Learning Unit - 5
Reading MaterialIntroduction :
To a common man, there is little difference between investing in shares and gambling.
This is true to some extent, because of the difficulties in predicting future trends in the
stock market. Many take risk by investing in shares based on analysis and reasoning.
The present situation in India is that individual investors have to compete with
professional and organized investors like bank sponsored mutual funds. In order to enable
them to take rational decisions, it is absolutely necessary for them to understand Portfolio
Management.
The main focus of analysis of Portfolio Management will be on ‘forecasting security
prices’. For this purpose it is necessary to understand the functioning of stock exchanges
in India.
In Learning Unit 2 we have discussed the use of Discounted Cash Flow Technique
(DCFT). DCFT is used to calculate the present value of future returns on share.
A technical analyst or a chartist may analyze stock prices based on the psychological
factors i.e., on mood of the crowd rather than on the reputation, earnings per share ratio,
dividends etc., this method often called as ‘technical analysis’
Most investors invest in several securities rather than on a single security. This kind of
diversification of investments reduces the variability of returns. This is the basis of
‘Modern Portfolio Theory’.
Bonds or debentures have a definite income when compared to shares. The only threat
for this definite income is change in the interest rate or default in payment of principal or
interest or both.
The income return will be calculated in terms of present value.
Convertible debentures are a mix of the characteristics of a share and a debenture. In
India, this is more popular as a financial resource.
For any given single security, one should estimate the return as well as the risk. But in
portfolio management the situation are as follows:-
ó One must have sufficient funds
ó Estimate, out of the available funds, how much the investor should invest in each
category of assets, such as equity, bonds and money market instruments. This is
nothing but asset allocation.