MF0010 Q.2 From the website of BSE India, explain how the BSE Sensex is calculated.

Answer: SENSEX: Sensex is the stock market index for BSE. It was first compiled in 1986. It is made of 30 stocks representing a sample of large, liquid and representative companies. The base year of SENSEX is 1978-79 and the base value is 100. The Bombay Stock Exchange SENSEX (acronym of Sensitive Index) more commonly referred to as SENSEX or BSE 30 is a free-float market capitalization-weighted index of 30 well-established and financially sound companies listed on Bombay Stock Exchange. The 30 component companies which are some of the largest and most actively traded stocks, are representative of various industrial sectors of the Indian economy. Published since January 1, 1986, the SENSEX is regarded as the pulse of the domestic stock markets in India. The base value of the SENSEX is taken as 100 on April 1, 1979, and its base year as 1978-79. On 25 July, 2001 BSE launched DOLLEX-30, a dollar-linked version of SENSEX. As of 21 April 2011, the market capitalisation of SENSEX was about 29,733 billion (US$660 billion) (42.34% of market capitalization of BSE), while its freefloat market capitalization was 15,690 billion (US$348 billion). The Bombay Stock Exchange (BSE) regularly reviews and modifies its composition to be sure it reflects current market conditions. The index is calculated based on a free float capitalization methoda variation of the market capitalisation method. Instead of using a companys outstanding shares it uses its float, or shares that are readily available for trading. The free-float method, therefore, does not include restricted stocks, such as those held by promoters, government and strategic investors. Initially, the index was calculated based on the full market capitalization method. However this was shifted to the free float method with effect from September 1, 2003. Globally, the free float market capitalization is regarded as the industry best practice. As per free float capitalization methodology, the level of index at any point of time reflects the free float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is multiplied by a free float factor to determine the free float market capitalization. Free float factor is also referred as adjustment factor. Free float factor represent the percentage of shares that are readily available for trading. The calculation of SENSEX involves dividing the free float market capitalization of 30 companies in the index by a number called index divisor.The divisor is the only link to original base period value of the SENSEX. It keeps the index comparable over time and is the adjustment point for all index adjustments arising out of corporate actions, replacement of scrips, etc. The index has increased by over ten times from June 1990 to the present. Using information from April 1979 onwards, the long-run rate of return on the BSE SENSEX works out to be 18.6% per annum, which translates to roughly 9% per annum after compensating for inflation. Following is the list of the component companies of SENSEX as on Feb 26, 2010. Code Name Sector Adj. Factor Weight in Index(%) 500410 ACC Housing Related 0.55 0.77 500103 BHEL Capital Goods 0.35 3.26 532454 Bharti Airtel Telecom 0.35 3 532868 DLF Universal Limited Housing related 0.25 1.02 500300 Grasim Industries Diversified 0.75 1.5 500010 HDFC Finance 0.90 5.21 500180 HDFC Bank Finance 0.85 5.03 500182 Hero Honda Motors Ltd. Transport Equipments 0.50 1.43 500440 Hindalco Industries Ltd. Metal,Metal Products & Mining 0.7 1.75 500696 Hindustan Lever Limited FMCG 0.50 2.08 532174 ICICI Bank Finance 1.00 7.86 500209 Infosys Information Technology 0.85 10.26 500875 ITC Limited FMCG 0.70 4.99

532532 Jaiprakash Associates Housing Related 0.55 1.25 500510 Larsen & Toubro Capital Goods 0.90 6.85 500520 Mahindra & Mahindra Limited Transport Equipments 0.75 1.71 532500 Maruti Suzuki Transport Equipments 0.50 1.71 532541? NIIT Technologies Information Technology 0.15 2.03 532555 NTPC Power 0.15 2.03 500304? NIIT Information Technology 0.15 2.03 500312 ONGC Oil & Gas 0.20 3.87 532712 Reliance Communications Telecom 0.35 0.92 500325 Reliance Industries Oil & Gas 0.50 12.94 500390 Reliance Infrastructure Power 0.65 1.19 500112 State Bank of India Finance 0.45 4.57 500900 Sterlite Industries Metal, Metal Products, and Mining 0.45 2.39 524715 Sun Pharmaceutical Industries Healthcare 0.40 1.03 532540 Tata Consultancy Services Information Technology 0.25 3.61 500570 Tata Motors Transport Equipments 0.55 1.66 500400 Tata Power Power 0.70 1.63 500470 Tata Steel Metal, Metal Products & Mining 0.70 2.88 507685 Wipro Information Technology 0.20 1.61

MF0010 Q.1 Frame the investment process for a person of your age group. Answer: It is rare to find investors investing their entire savings in a single security. Instead, they tend to invest in a group of securities. Such a group of securities is called a portfolio. Most financial experts stress that in order to minimize risk; an investor should hold a well-balanced investment portfolio. The investment process describes how an investor must go about making. Decisions with regard to what securities to invest in while constructing a portfolio, how extensive the investment should be, and when the investment should be made. This is a procedure involving the following five steps: Set investment policy Perform security analysis Construct a portfolio Revise the portfolio Evaluate the performance of portfolio 1. Setting Investment Policy This initial step determines the investors objectives and the amount of his investable wealth. Since there is a positive relationship between risk and return, the investment objectives should be stated in terms of both risk and return. This step concludes with the asset allocation decision: identification of the potential categories of financial assets for consideration in the portfolio that the investor is going to construct. Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds and cash. The asset allocation that works best for an investor at any given point in his life depends largely on his time horizon and his ability to tolerate risk. Time Horizon The time horizon is the expected number of months, years, or decades that an investor will be investing his money to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable with a riskier or more volatile investment because he can ride out the slow economic cycles and the inevitable ups and downs of the markets. By contrast, an investor who is saving for his teen-aged daughters college education would be less likely to take a large risk because he has a shorter time horizon. Risk Tolerance Risk tolerance is an investors ability and willingness to lose some or all of his original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favour investments that will preserve his or her original investment. The conservative investors keep a bird in the hand, while aggressive investors seek two in the bush. While setting the investment policy, the investor also selects the portfolio management style (active vs. passive management). Active Management is the process of managing investment portfolios by attempting to time the market and/or select undervalued? stocks to buy and overvalued? stocks to sell, based upon research, investigation and analysis. Passive Management is the process of managing investment portfolios by trying to match the performance of an index (such as a stock market index) or asset class of securities as closely as possible, by holding all or a representative sample of the securities in the index or asset class. This portfolio management style does not use market timing or stock selection strategies. 2. Performing Security Analysis This step is the security selection decision: Within each asset type, identified in the asset allocation decision, how does an investor select which securities to purchase. Security analysis involves examining a number of

individual securities within the broad categories of financial assets identified in the previous step. One purpose of this exercise is to identify those securities that currently appear to be mispriced. Security analysis is done either using Fundamental or Technical analysis (both have been discussed in subsequent units). Fundamental analysis is a method used to evaluate the worth of a security by studying the financial data of the issuer. It scrutinizes the issuers income and expenses, assets and liabilities, management, and position in its industry. In other words, it focuses on the basics? of the business. Technical analysis is a method used to evaluate the worth of a security by studying market statistics. Unlike fundamental analysis, technical analysis disregards an issuers financial statements. Instead, it relies upon market trends to ascertain investor sentiment to predict how a security will perform. 3. Portfolio Construction This step identifies those specific assets in which to invest, as well as determining the proportion of the investors wealth to put into each one. Here selectivity, timing and diversification issues are addressed. Selectivity refers 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 investors risk is minimized. The following table summarizes how the portfolio is constructed for an active and a passive investor. 4. Portfolio Revision This step is the repetition of the three previous steps, as objectives might change and previously held portfolio might not be the optimal one. 5. Portfolio performance evaluation This step involves determining periodically how the portfolio has performed over some time period (returns earned vs. risks incurred).

MF 0010 Security Analysis and Portfolio Management Set- 1

Q.1 Frame the investment process for a person of your age group. Ans. As investors, we would all like to beat the market handily, and we would all like to pick "great" investments on instinct. However, while intuition is undoubtedly a part of the process of investing, it is just part of the process. As investors, it is not surprising that we focus so much of our energy and efforts on investment philosophies and strategies, and so little on the investment process. It is far more interesting to read about how Peter Lynch picks stocks and what makes Warren Buffett a valuable investor, than it is to talk about the steps involved in creating a portfolio or in executing trades. Though it does not get sufficient attention, understanding the investment process is critical for every investor for several reasons: 1.The investment process outlines the steps in creating a portfolio, and emphasizes the sequence of actions involved from understanding the investors risk preferences to asset allocation and selection to performance evaluation. By emphasizing the sequence, it provides for an orderly way in which an investor can create his or her own portfolio or a portfolio for someone else. 1.The investment process provides a structure that allows investors to see the source of different investment strategies and philosophies. By so doing, it allows investors to take the hundreds of strategies that they see described in the common press and in investment newsletters and to trace them to their common roots. 1.The investment process emphasizes the different components that are needed for an investment strategy to by successful, and by so doing explain why so many strategies that look good on paper never work for those who use them. The best way of describing this book is by noting what it does not do. It does not emphasize individual investors or push an investment philosophy. It does not focus heavily on coming up with strategies that beat the market, though there is reference to some of them in the course of the book. Instead, it talks about the process of investing and how this process is the same no matter what investment philosophy one might have. The book is built around the investment process. The process always starts with the investor and understanding his or her needs and preferences. For a portfolio manager, the investor is a client, and the first and often most significant part of the investment process is understanding the clients needs, the clients tax status and most importantly, his or her risk preferences. For an individual investor constructing his or her own portfolio, this may seem simpler, but understanding ones own needs and preferences is just as important a first step as it is for the portfolio manager. The next part of the process is the actual construction of the portfolio, which we divide into three sub-parts. The first of these is the decision on how to allocate the portfolio across different asset classes defined broadly as equities, fixed income securities and real assets (such as real estate, commodities and other assets). This asset allocation decision can also be framed in terms of investments in domestic assets versus foreign assets, and the factors driving this decision. The second component is the asset selection decision, where individual assets are picked within each asset class to make up the portfolio. In practical terms, this is the step where the stocks that make up the equity component, the bonds that make up the fixed income component and the real assets that make

up the real asset component are picked. The final component is execution, where the portfolio is actually put together, where investors have to trade off transactions cost against transactions speed. While the importance of execution will vary across investment strategies, there are many investors who have failed at this stage in the process. The final part of the process, and often the most painful one for professional money managers, is the performance evaluation. Investing is after all focused on one objective and one objective alone, which is to make the most money you can, given the risk constraints you operate under. Investors are not forgiving of failure and unwilling to accept even the best of excuses, and loyalty to money managers is not a commonly found trait. By the same token, performance evaluation is just as important to the individual investor who constructs his or her own portfolio, since the feedback from it should largely determine how that investor approaches investing in the future. These parts of the process are summarized in Figure 1, and we will return to this figure to emphasize the steps in the process as we move through the book. The book is built around the same structure. It begins with a chapter that provides an overview of investment management as a business. The first major section is on understanding client needs and preferences, where we look at not only how to think about risk in investing but also at how to measure an investors willingness to take risk. The second section looks at the asset allocation decision, while the third section examines different approaches to selecting assets. The fourth section takes a brief look at the execution decision, and the fifth section develops different approaches to evaluating performance. Q.2 From the website of BSE India, explain how the BSE Sensex is calculated. Ans . Introduction SENSEX, first compiled in 1986, was calculated on a "Market CapitalizationWeighted" methodology of 30 component stocks representing large, wellestablished and financially sound companies across key sectors. The base year of SENSEX was taken as 1978-79. SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally accepted construction and review methodology. Since September 1, 2003, SENSEX is being calculated on a freefloat market capitalization methodology. The "free-float market capita

investors risk preferences to asset allocation and selection to performance

evaluation. By emphasizing the sequence, it provides for an orderly way in which an investor can create his or her own portfolio or a portfolio for