Standard Deviation: Standard deviation is a measure of how much an

investment's returns can vary from its average return. It is a measure of

volatility and in turn, risk.

Formula:

𝜎 = √∑𝑃[𝑅 − ∑(𝑃𝑅)] 2

Where σ = Standard Deviation

P = Probability
R = Expected Return

Question 1:

Calculate the standard deviation of the following two companies:

Company A

Return Probability
6 0.1
7 0.25
8 0.3
9 0.25
10 0.1
 Company B

Return Probability
4 0.1
6 0.2
8 0.4
10 0.2
12 0.1

SOLUTION:

𝜎 = √∑𝑃[𝑅 − ∑(𝑃𝑅)] 2

COMPANY A

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

6 0.1 0.6 6-8= -2 4 0.4
7 0.25 1.75 7-8= -1 1 0.25
8 0.3 2.4 8-8= 0 0 0
9 0.25 2.25 9-8=1 1 0.25
10 0.1 1 10-8=2 4 0.4
∑=8 ∑ = 1.3

σ=√𝟏. 𝟑

σ= 1.14
 COMPANY B

R P R*P R-∑(PR) [R-∑(PR)]2 P[R-∑PR)2

4 0.1 0.4 4-8= -4 16 1.6
6 0.2 1.2 6-8= -2 4 0.8
8 0.4 3.2 8-8= 0 0 0
10 0.2 2 10-8= 2 4 0.8
12 0.1 1.2 12-8= 4 16 1.6
∑=8 ∑= 4.8

σ=√𝟒. 𝟖

σ= 2.190
Question 2:

The returns for securities A and B are given below:

Probability Security A Security B

0.5 4 0
0.4 2 3
0.1 0 3
SOLUTION:

𝜎 = √∑𝑃[𝑅 − ∑(𝑃𝑅)] 2

Security A

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

4 0.5 2 4-2.8= 1.2 1.44 0.5*1.44=0.72
2 0.4 0.8 2-2.8= -0.8 0.64 0.4*0.64=0.256
0 0.1 0 0-2.8= -2.8 7.84 0.1*7.84=0.784
∑=2.8 ∑=1.76

σ=√𝟏. 𝟕𝟔

σ= 1.326
Security B

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

0 0.5 0 0-1.5= -1.5 2.25 0.5*2.25=
1.125
3 0.4 1.2 3-1.5= 1.5 2.25 0.4*2.25=
0.9
 3 0.1 0.3 3-1.5= 1.5 2.25 0.1*2.25=
0.225
∑=1.5 ∑= 2.25

σ=√𝟐. 𝟐𝟓

σ= 1.5
Question 3:

A stock costing Rs.50, pays no dividend. The possible prices of the

stock at the end of the year and the probabilities are given below:

End of year price Probability

60 0.1
65 0.2
70 0.4
75 0.2
80 0.1
a) Find out the expected return.
b) Find out the standard deviation of the returns.

SOLUTION:

𝜎 = √∑𝑃[𝑅 − ∑(𝑃𝑅)] 2

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

60 0.1 6 60-70 = -10 100 10
65 0.2 13 65-70 = -5 25 5
70 0.4 28 70-70 = 0 0 0
75 0.2 15 75-70 = 5 25 5
80 0.1 8 80-70 = 10 100 10
∑R = 70 ∑=30

σ=√𝟑𝟎
σ= 5.477

Expected Return = 70 Standard Deviation = 5.477

Question 4:

An investor has a choice of four stocks for investment. Their rates of

return and probabilities are given below:

A B C D
R P% R P% R P% R P%
-30 20 -20 15 -20 20 -10 10
0 40 0 35 10 40 0 25
30 30 20 45 40 30 10 40
70 10 40 5 80 10 20 25

a) Are all these stocks attractive investments? Give Reasons

b) Of those that are attractive, how should the investor choose one
to buy?

SOLUTION:

𝜎 = √∑𝑃[𝑅 − ∑(𝑃𝑅)] 2

STOCK A

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

-30 0.2 -6 -30-10 = -40 1600 320
0 0.4 0 0-10 = -10 100 40
30 0.3 9 30-10 = 20 400 120
70 0.1 7 70-10 = 60 3600 360
∑R = 10 ∑=840
σ=√𝟖𝟒𝟎
σ= 28.98

STOCK B

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

-20 0.15 -3 -20-8 = -28 784 117.60
0 0.35 0 0-8 = -8 64 22.40
20 0.45 9 20-8 = 12 144 64.80
40 0.05 2 40-8 = 32 1024 51.20
∑R= 8 ∑=256

σ=√𝟐𝟓
𝟔 σ= 16

STOCK C

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

-20 0.2 -4 -20-20 = -40 1600 320
10 0.4 4 10-20 = -10 100 40
40 0.3 12 40-20 = 20 400 120
80 0.1 8 80-20 = 60 3600 360
∑R = 20 ∑=840

σ=√𝟖𝟒𝟎
σ= 28.98
STOCK D

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

 -10 0.1 -1 -10-8 = -18 324 32.40
0 0.25 0 0-8 = -8 64 16
10 0.4 4 10-8 = 2 4 1.60
20 0.25 5 20-8 = 12 144 36
∑R = 8 ∑=86
σ=√𝟖𝟔
σ= 9.27

Returns = A= 10 B=8 C=20 D=8

Standard Deviation = A=28.98 B=16 C=28.98 D=9.27
 Beta: Beta is the slope of the characteristic regression line. Beta
describes the relationship between the stock’s return and the index
returns.

For eg.

a) If Beta = +1.0
Then One per cent change in market index return causes exactly 1 per cent change
in the stock return. It indicates that the stock is in tandem with the market.

b) If Beta = +0.5
Then One per cent change in market index return causes 0.5 per cent change in the
stock return. The stock is less volatile compared to the market.

c) If Beta = +2.0
Then One per cent change in market index return causes a 2 per cent change in the
stock return. The stock return is more volatile.

Formula:

∑(𝐑𝐢−⎺𝐑𝐢⎺)(𝐑𝐦−⎺𝐑𝐦⎺)
β=
∑(𝑹𝒎−⎺𝐑𝐦⎺)2
 Ri = Scrip Return or Stock Return

Ri (Bar) = Mean Stock Return or Average Stock Return

Rm = Market Index Return

Rm(Bar) = Mean Market Index Return or Average Market Index Return

Question 1:

The following data give the market returns and the Sun Company

scrip’s return for a particular period.

Index Return (Rm) Scrip Return (Ri)

0.50 0.30
0.60 0.60
0.50 0.40
0.60 0.50
0.80 0.60
0.50 0.30
0.80 0.70
0.40 0.50
0.70 0.60

a) What is the beta value of the Sun Company scrip?

b) If the market return is 2, what would be the scrip return?
Solution :
 Rm Ri Ri-⎺Ri⎺ Rm-⎺Rm⎺ (Rm-⎺Rm⎺)2 (Ri-⎺Ri⎺ )(Rm-⎺Rm⎺)
0.5 0.3 0.3-0.5= 0.5-0.6 = (-0.1)*(-0.1) (-0.2)*(-0.1) = 0.02
- 0.2 -0.1 = 0.01
0.6 0.6 0.6-0.5 = 0.6-0.6 = 0 0*0 = 0 0.1*0= 0
0.1
0.5 0.4 0.4-0.5 = 0.5-0.6 = 0.01 0.01
-0.1 -0.1
0.6 0.5 0.5-0.5 = 0 0.6-0.6 = 0 0 0
0.8 0.6 0.6-0.5 = 0.8-0.6 = 0.04 0.02
0.1 0.2
0.5 0.3 0.3-0.5 = 0.5-0.6 = 0.01 0.02
-0.2 -0.1
0.8 0.7 0.7-0.5 = 0.8-0.6= 0.04 0.04
0.2 0.2
0.4 0.5 0.5-0.5 = 0 0.4-0.6= 0.04 0
-0.2
0.7 0.6 0.6-0.5 = 0.7-0.6 = 0.01 0.01
0.1 0.1
5.4 4.5 0.16 0.12

Mean Rm= 0.6 = 5.4/9

Mean Ri = 0.5 = 4.5/9

𝟎.𝟏𝟐
β=
𝟎.𝟏𝟔

β = 0.75
Scrip Value (Ri) = α + βRm = 0.5 + 0.75(2) =2

Where,

α = First Value of Rm = 0.5

β = 0.75

Rm = 2

Question 2:

Calculate Beta Value and scrip value for Tata Company.

Market Return (Rm) Scrip Return (Ri)

0.4 0.2
0.3 0.4
0.3 0.4
0.6 0.6
0.7 0.8
0.9 0.3
0.8 0.9
0.2 0.6
0.4 0.7
0.8 0.5
 a) What is the Beta Value of the Company?
b) If Market Return is 4, what is the scrip return?

Solution

Rm Ri Ri-⎺Ri⎺ Rm-⎺Rm⎺ (Rm-⎺Rm⎺)2 (Ri-⎺Ri⎺ )(Rm-⎺Rm⎺)

0.4 0.2 0.2-0.54 = 0.4-0.54 = 0.0196 0.0476
-0.34 -0.14
0.3 0.4 0.4-0.54 = 0.3-0.54 = 0.0576 0.0336
-0.14 -0.24
0.3 0.4 0.4-0.54= 0.3-0.54 = 0.0576 0.0336
-0.14 -0.24
0.6 0.6 0.6-0.54 = 0.6-0.54 = 0.0036 0.0036
0.06 0.06
0.7 0.8 0.8-0.54= 0.7-0.54 = 0.0256 0.0416
0.26 0.16
0.9 0.3 0.3-0.54 = 0.9-0.54 = 0.1296 -0.0864
-0.24 0.36
0.8 0.9 0.9-0.54= 0.8-0.54 = 0.0676 0.0936
0.36 0.26
0.2 0.6 0.6-0.54= 0.2-0.54 = 0.1156 -0.0204
0.06 -0.34
0.4 0.7 0.7-0.54= 0.4-0.54 = 0.0196 -0.0224
0.16 -0.14
0.8 0.5 0.5-0.54 = 0.8-0.54 = 0.0676 -0.0104
-0.04 0.26
5.4 5.4 0.564 0.114

Mean Rm= 5.4/10 = 0.54

Mean Ri = 5.4/10 = 0.54

∑(𝐑𝐢−⎺𝐑𝐢⎺)(𝐑𝐦−⎺𝐑𝐦⎺)
β=
∑(𝑹𝒎−⎺𝐑𝐦⎺)2

𝟎.𝟏𝟏𝟒
β=
𝟎.𝟓𝟔𝟒

β = 0.2021

B) Scrip Value

Ri = α+ βRm
= 0.4 + 0.2021(4)

= 0.4 + 0.8085

= 1.2085
Question 3:

Calculate the return and scrip value for XYZ co.

Return (Rm) Scrip (Ri)

0.2 0.6
0.6 0.7
0.7 0.5
0.8 0.4
0.7 0.2
0.6 0.5
0.4 0.7
0.3 0.8

 Calculate Beta Values

 Calculate scrip values if the market return is 6.
Solution :

Rm Ri Ri-⎺Ri⎺ Rm-⎺Rm⎺ (Rm-⎺Rm⎺)2 (Ri-⎺Ri⎺ )(Rm-⎺Rm⎺)

0.2 0.6 0.05 -0.3375 0.11390625 -0.016875
0.6 0.7 0.15 0.0625 0.00390625 0.009375
0.7 0.5 -0.05 0.1625 0.02640625 -0.008125
0.8 0.4 -0.15 0.2625 0.06890625 -0.039375
0.7 0.2 -0.35 0.1625 0.02640625 -0.056875
0.6 0.5 -0.05 0.0625 0.00390625 -0.003125
0.4 0.7 0.15 -0.1375 0.01890625 -0.020625
0.3 0.8 0.25 -0.2375 0.05640625 -0.059375
4.3 4.4 0.31875 -0.195

Mean Rm= 4.3/8 = 0.5375

Mean Ri = 4.4/8 = 0.55

∑(𝐑𝐢−⎺𝐑𝐢⎺)(𝐑𝐦−⎺𝐑𝐦⎺)
β=
∑(𝑹𝒎−⎺𝐑𝐦⎺)2

−𝟎.𝟏𝟗𝟓
β=
𝟎.𝟑𝟏𝟖𝟕𝟓

β = -0.61176

Scrip Value Ri = α+ βRm

=0.2 + (-0.61176*6)
=0.2 + (-3.6702)
=-3.4702
 Characteristic Regression Line (CRL)
CRL or Characteristic Regression Line is a simple linear regression model
estimated for a particular stock against the market index to measure its
diversifiable and undiversifiable risk.

Formulas:

 Ri = (α+ βiRm + ei)

Where,

Ri = Return on the ith stock

α = Interception

β = Slope of the ith stock

Rm = Return on the Market
e = Standard error

 α = 𝒀 - β𝑿

 𝒏∑𝒙𝒚 –(∑𝒙)(∑𝒚)
β 𝒏∑𝒙𝟐−(∑𝒙)𝟐

x = index
y =stock Value
𝟐
 Rm = (∑𝒙−𝒙)
𝒏−𝟏
  X and Y Values =

𝐓𝐨𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞−𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞

( )* 100
𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞

Note:
In case of Characteristic Regression Line, only when the data is given in such a
way that you have to use the formula:

𝐓𝐨𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞−𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞

( )* 100
𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞
Then, the “n” value will not be all the values, but it will be minus 1.
For example: If total days are 10, then “n” would be 9 days and not 10 days.

Whereas, if the question directly gives x and y values, then you will take the n as
the exact number of days as given in the question
 Question 1:
Let us assume the daily price of Ganesh Auto Stock against NSE Index for the
th th
period of 5 May 2020 to 14 May 2020. The objective is to compute beta,
standard error being 0.0266.

Date NSE Index Ganesh Auto Stock

5/5/2020 904.95 597.80
6/5/2020 845.75 570.80
7/5/2020 874.25 582.95
8/5/2020 847.95 559.85
9/5/2020 849.10 554.60
10/5/2020 835.80 545.10
11/5/2020 816.75 519.15
12/5/2020 843.55 560.70
13/5/2020 835.55 560.95
14/5/2020 839.50 597.40
Calculation of X Values:

𝐓𝐨𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞−𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞

( )* 100
𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞

𝟗𝟎𝟒.𝟗𝟓 − 𝟎
5.5.2020 = ( )* 100 = Not Determinable
𝟎

6.5.2020 = 𝟖𝟒𝟓.𝟕𝟓
)* 100 = -6.54
−𝟗𝟎𝟒.𝟗𝟓

𝟗𝟎𝟒.𝟗𝟓

7.5.2020=( 𝟖𝟕𝟒.𝟐𝟓−𝟖𝟒𝟓.𝟕𝟓
)* 100 = 3.36
𝟖𝟒𝟓.𝟕𝟓

8.5.2020 =( 𝟖𝟒𝟕.𝟗𝟓−𝟖𝟕𝟒.𝟐𝟓
)*100 = -3.01
𝟖𝟕𝟒.𝟐𝟓

9.5.2020 =( 𝟖𝟒𝟗.𝟏𝟎−𝟖𝟒𝟕.𝟗𝟓
)*100 = 0.14
𝟖𝟒𝟕.𝟗𝟓
10.05.2020 = 𝟖𝟑𝟓.𝟖𝟎−𝟖𝟒𝟗.𝟏𝟎
)*100 = -1.57
( 𝟖𝟒𝟗.𝟏𝟎

11.05.2020 =( 𝟖𝟏𝟔.𝟕𝟓−𝟖𝟑𝟓.𝟖𝟎
)*100 = -2.28
𝟖𝟑𝟓.𝟖𝟎

𝟖𝟒𝟑.𝟓𝟓−𝟖𝟏𝟔.𝟕𝟓
)*100 = 3.28
𝟖𝟏𝟔.𝟕𝟓

13.05.2020 =( 𝟖𝟑𝟓.𝟓𝟓−𝟖𝟒𝟑.𝟓𝟓
)*100 = -0.95
𝟖𝟒𝟑.𝟓𝟓

14.05.2020 = 𝟖𝟑𝟗.𝟓𝟎−𝟖𝟑𝟓.𝟓𝟓
)*100 = 0.47
𝟖𝟑𝟓.𝟓𝟓
(

Calculation of Y Values:

𝐓𝐨𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞−𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞

( )* 100
𝐘𝐞𝐬𝐭𝐞𝐫𝐝𝐚𝐲′𝐬 𝐏𝐫𝐢𝐜𝐞
5.5.2020 = ( 𝟓𝟗𝟕.𝟖𝟎 − )* 100 = Not Determinable
𝟎

6.5.2020 = 𝟓𝟕𝟎.𝟖𝟎−𝟓𝟗𝟕.𝟖𝟎
)* 100 = -4.52
( 𝟓𝟗𝟕.𝟖𝟎

7.5.2020 = 𝟓𝟖𝟐.𝟗𝟓−𝟓𝟕𝟎.𝟖𝟎
)* 100 = 2.13
( 𝟓𝟕𝟎.𝟖𝟎

8.5.2020 = 𝟓𝟓𝟗.𝟖𝟓
)* 100 = -3.96
−𝟓𝟖𝟐.𝟗𝟓
(
𝟓𝟖𝟐.𝟗𝟓

9.5.2020 = 𝟓𝟓𝟒.𝟔𝟎−𝟓𝟓𝟗.𝟖𝟓
)* 100 = -0.94
𝟓𝟓𝟗.𝟖𝟓
(

10.5.2020 = 𝟓𝟒𝟓.𝟏𝟎−𝟓𝟓𝟒.𝟔𝟎
)* 100 = -1.71
( 𝟓𝟓𝟒.𝟔𝟎
11.5.2020 = 𝟓𝟏𝟗.𝟏𝟓−𝟓𝟒𝟓.𝟏𝟎
)* 100 = -4.76
( 𝟓𝟒𝟓.𝟏𝟎

12.5.2020 = 𝟓𝟔𝟎.𝟕𝟎−𝟓𝟏𝟗.𝟏𝟓
)* 100 = 8.00
( 𝟓𝟏𝟗.𝟏𝟓

13.5.2020 = 𝟓𝟔𝟎.𝟗𝟓−𝟓𝟔𝟎.𝟕𝟎
)* 100 = 0.04
( 𝟓𝟔𝟎.𝟕𝟎

14.5.2020 = 𝟓𝟗𝟕.𝟒𝟎−𝟓𝟔𝟎.𝟗𝟓
)* 100 = 6.51
( 𝟓𝟔𝟎.𝟗𝟓
NSE Index Ganesh Auto
Stock
X Y X2 XY
904.95 597.80 - - - -
845.75 570.80 -6.54 -4.52 42.77 29.56
874.25 582.95 3.36 2.13 11.36 7.18
847.95 559.85 -3.01 -3.96 9.06 11.92
849.10 554.60 0.14 -0.94 0.02 -0.13
835.80 545.10 -1.57 -1.71 2.47 2.69
816.75 519.15 -2.28 -4.76 5.20 10.85
843.55 560.70 3.28 8.00 10.76 26.24
835.55 560.95 -0.95 0.04 0.90 -0.04
839.50 597.40 0.47 6.50 0.22 3.06
-7.08 0.79 82.76 91.33

 α = 𝒀 - β𝑿
 𝒏∑𝒙𝒚 –(∑𝒙)(∑𝒚)
β 𝒏∑𝒙𝟐−(∑𝒙)𝟐

𝟐
 Rm = (∑𝒙−𝒙)
𝒏−𝟏
Solution:

𝐱 = -7.08/9 = -0.7866

𝒚 = 0.78/9 = 0.086

 𝒏∑𝒙𝒚 –(∑𝒙)(∑𝒚)
β 𝒏∑𝒙𝟐−(∑𝒙)𝟐

𝟗(𝟗𝟏.𝟑𝟑)−(−𝟕.𝟎𝟖)(𝟎.𝟕𝟗)
=
𝟗(𝟖𝟐.𝟕𝟔)−(−𝟕.𝟎𝟖)𝟐

𝟖𝟐𝟏.𝟗𝟕−(−𝟓.𝟓𝟗)
=
𝟕𝟒𝟒.𝟖𝟒 −𝟓𝟎.𝟏𝟐

𝟖𝟐𝟕.𝟓𝟔
=
𝟔𝟗𝟒.𝟕𝟐

β= 1.19
 (∑𝒙−𝒙)𝟐
 Rm =
𝒏−𝟏
[−𝟕.𝟎𝟖−(−𝟎.𝟕𝟖𝟔𝟔)]𝟐
=
𝟗−𝟏
[−𝟕.𝟎𝟖+𝟎.𝟕𝟖𝟔𝟔]𝟐
=
𝟖

(−𝟔.𝟐𝟗𝟑𝟒)𝟐
=
𝟖

𝟑𝟗.𝟔𝟏
=
𝟖

 Rm = 4.95
4.954.951
  α = 𝒀 - β𝑿

= 𝟎. 𝟎𝟖𝟔 − [𝟏. 𝟏𝟗𝟏(−𝟎. 𝟕𝟖𝟔𝟔)]

= 0.086 – [-0.94]
= 0.086 + 0.94

 α = 𝟏. 𝟎𝟐𝟔

Ri = (α+ βiRm + ei)

= [1.026 + 1.191(4.951) + 0.0266]
= [1.026 + 5.89 + 0.0266]
= 6.9426

Question 2:
The Normal Rate of Return for the company and the market return for
the securities are given below:

Date ABC Co (Y) Market Return (X)

11-5-2020 -5 -6
12-5-2020 14 16
13-5-2020 10 12
 14-5-2020 12 14
15-5-2020 17 20
Calculate the diversity of stock with error being 0.047.

Solution
X Y 2 XY
X
-6 -5 36 30

16 14 256 224

12 10 144 120

14 12 196 168

20 17 400 340

56 48 1032 882

𝒙 = 56/5 = 11.20
𝒚 = 48/5 = 9.60

 𝒏∑𝒙𝒚 –(∑𝒙)(∑𝒚)
β 𝒏∑𝒙𝟐−(∑𝒙)𝟐
 𝟓(𝟖𝟖𝟐)−(𝟓𝟔)(𝟒𝟖)
β 𝟓(𝟏𝟎𝟑𝟐)−(𝟓𝟔)𝟐

 𝟒𝟒𝟏𝟎−𝟐𝟔𝟖𝟖
β= 𝟓𝟏𝟔𝟎−𝟑𝟏𝟑𝟔

𝟏𝟕𝟐𝟐
β =
𝟐𝟎𝟐𝟒

β = 0.850
α = 𝒀 − 𝜷𝑿
= 9.60 – 0.850(11.20)
= 9.60 – 9.52
α = 0.08

(∑𝒙−𝒙)𝟐
 Rm =
𝒏−𝟏
(𝟓𝟔−𝟏𝟏.𝟐𝟎)𝟐
=
𝟓−𝟏
(𝟒𝟒.𝟖𝟎)𝟐
=
𝟒

𝟐𝟎𝟎𝟕.𝟎𝟒
 Rm =
𝟒
 Rm = 501.76

 Ri = (α+ βiRm + ei)

 Ri = [0.08 + 0.850(501.76) + 0.047]
 Ri = (0.08 + 426.496 + 0.047)

 Ri = 426.623
 Correlation
The Correlation Coefficient measures the nature and the extent of relationship
between the stock market index return and the stock return in a particular period.

𝒏∑𝑿𝒀−(∑𝑿)(∑𝒀)
r
√𝒏∑𝑿𝟐−(∑𝑿)𝟐 √𝒏∑𝒀𝟐−(∑𝒀)𝟐

The square of the correlation co-efficient is the coefficient of determination. It

gives the percentage of variation is the stock’s return explained by the variation in
the market’s return.
Solution for Question 1 from Characteristic

Regression Line.

NSE Index Ganesh Auto

Stock
X Y X2 Y2 XY
904.95 597.80 - - - - -
845.75 570.80 -6.54 -4.52 42.77 20.43 29.56
874.25 582.95 3.36 2.13 11.36 4.54 7.18
847.95 559.85 -3.01 -3.96 9.06 15.68 11.92
849.10 554.60 0.14 -0.94 0.02 0.88 -0.13
835.80 545.10 -1.57 -1.71 2.47 2.92 2.69
816.75 519.15 -2.28 -4.76 5.20 22.66 10.85
843.55 560.70 3.28 8.00 10.76 64.00 26.24
835.55 560.95 -0.95 0.04 0.90 0.0016 -0.04
839.50 597.40 0.47 6.50 0.22 42.25 3.06
-7.08 0.79 82.76 173.36 91.33

𝒏∑𝑿𝒀−(∑𝑿)(∑𝒀)
r
√𝒏∑𝑿𝟐−(∑𝑿)𝟐 √𝒏∑𝒀𝟐−(∑𝒀)𝟐
 𝟗(𝟗𝟏.𝟑𝟑)−(−𝟕.𝟎𝟖)(𝟎.𝟕𝟗)
r
√𝟗(𝟖𝟐.𝟕𝟔)−(−𝟕.𝟎𝟖)𝟐 √𝟗(𝟏𝟕𝟑.𝟑𝟔)−(𝟎.𝟕𝟗)𝟐

𝟖𝟐𝟏.𝟗𝟕−(−𝟓.𝟓𝟗𝟑𝟐)
r
√𝟕𝟒𝟒.𝟖𝟒−𝟓𝟎.𝟏𝟐𝟔𝟒 √𝟏𝟓𝟔𝟎.𝟐𝟒 − 𝟎.𝟔𝟐𝟒𝟏

𝟖𝟐𝟕.𝟓𝟔
r= √𝟔𝟗𝟒.𝟕𝟏𝟑𝟔 √𝟏𝟓𝟓𝟗.𝟔𝟏

𝟖𝟐𝟕.𝟓𝟔
r
𝟐𝟔.𝟑𝟔∗ 𝟑𝟗.𝟒𝟗

𝟖𝟐𝟕.𝟓𝟔
r
𝟏𝟎𝟒𝟎.𝟗𝟔

r= 0.795
 2 = 0.795 * 0.795 = 0.632
R
The Interpretation is that 63 per cent of variations in stock’s returns is
explained (Caused) by the variations in the NSE Index Return.
Question 2:

The monthly return data are presented below for ITC Stock and BSE
National Index for a period of 12 months.

MONTH ITC STOCK (Y) BSE NATIONAL INDEX (X)

1 9.43 7.41
2 0 -5.33
3 -4.31 -7.35
4 -18.92 -14.64
5 -6.67 1.58
6 26.57 15.19
7 20 5.11
8 2.93 0.76
9 5.25 -0.97
10 21.45 10.44
11 23.13 17.47
12 32.83 20.15

Calculate Correlation, Covariance and beta for the above problem.

SOLUTION:

𝒏∑𝑿𝒀−(∑𝑿)(∑𝒀)
r
√𝒏∑𝑿𝟐−(∑𝑿)𝟐 √𝒏∑𝒀𝟐−(∑𝒀)𝟐

MONTH X Y X2 Y2 XY
1 7.41 9.43 54.90 88.92 69.87
2 -5.33 0 28.41 0 0
3 -7.35 -4.31 54.02 18.58 31.68
4 -14.64 -18.92 214.32 357.97 276.98
5 1.58 -6.67 2.49 44.49 -10.53
6 15.19 26.57 230.74 705.96 403.59
7 5.11 20 26.11 400.00 102.20
8 0.76 2.93 0.58 8.58 2.22
9 -0.97 5.25 0.94 27.56 -5.09
10 10.44 21.45 108.99 460.10 223.93
11 17.47 23.13 305.20 534.99 404.08
12 20.15 32.83 406.02 1077.81 661.52
49.82 111.69 1432.75 3724.96 2160.45
r=
𝟏𝟐(𝟐𝟏𝟔𝟎.𝟒𝟓)−(𝟒𝟗.𝟖𝟐)(𝟏𝟏𝟏.𝟔𝟗)

√𝟏𝟐(𝟏𝟒𝟑𝟐.𝟕𝟓)−(𝟒𝟗.𝟖𝟐)𝟐 √𝟏𝟐(𝟑𝟕𝟐𝟒.𝟗𝟔)−(𝟏𝟏𝟏.𝟔𝟗)𝟐

r 𝟐𝟓𝟗𝟐𝟓.𝟒𝟎−𝟓𝟓𝟔𝟒.𝟑𝟗𝟓𝟖

√𝟏𝟕𝟏𝟗𝟑−𝟐𝟒𝟖𝟐.𝟎𝟑𝟐𝟒 √𝟒𝟒𝟔𝟗𝟗.𝟓𝟐−𝟏𝟐𝟒𝟕𝟒.𝟔𝟓𝟔𝟏

r 𝟐𝟎𝟑𝟔𝟏.𝟎𝟎𝟒𝟐

√𝟏𝟒𝟕𝟏𝟎.𝟗𝟔𝟕𝟔 √𝟑𝟐𝟐𝟐𝟒.𝟖𝟔𝟑𝟗

r 𝟐𝟎𝟑𝟔𝟏.𝟎𝟎𝟒𝟐

𝟏𝟐𝟏.𝟐𝟗∗𝟏𝟕𝟗.𝟓𝟏
r = 0.935/0.94

r2 = 0.874/0.87
 Covariance is a statistical term used in security and portfolio evaluation,
and it measures the amount which two assets move in relation to each
other. A positive covariance means the assets move in the same
direction, and the larger the value, the greater one asset moves in
relation to the other.

An example of covariance is as follows:

 Stock A has a covariance to Stock B of +1.4

 For every $1 increase of Stock B, Stock A will increase by $1.4

Covariance is typically calculated by multiplying the correlation

between the variables (correlation coefficient) by the standard deviation
of each variable.

Covariance of X

𝑵∑𝒙𝟐 −(∑𝒙)𝟐
=√
𝑵𝟐
Covariance of Y

𝑵∑𝒚𝟐 −(∑𝒚)𝟐
=√
𝑵𝟐
Covariance of X= 𝑵∑𝒙𝟐 −(∑𝒙)𝟐
√ 𝑵𝟐

(𝟏𝟐∗𝟏𝟒𝟑𝟐.𝟕𝟓)−(𝟒𝟗.𝟖𝟐)𝟐
=√ 𝟏𝟐𝟐

(𝟏𝟐∗𝟏𝟒𝟑𝟐.𝟕𝟓)−(𝟒𝟗.𝟖𝟐)𝟐
=√
𝟏𝟐𝟐

𝟏𝟕𝟏𝟗𝟑−𝟐𝟒𝟖𝟐.𝟎𝟑
=√
𝟏𝟒𝟒

𝟏𝟒𝟕𝟏𝟎.𝟗𝟕
=√
𝟏𝟒𝟒
=√𝟏𝟎𝟐. 𝟏𝟓𝟗
Covariance of X= 10.10

𝑵∑𝒚𝟐 −(∑𝒚)𝟐
√
Covariance of Y = 𝑵𝟐

𝟏𝟐∗𝟑𝟕𝟐𝟒.𝟗𝟔−(𝟏𝟏𝟏.𝟔𝟗)𝟐
=√ 𝟏𝟐𝟐

= √
𝟒𝟒,𝟔𝟗𝟗.𝟓𝟐−𝟏𝟐𝟒𝟕𝟒.𝟔𝟔
𝟏𝟒𝟒

= 𝟑𝟐,𝟐𝟐𝟒.𝟖𝟔
√ 𝟏𝟒𝟒
=√𝟐𝟐𝟑. 𝟕𝟖𝟑𝟕𝟓
Covariance of Y=14.95

𝑪𝒐𝒗 𝒙∗𝑪𝒐𝒗 𝒚
Beta (β) 𝟐
=
𝛔 𝒚

𝟏𝟎.𝟏𝟎∗𝟏𝟒.𝟗𝟓
= 𝟐𝟐𝟑.𝟕𝟖𝟑𝟕𝟓
β= 0.675
 COEFFICIENT OF VARIATION

In finance, the coefficient variation is important in investment selection. From a

financial perspective, the financial metric represents the risk-to-reward ratio where
the volatility shows the risk of an investment and the mean indicates the reward of
an investment.
By determining the coefficient of variation of different securities, an investor
identifies the risk-to-reward ratio of each security and develops an investment
decision. Generally, an investor seeks a security with a lower coefficient (of
variation) because it provides the most optimal risk-to-reward ratio with low
volatility but high returns. However, the low coefficient is not favorable when the
average (expected return) is below zero.
Formula:

 Coefficient of Variation = 𝟐.𝟐𝟓* 100

𝟓

= 45% = 0.45

 Coefficient of Variation = 𝟐.𝟐𝟓* 100

𝟒

= 56.25% = 0.5625
 Coefficient of variation = 𝟏.𝟕𝟓* 100
𝟓

= 35% = 0.35

Results:

 Coefficient of Variation is directly proportional to

Standard Deviation (Volatility)
 Coefficient of Variation is inversely proportional to
Expected Return.
1. Investors prefer a security with a low value of coefficient
of Variation because it has a lesser standard deviation OR
it has a higher expected return.
2. It is risky to go for a security with a higher coefficient of
variation because it has a higher standard deviation OR it
has a lower expected return.
Question 1:

Calculate the standard deviation, expected return and coefficient of

variation of the following two companies:
Company A

Return Probability
2 0.1
4 0.25
6 0.3
8 0.25
10 0.1

Company B

Return Probability
5 0.1
6 0.2
7 0.4
8 0.2
9 0.1

SOLUTION:

𝜎 = √∑𝑃[𝑅 − ∑(𝑃𝑅)] 2
 COMPANY A

R P R*P R-∑(PR) [R-∑PR)2 P[R-∑PR)2

2 0.1 0.2 2-6 = -4 16 1.6
4 0.25 1 4-6 = -2 4 1
6 0.3 1.8 6-6 = 0 0 0
8 0.25 2 8-6 = 2 4 1
10 0.1 1 10-6 = 4 16 1.6
∑PR = 6 ∑= 5.2

σ=√𝟓. 𝟐
σ= 2.28

Expected Return = 6

Coefficient of Variation =
𝑽𝒐𝒍𝒂𝒕𝒊𝒍𝒊𝒕𝒚
*100
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑹𝒆𝒕𝒖𝒓𝒏

𝟐.𝟐𝟖
= *100
𝟔
Coefficient of Variation = 38% or 0.38
 COMPANY B

R P R*P R-∑(PR) [R-∑(PR)]2 P[R-∑PR)2

5 0.1 0.5 5-7 = -2 4 0.4
6 0.2 1.2 6-7 = -1 1 0.2
7 0.4 2.8 7-7 = 0 0 0
8 0.2 1.6 8-7 = 1 1 0.2
9 0.1 0.9 9-7 = 2 4 0.4
∑PR = 7 ∑=1.2

σ=√𝟏. 𝟐
σ= 1.09

Expected Return = 7

Coefficient of Variation =
𝑽𝒐𝒍𝒂𝒕𝒊𝒍𝒊𝒕𝒚
*100
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑹𝒆𝒕𝒖𝒓𝒏

𝟏.𝟎𝟗
=
𝟕
*100

Coefficient of Variation = 15.57% = 0.1557

Question 2:

During the past five years, the returns of a stock were as follows:

Year Returns
1 0.07
2 0.03
3 -0.09
4 0.06
5 0.10
Compute the following:

a) Expected Return

b) Standard Deviation

c) Variance

d) Coefficient of Variation

Solution:

𝟎.𝟎𝟕+𝟎.𝟎𝟑+(−𝟎.𝟎𝟗)+𝟎.𝟎𝟔+𝟎.𝟏𝟎
a) Expected Return:
𝟓

𝟎.𝟏𝟕
= = 0.034 or 3.4%
𝟓
Year Return Deviation Variance

1 0.07 or 7 7-3.4 = 3.6 12.96

2 0.03 or 3 3-3.4 = -0.4 0.16

3 -0.09 or -9 -9-3.4 = -12.4 153.76

4 0.06 or 6 6-3.4 = 2.6 6.76

5 0.10 or 10 10-3.4 = 6.6 43.56

217.20

∑(𝑹−𝑹)
Variance= [ 𝒏−𝟏
𝟐 ]
𝟐𝟏𝟕.𝟐𝟎
Variance = [ 𝟓−𝟏
]
=
[ ]
𝟐𝟏𝟕.𝟐𝟎
𝟒

Variance = 54.30

Standard Deviation = √𝑽𝒂𝒓𝒊𝒂𝒏𝒄𝒆

= √𝟓𝟒. 𝟑𝟎 = 7.36 = 7.4%

Coefficient of Variation 𝑽𝒐𝒍𝒂𝒕𝒊𝒍𝒊𝒕𝒚
* 100
=
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑹𝒆𝒕𝒖𝒓𝒏

= 𝟕.𝟒* 100
𝟑.𝟒

Coefficient of Variation = 217.65% or 2.176