CHAPTER -- 1

INTRODUCTION MEANING AND NEED

INTRODUCTION
Security analysis deals with the analysis within
the framework of return and risk. Portfolio analysis begins where the security analysis ends. A combination or portfolio of securities can give better and beneficial results only if they are grouped together in a manner to secure the optimum combination of risk and return.

MEANING
Portfolio analysis deals with the
determination of future risk and return in holding various combinations of individual securities. The portfolio expected return is the weighted average of the expected returns, from each of the individual securities, with weights representing the proportionate share of the security in the total investment.

PORTFOLIO MANAGEMENT PROCESS

1. Specification of Investment objectives 2. 3. 4. 5. 6. 7.

and constraints Choice of the asset mix Formulation of portfolio strategy Selection of securities Portfolio execution Portfolio revision Performance evaluation

APPROACHES TO INVESTMENT DECISION MAKING

1. 2. 3. 4.

Fundamental approach Psychological approach Academic approach Eclectic approach

FUNDAMENTAL APPROACH
There is an intrinsic value of a security and this
depends upon underlying economic factors. At any given point of time, there are some securities for which the prevailing market price will differ from the intrinsic value. Superior returns can be earned by buying under-valued securities (intrinsic value>market prices) and selling over-valued securities (intrinsic value<market prices).

PSYCHOLOGICAL APPROACH
The psychological approach is based on the premise
that stock prices are guided by emotion, rather than reason. Stock prices are believed to be influenced by the psychological mood of the investors. When greed and euphoria sweep the market, prices rise to dizzy heights. On the other hand, when fear and despair envelop the market, prices fall to abysmally low levels. Those who subscribe to the psychological approach or the castles-in-the-air theory generally use some form of technical analysis which is concerned with a study of internal market data, with a view to developing trading rules aimed at profit-making.

ACADEMIC APPROACH
Stock markets are reasonably efficient in reacting
quickly and rationally to the flow of information. Hence, stock prices reflect intrinsic value fairly well. Put differently Market price = Intrinsic value Stock price behaviour corresponds to a random walk. This means that successive price changes are independent. As a result, past price behaviour cannot be used to predict future price behaviour. In the capital market, there is a positive relationship between risk and return. More specifically, the expected return from a security is linearly related to its systematic risk.

ECLECTIC APPROACH
The eclectic approach draws on all the three

1.
2. 3.

4.
5.

different approaches discussed above. The basic premises of the eclectic approach are as follows: Fundamental analysis is helpful in establishing basic standards and benchmarks. Technical analysis is useful in broadly gauging the prevailing mood of investors and the relative strengths of supply and demand forces. Combine fundamental and technical analyses to determine which securities are worth buying, worth holding, and worth disposing off. Respect market prices and do not show excessive zeal in beating the market. Accept the fact that the search for a higher level of return often necessitates the assumption of a higher level of risk.

APPROACHES IN PORTFOLIO CONSTRUCTION

Commonly, there are two approaches in

the construction of the portfolio of securities 1. Traditional approach 2. Modern approach

TRADITIONAL APPROACH
The traditional approach basically deals
with two major decisions. They are: 1. Determining the objectives of the portfolio 2. Selection of securities to be included in the portfolio Before formulating the objectives, the constraints of the investor should be analysed.

ANALYSIS OF CONSTRAINTS
Income needs (a)Need for current income (b)Need for constant income Liquidity Safety of the principal Time horizon Tax consideration temperament

STEPS IN TRADITIONAL APPROACH

Analysis of constraints Determination of objectives

Selection of portfolio

Bond and Common stock

Bond

Common stock

Assessment of risk and return

Diversification

Determination of objectives
Current income Growth in income Capital appreciation Preservation of capital

Selection of portfolio
Objectives and asset mix ---- 60% of the
investment is made on debts and 40% on equities. Growth of income and asset mix ---- 60 to 100% equities and 0 to 40% debt instruments. Capital appreciation and asset mix ---- 90 to 100% equities and 0 to 10% debts.

Risk and Return analysis

The individual prefers larger to smaller
returns from securities. To achieve this goal, the investor has to take more risk. The ability to achieve higher returns is dependent upon his ability to judge risk and his ability to take specific risks.

Diversification
According to the investors need for income and risk tolerance
level portfolio is diversified. In the bond portfolio, the investor has to strike a balance between the short term and long term bonds. Short term fixed income securities offer more risk to income and long term fixed income securities offer more risk to principal. In the stock portfolio, he has to adopt the following steps which are shown in the following figure:

Selection of Industries

Selection of Companies in the Industry

Determining the size of participation

MODERN APPROACH
Markowitz gives more attention to the
process of selecting the portfolio. His planning can be applied more in the selection of common stocks portfolio than the bond portfolio. The stocks are not selected on the basis of need for income or appreciation. But the selection is based on the risk and return analysis. Return includes the market return and dividend. The investor needs return and it may be either in the form of market return or dividend. They are assumed to be indifferent towards the form of return.

THANKS