Scdl - Pgdba - Finance - Sem 4 - Sa & Pm

Security Analysis & Portfolio Management Semester IV

Q.1. Explain the various investment avenues available for an investor in India? Ans.1 Investment: When you deposit a part of your savings in a fixed deposit account in a bank or apart of your salary in your provident fund account, you are making an investment. As you can see in the above examples, you are sacrificing current consumption or use for receiving benefits in the future. This can be depicted in a pictorial form as follows: B

X(1+r) C (x-y) (1+r)

A O X If the rate of return you receive on your investment is r per annum and you have Rs. X with you today, you have several alternatives. You can either spend all the money in the current period (represented by point A) or invest the entire amount for using it after one year (represented by point B). in the second case you will have an amount x(1+r) for consumption after one year where x.r. represents the return on your investment for one year. You can also have several other combinations of present and future consumption e.g. point C represented by a present consumption of Y and (x-y) (1+r) available for next year. The important characteristics of an investment are: Long term Horizon, Limited risk, Return commensurate with risk, Modest return, Careful evaluation. Investment Alternatives: The avenues can be broadly classified into Financial Assets and Real Assets. Real Assets may be in the form of Real Estate, Gold and Silver and precious objects. Art objects like paintings and sculptures are also avenues in this category. Financial Assets can be further classified into marketable Financial Assets and Non-Marketable Financial Assets. Investment

Financial Assets

Non-Marketable Financial Assets

Real Assets

Marketable Financial Assets

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Security Analysis & Portfolio Management Semester IV

Some examples of non-marketable financial assets are bank deposits, post office deposits and provident fund deposits. Marketable financial assets may be in the form of Equity Shares, Bond and money market instruments. Investing in Mutual funds enable you participate in the equity market indirectly. Mutual funds pool the investments from a number of retail investors and invest in equity shares are fixed income securities. Life Insurance Policies, though primarily sere the purpose of insuring an individual’s life, can also be used as an investment avenue. Life Insurance Companies offer different types of schemes like Money Back Policy, Endowment Policy, Children Educational Policy. Brief discussion on Investment Avenues:(A) Non-marketable financial Assets: The important non-marketable financial assets held by investors are: • Bank Deposits: These are convenient and very popular with investors. The interest rates on bank deposits have fallen over the years. At present the rates are around 6% for periods more than one year. The Deposit Insurance and Credit Guarantee Corporation (DICGC) provides a guarantee on deposits up to Rs.1,00,000 per depositor of a bank. Interest earned on bank deposits qualify for section 80L benefits up to a limit of Rs. 12,000 for a financial year. Many banks now offer the facility of transferring the balances above a specified limit in the savings account to the fixed deposit account. Banks also offer cheque facility for fixed deposit accounts making it convenient to withdraw money from fixed deposits when there is a need. • Post office monthly Income scheme: Post office monthly income scheme ( Post Office MIS) has a six year tenure and the rate of return is 8% payable monthly. In addition, the investor also gets a bonus of 10% of principal at the completion of the term. Interest earned qualifies for the benefit under section 80L. investors could either collect the monthly interest or transfer it to a saving or recurring account in the same post office. • Public Provident Fund (PPF): Public Provident Fund (PPF) is a good retirement planning instrument as well as a good tax saving vehicle. It is a 15 year instrument and carries an interest rate of 8%. The interest rates can be reset at a lower rate depending on the prevailing interest rates in the market. The principal along with the interest earned is payable at the end of the term. A minimum contribution of Rs. 500 is to be made every year. From the seventh year onwards, partial withdrawal facility is available. Loans can be taken from the third year onwards. After completion of the 15 year term, the tenure can be extended in blocks of five years. • National Saving Certificate: National Saving Certificate (NSC) has a tenure of six years and the amount paid on maturity includes the principal amount invested and the interest earned over the years. The interest earned qualifies for tax benefit under section 80L up to an overall limit of Rs. 12,000. The unique feature of this instrument is that the interest accrued each year up to the end of the fifth year is deemed to be reinvested in the scheme. • Company Fixed Deposits: The terms of company fixed deposits varies and normally for one, two or three years. The interest rates on these deposits are higher than that of bank fixed deposits but it carries a higher risk. For interest income up to Rs. 5,000 in a financial year, no income tax is deducted at source. There is no benefit under section

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Security Analysis & Portfolio Management Semester IV

80L for interest earned. Credit rating agencies assign ratings for these and the interest rates offered vary based on the rating.

•

Kisan Vikas Patra: The investment in this instrument doubles on completion of the term. At present the term us eight years and seven months which translates into a compounded annual return of 8.4%. There are no tax benefits available on the amount invested as well as interest earned.

(B) Money Market Instruments: Debt instruments which have a maturity of less than one year at the time of issue are called Money Market Instruments. These instruments are highly liquid and have negligible risk. The government, financial institutions, banks and corporates dominate the money market. Individual investors do not participate in the money market directly. • Treasury bills: These are the most important money market instruments. They represent the obligations of the government of India, which have a primary tenor like 91 days and 364 days. Reserve Bank of India sells these on an auction basis. They are sold at a discount and redeemed at par. These bills can be transacted readily and there is a very active secondary market for them. • Certificates of Deposits: These are short-term deposits, which are transferable from one party to another. Banks and financial institutions are the major issuers of CDs. CDs are issued in either bearer or registered form. They generally have a maturity of 3 months to 1 year. CDs are issued at a discount and redeemed at par. They are popular form of shortterm investment for companies due to the flexibility in terms of denominations and maturities and the risk free nature of these investments. Also they offer a higher rate of interest than Treasury Bills or term deposits. • Commercial Paper: These represents short-term unsecured promissory note issued by firms that are generally considered to be financially strong. A commercial paper usually has a maturity period of 90 to 180 days. It is sold at a discount and redeemed at par. • Repos: The term Repo is used as an abbreviation for repurchase agreement or ready forward. A Repo involves a simultaneous ‘ sale and repurchase’ agreement. Repos are a very convenient instrument for short-term investment. They are safe and earn a predetermined return. • Government Securities: Debt securities issued by the central government, state government and quasi government agencies are referred to as government securities or gilt edged securities. Banks, financial institutions, insurance companies and provident funds mainly because of certain statutory compulsions typically hold these. • Government of India Bonds: These bonds particularly the 6.5% tax free bonds are popular with high networth individuals. The 6.5% tax free bonds which can be redeemed after five years, offer liquidity to investors as there is a provision for premature encashment after three years. These bonds cannot be transferred except by way of gilft and are not tradable in the secondary market. The 8% taxable savings bonds are not liquid as these can be redeemed only after six years. • Private Sector Debentures: These are instruments used for raising long term debt. The obligation of the company towards its debenture holders is to pay interest and principal at specified periods. When a debenture is sold to the investing public, a trustee (usually a bank or a financial institution) is appointed through a deed. They are responsible for ensuring that the borrowing firm fulfills its contractual obligations. Typically, debentures are secured by a charge on the immovable properties, both present and future, of the company by way of an equitable mortgage. Debenture issues with a maturity period of more than 18 months have to be credit rated and a debenture redemption reserve has to be created for a

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•

•

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value equivalent to atleast 50percent of the amount of issue before redemption commences. Public Sector Undertaking Bonds (PSU): PSU Bonds are issued by public sector undertakings in two varieties : taxable bonds and tax-free bonds. They generally have the following features : (i) there is no deduction of tax at source on the interest paid on these bonds (ii) they are transferable by endorsement and delivery, (iii) there is no stamp duty applicable on transfer, and (iv) they are traded on the stock exchanges. Preference Shares: These represent a hybrid form of security that has some characteristics of equity shares and some characteristics of debentures. The salient features of preference shares are : (a) they carry a fixed rate of dividend. (b) Preference dividend is payable only out of distributable profits. (c) Preference dividend is generally cumulative. (d) Preference shares are redeemable and the redemption period is usually 7 to 12 years. Equity Shares : Investment in equity shares provides investors the possibility of higher returns at a greater risk. The potential rewards and penalties associated with equity shares make them an interesting and exciting propositions. Mutual Funds: Mutual Funds is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document. Investments in securities are spread across a wide cross section of industries and sectors and thus the risk is reduced. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unit holders.

Q.6 What are the different types of ratios you would use while analyzing the financial statements of a company? Give examples of each of these types. Ans.6 Financial ratio analysis is one of the important tools used for analyzing financial statements. Based on the specific characteristics, ratio are categorized into: a. Liquidity Ratios b. Leverage Ratios c. Turnover Ratios d. Profitability Ratios e. Valuation Ratios

a. Liquidity Ratios: Liquidity Ratios tell us about the ability of a firm to meet its short term financial obligations. These ratios are based on the relationship between current assets which provide the sources for meeting the short term obligations and current liabilities which are obligations to be met within one year. Current Ratio: Current ratio is defined as the ration between current assets and current Liabilities. For example: Current Asset (assumed) = 299 Current Libility (assumed) = 102 Current ratio = Current Asset/ Current liability

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Security Analysis & Portfolio Management Semester IV

Current Ratio = 299/102= 2.93 A higher value of current ratio indicates a better short term solvency of the firm. In additon, a firm that has a higher proportion of cash and receivables compared to inventories is better in terms of short term liquidity.

Acid Test Ratio: = Quick Assets/Current Liabilities. Quick assets are that part of the current assets which are highly liquid. These consist of current assets less inventories. It is more stringent measure of liquidity compared to the current ratio.

b. Leverage Ratio: A firm uses a combination of equity and debt for financing its assets. Debt is a riskier source of finance as it entails a fixed outgo of periodic interest payments and loan repayments. Leverage ratios help us in assessing the risk arising from the use of debt capital. Debt Equity Ratio, Interest coverage ratio and debt service coverage ratio are the important leverage ratios commonly used. Debt – Equity Ratio = Debt/Equity Debt(assumed)= 59 Equity(assumed)= 185 Debt Equity Ratio= 59/185= 0.32 The numerator includes all liabilities, short term as well as long term. The denominator is the total of equity i.e., net worth and preference capital. Interest Coverage Ratio: = Profit before interest and taxes/ Interest = 45/1=45 Interest coverage ratio is used by lenders to assess a firm’s ability to meet its interest obligations. Debt Service Coverage ratio: This ratio is used by financial institutions to assess the capacity of the borrower to repay the term loan. Debt Service Coverage ratio= Profit after tax + Depreciation + other non cash charges + interest on term loan Interest on term loan + Repayment of term loan c. Turnover Ratios Turnover Ratios help us to measure the efficiency of utilization of the assets of a firm. These are also called activity ratios or asset management ratios. Inventory Turnover Ratio: This ratio measures how fast the inventory is being converted through the conversation cycle and generating sales. Inventory turnover ratio= Net Sales / Inventory = 309/108= 2.86 Debtor Turnover Ratio: It tells us about the efficiency of credit management. Debtor Turnover = Net Credit Sales/Debtors = 309/107 = 2.89 A higher debtors turnover indicates better credit management.

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Average Collection Period: Average collection period is a measure similar to the Debtors turnover, telling us about the efficiency of credit management. As the name suggests, it indicates the average number of days taken to collect the receivables or the number of days of credit sales that is locked up in receivables. Average collection period= Debtors/ Average daily credit sales = 365/ Debtor Turnover = 365/2.89= 126 Fixed Asset Turnover: This ratio measures the efficiency of utilization of fixed assets in creating sales. It is measured as the sales per rupee of investment in fixed assets. Fixed Assets Turnover = Net Sales / Net Fixed Assets = 309 / 46 = 6.7 Total Asset Turnover: Similar to the Fixed Asset Turnover, this ratio measures the efficiency of utilization of total assets – both fixed as well as current assets. Total Asset Turnover

= Net Sales / Total Assets = 309 / 346 = 0.89

d. Profitability Ratios: Profitability ratio can be of two types. The first one are the ratios between profit and sales. The second type are the ratios between profit and investment. There are called rate of return measures. Gross Profit Ratio= gross Profit/Net Sales = 80/309= 0.26= 26% Gross profit ratio indicates the margin available after meeting the manufacturing expenses. It is measure of the efficiency of production and the price realization. The cost structure remaining same, a better price realization results in higher gross profit ratio. A lower gross profit ratio, with no significant change in cost structure can indicate a pressure on prices. Net Profit Ratio: It is the ratio of net profit to sales. Net profit Ratio = Net profit / Net Sales = 30/309 = 0.097= 9.7% Earning Power: Earning Power measures the profitability of operations without considering the influence of financial structure and tax rate. It focuses on the operating performance. Earning Power = Profit before interest and taxes / Total assets = 45 / 346 = 0.13 = 13% Return on Equity: Return on Equity measures the profitability of equity funds invested in the firm. Return on Equity = (Profit after tax – Preference Dividends) / Net Worth Net Worth = Paid up Capital + Reserves and Surplus.

e. Valuation Ratios

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Security Analysis & Portfolio Management Semester IV

Valuation ratios are measures of how the equity stock of the company is assessed in the capital market. The widely used valuation ratios are Price-Earning Ratio and market Value to book value ratio. Price Earning Ratio = Market price per share/ Earning per share Earning per share = Profit after tax – Preference Dividends / No. of outstanding equity shares Market Value to Book Value Ratio = Market value per share/ Book value per share

Q.8

Explain with illustration how you can reduce risk by diversification.

Ans.8 Avoiding risk is difficult no matter how you choose to invest. Most investors are aware that you must take greater risks to achieve higher returns. However, no one wants to take more risk than necessary to achieve one's financial goals. Diversification can help reduce risk. THE MEANING OF DIVERSIFICATION Diversification means dividing your investment among a variety of assets. Diversification helps to reduce risk because different investments will rise and fall independent of each other. The combinations of these assets more often than not will cancel out each other's fluctuation, therefore reducing risk. Diversification in investments can be achieved in many different ways. Individuals can diversify across one type of asset classification -- such as stocks. To do this, one might purchase shares in the leading companies across many different (and unrelated) industries. Many other diversification strategies are also possible. You can diversify your portfolio across different types of assets (stocks, bonds, and real estate for example) or diversify by regional decisions (such as state, region, or country). Thousands of options exist. Luckily, in almost every effective diversification strategy, the ultimate goal is clear -- to improve performance while reducing risks. Two basic types of risks associated with investments are unsystematic risk and systematic risk. Let's see how diversification may be able to help investors reduce these risks. UNSYSTEMATIC AND SYSTEMATIC RISK Unsystematic risk (also called diversifiable risk) is risk that is specific to a company. This type of risk could include dramatic events such as a strike, a natural disaster like a fire or something as simple as slumping sales. Two common sources of unsystematic risk are business risk and financial risk. Diversification can help eliminate unsystematic risk from a portfolio. It is unlikely that events such as the ones listed above would happen in every firm at the same time. Therefore, by diversifying, one can reduce their risk. There is no reward for taking on unneeded unsystematic risk. On the other hand, some events can affect all firms at the same time. This is known as systematic risk. Events such as inflation, war and fluctuating interest rates influence the entire economy, not just a specific firm or industry. Diversification cannot eliminate the risk of facing these events. Therefore, it is considered un-diversifiable risk. This type of risk accounts for most of the risk in a well-diversified portfolio. However, the expected returns on their investments can reward investors for enduring systematic risks. DIVERSIFICATION IN STOCKS Diversification offers you a way to reduce risk. It is possible to have a diversified portfolio of: just stocks; just bonds; stocks and bonds; or stocks, bonds, and cash, etc. The portfolio design is very important to effectively minimizing risk.

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Security Analysis & Portfolio Management Semester IV

When creating an effective diversified portfolio of stocks, considering how to reduce unsystematic risk is important. For example: it is possible that if you invest in the book publishing industry, that all the book binders in the industry make a pact to go on strike. The effects of such an event could lead the prices of all publishing stocks in that industry to plummet. Your holdings in publishing companies would be left at a deflated level.

However, if you also had holdings in other industries such as oil, consumer durables and electronics, it is unlikely that the unsystematic risks in the publishing industry will adversely affect your other holdings. What is more, unfortunate circumstances in the book publishing business may result in a boom in other industries. The delays in the traditional print publishing business mentioned previously could cause people to publish materials in electronic form. If you held stock in an electronic publishing company, your stock might even benefit from the troubles that are slowing the growth of your holdings in the book publishing industry. Unsystematic risks can be avoided by diversifying among different industries rather that just investing in the same one. They may also be effectively mitigated by diversifying across different asset classes such as (stocks, bonds, mutual funds, real estate holdings, etc.). Let us take a look how this is done. DIVERSIFICATION ACROSS ASSET CLASSES Diversification across asset classes provides a cushion against market tremors because each asset class has different risks, rewards and tolerance to economic events. By selecting investments from different asset classes, you can minimize risk. Investments whose price movements are opposite each other are negatively correlated. When negatively correlated assets are combined within a portfolio, the portfolio volatility is reduced. As mentioned earlier there are many diversification opportunities. All provide the well-desired reduction of risk. Diversification is a great process for investors to take advantage of and we hope you are now more familiar with it. THE PROS AND CONS OF DIFFERENT DIVERSIFICATION STRATEGIES As you have seen, diversification can help reduce risk by eliminating unsystematic risk from a portfolio. By choosing securities of different companies in different industries, you can minimize the risks associated with a particular company's "bad luck." By diversifying among asset classes that are negatively or weakly correlated, you further reduce the volatility of your portfolio. However, diversification can reduce the return of your portfolio as well. By selecting several assets, the overall return on your portfolio will be the weighted average of the returns of those assets. For example, let us look at a portfolio made up 50/50 of single stock and a single bond. In one year, the stock has a total return 30%, the bond 6%. The portfolio return will only be 18% (36 divided by 2). Whereas, if the entire portfolio was invested in the stock, the return would have been 30%. SOME FINAL COMMENTS ON DIVERSIFICATION Diversification can help to reduce portfolio risk by eliminating un-systematic risk for which investors are not rewarded. Investors are rewarded for taking market risk. Because diversification averages the returns of the assets within the portfolio, it attenuates the potential highs (and lows). Diversification among companies, industries and asset classes affords the investor the greatest protection against business risk, financial risk and volatility.

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Security Analysis & Portfolio Management Semester IV

Q.22 Describe the different categories of Mutual Funds. Ans.22 Mutual Funds: A security that gives small investors access to a well diversified portfolio of equities, bonds, and other securities. Each shareholder participates in the gain or loss of the fund. Shares are issued and can be redeemed as needed. The fund's net asset value (NAV) is determined each day. Each mutual fund portfolio is invested to match the objective stated in the prospectus. The Eight Categories of Mutual Funds Growth funds also strive for capital appreciation by investing in companies that are positioned for strong earnings growth potential. Funds in this group vary widely in the amount of risk they take. But in general, they are less risky than aggressive growth funds because they normally invest in more well-established companies. Neither aggressive growth funds nor growth funds strive for dividend income. In fact, the companies they invest in often do not pay dividends to their shareholders but reinvest the earnings to fuel future growth. Growth and income funds strive for both dividend income and capital appreciation by investing in companies with competitive records of dividend payments and capital gains. Of course, past performance is not indicative of future results. Most growth and income funds strive for yields equal to or better than the money market average and to provide capital appreciation that at least beats inflation. Some growth and income funds emphasize growth while others emphasize income. In addition, growth and income funds are generally less volatile than pure growth funds and tend to lag behind the overall market. The investment time horizon of growth and income fund investors tends to be anywhere from 2 to 10 years. Balanced funds offer one-stop shopping by combining stocks and bonds in a single portfolio. Balanced funds are generally more conservative than the previously discussed categories and usually invest in blue-chip stocks and high-quality taxable bonds. They normally hold up relatively well in rough markets, because when their stock investments fall, their bonds may do well, and vice versa. Because they offer broad diversification, balanced funds are often suitable for people with a small amount of cash to invest. Sector funds concentrate on one industry (such as technology, financial services, or consumer goods) or focus on certain commodities (such as gold, gas, or oil). Selected by more experienced investors who are willing to pay close attention to the market, sector funds are less diversified than the broader market and hence are often more volatile. In addition, mutual funds encompass bond funds, money market funds, and global and international funds.

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Security Analysis & Portfolio Management Semester IV

Bond funds can be divided into four broad categories. Within these categories, the funds are segmented by date of maturity, type of issuer, and credit quality of bonds. • • •

•

Tax-advantaged bond funds, preferred by people in higher tax brackets, buy bonds issued by state and municipal agencies. Taxable bond funds may invest in all other debt securities. High-quality bond funds stick with government and top-rated corporate or municipal bonds that offer relatively lower interest. High-yield bond funds buy lower-rated or non-investment grade corporate or municipal bonds, or "junk bonds," which may offer higher interest to compensate for the higher risk and volatility that investors take. Keep in mind that high-yield bonds are subject to greater loss of principal and interest, including default risk, than higher rated bonds.

Money market funds invest in short-term money market instruments, such as U.S. Treasury bills, commercial paper, certificates of deposit, and repurchase agreements. Striving to maintain a stable share price of $1.00, money market funds offer relative safety and liquidity. Global and international funds can help diversify your assets into a wide array of foreign stocks and bonds. The difference between the two groups is that global funds may buy a mix of U.S. and foreign stocks, whereas international funds invest exclusively overseas. There are many different types of mutual funds – each with differing objectives and exposure to risk. Below is a listing of the major types of funds that can be found under the broad asset classes of equities and fixed income. Be sure to consult a qualified financial professional to determine which funds might be appropriate for your portfolio.

Mutual Fund Performance, 1992-2002

Compare the difference in fluctuating value and long-term performance among different fund categories. Sector funds generally have performed better, but with wider fluctuations, than growth and income and bond funds. Past performance is no guarantee of future results. Source: Standard & Poor's, 12/31/02. Points to Remember 1. Mutual fund categories determine the types of individual securities that fund managers select for their funds. 2. Some equity fund categories are aggressive growth, growth, growth and income, balanced, sector, bond, money market, and global and international. 3. Bond funds include taxable and tax-advantaged funds and are also segmented by maturity, issuer, and credit quality.

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Security Analysis & Portfolio Management Semester IV

4. Investors should match their objectives to a particular category but be cautious about focusing too heavily in any one area. 5. Diversifying among both types and categories of funds is one way to manage risk in your portfolio. Bond Yield-to-Maturity

Q.18 Write short notes: Ans 1. Efficient market hypotheses: Market efficiency is generally discussed within the frame work presented by Fama in the article -*Efficient capital markets: A review of Theory and Empirical work” Fama defined efficient markets in terms of a ‘fair game’ where security prices ‘fully reflect’ the information available. If markets are efficient, securities are priced to provide a normal return for their level of risk. Fama suggested that the efficient, securities are priced to provide a normal return for their level of risk. Fama suggested that the efficient market hypothesis (EMH) can be divided into three categories: the weak form, the semistrong form and the strong form. The distinction between the weak, semistrong, and strong forms of the EMH are determined by the level of information being considered. WEAK-FORM EMH In the weak from EMH, the type is information being considered is restricted to only historical prices. If the weak-form EMH is correct, investors should not be able to consistently earn abnormal profits by simply observing the historical prices of securities. Technical anlaysis which relies on charts of stock prices over time is particularly vulnerable to the weak form EMH. SEMISTRONG- FORM EMH The semistrong – form EMH states that security prices adjust rapidly and correctly to the release of all publicly available information. Thus, under the semistrong-form current prices fully reflect not only all past price data but also such information such as earnings reports, dividend announcements, annual and quarterly reports, and news items in the financial press. In short, any information that is available to the public should be quickly reflected in security prices so that investors cannot consistently earn abnormal returns by acting on such public information. Since a great deal of the information used by security analysts is available to the public at large, STRONG- FORM EMH The strong form EMH represents the most extreme form of market efficiency possible. Under the strong form it is argued that security prices fully reflect all information including both public and private information. 2. SECURITY MARKET INDICATIORS Security market indicators are used to measure the general movement of the stock market. Stock market indices are used as a proxy for overall market movement. Indices can be constructed for narrower purposes as well for example for specific sectors. The steps involved in the construction of a stock market index based on market cap weightage are: i) Selecting a set of scrips to be used: The selection is made in such a way that the selected scrips reflect the overall market movement. In order to achieve this we will need scrips from various important industries. The key factors that we have to consider to select the representative scrips are (a) Market capitalization and (b) Trading volumes ii) Fixing a starting date.

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Security Analysis & Portfolio Management Semester IV

iii) Calculating the market capitalization of all companies in the index based on the closing prices on the starting date. The value of the index on the starting date is taken as 100 iv) Calculating the market capitalization of all companies in the index based on the closing prices on the required date. v) Calculating the value of the index on the required date by the formula: Value of the index on the required date = Total market capitalization on the required date x 100 Total market capitalization on the starting date 3. HEAD AND SHOULDER FORMATION: The head and shoulders formation is one of the reliable chart patterns and occurs at both market tops and market bottoms. The pattern consists of a final rally- the head separating two smaller though not identical rallies (the shoulders). Volume characteristics are important in assessing the validity of these patterns. Volumes are normally large during the formation of the left shoulders and also tends to be quite large as prices approach the peak. The real indication that a head and shoulder pattern is developing comes with the formation of the right shoulder, which is accompanies by distinctly lower volume. The line joining the bottoms of the two shoulders is called the neckline. It is essential to wait for a decisive break below the neckline. The deeper the pattern, the greater is the bearish significance once it has been completed. Similarly the longer the period of formation of the pattern, the longer the ensuring bear trend likely to be. 4. STUDY OF VOLUME IN TECHNICAL ANALYSIS Studying volume is useful because volume often leads price and thus offers an advance warning of a potential trend reversal. Some of the general principles that could be used in interpreting volume changes are given below: i)

A price rise accompanied by expanding volume is a normal market characteristics and carried no implications of a potential trend reversal. ii) A rally that reaches a new high in price on expanding volume but has an overall level of activity lower than the previous rally is suspect and warns of a potential trend reversal. iii) A rally that develops on contracting volume is suspect and warns of a potential trend reversal in price. iv) Sometime both price and volume expand slowly, gradually working into an exponential rise with a final sharp rise. Following this development, both volume and price fall off equally sharply. This represent an exhaustion move and is characteristic of a trend reversal. The significance of the reversal will depend upon the extent of the previous advance and the degree of volume expansion.

v) When price advances following a long decline and then reacts to a level at, or slightly above, or marginally below the previous trough, it is a bullish sign if the volume on the second trough is significantly lower than the volume on the first trough. 5. BREADTH INDICATORS: Breadth indicators measures the degree to which the vast majority of issues are participating in a market move. They therefore monitor the extent of a market trend. In general, it is seen that fewer the number of issues that are moving in the direction of the major averages, the greater the probability of an imminent reversal in trend. 6. MOMENTUM INDICATORS: The technique of trendlines, price patterns, and moving average analysis identify a change in trend after it has taken place. The use of momentum indicators can warn of latent strength or weakness in the indicator or price being monitored, often well ahead of the final turning point.

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Security Analysis & Portfolio Management Semester IV

Some of the important momentum indicators used widely are rate of change (ROC), relative strength indicator (RSI), moving average convergent divergence (MACD), breadth oscillators, and diffusion index. We will discuss some fo these indicators in detail.

Section – B Q.25 Find the present value of an annuity of Rs. 15000/- paid at the end of each year for ten years, if the discount rate is 10%. Ans Present Value = Annuity x [(1+k)n − 1] k(1+k)n Where k= Rate of interest N=Duration of the annuity In the above question- Annuity = Rs. 15000; k = 0.10; n= 10 Present value= Rs. 15000 x [(1 + 0.10)10 - 1] 0.10 1 + 0.10)10 = 15000 x [(1.10)10 - 1] 0.10 (1.10)10 = 15000 x [ 2.5937423 - 1] 0.10(2.5937423) = 15000 x [1.5937423] 0.2593742 = 15000 x 6.1445675 = Rs. 92168.512

Q.28 Ans.

The Table below gives the weekly data of the value of an index: Date Jan. 8 Jan. 15 Jan. 22 Jan. 29 Feb. 5 Feb. 12 Feb. 19 Feb. 26 Mar. 5 Mar. 12

Index 10 Week Total 10 Week Moving Average 101 100 103 99 96 99 95 91 93 89 966 96.6

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Security Analysis & Portfolio Management Semester IV

Mar. 19 Mar. 26 Apr. 2

90 95 103

955 950 950

95.5 95.0 95.0

Q. 26. Sol. Total Market Capitalization on the required date Value of the index on the required date = --------------------------------------------------------------------- X 100 Total Market Capitalization on the starting date Value of Index at base year

= 100

Total Market Capitalization on Base Year = Rs. 5,568.00 crores Security A

Price as on Day (in Rs.) 221.55

X No. of shares

outstanding Market Capitalisation on (in Crores) Day X (in crores) 220.00 48,741.00

B

405.55

105.00

42,582.75

C

4,817.50

6.60

31,795.50

D

55.90

520.00

29,068.00

E

792.25

25.00

19,806.25

F

256.00

53.00

13,568.00

G

144.00

63.00

9,072.00

H

670.20

12.00

8,042.40

I

89.25

79.00

7,050.75

J

228.85

28.00

6,407.80

Total

2,16,134.45

Total Market Capitalization on Day X = Rs. 2,16,134.45 Value of Index on Day X

= 2,16,134.45 5,568

X 100 = 3,881.725

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Security Analysis & Portfolio Management Semester IV

Q. 29. Sol. Total Market Capitalization on the required date Value of the index on the required date = --------------------------------------------------------------------- X 100 Total Market Capitalization on the starting date

Value of Index on Day 1

= 100

Total Market Capitalization on Day 1 = Rs. 96,625.00 Security A

Market Price as on No. of shares Price as on Capitalisation Day 1 (in Rs.) Million Day 2 (in Rs.) on Day 1 Rs. 55 125 62 6,875.00

Market Capitalisation on Day 2 Rs. 7,750.00

B

250

100

245

25,000.00

24,500.00

C

45

250

55

11,250.00

13,750.00

D

20

300

23

6,000.00

6,900.00

E

950

50

940

47,500.00

47,000.00

96,625.00

99,900.00

Total

Total Market Capitalization on Day 2 = Rs. 99,900.00 Value of Index on Day 2

= 99,900.00 X 100 = Rs. 103.389 96,625.00

Q.33

Beta = 0.8 Risk Free Rate = 8% Market Premium =15% Expected return = ?

Ans.

Expected return = 8% + 0.8 x 15%

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Security Analysis & Portfolio Management Semester IV

= 8 + 0.12 = 8.12%

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