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
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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.
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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.
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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
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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
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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.
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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
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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
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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
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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
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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
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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.
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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
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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.
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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
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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.
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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
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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
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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
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(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.
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(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.
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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.
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(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.
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.
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.
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.
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.
67
(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
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.
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.
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.
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
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