AIM OF THE STUDY:

The study focuses its attention on the functioning of stock markets and

Construction of the equity portfolio

OBJECTIVES:
 To study the investment decision process.

 To analysis the risk return characteristics of sample

scripts.

 Ascertain portfolio weights.

 To construct an effective portfolio which offers the

maximum return for minimum risk

INTRODUCTION , IMPORTANCE & NEED OF STUDY

Portfolio management or investment helps investors in

effective and efficient management of their investment to
achieve this goal
.
The rapid growth of capital markets in India has opened
up new investment avenues for investors.

The stock markets have become attractive investment

options for the common man.

But the need is to be able to effectively and efficiently

manage investments in order to keep maximum returns with
minimum risk.
 Hence this study on PORTFOLIO MANAGEMENT &
INVESTMENT DECISION” to examine the role process and
merits of effective investment management and decision.

PORTFOLIO MANAGEMENT

PORTFOLIO:

A portfolio is a collection of securities since it is really

desirable to invest the entire funds of an individual or an institution or a
single security, it is essential that every security be viewed in a portfolio
context. Thus it seems logical that the expected return of the portfolio.
Portfolio analysis considers the determine of future risk and return in
holding various blends of individual securities

Portfolio expected return is a weighted average of the expected

return of the individual securities but portfolio variance, in short contrast,
can be something reduced portfolio risk is because risk depends greatly on
the co-variance among returns of individual securities. Portfolios, which are
combination of securities, may or may not take on the aggregate
characteristics of their individual parts.

Since portfolios expected return is a weighted average of the expected

return of its securities, the contribution of each security the portfolio’s
expected returns depends on its expected returns and its proportionate share
of the initial portfolio’s market value. It follows that an investor who simply
wants the greatest possible expected return should hold one security; the one
which is considered to have a greatest expected return. Very few investors
do this, and very few investment advisors would counsel such and extreme
policy instead, investors should diversify, meaning that their portfolio
should include more than one security.

OBJECTIVES OF PORTFOLIOMANAGEMENT:
 The main objective of investment portfolio management is to
maximize the returns from the investment and to minimize the risk involved
in investment. Moreover, risk in price or inflation erodes the value of money
and hence investment must provide a protection against inflation.

Secondary objectives:

The following are the other ancillary objectives:

• Regular return.
• Stable income.
• Appreciation of capital.
• More liquidity.
• Safety of investment.
• Tax benefits.

Portfolio management services helps investors to make a wise

choice between alternative investments with pit any post trading hassle’s this
service renders optimum returns to the investors by proper selection of
continuous change of one plan to another plane with in the same scheme,
any portfolio management must specify the objectives like maximum
return’s, and risk capital appreciation, safety etc in their offer.

Return From the angle of securities can be fixed income securities such
as:

(a) Debentures –partly convertibles and non-convertibles debentures debt

with tradable Warrants.
(b) Preference shares
(c) Government securities and bonds
(d) Other debt instruments

(2) Variable income securities

(a) Equity shares
(b) Money market securities like treasury bills commercial papers etc.

Portfolio managers has to decide up on the mix of securities on the

basis of contract with the client and objectives of portfolio
NEED FOR PORTFOLIO MANAGEMENT:

Portfolio management is a process encompassing many activities of

investment in assets and securities. It is a dynamic and flexible concept and
involves regular and systematic analysis, judgment and action. The objective
of this service is to help the unknown and investors with the expertise of
professionals in investment portfolio management. It involves construction
of a portfolio based upon the investor’s objectives, constraints, preferences
for risk and returns and tax liability. The portfolio is reviewed and adjusted
from time to time in tune with the market conditions. The evaluation of
portfolio is to be done in terms of targets set for risk and returns. The
changes in the portfolio are to be effected to meet the changing condition.

Portfolio construction refers to the allocation of surplus funds in hand

among a variety of financial assets open for investment. Portfolio theory
concerns itself with the principles governing such allocation. The modern
view of investment is oriented more go towards the assembly of proper
combination of individual securities to form investment portfolio.

A combination of securities held together will give a beneficial

result if they grouped in a manner to secure higher returns after taking into
consideration the risk elements.

The modern theory is the view that by diversification risk can be

reduced. Diversification can be made by the investor either by having a large
number of shares of companies in different regions, in different industries or
those producing different types of product lines. Modern theory believes in
the perspective of combination of securities under constraints of risk and
returns

PORTFOLIO MANAGEMENT PROCESS:

Investment management is a complex activity which may be broken

down into the following steps:
 1) Specification of investment objectives and constraints:

The typical objectives sought by investors are current income,

capital appreciation, and safety of principle. The relative importance of
these objectives should be specified further the constraints arising from
liquidity, time horizon, tax and special circumstances must be identified.

2) choice of the asset mix :

The most important decision in portfolio management is the asset mix

decision very broadly; this is concerned with the proportions of ‘stocks’
(equity shares and units/shares of equity-oriented mutual funds) and ‘bonds’
in the portfolio.

The appropriate ‘stock-bond’ mix depends mainly on the risk

tolerance and investment horizon of the investor.

ELEMENTS OF PORTFOLIO MANAGEMENT:

Portfolio management is on-going process involving the following basic

tasks:

 Identification of the investor’s objectives, constraints and

preferences.
 Strategies are to be developed and implemented in tune with
investment policy formulated.
 Review and monitoring of the performance of the portfolio.
 Finally the evaluation of the portfolio
Risk:
Risk is uncertainty of the income /capital appreciation or loss or both.
All investments are risky. The higher the risk taken, the higher is the return.
But proper management of risk involves the right choice of investments
whose risks are compensating. The total risks of two companies may be
different and even lower than the risk of a group of two companies if their
companies are offset by each other.

The two major types of risks are:

 Systematic or market related risk.

 Unsystematic or company related risks.

Systematic risks affected from the entire market are (the problems, raw
material availability, tax policy or government policy, inflation risk, interest
risk and financial risk). It is managed by the use of Beta of different
company shares.

The unsystematic risks are mismanagement, increasing inventory, wrong

financial policy, defective marketing etc. this is diversifiable or avoidable
because it is possible to eliminate or diversify away this component of risk
to a considerable extent by investing in a large portfolio of securities. The
unsystematic risk stems from inefficiency magnitude of those factors
different form one company to another.

RETURNS ON PORTFOLIO:

Each security in a portfolio contributes return in the proportion of

its investments in security. Thus the portfolio expected return is the
weighted average of the expected return, from each of the securities, with
weights representing the proportions share of the security in the total
investment. Why does an investor have so many securities in his portfolio?
If the security ABC gives the maximum return why not he invests in that
security all his funds and thus maximize return? The answer to this questions
lie in the investor’s perception of risk attached to investments, his objectives
of income, safety, appreciation, liquidity and hedge against loss of value of
money etc. this pattern of investment in different asset categories, types of
investment, etc., would all be described under the caption of diversification,
which aims at the reduction or even elimination of non-systematic risks and
achieve the specific objectives of investors

RISK ON PORTFOLIO :

The expected returns from individual securities carry some degree

of risk. Risk on the portfolio is different from the risk on individual
securities. The risk is reflected in the variability of the returns from zero to
infinity. Risk of the individual assets or a portfolio is measured by the
variance of its return. The expected return depends on the probability of the
returns and their weighted contribution to the risk of the portfolio. These are
two measures of risk in this context one is the absolute deviation and other
standard deviation.

Most investors invest in a portfolio of assets, because as to spread

risk by not putting all eggs in one basket. Hence, what really matters to them
is not the risk and return of stocks in isolation, but the risk and return of the
portfolio as a whole. Risk is mainly reduced by Diversification.

RISK RETURN ANALYSIS:

All investment has some risk. Investment in shares of companies has its
own risk or uncertainty; these risks arise out of variability of yields and
uncertainty of appreciation or depreciation of share prices, losses of liquidity
etc

The risk over time can be represented by the variance of the returns. While
the return over time is capital appreciation plus payout, divided by the
purchase price of the share.
 Normally, the higher the risk that the investor takes, the higher
is the return. There is, how ever, a risk less return on capital of about 12%
which is the bank, rate charged by the R.B.I or long term, yielded on
government securities at around 13% to 14%. This risk less return refers to
lack of variability of return and no uncertainty in the repayment or capital.
But other risks such as loss of liquidity due to parting with money etc., may
however remain, but are rewarded by the total return on the capital. Risk-
return is subject to variation and the objectives of the portfolio manager are
to reduce that variability and thus reduce the risky by choosing an
appropriate portfolio.

Traditional approach advocates that one security holds the better, it

is according to the modern approach diversification should not be quantity
that should be related to the quality of scripts which leads to quality of
portfolio.

Experience has shown that beyond the certain securities by adding more
securities expensive.

Simple diversification reduces:

An asset’s total risk can be divided into systematic plus unsystematic risk, as
shown below:
Systematic risk (undiversifiable risk) + unsystematic risk (diversified
risk) =Total risk =Var (r).

Unsystematic risk is that portion of the risk that is unique to the firm (for
example, risk due to strikes and management errors.) Unsystematic risk can
be reduced to zero by simple diversification.

Simple diversification is the random selection of securities that are to be

added to a portfolio. As the number of randomly selected securities added to
a portfolio is increased, the level of unsystematic risk approaches zero.
However market related systematic risk cannot be reduced by simple
diversification. This risk is common to all securities.

Persons involved in portfolio management:

Investor:
Are the people who are interested in investing their funds

Portfolio managers:

Is a person who is in the wake of a contract agreement with a client,

advices or directs or undertakes on behalf of the clients, the management or
distribution or management of the funds of the client as the case may be.

Discretionary portfolio manager:

Means a manager who exercise under a contract relating to a

portfolio management exercise any degree of discretion as to the investment
or management of portfolio or securities or funds of clients as the case may
be
.
The relation ship between an investor and portfolio manager is of a highly
interactive nature

The portfolio manager carries out all the transactions pertaining to

the investor under the power of attorney during the last two decades, and
increasing complexity was witnessed in the capital market and its trading
procedures in this context a key (uninformed) investor formed ) investor
found him self in a tricky situation , to keep track of market movement
,update his knowledge, yet stay in the capital market and make money , there
fore in looked forward to resuming help from portfolio manager to do the
job for him .

The portfolio management seeks to strike a balance between risk’s and

return.

The generally rule in that greater risk more of the profits but
S.E.B.I. in its guidelines prohibits portfolio managers to promise any return
to investor.
Portfolio management is not a substitute to the inherent risk’s associated
with equity investment

Who can be a portfolio manager?

Only those who are registered and pay the required license fee are
eligible to operate as portfolio managers. An applicant for this purpose
should have necessary infrastructure with professionally qualified persons
and with a minimum of two persons with experience in this business and a
minimum net worth of Rs. 50lakh’s. The certificate once granted is valid for
three years. Fees payable for registration are Rs 2.5lakh’s every for two
years and Rs.1lakh’s for the third year. From the fourth year onwards,
renewal fees per annum are Rs 75000. These are subjected to change by the
S.E.B.I.
 The S.E.B.I. has imposed a number of obligations and a code of
conduct on them. The portfolio manager should have a high standard of
integrity, honesty and should not have been convicted of any economic
offence or moral turpitude. He should not resort to rigging up of prices,
insider trading or creating false markets, etc. their books of accounts are
subject to inspection to inspection and audit by S.E.B.I... The observance of
the code of conduct and guidelines given by the S.E.B.I. are subject to
inspection and penalties for violation are imposed. The manager has to
submit periodical returns and documents as may be required by the SEBI
from time-to- time.

.Functions of portfolio managers:

the main function of portfolio managers are :

• Advisory role: advice new investments, review the existing ones,

identification of objectives, recommending high yield securities etc.

• Conducting market and economic service: this is essential for

recommending good yielding securities they have to study the current
fiscal policy, budget proposal; individual policies etc further portfolio
manager should take in to account the credit policy, industrial growth,
foreign exchange possible change in corporate law’s etc.

• Financial analysis: he should evaluate the financial statement of

company in order to understand, their net worth future earnings,
prospectus and strength.

• Study of stock market : he should observe the trends at various

stock exchange and analysis scripts so that he is able to identify the
right securities for investment

• Study of industry: he should study the industry to know its future

prospects, technical changes etc, required for investment proposal he
should also see the problem’s of the industry.

• Decide the type of port folio: keeping in mind the objectives of

portfolio a portfolio manager has to decide weather the portfolio
 should comprise equity preference shares, debentures, convertibles,
non-convertibles or partly convertibles, money market, securities etc
or a mix of more than one type of proper mix ensures higher safety,
yield and liquidity coupled with balanced risk techniques of portfolio
management.

A portfolio manager in the Indian context has been

Brokers (Big brokers) who on the basis of their experience, market trends,
Insider trader, helps the limited knowledge persons.

The one’s who use to manage the funds of portfolio, now

being managed by the portfolio of Merchant Bank’s, professional’s like
MBA’s CA’s And many financial institution’s have entered the market in a
big way to manage portfolio for their clients.

According to S.E.B.I. rules it is mandatory for portfolio

managers to get them self’s registered.

Registered merchant bankers can act’s as portfolio manager’s

Investor’s must look forward, for qualification and performance and ability
and research base of the portfolio manager’s.
 Technique’s of portfolio management:

As of now the under noted technique of portfolio management: are in

vogue in our country
1. equity portfolio: is influenced by internal and external factors the
internal factors effect the inner working of the company’s growth
plan’s are analyzed with referenced to Balance sheet, profit & loss a/c
(account) of the company.
Among the external factor are changes in the government policies,
Trade cycle’s, Political stability etc.
2. equity stock analysis: under this method the probable future value of
a share of a company is determined it can be done by ratio’s of
earning per share of the company and price earning ratio

EPS == PROFIT AFTER TAX

NO: OF EQUITY SHARES

PRICE EARNING RATIO= MARKET PRICE

E.P.S (earning’s per share)

One can estimate trend of earning by EPS, which reflects trends of earning
quality of company, dividend policy, and quality of management.
Price earning ratio indicate a confidence of market about the company
future, a high rating is preferable.
.
The following points must be considered by portfolio managers while
analyzing the securities.

1. Nature of the industry and its product: long term trends of

industries, competition with in, and out side the industry, Technical
changes, labour relations, sensitivity, to Trade cycle.
2. Industrial analysis of prospective earnings, cash flows, working
capital, dividends, etc.

3. Ratio analysis: Ratio such as debt equity ratio’s current ratio’s net
worth, profit earning ratio, return on investment, are worked out to
decide the portfolio.
 The wise principle of portfolio management suggests that “Buy when
the market is low or BEARISH, and sell when the market is rising or
BULLISH”.

Stock market operation can be analyzed by:

a) Fundamental approach :- based on intrinsic value of share’s
b) Technical approach:-based on Dowjone’s theory, Random walk
theory, etc.

Prices are based upon demand and supply of the market.

i. Traditional approach assumes that

ii. Objectives are maximization of wealth and minimization of risk.
iii. Diversification reduces risk and volatility.
iv. Variable returns, high illiquidity; etc.

Capital Assets pricing approach (CAPM) it pay’s more weight age, to risk or
portfolio diversification of portfolio.

Diversification of portfolio reduces risk but it should be based on certain

assessment such as:

Trend analysis of past share prices.

Valuation of intrinsic value of company (trend-marker moves are known

for their

Uncertainties they are compared to be high, and low prompts of wave

market trends are constituted by these waves it is a pattern of movement
based on past).

The following rules must be studied while cautious portfolio manager before
decide to invest their funds in portfolio’s.

1. Compile the financials of the companies in the immediate past 3 years

such as turn over, gross profit, net profit before tax, compare the profit
earning of company with that of the industry average nature of product
manufacture service render and it future demand ,know about the
promoters and their back ground, dividend track record, bonus shares in
the past 3 to 5 years ,reflects company’s commitment to share holders the
 relevant information can be accessed from the RDC(registrant of
companies)published financial results financed quarters, journals and
ledgers.

2. Watch out the high’s and lows of the scripts for the past 2 to 3 years
and their timing cyclical scripts have a tendency to repeat their
performance ,this hypothesis can be true of all other financial ,

3. The higher the trading volume higher is liquidity and still higher the
chance of speculation, it is futile to invest in such shares who’s daily
movements cannot be kept track, if you want to reap rich returns keep
investment over along horizon and it will offset the wild intra day trading
fluctuation’s, the minor movement of scripts may be ignored, we must
remember that share market moves in phases and the span of each phase
is 6 months to 5 years.

a. Long term of the market should be the guiding factor to enable

you to invest and quit. The market is now bullish and the trend is
likely to continue for some more time.

b. UN tradable shares must find a last place in portfolio apart from

return; even capital invested is eroded with no way of exit with no way of
exit with inside.

How at all one should avoid such scripts in future?

(1) Never invest on the basis of an insider trader tip in a company which is
not sound (insider trader is person who gives tip for trading in securities
based on prices sensitive up price sensitive un published information relating
to such security).

(2) Never invest in the so called promoter quota of lesser known company

(3) Never invest in a company about which you do not have appropriate
knowledge.

(4) Never at all invest in a company which doesn’t have a stringent financial
record your portfolio should not a stagnate
(4) Shuffle the portfolio and replace the slow moving sector with active ones
, investors were shatter when the technology , media, software , stops have
taken a down slight.

(5) Never fall to the magic of the scripts don’t confine to the blue chip
company‘s, look out for other portfolio that ensure regular dividends.

(6) In the same way never react to sudden raise or fall in stock market index
such fluctuation is movementary minor correction’s in stock market held in
consolidation of market their by reading out a weak player often taste on
wait for the dust and dim to settle to make your move” .

PORT FOLIO MANAGEMENT AND DIVERSIFICATOIN:

Combinations of securities that have high risk and return features make
up a portfolio.

Portfolio’s may or may not take on the aggregate characteristics of

individual part, portfolio analysis takes various components of risk and
return for each industry and consider the effort of combined security.

Portfolio selection involves choosing the best portfolio to suit the

risk return preferences of portfolio investor management of portfolio is a
dynamic activity of evaluating and revising the portfolio in terms of
portfolios objectives

It is widely accepted that returns from individual scripts carry certain

rate of risk .portfolio held in spreading the risk in many security then the risk
is reduced. The basic principle is that of a port folio holds several assets or
securities
It may include in cash also, even if one goes bad the other will provide
protection from the loss even cash is subject to inflation the diversification
can be either vertical or horizontal the vertical diversification portfolio can
have script of different company’s with in the same industry.
 In horizontal diversification one can have different scripts chosen from
different industries.

CEMENT INDUSTRY .TEXTILE INDUSTRY

ACC CEMENT RELILANCE INDUSTRIES

JK CEMENT GARDEN SILK MILLS
ULTRA TECH NECP TEXTILE
BIRLA CEM BOMBAY DEYING
VISHNU CEM GRASIM INDUSTRIES
PRIYA CEM BORODA RAYON
RAM CO CEM CHESLIND TEXTILE

Horizontal Diversification

TISCO MANUFACTURING
ACC
GARDEN TEXTILE
INFOSYS (SOFTWARE)
BSES LTD (POWER)
ULTRA TECH (CONSTRUCTION)

Diversification should be either be too much nor too less

It should be an adequate diversification looking in to the size of

portfolio.
Traditional approach advocates the more security one holds in a portfolio , the
better it is according to modern approach diversification should not be quantified
but should be related to the quality of scripts which leads to the quality and
portfolio subsequently experience can show that beyond a certain number of
securities adding more securities become expensive.

Investment in a fixed return securities in the current market scenario which

is passing through a an uncertain phase investors are facing the problem of lack
of liquidity combined with minimum returns the important point to both is that
the equity market and debt market moves in opposite direction .where the stock
market is booming, equities perform better where as in depressed market the
assured returns related securities market out perform equities.

It is cyclic and is evident in more global market keeping this in mind an

investor can shift from fixed income securities to equities and vise versa along
with the changing market scenario , if the investment are wisely planned they ,
fetch good returns even when the market is depressed most , important the
investor must adopt the time bound strategy in differing state of market to
achieve the optimum result when the aim is short term returns it would be wise
for the investor to invest in equities when the market is in boom & it could be
reviewed if the same is done.

Maximum of returns can be achieved by following a composite pattern of

investment by having, suitable investment allocation strategy among the available
resources.

 Never invest in a single securities your investment can be allocated in the

following areas:

1. Equities:-primary and secondary market.

2. Mutual Funds
3. Bank deposits
4. Fixed deposits & bonds and the tax saving schemes

 The different areas of fixed income are as:-

Fixed deposits in company

Bonds
Mutual funds schemes

with an investment strategy to invest in debt investment in fixed deposit can be

made for the simple reason that assured fixed income of a high of 14-17% per
annum can be expected which is much safer then investing a highly volatile
stock market, even in comparison to banks deposit which gives a maximum
return of 12% per annum, fixed deposit s in high profile esteemed will
performing companies definitely gives a higher returns.

Additional facilities offered by most of the schemes

Instant loan facility

Advances payment of interest in the form of postdated warrants
Premature with drawl facility
Pre personal accident insurance

Fixed deposit does provide a Varity of schemes to suit the financial links of
investor a few of the schemes are:

 Monthly income deposits where the interest is paid every month.

 Quarterly income deposit where the interest is paid once in a quarter
 Cumulative deposit where interest is accumulated and paid at the time of
maturity.
 Recurring deposit similar to recurring deposit of banks
 Cash certificates schemes

An investor can look for the CRISIL, CARE, ICRA, ratings for fixed
deposits.

BETA:

The concept of Beta as a measure of systematic risk is useful in portfolio

management. The beta measures the movement of one script in relation to the
market trend*. Thus BETA can be positive or negative depending on whether
the individual scrip moves in the same direction as the market or in the
opposite direction and the extent of variance of one scrip vis-à-vis the market
is being measured by BETA. The BETA is negative if the share price moves
contrary to the general trend and positive if it moves in the same direction.
The scrip’s with higher BETA of more than one are called aggressive, and
those with a low BETA of less than one are called defensive.

It is therefore it is necessary, to calculate Betas for all scrip’s and

choose those with high Beta for a portfolio of high returns.

Findings : The markowirtz graphic selection of portfolio is set to be not an

efficient one because if an investor is ready to take risk at std deviation X. he
can vote the last portfolio Y .from the risk std deviation Z and Rx point of
view it is not an efficient portfolio.
 “X is a denominated portfolio.
“Y” and “Z” is a dominant portfolio.

When the outer points of an efficient portfolio are jointed a

shell is formed or a broken egg is formed. the shape depends upon degree of
correlation among securities, therefore the shell is called attainable set,
feasible set, it is so called because all the available investment opportunities in
the market like either on the border or with in the border.

CONCEPT OF EFFICIENT PORTFOLIO:

Assume that X is selected it is in –efficient portfolio because

1. If he is prepare to take a risk of STD deviation for the same risk “Y”. gives
in the higher rate of Ry . Therefore “Y” is a dominant portfolio and “X” is a
dominated portfolio.

2.if a investor is satisfied with the return of Rx , the same return can be earn
by choosing portfolio “Z” which has a similar risk of std deviation x (As
against larger risk std deviation x)

The dominants principle states that among all the investment

opportunities available with a given return, the investment with the least risk
is the most desirable one or among the investment in a given risk class, the
one with the highest return with the most desirable one. Risk principle is also
called Efficient set theorem.
In the light of this segment A, B is the relevant portion of the feasible set it is
called the Markowitz efficient frontier. It is so called because all efficient
portfolios lie on this frontier.

An efficient portfolio is one, that gives the highest return for

given return or a minimum risk for a given return, these efficient portfolios are
also refer as means variance efficient portfolios. The shape of the efficient
frontier is given by Delta RP /Delta STD deviation p.
 MODIFICATION TO THE EFFICIENT FRONTIER:

Two modifications to the efficient frontier must be discussed: what happens

when short selling is added, and what happens when leveraged portfolios are
added?

A. Short selling: the ability to short sell has two effects on the efficient
frontier. The frontier probably shifts up and to the left and it continuous to the
right. The ability to short sell securities created a new set of possible
investments. A security sold short produces a positive return when a security
has a large decrease in price and a negative return when its price increases. Its
potential improves the efficient frontier.

Because the ability to short sell doubles the number of possible investments.
Since investors are free not short sell, the introduction of the ability to short
sell cannot make investors worse off. If it never pays to short sell, the worst
that can happen is that the efficient frontier is unchanged. With out short sales,
all investors can do is not to hold securities that they believe do poorly.

With short sales, an opportunity is created that is expected to have

almost the opposite characteristics of the investment when purchased. With
short sales it is possible, in a sense to disinvest in poor investments and hence
gain poorly. If it ever pays to short sell any security, the efficient frontier is
shifted up and to the left. This is an example of the old economic adage that a
decision maker can not be worse o by being given additional choices and the
decision maker may well be better off. In addition short sales allow the
investor to decrease or eliminate market risk in a large well diversified
portfolio, unique risk is eliminated and only market risk remains. Short sales
allow the reduction of market risk to very low levels. Thus the additional of
short positions operates as a hedging mechanism, reducing the market
exposure of a portfolio.

The extension of the efficient frontier to the right arises from the
tendency of a very large amount of short selling to increase the risk and return
on the portfolio. This increase in risk is easy to understand. Short sales can
involve unlimited loss. The lesson to be learned from this is that short sales
can increase the possible level of return for any level of risk. Short sales can
be abused and positions taken that are too extreme. However short selling per
sec is not bad. Like any other investment strategy, it can be used prudently or
imprudently.
 B.LEVERAGED PORTFOLIO:

Markowitz model, which recognized the existence of both

systematic and unsystematic risk, did not allow for borrowing and lending
opportunities. The investor is assumed to have a certain amount of initial
wealth to invest for a given holding period. Off all the periods that are
available, the optimal one is shown to correspond to the point where one of
the investor’s indifference curves in tangent to the efficient set.

At the end of the holding period, the investor’s initial wealth will have
either increased or decreased, depending on the portfolio’s rate of return.
Again in the markowitz ‘s approach , it is assumed that the assets being
considered for investment are individually risky, that is each one of the N
risky assets has an uncertain return over the investor’s holding period. Since
none of the asset has a perfectly negitive correlation with any other asset, all
the portfolios also have uncertain returns over the investor is not allowed to
use borrowed money. A long with his or her initial wealth, to purchase a
portfolio of assets. This means that the investor is not allowed to use financial
leverage.

To expand the Markowitz approach investor can consider risk free assets
and financial leverage by first investing in not only risky assets but also in risk
free assets, and second by borrowing money at a given rate of interest.

1. RISK FREE ASSET:

Investment in risk free asset is often referred to as risk free lending. Since this
approach involves investing for a single holding period, it means that the
return of the risk free asset is certain. That is, if the investor purchases this
asset at the beginning of the holding period, then the investor knows exactly
what the value of the asset will be at the end of the holding project. Since
there is no uncertainty about the terminal value of the risk free asset, the
standard deviation of the risk free assets, by definition, zero. In turn, this
means that the covariance between the rate of return on the risk free asset and
the rate of return on any risky asset is zero.
2. INVESTMENT IN BOTH THE RISK FREE ASSETS AND A RISKY
ASSTS:

The efficient frontier would be altered substantially if a risk frees

securities is included among available investment opportunities. While a risk
free security does not exist in the strict sense of the word, there are securities,
which promise return with relative certainty. They are characterized by an
absence of default risk and return rate; full payment of principle is assured with
out serious prospect of capital loss arising from changes in the level of interest
rates. A risk free security of this type includes cash, short-term treasury bills,
and time deposits in banks or savings and loan association; cash would be
dominated by the other positive return investments.

Given the opportunity to either borrow or lend at the risk free rate, an
investor proceed to identify the optimal portfolio by plotting his or her
indifference curves on graph and nothing where once of them is tangent to the
indifference efficient set.

For example portfolio, has an expected return of 11% and a standard

deviation of 12.5%. However, portfolio is not efficient, since portfolio B has the
same expected return but a standard deviation of only 8%. Portfolio but not
efficient, l since portfolio f has a still higher return with the same degree of risk
as e and h. Portfolio A is a single equity portfolio that has the highest return
and risk; in no way can investor improve on its return-to-risk ratio. If investor
moves to the right on the curve, return decreases and risk decreased. Hence
investor moves to the left and down. The only way the investor can obtain a
higher return on the efficient frontier is to accept a higher return on the efficient
frontier is to accept a higher amount of risk.

Where investors operate on the capital market line depends on their

attitudes towards risk and return. Investors must determine their own preference
for risk and return by way of a difference cure. In theory, the investor will
invest the combination of securities found at the point where the highest
indifference curve just touches the capital market line. Investors might have
higher return and lower risk goals, but they can obtain those combinations only
on the capital market line, and will invest at some point that gives the
combination of returns and risk that allows them to maximize net worth and
make a satisfactory investment

. To be realistic, assume that the investor’s borrowing rate is above

the lending rate. Combination of lending or borrowing with a portfolio of risky
assets lies along a straight lines, with lending and borrowing the efficient
frontier. Noticed that for all investors, expect for those whose risk-return trade-
offs causes they to hold portfolios, the ability to lend and borrow improve their
opportunities. The ability to lend is hardly controversial. The borrowing part
may be more controversial. Borrowing and buying a less risky portfolio can
give higher returns and less risk and buying a more risky portfolio.

Higher expected return at the same risk level by borrowing. Of

course, borrowing like short sales, almost any financial mechanism can be
abused. It can be used to take extreme and imprudent risk position. On the other
hand, it can be used to enhance performance. Rejecting borrowing entirely
would throw out positive opportunities. For example, consider an investor
wishing to have a high portfolio with greater expected returns than offered by
portfolio B. this investor would have the same expected return and less risk by
buying port folio B and borrowing than by buying portfolio, which does not
involve borrowing.

Returning to the concept of the efficient frontier, it is necessary

to deal further into the subject of prudent investment. In an efficient frontier, an
investor should never hold a security or portfolio that lie below that frontier.
Because all single securities expect the risk less asset lie below the frontier,
there is almost never a situation where a single security is efficient. All efficient
portfolios are will diversified.

CAPITAL ASSET PRICING MODEL(CAPM)

The relevant risk for an individual asset is a systematic risk (or market –market
risk) because non market risk can be eliminated by diversification, the
relationship between an asset’s return and its systematic risk can be expressed
by the CAPM, which is also called the security market (SML). The equation for
the CAPM is as follows:
 E(ri)=R+[E(rm)-R]bi

Where E (ri) is the expected return for an asset,

R is the risk-free rate (usually assumed to be a short-term T-bill rate)
E (rm)equals the expectecmarket return (usually assumed to be the S&P500)
Bi denotes for the asset’s beta.

The CAPM is an equilibrium model for measuring the risk-return tradeoff for
all asset s including both inefficient and efficient portfolios. A graph of the
CAPM is given below:

Figure representing : RISK EXPOSURE OF PORTFOLIO

FINDINGS:

Depicts two assets, U and O that are not in equilibrium on the CAPM. Asset
U is undervalued and therefore , avary desirable asset to own. U”s price will
rise in the market as more investors purchase it. However as U’s price goes
up,its return falls. When U’s return falls to the return consistent with the beta on
the SML, equilibrium is attained. With O,just the opposite takes place.investor
will attempt to sell O,since it is overvalued and therefore, put down pressure on
O’s price. When the return on asset O increases to the rate that is coinsistent
with the beta risk level given by the SML, equilibrium will be achieved and
down ward price pressure will cease.
Assumptions underlying CAPM
 The Capital Asset Pricing Model {CAPM} is an equilibrium
model. The derivation of the model is based on several assumptions about
investors and the market, whichwe present below for completeness. Investors
are assumed to take in to account only two parameters of return distribution,
namely the mean and the varience , in making a choice of portfolio . in other
words, it is assumed that a secutity can be completely represented in terms of its
expected return and varience and those investors behave as if a security were a
commodity with two attributes,namely , expected return which is a desirable
attribute and varience, which is an undesirable attribute. Investors are supposed
to be risk averse and for every additional unit of risk they take, they demand
compensation in terms of expected returns.

Again the capital market is assumed to be efficient. An efficient

market implies that all new information which could possibly affect the share
price becomes available to all the investors quickly and more or less
simultaneously. Thus in an efficient market no single investor has an edge over
another it terms of the information possessed by him since all investor are
supposedly well informed and rational,meaning that all of them process the
available information more or less alilke. And finally in an efficient market, all
investors are price takers, i.e., no investor are so big as to affect the price of
security significantly by virtue of his trading in that security

The Capital Asset Pricing Model also assumes that the difference
between lending and borrowing rates are negligibly small for investors. Also,
the investors are assumed to make a single period investment decisions. The
cost of transactions and information are assumed to be negligibly small. The
model also ignores the existence of taxes, which may influence the investor’s
behavior.

The fact that some of the above assumptions are some what
restrictive has attracted considerable criticism of the model. This however need
not distract us from main thrust of the model. The Capital Asset Pricing Model
merely implies that in a reasonably well-functioning market where a large
number of knowledgeable financial analysts operate, all securities will yield
returns consistence with their risk, since if this were not is, the knowledgeable
analysts will be able to take advantage of the opportunities for disproportionate
returns and there by reduce such opportunities.

Hence, according to CAPM, in an efficient market, returns

disproportionate to risk are difficult to come by. assumptions concerning the
investor behavior, market efficiency, lending and borrowing rates, etc., are to be
taken not in their literal sense, but rather as approximate conditions. Factors
such as taxes, transaction cost, etc, can be easily incorporated in to the model
for greater rigor.

The security market line (SML) express the basic theme of the CAPM
i.e.., expected return of a security increases linearly with risk, as measured by
Beta. It can be drawn as follows.

The SML is upward sloping straight line with an intercept at the risk free
return securities and passes through the market portfolio. The upward slope of
the line indicates that greater expected return accompany higher level of Beta.
In equilibrium, each security or portfolio lies on the SML.

In the above figure that the return expected from portfolio or

investment is a
Combination of risk free return plus risk premium. An investor will come
forward to take risk only if the return on investment also includes risk premium.
The CAPM has shown the risk and return relationship of a portfolio in the
following formula.

E (Ri) =Rr +ßi-(Rm-Rr)

Where
E (Ri) = expected rate of return on any individual security (or portfolio of
security)

Rr =Risk free rate of return

Rm =expected rate of return on the market portfolio.

ßi =market sensitivity index of individual security (or portfolio of securities)

Advantage PMS

 Customised Portfolio

 Transparency

 Benefit from tactical cash management

 High level of client interaction

 Cost efficient

 Hassle free operation

 Diversification across or within the asset class

 SEBI regulated
Mutual Fund Vs PMS

Mutual Fund
PMS
Mass Customized
Personalized
Product
product product
services in the
form of access to
Services No personalized
service available fund manager and
dedicated
Entry/Exit relationship
No entry / Exit
Costs manger
loads loads
Option of fixed / performance based
Fee structure Fixed fees

Portfolio
No As per risk/reward appetite of the
investor
Profiling
Sector / Stock
Yes No
limits
Updates Monthly Daily
Cross
Yes No
subsidization
Transparency No Yes
 Investment Philosophy

 Stock specific selection procedure based on fundamental

research for making sound investment decisions.

 Focus on minimizing investment risk by following

rigorous valuation disciplines.

 Effort is to enhance absolute returns for investors.

 Belief in serving investors by a disciplined investment

approach – which combines an understanding of the
goals and objectives of the investor with a fine tuned
strategy backed by research.
Investment Process
 Reviewing publicly available historical information.

 Management meetings to get a better understanding of industry

trends, structure and peculiarities related to the industry.

 Preparing forecasted earnings model based on assumptions.

 Review meeting with the company management to validate the

assumptions.

 Accessing the competitive advantage the company enjoys vis-à-vis

buyers, suppliers, substitutes, barriers to entry.

 Evaluate management capabilities and corporate governance

standards.

 Using multiple valuation process for valuing the company which

includes relative valuations (P/E,PEG, P/BV etc.), determining intrinsic
value based on DCF and sum of parts valuation.

 Arranging periodic review meeting with the management to

revalidate the underlying assumptions.

 We follow strict selling discipline both in booking profits as well as

cutting losses in case the underlying premise of buying into a
particular stock has changed.