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March 25, 2011
Study of Top 30 Companies of Bombay Stock Exchange through Capital Asset Pricing Model
Project Report submitted in partial fulfillment of the requirements for the Degree of Masters of International Business
Under the guidance of Ms. Sunanina Kanojia
Submitted by Saurabh Chhabra MIB Batch of 2011 Department of Commerce Delhi School of Economics
March 25, 2011
University of Delhi
This is to certify that the dissertation titled “Portfolio Management: Study of Capital Asset Pricing Model on the Stocks of BSE Sensex” submitted in partial fulfillment of the requirements of the award of the degree of Masters of International Business program is based on original research work carried out by Saurabh Chhabra, conducted under the guidance of Ms Sunaina Kanojia, for submission to the Department of Commerce, Delhi University. It is further certified that the project report, or any part thereof, has not been submitted elsewhere for any other purpose, and no part of this work has been copied from any source. All references, wherever used, have been duly acknowledged.
) Saurabh Chhabra Master of International Business Roll No:44, IVth Semester
) Ms. Sunaina Kanojia Department of Commerce University of Delhi
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“No man is an island entire of itself” (John Donne, 1572-1631). The completion of this study would not have been possible without the help, encouragement and support of many individuals to whom I would like to express my deepest gratitude. I would take this opportunity to express my sincere gratitude to Ms. Sunaina Kanojia for her invaluable inspiration, guidance and support through out this project. I truly appreciate her inputs and count it a privilege to have worked under the supervision. This dissertation report has given me immense knowledge about the institution of Capital Asset Pricing Model in a broader sense, its problems and its road ahead. Thanks also to all the professors and teaching faculty for providing necessary guidance and valuable inputs. I would also like to extend my thanks to my friends in the Commerce Department (from Delhi School of Economics) who have helped me in the better understanding of the subject. Their insightful feedback about the project work helped a long way in shaping this final report.
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TABLE OF CONTENTS
Abstract……………………………….. ………………………………………………………………………………,……………………………… 6 Chapter 1: Introduction………. ……………………………………………………………………………………………………………… ………………….7 1.1 Scope of the dissertation….………………….…………………………………….…. …………………………………………….....8 1.2 Objectives of the Study………………….………………………………………………. ……………………………………………….9 1.3 Methodology……………………………………………………………………………………………… …………………………………..10 1.4 Organization of the dissertation………………..……. …………………………………………………………………………….11 1.5 Limitations……………………………………………...….…. ………………………………………………………………………………12
……………………………………………….2 Selection of Portfolios………………………….23 2.11 Summary……………………….….....10 Limitations of CAPM……….18 2..... ……………………………………………………………………………..6 Security Market Line…………. …………………………………………………………………………………………………………...4 Literature in Capital Asset Pricing Model……………………………………. ……………………………………………………………………13 2. …………………………………………………21 2.8 Market Portfolio……………………………………………….. ……………………………………………………………………………………………………………27 2... ……………………………………………………………………………………………………………28 Chapter 3: CAPM: Conceptual Research 5 .…….24 2. ………………………………………………………………………………. …………………………………….26 2..5 Background….3 Evolution of Portfolio Management…………………………………………….25 2. …………………………………………….7 Risk & Diversification………….………………………………………….15 2.14 March 25. ……………………………………………. 2011 2...……………………………………………………………………………….1 Introduction of Portfolio Management…………..……………16 2.9 Assumptions of CAPM………………………………………. …………………………………………………………………………….………………………………………………………….……………………………………………….PORTFOLIO MANAGEMENT Chapter 2: Conceptual Framework of Capital Asset Pricing Model Review of Literature..
2 Inferences of Empirical Study……………………………………………………………………………………………………… …... ………………67 6 .30 3.64 4.4 Is CAPM Useful……………………………………………………………………………………………………… ……………………….39 4..….3 Application of CAPM in Strategic Planning………………………………….PORTFOLIO MANAGEMENT 3. ………………………………………………………………………………………………….32 3.. Riskless Lending and Borrowing and Fund Separation………………………………………….2 Portfolio Theory.5 Summary………………………………………………………………………………………………… ………………………………..…..63 4.1 Introduction & Background of March 25. ………………………………………………….35 Chapter 4: Use of CAPM in BSE Sensex: An Empirical Study 4.1 Empirical Study of Applicabilty of CAPM in BSE Sensex…………………………………………………………………….65 Chapter 5 5.…...4 Building A Portfolio…………………………………………………………………………………………………… ……………….59 4.1 Conclusion………………….33 3.3 Capital Asset Pricing Model……………………………………………………………………………………………………… ……. 2011 Research………………………………………………………………………………………….
the technical and fundamental analysis. ……………………………………………………………………………………………………………… …71 Abstract The proposition of this dissertation is that an optimal portfolio can be built by making an extensive analysis of various stock in correlation with market index as a whole using Capital Asset Pricing Model as the basis whereby we can not only diversify the risk but maximize the overall return of the portfolio.PORTFOLIO MANAGEMENT March 25. 2011 References……………………………………………………………………………………………… …………………………………………. the systematic and unsystematic risks involved.. Finally. The dissertation concludes with Strategic implication of CAPM and with the conclusions drawn from the analysis for building the optimum portfolio.…69 Annexures…………………………. The dissertation starts with historical background and concepts involved in need for diversification. evolution of CAPM model and the basic concepts on which it is based upon. shifting the focus on the historical background of CAPM. The dissertation extends into analysis of CAPM in BSE Sensex and to interpret whether CAPM can be used as a true reflector of the returns as provided by the stocks over a period of time. 7 .
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Chapter 1 Introduction
Many modern financial applications such as portfolio construction and risk management, require estimates of the asset returns. The finance literature in the past paid less attention to the estimation. This lack of attention is due to two factors. First, there was limited computing technology to practically handle large amount of cross-sectional information for covariance estimation. Second, it was generally believed that in a mean-variance optimization process, compared to expected returns, covariance is more stable and causes fewer problems; hence it is
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less important to have good estimations for it. Recently, with development in both optimization and computational technologies and renewed interests in portfolio risk management, there has been increasing attention on CAPM. This dissertation studies the applicability of CAPM in Indian Stock market. The need for diversification arises from the concept of having higher returns with lower risk involved and for that return on equity has to be considered. The cost of capital DCF model was used. Since it had certain loopholes many models have been developed to calculate return on portfolio and stocks with CAPM being the earliest model. Since then models like Efficient Market hypothesis, three factor model have been developed but CAPM has still its stronghold for such estimation. Thus, it becomes imperative to analyze it as an estimator. In this study, we focus on that very aspect and try to evaluate its sustainability in Indian Stock market by undertaking an empirical study.
Scope of the study
The dissertation consists of five essays. The first essay is an empirical study on the need of diversification, history of Capital asset pricing model. We contribute to the literature by providing an up-to-date analysis of both old and new estimation methods. We compare these methods using the conventional comparison criteria. We need to find a more powerful measure to compare the performance of alternative models. For portfolio risk management purposes, we want a more robust assessment criterion where the risks of any portfolios can be measured. This leads to the second part of our thesis, where we propose
March 25, 2011
to use the applicability of Capital Asset Pricing model in order to determine if this model can be used as a true reflector of the actual returns provided by the stocks considered. Understanding the various dimensions of Portfolio Management
Need for building Optimal Portfolios Use of CAPM as a means to determine the optimal Portfolio
1.2 Objectives of the Study
The core idea behind undertaking the dissertation is to attain following objectives:Various Models have been developed over a period of time for the very purpose of calculating the “Return on Equity”. The earliest model was based on the concept of Cost of Capital. Since
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there were certain loopholes in this model, the first model for calculating return on Equity is considered to be developed by Markowitz. However, since model like Du Pont, Arbitrage Pricing theory, Three factor model have become more prominent this study has been undertaken to authenticate that CAPM is still one of the most important model for the analysis on return on equity and no analysis would be complete without it. i. Study the concept of Portfolio Management with the focus on Capital Asset Pricing Model. ii. To sketch the conceptual framework used for the analysis of Capital Asset Pricing Model.
iii. To highlight the relation and sustainability of Capital Asset pricing Model in Indian
Stock Market by doing the analysis of top 30 companies of Bombay Stock Exchange during a period of 10 years
iv. To draw the conclusions and give recommendations about the applicability.
1.3 Research Methodology
4 The organization of the dissertation 12 .PORTFOLIO MANAGEMENT March 25. 1. Hence. key concepts and bases with respect to CAPM have been analyzed. The study is related to obtaining a better estimation of the returns of a reasonably large number of stocks for portfolio risk management. representatives from the banking and financial industry based in Delhi to have a better analysis of the subject. Interactions: Extensive interactions were held with certain corporate. 2011 The cornerstones of my approach to study the Applicability of risk analysis in listed companies of NSE and recommending a sustainable roadmap for building a portfolio using Markowitz model. three factor model are used. The data for empirical study is basically collected from the various software like Prowess etc. we examine the returns offered by companies . I have focused on CAPM and used it to determine as a means. Along with that journals have been also considered. Extensive Secondary Research: Applicability of Markowitz Model in Indian Stock Market is not extensively researched in India. Du Pont analysis. it was necessary to analyze the conceptual framework. Next. Models like discounted cash flow. I have relied to a large extent on the publications and reports published in the international domain. research based out of the emerging markets has been considered. Hence. Case study based approach: All through the text my endeavor has been to study Markowitz Model as case study and try and draw out how it has been applied to calculate Return and risk on Equity. we calculated co-relation between these companies and finally studied the risk involved in all this exercise using Markowitz model. To ensure the relevance in the Indian markets. To set the stage for our analysis. Moreover empirical records of Markowitz Model are quite less. which in turn has helped me analyze the sector in a better way. The additional information about individual stock performances likes returns have been collected from financial journals as well as by studying of the Annual reports of the companies. Conceptual Analysis: In order to lay out a roadmap for CAPM. as part of exploring the best way to examine the risk involved in different stocks. arbitrage pricing theory.
This chapter extends as a tool for finding if CAPM could be used as a strategic planning. In Chapter 4. Chapter 2 reviews the literature on the Capital Asset Pricing Model. the rest of the dissertation is organized in the following way. 2011 Following the introduction of the dissertation report in Chapter 1. It focuses on the portfolio management. 13 . various risk involved. This chapter draws the final implication of the objectives of the study and the concepts of CAPM and the inferences drawn from the empirical study. we conclude and describes potential future research of CAPM model in Portfolio Management.PORTFOLIO MANAGEMENT March 25. Finally. These comparisons helps in finding the optimal portfolio management. assumptions and limitations Along with this. We examine how much CAPM is applicable in real life and if CAPM is a true reflector of the market value as reflected in prices of Stocks. Chapter 3 conducts a comprehensive empirical analysis of estimating the return on equity of various stocks of BSE Sensex using the CAPM Model. history of CAPM Model. where the returns are maximized and the risk diversified. need for diversification and CAPM as model to diversify the portfolio. evolution of portfolio management. we analyse the CAPM model as a whole robust optimal portfolio measurement means. the usefulness of CAPM is also factored in.
14 ..5 Limitations of the Study The following dissertation has following limitations.PORTFOLIO MANAGEMENT March 25. ➢ Time frame of data for analysis limited to a period of 10 years. 2011 1. ➢ Using CAPM as the only model for determining the optimal portfolio. ➢ Limiting the scope of Stock to blue chip companies or heavy weights only in which case the risk is already diversified and lesser risk factor involved thus a skewed result has high probability.
This chapter provides a brief review of the literature on estimating a return of an asset and portfolio as a whole with Capital Asset Pricing model as the basis. 2011 Chapter 2 Conceptual Framework of Capital Asset Pricing Model Literature Review Estimation of return on the asset returns plays an important role in both the theory and practice of modern portfolio analysis and financial risk management.PORTFOLIO MANAGEMENT March 25. numerous studies have been searching for methods that can provide the best estimates. there has been considerable progress in the design of optimal portfolios. Following the work of Markowitz. variance and covariance of every asset could be obtained. 15 . Markowitz's (1952) mean-variance portfolio optimization theory shows that we can construct optimal portfolios if accurate estimation of expected returns. Therefore.
Instead. 2011 2. This calls for periodic review and revision of investment portfolios of investors. Again he is faced with problem of deciding which securities to hold and how much to invest in each. “It is rare to find investors investing their entire savings in a single security. Creation of a portfolio helps to reduce risk. In such investments both rationale and emotional responses are involved. portfolio selection. without sacrificing returns. An investor invests his funds in a portfolio expecting to get good returns consistent with the risk that he has to bear. portfolio revision & portfolio evaluation. It is evident that rational investment activity involves creation of an investment portfolio. but involves a great deal of risk and calls for scientific knowledge as well artistic skill. debentures. 16 . and bonds is profitable as well as exciting. Portfolio management deals with the analysis of individual securities as well as with the theory and practice of optimally combining securities into portfolios. The risk and return characteristics of portfolios. Investing in financial securities is now considered to be one of the best avenues for investing one savings while it is acknowledged to be one of the best avenues for investing one saving while it is acknowledged to be one of the most risky avenues of investment. Such a group of securities is called portfolio”.PORTFOLIO MANAGEMENT March 25. It deals specifically with the security analysis. The return realized from the portfolio has to be measured and the performance of the portfolio has to be evaluated.1 Introduction to Portfolio Management Investing in securities such as shares. It is indeed rewarding. they tend to invest in a group of securities. The investor tries to choose the optimal portfolio taking into consideration the risk return characteristics of all possible portfolios. An investor who understands the fundamental principles and analytical aspects of portfolio management has a better chance of success. As the risk return characteristics of individual securities as well as portfolios also change. Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. portfolio analysis. Portfolio Management: An investor considering investment in securities is faced with the problem of choosing from among a large number of securities and how to allocate his funds over this group of securities.
It means that value of the investment made increases over the year. more return. 2. Proportion varies according to individual preference. sixty percent of the investment is made in debt instruments and remaining in equity. But the rule of the game is that more risk. Diversification Once the asset mix is determined and risk – return relationship is analyzed the next step is to diversify the portfolio. So while making a portfolio the investor must judge the risk taking capability and the returns desired. The debt may be included to minimize risk and to get tax exemption. The proportion of equity varies from 60 to 100 % and that of debt from 0 to 40 %.2 SELECTION OF PORTFOLIO The selection of portfolio under different objectives are dealt subsequently Objectives and asset mix If the main objective is getting adequate amount of current income. The selection of portfolio depends upon the objectives of the investor. 2011 Portfolio management makes use of analytical techniques of analysis and conceptual theories regarding rational allocation of funds. Generally old people are more sensitive towards safety.PORTFOLIO MANAGEMENT March 25. Safety of principle and asset mix Usually. Risk and return analysis The traditional approach of portfolio building has some basic assumptions. The main advantage of diversification is that the unsystematic risk is minimized. 17 . In the capital market. Portfolio management is a complex process which tries to make investment activity more rewarding and less risky. the risk adverse investors are very particular about the stability of principal. Here the investor requires a certain percentage of growth as the income from the capital he has invested. An investor wants higher returns at the lower risk. the value of the shares is much higher than the original issue price. Investment in real estate can give faster capital appreciation but the problem is of liquidity.
Woodlock in 1900. The other major method adopted was the study of stock price movement with the help of price charts. First 18 . In the early years of the century analyst used financial statements to find the value of the securities. According to J. The proposed type of analysis later on became the ―common-size analysis.PORTFOLIO MANAGEMENT March 25. although most of the writers adopted different ways to publish their data. His theory is known as Elliot Wave Theory. The advocates of technical analysis believed that stock prices movement is ordered and systematic and the definite pattern could be identified. The first to be analyzed using this was Railroad Securities of the USA. It evolved during 1900-1902 when Charles H. the founder of the Dow Jones and Co. Dow. presented his view in the series of editorials in the Wall Street Journal in USA. Many factors have contributed to the existence and development of the concept. John Moody in his book ―The Art of wall Street Investing‖. They generally advocated the use of different ratios for this purpose. After analyzing 75 years data of share price. As the time progressed this method became very important in the investment field. This method later on was known as Technical Analysis.3 Evolution of Portfolio Management Portfolio management is essentially a systematic method of maintaining one‘s investment efficiently. Elliot who published a book in the year 1938 titled ―The Wave Principle. Francis the development of investment management can be traced chronologically through three different phases. he concluded that the market movement was quite orderly and followed a pattern of waves. A booklet entitled ―The Anatomy of the Railroad was published by Thomas F. Another prominent author who supported the technical analysis was Ralph N.C. strongly supported the use of financial ratios to know the worth of the investment. There investment strategy was build around the identification of the trend and pattern in the stock price movement. 2011 2.
There research work was considered first work in the field of security analysis and acted as the base for further study. with proper knowledge to each and every investor. If we talk of the present the last two phases of Professionalism and Scientific Analysis are currently advancing simultaneously with investment in various financial instruments becoming safer. Investors began to analyze the security before investing. Second phase began in the year 1930. but a cake of few rich people. the investment industry began the process of upgrading its ethics. They are considered as pioneers of security analysis as a discipline. which was highly sought after.PORTFOLIO MANAGEMENT March 25. Investment management was an art and needed skills. 19 . During this period the research work of Benjamin Graham and David L. Price manipulation was resorted to by the investors. After coming up of the Securities Act. They published a book ―Security Analysis in 1934. Dood was widely publicized and publicly acclaimed. He provided technical tools for the analysis and selection of optimal portfolio. The work of Markowitz was extended by the William Sharpe. John Linter and Jan Mossin through the development of the Capital Asset Pricing Model (CAPM). The foundation of modern portfolio theory was laid by Markowitz. The result of this was the stock exchange crash in the year 1929. Finally the daring speculative ventures of investors were declared illegal in the US by the Securities Act of 1934. For his work he won the Noble Prize for Economics in the year 1990. During this time period pools and corners were used for manipulation. His pioneering work on portfolio management was described in his article in the Journal of Finance in the year 1952 and subsequent books published later on. 2011 phase is known as Speculative Phase. As a result the investments market became safer place to invest and the people in different income group started investing. He showed how the risk can be minimized through proper diversification of investment which required the creation of the portfolio. Investment was not a wide spread activity. He tried to quantify the risk. The phase was of professionalism. The process is speculative in nature. Third phase was known as the scientific phase. establishing standard practices and generating a good public image.
Jack Treynor (1962). After all. John Lintner (1965) and Jan Mossin (1966). stock and option markets had been in existence at least since 1602 when shares of the East India Company began trading in Amsterdam (de la Vega. and discusses its applications and enduring importance to the field of finance. A fundamental question in finance is how the risk of an investment should affect its expected return. 1996). and organized insurance markets had become well developed by the 1700s (Bernstein. But despite the long history of actual risk-bearing and risk-sharing in organized financial markets. The Capital Asset Pricing Model (CAPM) provided the first coherent framework for answering this question. The CAPM was developed in the early 1960s by William Sharpe (1964).PORTFOLIO MANAGEMENT March 25. the Capital Asset Pricing Model was developed 20 . In particular. The CAPM gives us insights about what kind of risk is related to return. a risk that can be diversified away when held along with other investments in a portfolio is. This paper lays out the key ideas of the Capital Asset Pricing Model. The CAPM is based on the idea that not all risks should affect asset prices. By 1960. not a risk at all. places its development in a historical context. 2011 2. insurance businesses had for centuries been relying on diversification to spread risk. 1688).4 Literature on Capital Asset Pricing Model The literature on estimating a return on portfolio is quite extensive. We focus our review on methods that use mostly historical stock return data but limited stock fundamental information such as the industry classifications in the estimation process. in a very real way.
These are arithmetic average returns. The first careful study of returns on stocks listed on the New York Stock Exchange was that of Fisher and Lorie (1964) in which they note: "It is surprising to realize that there have been no measurements of the rates of return on investments in common stocks that could be considered accurate and definitive.S. Portfolio theory." In that paper. especially in the work of von Neumann and Morgenstern (1944) and Savage (1954). and the cost of equity capital was backed out from the cash flows that investors could expect to receive on their shares in relation to the current price of the shares. The costs of debt and equity capital were inferred from the long-term yields of those instruments. when sufficient computing power became available so that researchers were able to collect. Bierman and Smidt. showing how investors can create portfolios of individual investments to optimally trade off risk versus return. in which a company's dividends are 1. The cost of debt capital was typically assumed to be the rate of interest owed on the debt. store and process market data for the purposes of scientific investigation. was not developed until the early 1950s by Harry Markowitz (1952. Fisher and Lorie report average stock market returns over different holding periods since 1926.2 percent per annum over the period 1919-1977. 1959) and Roy (1952). Carefully constructed estimates of the equity risk premium did not appear until Ibbotson and Sinquefield (1976) published their findings on longterm rates of return. prior to the development of the Capital Asset Pricing Model. A popular method of estimating the cost of equity this way was the Gordon and Shapiro (1956) model. the average amount by which the stock market outperformed risk-free investments although they do remark that rates of return on common stocks were "substantially higher than safer alternatives for which data are available. 2011 at a time when the theoretical foundations of decision making under uncertainty were relatively new and when basic empirical facts about risk and return in the capital markets were not yet known.8 percent per annum. They found that over the period 1926 to 1974. and the excess return over U. 1966). but not the standard deviation of those returns. In the 1940s and 1950s. Equally noteworthy." and the weighted average of these based on the relative amounts of debt and equity financing represented the cost of capital of the asset. Treasury bills was 8." Measured standard deviations of broad stock market returns did not appear in the academic literature until Fisher and Lorie (1968). Rigorous theories of investor risk preferences and decision-making under uncertainty emerged only in the 1940s and 1950s. the empirical measurement of risk and return was in its infancy until the 1960s. They also do not report any particular estimate of the equity risk premium that is. There was a "cost of equity capital" and a "cost of debt capital.9 percent per annum.1 percent per annum average return in excess of Treasury bills 21 . the reigning paradigm for estimating expected returns presupposed that the return that investors would require (or the "cost of capital") of an asset depended primarily on the manner in which that asset was financed (for example. the (arithmetic) average return on the Standard and Poor's 500 index was 10. The first careful study of the historical equity risk premium for UK stocks appeared in Dimson and Brealey (1978) with an estimate of 9. Ibbotson and Sinquefield (1976) were also the first to report the term premium on long-term bonds: 1.PORTFOLIO MANAGEMENT March 25.
not venture all his eggs in one basket. but was still awaiting an answer. In eighteenth-century English language translations of Don Quixote. Diversification cannot eliminate all variance. Sancho Panza advises his master. rather than the other way around. Correlation and Risk The notion that diversification reduces risk is centuries old. diversification was typically thought of in terms of spreading your wealth across many independent risks that would cancel each other if held in sufficient number (as was assumed in the new ventures example).. In this model. There is no simple way to determine the market's forecast of the growth rate of future cash flows. this process of inferring the cost of equity capital from future dividend growth rates is highly subjective. the value of a firm or an asset more broadly does not depend on how it is financed. "It is the part of a wise man to . These rules-of-thumb for incorporating risk into discount rates were ad hoc at best.1 From the perspective of modern finance. while a firm that cannot support much debt is probably risky and is thus assumed to command a high cost of capital. However." According to Herbison (2003). Indeed. if a firm's current dividend per share is D. the Capital Asset Pricing Model will show that there need not be any connection between the cost of capital and future growth rates of cash flows. In the pre-CAPM paradigm.. This means that the cost of equity capital likely is determined by the cost of capital of the asset. risks across assets were correlated to a degree. as shown by Modigliani and Miller (1958)." In short. investors could eliminate some but not all risk by holding a diversified portfolio. this approach to determining the cost of capital was anchored in the wrong place. The returns from securities are too inter correlated. Moreover. Harry Markowitz (1952) had the insight that. At least in a frictionless world. and the stock price of the firm is P. Markowitz wrote: "This presumption that the law of large numbers applies to a portfolio of securities. The working assumption was often that a firm that can be financed mostly with debt is probably safe and is thus assumed to have a low cost of capital. As Modigliani and Miller (1958) noted: "No satisfactory explanation has yet been provided as to what determines the size of the risk [adjustment] and how it varies in response to changes in other variables. because of broad economic influences. risk did not enter directly into the computation of the cost of capital. the proverb "Do not keep all your eggs in one basket" actually appeared as far back as Torriano's (1666) Common Place of Italian Proverbs. cannot be accepted. Diversification.PORTFOLIO MANAGEMENT March 25." Markowitz (1952) went on to show analytically 22 . As a result. 2011 over the period 1926-1974 assumed to grow in perpetuity at a constant rate g. then the cost of equity capital r is the dividend yield plus the dividend growth rate: r = D/P + g. the question of how expected returns and risk were related had been posed. and companies with high dividend growth rates will be judged by this method to have high costs of equity capital. before the arrival of the Capital Asset Pricing Model.
1962). The CAPM’s impact over the decades on the financial community has led several authors inclusive of Fama and French (2004) to suggest that the development of the CAPM marks “the birth of Asset Pricing models”. In this case. the two assets are substitutes for one another. often represented by the quantity beta (β) in the financial industry. as well as the expected return of the market and the expected return of a theoretical risk-free asset. They move in the same direction and in fixed proportions (plus a constant). The correlation between the returns of two assets measures the degree to which they fluctuate together. When the correlation is -1. 2. if that asset is to be added to an already welldiversified portfolio. the other goes down and in a fixed proportion (plus a constant). These are Harry Markowitz's important insights: 1) that diversification does not rely on individual risks being uncorrelated.0. just that they be imperfectly correlated.0. building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset.0. When the correlation is zero. the two assets act to insure one another. One of the fundamental tenants in financial theory is the CAPM as developed by Sharpe (1964). If Markowitz were restating Sancho Panza's advice. given that asset's non-diversifiable risk. 2011 how the benefits of diversification depend on correlation. In this case. and 2) that the risk reduction from diversification is limited by the extent to which individual asset returns are correlated. William Sharpe (1964).2 In finance. John Lintner (1965) and Jan Mossin (1966) independently. Lintner (1965) and Black (1972). When the correlation is 1. knowing the return on one asset does not help you predict the return on the other.0 and -1. the returns are perfectly negatively correlated meaning that when one asset goes up. Correlation coefficients range between 1. the two assets are perfectly positively correlated.5 Background: The model was introduced by Jack Treynor (1961. The model takes into account the asset's sensitivity to non-diversifiablerisk(also known as systematic risk or market risk).PORTFOLIO MANAGEMENT March 25. 23 . he might say: It is safer to spread your eggs among imperfectly correlated baskets than to spread them among perfectly correlated baskets.
static (one period) model. The model draws on the portfolio theory as developed by Harry Markowitz (1959). 2011 The CAPM is an ex-ante. we make use of the security market line(SML) and its relation to expected return and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. Estimation of the CAPM and the Security Market Line (purple) for the Dow Jones Industrial Average over the last 3 years for monthly data. For individual securities. where: is the expected return on the capital asset is the risk-free rate of interest such as interest arising from government bonds 24 . The CAPM is a model for pricing an individual security or a portfolio. thus: The market reward-to-risk ratio is effectively the market risk premium and by rearranging the above equation and solving for E(Ri).PORTFOLIO MANAGEMENT March 25. Therefore. The SML enables us to calculate the reward-to-risk ratio for any security in relation to that of the overall market. we obtain the Capital Asset Pricing Model (CAPM). when the expected rate of return for any security is deflated by its beta coefficient. The model’s main prediction is that a market portfolio of invested wealth is mean-variance efficient resulting in a linear cross-sectional relationship between mean excess returns and exposures to the market factor. the reward-to-risk ratio for any individual security in the market is equal to the market reward-to-risk ratio.
2011 (the beta) is the sensitivity of the expected excess asset returns to the expected excess market returns. that is. The CAPM model assumes a linear relationship between the expected return in a risky asset and its β and further assumes that β is an applicable and sufficient measure of risks that captures the cross section of average returns. is the expected return of the market is sometimes known as the market premium or risk premium (the difference between the expected market rate of return and the risk-free rate of return).g.PORTFOLIO MANAGEMENT March 25. Note 2: the risk free rate of return used for determining the risk premium is usually the arithmetic average of historical risk free rates of return and not the current risk free rate of return. β drives average returns because β measures how much the inclusion of additional stock to a well diversified portfolio increases the inherent risk and volatility of the portfolio. 25 . or also . S&P 500. the model assumes that assets can only earn a high average return if they have a high market β. BSE Sensex ). Note 1: the expected market rate of return is usually estimated by measuring the Geometric Average of the historical returns on a market portfolio (e.
discounted at the rate suggested by CAPM. an asset is correctly priced when its estimated price is the same as the present value of future cash flows of the asset. assuming that at time t + 1 the asset returns to the CAPM suggested price. If the observed price is higher than the CAPM valuation. To make this comparison. 2011 2. we can compare this required rate of return to the asset's estimated rate of return over a specific investment horizon to determine whether it would be an appropriate investment. E(Ri). When the asset does not lie on the SML. you need an independent estimate of the return outlook for the security based on either fundamental or technical analysis techniques.6 Security Market Line The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. and the y-axis represents the expected return. And a security plotted below the SML is overvalued since the investor would be accepting less return for the amount of risk assumed. The intercept is the nominal risk-free rate available for the market. this could also suggest mis-pricing. E(Rm)− Rf. The relationship between β and required return is plotted on the securities market line (SML) which shows expected return as a function of β. The equation of the SML is thus: It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable expected return for risk. M/B etc. The securities market line can be regarded as representing a single-factor model of the asset price.PORTFOLIO MANAGEMENT March 25. where Beta is exposure to changes in value of the Market. Since the expected return of the asset at time t is . is calculated using CAPM. 26 . The x-axis represents the risk (beta). then the asset is overvalued (and undervalued when the estimated price is below the CAPM valuation). Individual securities are plotted on the SML graph. Once the expected/required rate of return. it is undervalued since the investor can expect a greater return for the inherent risk. If the security's expected return versus risk is plotted above the SML. a higher expected return than what CAPM suggests indicates that Pt is too low (the asset is currently undervalued). including P/E. while the slope is the market premium. The market risk premium is determined from the slope of the SML. Assuming that the CAPM is correct.
expects performance in line with the market." In the CAPM context. Stock market indices are frequently used as local proxies for the market—and in that case (by definition) have a beta of one.e. Systematic risk refers to the risk common to all securities—i.e.as opposed to its "stand alone riskiness. the return that compensates for risk taken. has a beta of one. A rational investor should not take on any diversifiable risk. Given the accepted concave utility function. 27 . In other words the beta of the portfolio is the defining factor in rewarding the systematic exposure taken by an investor. less sensitive stocks will have lower betas and be discounted at a lower rate. Betas exceeding one signify more than average "riskiness". Depending on the market. a portfolio of approximately 30-40 securities in developed markets such as UK or US will render the portfolio sufficiently diversified such that risk exposure is limited to systematic risk only.PORTFOLIO MANAGEMENT March 25. and unsystematic risk which is also known as idiosyncratic risk or diversifiable risk.e. market risk. the market as a whole. diversified portfolio (such as a mutual fund). 2011 The CAPM returns the asset-appropriate required return or discount rate—i. Unsystematic risk is the risk associated with individual assets. the required return on an asset. Since beta reflects asset-specific sensitivity to non-diversifiable. Therefore. the CAPM is consistent with intuition—investors (should) require a higher return for holding a more risky asset. Unsystematic risk can be diversified away to smaller levels by including a greater number of assets in the portfolio (specific risks "average out"). In developing markets a larger number is required. by definition. 2. the rate at which future cash flows produced by the asset should be discounted given that asset's relative riskiness. market risk. as only non-diversifiable risks are rewarded within the scope of this model. its contribution to overall portfolio riskiness . therefore. Thus. less predictability. that is.e. i. must be linked to its riskiness in a portfolio context . An investor in a large. a more risky stock will have a higher beta and will be discounted at a higher rate.i. The same is not possible for systematic risk within one market. portfolio risk is represented by higher variance i. due to the higher asset volatilities. betas below one indicate lower than average. also known as undiversifiable risk.7 Risk & Diversification The risk of a portfolio comprises systematic risk.e.
The CAPM assumes that the risk-return profile of a portfolio can be optimized—an optimal portfolio displays the lowest possible level of risk for its level of return. comprise the efficient frontier. i. Additionally. only one of these portfolios will be optimal (in the sense of lowest risk). since each additional asset introduced into a portfolio further diversifies the portfolio. All such optimal portfolios. option 2 will generally have the lower variance and hence be the more efficient of the two. For a given level of return. by definition. Here. By investing all of one's wealth in a risky portfolio. Since the risk free asset is. uncorrelated with any other asset. the total risk of a portfolio can be viewed as beta. 2011 The (Markowitz) efficient frontier. (assuming no trading costs) with each asset value-weighted to achieve the above (assuming that any asset is infinitely divisible). 2. the optimal portfolio must comprise every asset. one for each level of return. the ratio of risky assets to risk free asset does not determine overall return—this relationship is clearly linear. It is thus possible to achieve a particular return in one of two ways: 1. however. For a 28 . CAL stands for the capital allocation line.PORTFOLIO MANAGEMENT March 25. 2. or by investing a proportion in a risky portfolio and the remainder in cash (either borrowed or invested). This relationship also holds for portfolios along the efficient frontier: a higher return portfolio plus cash is more efficient than a lower return portfolio alone for that lower level of return.e..8 Market Portfolio An investor might choose to invest a proportion of his or her wealth in a portfolio of risky assets with the remainder in cash—earning interest at the risk free rate (or indeed may borrow money to fund his or her purchase of risky assets in which case there is a negative cash weighting). Because the unsystematic risk is diversifiable.
Are price takers. This is the market portfolio. Can lend and borrow unlimited amounts under the risk free rate of interest.PORTFOLIO MANAGEMENT March 25. • • • • 29 Are rational and risk-averse. Are broadly diversified across a range of investments. there is only one optimal portfolio which can be combined with cash to achieve the lowest level of risk for any possible return. i. . 2. 2011 given risk free rate. they cannot influence prices.e..9 ASSUMPTIONS OF CAPM:All investors: • Aim to maximize economic utilities.
Deal with securities that are all highly divisible into small parcels. Assume all information is available at the same time to all investors. large swings (3 to 6 standard deviations from the mean) occur in the market more frequently than the normal distribution assumption would expect.10 LIMITATIONS OF THE MODEL ➢ The model assumes that either asset returns are (jointly) normally distributed random variables or that investor’s employ a quadratic form of utility.PORTFOLIO MANAGEMENT March 25. As a result. 2. 2011 • • • Trade without transaction or taxation costs. It is however frequently observed that returns in equity and other markets are not normally distributed. might be justified under the assumption of normally distributed returns. This 30 . but for general return distributions other risk measures (like coherent risk measures) will likely reflect ➢ The model assumes that the variance of returns is an adequate measurement of risk.
and Avanidhar Subrahmanyam (2001). New York in a paper by Fischer Black. It does not allow for investors who will accept lower returns for higher risk. ➢ The model assumes that the probability beliefs of investors match the true distribution of returns. rather it is the probability of losing: it is asymmetric in nature. ➢ The model does not appear to adequately explain the variation in stock returns. Michael Jensen. or it is irrational (which saves CAPM. Empirical studies show that low beta stocks may offer higher returns than the model would predict. such a market portfolio is unobservable and people usually substitute a stock index as a proxy for the true market portfolio..) In practice. ➢ The market portfolio consists of all assets in all markets. real estate. and is generally referred to as Roll's critique. causing market prices to be informationally inefficient. Some data to this effect was presented as early as a 1969 conference in Buffalo. Unfortunately. ➢ The model assumes that there are no taxes or transaction costs. and that investors choose assets solely as a function of their riskreturn profile. human capital. ➢ The model assumes that all investors have access to the same information and agree about the risk and expected return of all assets (homogeneous expectations assumption). but makes the EMH wrong – indeed. and Myron Scholes. which uses psychological assumptions to provide alternatives to the CAPM such as the overconfidence-based asset pricing model of Kent Daniel. This was presented in greater depth in a paper by Richard Roll in 1977. A different possibility is that investors' expectations are biased. this possibility makes volatility arbitrage a strategy for reliably beating the market). This assumes no preference between markets and assets for individual investors. Indeed risk in financial investments is not variance in itself. and it is possible that some stock traders will pay for risk as well. where each asset is weighted by its market capitalization.. and it has been said that due to the inobservability of the true market portfolio. the CAPM might not be empirically testable. ➢ The model assumes that given a certain expected return investors will prefer lower risk (lower variance) to higher risk and conversely given a certain level of risk will prefer higher returns to lower ones. Either that fact is itself rational (which saves the efficient-market hypothesis but makes CAPM wrong). 31 . It also assumes that all assets are infinitely divisible as to the amount which may be held or transacted. 2011 the investors' preferences more adequately. This possibility is studied in the field of behavioral finance. Casino gamblers clearly pay for risk. ➢ The market portfolio should in theory include all types of assets that are held by anyone as an investment (including works of art. although this assumption may be relaxed with more complicated versions of the model.PORTFOLIO MANAGEMENT March 25. David Hirshleifer. it has been shown that this substitution is not innocuous and can lead to false inferences as to the validity of the CAPM.
2011 ➢ The model assumes just two dates. This is in sharp contradiction with portfolios that are held by individual investors: humans tend to have fragmented portfolios or. we think differently about how investors should allocate their investment portfolios. The CAPM tells us that ownership of assets by diversified investors lowers their expected returns and raises their prices. 2. The basic insights of the model are extended and generalized in the intertemporal CAPM (ICAPM) of Robert Merton. so that there is no opportunity to consume and rebalance portfolios repeatedly over time. rather. Chapter 3 32 .PORTFOLIO MANAGEMENT March 25. we now think differently about the relationship between expected returns and risk. investors who hold undiversified portfolios are likely to be taking risks for which they are not being rewarded. and the consumption CAPM (CCAPM) of Douglas Breeden and Mark Rubinstein.11 SUMMARY The Capital Asset Pricing Model is a fundamental contribution to our understanding of the determinants of asset prices. multiple portfolios: for each goal one portfolio — see behavioral portfolio theory and Maslowian Portfolio Theory. and despite its mixed empirical performance. and we think differently about questions such as performance measurement and capital budgeting. ➢ CAPM assumes that all investors will consider all of their assets and optimize one portfolio. As a result of the model. Moreover.
This dissertation throws a brief light on the various aspects that have been covered in the research undertaken till now. 33 . 2011 Capital Asset Pricing Model: Conceptual Research There has been a lot of theoretical research already undertaken on Capital Asset Pricing Model.PORTFOLIO MANAGEMENT March 25.
Fama and French (2000) summarize the popularity of the CAPM by their statement: “The attraction of the CAPM is that it offers powerful and intuitively pleasing predictions about how to measures risk and the relation between expected return and risk.1 Introduction & Background of Research While relationships described by the CAPM have been the context of numerous empirical studies by many academics. Fama and French (1992) find that adding a "value" factor and a "size" factor (in addition to the overall market) greatly improves upon the explanatory power of the CAPM. Most notably.PORTFOLIO MANAGEMENT March 25. Another criticism of the Fama-French findings is that their value effect is based on giving equal weight to small and large companies and is much stronger than observed in capitalizationweighted value indexes. size per se cannot be a risk factor that affects expected returns. DeBondt and Thaler (1985) find that stocks with abnormally low long 34 .” Whether the basic CAPM or one of its multifactor extensions is the "correct" model of asset prices is ultimately an empirical question. one that is discussed in detail by Fama and French in their companion paper in this journal. However. provides an insight on the significance of this finance model.” Fama and French (2000) also offer their opinion on its relevance: “Unfortunately the empirical record of the model is poor – poor enough to invalidate the way it is used in applications. at best. Jensen and Scholes (1972) and Fama and MacBeth (1973) supported the theory in that high beta stocks were found to have had higher returns than low beta stocks. the relationship between beta and average returns was not as steep as indicated by the theoretical Securities Market Line. 1996)). Banz (1981) finds that Market Equity (ME) adds to the cross section of expected returns provided by the market β. Basu (1983) finds that low earnings-price ratios (E/P) stocks help explain the cross section of US stocks returns while high (E/P) stocks experiencing lower returns could be explained by the CAPM. During the 1980’s several studies resulted in the identification of additional factors that provide explanatory power other than β for average stock returns. they are proxies for risk. its use in many present day applications by fund managers and in finance based course curricula. Since this early work. However. 2011 3. Initial tests of the CAPM by Black. since small firms would then simply combine to form large firms. the value and size factors are not explicitly about risk. the forecast power of their model will be in doubt and the applications will be limited. Until the risks that underlie the Fama-French factors are identified. a vast body of research has looked for additional risk factors that affect expected returns. For example. Variables that have no special standing in asset pricing theory were shown to have reliable power in explaining the cross section of returns (these variables are referred to as anomalies by Fama and French (1993. The pervasiveness of these findings in follow-up research across time and other countries provides strong evidence that more than one systematic risk factor is at work in determining asset prices.
SMB (Small Minus Big . (E/P). Fama and French (1996) also observe that abnormal patterns of asset returns experienced during the 1980’s and 1990’s could not be explained by the CAPM but are however due to mis-specification in the expected returns model. These relationships could not be explained by the CAPM. financial leverage and BE/ME in the cross section of average returns on the New York Stock Exchange (NYSE). They find that two (2) factors. Jensen and Scholes (1972) time series regression model to identify these factors. Shleifer. explains significant return patterns on Lakonishok. 35 . They find that the Size and BE/ME variables capture the cross sectional variation in average stock returns associated and conclude that the CAPM model is violated in its predication of a cross sectional relationship between mean excess returns and exposures to the market factor. inclusive of the market factor.the Size proxy) and HML (High Minus Low . One of the major empirical arguments against the CAPM model is presented by Fama and French (1992). Fama and French (1993) find that five (5) common risk factors explain the returns in both stocks and bonds. Reid and Lanstein (1985) find a positive relationship between the average return and the ratio of a firm’s book value to market equity (BE/ME). and Vishny (1994) portfolios. Sheifer and Vishny (1994) find a strong positive relationship between average returns and BE/ME and cashflow/price ratio (C/P). firm Size and BE/ME portfolios explain the differences in the average cross section returns of stocks. They find that two other variables. In testing the relationship between risk factors and stocks returns.the BE/ME proxy). The resultant model is being coined the Fama and French Three Factor Model (TFM) in financial literature. Lakonishok. firm Size (ME). 2011 term returns (average returns in three years) experience abnormally high long term future returns (average returns in the next three years) and vice versa. Bhandari (1988) finds a positive relationship between leverage and the cross section of average return. They find that the cross section of average equity returns in the US market shows little statistical relation to the βs of the original CAPM model. Rosenberg. The authors evaluate the joint roles of the market β. and National Association of Securities Dealers Automated Quotations (NASDAQ) stocks. American Stock Exchange (AMEX). the authors use the Black.PORTFOLIO MANAGEMENT March 25. namely.
Or for each level of risk. (A "risk-free" instrument pays a fixed real return and is default free. Treasury bonds that adjust automatically with inflation called Treasury inflation-protected instruments. By holding both assets in a portfolio.PORTFOLIO MANAGEMENT March 25.) To see how riskless borrowing and lending affects investors' decision choices. and each investor can choose which of these best matches their risk tolerance. we need to examine how imperfect correlation among asset returns affects the investor's tradeoff between risk and return. U. You would choose the riskless asset has no risk but also the lowest expected return. there will be many combinations of assets with the same portfolio expected return but different portfolio risk. the efficient frontier simplifies in an important way. or TIPS and short-term U. You would choose to lend at the risk-free rate if you had a very low tolerance for risk. consider investing in the following three instruments: risky assets M and H. one obtains an expected return on the portfolio that is the same as either one of them.S. James Tobin (1958) showed that when investors can borrow as well as lend at the risk-free rate. the expected return on a portfolio of investments is just the weighted average of the expected returns of the underlying assets. Riskless Lending and Borrowing and Fund Separation To arrive at the CAPM. but a portfolio standard deviation that is lower than any one of them individually. we can solve for the combination of assets that has the highest expected return. While risks combine nonlinearly (because of the diversification effect). An Asset may have 36 ." For each level of expected return.S. Using optimization techniques. Generally. we can solve for the portfolio combination of assets that has the lowest risk. Suppose first that you had the choice of investing all of your wealth in just one of these assets. we can compute what Markowitz coined the "efficient frontier. The initial development of portfolio theory assumed that all assets were risky. and the riskless asset. The efficient frontier consists of the collection of these optimal portfolios. where the expected returns and risks of the assets. Treasury bills are considered close approximations of risk-free instruments. Diversification thus leads to a reduction in risk without any sacrifice in expected return. expected returns combine linearly. Which would you choose? The answer depends on your risk tolerance. 2011 3. That is. and there will be many combinations of assets with the same portfolio risk but different portfolio expected return. Imagine two assets with the same expected return and the same standard deviation of return.2 Portfolio Theory.
investors all will determine the same highest Sharpe Ratio portfolio of risky assets. but are needed to obtain the CAPM in its basic form.3 3. We begin with four assumptions. and you would choose this asset if you had a moderate tolerance for risk. the price (that is. standard deviations of return and the correlations among asset returns. each investor will allocate a portion of wealth to this optimal portfolio and the remainder to risk-free lending or borrowing. These assumptions represent a highly simplified and idealized world. Capital markets are perfect in several senses: all assets are infinitely divisible. information is costless and available to everyone. Depending on their risk tolerance. First.3 Capital Asset Pricing Model The rule for improving the Sharpe Ratio of a portfolio allows us to derive the Capital Asset Pricing Model in a straightforward and intuitive way. given prevailing prices. Investors all will hold risky assets in the same relative proportions. those proportions 37 . Investors all have access to the same investment opportunities. short selling restrictions or taxes. 2011 an intermediate risk and expected return.that you wish to invest some of your wealth and the balance in riskless lending or borrowing. For the market to be in equilibrium. If investors all hold risky assets in the same proportions.PORTFOLIO MANAGEMENT March 25. there are no transactions costs. Investors all make the same estimates of individual asset expected returns. We begin with four assumptions. The model has been extended in many ways to accommodate some of the complexities manifest in the real world. Suppose next that you can borrow and lend at the risk-free rate. investors are risk averse and evaluate their investment portfolios using the Capital Asset Pricing Model The rule for improving the Sharpe Ratio of a portfolio allows us to derive the Capital Asset Pricing Model in a straightforward and intuitive way. and all investors can borrow and lend at the risk-free rate. Investors are risk averse and evaluate their investment portfolios solely in terms of expected return and standard deviation of return measured over the same single holding period. the expected return) of each asset must be such that investors collectively decide to hold exactly the supply of the asset. But under these assumptions.
0. beta offers a method of measuring the risk of an asset that cannot be diversified away.PORTFOLIO MANAGEMENT March 25. It is the relationship between expected return and risk that is consistent with investors behaving according to the prescriptions of portfolio theory. respectively. but a stock need not have a high beta to have a high stand-alone risk. in equilibrium. the portfolio of risky assets with the highest Sharpe Ratio must be the market portfolio. the extent to which the stock is a substitute for investing in the market.1. The Capital Asset Pricing Model has a number of important implications:First. 2011 must be the proportions in which risky assets are held in the market portfolio the portfolio comprised of all available shares of each risky asset. In equilibrium. stock prices will adjust to the point where the CAPM becomes true. Moreover. and if sufficiently many investors do this. The stock's risk premium is determined by the component of its return that is perfectly correlated with the market that is. then investors will be able to outperform the market (in the sense of obtaining a higher Sharpe Ratio) by applying the portfolio improvement rule. This formula is the one that Sharpe. Moreover. Lintner and Mossin successfully set out to find. Beta satisfies this requirement. the capitalization weighted average of the market betas of all stocks is the beta of the market versus itself. The component of the stock's return that is uncorrelated with the market can be diversified away and does not command a risk premium. there is no way to obtain a higher Sharpe Ratio by holding more or less of any one asset. perhaps the most striking aspect of the CAPM is what the expected return of an asset does not depend on. For example. If this rule does not hold. It is true that a high beta stock will tend to have a high stand-alone risk because a portion of a stock's stand-alone risk is determined by its beta. the expected return of a stock does not depend on its stand-alone risk. The average stock therefore has a market beta of 1. the Sharpe Ratio of any asset is no higher than the Sharpe Ratio of the market portfolio (since p < 1). A stock with high stand-alone risk therefore will only have a high expected return to the extent that its stand-alone risk is derived from its sensitivity to the broad stock market. then the market beta of a 50/50 portfolio of these stocks is 1. assets having the same correlation with the market portfolio will have the same Sharpe Ratio. On a graph where the risk of an 38 . We saw earlier that any risk measure for determining expected returns would have to satisfy the requirement that the risk of a portfolio is the weighted average of the risks of the holdings in the portfolio.4. Another way of expressing the CAPM equation is Sharpe Ratio of Asset S= p X Sharpe Ratio of the Market Portfolio In other words. In particular. If the market portfolio has the highest attainable Sharpe Ratio. Second. therefore. The Capital Asset Pricing Model tells us that to calculate the expected return of a stock. investors need know two things: the risk premium of the overall equity market (assuming that equities are the only risky assets) and the stock's beta versus the market.8 and 1. if two stocks have market betas of 0. the average of the two stock betas. Treynor.
4 Is CAPM Useful The Capital Asset Pricing Model is an elegant theory with profound implications for asset pricing and investor behavior. in the Capital Asset Pricing Model. But how useful is the model given the idealized world that underlies its derivation. If not. all securities lie on a single line the so-called Securities Market Line. a parameter that is usually much easier to estimate than the expected future cash flows of the firm. Second. If the market is in equilibrium.4 3. many workers hold concentrated ownership of company stock in employee retirement savings plans and many executives hold concentrated ownership of company stock options. and so stocks were scattered over the diagram.PORTFOLIO MANAGEMENT March 25. as a consequence of capital market frictions being lessened through financial innovation. investors will be able to improve upon the market portfolio and obtain a higher Sharpe Ratio. To find the expected return of a company's shares. it might predict future investor behavior for example. if not always in a strict quantitative sense. According to the CAPM. in terms of direct expenses and taxes. Suboptimal Diversification Consider the CAPM prediction that investors all will hold the same (market) portfolio of risky assets. and least in a strong qualitative sense. the CAPM can serve as a benchmark for understanding the capital market phenomena that cause asset prices and investor behavior to deviate from die prescriptions of the model. Third. First. which is not a surprise since taxes alone will cause idiosyncratic investor behavior. all assets must lie on this line. presented earlier measured risk on the horizontal axis as stand-alone risk. the standard deviation of each stock. Third. and that investors are subject to behavioral biases 39 . One does not have to look far to realize that investors do not hold identical portfolios. On the other hand. we can examine whether real world asset prices and investor portfolios conform to die predictions of the model. 2011 asset as measured by beta is on the horizontal axis and return is on the vertical axis. Common explanations are that obtaining broad diversification can be costly. But remember that not all of the stand-alone risk of an asset is priced into its expected return. improved regulation and increasing capital market integration. popular index funds make it possible for investors to obtain diversification at low cost. pas. it is thus not necessary to carry out an extensive financial analysis of the company and to forecast its future cash flows. a stock's expected return does not depend on the growth rate of its expected future cash flows. In contrast. that is correlated with the market portfolio. all we need to know about the specific company is die beta of its shares. even if the model does not describe our current world particularly well. There are several ways to answer this question. just that portion of its risk. On one hand.
most likely due to the increased availability of low-cost vehicles to invest globally and greater investor appreciation of the need for diversification. with a portfolio beta of 1. Instead of investing in funds A and/or B. Suppose that the funds obtained returns of 12 percent and 18 percent.5. To draw a firmer conclusion.PORTFOLIO MANAGEMENT March 25. which in turn creates opportunities for investor education and financial innovation. we know from the CAPM that focusing on stand-alone risk is misleading if investors can hold diversified portfolios. Performance Measurement One of the earliest applications of the Capital Asset Pricing Model was to performance measurement of fund managers. Fund B. so fund B would appear to have been the better performing fund. investors could have held corre sponding mimicking or "benchmark" portfolios. The benchmark portfolios respectively would have returned 5 percent and 20 percent (= 5 percent + 1. fund A had greater risk and a lower return than fund B. For fund A. respectively. if valid. respectively. None of these reasons. 2011 and lack of sophistication. 40 .5 X (15 percent 5 percent)). the benchmark portfolio is an investment in the risk-free asset. Indeed. with a portfolio beta of zero. The CAPM tells us that investors pay a price for being undiversified in that they are taking risks for which they are not being compensated. Fund A thus outperformed its benchmark by 7 percent. Consider two funds. However. there exists the potential for port? folio improvement. that are actively managed in the hope of outperforming the market. A and B. since its beta is zero. while fund B underperformed its benchmark by 2 percent. for fund B. invests in selected high beta stocks. the benchmark is a position in the market portfolio leveraged 1. foreign ownership of equities in many countries has more than doubled over the last 20 years. we need to know how these funds are managed: Suppose that fund A consists of a high-risk but "marketneutral" portfolio that has long positions in some shares and short positions in others. Investors today seem to be much better diversified than in decades past. on the other hand. would mean that the CAPM is not useful. Thus. a trend that appears likely to continue. At first glance. Which fund had the better performance.5:1 with borrowing at the risk-free rate. Assume further that the standard deviation of funds A and B were 40 percent per annum and 30 percent per annum. during a period when the risk-free rate was 5 percent and the overall market returned 15 percent.
Beta can in many circumstances be accurately measured this way even over a relatively short period of time. Extensions of the CAPM The Capital Asset Pricing Model has been extended in a variety of ways. since such performance cannot be replicated with a passive strategy. it is customary to infer beta from comparable entities whose betas can be estimated. and even this may not be sufficient if the risk premium varies over time. Some of the best-known extensions include allowing heterogeneous beliefs. The hardest of all parameters to estimate is usually the market risk premium. An investor who held the market portfolio would. have obtained a higher return for the same risk by allocating money to fund A rather than to fund B. the market risk premium and the beta versus the market of the company or project. respectively. unlike variance-related measures like beta. average returns are very sensitive to the beginning and ending level of stock prices. however. Provided that the CAPM is the "right" model. eliminating the possibility of risk-free lending and borrowing. which across all investors aggregate to the market portfolio. an error in the discount rate is magnified manyfold when calculating the net present value. provided that there is sufficient high-frequency data. The key idea here is that obtaining high returns by owning high beta stocks does not take skill. no single portfolio of risky assets is optimal for everyone. Obtaining high returns with low beta stocks is much harder. funds A and B had alphas of 7 percent and 2 percent. investors allocate their wealth differentially among several risky portfolios. extensions to international investing . and employing weaker assumptions by relying on arbitrage pricing. The risk premium must therefore be measured over long periods of time. having some assets be nonmarketable. In most extensions of the CAPM. at the margin. Accuracy in estimating these parameters matters greatly for real world decisionmaking since. allowing for multiple time periods and investment opportunities that change from one period to the next.PORTFOLIO MANAGEMENT March 25. where alpha is the difference between a fund's performance and that predicted given the beta of the fund. When die company or project being valued is not publicly traded or there is no relevant return history. The historical risk premium is estimated from the average of past returns and. irrespective of difficulty. however. since investors can passively create a high beta portfolio simply through a leveraged position in the market portfolio. Beta is usually estimated with use of linear regression analysis applied to historical stock market returns data. Appropriately risk adjusted. The CAPM and Discounted Cash Flow Analysis According to the CAPM. for long-dated cash flows. fund A's performance (alpha = 7 percent) exceeded that of fund B (alpha = 2 percent). Rather. To 41 . beta too needs to be estimated. 2011 In terms of the CAPM framework. Investors therefore need to assess performance based on returns that have been appropriately risk adjusted. None of these measurement questions poses a problem for the CAPM per se. and its estimation needs to be performed regardless of the difficulty of the task. The market risk premium is common to all models of cash flow valuation. the appropriate discount rate for valuing the expected future cash flows of a company or of a new investment project is determined by the risk-free rate.
In the basic CAPM. This model takes into account that investors have consumption needs particular to the country in which they are resident.PORTFOLIO MANAGEMENT March 25. Thus. 2011 illustrate. investors care about only one risk factor the overall market. This insight leads to a model of expected returns involving not only the beta of an asset versus the overall market. Almost all variants of the CAPM have a multi-beta expression. but also the betas of the asset versus currency movements and any other risk that is viewed differently by different investor segments. the top heavy weights of BSE Sensex (30 Companies) from diversified sectors are considered and their return over a period of time is calculated using Risk free return. Risk Premium and Beta( Correlation of the market risk and security risk). they are also concerned about real currency fluctuations. As a result. British investors will worry about the purchasing power of pounds while American investors worry about the purchasing power of dollars. 42 . In this international version of the model. consider the International Capital Asset Pricing Model. they will hold somewhat different portfolios. 5 Chapter 4 Core Chapter: Use of CAPM in BSE Sensex: An Empirical Study The objective of this chapter is to make a comprehensive research on the application of CAPM as a true reflector of returns as shown by the stock over a period of time and not just he stock but the returns of the portfolio. In this particular case. which means that British and American investors will differently assess the incremental contribution that any particular asset makes to portfolio risk.
1 EMPIRICAL STUDY OF APPLICABILITY OF CAPM ON BSE SENSEX 43 .PORTFOLIO MANAGEMENT March 25. 2011 4.
58200% 55.22% -6.62% 4.24% 7.35% -5.91 0.64980% 0.10% -7.06% 3.20% 52.07% 12.52110% 0.05% 279.79% 5.50400% 0.50580% 0.55% 5.91 0.55% -5.79% -5.44% 60.91 0.Bill Rate Risk Premium BETA CAPM Cost of Equity 10.72757% 44 . 2011 Table 1: Risk Free Market Rate Rate Bajaj Auto Ltd.66150% 0.99% 276.48% -10.91 0.91 0.88090% 254.80% 0.07% 7.91 0.91 0.35% 5.91 0.54630% 18.62% -4.40950% 0.10% 7. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 364 T.60% -7.91 0.22% 6.60% 7.91 0.90900% 0.PORTFOLIO MANAGEMENT March 25.91 0.68% 20.
01 43.708900% 1.66% 286.10% -7.01 -20.28% -1.88% 42.22% 6.01 5.01 5.77% 39.01 40.727200% 1.28% 281.605600% 1.07% 7.94% 19.55% 5.172000% 1.01 -2.79% 5.35% -57.521700% 1.68 0.33% 0.33040% 195.01 80.68 0.06% -51.04% 124.89% -27.06% 3.83% 13.62% -2.80% 20.436300% 1.40280% 9.52% 35.01 0.22% 34.03440% 15.55% 5.17% 73.63% -1.21% 4.24% 7.Bill Rate Risk Premium BETA CAPM Cost of Equity 10.70% 5.79% 5.97680% 58.60% 7.68 3.68% 0.68 0.35200% -33.42920% 20.06560% 26.68 0.35% 5.62% 4.68 0.10% 7.82% 5.39% 79.60% 7.01 22.PORTFOLIO MANAGEMENT March 25. 2000 2001 2002 2003 2004 2005 2006 2007 2008 10.01 125.39% -10.86% -9.612800% 1.63% 22.972200% 1.Bill Rate Risk Premium BETA CAPM Cost of Equity Bharti Airtel Ltd.42% 120.72% 16.92% 28. 2011 Table 2: Risk Free Market Rate Rate Bharat Heavy Electricals Ltd 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 364 T.44% -5.68 0.68 0.62% 19.06% 82.135352% Table 3: Risk Free Market Rate Rate 364 T.20440% 45 .07% 7.20% 13.51% 76.22% 6.09% 37.62% 4.65% -19.68 0.54% 1.10% 7.220900% 1.35% 5.43% 11.01 20.23200% 2.204200% 1.01% 26.
51 2.43% 41.51 0.57% -0.Bill Rate Risk Premium BETA CAPM Cost of Equity 10.24% -14.51 0.51% -3.51 0.660100% 1.62% 4.355000% 24.24% 7. 2011 Risk Free Market Rate Rate Cipla Ltd.06% 3.246500% -10.54% -5.93% 27.550000% -9.20% -6.80% -11.51 0.51 0.51 0.50% 34.68% -3.578448% Table 4: 46 .03% 20.413400% 6.34% 1.51 0.90% -67.575400% 2.51 0.151000% -28.79% 5.33% -0.00% -29.PORTFOLIO MANAGEMENT March 25.485600% 0. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 364 T.92% 0.53% -24.79% 7.642000% 1.44% -13.55% 5.22% 6.68% -61.51 0.07% 7.20% -4.10% 7.15% -29.35% 5.35% -23.51 0.944700% 17.60% 7.
63 1.22% 6.98% 25.68% 42.22% 36.97820% -38.96% -3. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 364 T.60% 59.84% 0.55% 5.54860% 64.63 1.24% 7.296000% -6.92 0.62% -4.79% -5.63 -6.55% -5.13% -10.92 0.10% 7.10% -7.86650% -3.10% 7.42% 19.35% 5.63 1.14% -28.474400% 18.32% 12.71% -4.07% 7.79% 5.21% -21.63050% -3.60% 7.54060% -2.92 55.72728% Table 6: Risk Free Market Rate Rate 364 T.60% -7.52800% -4.06% 3.32% -36.63 1.24% 49.35% 5.79% 5.63 1.56% -43.113600% -2.06% -52.55% 5.92 0. 2011 Table 5: Risk Free Market Rate Rate DLF Ltd.63 1.Bill Rate Risk Premium BETA CAPM Cost of Equity 10.34% -7.721200% -4.36300% -4.43% 31.63 1.Bill Rate Risk Premium BETA CAPM Cost of Equity HDFC Bank Ltd 2000 2001 2002 2003 2004 2005 47 10.62% 4.63 1.32280% -63.92 0.63 1.58% -7.791600% 29.35% -5.212800% .92 0.77560% -87.81% 1.63 1.PORTFOLIO MANAGEMENT March 25.36% -10.62% 4.12% -55.64770% -3.55% -12.
2011 Table 9: 48 .PORTFOLIO MANAGEMENT March 25.
24% 2006 7.44 -32.22% -12.Bill 2010 4.60% 12.90% -19.71% 2000 10.76% -2.92 9.64% 13.62% -21.637600% 2003 Hindalco 2004 Industries 2005 Ltd.41% 2008 7.44 -12.68% 3.716800% 0.35% 67.310800% 4.PORTFOLIO MANAGEMENT March 25.79% -41. 2006 2007 2000 2008 2001 2009 2002 49 3.22% -34.06% 7.300000% 1.37% 2007 6. Ltd.47 33.92% -8.110400% 0.87% 2009 3.44 36.38% 7.214400% Cost of Equity 0.290500% Cost of Equity 0.06% Rate 3.47 -23.62% 2002 8.98% 63.31% Risk Free Rate70.33% 2001 7.92 17.719600% -20.47 -16.92 106.44 -20.92 8.44 -17.44 6.09% -62.Bill Rate 4.35% 31.75% -46.598800% 0.68% Rate T.34% 25.55% 2001 364 7.62% -8.70% 0.48% -1.07% -43.28% 5.28% 0.934000% 0.387700% 0.734000% Rate 5.436800% 1.33 13.10% 114.47 0.618856% 0.62% 9.47 1.07% 31.47 5.39% 0.468000% 0.24% 1.35% 42.79% 19.837300% 0.91% 3.06% Hero 2003 4.32% -75.532500% 0.721500% 0.55% 35.262400% 0.13% Motors Ltd 2005 5.41% 4.96% 5.84% 2002 5.34% -41.68% -59.690800% 0.92 4.60% 18.45% 21.Bill 2002 5.12% 6.10% 13.308500% 5.381600% 0.55% 4.47 0.10% -1.20% Honda2004 5.26% 2010 7.20% 0.33 5.91% 7.92 29.319200% .40% 2004 5.92 -10.47% -4.057200% 0.15% -26.44 34.138800% Free 2001 7.14% 12.47 0.90% 3.44 CAPM 0.06% 4.35% -49.33 -13.85% 10.371200% 0.24% 2009 35% 364 7.55% -55.22% -55.35% Rate 28. Table 7: Market Risk Free Risk Free Rate Rate 364 Rate T.70% 2007 6.92 11.06% 70.904000% 0.10% 12.79% 9.38% Premium 63.Table 8: 2000 Risk10.49% 104.78% 2.93% 5.31% -11.92 1.44 8.572800% 0.35% 5.87% 3.50% 2003 4.47 -6.62% 7.47 11.787600% 1.367200% 0.24% Cost of Equity 0.59% Risk -59. 2011 Hindustan Unilever Ltd.00% -1.694300% 0.489312% 364 T.69% 2006 Table 10: Market 7.919600% 0.60% -2.44 17.876800% 7.30% 2005 5.55% 60.Bill Rate Risk BETA Premium CAP CAPM Cost of Equity 2000 10.98% Housing Development Market Risk BETA CAPM Finance Rate Premium Corpn.44 11.96% -14.319600% BETA 0.60% 2008 7.55% 11.92 39.07% -53.81% -3.50% T.50% 7.47 17.44% 0.24% -72.
PORTFOLIO MANAGEMENT March 25. 2011 50 .
64% 19.24% 53.38 -34.75% -13.70% 47.15% 15.28% -17.55% 5.62% -30.435800% 1.91% 7.49% 1.32% 9.38 18.256400% 1.67% 14.38 183.38 18.38 -12.22% 6.055600% 1.21% -10. 2011 Table 12: Risk Free Market Rate Rate 364 T.38 24.45% 17.533600% 1.38 -17.018024% Table 13: 51 .62% 4.07% 7.Bill Rate Risk Premium BETA CAPM Cost of Equity ICICI Bank Ltd.12% 8.455600% 1.89% 58.38 22.79% 5.38 78.35% 5.06% 3.870400% 1.38 11.PORTFOLIO MANAGEMENT March 25.72% 2.381200% 1.60% 7.103800% 1.72% -22.51% 13.003000% 1.24% 7.97% -7.68% 135.015000% 1.10% 7.38 64.08% 43.85% 13. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.17% 125.
07% 7.45 0.45 0.01086% 52 .45 0.45 0.56650% -22.45 0.54100% 12.29% 40.40% 2.61% -2.63% 0.10% 7.45 5.63750% 9.79% 5.77% -59.95% 4.31% -10.45 0.55% 5. 2011 Risk Free Market Rate Rate 364 T.78% 9.45 0.45 0.Bill Rate Risk Premium BETA CAPM Cost of Equity Infosys Technolo gies Ltd.40750% 6.65% -2.55500% -0.51% -67.74% 51.71% -73.77% 10.45 0.39% -55.45 0.70% 17.68% -10.12650% 11.10% -17.62% 4.02% 17.22% 6. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.35% 5.80% 55.84% 34.60% 7.75% 8.06% 3.24% 7.40% 14.37800% 21.89300% 26.36450% 4.PORTFOLIO MANAGEMENT March 25.00050% -27.
95% -34.51% -0.94% -29.9350% 74.05% 26.06% 3.79% 5.24% 7.55% 5.64% -23.33% 527.55% 39.67% 141.79% 62.10% 7.45 1.64% 279.92% -6.41% 6.9340% -3.0530% 111.7 -7.718000% -26.89% 148.7 1.45 -32.92% Risk 82.0700% -5.3040% CAPM 144.1850% -4.PORTFOLIO MANAGEMENT March 25.1450% -3. 2011 Table 14: Risk Free Market Rate Rate 364 T.02% -27.03% BETA Cost of Equity Jindal Steel & Power Ltd.958500% 771.7 1.24% Table7.7 1.689500% 6.89% Premium -52.76% -17.659500% 42.60% 7.9236% Risk Free Rate 364 T.35% -5.45 1.71% 1.1530% -81.7 1.45 1.45 1.60% 7.68% 15: -10.7 1.62% -4.Bill Rate 68.62% 4.84% 32.79% 5.22% 6.15% 46.7 1.7 1.22% 6.566840% .66% 30.89% 121.10% 7.7 1.13% Rate -45.45 1.7 1.52% 0.89% 533.10% -7.668000% 408.6590% 247.46% 127.88% -15. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 53 10. Ltd.35% 5.45 1.824000% 281.45 1.69% -24.62% 1.62% 4.06% 3.07% 7.55% -5.68% -19.45 1.059500% 181.7 1.55% 5.86% Market 86.58% 282.Bill Rate Risk Premium BETA CAPM Cost of Equity Jaiprakash Ass.112500% 44.52% 191.3850% -52.14% 195.11% 25. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.07% 7.35% 5.45 1.634000% -1.45 1.220500% -28.
Bill Rate Risk Premium BETA CAPM Cost of Equity Larsen & Toubro Ltd.92200% 14.37% 1.2 1.66% 12.10% 7.48800% 172.72000% 15.2 1.2 1.35% 5.10% 6.07400% 28.89% 138.11% 144.70% 14.79400% 53.55% 5.2 -54.17% 40.17400% -13.68% -43.43% 18.07% 7.60% 7.62% 4.24% 7.04704% 54 .13% -6.2 1.2 1.06% 76.95% 37.2 1. 2011 Table 16: Risk Free Market Rate Rate 364 T.01% 34. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.2 1.09200% 96.PORTFOLIO MANAGEMENT March 25.2 1.79% 5.22% 6.96% 45.44% 1.53% 11.35200% 44.31% 7.19600% -0.24% -53.42% -17.27% 19.2 1.2 1.68% 80.13600% 20.06% 3.82% 24.49% -9.
06% 3.1 1.Bill Rate Risk Premium BETA CAPM Cost of Equity Mahindra & Mahindra Ltd.74748% 55 .1 1.33% 29.47600% -21.76100% 38.82300% -56.51% 28.63% 186.10% 7.PORTFOLIO MANAGEMENT March 25.96% 217.01% 181.1 -49.24% 7.65% -54.16800% 56.78% 23.22% 6.79% 5.55% 5.93100% 204.06% -19.1 1.1 1.02% 214.09100% 30.80% -22.1 1.60% 7.07% 7.1 1. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.41000% -17.62% 23.73% -14.97% 1.1 1.68% -44.95% -50.50800% 32.62% 4.1 1.77% 52.41% 20.93200% 30.73% -56.35% 5.65% 28.1 1.16% -26.98% 46.27% 28.11% 35. 2011 Table 17: Risk Free Market Rate Rate 364 T.1 1.16200% 239.
62% 51.47% -45.06% 3.62600% 1.35% 5.46120% 42.87% -4.10% -7.62% 4.55% 5.41% 0.74 0.79% 5.91100% 1.38340% 56 56.07% 7.60% 7.74% 116.84420% 5.98560% 10.75% -39.32% 119.83% -1.22% 6.24% -10.76% 5.74 0.74 0.77780% 2.35% -5.49% 11.43220% -27.74 2.37% 0.74 0.74 0.74 0.74 0.74 0.77240% 89.94% 6.10% 7. 2011 Table 18: Risk Free Market Rate Rate 364 T.74 0.97% -6.Bill Rate Risk Premium BETA CAPM Cost of Equity Maruti Suzuki 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 10.08% -9.PORTFOLIO MANAGEMENT March 25.65% .28920% -1.
06% 6.63% 0.07% 7.69 0.PORTFOLIO MANAGEMENT March 25.620% 4.20% -5.79% 4.27850% 10.47% -4.62% 0.24% 7.55% 5.95% -38.060% -18.37780% 7.070% -32.100% 1.69 0.18% -0.68% -17.10% -7.55% 5.675% 57 .87280% 6.69 0.240% 7.22% 5.69 3.53470% 5.79% 66.59210% 7.69 0.600% 29.35% 10.10% 7.Bill Rate Risk Premium BETA CAPM Cost of Cost Equity of Equity 2000 2002 2001 2003 2002 2004 2003 2005 2004 2006 2005 2007 2006 2008 2007 2009 2008 2010 2009 2010 10.69 0. 2001 364 Rate T.79% 40.01% -30. Videsh 2000 Ltd.74% 4% 70.71% 0.62% 5.74220% 7. 2011 Market Rate Risk BETA Premium CAPM Table 19: Table 20: Risk Free Market Risk Free Rate Rate Rate Bill 364 TNTPC ONGC Ltd.04% -11.78% -51.59% -28.71% -48.55490% 4.220% 18.62% 30.69 0.22% 7.02% 24.09% -41.80% -21.10% 5.350% 1.550% -5.24% 17.41% 5.80% -11.72% -10.62% 7.69 0.19% 34.60% 6.33% 0.12% -6.13100% 2.35% -27.39% -3.78% -5.16% -34.69 0.06% 7.79% 7.12% -1.35% 4.60% 5.82% 166.41050% 5.65% -10.17% -15.68% 3.81059% 3.790% -12.55% 161.69 0.20% -3.24% 7.30200% 5.69 0.68% 37.07% 3.38% 8.
17% 11.55% -5.31 1.31 1.18350% 138.39% -16.79% -5.62% -4.31 1.31 1. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.68% -10.85% -107.27850% -1.22% 6.31 1. 2011 Table 22: Risk Free Market Rate Rate 364 T.07% 58 .31 1.73% -33.35% 5.79490% -1.24% 7.62% 4.32450% 13.70101% 14.41050% -1.PORTFOLIO MANAGEMENT March 25.31 1.79% 5.07% 7.31 1.55% 5.06% 3.31 -3.97% -40.73600% 16.31 1.10% 7.10% -7.79% -104.32% -23.75% 1.74220% -1.31 1.60% 6.13100% -2.60% 7.2000% -45.35% -5.03920% -24.95% 5.Bill Rate Risk Premium BETA CAPM Cost of Equity Reliance Communic ations Ltd.
03 83.68% 26.54 -16.PORTFOLIO MANAGEMENT March 25.82% 75.55% Ltd.02% 12.Bill Rate Risk BETA Risk Premium BETA Premium CAPM CAPM Cost of Equity 2000 Rate 10.35% 57.103808% 1.16% 66.22% 2002 5.24% 2005 5.03 408.94% -22.69% -51.54 1.03 -46.03 -4.88% -16.03 -20.54 25.309000% 1.10% 2005 5.073900% 1.22% -8.95% 28.24% 2010 7.54 28.10% 2001 7.54 Equity 34.62% 2007 6.773200% 1.30% 23.66% 16.Bill 364 T.54 69.54 93.02% 9% -60.67% -14.68% 2006 7.15% -21.07% 2003 4.07% 2008 7.03 -3.16% -6.62% 1.46% -2.44% -11.35% 2006 7.708000% 1.54 1.03 76.56% 67.10% -2.22% 2007 6.31% -28.06% 2004 5.702400% 1.46% 267.62% Industries 2003 4.75% 62.79% 2000 10. 2004 5.68% -8.738600% 1.59% 5.04% 81.520200% 1.08% 261.13% 57.94% 10.48% 74.03 -17.60% 2010 7.12% 19.03 -97.434800% 1.61% 14.34% Cost of 1.498300% 1. 2011 Market Risk Free Market Rate Rate Rate Table 21: Reliance Risk Free Infrastruct Rate ure Ltd.893400% 1.507600% 1.480056% 59 .06% 2009 3.82% 17.044600% 1.54 23.54 13.55% 2008 7.60% -28.21% -33.007200% 9.23% 18.361800% 1.71% 22.35% Reliance 2002 5.60% 2001 7.049500% 1.79% 2009 3.03 -37.13% -27.970700% 1.51% -4.65% -67.54 26.174800% 1.026300% 1.770800% 1.89% -19. 364 T.29% -43.03 -71.364200% -2.
27% 21.08 1.558000% 59.582400% -6.956400% 1.65% 17.220384% 60 .08 1.18% -2.96% 8.50% 1.22% 6.08 1.20% 0.81% 6.85% 39.60% 49.190800% 6.658000% 48.55% 5.34% 14.22% 10.15% 3.06% 3.07% 7.35% 5.08 1.08 1.352000% 10.10% 7.PORTFOLIO MANAGEMENT March 25.Bill Rate Cost of Equity State Bank Of India Table 23: 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10. 2011 Market Rate Risk BETA Premium CAPM Table 24: Risk Free Rate 364 T.88% -5.08 1.08 7.76% 7.72% -12.56% -1.08 1.50% -5.08 1.95% 55.119200% 15.62% 4.24% 7.87% 1.840000% -2.68% 7.08 1.63% 45.60% 7.376000% 8.242000% 23.26% 1.08 1.08% -3.79% 5.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.68% -33.21% -29.41 164.41 -42.35% 5.43% 43.98% 1.87% 852.41 44.62% 4.79% -37.07% 7.16% 8.60% 7.252500% 1.235600% 1.41 65.41 -45.623900% 1.PORTFOLIO MANAGEMENT March 25.28% -22.41 1199.14% 151.79% 5.90% 18.11% 24.30% 39.536100% 1.21% 37.112000% 1.24% 7.009000% 1.20% 147.41 -34.55% 118.22% 6.Bill Rate Risk Premium BETA CAPM Cost of Equity Sterlite Industries (India) Ltd.51% 13.319500% 1.25% 847.869832% 61 .03% -30.41 58.41 17.11% 33.55% 5. 2011 Table 25: Risk Free Market Rate Rate 364 T.06% 3.41 211.41 32.10% 7.77880% 1.104100% 1.026100% 1.23% -28.68% 49.95% 111.01% 26.
62% -4.49 0.06% 3.07% 7.49 0.49 0.60% 7.74850% 2.77410% 1.18% -17.66440% 62 23.24% -10.32050% 14.55% 5.49 0.Bill Rate Risk Premium BETA CAPM Cost of Equity Tata Consultanc y Services Ltd.38% 135.49% -3.80% .32% 138.79% 5. 2011 Table 26: Risk Free Market Rate Rate 364 T.PORTFOLIO MANAGEMENT March 25.49 0.35% -5.95380% 69.09% -10.55% 18. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 10.22% 6.56% 0.94760% -24.15100% 3.86620% 2.54% -57.49 0.49 0.10% 7.35% 5.49 0.10% -7.62% 4.33% -8.76% -63.26% -1.69820% -2.49 0.49 5.96170% 2.97% -11.
96% -45.55% 5.67880% 369.44% -15.07% 7.35% 5.16 1.13% -32.97960% 86.16 1.13520% 47.1084% 41.52% 58.11% 1.Bill Rate 10. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Risk Premium BETA CAPM Cost of Equity 364 T.09% -63.19% -14.37% 324.31480% 121.43% 320.84% -8.68% -35.PORTFOLIO MANAGEMENT March 25.16 1.16 1.10% 7.28% 1.60% 7.37516% 63 .17% 52.99% 42.23% 49.15% 113.06% 3.16 1.26080% 44.65040% 22.16 1.31% -69.60% -8.24% 7.72% 47.16 63.16 1.62% 54.16 1. 2011 Table 27: Risk Free Market Rate Rate Tata Motors Ltd.06% -25.35040% 24.36720% 55.16 1.79% 5.16 1.22% 6.3796% 10.62% 4.53% 108.56% -4.
01 65.01 -17.20% 113.55% 5.118600% 1.22% -15.79% 5.01 13.26% -5. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 364 T.24% 7.78% 1.31% -27.22% 6.35% 5.26% 7.01 1.42% 54.68% 65.62% 4.212000% 1. Ltd.Bill Rate Risk Premium BETA CAPM Cost of Equity 10.82% -23.10% 7.01 120.222200% 1.01 -27.01 5.06% 3.86% -25.056000% 1.93% -1.60% 7.60% 115.01 -16.385200% 1.10% 1.295800% 1.98% 119.03% 43.01 -2.93% 36.52% -32.81% 13.07% 7.670952% 64 .28% 5. 2011 Table 28: Risk Free Market Rate Rate Tata Power Co.58% -7.PORTFOLIO MANAGEMENT March 25.33% 1.01 120.962600% 1.462600% 1.579300% 1.10% -17.548200% 1.01 44.98% 119.
66% 115.71% 16.724000% -24.62% 71.03% -13.07% 7.079500% 29.40% 77.623500% -21.52% -14. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.43% -20.73% 83.45 1.73% 2.Bill Rate Risk Premium BETA CAPM Cost of Equity Tata Steel Ltd.45 1.766000% 118.PORTFOLIO MANAGEMENT March 25.79% 5.55% 5.45 1.69% -47.45 1.22% 6.06% 3.26% 22.45 13.35% 5.45 1.45 1.48% -41.96% -23.24% 7.762340% 65 .89% -30.990500% -62.53% -12.45 1.683500% -11. 2011 Table 29: Risk Free Market Rate Rate 364 T.68% 12.60% 7.45 1.10% 7.72% 112.41% 1.484000% 165.966500% 194.08% 78.45 1.45 1.79% 135.27% -5.17% 130.12% -21.62% 4.129000% 110.310500% -37.
Telecommunications companies like Reliance Communication & Bharti Airtel have always driven on lower margins and higher cost.79% 0.70% -66.61% -24.PORTFOLIO MANAGEMENT March 25. Wipro posted a return of 85% by Wipro.75 0. But since the revival of economy all these stocks have shown robust performance which is reflected in the returns of CAPM model.527500% 15.247500% -12.75 0.75 0.75 12.400000% 85.92% -58.75 0.07% 7.87% -7.32% -70. 0%.52% -1.75 0.19% -15.Companies like TCS.75 0.75 0. 2011 Table 30: Risk Free Market Rate Rate 364 T.79% 5.88% 109.836300% 4.99% -15. The revenue & profit margins were deeply affected by Dot Com bubble which is basically reflected in the return provided by these stocks providing negative and returns close to zero and using the CAPM parameters this is reflected truly in the actual returns. Infosys & Wipro provided a very low return on Equity during the period of 2000. Companies like TCS provide return 5%.417500% -9.77% 12.01% -8.135000% -42.14% -65.35% 5.59% -23. The returns were 21% for year ’04 in case of Infosys and the returns of Wipro & TCS were close to that Infosys. 69% by TCS & 26% by Infosys in ’09.2 INFERENCES FROM EMPIRICAL STUDY Sector Wise Analysis:Information Technology:.Bill Rate Risk Premium BETA CAPM Cost of Equity Wipro Ltd. 9% & -22% during dot com bubble.24% 7.94% 3.10% 7. With introduction of more 66 . ’01 & ’02.06% 3.687500% 0.22% 18.75 0. These companies seemed to have revived post ’04 posting higher return with Infosys as the market leader in return.94% -1.130000% -48.515000% 4.2003 period.75 0.70% -3.62% 4.40% -18.22% 6. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10.60% 7.75 0.89% 3.68% 13.842500% -10.802500% 0. Telecommunication:. However in ’07 due to US Subprime crisis the return were affected.82% 112.09% -22. 3% & 2% in ’00. Stocks like Infosys provided return as 5%.55% 5.
A better performance during the period of ’04-’05 was shown by both the stocks HUL &ITC due to growing economic demand.The banking and financial sector was booming in the period of 2000. 78%. the demand slipped again and these sector have provided a negative returns with an exception of ’08 year and in last financial year. -8% & 20% during the same period. ICICI outperformed many of the other stocks and the returns through CAPM show the kind of hefty returns provided by these stocks. though Airtel has shown a better performance compared to Reliance simply because of company fundamentals being better. HUL returns were -6%. 59% & 23& before ’05. HDFC provided returns as 4%. SBI provided return close to 10%. -23% & -16%.PORTFOLIO MANAGEMENT March 25. It revived to 8% in ’10 showing signs of recovery. Bharti Airtel has performed well during growth years and provide returns as high as 159% in ’03 & followed it with return of 58% & 26% in subsequent years. However. FMCG:. The performance was sustained till the period of ’04 for the growing demand of ever expanding Indian economy. However. -2% in ’08 & ’09. 64% during the same period. The Cost of Equity (return on stocks) using CAPM shows the 67 .The performance of FMCG sector as a whole in the particular year has never been inspiring and government securities seems to be a safer bet. Banking & Financial Sector:. ITC returns were hovering around 13% but slipped to -5% & -8% again and so was the case with HUL with returns as -12% & -17%. ITC returns were close to 1%. 1% in 08 & ’09 respectively & provided higher return in ’10 with returns close to 19%. these stocks seemed to have revived and provided average returns since then a bit higher than to returns on government securities. it was the financial crisis so the banking sector was hit the hardest. Stocks like SBI. Another heavyweight ICICI provided returns as high as 183%. Moreover. Reliance provided heft return as 138% during ’09 period otherwise it has been below average performer. HDFC Bank. The performance of these stocks is shown in returns on CAPM. ITC returns in ’08 were 19% & in ’10 close to 16%. During recent years they have experienced a better surge but that has been a consistent growth and so the returns by CAPM reflect the situation of companies like Reliance Communication & Bharti Airtel. Return on reliance communication has been consistently been around -1%. Stocks like SBI provided returns like 15%. Same was the case with HDFC bank providing returns as 10%. 2011 companies the telecom space has become more competitive. These stocks have been below average performer with a few exceptional year around ’03-’04 where they experienced high growth opportunities.This sector provides average returns. In the period of ’00 the returns were higher than average return but since then the returns have been quite low even negative for HUL consistently. 0% & -7%.Recession had its own toll over telecom sector. However in post ’05 there was a decline in their return and post recession these stocks provided negative returns due to the coupling effect of economies of recession. HDFC.
BHEL &Reliance Industries have performed in correlation with Manufacturing Sector. But these companies fundamentals have been strong and they were able to quickly recover from it and again posted huge profit margins and higher returns for investor. the spurt in demand for automobiles in India because of higher disposable income post recession has ensured higher volumes for all companies & impressive growth for these companies and this is reflected in return calculated by CAPM model. M&M posted a return of around 200% in ’03 and has been consistently hovering around 30%-50% return to pre-recession period. Maruti Suzuki returns were -27% in ’07 but seemed to have recover and gave returns as close to 89% in ‘09 However. Again companies like Tata Steel. It showed negative returns since’04 before a high of 408% in ’07.Manufacturing Sector has been one of the strong hold of the Indian economy thus substantiating the point of India being one of the fastest growing economies. Companies faced a slight turbulence in ’04-’06 where certain stocks posted losses and their performance revived in first half of ’07 before they were affected by recession whose effect was felt in ’08. Snce then it has gradually recovered and provided average returns at par with industry. Hero Honda Motors have been providing par performance with the industry.Companies like Bajaj Auto. Tata Power. The sales of Tata Motors have outperformed Indian car segment. Jaiprakash Associates have performed outstandingly with return as high as more than 68 .PORTFOLIO MANAGEMENT March 25. Larsen Toubro return in ’07 were 172%. Automobile:.47%. Maruti Suzuki returns have hovered around 2% & 1% in 00’-’04 and same is the case with Bajaj Auto. Tata Motors returns were 63%. The automobiles sales domestic and export market was hit hard because of recession and all companies sales declined resulting in negative returns. Sterlite again posted a good performance return in ’07 before being hit by recessionary phase. 2011 kind of return thus ascertaining the position of FMCG sector as not a safe bet for investment and diversification of portfolio. Hero Honda. Like in case of Tata Motors despite recessionary period it provided returns of 86%. This sector has been outperforming with a high growth post ’00. Maruti Suzuki have been providing low returns with the sole exception of Hero Honda & Tata Motors. Sterlite have performed well with 65% & 44% returns in ’00 &’01. On the other hand.Steel & Power is another sector like Manufacturing sector that has been the stronghold of Indian economy. Jindal Steel & Power. 44% in ’07 & ’08 and a 369% return in ‘ post recession ’09 period. Steel & Power Sector:. Manufacturing Sector:. RIL provided returns of around 34 & 26% in ’00-’01 with a high of 93% in ’03. Hindalco. Companies like Sterlite have provided as high as 1192% return in ’03 and a high returns as 200% after recession along with M&M whose return were close to 240%. Companies have posted higher sales revenue and higher margins resulting in higher returns in not only stock returns but higher dividends as well.55% 121% during ’00-’04 period. L&T .
Both DLF and Reliance Infra provided much higher return. The recession didn’t help the situation further as the generic version exports from Indian market as well domestic competition reduced margins for the companies. Tata steel again outperformed the market with returns of 165% despite a -37% return in ’08. they faced slight decline during the period of ’05-’06 where Tata Steel returns declined 62% & 24%. Infrastructure has been booming and a robust performance was shown during the period of ’00-’04 but since then there has been a considerable slowdown in demand.The need for infrastructure has been growing with economy expanding. Return on Cipla were 2%. These stock being fundamentally strong with huge demand potential recovered by’09 and have performed well after that. The effects of which were felt in subsequent year. Stocks of PSU like NTPC. Pharmaceutical:. However. In ’08 returns were 28% but post recession they have touched the lows of 1% & 0%. Tata Power return post Subprime crisis were 5% and 1%. 26% . The sales further declined post this period with below average margins of pharma companies. The regulations of patents and constant scrutiny of the generic version was another hinderance in the performance. These stocks correlated with market risk and market return have given positive returns till ’04 but the slow down has resulted in negative returns. The performance of Indian generic industry was average in ’00-’01. 2011 100% in the financial year of ’03-’04. Jindal Steel returns were 181 &281% during the same years These stocks have performed consistently well even before this period like Tata Power returns were 65% & 44& in ’00 & ‘01. These performance are reflected in CAPM returns. Reliance Infrastructure provided return with 34%. 69 .Tata Power returns were 120% in ’07 and JP Associates returns were 247% in the same year. 13% and as high as 93%. -9% & -10% during the period of 2000-’04. 17%. They seemed to have revived but that even a slightly bit.This sector has been a laggard. This is reflected in the CAPM return of these stocks. 194% & 29% form ’02-’04 along with Tata Power return as 120% in ‘03. ONGC have been providing returns at par with the benchmark rate of government securities. These are shown in the result of CAPM return of pharmaceutical companies like Cipla in this case. After ’04 these stocks seemed to decline with returns as -46% & -97% in ‘05 & ‘06 period. Jindal Steel was the market leader with 408% return. Stocks like Jindal Steel returns were outstanding like 707% returns. Tata Steel returns were 110% . Tata Steel returns have been 118%. Infrastructure Sector:. But they again performed exceedingly well in ’07 when the economy was at its high before the Subprime crisis hit the world. this phenomena was short lived and due to credit crunch problem these sectors again declined and have slightly reviewed after ’08-’09 and a better performance is expected. As an exception to recession the sector became a safer investment haven as compared to financial instruments and so outperformed the market return. Reliance Infra provided return close to 408% in ‘08 However.PORTFOLIO MANAGEMENT March 25.
PORTFOLIO MANAGEMENT March 25. First. Under the CAPM 70 . management must decide which businesses in the portfolio should be retained and which should be removed (divested). for those businesses retained in or added to the portfolio.3 APPLICATION OF THE CAPM TO STRATEGIC PLANNING The strategic portfolio planning problem of the firm involves two interdependent decisions. Second. management must determine the amount to invest in each business. 2011 4.
the expected value of the firm's common stock.6 4.4 Building A Portfolio:Year 71 Higher Return Stocks . the standard deviation of the company's rate of return and the correlation coefficient between the company's rate of return and the market rate of return. The company's return from its entire portfolio of businesses depends not only on the variance of the returns of the businesses constituting the portfolio but also on the relationship between these businesses. negative covariances of returns . The first point to note about is that the company's management wields little or no influence over the risk-free interest rate i and the market price of risk p. 2011 framework. and values of that are close to zero or negative. The three parameters over which management has at least partial control are the company's profit stream . a company should strive for high profits in each business. low variances of return . in building a portfolio of businesses. By diversifying its portfolio to include businesses with low positive covariances or even possibly negative covariances. a conglomerate can reduce the dispersion of the probability distribution of possible returns In summary. which is denoted by the covariance .PORTFOLIO MANAGEMENT March 25. the primary strategic objective of management in making these two interdependent decisions is to maximize Vz.
Tata Power. L&T. Hindalco. 2011 2000 2001 2002 2003 HDFC. L&T. Reliance Infra. Tata Power. Tata Steel BHEL. RIL. Tata Steel Bharti Airtel. RIL Reliance Infra. Hindalco. Reliance Infra. Infosys. Bharti Airtel. Maruti Suzuki. ICICI. Hindalco HUL.JSPL. HUL. Tata Power. Reliance Infra. Tata Motor Bajaj Auto. ONGC. HDFC Bank. L& T. RIL. JSPL. Sterlite. Jai prakash Associates. Jai prakash Associates. Sterlite. Infosys.M&M. Maruti Suzuki. M&M. Reliance Communication. TCS. Tata Motors. Sterlite HDFC. M&M. Tata Motor. JSPL. ITC. Hero Honda. Tata Steel Wipro BHEL. Hero Honda. Sterlite. Hindalco. Bharti Airtel. M&M. Tata Steel. Sterlite. Tata Steel. Tata Power. JSPL. SBI. RIL. Reliance Communication. HDFC.ICICI. Tata Motors. M&M. Wipro Bajaj Auto. ICICI. DLF. ICICI.HDFC Bank. Sterlite. HUL. ITC. HDFC. TCS. Jai prakash Associates. Sterlite BHEL. L&T. M&M. Tata Motor.ITC.PORTFOLIO MANAGEMENT March 25. SBI BHEL. SBI. SBI. HDFC Bank. Tata Motors. Tata Motor BHEL. TCS. Reliance Infra. Tata Motors Bharti Airtel. Jai prakash Associates. Tata Motor 2004 2005 2006 2007 2008 2009 2010 72 . Tata Power. L&T. Cipla. HDFC Bank. RIL. ICICI. Hero Honda. HDFC. HDFC Bank. M&M. JSPL. JSPL. Tata Motors. ICICI.
Clearly. the capital asset pricing model appears to offer a company that owns a portfolio of risky businesses a useful conceptual framework for long-term strategic planning. not the interdependence of businesses within a multidivisional firm. However. each of which generates a value for the stream of profits. To be useful to management. That is. A corporate consolidation model that computes the value of the company would also be needed. deterministic portfolio optimization models and corporate simulation models. the competitive strategy models apply such well-known concepts as the growth-share matrix and the experience curve to the overall problem of competitive strategy. Little. competitive strategy models emphasize the interdependence of a business with its competitors. corporate simulation models enable management to examine a variety of strategic options. one for each business in the company's portfolio. and the variability of return for that business as well as other output variables of interest to management. capital asset pricing models must be linked to some type of corporate simulation model. On the other hand. the CAPM is merely one of several options available to strategic planners. one can envisage a series of business simulation models. 73 . Whereas the capital asset pricing model concentrates on risk.5 SUMMARY Although it has certain limitations. McKinsey and more recently by Michael Porter all have a quite different focus. That is. return and the value of a business. Competitive strategy models of the type proposed by the Boston Consulting Group. This consolidated model must in addition treat the interdependencies among the businesses in the company's portfolio. Among the other options available are competitive strategy models. and to evaluate their consequences on a multiplicity of financial marketing and production indicators. Arthur D.PORTFOLIO MANAGEMENT March 25. competitive strategy is an important element in a company's overall strategic plan. 2011 4.
74 .PORTFOLIO MANAGEMENT March 25. 2011 Chapter 5 Summary & Conclusion from the Study The following summarizes the various concepts that are understood in the dissertation and the Conclusion about CAPM as an effective tool for measurement of returns on stocks and portfolios.
ii. However. This information will further substantiate the robustness of CAPM model. The major findings of the study as follows:i. The optimal portfolio selection results from a well balanced multi-criteria approach rather than a single variable factor. the study had certain limitations like limiting the kind of stocks for determining the portfolio and the time frame considered. future research can concentrate on this model to evaluate risk and return of portfolios. Given these limitations. the return premium for risk undertaken & correlation of return on individual stock & Market return (Beta). Another aspect that can be researched in depth is considering the correlation of market return and individual stock return considering the actual returns provided by the companies over a period of time. iii.PORTFOLIO MANAGEMENT March 25. The contribution of fundamental analysis for selecting a stock in a portfolio is a pivotal factor in selecting appropriate mix of stocks. A further area of research can be the application of 75 . Among the various model for estimating the return. Higher risk does not always guarantee higher return. CAPM emphasis the strategy of incorporating both risk free return. 2011 CONCLUSION This study discussed the basic framework for applicability of Capital Asset Pricing Model in Indian stock Market. Better return can be obtained by diversification and using CAPM as a means for estimating the return can be effectively used.
The development of this integrated model should not be seen as a once. 76 . Considering such factors a stock should be selected.) may result in changes to optimal portfolio.Strategic changes can reflect in numerous ways. stock split.Changes in the financial performance must be incorporated. Strategic:. go for a right issue/ bonus issue.off task with the aim of finding optimal portfolios. the model should be used on regular basis to identify the changes to be incorporated. change in capital structure can affect the returns provided by the company and can affect the overall return on portfolio. 2011 approach to other decision making situations like merger & acquisition and other corporate decision like capital structure & dividends distribution. Once the optimal portfolio has been identified.g. Such changes can affect the availability of profits for distribution. A company may declare dividends. merger & acquisition. The value of the model lies in the benefits that the integration of various techniques and approaches offer. iii. ii. The model should be used when following situation take place because they would affect the company’s performance i. By using this model. The multi criterion function provides the company with a tool that optimizes its choices regarding selection of stocks. exchange rate.PORTFOLIO MANAGEMENT March 25. even firms can improve their capital structure. The model by incorporating “Beta” helps in bringing correlation to economic factors and so it remains as a powerful means for decision making process. inflation. The model thereby enables to take appropriate investment decision after taking into account its impact on the portfolio as a whole. business cycle etc. Financial:. Economic:.A fundamental change in economy ( e. The financial fundamentals if are brighter in the future would help in inject more & more capital and thus rising the overall market value of the stocks.
E. (1987) Modern Portfolio theory and Investment Analysis. Runkle. 2011 REFERNCES Brigham. Fundamental of Financial Management.J. New York Richard A. 7th edition. DeFusco.F (1989). South Western College Publication 77 . Wiley. Chicago Elton. E. Jerald E. 2001 edition.. Aimr Publication Reilly & Brown Investment Analysis & Portfolio Management. and Grubber M. Quantitative Techniques in Portfolio Management. 3rd edition. Dryden Press. 5th edition.J.PORTFOLIO MANAGEMENT March 25. Pinto and David E.
Stephen J. Jones.co. Galgotia Publications Chandra Prassana.org www. Financial Management. 6th edition.PORTFOLIO MANAGEMENT March 25. Financial Management. Prentice Hall Pandian Punithavathy. 9th edition.com Annual reports of top 30 BSE Sensex Companies 78 .rbi. Gruber. 6th edition.P. Vikas Publication www. Modern Portfolio Theory & Investment Analysis Charles P.M. 9th edition Investments: Analysis and Management Prasad G B R K. Chand Publications Khan M.wikipedia. 8th edition.bse. Elton. K. S. & Jain P.in www. 2nd edition. Tata McGraw Hill Publication Fisher & Jordan. Financial Management.K. Brown. How to Choose Winning Stocks: Rewriting Formulas for Investment Bhalla V.. William N.11th edition. Security Analysis & Portfolio Management. 2008 edition. 2011 Rustagi R..nse-india. Security Analysis & Portfolio Management. Martin J. Investment Analysis & Portfolio management. 3rd edition . 3rd edition. Security Analysis & Portfolio Management..org www. Portfolio Analysis and Management. Goetzmann.Y. Prentice Hall Publication Kevin S. Tata McGraw Hill Publication Pandey I. Vikas Publication Edwin J.
Bernardo. French CAPM vs.PORTFOLIO MANAGEMENT March 25. Beta & Cost of Capital – Antonio E.Francis Tapon Benchmark Beta. Perold CAPM Model: Theory & Evidence . Three Factor Model .C. Stapleton & M. Bhagwan Chaudhary & Amit Goyal The Value Premium & CAPM – Fama & French Prowess ANNEXURES BETA CHART 79 . Capital Market Equilibrium & Corporate Finance – R.Eugene F. Fama and Kenneth R.Riad Ramlogan CAPM – Lan Liu Market Imperfections. 2011 Research Papers & Journals from JStore (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) CAPM Research paper – Andre F. Subhramanyam CAPM as a Strategic Planning tool .G. CAPM & Pricing Anomalies – Eun Growth Options.
49 0.1 1.47 0.74 0.08 1.92 0.7 1.01 1.03 1.45 1.9 0. I C I C I Bank Ltd.38 1.1 1. Tata Steel Ltd.44 0. Ltd.16 1.45 1.44 0.38 1. Housing Development Finance Corpn.2 1.41 1.45 1.92 0.74 0.54 1.54 1.45 1.74 0.38 1.47 0.2 1. No.44 1. Wipro Ltd.01 1.49 0.45 0.75 0.33 1.01 1.54 1.38 1.41 1.69 0.38 1.7 1. No.03 1.51 0.7 1.45 0.44 0.9 1.44 0.51 0. 80 .16 1.PORTFOLIO MANAGEMENT Beta for top 30 Companies of BSE Sensex BSE BSE BSE BSE BSE BSE BSE BSE BSE BSE BSE No.01 1.49 0.47 0.47 0.33 1.41 1.16 1.92 0.54 1.45 1.08 1.47 0.33 1.33 1.68 0.9 0.41 1. Infosys Technologies Ltd.33 1. No. Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Beta Beta Beta Beta Beta Beta Beta Beta Beta Beta Beta 0.16 1.54 1.75 0.01 1.45 1.47 0.44 0.2 1.74 0.69 0.01 1.41 1.51 0.45 0.68 0.69 0.16 1.44 0. Reliance Communications Ltd.44 0.2 1.03 1.51 0.47 0.47 0.2 1.75 0.68 0.44 0. Ltd.01 1.16 1.33 1.92 0.75 0.08 1.92 0.47 0.33 1.68 0.7 1.74 0.01 1.41 1. No.2 1.92 0. No.51 0.2 1.38 1.75 0.33 1.54 1.49 0.1 1. Hindustan Unilever Ltd.69 0.9 0.45 1. N T P C Ltd.41 1.9 0.1 1.7 1.03 1.31 1.01 1.38 1.45 1.1 1.45 1.45 0. Bharti Airtel Ltd.31 1.92 0.47 0.45 1.68 0.1 1.47 0.38 1.08 1.08 1. Hindalco Industries Ltd. No.47 0.45 0.03 1.47 0.75 March 25.51 0. I T C Ltd.03 1.45 1. No.75 0.47 0.92 0. 2011 Company Name Bajaj Auto Ltd.92 0.74 0.41 1. Tata Motors Ltd.41 1.69 0.16 1. Maruti Suzuki India Ltd. Jindal Steel & Power Ltd. Cipla Ltd.01 1.47 0. Reliance Infrastructure Ltd.45 1.45 0.45 1.92 0.01 1.33 1.45 0.68 0. Jaiprakash Associates Ltd.54 1.51 0.68 0.44 0. Tata Power Co.51 0.69 0.92 0.91 1.38 1.45 1.01 1.9 0. D L F Ltd.45 0.45 1.49 0.16 1.01 1.45 1.49 1.01 1.47 0. State Bank Of India Sterlite Industries (India) Ltd. Reliance Industries Ltd.08 1.01 1.16 1.45 1.08 1.45 1.08 1.47 0.03 1. Tata Consultancy Services Ltd.47 0. H D F C Bank Ltd.54 1.31 1.49 0.01 1. No.51 0.03 1.2 1.31 1.01 1.92 0.33 0.75 0.9 0. Larsen & Toubro Ltd.38 0.54 1.01 0.45 0.92 0. No.08 1.74 0.44 0.2 1.54 1.92 0.47 0. Hero Honda Motors Ltd.45 1.16 1.1 0.1 1.63 1.01 1.68 0.7 1.92 0.08 1.51 0.45 0.41 0.03 1.92 1.31 1.92 0.91 0.45 1.45 1.01 1.45 1.08 1.9 0.03 1.47 0.16 1.01 1.75 0.92 0.74 0.41 1. Oil & Natural Gas Corpn.92 0.1 1.92 0.75 0.47 0.92 0.68 0. No.54 1.69 0.63 0.03 1.92 0.33 1. Bharat Heavy Electricals Ltd. Ltd. Mahindra & Mahindra Ltd.1 1.91 0.75 0.51 1.01 1.7 1.2 1.2 1.63 1.38 1.47 0.1 1.63 1.45 0.
28 -23.12 9.3 45.88 24.18 -30.7 52. D L F Ltd.65 -10.43 -44.93 59.15 -32.11 -4. Ltd.68 -19.12 7.15 10.14 195.4 1.87 -28.48 -19. H D F C Bank Ltd.16 -0.15 -1.51 54.22 43.71 17. Wipro Ltd.95 0.43 42.06 119.43 -4.9 -30. Jindal Steel & Power Ltd.66 -43.94 60.28 -57.45 32.9 49.81 13.84 31.63 186.7 11.49 -8.85 -7.11 35.96 58.5 70.06 -55.15 32.06 10.98 36.01 -16.73 -2.49 -50.52 -0.66 286.39 -55.23 5.6 13.89 -6.88 -0.2 8. Hindustan Unilever Ltd.52 45.89 17. Reliance Industries Ltd.39 41.33 56.13 9.51 46.21 15.34 49.04 124.95 -1.89 14. I C I C I Bank Ltd. Infosys Technologies Ltd.96 29.62 26.17 74. Bharti Airtel Ltd.88 4.27 21.14 -1.94 14.6 4.55 -11.26 -8.49 166. Tata Power Co.96 -17.27 112.22 -67.7 148.22 -41.86 -8.53 13.24 -36.11 119.79 -4.4 6.71 -3.3 20. Oil & Natural Gas Corpn. BSE (%) Dec-01 BSE (%) BSE BSE BSE BSE BSE BSE BSE BSE (%) (%) (%) (%) (%) (%) (%) (%) Dec-02 Dec-03 DEC '04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 20.73 -15.11 -35.9 11.43 -3. State Bank Of India Sterlite Industries (India) Ltd.87 -8.2 -104.7 5.33 31.29 127.82 -3.89 0.97 17.66 12.13 21.56 6.06 5.48 8.5 19.75 -21.98 -14.75 70. Housing Development Finance Corpn. Jaiprakash Associates Ltd.82 -8.76 40.46 -5.79 28. Larsen & Toubro Ltd.7 113.07 -19.73 3.78 -72.74 70.52 -2.37 1.65 -88.5 4.15 55.24 28.72 56.83 3.65 -25.21 -25.84 -27.73 -39.84 14.48 35 133.66 -19.04 -60.92 -2.8 -16.63 118.01 -61.31 -22.08 30.46 23.02 14.33 -12. Bharat Heavy Electricals Ltd. Mahindra & Mahindra Ltd.29 -28.88 82.94 81 .92 -17.18 15.53 -24.68 4.02 86.8 19.87 852.48 18.8 324.1 -21.81 135.37 -21.32 -9.05 5.62 71.58 -9. Hindalco Industries Ltd.68 80.37 217.12 -43.68 67. Tata Motors Ltd. Ltd.91 13.64 23.55 -22.65 -48.23 58.02 533.71 67.19 37.57 -21.77 -51.03 -15.66 -1.13 282.65 -33.79 -4.31 22.32 24.46 18.48 -21.56 -22.37 -34. Tata Consultancy Services Ltd.75 62.88 10.89 0.06 -23.93 -12.28 17.47 -55.22 -41. Reliance Communications Ltd.85 -0.09 -15.82 279.22 55.95 68.95 33.03 138.33 77.2 -7.4 58.32 23.96 5.38 0.17 26.55 114.82 28.77 11. N T P C Ltd.18 8.06 -10.41 -20.43 4.42 -1.2 -52.79 -1.96 -58.82 9 19.87 4 -5.32 -25.52 43.5 42. 2011 MARKET RETURN CHART MARKET RETURN BSE (%) Dec-00 Company Name Bajaj Auto Ltd.22 79.76 144.62 7.71 18.27 22.7 47. Maruti Suzuki India Ltd.8 -27.31 26. Reliance Infrastructure Ltd.01 40.24 12.65 119.72 39.31 -45.96 151.63 27.PORTFOLIO MANAGEMENT March 25.94 1.41 -34.2 5.69 -36.11 23.84 24.37 -10.26 -63. Ltd.08 -6. Hero Honda Motors Ltd.97 1.3 41.35 19.26 -66.4 -15.4 42.49 135.98 83.54 -8.1 115.51 267.34 19.87 28.99 20.26 2.86 -17.71 11.93 14.52 -18.41 -43.39 35.96 -3.03 12.46 -53.02 1.67 -4.42 -5.24 12.95 -14. I T C Ltd. Tata Steel Ltd.44 -2.88 37. Cipla Ltd.62 65.39 81.97 -19.05 -20.43 9.
Perold 2 CAPM Research paper – Andre F. Perold 4 CAPM Model: Theory & Evidence .G. Perold 3 CAPM Research paper – Andre F.C. Stapleton & M. French 5 Market Imperfections.1 CAPM Research paper – Andre F.Eugene F. Fama and Kenneth R. Subhramanyam 6 CAPM as a Strategic Planning tool .Francis Tapon . Capital Market Equilibrium & Corporate Finance – R.
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