Investment Process | Steps Involved while making Investment | Investment Environment | Finance MCQs
Step 1 : Setting Investment Objective
The investment objective is the motive of investors that stimulates the investors to invest in any investment alternatives. Investment Objectives should be stated in terms of both risks and return preference. Affecting factors of the objective are:
• Type of investors: There are three types of investors- risk seeker, risk-averse, or neutral. Risk seeker investors are those who seek a high rate of return and ready to bear a high level of risk. In contrast to risk seeker, risk-averse are those investors who want to avoid risk and be satisfied in less rate of return on the investment. Neutral investors are those who dont analyze the risk and return and have no specific preference.
• The age group of investors: Generally, young investors are risk takers, middle-age is risk averter, and retirement age people seek security.
• Amount of wealth: Investment is the unction of income, expenses, and saving. Higher-income and saving leads to higher investment rate.
Step 2 : Perform Security Analysis
It includes two types of analysis of securities of different companies in the market.
I. Technical Analysis (Trend Analysis)
Technical analysis the prediction of the price of securities based on the historical price of the securities. Technical analysis is the systematic evaluation of trading opportunities using statistics and makes a prediction. In this process price, volume and index are examined to find out the pattern of investment.
II. Fundamental Analysis
Fundamental analysis is the process of evaluation of the intrinsic value or theoretical value of securities. The intrinsic value of securities depends upon the economic and financial factors of the company and the economy. In the calculation of the intrinsic value of securities all environmental factors that affect the company operation should be considered.
• Market price < Theoretical value, it is undervalued securities so it should be purchased
• Market price > Theoretical value, it is overvalued Securities so it should be sold.
• Market price = Theoretical value, it is correctly priced security.
Step 3 : Construction of Portfolio
The collection of investment alternatives to diversify the risk is also called a portfolio. Portfolio construction is the process of diversification of risk. Invest in single security is like keeping all the eggs in a single basket. While the different portfolio is constructed optimum portfolio which earns the highest return on lowest risk should be chosen.
Step 4: Revision of Portfolio
Securities are again revised per risk and return as well as theoretical value and Market value of securities. Risk is the single factor of consideration in choosing an optimum portfolio. The portfolio should be revised according to theoretical value and technical analysis considering investment objectives.
Step 5 : Portfolio Performance Evaluation
Portfolios are evaluated based on their risk and return relationship. A constructed portfolio is evaluated based on the coefficient of variance. The lowest CV should be chosen.
|A||10||5||5/10 = 0.5 (good)|
|B||15||8||8/15 = 0.63|