You are on page 1of 24

1.3 INTRODUCTION TO RISK AND RETURN RISK Risk is an important consideration in holding any portfolio.

The risk in holding securities is generally associated with the possibility that realized returns will be less than the returns expected Risks can be classified as Systematic risks and Unsystematic risks.

Unsystematic risks: These are risks that are unique to a firm or industry. Factors such as management capability, consumer preferences, labor, etc. contribute to unsystematic risks. Unsystematic risks are controllable by nature and can be considerably reduced by sufficiently diversifying one's portfolio.

Systematic risks: These are risks associated with the economic, political, sociological and other macro-level changes. They affect the entire market as a whole and cannot be controlled or eliminated merely by diversifying one's portfolio.

The three main risk associated with investing in a share are 1. The value of your investment could fall. 2. The amount of income you receive can fall, or stop altogether.
3.

Your investment may increase at a lower rate than the rate of inflation, thus eroding the purchasing power of your investment.

1

How to minimize the risks? The company specific risks (unsystematic risks) can be reduced by diversifying into a few companies belonging to various industry groups, asset groups or different types of instruments like equity shares, bonds, debentures etc. thus, asset classes are bank

deposits, company deposits, gold, silver, land real estate, equity share, computer software etc. Each of them has different risk-return characteristics and investments are to be made, based on individual’s risk preferences. The second category of risk (systematic risk) is managed by the use of beta of different commodities.

METHODS TO CALCULATE THE RISK Standard Deviation: Volatility is a direct indicator of the risk of the fund. The standard deviation of a fund measures this risk by measuring the degree to which the fund fluctuates in relation to its average return of a fund over a period of time. A security that is volatile is also considered higher risk because its performance may change quickly in either direction at any moment.

Beta Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is fairly a commonly used measure of risk. It basically indicates the level of volatility associated with the fund as compared to the benchmark and is also known as "beta coefficient". So quite naturally the success of Beta is heavily dependent on the correlation between a fund and its benchmark. Thus if the

2

fund’s portfolio doesn’t have a relevant benchmark index then a beta would be grossly inadequate. Beta can be calculated using regression analysis, and beta is the tendency of a security's returns to respond to swings in the market. A beta that is greater than one means that the fund is more volatile than the benchmark, while a beta of less than one means that the fund is less volatile than the index. A fund with beta very close to 1 means the fund’s performance closely matches the index or benchmark.

RETURN The gain or loss of a commodity in a particular period is called return. The return consists of the income and the capital gains relative on an investment. It is usually quoted as a percentage. The general rule is that the more risk you take, the greater the potential for higher return - and loss. Return can come from two sources, capital growth and income. Capital growth occurs when the market value of the commodity increases. Income is the cash flow paid by an share such as dividends.

VOLATILITY Volatility is the degree to which an asset's value rises and falls. Typically, higher volatility equals higher risk. Generally, growth assets (such as shares and property) have a higher risk than defensive assets (such as government bonds and cash).

3

RELATIONSHIP BETWEEN RISK AND RETURN:

Risk-Return Tradeoff The principle that potential return rises with an increase in risk is called risk return trade off. Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. In other words, the risk-return tradeoff says that invested money can render higher profits only if it is subject to the possibility of being lost.

Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. Taking on some risk is the price of achieving returns; therefore, if you want to make money, you can't cut out all risk. The goal instead is to find an appropriate balance - one that generates some profit.

4

OBJECTIVE OF THE STUDY Primary: • • • To analyze the return and return pattern of selected securities in the four sectors To compare the performance of the stock with that of the Nifty index. To analyze the performance of the company securities before and after the announcement of the budget 2006.

Secondary: • To assess the impact of the securities return on Nifty index performance.

NEED FOR THE STUDY

In India, the MCX is the most scientific Index that was constructed keeping in mind Index funds and Index derivatives. All companies to be included in the Index have a market capitalization of Rs.5 billion or more. The MCX is a market capitalization – weighted Index i.e., price change in any of the Index Commodities will lead to a change in the index. This necessitates the need for analyzing the risk and return relationship of the selected commodities constituting the MCX index and their impact on the MCX index.

5

SCOPE OF THE STUDY

Study could be done to analyze the performance of the selected commodities for the year 2007 .

LIMITATIONS The limitations involved in this study are
• •

In each sector only two good performing commodities were selected for the study. The performance of the company securities were studied only for a year from 1st January to 31st December 2007.

6

RESEARCH METHODOLOGY

7

RESEARCH METHODOLOGY

RESEARCH DESIGN: The study was carried out to compare the selected commodities with the MCX index using their returns, and to analyze the risk involved in each comodity in the sectors and risk involved in the sector for investment. Thus the study undertaken was Descriptive study.

SAMPLING DESIGN

SAMPLING METHOD Judgmental sampling was used as sampling method. The sector and the companies in the sector were selected based on the recommendation given by the brokers in the firm.

SAMPLE SIZE SIZE: It

refers to the number of elements included in the study.

Four types of commodities were selected for the study and two commodities from each sector was selected based on the recommendation given by the brokers in the firm.

8

COMMODITIES TYPE SELECTED

=

4

The sample size of the project can be known by the following table COMMODITIES TYPE BULLION BASE METALS ENERGY AGRI COMMODITIES Total sample size NO OF COMMODITIES 2 2 2 2 8

COLLECTION The data collected were by means of secondary data. The data were collected from Internet, Greenbucks Comtrade records and magazines.

9

TOOLS USED FOR ANALYSIS  Beta  Correlation  Regression  Paired sample t test  Descriptive statistics o o  Return Return was calculated using the formula Return = yesterday’s price – today’s price yesterday’s price Mean standard deviation

10

ANALYSIS AND INTERPRETATION

11

ANALYSIS AND INTERPRETATION

ANALYSING THE IMPACT OF COMMODITIES ON MCX PERFORMANCE The commodities selected for study are: 1)GOLD 2)SILVER 3)CRUDE 4)NATURAL GAS 5)COPPER 6)NICKEL 7)CARDAMOM 8)JEERA

12

ANALYSING THE RISK AND RETURN
MONTH JANUARY FEBURARY MARCH APRIL MAY JUNE JULY AUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER GOLD 3.45 -2.01 2.66 -5.47 -3.37 -0.56 1.4 4.54 2.12 9.89 3.07 00.00 SILVER 5.79 -3.74 -0.41 -5.77 -2.14 -2.76 -1.97 9.73 -0.27 5.10 -3.19 00.00 CRUDE OIL 5.93 3.36 4.53 -6.58 5.57 6.10 NATURAL GAS 12.03 -4.25 1.85 -0.72 -4.17 -15.23 -1.51 2.47 5.36 11.74 5.15 6.03 -2.84 00.00 -10.90 00.00 9.67 00.00 8.93 00.00 -4.12 00.00 -14.58 00.00 -1.13 -1.62 25.28 CARDAMOM 13.94 1.15 2.70 -0.19 -2.69 8.17 JEERA 9.12 20.77 11.06 -10.61 1.81 -22.26 -14.50 COPPER -1.59 9.76 14.43 -2.57 -3.56 3.86 NICKEL 10.96 12.50 5.87 -0.81 -17.69 -20.63 -16.29 5.66 3.06 -1.58

-0.85 6.18 6.16 11.19

-5.05 0.95 2.71 -10.21

3.79 -0.16

13

1)CHART SHOWING RETURN OF SELECTED COMMODITIES

MONTHLY RETURNS
30 20 10 RETURN 0
JAN FE B MA R APR IL MA Y JUN E JUL Y AUG SEP T OC T NO V DE C

GOLD SILVER MCX CRUDE OIL NATURAL GAS CARDAMOM JEERA COPPER NICKEL MONTHS
14

-10 -20 -30

Table 3.1.1. b RISK OF THE SELECTED COMMODITIES

THE RELATIONSHIP OF THE MCX WITH THE SELECTED COMMODITIES
15

HYPOTHESIS Ho: There is no significant relationship between the selected Commodities return and MCXreturn. Ha: There is a significant relationship between the selected Commodities return and

MCX return. Table 3.1.2.a return.
COMMODITIES MCX SIGNIFICANT P-LEVEL GOLD SILVER CRUDE NATURAL GAS COPPER NICKEL CARDAMOM JEERA

Correlation between the selected Commodities return and MCX

0.675 0.748 YES YES .01 .01

0.878 YES .01

0.643 YES .01

0.221 YES .01

0.524 YES .01

0.148 YES .01

0.404 YES .01

INTERPRETATION:

The correlation factor was significant for gold, Silver, Crude, Natural gas and Nickel return to MCX return. They show a positive correlation of 0.675, 0.748, 0.878, 0.643 and 0.524 respectively [refer table 3.1.2.a].

THE IMPACT OF SELECTED COMMODITIES RETURN RETURN HYPOTHESIS

ON THE MCX

Ho : There is no significant impact of the return of the Commodities on the nifty return

16

Ha: There is a significant impact of the MCX return of the selected Commodities on the MCX return Table 3.1.3.a Anova table for MCX return and Commodities returns MODEL GOLD SILVER CRUDE NATURAL GAS
Regression Residual Total CARDAMOM Regression Residual Total JEERA Regression Residual Total COPPER Regression Residual Total NICKEL Regression Residual Total 0.034712 0.049288 0.084 0.01836 0.082164 0.084 0.013676 0.070324 0.084 0.04089 0.079911 0.084 0.023104 0.060896 0.084 1 10 11 1 10 11 1 10 11 1 10 11 1 10 11 0.034712 0.004929 170.043 0.01836 0.008216 122.3 0.013676 0.00070 159.45 0.04089 0.007991 150.12 0.023104 0.006090 137.94 Regression Residual Total Regression Residual Total Regression Residual Total Sum of Squares 0.038259 0.045741 0.084 0.04693 0.037064 0.084 0.064731 0.019269 0.084 df 1 10 11 1 10 11 1 10 11 Mean Square F 0.038259 0.004574 183.64 0.046936 0.00037 126.63 0.06473 0.00019 133.59 Sig.

0.000 0.00 0.00

0.00 0.00 0.00 0.00 0.00

Table 3.1.3.b R square table for MCX return and selected Commodities return.
Model R R Square Adjusted R Square Std. Error of the Estimate

GOLD SILVER

0.675 0.748

0.455 0.559

.401 0.525

0.02138 0.01925
17

CRUDE NATURALGAS CARDAMOM JEERA COPPER
Model

0.878 0.643 0.148 0.404 0.221
R

0.771 0.413 0.022 0.163 0.049
R Square

0.748 0.355 0.76 0.79 0.46
Adjusted R Square

0.01388 0.02222 0.02866 0.02651 0.02826
Std. Error of the Estimate

NICKEL

0.524

0.275

0.203

0.02467

Table 3.1.3.c
Model

Coefficient table for MCX return and Commodities return.
Unstandardized Coefficients B Standardized Coefficients Beta Sig. t

Std. Error

GOLD SILVER CRUDE NATURALGAS CARDAMOM JEERA COPPER NICKEL

0.463 0.454 0.496 0.218 0.079 0.081 0.091 0.125

0.160 0.128 0.086 0.082 0.167 0.058 0.127 0.064

0.675 0.748 0.878 0.643 0.148 0.404 0.221 0.524

2.892 3.559 5.796 2.654 0.473 1.395 0.715 1.948

0.016 .005 .000 .024 0.647 .193 .491 .080

INTERPRETATION: ANOVA significance value of 0.000 for all the selected comodities in the sector proves that the model taken for study was fit at a 95% level of confidence [refer table 3.1.3.a]. The R square value was less than 0.5 for all except Crude and Silver . This shows that the returns of commodities haaving R square value less than.5 would not have affected the MCX return very strongly as individuals [refer table 3.1.3.b]. Together they have an impact on the MCX return. The overall beta for the commodities were found to be 0.675, 0.748, 0.878, 0.643, 0.148, 0.404,0.221 ,0.524 for Gold,Silver,Crude,NaturalGas,Cardamom,Jeera,Copper and

18

Nickel return respectively [refer table 3.1.3.c]. Among these commodities Silver and Crude were found to be moderately risky commodities to invest in. the rest commodities were of less risk to invest in.Gold, Silver ,Crude ,Naturalgas,Cardamom,Jeera,Copperand Nickel returns had 67.5%, 74.8%, 87.8%, 64.3%,14.8%,40.4%,22.1%and52.4% impact on the MCX return respectively. Beta value is a indicator of risk. When beta value is greater than 1 then the commodities is a high risk commodities for investors.

3.1.4 DEPENDANCE OF MCX RETUN ON THE COMMODITIES RETURNS
Coefficients(a) Unstandardized Coefficients (Constant) GOLD SILVER CRUDE NATURAL GAS NICKEL B -.507 .078 .009 .385 .114 .017 Std. Error .441 .125 .138 .090 .052 .028 Standardized Coefficients Beta .114 .015 .682 .336 .086 B -1.150 2.626 .067 4.291 2.195 .626 Std. Error .294 .000 .000 .000 .000 .000

Model 1

a Dependent Variable: MCX

Model Summary Adjusted R Square .845 Std. Error of the Estimate 1.08771

Model 1

R .957(a)

R Square .915

a Predictors: (Constant), GOLD ,SILVER,CRUDE,NATUARLGAS,NICKEL

INTERPRETATION:

19

The dependence of the MCX return to highly correlated COMMODITIES returns can be given by the equation

MCXRETURN=
-0.507+.078(GOLD’sRETURN)+0.009(SILVER’sRETURN)+0.385(CRUDE’sRETURN)+ 0.114(NATURALGAS’s RETURN)+0.017(NICKEL’s RETURN)

The R square value of 0.915 proves that the Gold, Silver,Crude,Natural gas and Nickel commodities return have a good impact on the MCX return.

20

CONCLUSION

21

CONCLUSION

The risk and return plays a major role in the decision making process of the investors. The standard deviation and beta are the true measure of risk. Investors can make investment decisions based on the standard deviation and beta analysis. The performance of the selected company securities before and after the announcement of budget was also analyzed.

22

BIBLIOGRAPHY

BOOKS

1. Nandagopal.R, Arul rajan.K and Vivek.N , “Research Methods in Business”, ( First edition; New Delhi : Excel books, 2007) 2. Cooper R Donald and Schindler S Pamela, “Business Research Methods”,( Ninth edition ; New Delhi : Tata McGraw-Hill ,2006) 3. Van Horne C James. And Wachowicz Jr M John, “ Fundamentals of Financial Management “, ( Eleventh edition ; New Delhi: Prentice-Hall of India ,2006) 4. Pandey. I M, “Financial Management” , ( Ninth edition; New Delhi: Vikas Publishing House, 2007)
WEBSITES 1. 2. 3. 4. 5. www.mcxindia.com www.investmentwatch.com www.moneycontrol.com www.investmentcommision.in www.ncdexindia.com

23

24