PMS is ₹50 lakh (check latest SEBI rules). Mutual funds are another form of professional portfolio management.

Objectives:

1. Safety of principal – avoid big losses.
2. Stable income – regular dividends and interest.
3. Capital growth – increase in value over time.
4. Liquidity – part of the portfolio easily convertible to cash.
5. Risk reduction through diversification.
6. Tax efficiency – using tax-saving options (check latest tax rules).
7. Beating inflation and meeting the investor's goals.

Process: Planning (objectives, constraints) → Construction (asset allocation, security selection) → Execution → Monitoring and Revision → Evaluation (Sharpe, Treynor ratios).

Factors Affecting Financial Portfolio

1. Investment objective: Income, growth or safety.
2. Risk tolerance: Ability and willingness to bear loss.
3. Age and life stage: Young investors can hold more equity; retired people prefer fixed income. (Thumb rule: equity % ≈ 100 − age.)
4. Time horizon: Longer horizon → more equity.
5. Income and wealth of the investor.
6. Liquidity needs: Emergency fund, upcoming expenses.
7. Tax status of the investor.
8. Market conditions: Interest rates, inflation, valuations.
9. Legal and regulatory constraints (e.g. limits on what trusts or insurers can invest in).
10. Knowledge and preferences (e.g. ethical/ESG choices).

Asset Allocation and Diversification

Asset allocation means dividing the portfolio among broad asset classes – equity, debt, gold, real estate, cash – according to the investor's goals and risk profile. Studies show that asset allocation decides most of the variation in a portfolio's return.

1. Strategic asset allocation: A long-term target mix (e.g. 60% equity, 30% debt, 10% gold).
2. Tactical asset allocation: Short-term changes from the target to use market opportunities.
3. Dynamic allocation: Mix changes with market valuations (e.g. balanced advantage funds).

Diversification means spreading money over many securities, industries and asset classes – "don't put all your eggs in one basket". It reduces unsystematic risk; systematic risk remains. Diversification works best when the assets have low or negative correlation (e.g. gold often rises when shares fall). Markowitz's Modern Portfolio Theory showed that combining assets can lower risk without lowering expected return; the best portfolios lie on the "efficient frontier".

Illustration: 60% in share A (expected return 15%) and 40% in share B (10%). Portfolio return = 0.6 × 15 + 0.4 × 10 = 13%. Portfolio risk will be less than the weighted average of the two SDs if the correlation is less than +1.

Active vs Passive Portfolio Management

Portfolio Revision Strategies

Portfolio revision means changing the composition of a portfolio over time – selling some assets and buying others – because markets change, or the investor's goals change.

Need for revision: change in investor's age, income or goals; change in market prices disturbing the asset mix; new information about companies; changes in tax laws or interest rates.

1. Active revision strategy: Frequent changes based on forecasts and analysis.
2. Passive revision strategy: Changes only according to preset rules (formula plans).

Formula plans:

1. Constant rupee value plan: Keep a fixed rupee amount in shares; sell shares when their value rises above it, buy when it falls.
2. Constant ratio plan: Keep a fixed ratio between shares and bonds (e.g. 60:40) and rebalance when it moves.
3. Rupee cost averaging (like SIP): Invest a fixed amount at regular intervals – more units are bought when prices are low and fewer when high, reducing average cost.

Illustration (constant ratio): Target 60:40 on ₹10 lakh (equity ₹6 lakh, debt ₹4 lakh). Equity rises to ₹7.20 lakh; debt stays ₹4 lakh; total ₹11.20 lakh. Target equity = 60% of 11.20 = ₹6.72 lakh. So sell equity worth 7.20 − 6.72 = ₹0.48 lakh (₹48,000) and invest it in debt (debt becomes ₹4.48 lakh = 40%).

Likely exam questions

1. (Long, 8/16 marks) Explain the meaning and objectives of portfolio management. What factors affect a financial portfolio?
2. (Long, 8/16 marks) What is portfolio revision? Explain the various portfolio revision strategies including formula plans.
3. (Short, 4 marks) Explain asset allocation and diversification.
4. (Short, 4 marks) Distinguish between active and passive portfolio management.
5. (Short, 4 marks) What is rupee cost averaging?