1.

In Portfolio construction three issues are addressed – selectivity, timing

and diversification. Explain

Ans.

Portfolio Construction

This step identifies those specific assets in which to invest, as well as determining the
proportion of the investor’s wealth to put into each one. Here selectivity, timing and
diversification issues are addressed.

Selectivity refer to security analysis and focuses on price movements of individual

securities.

Timing involves forecasting of price movement of stocks relative to price movements

of fixed income securities (such as bonds).

Diversification aims at constructing a portfolio in such a way that the investor’s risk
is minimized.

Assets Allocation Security Selection

Active investor Market timing Stock picking

Passive Investor Maintain Pre- Try to track a well-known

determined selections market index like Nifty, Sensex
 2. Briefly explain money market instrument bringing in the latest updates.

Ans.

The important money market instruments are:

Treasury bill:

These are short terms obligations issued by the government at present, the
Government of India issues 4 types of T-Bills i.e., 14 days, 91 days, 182 day and 364
days. The T-Bills are issued for minimum amount of Rs. 25,000/- and in multiple of
Rs. 25,000/-, T-Bills are issued at a discount and redeemed at par.

Call Money:

These are short term funds transferred between financial institutions usually for no
more than one day. The call money market is a part of the money market where, day
to day surplus funds, mostly of banks are traded. The maturity period of call loans
vary from 1 to 14 days. The money that is lent for one day in call money market is
also known as “overnight money” in India. Call money lent mainly to even out the
short term mismatches of assets and liabilities and to meet CRR requirement of banks.

Repurchase Agreements:

It is an agreement, which involves a sale of a security with an undertaking to buy-

back the same security at a pre-determined price and at a future date.

A party sells Treasury securities, but agrees to buy them back at a certain date
(usually 3-14 days later) for a certain price. The transaction is called repo from the
point of the seller of the security whereas the same is viewed as revere repo from the
point of the buyer of the security.

Negotiable Certificates of Deposit (CD):

These are bank-issued time deposit that specifies an interest rate and maturity date,
and is negotiable. CDs are issued at a discount to face value. The discount rate is
freely determined by the issuing bank considering the prevailing call money rates.
Treasury bills rate, maturity of the CDE and its relation with the customer, etc. the
minimum size for the issue of CDs is Rs. 5 Lakh (face value) an thereafter in
multiples of Rs. 1 lakh.

Commercial Paper (CP):

These paper short-term unsecured promissory notes issued by a company to raise

short-term cash. They mature in no more than 270 days. Only the largest and
creditworthy companies issue this commercial paper. CPs as source of short-term
finance is used by companies as a alternative to bank finance for working capital.
Generally, companies prefer to raise funds though this route when the interest rate on
working capital charges by banks is higher than the rate at which funds can be raised
through CP.

Banker’s Acceptances:

These are time draft payable to a seller of goods, with payment guaranteed by a bank.
Banker’s acceptance is essentially a post-dated check on which a bank has guaranteed
payment. These are commonly used to finance international trade transactions.

3. Explain the misconception about EMH.

Ans.

There are three classic misconceptions:

Any share portfolio will perform as well as or better than a special trading rule
designed to outperform the market:

A monkey choosing a portfolio of shares for a “buy and hold” strategy is nearly, but
not exactly, what the EMH suggests as a strategy that is likely to be as rewarding as
any trading rule proposed to exploit inefficiencies in the market. The portfolio
required by EMH for investing must be a fully diversified one. A monkey does not
have the financial expertise that is required to construct a board-based portfolio.
Therefore, it is wrong to conclude from efficient market hypothesis that it does not
matter what the investor does, and portfolio as acceptable.

Market efficiency does not mean that it does not make a difference how you invest,
since the risk/return trade-off applies at all times. What it means is that you cannot
expect to consistently “beat the market” on a risk-adjusted basis, using costless
trading strategies.

There should be fewer price fluctuations:

The constant fluctuations of market prices can be viewed as an indication that markets
are efficient. New information that affects the value of securities arrives constantly.
This causes continuous adjustment of prices to the information updates. In fact, if we
observe that prices do not change then it will be inconsistent with market efficiency,
since we know that relevant information is arriving almost continuously.

EMH presumes that all investors have to be informed, skilled, and able to constantly
analysis the flow of new information. Still the majority of common investors are not
trained financial experts. Therefore market efficiency cannot be achieved:

This too is wrong. Not all investors have to be informed. In fact, market efficiency
can be achieved even if only a relatively small core of informed and skilled investors.
Trade in the market. It only needs a few trades by informed using all the publicly
available information to drive the share price to its semi-strong-form efficient price.