Preface
In the last five decades or so, the field of investments has received considerable attention
from academic researchers keen on understanding issues like:
. How should risk be measured?
. What is the relationship between risk and return?
. How should financial assets be valued?
. How efficiently do financial markets function?
. What is the importance of asset allocation?
. How can financial derivatives like options and futures be valued?
. What is the role of derivatives in portfolio management?
. How successful are the various strategies followed by investment practitioners?
Scientific research has provided valuable insights into these issues and, even more
important, has significantly shaped the practice of investment management. The effect has
indeed been very profound and is vividly captured in the title of an exceptionally incisive
and thought provoking book, The Capital Ideas: The Improbable Origins of Wall Street. In
this book Peter Bernstein discusses how the insights provided by academic research have
shaped the investment practice on Wall Street. No wonder the pioneers of modem finance
and investments like Harry: Markowitz, William Sharpe, James Tobin, Merton Miller,
Robert Merton, and Myron Scholes went on to become Nobel Laureates in Economics. The
ideas that have revolutionised investment management practice on Wall Street and
elsewhere have become relevant in other capital markets including the Indian capital
market, which have in turn witnessed major transformation in recent times.
Investment Analysis and Porfolio Management seeks to capture the essence of m.odem
developments in investments. It is an introductory book aimed primarily at two audiences:
* MBA students taking a course on Investments (popularly called Security
Analysis and Portfolio Management or SAPM in most Indian universities).
. Investment practitioners like equity researchers, portfolio managers, investment
counsellors, and corporate treasurers.
Given its introductory nature, I have tried to present the material in an intuitive and non-
mathematical manner as far as possible. Only elementary statistics and simple algebra are
used. Thanks to its relatively non-technical nature, the book would also appeal to lay
investors interested in managing their investments in a rational and systematic manner.
Investment Analysis and Portfolio Management provides a guided tour of the so-called
'complex' world of investments and seeks to improve your skills in managing investments.
The book:
. Describes the characteristics of various investment alternatives available to
investors. · Discusses how the securities market functions. . Explains the techniques
used by professionals for analysing and valuing
investment alternatives.
. Explores the implications of modem research in the field of investments.
. Explains how financial derivatives, viz. options and futures, are valued.
. Presents a framework for portfolio management.
. Provides insights into the strategies followed by investment wizards of the world. .
Sensitises the reader to the pitfalls in the investment game.
. Offers a set of guidelines for investors with varying inclinations.
Many people consider investing to be a daunting activity. They are bewildered by the
profusion and proliferation of investment alternatives, rattled by the fluctuations in financial
prices, overwhelmed by the presence of mighty institutional investors, confounded by exotic
instruments and complicated investment strategies, confused by the intricacies of the tax
system, and exasperated by the financial scams that periodically rock the market.
Notwithstanding these concerns, investing can be a fairly manageable, rewarding, and
enjoyable experience, if you adhere to certain principles and guidelines. This book is based
on the premise that an intelligent lay investor does not suffer any handicap vis-a.-vis
sophisticated professionals. As Warren Buffett, arguably the most successful investor of our
times~ writes, "To invest successfully over a lifetime does not require a stratospheric IQ,
unusual business insights, or inside information. What's needed is a sound intellectual
framework for making a decision and the ability to keep emotions from corroding that
framework." This book seeks to discuss the intellectual framework for decision making. Of
course, the necessary emotional discipline must be provided by you.
What's New in the Second Edition
The excellent response to the first edition of the book encouraged me to add new materials to
expand and strengthen the book. The important additions are described below.
Chapters Four new chapters have been added to make the book more comprehensive:
. Chapter 3 : Mutual Funds
. Chapter 11 : Behavioural Finance
. Chapter 13 . Bond Portfolio Management
Chapter 15 Macroeconomic and Industry Analysis
Sections Six new sections titled 'Participants in the Securities Market, 'Going Beyond the
Numbers, "Other Comparative Valuation Ratios,' 'Forecasting the Aggregate Stock Market
Return,' 'Mechanics of Trading,' and 'John Bogle: Twelve Pillars of Investment Wisdom,'
have been added.
Appendices Three new appendices titled 'An Illustrative Equity Research Report,' 'Fama's Net
Selectivity Measure,' and 'Regression Analysis' have been added.
Minicases Eight minicases have been added on the following topics: 'The Time Value of
Money,' 'Financial Statement Analysis,' 'Capital Asset Pricing,' 'Bond Prices and Yields,'
'Equity Valuation,' 'Company Analysis,' 'Options,' and 'Portfolio Management' .
Boxed Material A number of boxes containing valuable perspectives, insightful observations,
and investment wisdom have been included.
Apart from the above, numerous minor changes and revisions have been made to
make the book up-to-date and reader-friendly.
Thanks to the above additions, this book represents a significant improvement over
it predecessor.
Solutions Manual and Powerpoint Presentations
A solutions manual containing solutions to the end of the chapter problems and cases and
powerpoint presentations of all chapters are hosted on the web site of Tata McGraw-Hill
(http://novella.mhhe.com:80/sites/0070599408).This can be accessed by the
instructors who adopt the book. They may contact Tata McGraw-Hill for assistance in
accessing the solutions manual.
Organisation of the Book
The book is organised into seven parts as follows.
Part I: Introduction Consisting of Chapters 1 through 4, Part I presents the investment
setting. Chapter 1 provides an overview of the field of investments. Chapter 2 describes the
features of various investment alternatives. Chapter 3 discusses the operation and schemes of
mutual funds. Chapter 4 explains how the securities market functions.
Part II: Basic Concepts and Methods Part II covers basic concepts and methods useful in
investments. Chapter 5 introduces the concepts of risk and return. Chapter 6 discusses the
methods for analysing the time value of money. Chapter 7 explains the tools of financial
statement analysis.
x Preface
Part III: Modern Portfolio Theory Chapters 8 through 11 present the central ideas of modem
investment theory and behavioural finance. Chapter 8 discusses the basic tenets of portfolio
theory. Chapter 9 dwells on the equilibrium relationship between risk and return. Chapter 10
explains the efficient market hypothesis. Chapter 11 distills the essence of behavioural
finance.
Part IV: Fixed Income Securities Part IV contains two chapters. Chapter 12 discusses bond
prices and yields. Chapter 13 explains the basic tools of bond portfolio management.
Part V: Equity Shares Consisting of Chapters 14 through 17, Part V looks at equity shares.
Chapter 14 discusses equity valuation models. Chapter 15 presents the basics of
macroeconomic and industry analysis. Chapter 16 discusses the tools for fundamental
analysis. Finally, Chapter 17 introduces technical analysis.
Part VI: Derivatives Part VI has two chapters that discuss financial derivatives. Chapter 18
explains the methods for valuing options and the strategies for using options. Chapter 19
looks at the valuation and use of futures.
Part VII: Portfolio Management Consisting of Chapters 20 through 22, Part VII focuses on
portfolio management. Chapter 20 presents a framework for portfolio management. Chapter
21 dwells on the basic guidelines for investment decisions. Chapter 22 explains the strategies
of the great masters.
PRASANNA
CHANDRA
chandra@cfm-
india.com
