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Chapter One

Portfolio

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Regasa Gutema
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21 views

Chapter One

Portfolio

Uploaded by

Regasa Gutema
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Chapter-One

Overview of Investment
1.1 CONCEPT OF INVESTMENT

 In its broadest sense, an investment is a sacrifice


of current money or other resources for future
benefits.
 What are investment alternatives (avenues)?
 You can deposit money in the bank account or
purchase a long-term government bond or invest
in the equity shares of a company or contribute
to a provident fund account or buy stock option
or acquire a plot of land or invest in other form.
 The two key aspects of investment are time
and risk.
 The sacrifice takes place now and is certain.
The benefit is expected in the future and tends
to be uncertain.
• In some investments (like government bonds)
the time element is the dominant attribute.
• In other investments (like stock options) the
risk element is the dominant attribute.
• In yet other investments (like equity shares)
both time and risk are important.
 Almost everyone owns a portfolio of
investments.
 The portfolio is likely to comprise the
financial assets (bank deposits, bonds, stocks,
and so on) and real assets (car, house, and so
on).
 You economic wellbeing in the long run
depends on how wisely or foolishly you
invest.
• Generally, an investment is the current
commitment of dollars for a period of time in
order to derive future payments that will
compensate the investor for
(1) The time the funds are committed,
(2) The expected rate of inflation during this
time period, and
(3) The uncertainty of the future payments.
 The “investor” can be an individual, a
government, a pension fund, or a corporation.
 They invest to earn a return from savings due
to their deferred consumption.
 They want a rate of return that compensates
them for the time period of the investment, the
expected rate of inflation, and the uncertainty
of the future cash flows.
1.2 Investment vs. Speculation

Investor Speculator
 An investor has  A speculator has very
relatively longer short planning horizon.
planning horizon. His His holding period may
holding period is be a few days to a few
usually at least one year. months.
 An investor is normally  A speculator is
not willing to assume ordinarily willing to
more than moderate assume high risk.
risk.
Continued…

Investor Speculator

 An investor seeks a modest  A speculator looks for a


rate of return which is high rate of return in
commensurate with the exchange for the high risk
limited risk assumed by borne by him.
him.
 A speculator relies more
 An investor attaches greater
on hearsay, technical
significant to fundamental
factors and attempts a charts, and market
careful evaluation of the psychology.
prospects of the firm
Continued…

Investor Speculator
• Typically an investor • A speculator normally
uses his own funds and resorts to borrowings,
eschews borrowed which can be very
funds. substantial, to
supplement his personal
resources
1.3 Investment vs. Gambling

 Compared to investment and speculation, the


result of gambling is known more quickly.
Example: The outcome of a roll of dice or the
turn of a card is known almost immediately.
 Rational people gamble for fun, not for
income.
 Gambling does not involve a bet on an
economic activity. It is based on risk that is
created artificially.
 Gambling creates risk without providing any
commensurate economic return.
1.4 Investment alternatives (Avenues)
1.5 Criteria for Evaluation

• For evaluating an investment avenue, the


following criteria are relevant.
1. Rate of Return
2. Risk
3. Marketability
4. Tax shelter
5. Convenience
1. Rate of return: The rate of return on an
investment for a period (which is usually a
period of one year) is defined as follows:
• Rate of Return
2. Risk: The risk of an investment refers to the
variability of its rate of return:
• How much do individual outcomes deviate
from the expected value?
• A simple measure of dispersion is the range of
values, which is simply the difference between
the highest and the lowest values. Other
measures used commonly in finance are as
follows:
• Variance : This is the mean of the squares of
deviations of individual returns around their
average value
• Standard deviation: This is the square root of
variance
• Beta: This reflects how volatile the return
from an investment relative to market swings
is.
3. Marketability: An investment is highly marketable or
liquid if:
 It can be transacted quickly;
 The transaction cost is low; and
 The price change between two successive transactions
is negligible.
• High marketability is a desirable characteristics and
low marketability is undesirable one.
• Investors value liquidity because it allows them to
change their minds.
4. Tax shelter: some investments provide tax benefits;
others do not.
1. Initial tax benefit: An initial tax benefit refers to the
tax relief enjoyed at the time of making investment.
2. Continuing tax benefit: A continuing tax benefit
represents the tax shield associated with the periodic
returns from the investment.
3. Terminal tax benefit : A terminal tax benefit refers to
relief from taxation when an investment is realized or
liquidated.
5. Convenience: convenience broadly refers to
ease with which the investment can be made and
looked after.
• Can the investment be made readily?
• Can the investment be looked after liquidated
easily?
Portfolio Management Process

1. Specification of Investment Objectives and


Constraints:
2. Quantification of Capital Market Expectations:
3. Choice of the Asset mix:
4. Formulation of the Portfolio Strategy:
5. Selection of Securities:
6. Portfolio Execution:
7. Portfolio Revision:
8. Performance Evaluation:

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