1

A

COMPREHENSIVE PROJECT REPORT

ON

“PORTFOLIO CONSTRUCTION, COMPARISION & EVALUATION”

Submitted to

C K SHAH VIJAPURWALA INSTITUTE OF MANAGEMET

IN PARTIAL FULFILLMENT OF THE

REQUIREMENT OF THE AWARD FOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

Under

Gujarat Technological University

UNDER THE GUIDANCE OF

NIRAV MAJMUDAR

Submitted by

NIKESH SHAH VIHANG SHAH

Enrollment No: 097050592048 Enrollment No: 097050592058

M.B.A-SEMESTER IV

C. K. Shah Vijapurwala Institute of Management

M.B.A-PROGRAMME

Affiliated to Gujarat Technological University

Ahmedabad

April 2011

2

PREFACE

The Professional training is the internal part of a MBA Program. It helps the

students understand practical aspects of Business Management in a better

way as a part of our MBA program at “C K Shah Vijapurwala Institute of

Management”.

We were required to undertake a detailed study of the “Portfolio

Construction, Comparison & Evaluation” using Sharpe‟s single index

model & CAPM (capital asset pricing model).

It helped us to apply theoretical knowledge into practical experience about

constructing the different portfolio with the help of the Sharpe & CAPM model.

Looking at the Indian stock Market Imperial Portfolio construction has one of

the best way for diversifying the risk & getting maximum returns from the

stocks.

To be a Master of Business Administration student‟s is a matter of pride

because we are in a field, which helps us to develop from a normal human

being into a disciplined, and dedicated professional. One has to be a good

learner to sharper knowledge in the particular field to achieve and attain the

desired goals and heights. Along with general training, we have conducted a

research to gain an understanding about the Capital Market and detail study

on sectorial whom have highest contribution of the GDP. To find about the

Portfolio construction, comparison and evaluation we used research on

highest contribution of top 3 sectors in India .We had learned lot during our

comprehensive project and we hope this will be helpful and useful.

3

ACKNOWLEDGEMENT

We have been able to prepare our report successfully and acknowledge a

special thanks to all those people without whose support it was impossible for

us to make the project report. It has been an enriching experience for us to

undergo our Comprehensive Project which would have not been possible

without the goodwill and support of the people around.

We would hereby take this opportunity to show our gratitude towards all my

mentors for what we have learnt during our training. A good response,

feedback and co-operation given by whole staff helped us in gaining

knowledge and solving our queries.

Motivation and co-operation are the main two pillars on which the success of

any project relies. So first of all we would like to thank core faculty and our

project guide MR.NIRAV MAJMUDAR who made us aware about the project

and motivated us to work on the guidelines of this unique, new and knowledge

based project. He has guided us at each and every stage of the project. He

has been enthusiastically involved in every aspects of the project. Overall we

are highly indebted to him for all the knowledge, guidance and motivation that

He has provided us throughout our project.

We would like to thanks our honorable Director Dr. Rajesh Khajuria who

provided us the permission for the Comprehensive Project and also for

guiding. We would also like to thank our faculty members and staff of the

institute who co-cordially helped us about morally and provided us all the

academic and other information required for this project.

4

DECLARATION

I Mr. VIHANG SHAH & Mr. NIKESH SHAH hereby declare that the report for

“Comprehensive Project” entitled “Portfolio Construction, Comparision &

Evaluation” is a result of our own work and our indebtedness to other work

publications, references, if any, have been duly acknowledged.

PLACE: BARODA

DATE: VIHANG SHAH

NIKESH SHAH

5

EXECUTIVE SUMMARY

Master of Business Administration student is a matter of pride because we are

in a field, which helps us to develop from a normal human being into a

disciplined, and dedicated professional. One has to be a good learner to

sharper knowledge in the particular field to achieve and attain the desired

goals and heights. Being M.B.A finance student‟s and the interest area

towered the financial Market we are taking the topic of Portfolio construction,

comparison & evaluation for the research purpose. From this research we

actually fulfill our purpose of how the individual investee will look towards the

Financial Market and how he/she invest money in financial market.

In this topic our objective is to find out how we can make investment by taking

top three GDP contribution sectors and compare the return by applying the

Sharpe Single Index model & CAPM (Capital Asset Pricing Model) to beat the

market return.

For finding out the return of the Portfolio we are taking the individual sector for

investing the money. We are taking the top three GDP contribution sector and

taking them for investment purpose to find out the return. We are taking the

closing price of each security listed in each sector from 01-01-2008 to 31-12-

2010 and match them with the closing price of the Nifty index prices. After this

we are finding the year wise average return, beta, systematic risk,

unsystematic risk, standard deviation, and average return of the market

6

After finding the inputs for the Sharpe & CAPM Model we put them in to the

table and find out the proportion of the interment by Sharpe single index

model and underpriced/overprice from the CAPM model. And from this

conclusion we invest the one lakh rupees in each sector at the end of the

year, hold them for a year and sale those at the end of the next year and find

out the gain by investing into the Portfolio. And compare that portfolio with the

return by both Sharpe Single Index model & CAPM model.

Completion of the comparison of the portfolio we can compare them with the

Sharpe, Treynor, Jenson ratios. Form the evaluation ratios we find that the

individual Portfolio is differ from different ratios and they evaluate differently.

Also apart from the evaluation tool the individual portfolio will differ from the

ability of the fund manager & also from the prediction ability of the Portfolio

Manager.

7

TABLE OF CONTENT

SR. NO.

PARTICULARS

PAGE NOS.

01

PART – 1 GENERAL INFORMATION

01

1.1

1.2

1.3

1.4

About the Industry

World Market

Indian Market

Growth of the industry

02

10

13

21

PART – 2 PRIMARY STUDY

24

2.1

Introduction of the Study

2.1.1Literature Review

2.1.2Background of the Study

2.1.3Problem Statement

2.1.4Objectives of the Study

25

27

32

32

2.2

Research Methodology

2.2.1Research Design

2.2.2Source of Data

2.2.3Sampling Frame

2.2.4Population

2.2.5Stastical tool

2.2.6Stastical Technique

34

35

35

35

35

35

3

Data Analysis and Interpretation

36

4

Results and Findings

56

5

Limitations of the Study

58

6

Conclusions

61

8

LIST OF TABLES

TABLE NOS.

PARTICULARS

PAGE NO.

01 Financial deepening

beckons in India

19

02 India‟s Stock Markets

20

03

International Market:

Comparision

23

04

Sector wise GDP

Contribution

37

05

Closing Price of the

Ganesh Housing Finance

sector & Nifty

39

06

Inputs of Sharpe &

CAPM

40

07

Cut off of Sharpe portfolio

of 2009

42

08

Investment through

Sharpe

43

09

CAPM MODEL

44

10

Selection through CAPM

Model

45

11

Investment through

CAPM Model

46

12

Comparison through

CAPM Model

49

13

comparison Sheet of

Sharpe & CAPM

51

14

Evaluation through

Sharpe, Jenson &

Treynor ratios

53

9

LIST OF DIAGRAMS

TABLE NOS.

PARTICULARS

PAGE NO.

01 Sharpe Portfolio,

2009

47

02 CAPM Portfolio, 2009 50

03 Comparison of

Sharpe & CAPM in

2009

52

04 Evaluation through

Sharpe, Jenson &

Treynor ratios

54

05 Comparison with Nifty

Return

55

10

PART-I: GENERAL

INFORMATION

11

Part I – General Information

1.1 About the Industry

An Overview of Capital Markets

The capital market is a financial market for medium and long-term

capital, used by firms and the state to finance investments and other

expenditures. Examples include the market for long-term loans called

the bond market and the stock market, the market for equity capital.

In capital market we deal with issues like the role of the capital markets,

the major capital markets in the US, the initial public offerings and the

role of the venture capital in capital markets, financial innovation and

markets in derivative instruments, the role of securities and the

exchange commission, the role of the federal reserve system, role of the

US Treasury and the regulatory requirements on the capital market.

The market where investment funds like bonds, equities and mortgages

are traded is known as the capital market. The financial instruments that

have short or medium term maturity periods are dealt in the money

market whereas the financial instruments that have long maturity periods

are dealt in the capital market.

Capital Markets is often regarded as a securities market, and the

participants are divided into the capital market investors, borrowers and

intermediaries. The investors, which are also known as capital providers

render capital for investment purposes.

12

The role of intermediaries, also called the facilitators is to ensure the

balance between capital supply and demand when they conduct

transactions in the cash flows of capital demand to improve information

and trade execution.

In most developed countries, capital markets are stronger and more

dynamic. The weakness of these markets in developing countries

hinders the formation of savings and is a serious obstacle to

development, forcing them to engage in international capital markets.

The contracts are carried out individually between the two parties and

their obligations are generally not transferable. And there is financial

intermediation, where a commercial bank acts as the intermediary

between the borrower and issuer.

The short term market can be divided into three main segments:

interbank money market, public debt market and the market for

corporate debt.

The interbank money market (which also covers the inter-bank bond

market) is an important segment of the money market, built exclusively

by banks, including the issuing bank. It is a market for large volume of

daily transactions and high liquidity.

Source:http://www.bukisa.com/articles/442796_capital-markets-an-

overview#ixzz1KgqtH7su

13

Role of the Capital Market

The main function of the capital market is to channelize investments

from the investors who have surplus funds to the investors who have

deficit funds. The different types of financial instruments that are traded

in the capital markets are equity instruments, credit market instruments,

insurance instruments, foreign exchange instruments, hybrid instruments

and derivative instruments. The money market instruments that are

traded in the capital market are Treasury Bills, federal agency securities,

federal funds, negotiable certificates of deposits, commercial paper,

bankers' acceptance, repurchase agreements, Eurocurrency deposits,

Eurocurrency loans, futures and options.

The capital market in the US is very advanced and uses very modern

technologies in its operation. The capital market instruments are either

traded in the Over-the – Counter markets or in the exchanges. The New

York Stock Exchange is the oldest and the most prominent exchange in

the US capital Market.

Initial Public Offering and the role of Venture Capital in

the capital market

The companies raise their long term capital through the issue of shares

that are floated in the capital market in the form of Initial Public Offering.

The Venture Capital is the funds that are raised in the capital market via

the specialized operators. This is also a very important source of finance

for the innovative companies.

14

Markets in Derivatives

The derivatives like the options, futures, credit derivatives etc are traded

in the capital markets.

Emerging Capital Markets

Emerging Capital Markets are financial markets that reside in the low or

middle income economies or where the ratio of investable market

capitalization to GNP is low. Such parameters to classify the financial

market are set by the International Finance Corporation.

The emerging capital market nations have a large population size but a

very low share of the world GNP. Out of 155 of the Emerging Market

Nations only 81 have equity markets. Although the world equity market

has grown from below $3.0 trillion in 1980 to above $31 trillion in 1999,

the emerging capital market economies have grown only by 12.5%.

As far as the equity market is concerned, the IFC has listed 7 countries

which have a market capitalization below $100 million. China, Taiwan

and Korea are the largest emerging equity markets. Although the size of

the emerging equity market is very small, more number of domestic

companies participates in these markets as compared to the equity

markets of the developed countries.

Capital Market Analyst

The Capital Market Analyst is required to have extensive knowledge of

finances, risk management products and financial markets. The capital

market analyst should have strong analytical and presentation skill. He

should also be capable of negotiating.

15

The following is the list of functions by the capital market analyst.

The capital market analyst is supposed to assist his clients in the

different capital market transactions and financing structures.

The capital market analyst is also responsible for assessing the

structures and the financial products.

The capital market analyst analyzes financing and the financial

risk management proposals.

The capital market analyst negotiates the finance related agreements.

The capital market analyst analyzes the financial risk management

products which includes the derivatives and thereby keeps the financial

market under close watch.

The capital market analyst should be skilled in collecting and

documenting the business requirements.

The capital market analyst is also responsible for issuing the earnings

estimates for companies. The earnings estimate is basically the estimate

of the earnings per share. The earnings estimate has gained prominence

in Wall Street.

Source: http://www.economywatch.com/market/capital-market/

The difference between capital markets and money markets .In order to

understand what the differences between things are you first need to

understand what each of the items is.

16

What is capital market?

Basically the capital market is a type of financial market, it includes the

stocks and bonds market as well. But in general the capital market is the

market for securities where either companies or the government can

raise long term funds. One way that the companies or the government

raise these long term funds is through issuing bonds, which is where a

person buys the bond for a set price and allows the government or

company to borrow their money for a certain time period but they are

promised a higher return for allowing them to borrow the money, the

higher return is paid through interest that accrues on the money that the

government or company borrows.

Another way that the companies or government can raise money in the

capital market is through the stock market, most of the time you don't

see the government as a part of the stock market, but it can actually

happen so we need to include them. But how the stock market works is

that the companies decide to sell shares of their stock, which is basically

ownership in the company, to ordinary people and other companies, as a

way to raise money. The people who buy the stock are usually given

dividends each year, if the company has agreed to pay out dividends, so

that is another possible return on their investment.

The capital market actually consists of two markets. The first market is

the primary market and it is where new issues are distributed to

investors, and the secondary market where existing securities are

traded. Both of these markets are regulated so that fraud does not occur

and in the United States the U.S. Securities and Exchange Commission

is in charge of regulating the capital market.

17

What is the money market?

Basically the money market is the global financial market for short-term

borrowing and lending and provides short term liquid funding for the

global financial system. The average amount of time that companies

borrow money in a money market is about thirteen months or lower.

Some of the more common types of things used in the money market

are certificates of deposits, bankers' acceptance, repurchase

agreements and commercial paper to name a few.

Basically what the money market consists of is banks that borrow and

lend to each other, but other types of finance companies are involved in

the money market. What usually happens is the finance companies fund

themselves by issuing large amounts of asset backed commercial paper

that is secured by the promise of eligible assets into an asset backed

commercial paper conduit. Your most common examples of these are

auto loans, mortgage loans, and credit card receivables.

18

What is the difference?

i) Basically the difference between the capital markets and money

markets is that capital markets are for long term investments, companies

are selling stocks and bonds in order to borrow money from their

investors to improve their company or to purchase assets. Whereas

money markets are more of a short term borrowing or lending market

where banks borrow and lend between each other, as well as finance

companies and everything that is borrowed is usually paid back within

thirteen months.

ii) Another difference between the two markets is what is being used to

do the borrowing or lending. In the capital markets the most common

thing used is stocks and bonds, whereas with the money markets the

most common things used are commercial paper and certificates of

deposits.

Source:http://www.businessknowledgesource.com/investing/the_differenc

e_between_capital_markets and money markets 024885.html

19

1.2 World Market

20

1.2 World Market

Global Market Economy – Current Scenario

During last one-decade capital markets around the globe witnessed

a series of developments in terms of its movements, volatility and

capitalization. Despite the bearishness in the first half of 2003 due

to war on terrorism, epidemic outbreaks, and economic

sluggishness, the markets in the advanced economies received

substantial benefits in terms of rise in Gross Domestic Product

(GDP). For example, in high-Income Countries, the market capitalization

as a percentage of GDP was as high as 103.9%, where as in

low-income countries it was at 18.3% (For India, it was 23.1% as against

the world„s percentage at 90.7). A number of initiatives undertaken to

attract cross border Investments through liberalized trade policies,

globalised economic reforms, portfolio investments ranging from

24% to 100% of the paid-up capital with repatriation facility in

certain cases were the prime factors of Asia now being in focus in

the capital market. At present the Foreign Institutional Investors

(FIIs) are concentrating in the emerging markets due to the fact that

the rate of return on investment as well inflation rate in the emerging

economies are slightly higher than the market to which they belong.

World Trade

The trade volume of the world is estimated at 3% for 2003, which is less

the growth rate 3.2% for the year2002. A sharp rise in oil prices has

surged the commodity prices. Consumer goods prices in the advanced

countries reached around 1.8% as compared to 1.5% in 2002

whereas it is 5% in developing countries for both of the years.

21

Increase in the volume of trade is one of the potential causes for

development of capital market of the economy. Ongoing discussions

among the member countries of the World Trade Organization (WTO)

have to be taken into account for overall development and integration of

global capital markets.

World stock market & Bullion Market

The sharp fall of US dollar as against the Euro, Sterling and yen have

brought worries to the international investors in the US market and

therefore there was lesser demand for US securities. This situation

made US to start investing elsewhere in the global market. As a

result the Asian countries received substantial increase in the foreign

exchange reserves. The evolution of Euro currency due to the co-

ordinate efforts of member countries set a classic example of how

common currency can stabilize the economic growth. In the bullion

market, Gold is now commanding at its very high in its 13 years

of track record and other metals like silver and platinum are

showing an upward trend.

22

1.3 Indian Capital market

23

1.3 Indian Capital market

Meaning of Capital Market

Capital Market may be defined as a market dealing in medium and long-

term funds. It is an institutional arrangement for borrowing medium and

long-term funds and which provides facilities for marketing and trading of

securities. So it constitutes all long-term borrowings from banks and

financial institutions, borrowings from foreign markets and raising of

capital by issue various securities such as shares debentures, bonds,

etc.

The market where securities are traded known as Securities market. It

consists of two different segments namely primary and secondary

market.

The primary market deals with new or fresh issue of securities and is,

therefore, also known as new issue market;

Whereas the secondary market provides a place for purchase and sale

of existing securities and is often termed as stock market or stock

exchange.

1) PRIMARY MARKET

The Primary Market consists of arrangements, which facilitate the

procurement of long term funds by companies by making fresh issue of

shares and debentures. You know that companies make fresh issue of

shares and/or debentures at their formation stage and, if necessary,

subsequently for the expansion of business. It is usually done through

24

private placement to friends, relatives and financial institutions or by

making public issue.

2) SECONDARY MARKET

The secondary market known as stock market or stock exchange plays

an equally important role in mobilizing long-term funds by providing the

necessary liquidity to holdings in shares and debentures. It provides a

place where these securities can be encased without any difficulty and

delay. It is an organized market where shares, and debentures are

traded regularly with high degree of transparency and security. In fact,

an active secondary market facilitates the growth of primary market as

the investors in the primary market are assured of a continuous market

for liquidity of their holdings. The major players in the primary market are

merchant bankers, mutual funds, financial institutions, and the individual

investors; and in the secondary market you have all these and the

stockbrokers who are members of the stock exchange who facilitate the

trading.

After having a brief idea about the primary market and secondary market

let see the difference between them.

DISTINCTION BETWEEN PRIMARY MARKET AND

SECONDARY MARKET

The main points of distinction between the primary market and

secondary market are as follows:

1. Function: While the main function of primary market is to raise long-

term funds through fresh issue of securities, the main function of

secondary market is to provide continuous and ready market for the

existing long-term securities.

25

2. Participants: While the major players in the primary market are

financial institutions, mutual funds, underwriters and individual investors,

the major players in secondary market are all of these and the

stockbrokers who are members of the stock exchange.

3. Listing Requirement: While only those securities can be deal within

the secondary market, which have been approved for the purpose

(listed), there is no such requirement in case of primary market.

4. Determination of prices: In case of primary market, the prices are

determined by the management with due compliance with SEBI

requirement for new issue of securities. But in case of secondary market,

the price of the securities is determined by forces of demand and supply

of the market and keeps on fluctuating.

History of Indian Capital Markets

The history of the Indian capital markets and the stock market, in

particular can be traced back to 1861 when the American Civil War

began. The opening of the Suez Canal during the 1860s led to a

tremendous increase in exports to the United Kingdom and United

States.

Several companies were formed during this period and many banks

came to the fore to handle the finances relating to these trades. With

many of these registered under the British Companies Act, the Stock

Exchange, Mumbai, came into existence in 1875. It was an

unincorporated body of stockbrokers, which started doing business in

the city under a banyan tree. Business was essentially confined to

company owners and brokers, with very little interest evinced by the

general public. There had been much fluctuation in the stock market on

26

account of the American war and the battles in Europe. Sir Premchand

Roychand remained a kingpin for many years.

Sir Phiroze Jeejeebhoy was another who dominated the stock market

scene from 1946 to 1980. His word was law and he had a great deal of

influence over both brokers and the government. The planning process

started in India in 1951, with importance being given to the formation of

institutions and markets. The Securities Contract Regulation Act 1956

became the parent regulation after the Indian Contract Act 1872, a basic

law to be followed by security markets in India. To regulate the issue of

share prices, the stock markets have had many turbulent times in the

last 140 years of their existence. The imposition of wealth and

expenditure tax in 1957 by Mr. T.T.Krishnamachari, the then finance

minister, led to a huge fall in the markets. The dividend freeze and tax on

bonus issues in 1958-59 also had a negative impact. War with China in

1962 was another memorably bad year, with the resultant shortages

increasing prices all round. This led to a ban on forward trading in

commodity markets in 1966, which was again a very bad period,

together with the introduction of the Gold Control Act in 1963. The

markets have witnessed several golden times too. Retail investors

began participating in the stock markets in a small way with the dilution

of the FERA in 1978. Multinational companies, with operations in India,

were forced to reduce foreign share holding to below a certain

percentage, which led to a compulsory sale of shares or issuance of

fresh stock. There was no free pricing and their formula was very

conservative. The next big boom and mass participation by retail

investors happened in 1980, with the entry of Mr. Dhirubhai Ambani.

Dhirubhai can be said to be the Father of modern capital markets. The

Reliance public issue and subsequent issues on various Reliance

companies generated huge interest. The general public was so

unfamiliar with share certificates that Dhirubhai is rumored to have

distributed them to educate people. Mr. V.P. Singh‟s fiscal budget in

1984 was path breaking for it started the era of liberalization. The

27

removal of estate duty and reduction of taxes led to a swell in the new

issue market and there was a deluge of companies in 1985. Mr.

Manmohan Singh as Finance Minister came with a reform agenda in

1991. This history shows us that retail investors are yet to play a

substantial role in the market as long-term investors. Investors who hold

shares in limited companies and mutual fund units are about 20-30

million. Those who participated in secondary markets are 2-3 million.

Capital markets will change completely if they grow beyond the cities

and stock exchange centers reach the Indian villages. Both SEBI and

retail participants should be active in spreading market wisdom and

empowering investors in planning their finances and understanding the

markets.

India‟s capital markets have experienced sweeping changes since the

beginning of the last decade. Its market infrastructure has advanced

while corporate governance has progressed faster than in many other

emerging market economies. But in contrast to several developed

countries and Asian economies, India‟s capital markets are still shallow,

implying that further reforms are needed to make India a world-class

financial centre. At nearly 40% of GDP, the size of India‟s government

bond segment is comparable to many other emerging market

economies.

India boasts a dynamic equity market. The sharp rise in India‟s stock

markets since 2003 reflects its improving macroeconomic fundamentals.

However, the large size of insider holdings and the small presence of

institutional investors belie these impressive figures. Innovative products

such as securitized debt and fund products based on alternative assets

are starting to break ground. But an enabling environment is not yet in

place and there remains an overriding need to increase domestic

investors‟ knowledge regarding the merits and risks of capital market

investing

28

(Table-1) Financial deepening beckons in India

Improving macroeconomic fundamentals, a sizeable skilled labor force

and greater integration with the world economy have increased India‟s

global competitiveness, placing the country on the radar screens of

investors the world over. The global ratings agencies Moody‟s and Fitch

have awarded India investment grade ratings, indicating comparatively

low sovereign risks. These positive dynamics have led to a sustained

surge in India‟s equity markets since 2003, attracting sizeable capital

from foreign investors. Net cumulative portfolio flows from 2003-2006

(Bonds and equities) amounted to USD 35 bn. Moreover, India‟s stock

market has outperformed world indices in recent years. And, despite its

increasing correlation with world markets in recent years, India still offers

diversification in global portfolios.

29

(Table-2) India’s Stock

Markets

The bond market is dominated by government bonds. Government bond

issuances, resulting from persistently high fiscal deficits, as well as

specific regulatory requirements, have underpinned the supply and

demand conditions in India‟s debt capital markets. Nearly 90% of total

domestic bonds outstanding are government issuances (i.e. Treasury

bills, notes and bonds), squeezing out corporate and other marketable

debt securities. Initiatives to lift the corporate bond market from its

nascent stages have been slow to progress, leaving companies unable

to realize their optimum capital structure as a result. And unlike the

derivative instruments that are available for equities, those for fixed

income instruments (e.g. options in interest rates) in the organized

exchanges have failed to take off, limiting the price discovery in the

secondary markets. We believe that India‟s economic transformation is

irreversible.

30

1.4 Growth of the Stock Market

31

1.4 Growth of the Stock Market

Despite the international disturbances like Iraq war, SARS, Bird flu in

Asia, terrorism threats and other natural calamities, capital market has

shown steady growth in 2003. There was an increased demand for the

Asian equities. The favorable liquidity conditions and macro environment

factors accelerated further growth in Asian markets. Indian sensex rose to

80% outperforming all the major global indices. European markets have also

shown remarkable progress. Currently factors are encouraging FIIs to think

about the investment proposals in other countries. Another interesting factor

in the global scenario is that the cross border capital flow is largely

flowing from FII„s in the private sectors as compared to public sectors of

developing economies. There are few countries in the world, which received

higher turnover-ratio than India. The FII„s investment in India as on June

2003 was at US $ 17.39 billion with 509 registered FII„s. India stood 19th

place in terms of capitalization . In terms of turnover-ratio, India ranked 7th

in position. Emerging Economies: The year 2003 was the year for emerging

economies. These economies undertook a number of initiatives in

relation to their fiscal and economic policies, which have contributed,

substantially to the stability of the world economy. The current fiscal

year 2004 is a year of prospects and promises for higher economic

growth and fruitful activity in the capital market. Lower exchange

reserves and it has been predicted that the largest economies in 2050

would be China, India, Russia and Japan. China showed strong growth

of indication with a real GDP at 8.7%. It has a market capitalization of 220

billion dollars Nearly 20 out of 25 emerging country economies stock prices

rose by 25% and amongst eight countries it was more than 75%.

Further, currencies of these countries appreciated against the US dollar.

32

(Table-3) International Market: Comparision Particulars USA UK Japan Germany Singa

pore

Hong

kong

China India

No.of Listed

Companies

5.685 1,701 3,058 715 434 968 1,235 5,650

Market

Capitalisaton

($)

11,052 1,864 2,126 686 102 463 463 131

Market

Capitalisaton

Ratio (%)

113 126.2 47 35.4 114.7 271.9 40.9 27.4

Turnover ($) 25,371 2,721 1,573 1,233 56 211 333 197

Turnover

Ratio (%)

202.5 135.4 71 140.5 39.3 43.5 67.6 165

Source:S&P Emerging stock Market Fact Book

The above table in general reveals that in terms of market turnover

ratio, there are very few countries, which have higher turnover ratio

than India. The data on the number of listed companies in India as at the

end of March, 2003 is 9,413 companies, whereas data of S & P took

into account only 5,650 companies. Therefore, if the entire market were

taken into consideration, the performance of position of India will be

prospectively better. Economies of the different countries are intensifically

integrating by converging their legislations in accordance with the global

economies. World is experiencing a new and ever expected fast growth with

key economic factors like, low cost of transportation.

33

PART: II PRIMARY STUDY

2.1 Introduction of the study

34

2.1 Introduction of the study

2.1.1 Literature Review

Sharpe (1966) analyzed 34 open-end mutual funds over period from 1954-63.

His major finding is that the capital market is highly efficient and that

managers concentrate on evaluating risk and providing diversification rather

than focusing on evaluating incorrectly priced securities. Michel Jensen

(1968) in his analysis also based on 115 funds from period 1955-64 shows

that on average the mutual funds net of expenses are not able to predict the

security prices well enough to outperform the passive benchmark. He has

also shown that there was very little evidence that any individual fund was

able to perform significantly better than if a portfolio was picked at random.

Treynor and Mazuy (1966) in their studies, of 57 actively managed funds in

the period from 1953 to 1962, show that an investor in mutual fund is

completely depended on the fluctuations in the general market. They suggest

that an improvement in the rate of return of a mutual fund will be more due to

managers‟ ability to indentify underpriced industries rather than outguess the

market turns. Hendrickson and Merton (1981) derive a market timing test in

accordance with CAPM framework. However, there is a main difference in

contrast to Jensen‟s formulation of the model. Henriksson and Merton‟s

parametric test permits to indentify the contribution from micro as well as

macro forecasting abilities to a portfolio return using as the only data excess

returns on the market as well as on the portfolio. Henriksson (1984) has also

set out on his own and evaluated a performance of open-end mutual funds

and found no empirical results that would support the hypothesis that mutual

funds managers follow a strategy what would successfully enable them to

time return on the market portfolio. Treynor in his article describes a new

performance measure that can be used in the analysis of individual trusts,

pension and mutual funds. His self-criticism points out however that the

certain assumption has to be made - consistent investment policy of the

35

investors. As it is quite dubious assumption in turn it reflects negatively on the

measure.

Grinblatt and Titman (1989) assess gross returns based on a sample of

mutual fund quarterly holdings from 1975 to 1984. They specify that the

sample is not subject to survivorship bias and consists of data comprised of

net returns. They conducted performance tests over their sample chosen and

found indication that the risk-adjusted gross returns of some funds were

significantly positive. Grinblatt and Titman (1992), over a sample of monthly

returns for 279 funds and period from 1974 to 1984, have evaluated yet again

the performance of mutual funds. They have analyzed how the mutual fund

performance relates to past performance using a multiple portfolio benchmark

tests. They found evidence that there are differences in the performance

between mutual funds persistence over time and that this persistence is

consistent with the ability of fund managers to earn abnormal returns. Further

in their studies Grinblatt and Titman (1994) specify that the Jensen‟s measure

is biased if the fund and benchmark returns are not jointly normal or are non-

linear.

Source: http://pure.au.dk/portal-asb-student/files/7309/Final.pdf

36

2.1.2 Background of the study

Sharpe’s Single Index Model

The foundation of Modern Portfolio Theory was laid by Markowitz in 1951. He

began with the simple premise that since almost all investors invest in multiple

securities rather than one, there must be some benefit in investing in a

portfolio of securities. He measured riskiness of a portfolio through variability

of returns and showed that investment in several securities reduced this risk.

His work won him the Nobel Prize for Economics in 1990. Markowitz‟s work

was extended by Sharpe in 1964, Lintner in 1965 and Mossin in 1966. Sharpe

shared the Nobel Prize for Economics in 1990 with Markowitz and Miller for

his contribution to the Capital Asset Pricing Model (CAPM). This model breaks

up the riskiness of each security into two components - the market related risk

which cannot be diversified called systematic risk measured by the beta

coefficient and another component which can be eliminated through

diversification called unsystematic risk.

Single Index Model

The Markowitz model is extremely demanding in its data needs for generating

the desired efficient portfolio. It requires N(N+3)/2 estimates (N expected

returns + N variances of returns + N*(N-1 )/2 unique covariance‟s of returns).

Because of this limitation the single index model with less input data

requirements has emerged. The Single index model requires 3N+2 estimates

(estimates of alpha for each stock, estimates of beta for each stock, estimates

of variance for each stock, estimate for expected return on market index and

an estimate of the variance of returns on the market index to use the

Markowitz optimization framework. The single index model assumes that co-

movement between stocks is due to movement in the index. The basic

equation underlying the single index model is:

37

Ri = ai + b*Rm

Where,

Ri = Return on the stock

ai = Component of security is that is independent of market performance

b = Coefficient that measures expected change in Ri given a change in Rm

Rm = Rate of return on market index

The term ai in the above equation is usually broken down into two elements ai

which is the expected value of ai and ei which is the random element of ai the

single index model equation, therefore, becomes:

Ri = ai + b*Rm + ei

Single index model has been criticized because of its assumption that stock

prices move together only because of common co-movement with the market.

Many researchers have found that there are influences beyond the market,

like industry-related factors, that cause securities to move together. Empirical

evidence, however, reveal that the more complex models have not been able

to consistently outperform the single index model in terms of their ability to

predict ex-ante co-variances between stock returns.

38

Capital Asset Pricing Model – CAPM

What Does Capital Asset Pricing Model - CAPM Mean?

A model that describes the relationship between risk and expected

return and that is used in the pricing of risky securities.

The general idea behind CAPM is that investors need to be compensated in

two ways: time value of money and risk. The time value of money is

represented by the risk-free (Rf) rate in the formula and compensates the

investors for placing money in any investment over a period of time. The other

half of the formula represents risk and calculates the amount of compensation

the investor needs for taking on additional risk. This is calculated by taking a

risk measure (beta) that compares the returns of the asset to the market over

a period of time and to the market premium (Rm-Rf).

The Capital Asset Pricing Model (CAPM) is a theory based upon the above

theory of portfolio selection. The basic premise is that in capital markets

people are rewarded for bearing risk. Any asset is priced in equilibrium so that

if the asset is risky people receive a higher rate of return than they would

receive if they held a risk free asset. This higher rate of return is called a risk

premium. But the market does not reward people for bearing unnecessary

risk, risk that can be avoided by diversification. The risk premium on an asset

39

is thus not related to its “standalone” risk, but rather to its contribution to an

efficiently diversified portfolio.

40

CAPM ASSUMPTIONS

The CAPM is often criticized as being unrealistic because of the assumptions

on which it is based, so it is important to be aware of these assumptions and

the reasons why they are criticized. The assumptions are as follows:

Investors hold diversified portfolios

This assumption means that investors will only require a return for the

systematic risk of their portfolios, since unsystematic risk has been removed

and can be ignored.

Single-period transaction horizon

A standardized holding period is assumed by the CAPM in order to make

comparable the returns on different securities. A return over six months, for

example, cannot be compared to a return over 12 months. A holding period of

one year is usually used.

Investors can borrow and lend at the risk-free rate of return

This is an assumption made by portfolio theory, from which the CAPM was

developed, and provides a minimum level of return required by investors. The

risk-free rate of return corresponds to the intersection of the security market

line (SML) and the y-axis. The SML is a graphical representation of the CAPM

formula.

41

Perfect capital market

This assumption means that all securities are valued correctly and that their

returns will plot on to the SML. A perfect capital market requires the following:

that there are no taxes or transaction costs; that perfect information is freely

available to all investors who, as a result, have the same expectations; that all

investors are risk averse, rational and desire to maximize their own utility; and

that there are a large number of buyers and sellers in the market.

“Overpricing”/“Under pricing” and the SML

In the “CAPM world”, there is no such thing as overpricing/underpricing. Every

asset is correctly priced, and is positioned on the SML. For practical real-

world purposes, however, we can compare an asset‟s given price or expected

return relative to what it should be according to the CAPM, and in that context

we talk about over/under pricing.

42

2.1.3 Problem Statement

“Can we construct a Equity Portfolio to beat the Indian Stock Market?”

2.1.4 Objective of the Study

1. To construct Portfolio using Sharpe Single index Model & Capital Asset Pricing Model.

2. To evaluate constructed portfolios using Sharpe Ratio, Treynor Ratio & Jensen Ratio.

3. To compare the portfolios derived using Sharpe Single index Model &

CAPM.

43

2.2 Research Methodology

44

2.2 Research Methodology

2.2.1 Research Design

Descriptive research can be either quantitative or qualitative. It can involve

collections of quantitative information that can be tabulated along a continuum

in numerical form, such as scores on a test or the number of times a person

chooses to use a-certain feature of a multimedia program, or it can describe

categories of information such as gender or patterns of interaction when using

technology in a group situation. Descriptive research involves gathering data

that describe events and then organizes, tabulates, depicts, and describes the

data collection (Glass & Hopkins, 1984). It often uses visual aids such as

graphs and charts to aid the reader in understanding the data distribution.

Because the human mind cannot extract the full import of a large mass of raw

data, descriptive statistics are very important in reducing the data to

manageable form. When in-depth, narrative descriptions of small numbers of

cases are involved, the research uses description as a tool to organize data

into patterns that emerge during analysis. Those patterns aid the mind in

comprehending a qualitative study and its implications.

Descriptive studies report summary data such as measures of central

tendency including the mean, median, mode, deviance from the mean,

variation, percentage, and correlation between variables. Survey research

commonly includes that type of measurement, but often goes beyond the

descriptive statistics in order to draw inferences.

45

2.2.2 Sources of Data

We are taking the secondary data of the top GDP contribution sectors

securities form the National stock exchange. We take the data of the closing

price of the securities from the date 01-01-2008 to 21-4-2011. The source is

mention below about the data.

http://nseindia.com/content/equities/eq_historicaldata.htm/eq_scrphistdata.ht

m

2.2.3 Sampling Frame

Top3 GDP contribution Sector wise companies listed in National Stock

Exchange.

2.2.4 Population

All the securities listed in stock exchange of India.

2.2.5 Statistical tool

Average Return Ri for Individual year, Beta of the Stock i.e. β, Standard

Deviation of Nifty for individual year ,Risk free Rate for individual year Rf,

Excess Return i.e. Ri-Rf, Systematic Risk: σm2 _ β, Standard Deviation of

Security for individual year ,Unsystematic Risk: σ2 _ β2*σm2

2.2.6 Statistical technique

We are using the Microsoft Excel for calculation of the above findings.

46

3 Data Analysis & Interpretation

47

3 Data Analysis & Interpretation

Following are findings of the Percentage contribution of scripts listed in Nifty

to India‟s GDP.

(Table 4) Sector wise GDP Contribution

Industry Equity Capital Percentage

contribution

in Nifty

Contribution

to India's

GDP in %

ELECTRICAL EQUIPMENT 423,816,750 0.087932549 2

CEMENT AND CEMENT

PRODUCTS

1,877,402,020 0.389519162 7

CEMENT AND CEMENT

PRODUCTS

3,046,612,130 0.632104255 7

BANKS 4,032,084,690 0.836567892 3.3

TELECOMMUNICATION –

SERVICES

37,969,519,800 7.877830844 1.5

ELECTRICAL EQUIPMENT 4,895,200,000 1.015645121 2

REFINERIES 3,615,421,240 0.750119493 4.2

OIL

EXPLORATION/PRODUCTION

18,966,678,160 3.935163863 10

PHARMACEUTICALS 1,605,842,714 0.333176646 2

CONSTRUCTION 3,394,502,566 0.704283782 11

GAS 12,684,774,000 2.631808471 15

CEMENT AND CEMENT

PRODUCTS

916,820,010 0.19021976 7

COMPUTERS – SOFTWARE 1,346,219,552 0.279310615 6

FINANCE – HOUSING 2,858,553,370 0.593086245 7

BANKS 4,552,365,640 0.944514617 3.3

48

AUTOMOBILES – 2 AND 3

WHEELERS

399,375,000 0.08286143 4

ALUMINIUM 1,913,433,052 0.3969948 3

DIVERSIFIED 2,181,441,805 0.452600655 5.2

BANKS 11,137,408,530 2.310764553 3.3

TELECOMMUNICATION –

SERVICES

31,000,952,090 6.432008039 1.5

FINANCIAL INSTITUTION 12,960,901,040 2.689098691 4.94

COMPUTERS – SOFTWARE 2,867,676,165 0.594979022 6

CIGARETTES 3,795,325,160 0.787445555 1

STEEL AND STEEL

PRODUCTS

930,781,836 0.193116529 3

Interpretation

From the above Data we are finding the sector wise contribution to

India‟s GDP for finding out the highest contribution of the sectors for

constructing the portfolio taking top sectors for investing the money in

Stock Market.

After finding the Contribution we are taking top 3 sectors for

constructing the Portfolio.

They are:-

I. FINANCE SECTOR

II. POWER SECTOR

III. CONSTRUCTION SECTOR

49

After deciding the sectors, we are taking the closing Price of Script Of

Finance, Power & construction sector and comparing it with nifty Closing

Prices From 01-01-2008 to 31-12-2010.

(Table 5) Closing Price of the Ganesh Housing Finance sector & Nifty

Symbol Date Close

Price

Daily

Returns

NIFTY

Date

Close Daily

Returns

GANESHHOUC 17-Mar-08 293.9 17/03/08 4503.1

GANESHHOUC 18-Mar-08 327.8 0.1154 18/03/08 4533 0.00664

GANESHHOUC 19-Mar-08 308.35 -0.059 19/03/08 4574 0.00903

GANESHHOUC 24-Mar-08 297.5 -0.035 24/03/08 4609.9 0.00785

GANESHHOUC 25-Mar-08 298.55 0.0035 25/03/08 4877.5 0.05806

GANESHHOUC 26-Mar-08 292.25 -0.021 26/03/08 4828.9 -0.01

GANESHHOUC 27-Mar-08 310.6 0.0628 27/03/08 4830.3 0.00029

GANESHHOUC 28-Mar-08 325.8 0.0489 28/03/08 4942 0.02314

GANESHHOUC 31-Mar-08 328.5 0.0083 31/03/08 4734.5 -0.042

GANESHHOUC 1-Apr-08 311.25 -0.053 1/4/2008 4739.6 0.00107

GANESHHOUC 2-Apr-08 317.55 0.0202 2/4/2008 4754.2 0.00309

GANESHHOUC 3-Apr-08 321 0.0109 3/4/2008 4771.6 0.00366

GANESHHOUC 4-Apr-08 321.1 0.0003 4/4/2008 4647 -0.0261

GANESHHOUC 7-Apr-08 312.05 -0.028 7/4/2008 4761.2 0.02458

GANESHHOUC 8-Apr-08 324.3 0.0393 8/4/2008 4709.7 -0.0108

GANESHHOUC 9-Apr-08 320 -0.013 9/4/2008 4747.1 0.00794

GANESHHOUC 10-Apr-08 320 0 10/4/2008 4733 -0.003

GANESHHOUC 11-Apr-08 320 0 11/4/2008 4777.8 0.00947

GANESHHOUC 15-Apr-08 371.75 0.1617 15/04/08 4879.7 0.02132

50

After taking the closing price of the stock we find the inputs for the Sharpe &

CAPM Model.

They are:

Average Return Ri for Individual year

Beta of the Stock i.e. β

Standard Deviation of Nifty for individual year

Risk free Rate for individual year Rf

Excess Return i.e. Ri-Rf

Systematic Risk: σm2 _ β

Standard Deviation of Security for individual year

Unsystematic Risk: σ2 _ β2*σm2

(Table 6) Inputs of Sharpe & CAPM

Inputs 2008 2009 2010

Return -0.007776705 0.00443137 0.002199841

Beta 0.682456951 0.60578012 1.284266789

Std Deviation 0.027544601 0.02186029 0.01023431

Risk Free Rate 0.000164384 0.00019178 0.000205479

Excess Return -0.007941089 0.00423959 0.001994362

Systematic Risk 0.000353365 0.00017536 0.000172754

Std. Dev of Security 0.048151029 0.04309 0.033280987

Unsystematic Risk 0.001965157 0.00168138 0.00093487

51

We are taking 25 scripts of Finance, 14scripts of Power & 9 Scripts of

Construction. The lists of them are as under, we done the same interpretation

as mention above foe all 48 Scripts.

Symbol power

NTPC

SURANATELE

POWERGRID

PTC

GVKPIL

TATAPOWER

TORNTPOWER

BILPOWER

JINDALSTEL

HONDAPOWER

APIL

INDLMETER

MSPL

HBLPOWER

GPIL

BILPOWER

KALPATPOWR

Symbol

Finance

SRTRANSFIN

SHIVTEX

TFL

SHRIRAMCIT

GRUH

MOTOGENFIN

SUNDARMFIN

BAJAUTOFIN

GANESHHOUC

LLOYDFIN

LICHSGFIN

TCIFINANCE

GICHSGFIN

CHOLADBS

PFC

DEWANHOUS

SREINTFIN

VIDEOIND

TFCILTD

52

After Finding the input for Sharpe we them into table to find out the cut-off

Price for taking the scripts into the Portfolio.

IFCI

IDFC

VLSFINANCE

KOTAKBANK

HDFC

MAGMA

Symbol

construction

HCC

CANDC

ACE

ITDCEM

ANSALHSG

PETRONENGG

MAYTASINFR

CCCL

ERAINFRA

53

Symbol Mean Ri Risk

Free

Rate

Rf

Excess

Return

Ri-Rf

Beta Unsystematic( Risk std

square*Beta square)

Systematic

Risk

Excess

Return

to beta

Ri-

Rf*Bi/unsys.

cumulative Bi2/unsys cumu Ci

LLOYDFIN -0.003 0.0002 -0.0032 -0.003 0.002677 0.000378 1.05501 0.00352 0.0035 0.003336 0.00334 0.0035

LICHSGFIN 0.00055 0.0002 0.00038 1.183 0.001112 0.001063 0.00033 0.409635 0.4132 1259.241 1259.24 0.2101

PFC 0.00033 0.0002 0.00016 0.842 0.000728 0.000538 0.00019 0.188549 0.6017 973.4317 2232.68 0.2217

SHRIRAMCIT 0.00016 0.0002 -8E-06 0.257 0.000372 5.14E-05 -3E-05 -0.00533 0.5964 177.3287 2410 0.2093

MOTOGENFIN -8E-05 0.0002 -0.0002 0.737 0.002317 0.000416 -0.00033 -0.07684 0.5195 234.1475 2644.15 0.1715

HDFC -0.0012 0.0002 -0.0013 1.286 0.000676 0.001254 -0.00102 -2.50667 -1.987 2446.125 5090.28 -0.405

KOTAKBANK -0.0015 0.0002 -0.0016 1.328 0.001078 0.001338 -0.00123 -2.00521 -3.992 1636.055 6726.33 -0.6478

DEWANHOUS -0.0009 0.0002 -0.0011 0.818 0.0015 0.000508 -0.0013 -0.58019 -4.573 446.4477 7172.78 -0.7029

IFCI -0.0023 0.0002 -0.0025 1.503 0.001378 0.001714 -0.00164 -2.69671 -7.269 1639.903 8812.68 -0.9362

IDFC -0.0023 0.0002 -0.0024 1.466 0.001374 0.001631 -0.00165 -2.57656 -9.846 1564.073 10376.8 -1.0983

TFCILTD -0.0015 0.0002 -0.0016 0.64 0.00103 0.000311 -0.00256 -1.01844 -10.86 398.2533 10775 -1.1719

VIDEOIND -0.0033 0.0002 -0.0035 1.113 0.001232 0.00094 -0.00313 -3.14312 -14.01 1005.265 11780.3 -1.3949

VLSFINANCE -0.0023 0.0002 -0.0025 0.777 0.001305 0.000463 -0.0032 -1.47816 -15.49 462.4298 12242.7 -1.4894

MAGMA -0.002 0.0002 -0.0022 0.625 0.002129 0.000307 -0.00344 -0.63134 -16.12 183.4581 12426.2 -1.5294

GICHSGFIN -0.0019 0.0002 -0.0021 0.449 0.000529 0.000153 -0.0046 -1.75059 -17.87 380.6927 12806.9 -1.6498

GRUH -0.0019 0.0002 -0.0021 0.405 0.00122 0.000133 -0.00512 -0.68848 -18.56 134.5489 12941.4 -1.6972

TCIFINANCE -0.0037 0.0002 -0.0039 0.607 0.002109 0.00022 -0.00641 -1.11918 -19.68 174.6983 13116.1 -1.7778

TFL -0.0035 0.0002 -0.0036 0.557 0.00253 0.00024 -0.00653 -0.79972 -20.47 122.459 13238.6 -1.8344

54

(Table 7) Cut off of Sharpe portfolio of 2009

SREINTFIN -0.0054 0.0002 -0.0055 0.811 0.001672 0.000499 -0.00684 -2.69052 -23.17 393.4011 13632 -2.0208

SRTRANSFIN -0.0022 0.0002 -0.0024 0.348 0.00057 9.2E-05 -0.00692 -1.47006 -24.64 212.4927 13844.5 -2.1189

CHOLADBS -0.0061 0.0002 -0.0062 0.627 0.001656 0.000302 -0.00996 -2.36672 -27 237.5629 14082 -2.2866

55

Interpretation

1. From the Above table we interpret the steps for finding out

the stocks included in the optimal portfolio are given below.

2. Find out the Excess return to beta ratio for each stock

under construction.

3. Rank them from highest to the Lowest.

4. Proceed to calculate Ci for all the stocks according to the

rank order.

5. The cumulated values of Ci start deciding after a particular

Ci and that is taken as the cutoff point and that stock is the cut off ratio

(Table 8) Investment through Sharpe

Symbol Mean Ri Risk Free

Rate Rf

Excess

Return

Ri-Rf

Beta Unsystematic(

Risk std

square*Beta

square)

Systematic

Risk

Excess

Return to

beta

LLOYDFIN -0.002988 0.000164 -0.003153 -0.00299 0.0026766 0.0003778 1.0550083

LICHSGFIN 0.0005494 0.000164 0.000385 1.183485 0.0011123 0.0010627 0.0003253

PFC 0.0003274 0.000164 0.000163 0.841859 0.0007281 0.0005377 0.0001937

Ri-

Rf*Bi/unsys.

Cumu Bi2/unsys cumu Ci C* Zi total Prop

0.00352 0.00352 0.003336 0.003336 0.00352 0.22173 -0.9303 -492.661 0.001888

0.4096352 0.413155 1259.241 1259.245 0.210092 0.22173 -235.57 -492.661 0.478167

0.1885493 0.601704 973.4317 2232.676 0.221727 0.22173 -256.16 -492.661 0.519945

56

Interpretation

The eights Colum is the expected excess return on particular stock based on the

expected performance of optimum port folio. The eights column is the expected

excess return on individual stock. Thus we believe that a particular stock will perform

better than the expected return based on its relationship to optimal portfolio. We

would add the stock to the Portfolio.

After determining the securities tube selected, we should find out how much

should be invested in each security.

After doing above calculation we calculate the CAPM model for taking the security

into the Portfolio.

(Table 9) CAPM MODEL

Symbol Mean Ri Beta Rm Risk

Free

Rate

Rf

Rm-Rf Rf/Bi

(Rm-Rf)

Estimated Under

prised/Over

prised

LLOYDFIN -0.003 0.7 -0.002 0.0002 -0.002 -0.002 -0.001 Overpriced

LICHSGFIN 0.00055 1.18 -0.002 0.0002 -0.002 -0.003 -0.002 Underpriced

PFC 0.00033 0.84 -0.002 0.0002 -0.002 -0.002 -0.002 Underpriced

SHRIRAMCIT 0.00016 0.26 -0.002 0.0002 -0.002 -6.00E-

04

-4.00E-04 Underpriced

MOTOGENFIN -8.00E-05 0.74 -0.002 0.0002 -0.002 -0.002 -0.001 Underpriced

HDFC -0.0012 1.29 -0.002 0.0002 -0.002 -0.003 -0.003 Underpriced

KOTAKBANK -0.0015 1.33 -0.002 0.0002 -0.002 -0.003 -0.003 Underpriced

DEWANHOUS -0.0009 0.82 -0.002 0.0002 -0.002 -0.002 -0.002 Underpriced

IFCI -0.0023 1.5 -0.002 0.0002 -0.002 -0.003 -0.003 Underpriced

IDFC -0.0023 1.47 -0.002 0.0002 -0.002 -0.003 -0.003 Underpriced

TFCILTD -0.0015 0.64 -0.002 0.0002 -0.002 -0.001 -0.001 Overpriced

VIDEOIND -0.0033 1.11 -0.002 0.0002 -0.002 -0.002 -0.002 Overpriced

VLSFINANCE -0.0023 0.78 -0.002 0.0002 -0.002 -0.002 -0.002 Overpriced

57

MAGMA -0.002 0.62 -0.002 0.0002 -0.002 -0.001 -0.001 Overpriced

GICHSGFIN -0.0019 0.45 -0.002 0.0002 -0.002 -0.001 -8.00E-04 Overpriced

GRUH -0.0019 0.41 -0.002 0.0002 -0.002 -9.00E-

04

-7.00E-04 Overpriced

TCIFINANCE -0.0037 0.61 -0.002 0.0002 -0.002 -0.001 -0.001 Overpriced

TFL -0.0035 0.56 -0.002 0.0002 -0.002 -0.001 -0.001 Overpriced

CAPM model suggests that whether the stock is overpriced or overpriced, by

comparing between expected and actual return of the respective stock. If the

expected return of security calculated according to CAPM is lower than the actual or

estimated return offered by the security, the security will be considered to be

underpriced. On the contrary, security will be considered to be overprized when the

expected return o the security according to CAPM formulation is higher than the

actual return offered by the security.

(Table 10) Selection through CAPM Model

Symbol Mean

Ri

Beta Rm Risk Free

Rate Rf

Rm-Rf Rf+Bi

(Rm-Rf)

Estimated Underpriced/

Overpriced

LICHSGFIN 0.00055 1.18349 -0.00206 0.000164384 -0.00222 -0.00263 -0.00247 Underpriced

PFC 0.00033 0.84186 -0.00206 0.000164384 -0.00222 -0.00187 -0.00171 Underpriced

SHRIRAMCIT 0.00016 0.25683 -0.00206 0.000164384 -0.00222 -0.00057 -0.00041 Underpriced

MOTOGENFIN -8E-05 0.73653 -0.00206 0.000164384 -0.00222 -0.00164 -0.00147 Underpriced

HDFC -0.0012 1.28575 -0.00206 0.000164384 -0.00222 -0.00286 -0.0027 Underpriced

58

KOTAKBANK -0.0015 1.32803 -0.00206 0.000164384 -0.00222 -0.00295 -0.00279 Underpriced

DEWANHOUS -0.0009 0.81842 -0.0020 0.000164384 -0.00222 -0.00182 -0.00166 Underpriced

IFCI -0.0023 1.50308 -0.0020 0.000164384 -0.00222 -0.00334 -0.00318 Underpriced

IDFC -0.0023 1.46617 -0.00206 0.000164384 -0.00222 -0.00326 -0.0031 Underpriced

On the Basis of Sharpe Model:

After deciding the Portfolio scripts we make the year wise portfolio taking the closing

price of year 2008 and invest 1Lakh Rs. & then we are selling those scripts at the

end of the year 2009. This means that we make investment at the end of the year

hold that securities for 1year and find out the returns at the end of year.

(Table 11) Investment through CAPM Model

Symbol Mean

Ri

Rf Ri-Rf Beta Un sys Sys. Excess

Return

to beta

LLOYDFIN -0.003 0.0002 -0.003 0.7 0.0027 0.0004 -0.00451

LICHSGFIN 0.0005 0.0002 0.0004 1.183 0.0011 0.0011 0.00033

PFC 0.0003 0.0002 0.0002 0.842 0.0007 0.0005 0.00019

NTPC 0.0002 0.0002 5.00E-05 0.843 0.0003 0.0005 0.000057

Ri- cumulative Bi2/unsys cumu Ci C*

59

Rf*Bi/unsys

-0.82417 -0.8242 182.911 182.91 -0.72 0.222

0.40964 -0.4145 1259.24 1442.2 -0.2 0.222

0.18855 -0.226 973.432 2415.6 -0.08 0.222

0.13707 0.1371 2388.77 2388.8 0.048 0.048

Zi total Prop Buy Amt Buy

Price

Units Sale

Price

Sale Amt Returns

-59.1 -492.7 0.12 12004 1.25 9603 2.5 24009 1

-236 -492.7 0.48 47817 231 207 803 2.00E+05 2.483

-256 -492.7 0.52 51994 133 391 261 1.00E+05 0.964

-135 -135 1 1.00E+05 181 554 236 1.00E+05 0.305

Interpretation

From the above table we make the investment of 1Lakh Rs on the basis of

proportion investing in each sector with the closing price of 2008 and hold them for

the year 2009, at the end of the year 2009 we sale them and earn some profit.

(Diagram 1) Sharpe Portfolio, 2009

60

Interpretation

After determine the securities to be selected we should find out how much should

invested in each security. The percentage of return on investment is interpret from

the above diagram that we should get 100% return in Lloyd finance ,248% return in

LIC housing finance , 96% return in PFC and 30% return in NTPC.we also interpret

that there is no negative return in the year 2009.

On the Basis of CAPM Model

After deciding the Portfolio scripts we make the year wise portfolio taking the closing

price of each year to invest 1Lakh Rs. & then we are selling those scripts at the end

of the next year this means that we had make and investment at the end of the year

hold that securities for 1year and find out the returns at the end of each year.

61

62

(Table 12) Comparison through CAPM Model

Symbol Mean Ri Beta Rm Risk

Free

Rate Rf

Rm-

Rf

Rf+Bi(Rm-

Rf)

Estimated Remarks Buy

Amt

cl

price

units cl

price

Sale

Amt

Returns

LICHSGFIN 0.000549 1.1835 -0.0021 0.00016 -0.002 -0.0026 -0.002 Underpriced 11111 230.5 48.2 803 38698 2.483

PFC 0.000327 0.8419 -0.0021 0.00016 -0.002 -0.0019 -0.002 Underpriced 11111 133.1 83.48 261 21826 0.964

SHRIRAMCIT 0.000157 0.2568 -0.0021 0.00016 -0.002 -0.0006 -4E-04 Underpriced 11111 345.6 32.15 393 12637 0.137

MOTOGENFIN -7.7E-05 0.7365 -0.0021 0.00016 -0.002 -0.0016 -0.001 Underpriced 11111 2959 3.755 5201 19529 0.758

HDFC -0.00115 1.2857 -0.0021 0.00016 -0.002 -0.0029 -0.003 Underpriced 11111 1486 7.475 2676 20002 0.8

KOTAKBANK -0.00146 1.328 -0.0021 0.00016 -0.002 -0.003 -0.003 Underpriced 11111 357.5 31.08 807 25080 1.257

DEWANHOUS -0.0009 0.8184 -0.0021 0.00016 -0.002 -0.0018 -0.002 Underpriced 11111 86.35 128.7 188 24236 1.181

IFCI -0.00231 1.5031 -0.0021 0.00016 -0.002 -0.0033 -0.003 Underpriced 11111 21.6 514.4 54.4 27984 1.519

IDFC -0.00225 1.4662 -0.0021 0.00016 -0.002 -0.0033 -0.003 Underpriced 11111 66.8 166.3 154 25665 1.31

NTPC 0.000213 0.8431 -0.0021 0.00016 -0.002 -0.0019 -0.002 Underpriced 14286 180.6 79.1 236 18640 0.305

SURANATELE 0.000103 0.5382 -0.0021 0.00016 -0.002 -0.0012 -0.001 Underpriced 14286 22.05 647.9 38.6 24976 0.748

POWERGRID -2.7E-05 0.8599 -0.0021 0.00016 -0.002 -0.0019 -0.002 Underpriced 14286 83.15 171.8 110 18924 0.325

PTC -0.00054 0.7335 -0.0021 0.00016 -0.002 -0.0016 -0.001 Underpriced 14286 68.75 207.8 113 23460 0.642

GVKPIL -0.0014 1.1647 -0.0021 0.00016 -0.002 -0.0026 -0.002 Underpriced 14286 22.25 642.1 46.5 29823 1.088

TATAPOWER -0.00135 1.0372 -0.0021 0.00016 -0.002 -0.0023 -0.002 Underpriced 14286 749.2 19.07 1381 26343 0.844

TORNTPOWER -0.00131 0.8614 -0.0021 0.00016 -0.002 -0.0019 -0.002 Underpriced 14286 74.15 192.7 323 62171 3.352

BILPOWER -0.00144 0.852 -0.0021 0.00016 -0.002 -0.0019 -0.002 Underpriced 14286 111.8 127.8 181 23106 0.617

63

Interpretation

From the above table we have make the investment of 1Lakh Rs on the basis of

proportion investing in each sector with the closing price of 2008 and hold them for

the year 2009, at the end of the year 2009 we sale them and earn some profit.

(Diagram 2) CAPM Portfolio, 2009

Interpretation

The CAPM model postulates every security is expected to earn a return

commensurate with its risk as measured by the beta. CAPM establish a linear

relation relationship between the expected return and systematic risk of al assets.

This relation can be used to evaluate the pricing of asset in making investment. We

also interpret that Torentpower Company is the best company in terms of return.

After doing above calculation we compare the Sharpe & CAPM model for taking the

security into the Portfolio.

64

Symbol Amt

Buy

CLOSING

PRICE2008

UNITS CLOSING

PRICE2009

Sale

Amt

Return Symbol Amt

Buy

Close

price

units Close

price

Sale Amt Return

LLOYDFIN 12004.4 1.25 9603 2.5 24009 1 LICHSGFIN 11111 230.5 48.2 802.8 38698.48 2.48286

LICHSGFIN 47816.7 230.5 207.4 803 2E+05 2.483 PFC 11111 133.1 83.48 261.45 21825.69 0.96431

PFC 51994.5 133.1 390.6 261 1E+05 0.964 SHRIRAMCIT 11111 345.55 32.15 393 12636.86 0.13732

NTPC 100000 180.6 553.7 236 1E+05 0.305 MOTOGENFIN 11111 2959.2 3.755 5201.1 19529.07 0.75762

HDFC 11111 1486.4 7.475 2675.8 20002.09 0.80019

KOTAKBANK 11111 357.5 31.08 806.95 25080.03 1.2572

DEWANHOUS 11111 86.35 128.7 188.35 24235.99 1.18124

IFCI 11111 21.6 514.4 54.4 27983.54 1.51852

IDFC 11111 66.8 166.3 154.3 25665.34 1.30988

NTPC 14286 180.6 79.1 235.65 18640.25 0.30482

SURANATELE 14286 22.05 647.9 38.55 24975.7 0.7483

POWERGRID 14286 83.15 171.8 110.15 18924.49 0.32471

PTC 14286 68.75 207.8 112.9 23459.74 0.64218

GVKPIL 14286 22.25 642.1 46.45 29823.43 1.08764

65

(Table 13) comparison Sheet of Sharpe & CAPM

TATAPOWER 14286 749.15 19.07 1381.5 26343.19 0.84402

TORNTPOWER 14286 74.15 192.7 322.7 62171.27 3.35199

BILPOWER 14286 111.75 127.8 180.75 23106.42 0.61745

66

(Diagram 3) Comparison of Sharpe & CAPM in 2009

Interpretation

From the above Bar Diagram we conclude that the above three securities were same

in both the model and Return will same by comparing with both model.

Now, Portfolio Evaluation using Sharpe, Treynor & Jensen Ratios.

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(Table 14) Evaluation through Sharpe, Jenson & Treynor ratios

Symbol Average

Return

PROP TOTAL std Rf wi*std Beta WI*beta Sharpe Treynor Rm-Rf B*Rm-Rf Jensen

LLOYDFIN 0.003866 0.12 0.000464 0.0382 0.0002 0.004583 0.52957 0.06357 0.0647 0.00132 0.00367 0.001946 0.00581

LICHSGFIN 0.005767 0.4782 0.002758 0.0356 0.0002 0.017031 0.92803 0.44376 0.09818 0.002 0.00558 0.005174 0.01094

PFC 0.003168 0.5199 0.001647 0.028 0.0002 0.014544 0.74749 0.38865 0.05241 0.00107 0.00298 0.002225 0.00539

NTPC 0.001305 1 0.001305 0.0206 0.0002 0.02063 0.58096 0.58096 0.01961 0.00075 0.00111 0.000647 0.00195

Total 0.056788 2.78605 1.47694

68

69

(Diagram 4) Evaluation through Sharpe, Jenson & Treynor ratios

70

Interpretation

From the above bar diagram we interpret that by using the Sharpe, Treynor &

Jenson ratios.

Sharpe’s index measures the Risk premium of the portfolio relative to the total

Amount of Risk in the Portfolio. This Risk Premium is the difference between the

portfolios average rate of return & the riskless rate of return. The standard

Deviation of the portfolio indicates the risk.

Treynor index measures the fund‟s performance in relation to the market

performance. The ideal funds return rises at a faster rate than the general market

performance when the Market is moving upwards and its rate of return declines

slowly then the market return, in the decline.

Jenson index measures the Managers predictive ability. Successful prediction of

security price would enable the Manager to earn higher returns than the ordinary

investor expects to earn in given level of Risk.

71

Finally we are comparing the Sharpe single index model portfolio & CAPM Model

Portfolio with Nifty Returns.

(Diagram 5) Comparison with Nifty Return

Interpretation

From the above Bar Diagram we interpret that the Return of Sharpe & CAPM

Portfolio is higher than the nifty return. So, sectorial Investment is much better

than nifty return.

72

4 Results & Findings

73

4 Results & Findings

From the above data analysis we find the certain things which discuses below.

1) We are taking the highest contribution of the GDP sector and taking them for

the investment in Portfolio.

2) After selecting sectorial we take each security listed in sector and find the

closing price and match it with the Nifty closing price.

3) We also find out the average return, Beta, Standard Deviation, risk free rate of

return systematic risk, unsystematic risk, and average return of the market.

4) After finding the inputs for CAPM &Sharpe Model we put those values into the

table & deciding the proportions i.e. C* for investing into the securities with

Sharpe model & taking undervalue securities in to the portfolio.

5) Deciding the security we invested 1lakh rupees in each sector for one year

and sale them at the end of the year and find out that how much return we get

from those securities.

6) After measuring the return from the portfolio, we compare the returns of the

sectors by comparing with both return from Sharpe single index model & CAPM

model.

7) Doing the all the above matter we can evaluate those securities by the

Sharpe, Treynor & Jenson ratios to find out the actual performance of the

portfolio.

8) And finally after evaluation we match those returns with the nifty returns and

find out that we can actually beat the market return or not by investing in different

sectors.

74

75

5 Limitations of the study

76

5 Limitations of the study

(1) Limitations of Sharpe’s Model

1). A tradeoff to simplifying Markowitz‟s Model is that it ignores much of the

information that is contained in the covariance matrix, and hence accuracy of the

optimization is sacrificed. Although this is an apparent tradeoff, Sharpe explains

that his analysis would indicate that accuracy is not sacrificed to a large extent.

His analysis, which he points out is not conclusive, would indicate that the

Diagonal Model is still able to represent the relationships among securities well

(Sharpe 292).

2). In Insignificant Betas and the Efficacy of the Sharpe Diagonal Model for

Portfolio Selection, Frankfurter and Lamoureux point out that the selection

algorithm of Sharpe‟s model has the tendency to select securities with the lowest

βs. When a security‟s β is statistically indistinguishable from zero, it essentially

means that the performance of the security has a very low to no relationship with

the performance of the market. The issue is that the relationship between the

market and each individual security is supposed to indirectly measure each

security‟s covariance with all the other securities in the portfolio. Thus, the

question arises whether the model is still viable if it is selecting securities that

have very low βs and in turn have no relation to the market (Frankfurter and

Lamoureux 853). To improve the performance of Sharpe‟s model, the two of

them propose a simple heuristic of excluding any stock with an insignificant β

from the set of stocks that would be analyzed by the model.

77

3). Markowitz‟s model, Sharpe‟s Diagonal Model is a single point in time analysis.

This deterministic model does not take into account uncertainty in the βs over a

period of time. As a result, it makes the optimization valid for one point in time.

This is not very practical for investors who are interested in long term

investments.

4). Sharpe was able to develop a simplified and more practical model in

response to Markowitz‟s full covariance model. However there are still many

limitations to the model that could be resolved through modifications and

heuristics as shown in Frankfurter and Lamoureux‟s article.

(2) Limitations of the CAPM

1).The model makes unrealistic assumptions.

2).The parameters of the model cannot be estimated precisely. Definition of a

market index Firm may have changed during the 'estimation' period.

3).The model does not work well if the model is right, there should be a linear

relationship between returns and betas. The only variable that should explain

returns is betas.

4).The reality is that the relationship between betas and returns is weak. Other

variables (size, price/book value) seem to explain differences in returns better.

78

6 Conclusions

79

6 Conclusions

1).From all the above study we conclude that we can beat the market return by

investing the money into the top three GDP contribution sectors with using the

Sharpe & CAPM model.

2).We find that the no of securities in CAPM model were high as compare to the

Sharpe single index model. So the Sharpe model is investing the money in less

no of securities as compare to CAPM model. and the risk is more diversify in

CPAM rather than in Sharpe Model.

3).But the comparison of both Sharpe single index model & CAPM model we find

that the some securities were same in both the model & will generate the same

return.

4).So we suggest that both the model are good for measuring the risk & return of

the portfolio.

80

Bibliography (APA Format)

1. B.Vohra. N, Bagri. B, (2003), Futures and Options, 2ed,

Tata McGraw Hill, New Delhi.

2. Reilly/Brown, Investments- Analysis and Portfolio

Management, Cengage Learning Latest Edition.

3. Zvi Bodied, Alex Kane, Alan J Marcus and Pitabas

Mohanty, Investments Tata McGraw Hill Latest Edition.

4. M. Rangnatham and R. Madhumathi, Investment

Analysis and Portfolio Management Pearson Latest Edition.

5. Fischer and Jordon, Security analysis and Portfolio

Management Pearson Latest Edition.

6. Prasanna Chandra, Investment Analysis and Portfolio

Management Tata McGraw Hill Latest Edition