Factors Affecting Investment Decisions and Fundamental versus Technical Approaches

1) Amount of Investment The amount of surplus funds available with the organization.
The purpose of best utilization of their available surplus
cash resources.
2) Objective of investment
portfolio
High capital appreciation
Assure safety of the funds & a steady return
3) Selection of Investment What to buy
3A) Type of securities Debentures convertible / non convertible, etc
3B) Proportion between fixed & variable yield securities Fixed yield securities
Debentures / Government securities / Preferences shares /
Variable yield securities
Do not ensure a fixed return. The return depends upon the
earnings of the company.
3C) Selection of Industries Select the industries whose securities should comprise his
investment portfolio.
This will require a careful analysis of the past performance &
future prospectus of different industries.
3D) Selection of companies The FM has to select particular companies in that industry
whose securities have to constitute his investment portfolio.
4) Timing of Purchase The time of purchasing the securities is also of crucial
significance for the FM.

Fundamental versus Technical Approaches
According to the Fundamental Approach, the intrinsic value of a security is
equivalent to the present value of the future stream of income from the security
discounted at an appropriate risk adjusted interest rate.
The estimate of the real work of the security can be made on the basis of...
1) Earning potentials of the company & various other factors like business
environment.
2) Prevalent competition in the industry
3) Competitive strength of the company
4) Quality of management
5) Operational efficiency
6) Stock exchange quotations
According to Technical Approach, the decision to buy / sell a security can be
made on the basis of assessment of the demand & supply factors.
Technical Approach is basically based on this premise that there are persistent
& recurring patterns of price movements.
3 categories…
1) Stock Price & Volume Techniques
A) Primary Movements
B) Secondary Movements
C) Daily Movements
Dow Jones Theory
2) General Market Analysis Attempts to determine the basis & the general
trend of security prices.
3) Theory of Contrary Opinion Based on the general principle "Go against the
market".
 Dow Jones Theory
1) Primary Movements
These are the long term movements of the prices of securities
on the stock exchange.
Market prices show a rising trend – Bull Phase
Market prices show a falling trend – Bear Phase
2) Secondary Movements
These represent short term movements in stock exchange.
They are opposite in direction to the primary movements.
Market prices show a rising trend – Bear Phase
Market prices show a falling trend – Bull Phase
3) Daily Movements These represent daily irregular fluctuations in the stock
exchange prices.
They are without any definite trend.
This fluctuation can only be of interest to a speculator.
 Random Walk Theory
The theory predictions can be made about the future behavior of stock
exchange prices.
According to the theory, the stock exchange prices can never be predicted.
Stock exchange prices are absolutely unconnected & they are a mere statistical
happening.
Stock exchange prices exactly behave in a way in which a drunken person
would behave.
The stock exchange prices are absolutely independent & they can not form a
proper base for the Finance Manger to take investment decisions.
 Formula Plans
This plan provides an automatic timing device for the investor when to buy &
sell the securities.
1) Rupee cost
Averaging Plan
Rupee averaging / Strict rupee averaging plan
This plan consists of investing at regular intervals a fixed rupee
amount in selected securities / group of securities.
2) Modified rupee
averaging plan
The investor should put an equal amount of money into each of
the fixed list of securities at the same time each year.
An investor may investor a fixed amount every time but may
continuously vary the securities purchased.
The investor may buy the same securities each time but may
vary the timings of his investment during the year.
3) Ratio Formula
Plan
Ratio formula plan requires an alternation of investment
between different securities.
Ratio formula plan requires an alternation of investment
between different securities.
The investor switch from shares when others are anxious to sell
them.
Sale of securities is made gradually as the prices rise &
purchases are made which will automatically determine the
timing & amount of transaction.
3A) Constant ratio formula plans
The amount available for investment is pre determined.
The population between fixed yield bearing securities
Variable yield securities - Defensive component.
Variable yield bearing securities – Aggressive component
At pre determined intervals, as the case may be the market
value of total investment portfolio is worked out.
3B) Variable ratio
formula plan
The FM under this plan sells the shares within their prices rise &
buys the bonds in their price.
He continuously reduces the proportion of his portfolio when the
share prices fall.
 Markowitz Efficient Model
An investor should seek a portfolio of securities that lies on the efficient frontier.
Markowitz emphasized that variance of the return was a significant yardstick for
measuring risk under reasonable assumptions.
Assumptions regarding the Markowitz Model…
1) An investor considers each investment alternative as being represented by
a probable distribution of the expected returns over the some holding
period.
2) An investor estimates his risk on the basis of variability of expected returns.
3) The decision of the investor regarding selection of his investment portfolio
lays basically on expected return & risk from the investment.
4) The investor prefers a higher return to lower return for a given degree of risk
level. He prefers less risk to more risk for a given level of expected return.
 Capital Assets Pricing Model
The model explains the relationship between the expected return, unavoidable
risk & the valuation of securities.
The term unavoidable risk means the risk which simply can not be avoided by
diversification.
CAPM expresses the following ideas…
1) The required rate of return of all financial assets depends in part on risk less
rate of return.
2) Investors are primarily concerned with unavoidable risk.
3) Investors require premium for bearing the risk depending upon the degree
or risk.
4) Since the investors are risk - averse, the higher the risk the greater is the
expected return.
Re = Rf + (Rm – Rf)
Re = Expected return
Rf = Risk free return
Rm – Rf = Risk premium = Risk management
The CAPM is based on the following assumptions…
1) Capital markets are highly efficient & investors are well informed.
2) Transactions costs are nil & there are negligible restrictions on investment.
3) No investor is large enough to affect the market price of the stock.
4) Investors are risk averse.
5) Investors have homogenous expectations regarding risk & return on
securities.