· Meets future financial goals UNIT 1

· Protects against inflation

· Provides retirement security
· Creates financial independence

2. Importance for Businesses

· Expands production capacity Investment – Concept, Objectives and
·
·
Purchases machinery and equipment
Funds research and development
Process of Investment Management
· Increases profitability
· Strengthens competitive position Introduction
Investment is one of the most important concepts in financial management and
3. Importance for Economy economics. In modern life, individuals, companies, and governments invest funds
to earn returns, create wealth, and achieve future financial goals. Proper investment
· Generates employment
decisions help in increasing income, preserving capital, and meeting long-term
· Increases national income
needs such as education, retirement, expansion of business, and economic
· Develops infrastructure
development.
· Encourages entrepreneurship
· Promotes economic growth Investment management is the systematic process of planning, selecting,
monitoring, and controlling investment alternatives in order to maximize returns
with minimum possible risk. It involves analysis of financial markets, evaluation of
securities, diversification of funds, and regular review of portfolio performance.
Objectives of Investment
In today’s dynamic financial environment, investment management has gained
Different investors have different objectives depending on age, income, risk great importance due to increasing savings, inflation, changing interest rates,
tolerance, and financial goals. Major objectives are as follows: development of stock markets, and growing awareness among investors.

1. Safety of Principal
The first objective of many investors is protection of capital. They prefer Meaning and Concept of Investment
investments where chances of loss are minimal, such as bank deposits or
government securities. Investment means committing money or capital to an asset or financial instrument
with the expectation of earning future returns. In simple words, investment is the
2. Regular Income sacrifice of current consumption for future benefits.

Many investors seek stable periodic income in the form of interest, dividends, rent, When a person saves money and uses it to purchase shares, bonds, real estate, gold,
or pension. Retired persons often prefer income-generating investments. mutual funds, or business assets, it is called investment.

Definitions of Investment

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To generate the highest possible return consistent with investor goals.

Investment vs Speculation
2. Minimization of Risk Investment and speculation are often confused, but they are different.
To control and reduce risk through diversification and careful selection.
Basis Investment Speculation
3. Preservation of Capital Objective Long-term returns Quick profits
Risk Moderate High
To protect original investment amount. Time Horizon Long-term Short-term
Analysis Based on fundamentals Based on market fluctuations
4. Liquidity Management Capital Safety Important Less important
To ensure availability of cash when needed.
Investment focuses on stable returns, while speculation aims at profit from price
movements.
5. Tax Efficiency
To maximize after-tax returns.

6. Achievement of Financial Goals Types of Investment

To align investments with goals like retirement, education, or expansion. 1. Financial Investments
7. Portfolio Stability These are investments in financial instruments.

To maintain balanced and consistent performance. · Shares

· Debentures
· Bonds
· Mutual funds
Bank deposits
Process of Investment Management ·
· Insurance products
Investment management is a systematic process. Major steps are:
2. Real Investments
1. Setting Investment Objectives These involve physical assets.
The first step is to define goals clearly.
· Land
· Buildings
Examples:
· Machinery
· Retirement after 20 years · Gold
· Monthly income generation · Commodities

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4. Diversification 4. Security Selection
Do not invest all funds in one asset. After deciding asset allocation, specific securities are selected.

5. Tax Planning Examples:

Choose tax-efficient options. · Shares of strong companies

· Government bonds
6. Market Knowledge · Mutual funds
· Bank deposits
Understand economic and market trends.
Selection is based on:
7. Long-term Perspective
· Return potential
Avoid emotional decisions based on short-term fluctuations. · Risk level
· Market conditions
· Credit rating
· Liquidity
Risk in Investment Management
5. Portfolio Construction
Risk means possibility of lower than expected return or loss.
Selected assets are combined into a portfolio. A good portfolio balances risk and
Types of Risk return.

1. Market Risk Principles:

Price changes in securities. · Diversification

· Balance between growth and safety
2. Credit Risk · Sector allocation
· Geographic spread
Default by borrower.

3. Interest Rate Risk

6. Implementation
Changes in rates affect bond prices. Funds are invested according to the plan through stock exchanges, banks, brokers,
or fund houses.
4. Inflation Risk
7. Monitoring and Review
Purchasing power decreases.
Regular review is essential because market conditions change.
5. Liquidity Risk

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Portfolio management is part of investment management where a collection of

investments is managed scientifically.
Conclusion Objectives:
Investment is the process of committing funds today to earn future returns. It is · Maximize return
essential for wealth creation, financial security, and economic growth. Investment · Reduce risk
management is the scientific and systematic handling of investments to achieve · Maintain liquidity
objectives such as safety, income, liquidity, tax efficiency, and capital
· Meet investor goals
appreciation.

A sound investment management process includes setting goals, assessing risk,

allocating assets, selecting securities, monitoring performance, and periodic
rebalancing. Successful investing requires patience, discipline, diversification, and Modern Trends in Investment Management
long-term vision.
1. Mutual Funds
In the modern financial world, proper investment management has become a
necessity for every individual and organization. Those who invest wisely today Professional fund management for small investors.
build a secure and prosperous tomorrow.
2. SIP (Systematic Investment Plan)
Financial and Non-Financial Forms of Regular small investments over time.
Investment
3. Digital Investment Platforms
Investment means committing money or resources today with the expectation of
earning future returns or benefits. Investors choose different forms of investment Online investing apps and robo-advisors.
depending on their objectives, risk tolerance, liquidity needs, and time horizon.
Broadly, investments are classified into financial forms of investment and non- 4. ESG Investing
financial forms of investment.
Investment based on environmental, social, and governance factors.

1. Financial Forms of Investment 5. Global Diversification

Financial investments involve placing money in financial assets or instruments Investment in foreign markets.
issued by governments, companies, banks, or financial institutions. These assets
represent claims on future income or ownership.

Major Financial Forms of Investment

Common Mistakes in Investment
a) Equity Shares
· Lack of planning
· Emotional decisions

%# %"
decisions also require reliable information. Therefore, understanding various Limitations
investment avenues and sources of investment information is very important.
· Market risk in shares and mutual funds
Various Investment Avenues · Lower returns in safe investments
· Inflation may reduce real returns
1. Bank Deposits

Savings accounts, fixed deposits, and recurring deposits are common investment
avenues. They provide safety, liquidity, and fixed returns. Suitable for conservative 2. Non-Financial Forms of Investment
investors.
Non-financial investments involve purchase of physical or tangible assets. These
2. Government Securities assets may provide income, utility, or value appreciation over time.
These include treasury bills, bonds, and savings certificates issued by the Major Non-Financial Forms of Investment
government. They are considered safe and provide regular income.
a) Real Estate
3. Equity Shares
Investment in land, residential property, commercial buildings, or plots. It provides
Investment in shares gives ownership in a company. Returns come through rental income and long-term appreciation.
dividends and increase in market price. Shares offer high return potential but
involve higher risk. b) Gold and Precious Metals

4. Debentures and Bonds Gold is a traditional investment and store of value. It is popular during inflation
and economic uncertainty.
These are fixed-income instruments issued by companies or governments.
Investors receive interest at regular intervals and principal on maturity. c) Commodities

5. Mutual Funds Investments in silver, agricultural goods, oil, or metals through physical purchase
or commodity markets.
Mutual funds collect money from many investors and invest in shares, bonds, or
other assets. They are professionally managed and suitable for small investors. d) Collectibles

6. Insurance Plans Artworks, antiques, coins, stamps, and rare items may appreciate in value.

Life insurance, ULIPs, pension plans, and endowment policies combine protection e) Business Investment
with savings or investment benefits.
Starting or expanding a business is also a non-financial investment.
7. Provident Funds
Advantages of Non-Financial Investments
Public Provident Fund (PPF), Employees’ Provident Fund (EPF), and National
Pension System (NPS) are popular long-term investment options with tax benefits. · Tangible assets with real ownership

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Deals in short-term funds and instruments with maturity up to one year. Annual reports contain financial statements, profit details, management discussion,
and future plans of companies.
Examples:
3. Stock Exchanges
· Treasury bills
· Commercial paper Stock exchanges provide information about listed securities, market trends, and
· Certificates of deposit trading volumes.
b) Capital Market
4. Company Websites
Deals in medium-term and long-term funds.
Official websites give details about products, results, investor presentations, and
Examples: corporate announcements.

· Shares 5. Financial Advisors and Brokers

· Debentures
· Bonds Professional advisors help investors choose suitable avenues based on risk and
· Mutual funds return preferences.

Functions of Financial Market 6. Research Reports

· Mobilizes savings Reports from brokerage houses, banks, and rating agencies provide investment
· Provides liquidity recommendations and industry analysis.
· Helps price determination
· Facilitates capital formation 7. Government Publications
· Promotes economic growth
Budget documents, RBI reports, SEBI notifications, and economic surveys provide
useful policy information.
2. Investment Instruments 8. Television and Digital Media
Investment instruments are financial assets in which investors place money to earn
Business news channels and financial websites offer daily updates on markets and
returns.
investments.
a) Equity Shares
9. Credit Rating Agencies
Represent ownership in a company. Returns through dividends and capital
appreciation. Agencies such as CRISIL, ICRA, and CARE rate bonds and fixed-income
instruments, helping assess risk.
b) Preference Shares

Provide fixed dividend and preference over equity shareholders.

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 UNIT 2 · Professionally manage pooled funds
· Provide diversification and expert management

d) Portfolio Managers
Analysis of Risk & Return, Concept of Total Risk, Factors · Manage investments on behalf of clients
Contributing to Total Risk, Systematic and Unsystematic Risk, · Design portfolios based on risk and return objectives
Default Risk, Interest Rate Risk, Market Risk, Management Risk,
Purchasing Power Risk e) Insurance Companies

· Offer life insurance and investment-linked products

Introduction
f) Depositories
Investment decisions are based on two important factors: risk and return. Every
investor expects maximum return with minimum risk. However, higher returns · Hold securities in electronic form through demat accounts
usually involve higher risk. Therefore, proper analysis of risk and return is
essential in investment management. Understanding different types of risk helps g) Credit Rating Agencies
investors make sound decisions and build efficient portfolios.
· Rate debt instruments and assess credit risk

Importance of Intermediaries
Meaning of Return
· Expert guidance
Return is the gain or income earned from an investment over a period of time. It · Easy market access
may arise in two forms: · Reduced transaction cost
· Better risk management
1. Current Income – Interest, dividend, rent, etc. · Efficient fund allocation
2. Capital Gain – Increase in market price of an asset.

Formula of Return

Return=Income+Price ChangeInitial Investment×100Return = \frac{Income +

4. Regulatory Framework in Financial Market
Price\ Change}{Initial\ Investment} \times The regulatory framework consists of laws, institutions, and rules governing
100Return=Initial InvestmentIncome+Price Change×100 financial markets to ensure transparency and investor confidence .
Example: If shares purchased for ₹100 rise to ₹110 and dividend of ₹5 is received,
Main Regulatory Authorities in India
total return is 15%.
a) SEBI (Securities and Exchange Board of India)

· Regulates capital market

Meaning of Risk · Protects investors
· Controls stock exchanges, brokers, and mutual funds

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· Corporate bonds Several factors contribute to total risk:

· Debentures
· Loans 1. Economic Conditions

Causes Inflation, recession, unemployment, and GDP growth affect returns.

· Weak financial position 2. Political Environment

· Bankruptcy
· Poor cash flow Government policies, taxation, wars, and instability affect markets.

Control Measures 3. Industry Conditions

· Credit ratings Demand changes, competition, technology shifts, and regulations affect industries.
· Investing in strong companies
· Diversification 4. Company Performance

Profitability, management efficiency, debt level, and reputation affect specific

firms.
Interest Rate Risk
5. Interest Rate Changes
Interest rate risk arises due to changes in market interest rates. It mainly affects
fixed-income securities like bonds. Changes in rates influence borrowing cost and asset values.

Effect 6. Market Sentiment

· If interest rates rise, bond prices fall. Investor confidence and speculation affect prices.
· If interest rates fall, bond prices rise.
7. Global Events
Long-term bonds face greater interest rate risk than short-term bonds.
Pandemics, crises, and international conflicts affect markets worldwide.

Market Risk
Systematic Risk
Market risk refers to losses caused by broad market movements due to economic or
Systematic risk is the risk caused by external factors affecting the entire market or
political changes.
economy. It cannot be eliminated through diversification.
Examples
It affects all securities to some extent.
· Stock market crash
Examples
· Recession
· Global financial crisis

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 · C = Annual coupon interest Measures dispersion of returns.
· F = Face value
· r = Required rate of return 2. Standard Deviation
· n = Number of years
Shows volatility of returns.
2. Yield to Maturity (YTM) Method
3. Beta
YTM is the discount rate that equates present value of future cash flows with
current market price. It represents the total return if the bond is held till maturity. Measures systematic risk relative to market.

3. Current Yield Method · Beta = 1 : same as market

· Beta > 1 : more risky
Current yield measures annual interest income as a percentage of current market · Beta < 1 : less risky
price.

Current Yield=Annual InterestMarket Price×100Current\ Yield = \frac{Annual\

Interest}{Market\ Price} \times 100Current Yield=Market PriceAnnual Interest Risk Management Techniques
×100
1. Diversification
4. Zero-Coupon Bond Valuation 2. Asset allocation
3. Credit analysis
Zero-coupon bonds do not pay periodic interest. They are issued at discount and 4. Investing for long term
redeemed at face value. 5. Hedging with derivatives
6. Regular review of portfolio
P=F(1+r)nP = \frac{F}{(1+r)^n}P=(1+r)nF

5. Perpetual Bond Valuation

Importance of Risk Analysis
Perpetual bonds pay interest forever without maturity.
· Helps select suitable investments
P=CrP = \frac{C}{r}P=rC · Protects capital
· Improves portfolio returns
Factors Affecting Debt Valuation · Reduces uncertainty
· Assists in financial planning
1. Market interest rate
2. Coupon rate
3. Credit rating of issuer
4. Time to maturity Conclusion
5. Inflation expectations
6. Liquidity of security Risk and return are inseparable elements of investment decisions. Total risk
consists of systematic and unsystematic risk. Other important risks include default
risk, interest rate risk, market risk, management risk, and purchasing power risk.

'# '"

Suitable for investment or holding companies. Investing in bonds with different maturities.

4. Price Earnings (P/E) Ratio Method 5. Holding Government Securities

Value is estimated by multiplying earnings per share with industry P/E ratio. They carry lower default risk.

6. Regular Portfolio Review

Monitoring market rates and issuer quality.

Conclusion

Debt instruments are important investment options providing fixed income and
capital safety. Their valuation depends on future cash flows, interest rates, and risk
Widely used in stock market analysis. factors. Investors use methods such as bond pricing, YTM, and current yield to
assess value. Proper risk management through diversification, credit analysis, and
5. Discounted Cash Flow (DCF) Method maturity planning helps achieve stable and secure returns in the debt market.
Value is based on present value of future free cash flows of the company.

Valuation of Equity – Methods of Valuation including

CAPM and their Relevance
Introduction

Equity shares represent ownership in a company. Shareholders receive returns in

the form of dividends and capital appreciation. The market price of shares changes
frequently, so investors need to know the fair value of equity before making
Used for long-term valuation and corporate finance decisions. investment decisions. Valuation of equity means determining the intrinsic or real
value of a share based on expected earnings, dividends, growth, and risk.

Proper equity valuation helps investors decide whether a share is undervalued,

CAPM (Capital Asset Pricing Model) overvalued, or fairly priced.
CAPM is an important method used to determine the required rate of return on Meaning of Equity Valuation
equity by considering market risk.
Equity valuation is the process of estimating the worth of a company’s shares. It is
useful for investors, analysts, managers, and companies during investment
decisions, mergers, acquisitions, and portfolio management.

Methods of Valuation of Equity

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Currency appreciation or depreciation affects imports, exports, and multinational UNIT 3
company earnings.

7. Employment Level Fundamental Analysis: Concept & Significance of

Higher employment increases income and consumer demand, benefiting Economic Analysis
companies.
Introduction
8. Political Stability
Investment in securities requires careful study before making decisions. One of the
Stable government and clear policies encourage investment and economic growth. most important approaches used by investors is fundamental analysis. It helps
determine the intrinsic value of a security by examining economic, industry, and
9. Balance of Payments company factors. Fundamental analysis is widely used in equity investment
because it identifies whether a share is undervalued or overvalued.
A healthy external sector improves confidence in the economy.
Economic analysis is the first step of fundamental analysis. It studies the overall
economic environment because company performance and stock prices are greatly
influenced by economic conditions.
Significance of Economic Analysis

1. Basis for Investment Decisions

Concept of Fundamental Analysis
Economic conditions influence all industries and companies. Investors study the
economy before selecting securities. Fundamental analysis is a method of evaluating securities by analyzing factors that
affect the value of a company. It aims to estimate the real or intrinsic value of
2. Forecasting Market Trends shares based on financial and economic data.

Bull and bear phases in stock markets are often linked to economic cycles. If market price is below intrinsic value, the share may be undervalued and worth
buying. If market price is above intrinsic value, it may be overvalued.
3. Selection of Suitable Sectors
Fundamental analysis generally follows a top-down approach:
Different sectors perform differently under varying economic conditions.
1. Economic Analysis
Example: 2. Industry Analysis
3. Company Analysis
· Infrastructure may grow during expansion.
· FMCG may perform better during slowdown. Thus, economic analysis forms the base of investment decisions.

4. Risk Reduction

Understanding economic trends helps investors avoid losses during recessions or

high inflation.

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Suitable during uncertain times.

3. Growth Industries Meaning of Industry Analysis

Industries with high future expansion potential. Industry analysis means systematic study of the characteristics, structure,
performance, risks, and future prospects of a particular industry. It evaluates how
Examples: external factors and competition affect companies in that sector.
· Information technology Examples of industries:
· Renewable energy
· Telecom · Automobile industry
· E-commerce · Banking industry
· Information technology industry
4. Mature Industries · Pharmaceutical industry
· Cement industry
Industries with stable demand and moderate growth. · FMCG industry
Examples: By studying an industry, investors can estimate future sales, profits, risks, and
growth opportunities.
· Banking
· Textiles
· Consumer durables

5. Declining Industries
Need for Industry Analysis
1. Selection of Profitable Sectors
Industries facing falling demand due to technology or changing preferences.
Different industries perform differently at different times. Industry analysis helps
Examples:
investors choose sectors with strong growth potential.
· Typewriters
2. Understanding Competitive Position
· Traditional film cameras
· Some print media segments It shows the level of competition, entry barriers, and market share within the
industry.
6. Seasonal Industries
3. Estimation of Future Earnings
Demand varies by season.
Industry trends affect revenue and profitability of companies.
Examples:

· Air conditioners 4. Risk Assessment

· Woollen garments Some industries are cyclical and risky, while others are stable.
· Tourism

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Supply and cost of inputs. · Exit of firms

6. Labour Conditions Investors should be cautious.

Skill availability and wage levels.

7. Regulatory Environment Economic Factors & Industry Analysis

Licensing, pollution norms, safety rules. Industry performance is strongly linked with economic conditions.

8. Innovation Capability 1. GDP Growth

Research and product development strength. Higher GDP growth increases demand for goods and services, helping many
industries.

2. Interest Rates
Importance of Industry Analysis for Investors
Low interest rates encourage borrowing and investment.
· Helps identify future winners
· Avoids weak sectors Positive for:
· Supports long-term portfolio strategy
· Improves stock selection · Real estate
· Reduces investment risk · Auto industry
· Capital goods

3. Inflation
Limitations of Industry Analysis
High inflation raises raw material and wage costs.
· Future demand may change unexpectedly
· Sudden policy changes affect industries Negative for many industries unless costs can be passed to consumers.
· Disruptive technology can alter prospects quickly
· Industry leaders may lose advantage unexpectedly 4. Government Policy

Tax benefits, subsidies, regulations, and incentives influence industries.

Conclusion Examples:

Industry analysis is a vital stage of fundamental analysis because company success · PLI schemes help manufacturing
depends greatly on industry conditions. It helps investors understand sector · Tax cuts may help automobiles
growth, competition, risks, and opportunities. By studying industry classification,
life cycle stages, and economic influences, investors can select strong sectors and 5. Exchange Rate

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Measure short-term financial position. Nature of Management

· Current Ratio Nature of management refers to the quality, competence, honesty, and experience
Current Ratio=Current AssetsCurrent LiabilitiesCurrent\ Ratio = of top executives and directors.
\frac{Current\ Assets}{Current\
Liabilities}Current Ratio=Current LiabilitiesCurrent Assets Important aspects include:
· Quick Ratio
1. Vision and Leadership – Ability to set long-term goals.
2. Profitability Ratios 2. Experience – Industry knowledge and decision-making skills.
3. Integrity – Ethical practices and transparency.
Measure earning capacity. 4. Efficiency – Proper use of resources.
5. Innovation – Ability to adapt to market changes.
· Net Profit Ratio
· Return on Equity (ROE) Style of Management
ROE=Net ProfitShareholders′ Equity×100ROE = \frac{Net\
Profit}{Shareholders'\ Equity} \times Management style means the way decisions are made and operations are
100ROE=Shareholders′ EquityNet Profit×100 controlled.

3. Solvency Ratios Types of Management Style

Measure long-term stability. 1. Conservative Style

· Debt-Equity Ratio Focuses on safety, steady growth, and low risk.

· Interest Coverage Ratio
2. Aggressive Style
4. Efficiency Ratios
Focuses on rapid expansion, higher risk, and innovation.
Measure operational efficiency.
3. Professional Style
· Inventory Turnover Ratio
· Asset Turnover Ratio Uses expert managers, modern systems, and data-based decisions.

5. Market Ratios 4. Family-Controlled Style

Useful for investors. Common in many firms where ownership and management remain with family
members.
· Earnings Per Share (EPS)
· Price Earnings Ratio (P/E) Investors usually prefer transparent, professional, and growth-oriented
management.

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Close < Open 1. Market discounts everything.
2. Prices move in trends.
Importance 3. History repeats itself.

Candlestick patterns provide signals of trend reversal or continuation.

Types of Charts Used in Technical Analysis

Reversal Patterns 1. Line Chart

Reversal patterns indicate that an existing trend may change direction. A line chart is the simplest chart used in technical analysis. It joins the closing
prices of a security over a period with a line.
1. Head and Shoulders Pattern
y=f(t)y = f(t)y=f(t)
Signals reversal from upward trend to downward trend.
Features
Structure:
· Easy to understand
· Left shoulder · Shows general trend clearly
· Head · Useful for long-term analysis
· Right shoulder
Uses
Often considered reliable.
· Identifying upward or downward trend
2. Inverse Head and Shoulders · Comparing performance over time
Signals reversal from downtrend to uptrend.

3. Double Top 2. Bar Chart

Price reaches same high level twice and falls. A bar chart provides more information than a line chart. Each vertical bar shows:
Indicates bearish reversal. · High price
· Low price
4. Double Bottom · Opening price
· Closing price
Price reaches same low level twice and rises.
Features
Indicates bullish reversal.
· Better than line chart for daily analysis
5. Triple Top / Triple Bottom
· Shows volatility and range

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Conclusion Dow Theory is one of the oldest and most important principles of technical
analysis developed by Charles Dow.
Technical analysis is an important method for forecasting market trends using
charts and price patterns. Tools such as line charts, bar charts, point and figure It explains market trends and stock market behavior.
charts, and candlestick charts help understand market movements. Reversal and
continuation patterns guide trading decisions. Dow Theory explains trend behavior, Main Principles of Dow Theory
while Elliott Wave Theory studies cyclical market psychology. Though not perfect,
technical analysis is highly useful for market timing and trend-based investment 1. Market Discounts Everything
decisions.
All known information is reflected in prices.

2. Three Types of Trends

· Primary Trend – Long-term movement

· Secondary Trend – Intermediate correction
· Minor Trend – Short-term fluctuations

3. Trends Continue Until Reversal

A trend remains in force until clear signal of change.

4. Volume Confirms Trend

Volume should rise in direction of trend.

5. Indices Must Confirm

Different market indices should move together.

Importance

Dow Theory helps identify long-term market direction.

Elliott Wave Theory

Elliott Wave Theory was developed by Ralph Nelson Elliott. It states that market
prices move in repetitive wave patterns caused by investor psychology.

Basic Structure

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Criticism of EMH Higher expected return is generally associated with higher risk.

1. Markets may overreact or underreact. 2. Diversification

2. Investor emotions can create bubbles and crashes.
3. Insider information may provide unfair advantage. Investing in different securities reduces unsystematic risk.
4. Some investors outperform markets for long periods.
3. Correlation
Behavioral finance challenges strict EMH assumptions.
The relationship between returns of assets affects total portfolio risk. Combining
assets with low or negative correlation reduces risk.

Importance for Investors 4. Efficient Portfolio

· Encourages low-cost diversified investing An efficient portfolio gives maximum return for a given level of risk or minimum
· Reduces reliance on rumors risk for a given return.
· Supports long-term investment discipline
· Highlights importance of risk rather than prediction
Efficient Market Hypothesis (EMH)

Conclusion The Efficient Market Hypothesis was developed by Eugene Fama. It states that
security prices quickly and accurately reflect all available information.
Portfolio theory focuses on balancing risk and return through diversification and
efficient asset selection. Efficient Market Hypothesis complements this theory by According to EMH:
stating that market prices already reflect available information. Therefore,
consistently beating the market is difficult. For most investors, a diversified long- · Current prices are fair prices.
term portfolio remains a practical and effective investment strategy. · No investor can consistently outperform the market using publicly available
information.
· Price changes occur when new information arrives.

Random Walk Theory

Forms of Efficient Market Hypothesis
Introduction
1. Weak Form Efficiency
Portfolio theory is an important concept in investment management that helps
investors select a combination of securities to maximize returns and minimize risk. Current prices reflect all past price and volume data.
It emphasizes diversification, risk management, and efficient allocation of funds.
Implication:
One important concept related to portfolio theory and market behavior is the
Random Walk Theory. Technical analysis cannot consistently produce abnormal profits.

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Conclusion Portfolio theory suggests that risk can be reduced through diversification. Random
Walk Theory adds that since price movements are unpredictable, investors should
Random Walk Theory states that stock prices move randomly and future price focus on building diversified portfolios instead of trying to forecast short-term
changes cannot be reliably predicted from past movements. It supports the idea that prices.
investors should avoid unnecessary speculation and instead build diversified
portfolios. In portfolio theory, the main lesson is that managing risk through Thus, rather than selecting “winning stocks,” investors should manage risk
diversification and long-term planning is more practical than attempting to forecast efficiently.
daily market movements.

Implications for Investors

Markowitz Diversification Model 1. Technical Analysis has Limited Value

Introduction Since future prices do not follow predictable patterns, chart analysis may not
consistently produce excess returns.
The Markowitz Diversification Model is one of the most important concepts in
modern portfolio theory. It was developed by Harry Markowitz in 1952. This 2. Difficult to Time the Market
model explains how investors can reduce risk and maximize returns by combining
different securities in a portfolio. Markowitz showed that investors should not Buying at exact low prices and selling at highs consistently is difficult.
evaluate investments individually but as a group within a portfolio.
3. Passive Investing is Preferred
The model is based on the principle that diversification can reduce overall portfolio
risk without necessarily reducing expected return. Index funds and diversified portfolios may be better than frequent trading.

4. Long-Term Investment Strategy

Meaning of Markowitz Diversification Model Investors should focus on long-term wealth creation rather than short-term
speculation.
The Markowitz model is a scientific approach to portfolio selection that focuses on
the relationship between risk and return. It helps investors create an optimal
portfolio by selecting securities that provide the best possible return for a given
level of risk. Advantages of Random Walk Theory

According to the model, total portfolio risk depends not only on the risk of 1. Encourages rational investment behavior.
individual securities but also on how their returns move relative to each other. 2. Reduces excessive speculation.
3. Supports diversification.
4. Highlights uncertainty in markets.
5. Promotes passive investment strategies.
Basic Assumptions

1. Investors are rational and risk-averse.

)! )&
Assumptions of APT Example:

1. Investors behave rationally. If one security falls while another rises, losses are offset.
2. Security returns are affected by common factors.
3. Markets do not allow long-term arbitrage opportunities. Thus, “do not put all eggs in one basket.”
4. Investors can diversify unsystematic risk.

Advantages of APT
Efficient Frontier
· Considers multiple economic factors.
· More flexible than CAPM. Markowitz introduced the concept of efficient frontier. It represents a set of
· Useful for portfolio management. portfolios offering:
· Helps estimate fair return.
· Maximum return for a given risk, or
Limitations of APT · Minimum risk for a given return.

· Difficult to identify correct factors. y=f(σ)y = f(\sigma)y=f(σ)

· Requires complex calculations.
· Assumptions may not hold perfectly. Investors should choose portfolios on the efficient frontier.

Conclusion

Arbitrage Pricing Theory is a useful model for estimating security returns by Advantages of Markowitz Model
considering various macroeconomic influences. It helps investors understand how
1. Scientific portfolio selection method.
different factors affect investments and assists in better pricing and portfolio
2. Reduces risk through diversification.
decisions.
3. Balances risk and return.
4. Helps identify efficient portfolios.
5. Forms basis of modern portfolio management.
Portfolio Building Process, Tools Used by Value
Investors, Portfolio Performance Evaluation –
Limitations
Sharpe’s and Treynor’s Measures
1. Requires large amount of data.
Introduction 2. Calculation becomes complex with many securities.
3. Assumes past data predicts future behavior.
Portfolio management involves selecting and managing a group of investments to 4. Market conditions may change suddenly.
achieve desired return with acceptable risk. A good portfolio is built systematically
through proper planning and diversification. After construction, portfolio
performance must be evaluated using scientific measures such as Sharpe’s and
Importance in Investment Management

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Interpretation Investment is spread across sectors and asset classes to reduce unsystematic risk.

Higher Treynor ratio indicates superior performance relative to market risk. 6. Portfolio Implementation

Use Actual purchase of securities according to plan.

Best when portfolio is well diversified. 7. Monitoring and Revision

Portfolio should be reviewed regularly and rebalanced when required.

Difference Between Sharpe and Treynor

Basis Sharpe Treynor Tools Used by Value Investors

Risk Used Total Risk Systematic Risk
Value investing means purchasing securities trading below intrinsic value.
Measure Standard deviation Beta Popularized by Benjamin Graham and Warren Buffett.
Suitable For Total portfolio Diversified portfolio
Main Tools

Conclusion 1. Price Earnings Ratio (P/E)

Portfolio building is a continuous process involving goal setting, risk assessment, Low P/E may indicate undervaluation.
diversification, and monitoring. Value investors use tools such as P/E ratio, P/B
ratio, DCF, and margin of safety to identify undervalued stocks. Portfolio P/E=Market PriceEPSP/E = \frac{Market\ Price}{EPS}P/E=EPSMarket Price
performance should be evaluated scientifically using Sharpe’s and Treynor’s
measures to ensure better returns for the level of risk taken. 2. Price to Book Value Ratio (P/B)

Compares market price with net asset value.

3. Dividend Yield

Higher yield may indicate attractive valuation.

4. Margin of Safety

Buying well below intrinsic value to reduce risk.

5. Discounted Cash Flow (DCF)

Estimates present value of future cash flows.

6. Financial Strength Analysis

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1. Constant Rupee Value Plan 5. Meet changing financial goals.
6. Capture new opportunities.
Investor maintains fixed rupee amount in equity. If equity rises, some shares are
sold; if it falls, more shares are bought.

Example: Maintain ₹1,00,000 in equity. Active Strategies in Portfolio Revision

2. Constant Ratio Plan Active strategy involves frequent monitoring and regular changes in portfolio to
outperform the market.
Fixed percentage is maintained between equity and debt.
Features
Example: 60% equity and 40% debt.
· Continuous research and market tracking
If ratio changes, portfolio is rebalanced. · Frequent buying and selling
· Selection of undervalued securities
3. Variable Ratio Plan · Market timing attempts
Ratio between equity and debt changes according to market conditions. Methods of Active Strategy
· Increase equity when market falls 1. Security Selection
· Reduce equity when market rises
Choosing stocks expected to perform better than market.
4. Dollar Cost Averaging / Rupee Cost Averaging
2. Sector Rotation
Fixed amount invested periodically regardless of market price.
Moving investments from weak sectors to strong sectors.
This averages purchase cost over time.
3. Market Timing

Increasing equity exposure during expected rise and reducing during expected fall.
Advantages of Formula Plans
Advantages
1. Disciplined investing
2. Reduces emotional decisions · Possibility of higher returns
3. Encourages buy low, sell high · Flexibility
4. Suitable for long-term planning · Quick response to changes

Limitations

Limitations of Formula Plans · High transaction costs

· Requires expertise
1. Works less effectively in highly volatile markets · Difficult to beat market consistently

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