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Security Analysis and Portfolio Management

Davinder Kaur

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Punjab Technical University (PTU), MBA, Third Semester
Syllabus
 
MBA 921: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
 
Max. Marks: 100                                                                                                      External Assessment: 60
                                                                                                                                 Internal Assessment: 40
 
Unit-I
Introduction: Concepts of Investment, Objectives of Investment, Various Alternatives of Investments, Investment vs. Speculation. Financial Markets: Primary Markets and Secondary Markets. Introduction to Primary Market, Primary Market Design and its Role, Types of Offers in the Primary Market, Major Eligibility Guidelines for the Issuers in Primary Market, Contribution of Promoters, Issue of Sweat Equity.
Secondary Market: Introduction, Major Players, Trading and Settlement Mechanism, Types of Orders, Stop Loss, Trading on Margin and how Margin Works, Short Selling Price Freeze, Market Wide Circuit Breaker, Basis of Market Wide Circuit Breaker, Insider Trading, Odd lot Trading, Bulk Deals, Block Deals, Arbitrage Opportunity in the Market.
Risk and Return: Concept, Types and Measurement of Risk and Return.
 
Unit-II
Security Analysis: Fundamental Analysis: International Environment: Global Economy Overview, Global Markets, Global Market and Indian Market Inter Linkages. Economic Analysis: GDP, Fiscal Policy, Monetary Policy and Liquidity, Inflation, Interest Rate, Unemployment, Individual Savings, Domestic Corporate Tax Rate, Balance of Trade. Industry Analysis: Tools for Industry Analysis, Cross Sectional Industry Performance over Time, Industry Life Cycle. Company Analysis: Analysis of Financial Statements.
Technical Analysis: Introduction, Basic Tenets of Dow Theory , Characteristic Phases of Bull and Bear Trends, Critical Appraisal of Dow Theory, Different Types of Charts, Concept of Trend, Trend Lines: Support and Resistance, Importance of Volume, Reversal Patterns, Continuation Pattern, Moving Averages, Other Market Indicators.
 
Unit-III
Portfolio Management: Meaning, Importance and Approaches of Portfolio Management, Portfolio Analysis, Portfolio Evaluation and Revision Techniques.
Portfolio Theory: Markowitz Model, Capital Asset Pricing Model, Single-Index Model, Arbitrage Pricing Theory. Market Efficiency and Behavioral Finance.
 
Unit-IV
Derivatives: Introduction, Meaning of Future Contracts, Forward Contracts, Difference, Trading of Stock Futures. Option Contracts: Introduction, Types, Payoffs and Option Strategies.
 
Note: Relevant Case Studies should be discussed in class.
Unit 1: Introduction to Investment, Financial Market and Risk & Return
1.1.          Investment
13
1.1.1.       Concept of Investment
13
1.1.2.       Characteristics of Investment
13
1.1.3.       Objectives of Investment
14
1.1.4.       Constraints of Investment
15
1.1.5.       Investment versus Speculation
15
1.1.6.       Various Alternatives of Investments
16
1.1.6.1.    Financial Forms of Investment/ Financial        Assets
16
1.1.6.2.    Non Financial Forms of Investment/ Real        Assets
19
1.2.          Financial Market
20
1.2.1.       Meaning of Financial Market
20
1.2.2.       Features of Financial Market
21
1.2.3.       Functions of Financial Market
21
1.2.4.       Types of Financial Markets
21
1.3.          Primary Market
22
1.3.1.       Meaning and Definition of Primary Market
22
1.3.2.       Features of Primary Market
22
1.3.3.       Primary Market Design and its Role
23
1.3.4.       Types of Offers in The Primary Market
24
1.3.4.1.    Public Issue
24
1.3.4.2.    Rights Issue
25
1.3.4.3.    Private Placement
25
1.3.4.4.    Preferential Allotment
26
1.3.4.5.    Issue of Sweat Equity
27
1.3.5.       Intermediaries in Primary Market
27
1.3.6.       Major Eligibility Guidelines for the Issuers     in Primary Market
28
1.3.7.       Contribution of Promoters
30
1.3.8.       Advantages of Primary Market
30
1.3.9.       Disadvantages of Primary Market
31
1.4.          Secondary Market/Stock Exchanges
31
1.4.1.       Meaning and Definition of Secondary             Market
31
1.4.2.       Features of Secondary Market
32
1.4.3.       Functions of Stock Exchange
32
1.4.4.       Major Players in Secondary Market
33
1.4.5.       Advantages of Secondary Market
34
1.4.6.       Disadvantages of Secondary Market
35
1.4.7.       Relationships between Primary and Secondary Market
35
1.4.8.       Difference between Primary & Secondary       Market
36
1.4.9.       Trading and Settlement Mechanism  in            Secondary Market
36
1.4.9.1.    Trading Procedure
36
1.4.9.2.    Settlement Procedure
39
1.4.10.     Types of Orders
40
1.4.10.1.  Stop Loss Order
40
1.4.10.2.  Stop Limit Order
40
1.4.10.3.  Market Order
40
1.4.10.4.  Limit Order
41
1.4.10.5.  Other Orders
41
1.4.11.     Types of Transactions
41
1.4.12.     Trading Rules and Regulations of    Secondary Market
43
1.4.12.1.  Market-Wide Circuit Breakers
43
1.4.12.2.  Insider Trading
44
1.4.12.3.  Odd-Lot Trading
44
1.4.12.4.  Bulk Deals
45
1.4.12.5.  Block Deals
45
1.4.13.     Arbitrage Opportunities in Secondary             Market
45
1.5.          Risk
46
1.5.1.       Concept of Risk
46
1.5.2.       Causes of Risks
46
1.5.3.       Types/Classification/Sources of Risks
47
1.5.3.1.    Systematic Risk
47
1.5.3.2.    Unsystematic Risk
47
1.5.4.       Measurement of Risk
48
1.5.4.1.    Standard Deviation
48
1.5.4.2.    Variance
49
1.5.5.       Managing Risk
51
1.6.          Return
52
1.6.1.       Concept of Returns
52
1.6.2.       Types of Return
52
1.6.3.       Components of Return
52
1.6.4.       Measurement of Return
52
1.6.4.1.    Traditional Methods of Measurement
52
1.6.4.2.    Modern Methods of Measurement
53
1.6.5.       Relationship between Risk and Return
54
1.7.          Exercise
55
 
 
Unit 2: Security Analysis
2.1.          Security Analysis
56
2.1.1.       Introduction
56
2.1.2.       Objectives of Security Analysis
56
2.1.3.       Benefits of Security Analysis
56
2.2.          Fundamental Analysis
57
2.2.1.       Concept of Fundamental Analysis
57
2.2.2.       Objectives of Fundamental Analysis
57
2.2.3.       Strengths of Fundamental Analysis
57
2.2.4.       Weaknesses of Fundamental Analysis
57
2.2.5.       EIC-Economy-Industry-Company     Framework
58
2.2.6.       International Environment
58
2.2.6.1.    Global Economy Overview
58
2.2.6.2.    Global Market
58
2.2.6.3.    Global Market and Indian Market     InterLinkages
59
2.3.          Economic Analysis
59
2.3.1.       Introduction
59
2.3.2.       Concept of Environment
59
2.3.3.       Factors Affecting Economic Analysis
60
2.3.3.1.    Gross Domestic Product (GDP)
60
2.3.3.2.    Fiscal Policy
61
2.3.3.3.    Monetary Policy and Liquidity
61
2.3.3.4.    Inflation
61
2.3.3.5.    Interest Rates
61
2.3.3.6.    Unemployment
62
2.3.3.7.    Individual Savings
62
2.3.3.8.    Domestic Corporate Tax Rate
62
2.3.3.9.    Balance of Trade
62
2.3.3.10.  Government Revenue, Expenditure, and          Deficits
62
2.3.3.11.  Exchange Rates
62
2.3.3.12.  Economic and Political Stability
63
2.3.3.13.  Infrastructure
63
2.3.3.14.  Monsoon
63
2.4.          Industry Analysis
63
2.4.1.       Introduction
63
2.4.2.       Industry Classification
63
2.4.3.       Factors Affecting Industry Analysis
64
2.4.4.       Tools for Industry Analysis
65
2.4.4.1.    Cross-Sectional Industry Performance
65
2.4.4.2.    Industry Performance over Time
65
2.4.4.3.    Industry Life Cycle Stages
66
2.4.4.4.    Differences in Industry Risk
66
2.4.4.5.    SWOT Analysis of Industry
67
2.4.5.       Problems of Industry Analysis
67
2.5.          Company Analysis
68
2.5.1.       Introduction
68
2.5.2.       Analysis of Financial Statements
68
2.5.3.       Factors Affecting Company Analysis
71
2.6.          Technical Analysis
71
2.6.1.       Introduction
71
2.6.2.       Assumptions of Technical Analysis
72
2.6.3.       Factors Considered in Technical Analysis
72
2.6.4.       Distinctions between Fundamental and           Technical Analysis
72
2.6.5.       Tools And Uses of Technical Analysis
72
2.6.5.1.    Price Indicators
73
2.6.5.2.    Volume Indicators
73
2.6.6.       Dow Theory
73
2.6.6.1.    Basic Tenets of Dow Theory
74
2.6.6.2.    Characteristics Phases of Bull and Bear           Trends
75
2.6.6.3.    Critical Appraisal of Dow Theory
76
2.6.7.       Elliot Wave Theory
77
2.6.8.       Breadth of Market
78
2.6.9.       New Highs and New Lows
78
2.6.10.     Market Sentiment Indicators
78
2.6.11.     Confidence Indicator (Disparity Index)
79
2.6.12.     Most Active List
79
2.6.13.     Charts
79
2.6.13.1.  Different Types of Charts
79
2.6.13.2.  Chart Pattern
82
2.6.13.3.  Reversal Patterns
82
2.6.13.4.  Continuation Patterns
83
2.6.14.     Concept of Trend and Trend Lines
84
2.6.15.     Support and Resistance Level
85
2.6.16.     Moving Average Analysis (MAA)
86
2.6.17.     Oscillators
86
2.6.18.     Other Market Indicators
87
2.6.18.1.  Relative Strength Analysis
87
2.6.18.2.  Short-Selling Theory
87
2.6.18.3.  Odd-Lot Theory
88
2.7.          Exercise
88
 
 
Unit 3: Portfolio Management and Theory
3.1.          Portfolio Management
89
3.1.1.       Meaning of Portfolio Management
89
3.1.2.       Objectives of Portfolio Management
89
3.1.3.       Scope of Portfolio Management
90
3.1.4.       Importance of Portfolio Management
90
3.1.5.       Approaches of Portfolio Management
90
3.2.          Portfolio Analysis
91
3.2.1.       Concept of Portfolio
91
3.2.2.       Portfolio Risk and Return
91
3.2.3.       Expected Returns of a Portfolio/ Calculation   of Portfolio Returns
92
3.2.4.       Portfolio Risk
93
3.2.4.1.    Calculation of Portfolio Risk
93
3.2.4.2.    Diversification of Risk
94
3.2.4.3.    Portfolio with Two Assets
95
3.2.4.4.    Portfolio with More Than Two Assets
96
3.3.          Portfolio Revision
98
3.3.1.       Meaning of Portfolio Revision
98
3.3.2.       Objectives of Portfolio Revision
98
3.3.3.       Need for Revision
99
3.3.4.       Constraints in Portfolio Revision
99
3.3.5.       Portfolio Revision Techniques/Strategies
99
3.3.6.       Formula Plan
100
3.3.6.1.    Assumptions of Formula Plan
100
3.3.6.2.    Types of Formula Plan
100
3.3.6.3.    Advantages of Formula Plan
102
3.3.6.4.    Disadvantages of Formula Plan
102
3.4.          Portfolio Evaluation
102
3.4.1.       Meaning of Portfolio Evaluation
102
3.4.2.       Measures of Portfolio Performance
103
3.4.2.1.    Sharpe’s Ratio
103
3.4.2.2.    Treynor’s Ratio
104
3.4.2.3.    Jensen Ratio
104
3.4.2.4.    Modigliani & Modigliani Measure (M2           Measure)
106
3.5.          Portfolio Theory
107
3.5.1.       Concept of Modern Portfolio Theory (MPT)
107
3.5.2.       Features of Modern Portfolio Theory
107
3.5.3.       Assumptions of Modern Portfolio Theory
108
3.5.4.       Markowitz Model
108
3.5.4.1.    Assumptions of Markowitz Model
109
3.5.4.2.   OpportunitySet/Feasible Set of Portfolios
109
3.5.4.3.    Efficient Set of Portfolio
109
3.5.4.4.    Efficient Frontier
110
3.5.4.5.    Selection of Optimum/Optimal Portfolio
112
3.5.4.6.    Risk Diversification/ Markowitz        Diversification
113
3.5.5.       Capital Asset Pricing Model (CAPM)
114
3.5.5.1.    Basic Assumptions of CAPM
114
3.5.5.2.    Systematic and Unsystematic Risk
115
3.5.5.3.    Terms in CAPM
116
3.5.5.4.    CML and SML
117
3.5.5.5.    Shortcomings of CAPM
120
3.5.6.       Sharpe Single Index Model
120
3.5.6.1.    Assumptions of Single Index Model
121
3.5.6.2.    Calculation of Return under Single Index        Model
121
3.5.6.3.    Uses of Single Index Model
124
3.5.7.       Arbitrage Pricing Theory (APT)
124
3.5.7.1.    Equation of APT
124
3.5.7.2.    Assumptions of APT
125
3.5.7.3.    Arbitrage
125
3.5.7.4.    Factor Model
126
3.5.7.5.    Equilibrium of APT
129
3.6.          Market Efficiency
130
3.6.1.       Introduction
130
3.6.2.       Meaning of Efficient Market Hypothesis
131
3.6.3.       Assumptions of Efficient Market Hypothesis
131
3.6.4.       Random Walk Theory
131
3.6.4.1.    Implications of Random Walk Theory
132
3.6.4.2.    Limitations of Random Walk Theory
132
3.6.5.       Forms of Market Efficiency
133
3.6.6.       Empirical Tests for Different Forms of              Market Efficiency
133
3.6.6.1.    Empirical Tests of Weak Form
134
3.6.6.2.    Empirical Tests of Semi-Strong Form
135
3.6.6.3.    Empirical Tests of Strong Form
135
3.6.7.       Evidence against Efficient Markets Hypothesis
136
3.7.          Behavioral Finance
137
3.7.1.       Introduction
137
3.7.2.       Interpretation of Behavioral Finance
137
3.7.3.       Biases in Behavioral Finance
137
3.7.4.       Critics of Behavioral Finance
138
3.7.5.       Behavioral Finance and Efficient Market         Theory
138
3.8.          Exercise
139
 
 
Unit 4: Derivatives
4.1.          Derivatives
140
4.1.1.       Introduction of Derivatives
140
4.1.2.       Features of Derivatives
140
4.1.3.       Participants in a Derivatives Market
141
4.1.4.       Functions of the Derivatives Market
142
4.1.5.       Advantages of Derivatives
143
4.1.6.       Disadvantages of Derivatives
143
4.1.7.       Types of Derivatives
144
4.2.          Futures Contracts
145
4.2.1.       Meaning of Futures Contracts
145
4.2.2.       Features of Futures Contracts
145
4.2.3.       Terminologies Used in Futures Contracts
146
4.2.4.       Advantages of Futures Contracts
146
4.2.5.       Disadvantages of Futures Contracts
147
4.2.6.       Types of Futures Contracts
147
4.2.7.       Trading of Stock Futures
148
4.2.7.1.    Features of Stock Futures
148
4.2.7.2.    Factors Contributing the Growth of Stock       Futures
148
4.3.          Forward Contract
149
4.3.1.       Meaning of Forward Contract
149
4.3.2.       Features of Forward Contract
149
4.3.3.       Types of Forward Contract
150
4.3.4.       Advantages of Forward Contract
150
4.3.5.       Disadvantages of Forward Contract
151
4.3.6.       Difference between Forward and Futures
151
4.4.          Option Contracts
151
4.4.1.       Introduction to Options
151
4.4.2.       Terminologies Used in the Options Market
151
4.4.3.       Participants in the Options Market
152
4.4.4.       Types of Options
153
4.4.4.1.    Call Options
153
4.4.4.2.    Put Options
154
4.4.4.3.    American Options and European Options
154
4.4.4.4.    Option In-the-Money (ITM), At-the-Money (ATM), Out-of-the-Money (OTM)
155
4.4.5.       Uses of Options
155
4.4.6.       Difference between Futures and Options        Contract
155
4.4.7.       Payoffs in Options
156
4.4.7.1.    Call Options Payoffs
156
4.4.7.2.    Put Options Payoffs
158
4.4.8.       Options Strategies
162
4.4.9.       Bull/Bullish Strategies
162
4.4.9.1.    Protective Put
162
4.4.9.2.    Covered Call
163
4.4.9.3.    Long Call (Buy Call)
163
4.4.9.4.    Short Put
164
4.4.9.5.    Bull Spread
165
4.4.9.6.    Straps
165
4.4.10.     Bear/Bearish Strategies
165
4.4.10.1.  Short Call
165
4.4.10.2.  Long Put
166
4.4.10.3.  Call Bear Spread
166
4.4.10.4.  Put Bear Spread
167
4.4.10.5.  Strips
167
4.4.11.     Strategies for Volatile Situations
167
4.4.11.1.  Butterfly
168
4.4.11.2.  Straddle
168
4.4.11.3.  Strangle
170
4.4.11.4.  Calendar Spread
170
4.4.11.5.  Diagonal Spread
171
4.4.11.6.  Ratio Put Spread
171
4.4.11.7.  Ratio Call Spread
172
4.5.          Exercise
172
 
 
Case Studies
 
Solved Case Studies
 
Case Study 1: Risk and Return
173
Case Study 2: Fundamental Analysis
174
Case Study 3: Technical Analysis – Charts Watch
176
Case Study 4: Future Contract
179
Unsolved Case Studies
 
Case Study 1: Fundamental Analysis
179
Case Study 2: Capital Asset Pricing Model
180
Case Study 3: Optimal Portfolio Construction
181
Case Study 4: On Performance Evaluation
182
 
 
Solved Paper – 2011
184
Solved Paper – 2012
181
Solved Paper – 2013
199
Classification
207
Model Papers
209

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Security Analysis and Portfolio Management

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Davinder Kaur

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