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MBA III Semester

Unit-1
Investment Analysis and Portfolio Management

MEANING OF INVESTMENT
The term ‘investing” could be associated with the different activities, but the common
target in these activities is to “employ” the money (funds) during the time period
seeking to enhance the investor’s wealth.

Funds to be invested come from assets already owned, borrowed money and savings. By
foregoing consumption today and investing their savings, investors expect to enhance
their future consumption possibilities by increasing their wealth. Some information
presented in some chapters of this material developed for the investments course could be
familiar for those who have studied other courses in finance, particularly corporate finance.
Corporate finance typically covers such issues as capital structure, short -term and long-term
financing, project analysis, current asset management. Capital structure addresses the
question of what type of long-term financing is the best for the company under current and
forecasted market conditions; project analysis is concerned with the determining whether a
project should be undertaken. Current assets and current liabilities management addresses
how to manage the day-by-day cash flows of the firm. Corporate finance is also
concerned with how to allocate the profit of the firm among shareholders (through the
dividend payments), the government (through tax payments) and the firm itself (through
retained earnings). But one of the most important questions for the company is
financing. Modern firms raise money by issuing stocks and bonds. These securities are traded
in the financial markets and the investors have possibility to buy or to sell securities
issued by the companies. Thus, the investors and companies, searching for financing,
realize their interest in the same place in financial markets.

Corporate finance area of studies and practice involves the interaction between firms
and financial markets and Investments area of studies and practice involves the interaction
between investors and financial markets. Investments field also differ from the corporate
finance in using the relevant methods for research and decision making. Investment
problems in many cases allow for a quantitative analysis and modeling approach and the
qualitative methods together with quantitative methods are more often used analyzing
corporate finance problems. The other very important difference is, that investment analysis
for decision making can be based on the large data sets available from the financial
markets, such as stock returns, thus, the mathematical statistics methods can be used.

INVESTMENT DEFINITIONS
(i) “An investment is a commitment of funds made in the expectation of some positive
rate of returns. If the investment is properly undertaken, the returns will
commensurate with the risk the investor assumes”.
(ii) “The Purchase by an individual or institutional investor of a financial or real asset
that produces a return in proportion to the risk assumed over some future investment
period”.
(iii) “Investment means conversion of cash or money into monetary asset or a claim on
future money for a return. Purchase of asset like shares and securities can either for
investment or speculate or both Investments are long term in nature”.
In the financial sense, investment is the commitment of a person’s funds to derive future
income in the form of interest, dividend, premiums, pension’s benefits or appreciation in the
value of their capital. Purchasing of shares, debentures, post offices savings certificates,
insurance policies are all investments in the financial sense. Such investments generate
financial assets.
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Nature and Scope of Investment:

Investment involves making of a sacrifice in the present with the hope of deriving future
benefits. Two most important features of an investment are current sacrifice and future benefit.
Investment is the sacrifice of certain present values for the uncertain future reward. It involves
numerous decision such as type, mix, amount, timing, grade etc., of investment the decision
making has to be continues as well as investment may be defined as an activity that commits
funds in any financial/physical form in the present with an expectation of receiving
additional return in the future. The expectation brings with it a probability that the quantum of
return may vary from a minimum to a maximum. This possibility of variation in the actual
return is known as investment risk. Thus, every investment involves a return and risk.

Investment as the process of, “sacrificing something now for the prospect of gaining something
later”. So, the definition implies that we have four dimensions to an investment- time, today be
sacrifice and prospective gain. The word investment has many interpretations as it means
different things to different persons. For a person who has lent money to another, it may be an
investment for a return. Similarly, if a person purchases share of a company, bullion or real
estate’s for the purpose of price appreciation, it is also an investment for him and an insurance
plan or a pension plan is an investment to its purchaser. It is clear that investment is a
commitment of funds for an earning additional income. In other words, investment is
considered the scarifies of certain value of money in anticipation of a reward.

Investment in financial assets differs from investment in physical assets in those

important aspects:

Investment generally involves commitment of funds in two types of assets:

- Real assets - Financial assets
Real assets: Investment in this sense includes the information of new productive capital in the
form of new construction, plant and machinery; inventories etc., such investment generate Real
assets. Real assets are tangible material things like building, automobiles, land, gold etc.

Financial assets: In the financial sense, investment is the commitment of a person’s funds to
derive future income in the form of interest, dividend, premiums, pension’s benefits or
appreciation in the value of their capital. Purchasing of shares, debentures, post offices savings
certificates, insurance policies are all investments in the financial sense. Such investments
generate financial assets.

In the Economic sense, investment means the net addition to the economy’s capital stock which
consists of goods and services that are used in the production of other goods services that are
used in the production of other goods and services. Financial assets are piece of paper
representing an indirect claim to real assets held by someone else. These pieces of paper
represent debt or equity commitment in the form of IOUs or stock certificates. Investments in
financial assets consist of –
- Securities (i.e. security forms of) invest
- Non-securities investment
The term ‘securities’ used in the broadest sense, consists of those papers which are quoted and
are transferable. Under section 2 (h) of the Securities Contract (Regulation) Act, 1956 (SCRA)
‘securities’ include:
1. Shares, Scrip’s, stocks, bonds, debentures, debenture stock other marketable
securities of a like nature in or of any incorporated company or other body
corporate.
2. Government securities.
FINAICIAL ASSETS REAL ASSETS
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Marketable Assets Real Estate

 Shares SAVER  House

 Bonds  Land
 MF Schemes ↕  Buildings
 UTI Units  Flats
 Govt. Securities Bullion
Non-Marketable Assets
INVESTOR  Gold
 Bank Deposits  Silver
 PF &LIC Schemes  Diamond
 Pension Schemes Art Instruments
 PO Deposits
 Paintings
 Sculptures
Consumer Durables

3. Such other instruments as may be declared by the central

4. Government as securities

OBJECTIVES OF INVESTMENTS
The main investment objectives are increasing the rate of return and reducing the risk. Other
objectives like safety, Liquidity and hedge against inflation can considered as subsidiary
objectives. Return- Investors always expects a good rate of return from their investments. Rate
of return could be defined as the income the investor receives during the holding period stated
as a percentage of the purchasing price at the beginning of the holding period.

Return: Investors wish to earn a return on their money. Cash has an opportunity cost. By
holding cash, you forego the opportunity to earn a return on that cash. Furthermore, in an
inflationary environment, the purchasing power of cash diminishes, with high rates of
inflation bringing a relatively rapid decline in purchasing power. In investments it is critical
to distinguish between an expected return (the anticipated return for some future period) and a
realized return (the actual return over some past period). Investors invest for the future for the
returns they expect to earn but when the investing period is over, they are left with their
realized returns. What investors actually earn from their holdings may turn out to be more
or less than what they expected to earn when they initiated the investment. This point is the
essence of the investments process; Investors must always consider the risk involved in
investing.

Return= End period value- Beginning period value +Dividend/Beginning Period Value X
100
Return= Sale Price value –Purchasing price value+ Dividend Yield / Purchasing Price value X
100
Return= Capital Gains or Price changes or Capital appreciation + Dividend Yield.

Risk: Risk is inherent in any investment. Risk may relate to loss of capital, delay in
repayment of capital, nonpayment of return or variability of returns. The risk of an
investment is determined by the investments, maturity period, repayment capacity, nature of
return commitment and so on. Risk and expected return of an investment are related.
Theoretically, the higher the risk, higher is the expected returned. The higher return is a
compensation expected by investors for their willingness to bear the higher risk.

Risk of holding securities is related with probability of actual return becoming less than the
expected return. The word risk is synonymous with the phrase variability of return. Investment’
risk is just as important as measuring its expected rate of return because minimizing risk and
maximizing the rate of return are interested objectives in the investment management. An
investment whose rate of return varies widely from period to period is risky than whose return
that does not change much.
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Safety: The safety of investment is identified with the certainty of return of capital without
loss of time or money. Safety is another feature that an investor desires from investments.
Every investor expects to get back the initial capital on maturity without loss and without delay.
The selected investment avenue should be under the legal regulatory frame work. If it is not
under the legal frame work, it is difficult to represent the grievances, if any approval of the law
itself adds a flour of safety. Even though approved by law, the safety of the principal differs
from one mode of investment to another.

Liquidity: An investment that is easily saleable without loss of money or time is said to be
liquid. A well-developed secondary market for security increase the liquidity of the
investment. An investor tends to prefer maximization of expected return, minimization of
risk, safety of funds and liquidity of investment. Marketability of the investment provides
liquidity to the investment. The liquidity depends upon the marketing and trading facility

Hedge against inflation since there is inflation in almost all the economy, the rate of return
should ensure a cover against the inflation. The return rate should be higher than the rate of
inflation; otherwise the investor will have loss in real terms. Growth stocks would appreciate
in their values overtime and provide a protection against inflation. The return thus earned
should assure thus should the safety of the principal amount, regular flow of income and be
hedge against inflation.

Tax Planning in Practice, many investors are taxpaying individuals. As the income tax rates
vary from 10% to 30% with a surcharge, the tax liability of those with higher income brackets
is somewhat heavy. The interest earned by the investor from his investment is a taxable income
and in certain cases tax is to be deducted at source of interest income (TDS). An Investor
generally prefers liquidity for his investment along with safety of his funds, a good return with
minimum stock.
SECURITIES
Security forms of investments include Equity shares, preference shares, debentures,
government bonds, Units of UTI and other Mutual Funds, and equity shares and bonds of
Public Sector Undertakings (PSUs). Non-security forms of investments include all those
investments, which are not quoted in any stock market and are not freely marketable. viz.,
bank deposits, corporate deposits, post office deposits, National Savings and other small
savings certificates and schemes, provident funds, and insurance policies. Another popular
investment in physical assets such as Gold, Silver, Diamonds, Real estate, Antiques etc. Indian
investors have always considered the physical assets to be very attractive investments. There
are a large number of investment avenues for savers in India. Some of them are marketable
and liquid, while others are non-marketable, Some of them are highly risky while some
others are almost risk less. The investor has to choose proper avenues from among them,
depending on his specific need, risk preference, and return expectation. Investment avenues can
be broadly Classification of securities under the following heads: -

INVESTMENT PROCESS

The investment process involves a series of activities leading to purchase of securities of other
investment alternatives. The investment process can be divided into five stages. They are:

1. Framing of investment policy or knowledge about investments

2. Investment Analysis
3. Portfolio Selection
4. Portfolio construction
5. Portfolio Evaluation(Appraisal)
6. Portfolio Revision
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1. Investment Policy: The government or the investor before proceeding into the
investment formulates the policy for the system functioning. The essential
ingredients of the policy are the investible funds, objective and knowledge about
investment alternatives and market.
2. Security analysis: After formulating the investment policy, the securities to be
bought have to be scrutinized through the market industry and company analysis
3. Valuation: The valuation helps the investor to determine the return and risk
expected from an investment in the common stock. The intrinsic value of the
share is measured through the book value of the share and price earnings ratio.
Simple discounting models also be adopted to value the shares. The stock
market analysis has developed many advanced models to value the shares. The
real worth of the share is compared with the market price and then investment
decisions are made.
4. Portfolio construction: A portfolio is a combination of securities. The portfolio
is constructed in such a manner to meet the investor goals and objectives. The
investor should decide how best it meets the goals with the securities available.
The investor tries to attain maximum return with minimum risk. Towards this
end, he diversifies his portfolio and allocates funds among the securities. The
main objective of diversification is the reduction of risk in the loss of capital and
income. A diversified portfolio is comparatively less risky than holding a single
portfolio.

4.4 Selection: Based on the diversification level, industry and company analyses the securities
have to be selected. Funds are allocated for the selected securities and allocation of funds will
help the managers to construct sound portfolio management process.

5. Evaluation of Portfolio: The portfolio has to be managed efficiently. The efficient

management calls for evaluation of the portfolio. This process consists of portfolio appraisal
and revision.

5.1 Appraisal: The return and risk performance of the security may vary from time to time.
The variability in returns of the securities is measured and compared. The developments in the
economy, industry and relevant companies from which the stocks are brought have to be
appraised. The appraisal may predict the loss and steps can be taken to avoid such losses.

6. Revision: Revision depends on results of the appraisal. The low yielding securities with high
risk are replaced with high yielding securities with low risk factor. To keep the return at a
particular level necessitated the investor to revise the components of the portfolio periodically.

Various types of securities are traded in the market. According to the securities Contracts
Regulation Act, Securities include shares, scripts, stocks, bonds, debentures or other marketable
securities of any incorporated company or other body corporate, or government. Securities are
classified on the basis of return and the source of issue. Based on the income, they may be
classified as fixed or variable income securities. Sources of issue may be government, semi
government and corporate. Corporate houses generally raise funds through fixed or variable
income securities. Sources of issue may be government, semi government and corporate.
Corporate houses, generally raise funds through fixed and variable income securities like equity
shares, preference shares and debentures.

SPECULATOR
An investor has a longer planning horizon. His holding period is usually at least one year. A
speculator has a relatively short planning horizon. His holding may be a few days to a few
months. Risks disposition an investor is normally not willing to assume more than moderate
risk. Rarely does he assume high risk. A speculator is ordinarily willing to assume high risk
Return expectation an investor usually seeks a modest rate of return, which is commensurate
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with the limited risk assumed by him. Return expectation. An investor usually seeks a modest
rate of return, which is commensurate with the limited risk assumed by him. A speculator looks
for a high rate of return in exchange for the high risk borne by him. Basis of decisions and
investor attaches greater significance to fundamental factors and attempts a careful evaluation
of the prospects of the firm. A speculator relies more on hearsay, technical charts and market
psychology. Leverage Typically an investor uses his own funds and eschews borrowed funds.
Leverage Typically an investor uses his own funds and eschews borrowed funds. A speculator
normally resorts to borrowings, which can be very substantial, to supplement his personal
resources.

ROLE OF SPECULATOR
 The speculator seeks opportunities promising very large returns earned
quickly and is the prepared to take higher risk.
 The speculator is interested in getting abnormal return i.e., extremely
high rate of return than the normal return in the short-run.
 Speculator investments are made for short-term trade gains through
buying and selling investments.
 The speculator is more interested in the market action and its price
movement.
 The speculator would like to assure greater risk than the investors. The
negative short term fluctuations affect the speculators in worse manner
then the investors.

Speculation means taking up the business risk in the hope of getting short term gain.
Speculation essentially involves buying selling activities with the expectation of getting profit
from the price fluctuations. The speculator is more interested in the action and its price
movement. The investor constantly evaluates the worth of security whereas the speculator
evaluates the price movement. He is not worked about the fundamental factors like his
counterpart, the investor. Difference between Investor and Speculator

Investor Speculator
Time Plans for a longer time horizon.Plans
His for a very short period. Holding period
holding period may be from one year
varies
to from few days to months
few years.
Risk Assumes moderate risk Willing to undertake high risk.
Return Likes to have moderate of return Like to have high return for assuming high risk.
associated with limited risk.
Decision Considers fundamental factors Considers
and inside information, here says and
evaluates the performance ofmarket
the behavior
company regularly.

Funds Uses his own funds and avoids borrowed

Uses borrowed funds to supplement these
funds personal resources.
Basis Investment Speculation
Type of contract Creditor Ownership
Basis of acquisition Usually by outright purchase Often- on-margin
Length of commitment Comparatively long term For a short time only
For a short time only Earnings of enterprise Change in market price
Quantity of Risk Small Large
Stability of income Very stable Uncertain and erratic
Psychological attitude Daring
of and careless reasons for purchase
Cautious and conservative
Participants Scientific analysis of
intrinsic worth Hunches, tips, “inside
dope”, etc.
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GAMBLING
Gambling is the wagering of money or something of material value on an event with an
uncertain outcome with the primary intent of winning additional money and/or material goods.
Gambling thus requires three elements be present: consideration, chance and prize. Typically,
the outcome of the wager is evident within a short period. Betting (wagering) that
must result either in a gain or a loss. Gambling is neither risk taking in the sense of speculation
(assumption of substantial short-term risk)nor investing (acquiring property or assets for
securing long-term capital gains).
Investment has also to be distinguished from gambling. Typical examples of gambling are
horse races, card games, lotteries etc., Gambling involves taking high risks not only for high
return but also for thrill and excitement. Gambling is unplanned and nonscientific, without
knowledge of the nature of the risk involved. It is surrounded by uncertainty and is based on
tips and rumors’. In gambling artificial and unnecessary risks are created for increasing the
returns.
Investment is an attempt of careful planning, evaluation and allocation of funds to various
investments outlets which offer safety of principal with moderate and continuous return over a
long period of time. It also differs from insurance which may reduce or eliminate the risk of
loss but offers no legitimate chance of gain Gambling, defined as ‘the act of betting on an
uncertain outcome’. Investing means committing money in order to earn a financial return. The
definitions seem to indicate a higher element of chance or randomness in gambling, while
investing appears to be more rational.
INVESTMENT AND GAMBLING
Investment has also to be distinguished from gambling. Typical examples of gambling are
horse races, card games, lotteries etc., Gambling involves taking high risks not only for high
return but also for thrill and excitement. Gambling is unplanned and nonscientific, without
knowledge of the nature of the risk involved. It is surrounded by uncertainty and is based on
tips and rumors’. In gambling artificial and unnecessary risks are created for increasing the
returns. Investment is an attempt of careful planning, evaluation and allocation of funds to
various investments outlets which offer safety of principal with moderate and continuous
return over a long period of time.
SOURCES OF INVESTMENT INFORMATION
Security analysis calls for collection of vast information relating to industry, company and
market. The market for securities can be regarded as perfect when demand and supply forces
determine the prices of securities. Availability of money and flow of information into market
largely affect the demand and supply forces determine the prices of securities. Availability of
money and flow of information into market largely affect the demand and supply forces.
Besides the market price, the investors are interested in knowing the intrinsic value of shares.
Intrinsic value of shares means the value of net assets available per equity share of the
company. Intrinsic value always revolves around the market price. When the intrinsic value is
less than the market price, it is advisable to sell the shares. The sources and types of
information areà
1. World affairs 2. Domestic Economic and Political
Factors.
3. Industry information 4. Company information
5. Security market information 6. Security Price quotations
7. Data on related markets 8. Data on mutual funds
9. Data on new Issue market 10. Financial information
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World Affairs: International Factors such as international political developments, wars,

foreign markets etc., influence domestic income, output, employment and investment for
domestic market. Besides, financial journals like Economic Times, Financial Express and
Business Line etc., report on world economic affairs.
Domestic Economic and Political Factors: Domestic economic and political factors relate to
gross domestic products (GDP), agricultural output, monsoon, money supply, inflation,
government policies, taxation etc., besides the leading newspapers, financial dailies like
economic times, financial express, and business line. Etc.
Industry Information: Industry information is quite essential for investment decision-
making. It includes market demand, installed capacity, capacity utilization competitor’s
activities and their share in the market, market leaders, prospects of the industry, and
requirements of foreign buyers, inputs and capital goods in foreign countries.
Company Information: Company information relates to the corporate data, annual reports,
stock Exchange publications, Department of company affair’s circulars, press releases on
corporate affairs by government industry, chamber, and financial papers fortnightly journals of
capital markets, Dalai Street, business India furnish information about the companies listed on
recognized stock exchanges. They also publish the results of equity and market research.
Weekly reviews and monthly reviews of Bombay stock Exchange provide useful information
required for security analysis
Security Market Information: Investment management needs information about security
market. The credit rating of companies, market analysis, market reports, equity research
reports, trade and settlement data, listing and delisting records, book closures, BETA factors
etc., are called security market information.
Security Price Quotations: Generally, technical analysis is based on security price
quotations. These include price indices, price and volume data, breadth, daily volatility etc.
Each stock exchange publishes daily prices and also low and closing quotations of securities
traded in it. It is also publishes volume of trade for securities.
Data on Related Markets: Government securities market, money market and Forex market
are closely related to security market. Publications of RBI, DFHI, Indian banks association’s
securities trading corporation, banks, NSE give data on such related markets. RBI
publications, foreign exchange Dealers Associations and foreign banks particularly report on
Forex market.
Data on Mutual Fund: Various schemes of mutual funds and their performance, net asset
value (NAV) and repurchase prices are useful in analyzing various investments avenues
available to modern investors. Daily financial papers, investment weekly and Investors’ guide
publish data on mutual funds. They contain information on current mutual fund schemes,
NAV of each scheme, repurchase price, redemption rate of close-ended funds, daily purchase
and sale prices for open-ended funds. Most of the mutual funds are quoted on the stock
exchanges. In addition, capital market Dalai Street Business India also gives information on
mutual funds.
New Issue Market: New issue market is primary market for securities. IN this market,
companies issue securities to the investors directly for raising long-term capital. Reports of the
merchant bankers and SEBI have firsthand information on the various new issues floated in
the market. They get draft prospectus for vetting. A magazine called Prime Publication
publishes all information relating to the new issues that are the pipeline. Merchant bankers,
underwriters and brokers in the new issue market analyze the performance of the issuing
companies. Cable operators financial journals, etc., give write ups on forthcoming issues.
Reserve bank of India Department of Company Affairs publishes periodically data on new
issues in the primary market.
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Financial Information: The balance sheet analysis done by stock market is based on the
financial data furnished by financial statements of a company. The term financial statements
refer to the balance sheet, or other statements of financial position of a company and the
income and expenditure statement or the profit and loss statement. I addition, the profit
allocations statement reconciles the balance in this account at the end of the period with that
the beginning. Thus, financial statements contain a summary of the accounts of a company
over a period of one year i.e., one financial year (from 1 st April to 31 March). The balance
sheets show the assets, liabilities and capital at the end of the year. The financial statements of
a company help financial analysts to know the financial soundness of the company and its
management. Financial statements help the investors in ascertaining whether it is profitable to
invest in securities of a particular company.

MEASUREMENT OF RISK AND RETURN

Investment decisions are made in anticipation of increased return in the future. Therefore, it is
necessary to estimate the future return of benefits accruing from the investment proposal.
Different investment proposals have different degrees of risk and uncertainty. Risk involves
situations in which the probabilities of particular even occurring are known whereas in
uncertainty these probabilities are unknown. Generally, risk and return are inseparable. There is
no return without risk. The investment process must be considered in terms of both aspects risk
and return.

Return is a precise statistical term, which is measurable also. Risk is not a precise statistical
term but we use statistical terms to quantify it. The investor should keep the risk associated with
the return proportional as risk is directly correlated with return. Normally, higher the risk the
greater the reward but seeking excessive risk does not ensure excessive return. At a given level
of return, each security has different degree of risk. At a given level of return, each security has
different degree of risk. The entire process of estimating return and risk for individual securities
is called “Security Analysis “.

The main objective of the investor is to derive a portfolio of securities that meets his preference
for risk and expected return. Securities refer to spectrum of risks ranging from virtually risk-free
debt instruments to highly speculative bonds, common stocks and warrants. The investor will
select from this spectrum of risks those securities that maximize his utility, and management of
securities may be viewed as comprising two functional areas. First, the risk and return co-
incident with individual securities must be determined.

These estimates must be used to form portfolios that best meet the needs of the investor. This
decision involves the “trade-off” between risk and expected return. To arrive at this trade-off,
the investor has to constantly review and ask certain questions and find solutions to the
problems.

Some of the questions are: Should the portfolio contain only bonds or only common stock? In
case, it is decided to have a mix, what should be the combination of the two kinds of securities?
What part of it should contain stocks and what part bonds? Additionally, the decisions will
predict market behavior in order to improve the return of the investor. The investor may also
consider the value of time in his investments. If investment timing is considered, several
different policies may have to be considered.

Types of Risks: risk consists of two components. They are

1. Systematic Risk
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2. Un-systematic Risk

1. Systematic Risk: Systematic risk refers to that portion of total variability in return caused by
factors affecting the prices of all securities. Economic, Political and sociological changes are
sources of systematic risk. Their effect is to cause prices of nearly all individual common stocks
and/or all individual bonds to move together in the same manner.
Market Risk: Variability in return on most common stocks that are due to basic sweeping
changes in investor expectations is referred to as market risk. Market risk is caused by investor
reaction to tangible as well as intangible events.
Interest rate-Risk: Interest –rate risk refers to the uncertainty of future market values and of
the size of future income, caused by fluctuations in the general level of interest rates.
Purchasing-Power Risk: Purchasing power risk is the uncertainty of the purchasing power of
the amounts to be received. In more events everyday terms, purchasing power risk refers to the
impact of or deflation on an investment.
2. Unsystematic Risk: Unsystematic risk is the portion of total risk that is unique to a firm or
industry. Factors such as management capability, consumer preferences, and labor strikes Cause
systematic variability of return in a firm. Unsystematic factors are largely independent of
factors affecting securities markets in general. Because these factors affect one firm, they must
be examined for each firm.
Unsystematic risk that portion of risk that is unique or peculiar to a firm or an industry, above
and beyond that affecting securities markets in general. Factors such as management capability,
consumer preferences, and labor strikes can cause unsystematic variability of return for a
company’s stock.
Business Risk: Business risk is a function of the operating conditions faced by a firm and the
variability these conditions inject into operating income and expected dividends.
Business risk can be divided into two broad categories
a. Internal Business Risk
b. External Business Risk
a. Internal business risk is associated with the operational efficiency of the firm. The
operational efficiency differs from company to company. The efficiency of operation is
reflected on the company‘s achievement of its pre-set goals and the fulfillment of the promises
to its investors.
b. External business risk is the result of operating conditions imposed on the firm by
circumstances beyond its control. The external environments in which it operates exert some
pressure on the firm. The external factors are social and regulatory factors, monetary and fiscal
policies of the government, business cycle and the general economic environment within which
a firm or an industry operates.
Financial Risk: Financial risk is associated with the way in which a company finances its
activities. Financial risk is avoided risk to the extent that management has the freedom to decide
to borrow or not to borrow funds. A firm with no debit financing has no financial risk
The term return from an investment refers to the benefits from that investment. In the field of
finance in general and security analysis in particular, the term return is almost invariably
associated with a percentage and not a more amount. .In security analysis we are primarily
concerned with return from investor’s perspective. Our concern is to compute the return for an
investor from a particular investment say, a share a debenture or some other financial
instrument.
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Single period Returns: It refers to a situation where an investor is concerned with return from
a single period. (Say one day, one month or one year etc.).
Multi period Returns: It refers to a situation when more than a single period returns are under
consideration. Investor is concerned with computing the return per period, over a longer period.
`
Ex-Post Return: Ex-post returns refer to the actual returns obtained from the investments.
They properly measure the returns generated by an investment, one must consider both the price
change and cash flow derived from the investment. The measurement of returns from the
historical data can be referred to ex-post returns. This includes both current income and capital
gains or losses. The income and capital gains price of the security. The income and capital gains
are then express as percentage of the initial investment.
Ex-Ante Return: The majority of investors tend to emphasize the returns they expect from a
security while making investment decision and the expected return of a security. This enables
investor to look into future prospects from an investment and the measurement of return from
expectations of benefits is known as Ex-Ante Returns. The equations for quantifying the return,
variance and standard deviation of individual security returns for both ex-post and ex-ante data
are summarized in the following table