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Investment Analysis and Portfolio Management

Unit 1: Investments

Nature, Scope, and Objective of Investments

Nature: Investments involve committing money to an asset with the expectation of generating future returns. They can take various forms, such as stocks, bonds, real estate, or mutual funds.

Scope: The scope of investments covers a wide range of activities, including identifying investment opportunities, analyzing risks and returns, diversifying portfolios, and monitoring investment performance.

Objective: The primary objectives of investments are to maximize returns, minimize risk, ensure liquidity, and achieve specific financial goals like wealth creation, retirement planning, or saving for education.

Process of Investment Analysis

• Setting Investment Goals: Define financial goals and objectives, considering factors like time horizon, risk tolerance, and return expectations.
• Asset Allocation: Determine the appropriate mix of asset classes (e.g., stocks, bonds, real estate) based on the investor's goals and risk profile.
• Security Selection: Choose specific securities within each asset class that align with the investment strategy.
• Portfolio Construction: Combine selected securities into a diversified portfolio to balance risk and return.
• Monitoring and Rebalancing: Regularly review the portfolio's performance and make adjustments to maintain the desired asset allocation and risk level.

Concept of Return and Risk Analysis

Return: The gain or loss on an investment over a specified period, expressed as a percentage of the investment's initial cost. Returns can be in the form of income (dividends, interest) or capital appreciation.

Risk: The uncertainty associated with the expected return on an investment. Risk arises from various factors that can affect the performance of an investment.

Measurement of Return and Risk

• Return Measurement:
  • Historical Return: Calculated based on past performance data.
  • Expected Return: The anticipated return on an investment, considering historical data and future expectations.
  • Formula: Return = (Ending Value - Beginning Value + Dividends/Interest) / Beginning Value * 100
• Risk Measurement:
  • Variance and Standard Deviation: Measure the dispersion of returns around the mean return. Standard deviation is the square root of variance.
  • Formula for Variance: Variance (σ²) = 1/(N-1) * Σ(Ri - R̄)² where Ri is the return for period i, R̄ is the average return, and N is the number of periods.
  • Formula for Standard Deviation: Standard Deviation (σ) = √Variance

Systematic and Unsystematic Risk

Systematic Risk: Also known as market risk, it affects the entire market or a large segment of it. It is non-diversifiable and includes risks such as interest rate changes, inflation, recessions, and political instability.

Measurement: Beta (β) coefficient measures the sensitivity of a stock's returns to market returns.

Formula: β = Covariance (Stock, Market) / Variance (Market)

Unsystematic Risk: Also known as specific or idiosyncratic risk, it is unique to a particular company or industry. It can be diversified away by holding a diversified portfolio.

Examples: Business risk, financial risk, management risk, and industry-specific risks.

Reduction: Achieved through diversification, where investing in a variety of assets reduces the impact of any single asset's poor performance.