Ponfolio Re"'ision I{SS]

2.Thesecondassumptionistlratifthemarketmoveshigher,theproportionofstocksintheportfoliomaywhen defensive

3. 4.
ttto
Frs

is more aggressive in the low market and either decline or remain constant. The portfolio the market is on the rise. the and sold whenever there is a significant change in The third assumption is that the stocks are bought with the help of indices like BSE-Sensitive price. The changes in the level of market coulJbe measured

Index and NSE-NiftY'

5.

fhe

it' should strictly follow the formula plan once he chooses The fourth assumption requires that the investor to act on the plan' He should not abandon the plan but continue the risk and move along with the market. They should reflect The investors should select good stocks that market price movement shoukl be closely correlated with the return features of the market. The stock
movementandthebetavalueshouldbearoundl.0'ThestocksofthefundamentallyStrongcompanieshave to be included in the Portfolio'

tct
tin
bEn

Advantages Of the Formula Plan

-Basicrulesandregulationsforthepurchaseandsaleofsecuritiesareprovided' to overcome human emotion' - The rules and regulations are rigid and help

)be

F
ioe

-Theinvestorcanearnhigherprofitsbyadoptingtheplans. -Acourseofactionisformulatedaccordingtotheinvestor'sobjectives.
by the investor' - It controls the buying and selling of securities of investments' - It is useful for taking decisions on the timing

ueI ble

Disadvantages
-Theformulaplandoesnothelptheselectionofthesecurity.Theselectionofthesecurityhastobe doneeitheron,h"bu,i,ofthefundamentalortechnicalanalysis' -ItisStrictandnotflexiblewiththeinherentproblemofadjustment.
-Theformulaplanshouldbeappliedforlongperiods,otherwisethetransactioncostmaybehigh' -Eveniftheinvestoradoptstheformulaplan,heneedsforecasting.Marketforecastinghelpshimto
identifY the best stocks'

a=

rb
iar lt3

irr d

Rupee Gost Averaging

Thesimplestandmosteffectiveformulaplanisrupeecostaveraging.First,stockswit}rgoodfundamentalsand longtermgrowthprospectsshouldbeselected.suchstocls'pricestendtobevolatileinthemarketandprovide

E hl !+

maximumbenefitfromrupeecostaveraging.Secondly,theinvestorshouldmakearegularcommitmentof he should purchase the shares regardless of

makes a commitment' buying shares at regular inierrals. Once he affecting the stock market' term performance and the economic factors the stock,s price, the company's short

tu
rin

Intherupeecostaveragingplan,theinvestorbuysvaryingnumberofsharesatvariouspointsofthestock marketcycle'Inaway,itcanbecalledtimediversification.L,etusassumethataninvestordecidestobuy Rs|l000wqrthorparticularsharesforfourquartersinoneparticularyear,ignoringthetransactioncosts,The

details are given in table 2l
'
1

[eSeJ Securiry Analysis and ponfolio Marugemenr

Thble Quafter

2l.l

Rupee Cost Areraging

Market Price

Slnres
Purchased

Cumulative Investment

Market
Value

(In Rs) Unrealked Average

Average

Profit or
Loss

Cost Per Share

100

(In
1.

Rs.)

Market Price Per

Sltare
100

100

10
11

1,000 1,990

1,000 1,890 3,100

0
(100)
110

2. 3.

90

94.76 96.4s 99.s0

n0
110

%
96.67

r0 9

2,990
3.990

4.

4.m

420

lm

In the above example, the stock price fell in the second quarter but recovered in ttre third quarter.The investor was able to buy more stocls in the second quarter than in the first quarter.The benefits of this policy can be viewed by comparing the last two columns. in the second quarter, the average cost per share is lower than the average market price per share. This is the benefit derived from rupee cost averaging.
The rupee cost averaging for the Hero Honda stock is given in table zl.2. The process of investment is
assumed to commence in January 1996 afrd end

in 199g, cwering

12 quarters.

Advantages
The advantages of the rupee cost averaging plan are

1. Reduces the average cost per share and improves the possibility of gain over a long period. 2. Takes away the pressure of timing ttre stock purchase from investors 3' Makes the investors to plan the investment programme thoroughly on the commitrnent of funds that has
to be done periodically

4-

Applicable to bothfalling and rising marker, although

declinirlg rritrket.

it works

best

if

the stocks are acquired in

lr

In a nut shell, the investor must decide in advance the sum and periodic interrals at which he has to invest. Once it is decided, the implementation is rnechanical.

Llmitatlons

l. 2. 3. 4. 5. 6.

Extra transaction costs are involved with small and frequent purchase ofshares The plan does not indicate when to sell. It is strictly a strategy for buying

Ii

does not eliminate the necessity for selecting the individual stocks that are to be purchased

There is no indication of the appropriate intenal between purchases The averaging advantage does not yield profit

if the stock price is in a downward trend

The plan seems to work better when stock prices have qrclical patterns.

The rupee cost averaging plan yields better results when applied to no load mutual funds. The problems of high transaction costs and stock selection are eliminated. The broad based index fund experiences profit

if

the

orice is volatile, alloving theaveraging effect to result in cost reduction. The investor has only to decide on the size of the frrnd and the length of the interral between the purchases.

Quarters

Price
(Rs)

Shares

Total
Number of Sltares
4
90
160

Investment (R9

Comulative
Investment
(Rs)
6 10080

Market
Value (Rs)
7 10080

Unrealised

Average
Cost

Bought

Profits (R9
8

(R9
9

verog=e Pric-e (R--)

t0 n2
t27
139

I
15.1.96 15.4.96

2 I12.00 t42.50
162.00 130.00 1s2.00 1s6.50 301.75
381 .88

3
90 70 62
T7

5
10080

n2
2745 5865 125

997s

20055
30099 40109 50141

228W

rs.7.96
15.10.96

D2
299 36s
429

lw44
10010 10032 10016 99s8

3s9&
38870 55480 67139

t36
134

(r23e)
5339

t37

ls.r.97
7.4.97

6
&
33

r37
140

IN
t43

ffir57
701ls
80044

6982 6v294
1063 13

t5.7.97
15.10.97 15.1.98 15.4.98 15.7.98 15.10.98

M2
488 514 530
553

r39N9
1

ts2

l6s ly2

?5 26
16

w29
r0160

86357

t&
176
189

390.75 606.25

gUM
99n4
110105

200u6
321313 2452s6 325470

tr0&2
2214f/9
135151

2t4

*
(\

97n
10201

2y

q (\
o

M3.50
s71.00

n
n

r99

nl
296

\
(\
lt1

s70

9707

n98r2

20s658

2t0

\ frl
|<

Col 7 Col 8 Col 9 Col 10

Col 2 x Col4

h (\
o a
.o

iJ

Col

7-Col

Col 6+Col 4

\ \ s \
(^j

I Qr Price + II Qr Pric e + 2 and so on.

iJ

[$8J

Securin emtysis and ponfolio Managemet

Gonstant Rupee plan

constant rupee' constant ratio and variable ratio plans are considered to be true formula timing prans. plans force the investor to sell These when the prices.rise and purchar" pri.o r"ri. guide buying and selling'The ,"quir.d to ", actions suggested by.the formuru iirin! prun automatica[y herp the investor ro reap the benefits of the fluctuations in th-e-stock prices.

Accord bonds 50:.

and bougt

;;;."*#'not

the third q

frjl;t"?jt*
The

The essential feature of this plan is that the portfolio is divided into two parts, which consists of aggressive or conse^ative portfolios. The portfolio mix facilitates the automatic selling and buying of bonds

In the t point the i the portto total portf The m the invest
lower pric

plan The constant rupee plan enables the shift of investment from bonds to stocks and vice-versa by maintaining a constant amount invested in the stockportion of the porrrolio. rr," constant rupee plan starts with a fixed amount of money invested in selected stocks and bonds. when the price of ttre stocks increases, investor sells sufficient amount the of stocks to return to the original amount of the investment in stocks. By keeping the mlue of aggressive portfolio constant, remainder is invested in the conserrative portfolio. The investor must choose action points or reraluation points. The action points are the times at investor has to readjust the valires which the orirt.

high pricr

may be ei

Gonsta
Constani The ratic

ilflll"-Tf::T::i:","" A"owing"",v,;i;".:::i,::,T:ff:"ifflfijiJi,'J",""l
"onrtint

the same watchtul of the marketprice movements. Stocra' rarue in the portforio can be ailorved

,torr.rln trr" porttotio. stocl$,

*ru., ,u*o,

be continuousry

the investor' If the action points are ioo large, the investor *uy no, ir-uble get full benefit out fluctuations' The table 2l .3 shows of the price th" *pee plan. The transaction costs are
not considercd.

ii,?3:ffi:"11T":Llimll**x*it

ratio. T:,
Once the by the in'. up or dou
shou's the

Thble 21.3 Constant

Value (Rs)
50
44 40 40

of

Defensive portfolio
2W

10,000

10,000 10,000

2m

9,900 8,000
10,000

2n
?50

10,000

8,000

Bought 50 Shares

Sold 50 Shares

P ortfo li o Re t' is

i'tn I ll I ]

and 20.000 to invest and he divides it equally between stocks According ro the Thble 21 .3, the investor has Rs rises by 20% ' ln quaflerly adjustment if the stock portion talls or boncls 50:50 that is 10,000: 10,000. He makes porrion initiating the action. He shified Rs 2000 trom rhe bonds' the thircl quarter, the stock prices fell by 20%

arrdbought50shares.rrrisliftedtirevalueofStockportionagaintoRs10.000.

Inthefifthquarter,thestockpricelrasincreasedfronrRs40toRs50,a20percentincrease.lnthisaction pointtheinvestordisposesoffthesharesandshiftsthemoneytothebondportion'Bythisthestockalnountin to gain by rhe

stands totar portfolio vaiue has increased. The invcstor the portfolio has remained constant but the

total portfolio value appreciation'

T1," n ulo. rJua,rttgg 0f t|1ig

fllill

[|1il ru16f1nil nil$ unif,il

f,lf, $?lcr.*in'd

automaticauv rhis thcilitates

theinvestortoearncapitalgainbysellingthestockswhentlrepriceincreasesandbuyingitatarelatively cither at the starting point, stocks should not be purchased lower price. To make tne ptai operate effectively,
high prices or at too low prices. lf may be either too small or too large'

at

price level' the stock ftlnd the investor starts the purchase at the extrene

Gonstant Ratio Plan

Constantratioplanattemptstomaintainaconstantratiobetweentheaggressiveandconservativt-portfolios. the role irl lixing attitude towards risk and return plavs a major The ratio is fixed by the investor. The i'vestor's

ratio.Theconservativcinvestornray|iketoliavenroreofbonclandtheaggressiveillvcstor.nroreofStoctris' action points ma'v be fixed

the market moves up and down' As usual' Once the ratio is fixecl, it is maintainccl as the stock price meves to investor' r\s in the previous example' whcn by the investor. lt nay vary from investor

upordownbyl0to20p.r".nractionwouldbctaken'Here'l0irercentistakenasactionpoint'Thetairle2l'4
shows the constant ratio Plan'

Table 2l .4 Constant ltatio Plan

[V[arket

Pric

5.5 shai'es purchased Its 24g translerrecl from bond portioi: and
45

40.5

l3l

bond portion. nougt,t 5.g shares by transferring F.s 239lrom

40.5
44.5

l \W-:;rl

\-'"?
4st1
4)ll +stt

l.m

q'o

Iu4
1l
.

| '
|

+stz | no<? I
+gSl ,

I |
:

9,#)B

tc makc ths i"atio equal 5 shares are solti aud investcd in bonCs

[440]

Security Analysis and portfulio Managenent

The advantage of constant ratio plan is the automatism with which it forces the manager to counter adjust his portfolio cyclically. But this approach does not eliminate the necessity of selecting individual security. The limitation of the plan is that the money is shifted from the stock portion to bond portion. Bond is also a capital market instrument and responds to market pressures. Bond and share prices may both rise and fall at the same time. In the downtrend both prices may decline and then gain.

VARIABLE RATIO PLAN

According to this plan, at \arying levels of market price, the proportions of the stocks and bonds change. Whenever the price of the stock increases, the stocl$ are sold and new ratio is adopted by increasing the proportion of defensive or conserntive portfolio. To adopt this plan, the investor is requirerJ to estimate a long term trend in the price of the stocks. Forecasting is very essential to this plan. When there is a wide fluctuation variable ratio plan is useful. The table 21.5 explains the variable ratio plan.
Table 21.5 Variable Ratio Plan Share Value
(Rs)
10,000

of

Value
(Rs)

of

Tbtal

Stock as

Portfolio

Price
(Rs)
100

Stock portion

Defensive

Portfolio
Value (Rs)
20,000 19,000
18,000 18,040

a Percentage

of Adjustment

Shares in Stock Portiort

(Rs)
100

Advanl
chan,-ees.

Portfolio (Rs)
50.m
47.37 44.4 70.06 Bought 58 Shares

the rarial

10,000 10,000 10,000

m
80 80

9,000 8,000
12,640

lm lm
158

Limita

5,400

1. 2.
3.
\lfth

The i
The

nol
158

90
100 100

14,220 15,800
10,900

5,400 5,400
10,800

19,620

72.48 74.53

21,2m

If

Sold 50 Shares

rl:

158
108

2l.m

50.m

RE\/tSil
the

In the above example, the portfolio is adjusted for every 20 per cent change in the stock price. This adjustment criterion may be different for different investors depending upon their attitude towards risk and return. The portfolio is divided into two equal portions as in the case of other plans, with Rv10,000 irr each. Let
fall in the price of the stock, then, the percentage of stock in the portfolio declines. As the market price for the stock reaches a 20 per cent decline, that is to Rs,80, the adjustment action takes place. Thepurchaseof 58sharesraisesthestockportion to72.48percent. Onceagain, whenthereisa20per
us assume that there is a

rerurn. Tr also ma) revision cl

on the b;.. that the

spread R

cent change, the adjustment action is triggered. When the prices have increased to Rs 100, the investor sells 50 shares and the stock portion in the portfolio is reduced back to 50 per cent. The figure

the bene--: e.\peclec

2l.I

explains the variable ratio plan.

The middle line is the trend line that represents the investor's expectation about of future course of prices. Zone I and 3 represent respectively of l0 and 20 per cent deviations above the expected trend, and zones 2 and 4 represent respectively l0 and 20 per cent deviations below the expected trend. Starting at Rs 50, the portfolio's bonds and stocks ratio is 50:50 . At point A, the portfolio is adjusted to the next proportion, in this case 60 per
cent bonds and 40 per cent stocla. At B, again it is 50:50. Below point C there would be more stocks than bonds. Because of the decline in stock price, more stocks are purchased. Above the point D, it is again 50:50. The line moves closer to the trend line.

Swaps
S*ao ls a
based

The ltrqr ;,

o: :

are ba-.ed

ffiilpilililfl il0ilff llr pllt[tlaffir 10000 illilnr

ruilt0ll0

iltt

t0fil|ffi}l

fliillilill

LJ,,, ,l ll .1il [,,ll, ,

'

i lrllllllll

,,ill,'
"lr,*h

l,

,,r|,

,l',, ,,

il,,, , , ,lf, 1,,

t Ratio plan

Action
20.00
21,00 22.00 22.00 20.00 21.00.. 22.00 22.00 10.00 10.00 10,00 10.50 10.00 10.50 11.00 10.50

of snarei in tiie Aggressive portfolio

20.00 20.50
21.00 21.00

1.00
t.&

0.5000

1.00
0.95

'l;, $yW';'::; nmr

setr oloee

shares at Rs.22.00
21.00 21.00 10.50 10.50 10.50 10.02

0.4773

20.00
19.80 19.80

20.52 2A.0s 19.95

20 00
19 80 19.80

9.5s
9.45

9.975

9.975

19.95

1.oo ,,;bX'f,

oel tlie{
lakh shares at Rs.19.80

0.91

1a1io the buy-and_r,ora po,troilo

porrion of the constant

ilfr;ff #t",t:!il."L,:";:'[:liffi ]+lJ; zo.oo i;[h.;, d lnu"rnn.nt *u, price of the shares1l:-J'1,;l;;;;;s-,l", qo. and we r,uu" toLmtain it. rhe that constitutJ ,r" f;"r-g,r,ora
the varue of the buv-and-hord made equally, ,n"

portroriowerormrirate.a.iljf

p""r"ri" *u, n, i"

aggressive porrion

;;;;;;;e ugg,.,,ru" ;;;r;;i; ;",ffiff1';J.ilItti:oe*

the buyln4-6o16

Rs'19'80 each using tunds from rh;

n;il;h*Hiro T,. niiq.g6, ii.""rrr" gr thi aggressive Rs.20,00 porrforio is th" .onrr*uii"" oonr"ri" ,",nuin-"d at Rs.10.50 lakh. The rario now becomes q.ayib l0'= l0 percent and cails for rebarancing b.nii, *f,r"r, i, rrrrr, ,ir"""*"'*., ratio by oi.. rebalancing is done io..rtor" ratio ro r.00. we buv shares th" "r"ir, thii time--'*a. wr-uuy
and turther to Rs.r9.80. a, Rs'9'45 lakh' The value,of

fr", ,"""i"0 the action point. Rebalancing is aimed at restoring the 0'0227 rakh shares at. Rs.22.d0 ratio to 1.00. we can achieve this by selring conservarive porrforio.(that "rJ--ir".rirg the amount ,"utira is, in u"iarj.'a11r,Is point,-t-iJri#pri". in the moving downwards' rkst it started r.ri rii,.i.)oo ,r,,ir,il down the value of rhe aggressive portforio ro nr.r-o.oi-r"n, tsut this is st'r above rhe a*ion point oio.-oo. ""Jil.'r"r. Jiri?0,"" to 0.95. ,r,1*

"hang"s-io;i.d;il.;; rebalance the portfolio as the ratio

Rs'22'00 from Rs.2r.0o. Iakh and rhe ratio

portror io at trris staee i' I b. s iiz r b. ijr :', t'10' So no actionis re_quired at trris stagel'The

:i EiJ'fl3*'Tffi:Tfl"T#T#gg j!
n".,' irr.'r"r"3

portilio "ii'*, aggressive -,jiJ'#-;I. "1"rg"a ry.21^oo"n". lir.icoo The varue of ;;;;;*; i.,.2 r..oo uuru" or the "11ry.gryt""it"ri" piil "tung"d--to *.r,i.io lakh. As the ^"#'*
pr""

;;;iG

"ir*,"..ggressive portrotio is Rs.r.00 =. r.10. at mii point, we have to

lff*ff 'J:ff ;,;f?# ';ffi:ffi :i j; nexr;;;;;ffi;'lnl.e p.ice i, to

ra,io p,an

r."-

*rJi il;

d.ozos iakh shares at portfolio. Thus, the value of the _ borh become equar to Rs.e e75

W&t

us

rake

in this plan tn comparison _^

with

209