1.
Significance of Investment Planning and Its Components
Definition:
Investment planning is the process of identifying financial goals and aligning investments to
achieve them effectively.
Components & Significance:
• Goal Setting: Helps identify short-term and long-term financial objectives.
• Risk Assessment: Evaluates the investor’s risk tolerance before selecting instruments.
• Asset Allocation: Ensures diversification across asset classes like equity, debt, real estate,
etc.
• Time Horizon: Determines the investment strategy based on the period until funds are
needed.
• Liquidity Planning: Ensures funds are available when required, especially in emergencies.
• Tax Planning: Maximizes post-tax returns by selecting tax-efficient investments.
• Monitoring and Rebalancing: Periodic review ensures the portfolio aligns with financial
goals.
2. Difference between Investment and Speculation
Definition:
Investment focuses on long-term wealth creation, while speculation is about short-term profit
through price movements.
Differences:
• Objective: Investment is for long-term growth; speculation is for quick profits.
• Risk Level: Investment involves calculated risk; speculation involves high risk.
• Analysis: Investment is based on fundamental analysis; speculation relies on market trends
or rumors.
• Holding Period: Investment is long-term; speculation is short-term or intraday.
• Returns: Investment yields stable returns; speculation can lead to high profits or heavy
losses.
• Information Basis: Investors study company fundamentals; speculators act on tips or news.
• Ownership: Investments often involve asset ownership; speculation may not (e.g., futures
trading).
3. Conceptual Framework of Portfolio Management and Markowitz Approach
Definition:
Portfolio management is the art of selecting and managing a mix of investments to achieve
financial goals.
Concepts:
• Diversification: Reduces risk by investing in different asset classes.
• Risk-Return Trade-off: Higher returns come with higher risks.
• Portfolio Risk: Depends on the correlation between assets.
• Efficient Frontier: Set of portfolios offering maximum return for a given risk.
• Markowitz Model: Uses mean (return) and variance (risk) to choose the optimal portfolio.
• Covariance & Correlation: Essential to assess how assets move together.
• Optimization: Markowitz’s model helps investors achieve the best risk-return balance using
mathematical models.
4. E-I-C Approach in Fundamental Analysis
Definition:
E-I-C (Economy-Industry-Company) approach evaluates investments starting from macro to
micro levels.
Steps:
• Economic Analysis: Studies GDP growth, inflation, interest rates, and monetary policies.
• Industry Analysis: Evaluates industry lifecycle, competition, government regulations.
• Company Analysis: Focuses on financial statements, management quality, and profitability.
• Variables in Economic Analysis: Inflation rate, fiscal deficit, global economic trends.
• Variables in Industry Analysis: Market demand, raw material availability, tech changes.
• Variables in Company Analysis: EPS, ROE, debt-equity ratio, business strategy.
• Time Relevance: Long-term economic forecasts influence industry, which in turn affects
companies.
5. Efficient Market Hypothesis (EMH) and Forms of Market Efficiency
Definition:
EMH states that stock prices fully reflect all available information.
Forms:
• Weak Form Efficiency: Past prices are reflected; technical analysis is ineffective.
• Semi-Strong Form: All public info is reflected; neither technical nor fundamental analysis
works.
• Strong Form Efficiency: All public and private info is reflected; even insiders can’t beat the
market.
• Implications: Makes it hard for investors to consistently outperform the market.
• Random Walk Theory: Prices move randomly in an efficient market.
• Assumptions: Rational investors, instant information dissemination.
• Criticism: Real-world markets often display anomalies (like bubbles and crashes).
6. Technical Analysis vs Fundamental Analysis
Comparison:
• Basis: Technical uses price charts; fundamental uses financial data.
• Time Frame: Technical suits short-term traders; fundamental suits long-term investors.
• Tools: Technical uses RSI, MACD, Bollinger Bands; fundamental uses P/E ratio, EPS.
• Assumptions: Technical assumes patterns repeat; fundamental assumes intrinsic value
matters.
• Risk Understanding: Technical focuses on market trends; fundamental on company risk.
• Decision Making: Technical is quicker; fundamental is more in-depth.
• Objective: Technical aims to time the market; fundamental focuses on value investing.
7. What is Investment? Is it Different from Speculation?
Definition:
Investment is the commitment of funds for future returns with minimal risk.
Comparison with Speculation:
• Time Horizon: Investment is long-term; speculation is short-term.
• Analysis Depth: Investment uses thorough analysis; speculation uses quick judgment.
• Risk Profile: Investment is moderate risk; speculation is high risk.
• Return Expectation: Investment expects reasonable returns; speculation expects windfall
gains.
• Behavior: Investors are cautious; speculators are aggressive.
• Example: Buying a company’s stock after research is investment; buying based on tips is
speculation.
• Regulatory View: Investment is encouraged; speculation is often discouraged by regulators.
8. What is Beta? Is it Better than Standard Deviation?
Definition:
Beta measures a stock’s volatility relative to the market.
Key Points:
• Beta >1: Stock is more volatile than market.
• Beta <1: Less volatile than market.
• Beta =1: Same volatility as market.
• Systematic Risk: Beta captures only market risk, not company-specific risk.
• Standard Deviation: Measures total risk, both systematic and unsystematic.
• Better Use: Beta is better for diversified portfolios; standard deviation for individual assets.
• CAPM: Beta is a key component in the Capital Asset Pricing Model (CAPM).
9. Portfolio Revision Methods
Definition:
Portfolio revision refers to modifying the existing portfolio to realign it with the investor’s
goals.
Methods:
• Active Strategy: Frequent buying/selling based on market trends or news.
• Passive Strategy: Buy-and-hold with periodic minor adjustments.
• Constant Mix Strategy: Maintain a fixed ratio between equity and debt by rebalancing.
• Constant Proportion Portfolio Insurance (CPPI): Adjust equity exposure based on a cushion
value.
• Rupee Cost Averaging: Invest a fixed amount periodically to average out market
fluctuations.
• Tactical Asset Allocation: Short-term deviations from strategic allocation to exploit
opportunities.
• Calendar-Based Revision: Periodic review (e.g., quarterly or annually), regardless of market
conditions.
10. Markowitz Diversification and Its Assumptions
Definition:
Markowitz Diversification focuses on minimizing risk through efficient portfolio
construction using statistical measures.
Key Aspects:
• Mean-Variance Optimization: Maximizing return for a given level of risk using expected
return and variance.
• Efficient Frontier: Set of optimal portfolios offering maximum returns for various risk
levels.
• Correlation: Combining uncorrelated or negatively correlated assets reduces total risk.
• Diversification Benefit: Risk is reduced more significantly when asset returns don’t move
together.
• Assumption 1: Investors are rational and risk-averse.
• Assumption 2: Returns are normally distributed and markets are efficient.
• Assumption 3: No transaction costs or taxes in the investment process.
12. Fundamental Analysis: Steps and Factors
Definition:
Fundamental analysis involves evaluating securities by examining financial and economic
factors.
Steps:
• Economic Analysis: Analyze macroeconomic indicators like GDP, inflation, interest rates.
• Industry Analysis: Study industry growth, competition, regulations, tech changes.
• Company Analysis: Evaluate financial statements, management quality, and profitability.
• Financial Ratios: Use liquidity, profitability, and solvency ratios to assess health.
• Intrinsic Value: Estimate the stock’s true worth and compare with market price.
• Earnings Forecasting: Predict future earnings based on trends and projections.
• Investment Decision: Buy if undervalued, sell if overvalued.
13. Rationale for Efficient Capital Market and Differentiating Efficiency
Rationale for EMH:
• Information Availability: Prices adjust instantly to new information.
• Rational Investors: Markets are driven by rational decisions.
• Arbitrage: Any mispricing is corrected quickly by traders.
• Liquidity: Ease of buying and selling helps maintain efficiency.
• Fair Pricing: No investor can consistently beat the market.
• Technology Use: Advanced tools allow fast information processing.
• Transparency: Regulatory frameworks promote fairness.
Factors to Differentiate Efficiency:
• Information Response Speed: How quickly price reacts to news.
• Trading Volume: Higher volume indicates greater efficiency.
• Price Volatility: Low volatility with high news flow shows efficiency.
• Bid-Ask Spread: Narrow spreads indicate high efficiency.
• Analyst Coverage: More coverage implies more efficient pricing.
• Historical Anomalies: Fewer anomalies mean higher efficiency.
• Market Accessibility: Open markets are more efficient.
14. Recent Developments in Indian Stock Market
• T+1 Settlement: Faster transaction settlement enhances liquidity.
• Direct Retail Participation: Rise in retail investors through online trading platforms.
• Increased IPOs: Many startups and tech companies going public.
• SEBI Reforms: Stricter rules for disclosures, insider trading, and IPO norms.
• Stock Connect Programs: Integration with global platforms (e.g., GIFT IFSC).
• Algo Trading: Growth in algorithmic and high-frequency trading.
• Introduction of Social Stock Exchange: For funding NGOs and social enterprises.
15. Separation Theorem of CAPM
Definition:
The Separation Theorem states that portfolio selection can be separated into two independent
tasks.
Key Concepts:
• Two-Step Process: First, determine the optimal risky portfolio; second, combine with risk-
free asset.
• All Investors Hold Market Portfolio: According to CAPM, optimal portfolio is same for all.
• Personal Risk Preference: Decides the proportion of risky and risk-free assets.
• Efficient Frontier: Investors select on a common tangent from risk-free asset to the frontier.
• Capital Market Line (CML): Represents optimal combinations.
• Assumptions: Investors are rational and markets are perfect.
• Application: Useful in fund management and structuring mutual funds.
16. Importance of RSI (Relative Strength Index)
Definition:
RSI is a momentum oscillator used in technical analysis to identify overbought or oversold
conditions.
Importance:
• Measures Speed and Change: Indicates strength of recent price movements.
• Overbought/Oversold Zones: RSI >70 indicates overbought; <30 indicates oversold.
• Helps in Entry/Exit Decisions: Signals when to buy or sell.
• Divergence Signal: RSI divergence from price trend indicates reversal potential.
• Works with Other Indicators: Confirms trends with MACD, Bollinger Bands.
• Short-Term Trading: Popular for intraday and swing trading.
• Risk Reduction: Helps avoid buying at peak or selling at bottom.
17. Money Market Instruments
Definition:
Short-term debt instruments used for borrowing and lending in the money market.
Types:
• Treasury Bills (T-Bills): Government-issued, zero-coupon, highly liquid.
• Commercial Papers (CPs): Unsecured promissory notes by corporations.
• Certificates of Deposit (CDs): Time deposits by banks with fixed interest.
• Call Money: Overnight borrowing between banks.
• Repurchase Agreements (Repo): Short-term borrowing using securities as collateral.
• Banker’s Acceptance: Time draft guaranteed by a bank.
• Inter-Corporate Deposits: Short-term loans between companies.
18. Behavioral Finance and Investor Biases
Statement Meaning:
Behavioral finance studies how psychological factors affect financial decisions, often
deviating from rational models.
Investor Biases:
• Overconfidence Bias: Overestimating one’s knowledge or ability to predict.
• Anchoring Bias: Relying too heavily on initial information.
• Herding Behavior: Copying others’ investment actions.
• Loss Aversion: Fear of loss outweighs joy of gain.
• Mental Accounting: Treating money differently based on source or purpose.
• Confirmation Bias: Focusing on information that confirms existing beliefs.
• Framing Effect: Decisions influenced by the way information is presented.
