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CFM-MH Professional Series in Finance Investment Analysis and Portfolio Management Fourth Edition  CFM-MH Professional Series in Finance Honorary Consulting Editor: Dr. Prasanna Chandra The CFM-MH Professional Series in Finance, a joint initiative...

CFM-MH Professional Series in Finance Investment Analysis and Portfolio Management Fourth Edition  CFM-MH Professional Series in Finance Honorary Consulting Editor: Dr. Prasanna Chandra The CFM-MH Professional Series in Finance, a joint initiative of the Centre for Financial Management and McGraw-Hill Education, India, seeks to synthesise the ûndings of ûnancial research with the concerns of practitioners. The aim of the books in this series is to convey the important developments in the theory and practice of ûnance in a rigorous, but relatively non-technical, manner for the beneût of (a) ûnance practitioners and (b) students of MBA. Titles in the Series Financial Management: Prasanna Chandra Theory and Practice, 8/e Projects: Planning, Analysis, Prasanna Chandra Selection, Financing, Implementation and Review, 7/e Finance Sense: Finance for Prasanna Chandra Non-ûnance Executives, 3/e Investment Analysis and Prasanna Chandra Portfolio Management, 4/e Corporate Valuation and Value Creation Prasanna Chandra International Finance: Prakash G Apte A Business Perspective, 2/e Investment Banking: Pratap G Subramanyam Concepts, Analyses and Cases Investment Banking: Pratap G Subramanyam An Odyssey in High Finance Macroeconomic Policy Environment, 2/e Shyamal Roy Corporate Governance and Stewardship: Emerging Role and Resposibilities of Corporate Boards and Directors N Balasubramanian A Case Book on Corporate Governance N Balasubramanian and Stewardship  CFM-MH Professional Series in Finance Investment Analysis and Portfolio Management Fourth Edition Prasanna Chandra Director Centre for Financial Management Bangalore www.cfm.india.com Tata McGraw Hill Education Private Limited NEW DELHI New Delhi New York St Louis San Francisco Auckland Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal San Juan Santiago Singapore Sydney Tokyo Toronto Published by Tata McGraw Hill Education Private Limited, 7 West Patel Nagar, New Delhi 110 008 Copyright © 2012, Tata McGraw Hill Education Private Limited. No part of this publication may be reproduced or distributed in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise or stored in a database or retrieval system without the prior written permission of the publishers. The program listings (if any) may be entered, stored and executed in a computer system, but they may not be reproduced for publication. This edition can be exported from India only by the publishers, Tata McGraw Hill Education Private Limited. ISBN (13): 978-1-25-900599-2 ISBN (10): 1-25-900599-2 Ajay Shukla Publishing Manager4Professional: Sr. Copy Editor: Manager4Production: Asst. General Manager4Sales and Business Development4Professional: General Manager4Production: ! Manager4Production: " Information contained in this work has been obtained by Tata McGraw-Hill, from sources believed to be reliable. However, neither Tata McGraw-Hill nor its authors guarantee the accuracy or completeness of any information published herein, and neither Tata McGraw-Hill nor its authors shall be responsible for any errors, omissions, or damages arising out of use of this information. This work is published with the understanding that Tata McGraw-Hill and its authors are supplying information but are not attempting to render engineering or other professional services. If such services are required, the assistance of an appropriate professional should be sought. Typeset at Script Makers, 19, A1-B, DDA Market, Paschim Vihar, New Delhi 110063 and printed at *** Cover Printer: *** Cover Designer: Kapil Gupta ********  To my readers for their encouragement and to Padma for her support and Siddharth and Samarth for their contribution  Preface to the Fourth Edition In the last six decades or so, the ûeld 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 ûnancial assets be valued? How efûciently do ûnancial markets function? What is the importance of asset allocation? How can ûnancial 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? Scientiûc research has provided valuable insights into these issues and, even more important, has signiûcantly 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. The enthusiastic response to this book and the rapid evolution of investment practice prodded Peter Bernstein, undoubtedly today9s foremost ûnancial historian, to write an equally insightful sequel, Capital Ideas Evolving. This book tells the story of the remarkable success of a group of institutions who founded their strategies on a set of ideas and principles that emanated in the academic world. No wonder the pioneers of modern ûnance 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 Portfolio Management seeks to capture the essence of modern 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 viii Preface to the Fourth Edition 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 Porfolio Management provides a guided tour of the so- called 8complex9 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 modern research in the ûeld of investments. Explains how ûnancial 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 ûuctuations in ûnancial 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 ûnancial 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, perhaps the most successful investor of our times, writes: