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Security Analysis and Portfolio Management




                    Notes              one of these, we may point out basic assumptions and ground rules of formula plans as
                                       follows:
                                   2.  Basic Assumptions and Ground Rules of Formula Plan

                                       The formula plans are based on the following assumption.
                                       (a)  The stock prices move up and down in cycle.
                                       (b)  The stock prices and the high-grade bond prices move in the opposite directions.
                                       (c)  The investors cannot or are not inclined to forecast direction of the next fluctuations
                                            in stock prices, which may be due to lack of skill and resources or their belief in
                                            market efficiency or both.

                                       The use of formula plans call for the investor to divide his investment funds into two
                                       portfolios, one aggressive and the other conservative or defensive. The aggressive portfolio
                                       usually consists of  stocks while conservative portfolio  consists of  bonds. The formula
                                       plans specify predesignated rules for the transfer of funds from that aggressive into the
                                       conservative and vice-versa such that it automatically causes the investors to sell stocks
                                       when  their prices are rising  and buy  stocks when their prices are falling. Let us now
                                       discuss, one by one, the three formula plans.

                                                 What is Constant Dollar-Value Plan?
                                     Did u know?
                                     Constant Dollar value plan is a investment strategy designed to reduce volatility in which
                                     securities, typically mutual funds, are purchased in fixed dollar amounts at regular intervals,
                                     regardless of what direction the market is moving. Thus, as prices of securities rise, fewer
                                     units are bought, and as prices fall, more units are bought also called constant dollar plan,
                                     also called dollar cost averaging.
                                   3.  Dollar Cost Averaging: Periodic investment of a fixed dollar amount, as in a particular
                                       stock or fund or  in the  market as  a whole, on the belief that  the average  value of the
                                       investment will rise over time and that it is not possible to foresee the intermediate highs
                                       and lows.

                                       Dollar-Cost Averaging – DCA: It is a technique of buying a fixed dollar amount of a particular
                                       investment on a regular schedule, regardless of the share price. More shares are purchased
                                       when prices are low, and fewer shares are bought when prices are high. Also referred to as
                                       “constant dollar plan”.

                                       Investopedia says: “Eventually, the average cost per share of the security will become smaller
                                       and smaller. Dollar-cost averaging lessens the risk of investing a large amount in a single
                                       investment at the wrong time. In the UK, it is known as “pound-cost averaging.”

                                       The Constant-Dollar-Value  Plan (CDVP)  asserts that the  dollar value (or rupee value in
                                       Indian context) of the stock portion of the portfolio will remain constant. This in operational
                                       terms, would mean that as the stock rises, the investor must automatically sell some of the
                                       shares to keep the value of his aggressive portfolio constant. If, on the other hand, the
                                       prices of the stocks fall, the investors must buy additional stocks to keep the value of the
                                       aggressive portfolio  constant. By  specifying that the aggressive  portfolio will  remain
                                       constant in dollar  value, the  plan implies that the remainder of the total  fund will  be
                                       invested in the conservative fund. In order to implement this plan, an important question
                                       to answer is what will be the action points? Or, in other words, when will the investor
                                       make the transfer called for to keep the dollar value of the aggressive portfolio constant?
                                       Will it be made with every change in the prices of the stocks comprising the aggressive




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