MF0001 – Security Analysis and Portfolio Management

(Book ID: B1035)

Assignment Set- 1 (30 Marks)
Note: Each question carries 10 Marks. Answer all the questions.
Question 1. What is portfolio management style? Why this is necessary for an inv
estor
while setting his/her investment policy?
Answer:
It is rare to find investors investing their entire savings in a single security
. Instead, they tend to invest in a group of securities. Such a group of securit
ies is called aportf ol i o. Most financial experts stress that the in order to
minimize risk, an investor should hold a well-balanced investment portfolio. The
investment process describes how an investor must go about making decision with
regard to what securities to invest in while constructing a portfolio, how exte
nsive the investment should be, and when the investment should be made. This is
a procedure involving the following five steps:
•
Set investment policy
•
Perform security analysis
•
Construct a portfolio
•
Revise the portfolio
•
Evaluate the performance of portfolio
While setting the investment policy, for an investor it is necessary to select o
ne of the portfolio management styles i.e active or passive because it plays an
important role in achieving financial goals. the various styles are defined belo
w:
Active Management is the process of managing investment portfolios by attempting
to time
the market and/or select ‘undervalued ‘ stock to buy and ‘overvalued’ stock to sell base
d upon
research, investigation and analysis.
Active asset management is based on a belief that a specific style of management
or analysis can produce returns that beat the market. It seeks to take advantag
e of inefficiencies in the market and is typically accompanied by higher than av
erage costs (for analysts and managers who must spend time to seek out these ine
fficiencies).
For those who favor an active management approach, stock selection is typically
based on
one of two styles:
• T op- down- Managers who use this approach start by looking at the market as a w
hole,
then determine which industries and sectors are likely to do well given the curr
ent economic cycle. Once these choices are made, they then select specific stock
s based on which companies are likely to do best within a particular industry.
•
Bottom-up- This approach ignores market conditions and expected trends. Instead,
companies are evaluated based on the strength of their financial statements, pro
duct pipeline, or some other criteria. The idea is that strong companies are lik
ely to do well no matter what market or economic conditions prevail
Passive Management is the process of managing investment portfolios by trying to
match the
performance of index or asset class of securities as closely asses possible by h
olding all or a representative sample of securities in the index or asset class.
This portfolio management style does not use market timing or stock selection s
trategies.
Passive asset management is based on the concept that markets are efficient, tha
t market
returns cannot be surpassed regularly over time, and that low cost investments h
eld for the
long term will provide the best returns.
Passive management concepts to know include the following:
• Efficient market theory- This theory is based on the idea that information that
affects
the markets (such as changes to company management, Fed interest rate announceme
nts, etc.) is instantly available and processed by all investors. As a result, t
his information is always taken into account in market prices. Those who believe
in this theory believe there is no way to consistently beat market averages.
• I ndexing- One way to take advantage of the efficient market theory is to use in
dex
funds (or to create a portfolio that mimics a particular index). Since index fun
ds tend to have lower than average transaction costs and expense ratios, they ca
n provide an edge over actively managed funds which tend to have higher costs