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