Project

INTRODUCTION
PROBLEM STATEMENT OBJECTIVE OF THE STUDY SCOPE OF THE STUDY METHODOLOGY LIMITATIONS COMPANY PROFILE
CHAPTER ONE: INTRODUCTION:

A portfolio is a bundle or a combination of individual assets or securities. The portfolio theory provides a normative approach to investors to make decisions to invest their wealth in assets or securities under risk. It is based on the assumption that investors are riskaverse. This implies that investors hold well diversified portfolio instead of investing their entire wealth in a single or a few assets. One important conclusion of the portfolio theory is that if the investor of the portfolio theory is that if the investor holds a well diversified portfolio of assets, then their concerns should be the expected rate of return and risk of the portfolio, rather than individual assets and the contribution of individual asset to the portfolio risk. The second assumption of the portfolio theory is that the returns of assets are normally distributed. This means that the mean and variance analysis is the foundation of the portfolio decisions. Further, we can extend the portfolio theory to derive a framework for valuing risk assets. This framework is referred to as CAPM.
1.1 PROBLEM STATEMENT:

Earning maximum returns on investments is definitely the motto for any investor. Selecting stocks however, exclusively on the basis of maximization of return is not enough. The fact that most investors do not place their available funds in few stocks promising higher returns suggests that other factors must be considered besides returns in selection process. Investors want to maximize expected return subject to their assessment and capacity to take risk. The risk associated with the holdings is that the return that is achieved will be less than the return that was expected. Hence, the study of risk vis--vis reruns always holds a great significance, which immensely helps, in key decision-making process.
Investors thus need to make decisions as to what securities should be held. Estimates need to be prepared of the return and risk associated with the securities for a certain period of time. This is known as security analysis and is built around the idea that investors are concerned with expected return and risk, the two principal properties inherent in securities. Thus the return and risk and their measurement using Capital Asset Pricing Model (CAPM) will be the core of the study undertaken. The attachment of the paramount importance of these two principal properties, return and risk, inherent in securities with the analysis of any investment decision makes the study significant. Investments made in securities are rewarded with a fair rate of return. Another inherent component involved in security investment along with the return is the risk, that the return achieved will be less than the expected, or simply put the financial loss. Investors generally being risk averse in nature, for any increase in risk, the return required by investor for bearing the risk must also increase. A significant portion of risk being reduced or eliminated either, with judicious diversification of stocks, the only portion of risk is concern is the non-diversification of stocks, the only portion of risk is concern is the nondiversification risk or more formally systematic risk, common to the market. In this context investors and professionals use beta as a measure of risk. Beta quantifies volatility of a security to the market, thus helps to arrive the returns expected at a particular level of risk. Higher the beta, higher will be the returns.
1.2 Objectives of the study:

1. To measure the return on securities selected i.e. FMCG, Petrochemical & Refinery, banking, cement and Pharmaceutical industries. 2. To measure the systematic risk of the security by using beta as a measure of risk. 3. To calculate expected rate of return using CAPM and the stock return using the MARKET MODEL. 4. To evaluate the performance of stocks using CAPM model and the MARKET MODEL.
1.3 Scope of the study:

1. Scope segments of the economy such as shipping, textile are not considered for lack of sufficient data points and hence a few good performing companies were eliminated. 2. The grouping of industries into segments varies among individuals. E.g.: - Asian Paints is considered as a FMCG. But since Asian Paints is a major wealth creating company. It could be classified under a different such as paints. 3. It is assumed that the firm selected is representative of the segment. 4. The index selected is S & P CNX NIFTY changes the index could result in discrepancies in the result obtained. 5. The firm selected for analysis have to be listed on NIFTY (since NIFTY is considered as the index)
1.4 METHODOLOGY:
Research Design: This study is based on empirical research methodology. Empirical
research methods are a class of research methods in which Empirical observations or Data are collected in order to answer research question.
Sample Design Methodology

STEP: 1
Selection of Companies: The economy was classified into segments as shown. In each of these segments a leading firm was selected. representative of the top performing firms in the segments. This firm is considered as a
SEGMENT Cement Banking Pharmaceutical Industry Automobiles FMCG
FIRM ACC Axis Bank Ltd Sun pharmaceuticals Maruti Suzuki India Ltd Hindustan Unilever Limited
STEP: 2 Daily share price of the stock was collected from the website of National stock exchange (www.nseindia.com) from CSV files. STEP: 3 The Daily Index Value (NIFTY) was downloaded from the National Stock Exchange website (www.nseindia.com). The composition of NIFTY is subjected to scrutiny on a periodic basis. Any change in the composition of the NIFTY could impact on the index value. STEP: 4 The Daily return (in percentage terms) of the stock and the index is calculated. STEP: 5 5
These daily returns can be annualized in two ways: (a) Arithmetic mean (b) Geometric mean Geometric method is always a better option since compounding is taken into account thought returns could be annualized using natural logarithm. The geometric method of annualizing the return (by compounding) was preferred for its simplicity. Note: the data has been analyzed from 1st January 2007 to 31st December 2011 (i.e., for a period of 5 years). Even stock splits are considered over a period of time. STEP: 6 To find Beta Value of the stock is calculated using MS-EXCEL. Beta is the only measure in the CAPM concept. Market model is used for the calculation of beta and the stock return. STEP: 7 Expected return calculation needs the risk free rate. RF is Treasury bill. So we have assumed it as 6%. STEP: 8 Expected Return by CAPM E(R) Where, Rm = Rf + (Rm Rf) = Market Return of NIFTY
= Beta Value (Return of Scripts and return of Index) STEP: 9 Construction of security market line keeping Beta is the only measure scrutiny market line was constructed for each firms in order to identify the undervaluation and over valuation of stock. The valuation of the stock is done by the comparison of the returns from the CAPM model and the Market model. 6
STEP: 10 An detail analysis has been made with various sector stocks that the performance of the stock could indicate that the expected return forecasted for a stock is more or less than its fair return given its risk and it is also analyzed that this model helps us to make an educated guess as the expected return on asset that have not yet been traded in the market place. Although the CAPM does not fully with stand empirical tests. It is widely used because the insight it offers and because its accuracy suffices for important applications.
1.5 LIMITATIONS
As we consider Beta only, the bonus shares issued is not considered. The dividends issued on the shares are also not taken into account, since the effect on the return on the share would be minimal. Since the study concentrates on data from 1st January 2007 the effect if the change in NIFTY values would not have an impact on the study. Since the returns the calculated on yearly vise the Risk free Rate (RF) was assumed as 6%, which would not give us a realistic picture for the expected return. Since it is an academic exercise it may not have totally practical study. Unfortunately procedure is not very practical since information on investor expectation is very sketchy. There may be a variation in calculation because we have tested the CAPM using ex post data, than ex ante data.
1.6 COMPANY PROFILE:

The Karvy Group was formed in 1983 at Hyderabad, India. Karvy ranks among the top player in all the fields it operates. Karvy was started by a group of five chartered accountants in 1979. The first firm in the group, Karvy Consultants Limited was incorporated on 23rd July, 1983. In a very short period, it became the largest Registrar and Transfer Agent in India. This business was spun off to form a separate joint venture with Computershare of Australia, in 2005. Karvys foray into stock broking began with marketing IPOs in 1993. Karvy was among the first few members of National Stock Exchange, in 1994 and became a member of the Stock Exchange Mumbai in 2001. Dematerialization of shares gathered pace in mid-90s. Karvy has 575 offices over 375 locations across India and overseas at Dubai and New York. Karvy has a professional management team and ranks among the best in technology, operations, and more importantly, in research of various industrial segments. Investment is the stepping stone to achieving ones financial dreams. Mutual funds offer an opportune way to long-term wealth creation. However, with more and more funds flooding the market, the task of selecting the most suitable scheme gets even more complicated. Mutual fund Advisory Service at Karvy guides through this maze and ensures that the investments are backed by our quality research. At Karvy, they help to reach the goals by offering: Products of 33 AMCs Research reports (existing funds and NFOs; strategy reports etc.) Customized mutual fund portfolios
Portfolio revision (depending on changing market outlook and evolving trends). Access to online consolidated portfolio statement.
Vision:
To have a single minded focus on investor servicing. To establish Karvy as a household name for financial services. To set industry standards. To establish a leadership position in all chosen areas of business.
Mission:
To be a leading and preferred service provider to customer and to achieve this leadership position by building an innovative, enterprising, and technology driven organization which will set the highest standards of service and business ethics.
Quality policy:
To achieve and retain leadership, Karvy shall aim for complete customer satisfaction, by combining its human and technological resources, to provide superior quality financial services. In the process, Karvy will strive to exceed Customer's expectations.
Quality Objectives:
Build in-house processes that will ensure transparent and harmonious relationships with its clients and investors to provide high quality of services. Establish a partner relationship with its investor service agents and vendors that will help in keeping up its commitments to the customers. Provide high quality of work life for all its employees and equip them with adequate knowledge & skills so as to respond to customer's needs.
Continue to uphold the values of honesty & integrity and strive to establish unparalleled standards in business ethics. Use state-of-the art information technology in developing new and innovative financial products and services to meet the changing needs of investors and clients.
Strive to be a reliable source of value-added financial products and services and constantly guide the individuals and institutions in making a judicious choice of same.
Strive to keep all stake-holders proud and satisfied.
Achievements:

Among the top 5 stock brokers in India (4% of NSE volumes) India's No. 1 Registrar & Securities Transfer Agents Among the top 3 Depository Participants Largest Network of Branches & Business Associates ISO 9002 certified operations by DNV Among top 10 Investment bankers Largest Distributor of Financial Products Adjudged as one of the top 50 IT uses in India by MIS Asia Fully Fledged IT driven operations
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LITERATURE REVIEW
CAPM SML Beta

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MARKET MODEL
CHAPTER TWO LITERATURE REVIEW

This is the central part of the paper that aims to provide the reader the details of the CAPM and the testing methods for the forthcoming analysis. The basic definitions about CAPM, its support and the debate around this theory is described here; the most important one is the procedure of testing the CAPM, which is the foundation of the later analysis.
2.1 The classic theory - CAPM

The Capital Assets Pricing Model, denoted CAPM, describes the relationship between risk and expected return and is used in the pricing of risky securities. This relationship was first proposed independently by John Lintner, William F. Sharpe and Mossin, which can be represented by the following linear equation: E[Ri] = R f +i (E[Rm] -Rf) Where: Rf = Risk free rate of return i = Beta of the security i E [Rm] = Expected return on market (Rm Rf) = Market premium
The CAPM introduced that the expected return of a security or a portfolio equals the rate of return on a risk-free rate plus a risk premium. This model offers a simple tool for investors to evaluate their investments. If this expected return does not meet or beat the required return, then the investment should not be undertaken. 12
The CAPM is a ceteris paribus model. It is only valid within a special set of assumptions, which are mainly listed below. All the investors are risk averse; they will maximize the expected utility of their end of period wealth. Implication: The model is a one period model. All the investors use the same expected return and covariance matrix of stock return to form the optimal risky portfolio. That is referred to as homogenous expectations (beliefs) about asset returns. Implication: All the investors use the same information at the same time. A fixed risk-free rate exists, and allows the investors to borrow or lend unlimited amounts to the same interest rate. There are a definite number of stocks and their quantities are fixed within the one period world. All stocks are perfectly divisible and priced in a perfectly competitive market. Implication: Education (human capital), private enterprise, and governmentally funded assets such as town halls and international airports are non-tradable. There are no market imperfections. Implication: there are no taxes, regulations, or trading costs. There is no uncertainty about expected inflation; or, alternatively all security prices fully reflect all changes in future inflation expectations. Capital markets are in equilibrium. That is, all investment decisions have been made and there is no further trading without new information. Some of the above assumptions are clearly unrealistic. However, the assumptions are not as restrictive as it appears initially and some of them can be relaxed without altering the basic nature of the model as it is explain below. [Sears and Trennepohl (1993)] Theoretical Implications of Relaxing the above-mentioned assumptions: 13
Inclusion of skewness (third moment) in the pricing model has led to the three moment CAPM. Different borrowing and lending rates lead to different CAPM lines and no general equilibrium pricing model. No risk less asset exists, leading to the zero beta CAPM, which provides for a Theoretical explanation of the basic CAPM empirical results. There is riskless lending but no riskless borrowing, leading to the zero beta CAPM CAPM would be series of line segments, each representing portfolio positions with no fractional shares. Different expectations lead to different CAPM lines and no general equilibrium pricing model. Inclusion of transactions costs in the model would produce bands around the relationship, leading to fuzzy equilibrium. Consideration of taxes leads to an alternative CAPM model that incorporates The differential tax effects of dividends and capital gains. These assumptions are all hard to fulfill in reality, but as a financial theory, it may
still describe reality in a reasonably way. One of the important outcomes of the CAPM assumptions is that all investors hold a portfolio which is a combination between riskless portfolio and market portfolio. This is because all investors will have identical efficient frontiers due to the assumption of homogeneous expectations. They can however have different utility functions, which will decide what combination of riskless portfolio and market portfolio the investor will choose. This implies that all investors hold the same combination of risky securities namely, the market portfolio. This is also known as the separation theorem. The market portfolio in CAPM is the unanimously desirable risky portfolio which contains all risky assets. Thus return on market portfolio is weighted average of return of all risky assets in the market and in theory it should contain, besides ordinary shares, all assets, like art objects, commodities, and real estates and so on. 14
However in practice it is impossible to construct a market proxy which contains all assets and thus, all the commonly used market indices roughly replicate the market. The total risk of a portfolio can be measured by the variance of its return. In a more general situation of a portfolio p consists of n shares and any individual share i has a weightage of Xi in the portfolio, then the total risk can be expressed as follows:
2p = n t=1 Xi2 + (n t=i Xi i)2 2m

i-e
2p = 2ep + p2 2m
Total Risk = Unsystematic Risk + Systematic Risk If CAPM holds, then investors should hold diversified portfolios and the systematic risk or non-diversifiable risk will be the only risk which will be of importance to the investors. The other part of the risk, known as the diversifiable risk or unsystematic risk will be reduced to nil by holding a diversified portfolio. Thus beta, which is a measure of the non-diversifiable risk in a portfolio, is most important for investors, from the point of view CAPM theory. In case the CAPM holds in the market, an investor will no longer require any sophisticated portfolio selection technique to select his portfolio. He will choose a mix between risk-free rate and the market portfolio based on his utility function. In other words optimal investment decision will be simply to buy the market portfolio. This investment decision is independent from the decision about how to finance the investment i.e. whether to lend or borrow at the risk-free rate. Ideally, if CAPM holds, there will not be any identifiable inefficiency in the market and all securities will lie on the security market line (no security can be found which is wrongly priced). However, such a situation is not realistic even in a highly developed and efficient capital market as in the United States. But on an average, if the inefficiencies in the market are not extreme, the assumptions of the CAPM can be approximately valid even in a 15
realistic situation. In such a situation majority of the securities (assets) in the market will be efficiently priced. Thus even though it is known that no market in the world is efficient in a perfect sense, empirical tests of CAPM can still give meaningful results. Thus capital asset pricing model, almost always referred to as the CAPM, is a centerpiece of modern financial economics. The model gives us a precise prediction of the relationship that we should observe between the risk of an asset and its expected return. This relationship serves two vital functions. First, it provides a benchmark rate of return for evaluating possible investments. For example, if we are analyzing securities, we might be interested in whether the expected return we forecast for a stock is more or less than its fair return given its risk. Second, the model helps us to make an educated guess as to the expected return on assets that have not yet been traded in the marketplace. The capital asset pricing model is a set of predictions concerning equilibrium expected returns on risky assets
WHAT IS RISK?
Risk and Uncertainty are in integral part of an investment decision. Technically risk can be defined as a situation where the possible consequences of the decision that is to be taken are known. Uncertainty is generally defined to apply to situations where the probabilities cannot be estimated. However, risk and uncertainty are used inter changeably. Risk is composed of the demands that bring in variations in return of income. The main forces contributing to risk are price and interest. Risk is also influenced by external and internal considerations. External risks are uncontrollable and broadly affect investments. These external risks are called systematic risk. Risk due to internal environment of a firm or that affecting a particular industry is referred to as unsystematic risk.
DEFINING RISK
Risk in holding securities is generally with the possibility that realized returns will be less that the returns that were expected in the most basic sense; risk is the chance and financial loss. 16
Forces that contribute to variation is return, in return-price or in dividend contribute demeans of risks, some influences are external to the firm that cannot be controlled and affect coverage number of securities and other influences are internal to time firm and are controlled to a large degree.
TYPES OF RISK
Non-Diversifiable or systematic risk: It influences a large number of assets, each to a greater or lesser extent. This risk arises on account of economy-wide uncertainties and the tendency of the securities to move together with changes in the market. It is also referred to as market risk. This part of the risk cannot be reduced through diversification. Thus investors are exposed to market risk even when they hold well-diversified portfolios of securities.
Examples of Systematic risk:

The Reserve Bank of India introduces a restrictive credit policy. The corporate tax is increased. The inflation rate increases.
Diversifiable risk or unsystematic risk: It affects a single asset or only a small group of assets. Since these risks are specific to individual companies or assets, they are sometimes referred to as unique or asset-specific risks. This risk arises from the uncertainties which are unique to individual securities and which are diversifiable if a large number of securities are combined to form well-diversified port folios.
Examples of unsystematic risks:

Workers declare strike in a company. The R&D expert of a company leaves. The company is not able to obtain adequate quantity of raw material from the supplier.
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2.1.1RETURN MEASUREMENT
The returns incorporate both income and price change into a total return. Return across the time or from different securities can be measured and compared using the total return concept. The total return for a given holding period relates all the cash flows received by an investor during any designated time period to the amount of money invested in asset. It is defined as, TOTAL RETURN = Cash Payment Received + Price Change Over the Period Purchase Power of the Asset The price change ones the period is the difference between the beginning (or purchase) price and the ending price (or sales) price. Symbolically it can be defined as Rt = Pt - Pt-1 + Ct Pt-1 Where, Rt = Actual return during periodt Pt = Price of asset at timet Pt-1 = Price of asset at timet Ct = Cash flow received from the asset in the time period (t-1) to 1
GEOMETRIC MEAN
= [(1+R1) (1+R2) (1+Rn)]^ (1/n) - 1
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2.1.2 Beta
The beta coefficient, in terms of finance and investing, describes how the expected return of a stock or portfolio is correlated to the return of the financial market as a whole. An asset with a beta of 0 means that its price is not at all correlated with the market; that asset is independent. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up and vice versa (as is common with precious metals). Correlations are evident between companies within the same industry, or even within the same asset class (such as equities. This correlated risk, measured by Beta, creates almost all of the risk in a diversified portfolio. The beta coefficient is a key parameter in the capital asset pricing model (CAPM). It measures the part of the asset's statistical variance that cannot be mitigated by the diversification provided by the portfolio of many risky assets, because it is correlated with the return of the other assets that are in the portfolio. Beta can be estimated for individual companies using regression analysis against a stock market index. The formula for the Beta of an asset within a portfolio is
Where ra measures the rate of return of the asset, rp measures the rate of return of the portfolio, and Cov(ra,rp) is the covariance between the rates of return. In the CAPM formulation, the portfolio is the market portfolio that contains all risky assets, and so the r p terms in the formula are replaced by m, the rate of return of the market.
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2.1.3 Market model

The market model represents the relationship between the market return (Rm) and the return Ri of a given asset i at a given time t. In general, it is reasonable to assume that the Market model is got by the straight line called SCL and it can be illustrated as a statistical equation:
Where i is called the asset's alpha coefficient and i the asset's beta coefficient. A line formed using regression analysis that summarizes a particular security or portfolio's systematic risk and rate of return. The rate of return is dependent on the standard deviation of the asset's returns and the slope of the characteristic line, which is represented by the asset's beta. A characteristic line of a stock is the same as the security market line, and is very useful when employing the capital asset pricing model, or when using modern portfolio formation techniques. The slope of the line, which is a measure of systematic risk, determines the risk-return tradeoff. According to this metric, the more risk you take on - as measured by variability in returns - the higher the returns you can expect to earn.
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2.1.4 The Security Market Line

We can view the expected returnbeta relationship as a reward-risk equation. The beta of a security is the appropriate measure of its risk because beta is proportional to the risk that the security contributes to the optimal risky portfolio. Risk-averse investors measure the risk of the optimal risky portfolio by its variance. In this world we would expect the reward or the risk premium on individual assets, to depend on the contribution of the individual asset to the risk of the portfolio. The beta of a stock measures the stocks contribution to the variance of the market portfolio. Hence we expect, for any asset or portfolio, the required risk premium to be a function of beta. The CAPM confirms this intuition, stating further that the securitys risk premium is directly proportional to both the beta and the risk premium of the market portfolio; that is, the risk premium equals [E(rM) rf]. The expected returnbeta relationship can be portrayed graphically as the security market line (SML) in Figure 3.1. Because the market beta is 1, the slope is the risk premium of the market portfolio. At the point on the horizontal axis where beta is 1 (which is the market portfolios beta) we can read off the vertical axis the expected return on the market portfolio. It is useful to compare the security market line to the capital market line. The CML graphs the risk premiums of efficient portfolios (i.e., portfolios composed of the market and the risk-free asset) as a function of portfolio standard deviation. This is appropriate because standard deviation is a valid measure of risk for efficiently diversified portfolios that are candidates for an investors overall portfolio.
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Figure 2.1Security Market Line (SML) The SML, in contrast, graphs individual asset risk premiums as a function of asset risk. The relevant measure of risk for individual assets held as parts of well-diversified portfolios is not the assets standard deviation or variance; it is, instead, the contribution of the asset to the portfolio variance, which we measured by the assets beta. The SML is valid for both efficient portfolios and individual assets. The security market line provides a benchmark for the evaluation of investment performance. Given the risk of an investment, as measured by its beta, the SML provides the required rate of return necessary to compensate investors for both risk as well as the time value of money. Because the security market line is the graphic representation of the expected Return beta relationship, fairly priced assets plot exactly on the SML; that is, their expected 23
returns are commensurate with their risk. Given the assumptions we made at the start of this section, all securities must lie on the SML in market equilibrium. Nevertheless, the CAPM may be of use in the money-management industry. Suppose that the SML relation is used as a benchmark to assess the fair expected return on a risky asset. Then security analysis is performed to calculate the return actually expected. If a stock is perceived to be a good buy, or underpriced, it will provide an expected return in excess of the fair return stipulated by the SML. Underpriced stocks therefore plot above the SML: Given their betas, their expected returns are greater than dictated by the CAPM. Overpriced stocks plot below the SML. The difference between the fair and actually expected rates of return on a stock is called the stocks alpha, denoted .
2.2 The support of the theory

The earliest empirical studies that found supportive evidence for CAPM is written by Black, Jensen and Scholes (BJS). They used monthly return data and portfolios instead of the individual stocks. Black et al tested whether the cross-section of expected returns is linearly related the portfolio betas. In order to enhance the precision of the beta estimates and the expected rate of return, they combined securities into portfolios thereby diversifying away most of the firm-specific component of the returns. The authors found that their results were consistent with what CAPM predicted, i.e. the relation between the average rate of return and beta is very close to linear with each other and the portfolios with high/low betas have high/low average rate of returns. Another empirical study that supports the theory was written by Fama and McBeth (FM) in 1973; they found that there is a positive linear relationship between average return and beta. 24
2.2.1 The classic support of the theory

The model was developed in the early 1960s by Sharpe [1964], Lintner [1965] and Mossin [1966]. In its simple form, the CAPM predicts that the expected return on an asset above the risk-free rate is linearly related to the non-diversifiable risk, which is measured by the assets beta. One of the earliest empirical studies that found supportive evidence for CAPM is that of Black, Jensen and Scholes [1972]. Using monthly return data and portfolios rather than individual stocks, Black et al tested whether the cross-section of expected returns is linear in beta. By combining securities into portfolios one can diversify away most of the firm-specific component of the returns, thereby enhancing the precision of the beta estimates and the expected rate of return of the portfolio securities. This approach mitigates the statistical problems that arise from measurement errors in beta estimates. The authors found that the data are consistent with the predictions of the CAPM i.e. the relation between the average return and beta is very close to linear and that portfolios with high (low)betas have high (low) average returns. Moreover, the authors investigated whether the squared value of beta and the volatility of asset returns can explain the residual variation in average returns across assets that are not explained by beta alone.
2.3 Challenges to the theory

In the early 1980s several studies suggested that there were deviations from the linear CAPM risk return trade-off due to other variables that affect this tradeoff. Some empirical studies found out that there are some contradictions to the CAPM, such as the Size effect. Banz published one of the earliest articles on the Small-firm effect, which is also known as the Size-effect. It states that over long periods of time, small firms (small part of capitalization or assets) tend to generate larger returns than large-company stocks. Many studies have shown that small firms tend to outperform large ones. According to the empirical data, the size of the firms and the return of the common stocks are inversely 25
related, while CAPM states that only systemic risk is a factor that affects expected returns. Thus CAPM fails to predict the expected return in this case. In 1992, Fama and French used the same method as Fama and McBeth did in 1973 but arrived at very different conclusions, Fama and McBeth found the positive relationship between average return and its beta, while Fama and French found the CAPM could not fully prove the positive relationship between each other. Black argued that data are too noisy to invalidate the CAPM.
2.4 Empirical method of CAPM testing

2.4.1 Sample Selection
The study covers the period from 01-01-2007 to 31-12-2011. The selection of stocks was made on the basis of the SELECTED industries in India, in order to cover the SELECTED market as a whole. From more than 30 stocks, stocks that were traded irregularly or had small trading volumes were excluded. Only 10 stocks fit the requirements. For the purpose of the study, 5 stocks were then randomly selected from the pool of these stocks.
2.4.2 Data Selection

The study uses monthly stock returns for the sampled 5 companies listed on the National Stock Exchange for the period of 01-01-2007 to 31-12-2011. The data were obtained from the NSE website, and from Yahoo Finance. In order to obtain better estimates of the value of the beta coefficient, the study utilizes monthly stock returns. On the other hand, high frequency data such as daily returns might result in the use of very noisy data and thus incur inefficient estimation for beta.
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The monthly return of the CNX NIFTY Index is used as a proxy for the market. Furthermore, in order to find the precise risk free asset, we assumed the 5-year Treasury bill as 6%.
2.4.3 Procedure of CAPM testing

The study covers the period from 01-01-2007 to 31-12-2011. Since the purpose of this study is to test the prediction of CAPM, and due to the short observation period, monthly data was used to estimate the beta of the stocks. The test is based on the time series regressions of stock return on market return, which can be express by the equation below: Rit - Rft = i +i (Rmt Rft) + eit (1) Where: Rit is the rate of return on asset i (or portfolio) at time t, Rft is the risk-free rate at time t, Rmt is the rate of return on the market portfolio at time t. i is the beta of stock i. [can be also express by Cov(Ri , Rm)/Var(Rm)] eit is the is random disturbance term in the regression equation at time t.
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EMPIRICAL ANALYSIS
Calculation of Returns Beta estimation SML line Plot Regression Outputs
Market model
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CHAPTER THREE EMPIRICAL ANALYSIS

This chapter is focuses on the test of the CAPM by using the methods mentioned in the last chapter; furthermore, brief interpretations are followed at each section.
3.1 Empirical analysis of the CAPM
3.1.1 S&P CNX Nifty Index

S&P CNX Nifty is a well diversified 50 stock index accounting for 22 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios index. S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a joint venture between NSE and CRISIL. IISL is India's first specialized company focused upon the index as a core product. IISL has Marketing and licensing agreement with Standard & Poor's (S&P), who world leaders are in index services. The average total traded value for the last six months of all Nifty stocks is approximately 62.45% of the traded value of all stocks on the NSE Nifty stocks represent about 63.98% of the total market capitalization as on Jan. 30, 2009. Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crores is 0.16% S&P CNX Nifty is professionally maintained and is ideal for derivatives trading. It is a simplified tool that helps investors and ordinary people alike, to understand what is happening in the stock market and by extension, the economy. If the Nifty Index performs well, it is a signal that companies in India are performing well and consequently that the country is doing well. A rising index is also indicative that the investors are gung-ho about the future. The Nifty Index is based upon solid economic research. It is internationally respected and recognized as a pioneering effort in providing simpler understanding of stock market complexities. 29
CALCULATIONS OF MARKET RETURN FOR THE YEAR 2007
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07
3966.25 4083.4 3745.4 3820 4089.45 4296.05 4318.4 4528.85 4466.65 5021.5 5903.8 5765.45
4082.7 3745.3 3821.55 4087.9 4295.8 4318.3 4528.85 4464 5021.35 5900.65 5762.75 6138.6
0.02936 -0.08279 0.02033 0.07013 0.05046 0.00518 0.04873 -0.01432 0.12419 0.17508 -0.02389 0.06472
Table 3.1: Market Returns Estimation for year 2007
30
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
6136.75 5140.6 5222.8 4735.65 5265.3 4869.25 4039.75 4331.6 4356.1 3921.85 2885.4 2755.15
5137.45 5223.5 4734.5 5165.9 4870.1 4040.55 4332.95 4360 3921.2 2885.6 2755.1 2959.15
-0.16283 0.01612 -0.09340 0.09085 -0.07505 -0.17019 0.07258 0.00656 -0.09984 -0.26422 -0.04516 0.07404
31
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
2963.3 2872.3 2764.6 3023.8 3478.7 4450.4 4292.3 4633.8 4662.2 5087.2 4712.2 5039.7
2874.8 2763.6 3020.9 3473.9 4448.9 4291.1 4636.4 4662.1 5083.9 4711.7 5032.7 5201.0
-0.02986 -0.03784 0.09273 0.14885 0.278911 -0.03579 0.08017 0.00611 0.09046 -0.07381 0.06791 0.03201
32
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
5200.9 4882.05 4935.6 5249.2 5278.4 5086.25 5312.05 5369.55 5403.05 6030.3 6092.3 5871
4882.05 4922.3 5249.1 5278 5086.3 5312.5 5367.6 5402.4 6029.95 6017.7 5862.7 6134.5
-0.06130 0.00824 0.06352 0.00548 -0.03639 0.04448 0.01046 0.00612 0.11603 -0.00209 -0.03768 0.04488
33
CALCULATIONS OF NIFTY MARKET RETURN FOR THE YEAR 2011
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
6177.45 5537.3 5382 5835 5766.9 5561.05 5705.75 5527.5 5109.8 4874.4 5278.6 4970.85
5505.9 5333.25 5833075 5749.5 5560.15 5647.4 5482 5001 4943.25 5326.6 4832.05 4624.3
-0.10871 -0.03685 0.083937 -0.014653 -0.035851 0.015527 -0.039215 -0.095251 -0.032594 0.0927704 -0.084596 -0.069716
34
Year 2007 2008 2009 2010 2011 MARKET RETURN %
Return 0.54482 -0.5265 0.74796 0.15967 -0.29747
Relative Return 1.54482 0.4735 1.74796 1.15967 0.70253 0.81986
Table 3.6: Overall Market Returns Estimation for year 2007-2011
For calculating market return GEOMETRIC MEAN = [(1+R1) (1+R2) (1+Rn)]^ (1/n) - 1
35
3.1.2 OVERVIEW OF ACC LIMITED:
ACC (ACC Limited) is India's foremost manufacturer of cement and concrete. ACC's operations are spread throughout the country with 14 modern cement factories, more than 30 Ready mix concrete plants, 20 sales offices, and several zonal offices. It has a workforce of about 10,000 persons and a countrywide distribution network of over 9,000 dealers. ACC's research and development facility has a unique track record of innovative research, product development and specialized consultancy services. Since its inception in 1936, the company has been a trendsetter and important benchmark for the cement industry in respect of its production, marketing and personnel management processes. Its commitment to environment-friendliness, its high ethical standards in business dealings and its on-going efforts in community welfare programmes have won it acclaim as a responsible corporate citizen. ACC has made significant contributions to the nation building process by way of quality products, services and sharing its expertise. In the 70 years of its existence, ACC has been a pioneer in the manufacture of cement and concrete and a trendsetter in many areas of cement and concrete technology including improvements in raw material utilization, process improvement, energy conservation and development of high performance concretes. ACCs brand name is synonymous with cement and enjoys a high level of equity in the Indian market. It is the only cement company that figures in the list of Consumer Super Brands of India. The company's various businesses are supported by a powerful, in-house research and technology backup facility - the only one of its kind in the Indian cement industry. This ensures not just consistency in product quality but also continuous improvements in products, processes, and application areas. ACC has rich experience in mining, being the largest user of limestone, and it is also one of the principal users of coal. As the largest cement producer in India, it is one of the biggest customers of the Indian Railways, and the foremost user of the road transport network services for inward and outward movement of materials and products. 36
ACC has also extended its services overseas to the Middle East, Africa, and South America, where it has provided technical and managerial consultancy to a variety of consumers, and also helps in the operation and maintenance of cement plants abroad. ACC is among the first companies in India to include commitment to environmental protection as one of its corporate objectives, long before pollution control laws came into existence. The company installed pollution control equipment and high efficiency sophisticated electrostatic precipitators for cement kilns, raw mills, coal mills, power plants and coolers as far back as 1966. Every factory has state-of-the art pollution control equipment and devices. ACC demonstrates the practices of being a good corporate citizen undertaking a wide range of activities to improve the living conditions of the under-privileged classes living near its factories.
37
CALCULATION OF ACC LIMITED RETURNS FOR THE YEAR 2007
DATE
OPENING PRICE 1,096.00 1,034.00 902.05
CLOSING PRICE 1,020.40 902 735.25 839.2 850.85 934.95 1,063.85 1,067.45 1,197.10 1,077.30 1,090.40 1,024.80
RETURNS -0.068978102 -0.127659574 -0.184912145
MARKET RETURN 0.02936 -0.08279 0.02033
Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07
720 848 870 935 1,060.85 1,066.80 1,205.00 1,099.95 1,103.80
0.165555556 0.003360849 0.074655172 0.137807487
0.07013 0.05046 0.00518 0.04873
0.006221426 0.122140982 -0.105975104 -0.008682213
-0.01432 0.12419 0.17508 -0.02389
-0.071570937 0.06472
Dec-07 Table 3.7: ACC Returns Estimation for year 2007
38
DATE
OPENING PRICE 1,035.00 780 795.95 829.05 789.9 661 525.5 575 555 619 519 411
CLOSING PRICE 768.1 795.95 826.15 758.65 661.3 525.5 583.4 562.35 614.95 493.75 405.6 480.15
RETURNS -0.257874396 0.020448718 0.037942082 -0.084916471 -0.162805418 -0.204992436 0.11018078 -0.022 0.108018018 -0.202342488 -0.21849711 0.168248175
MARKET RETURN -0.16283 0.01612 -0.09340 0.09085 -0.07505 -0.17019 0.07258 0.00656 -0.09984 -0.26422 -0.04516 0.07404
Table 3.8: ACC Returns Estimation for year 2008
39
DATE
OPENING PRICE 408 508 530.25 576.8 660 790 765 871.3 809.5 822.5 743.95 802
CLOSING PRICE 506.4 540.05 574.4 654.35 782.5 765.75 880.8 807 820.25 750.65 797.65 872.45
RETURNS
MARKET RETURN -0.02986 -0.03784 0.09273 0.14885 0.278911 -0.03579 0.08017 0.00611 0.09046 -0.07381 0.06791 0.03201
0.05467041 0.06309055 0.08326261 0.13444868 0.18560606 -0.0306962 0.15137254 -0.07379777 0.01327980 -0.08735562 0.07218227 0.08784289
CALCULATION OF ACC LIMITED RETURNS 40
FOR THE YEAR 2010
DATE
OPENING PRICE 890 873 913.9 954.4 904 819.9 862.25 835 878.95 990 989 989.7
CLOSING PRICE 871.7 923.1 951.05 905.05 818.55 878.1 831 870.35 989.85 985.35 983.8 1075.6
RETURNS -0.020561 0.057388 0.040650 -0.051707 -0.094524 0.070984 -0.036242 0.042335 0.126173 -0.004668 -0.005257 0.086793
MARKET RETURN -0.06130 0.00824 0.06352 0.00548 -0.03639 0.04448 0.01046 0.00612 0.11603 -0.00209 -0.03768 0.04488
CALCULATION OF ACC LIMITED RETURNS 41
FOR THE YEAR 2009
DATE
OPENING PRICE 989 992 974.2 1070 1114.8 1030 952.05 1010 1035.85 1096.7 1199 1164.7
CLOSING PRICE 991.65 969.35 1074.55 1112.8 1027.25 950.45 1011.6 1002.8 1098.55 1195.05 1144.3 1136.9
RETURNS
MARKET RETURN
0.002679 -0.022832 0.103007 0.04 -0.078534 -0.077233 0.062549 -0.007128 0.063610 0.089678 -0.045621 -0.023868
-0.10871 -0.03685 0.083937 -0.014653 -0.035851 0.0155276 -0.039215 -0.095251 -0.032594 0.0927704 -0.084596 -0.069716
42
Year 2007 2008 2009 2010 2011 ACC RETURN (%)
Return -0.12051 -0.58057 0.82135 0.20649 0.0886
Relative Return 0.87949 0.41943 1.82135 1.20649 1.0886 -2.471
Table 3.12: Overall ACC Returns Estimation for year 2007-2011
3.1.3 OVERVIEW OF AXIS BANK LTD 43
Axis Bank was the first of the new private banks to have begun operations in 1994, after the Government of India allowed new private banks to be established. The Bank was promoted jointly by the Administrator of the specified undertaking of the Unit Trust of India (UTI - I), Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC) and other four PSU insurance companies, i.e. National Insurance Company Ltd., The New India Assurance Company Ltd., The Oriental Insurance Company Ltd. and United India Insurance Company Ltd. The Bank today is capitalized to the extent of Rs. 359.00 crores with the public holding (other than promoters) at 57.60%. The Bank has a very wide network of more than 850 branches and Extension Counters (as on 31st March 2010). The Bank has a network of over 3634 ATMs (as on 31st March 2010) providing 24 hrs a day banking convenience to its customers. This is one of the largest ATM networks in the country. Milestones Axis Bank launches Platinum Credit Card, India's first EMV chip based card Axis Bank gets AAA National Long-Term Rating from Fitch Ratings Axis Bank ties up with Banque Prive Edmond de Rothschild Europe for Wealth Management
CALCULATION OF AXIS BANK LTD RETURNS FOR THE YEAR 2007 44
DATE
OPENING PRICE 471.8 535.5 466.95 469.95 470 580 624.7 623.7 635 766.9 925 936.15
CLOSING PRICE 534.6 460.7 490.4 468.2 574.95 605.5 625.9 635 764.6 917.35 930.65 970.45
RETURNS
MARKET RETURN 0.02936 -0.08279 0.02033 0.07013 0.05046 0.00518 0.04873 -0.01432 0.12419 0.17508 -0.02389 0.06472
0.133107 -0.13968 0.05022 -0.00372 0.223298 0.043966 0.001921 0.018118 0.204094 0.196179 0.006108 0.036639
Table 3.13 Axis Bank Returns Estimation for year 2007
CALCULATION OF AXIS BANK LTD RETURNS FOR THE YEAR 2008 45
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
MARKET RETURN
970.3 1,140.00 965 809 935 775 610 650 720.05 722 582.3 412.5
1,120.80 1,022.55 789.85 923.55 793.25 605.05 653.9 723.4 720.25 562.95 408.5 504.7
0.155107 -0.10303 -0.1815 0.141595 -0.1516 -0.21929 0.071967 0.112923 0.000278 -0.22029 -0.29847 0.223515
-0.16283 0.01612 -0.09340 0.09085 -0.07505 -0.17019 0.07258 0.00656 -0.09984 -0.26422 -0.04516 0.07404
Table 3.14 Axis Bank Returns Estimation for year 2008 CALCULATION OF AXIS BANK LTD RETURNS FOR THE YEAR 2009 46
DATE
OPENING PRICE 508.5 433.00 343.00 420.00 575.00 791.00 838.00 920.50 914.00 979.95 907.00 1,010.00
CLOSING PRICE 433.7 347.90 414.95 557.30 778.95 832.25 917.15 905.30 985.15 907.40 999.40 989.20
RETURNS
MARKET RETURN -0.029865 -0.037843 0.0927258 0.148849 0.278911 -0.035794 0.080178 0.006107 0.090461 -0.073812 0.067912 0.032015
-0.14709 -0.19653 0.20977 0.32690 0.35469 0.05214 0.09445 -0.01651 0.07784 -0.07403 0.10187 -0.02059
Table 3.15 Axis Bank Returns Estimation for year 2009
CALCULATION OF AXIS BANK LTD RETURNS FOR THE YEAR 2010
47
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
MARKET RETURN
993.90 1,026.00 1,131.00 1,168.00 1,268.00 1,235.00 1,242.00 1,350.10 1,330.65 1,538.00 1,488.90 1,370.05
1,025.70 1,124.50 1,168.25 1,270.00 1,232.35 1,242.40 1,343.45 1,330.65 1,536.60 1,471.05 1,366.85 1,350.10
0.03199 0.09600 0.03294 0.08733 0.02812 0.00599 0.08168 0.01441 0.15477 -0.04353 -0.08197 -0.01456
-0.06130 0.00824 0.06352 0.00548 -0.03639 0.04448 0.01046 0.00612 0.11603 -0.00209 -0.03768 0.04488
Table 3.16: Axis Bank Returns Estimation for year 2010 CALCULATION OF AXIS BANK LTD RETURNS FOR THE YEAR 2011
48
DATE Jan-11 Feb-11 Mar-11 Year Apr-11 May-11 Jun-11 Jul-11
OPENING PRICE 1365 1253.65 1235 1410.3 2007 1297.9 2008 1282.25 2009 2010 1314
CLOSING PRICE 1242.2 1218.55 1403.85
RETURNS -0.089963 -0.027998 0.136712
MARKET RETURN -0.10871 -0.03685 0.083937 -0.014653 1.99605 -0.035851 0.51213 0.015527 1.81777 1.44054 -0.039215 0.53209 -0.095251 7.32977
Return 1286.6 Relative-0.087712 Return 0.99605 1282.5 -0.48787 1289.55 0.81777 0.44054 1337.5 -0.46791 1072.75 -0.011865 0.005693 0.017884 -0.204781
2011 Axis Bank Return Aug-11 1349 (% )
1104 Sep-11 1003 Oct-11 1150 Nov-11 985.1 Dec-11
1018.9 1159.35 947.65 808.1
-0.077083 -0.032594 0.155882 0.0927704 -0.175956 -0.084596 -0.179677 -0.069716
Table 3.17: Axis Bank Returns Estimation for year 2011 Table 3.18: Overalls Axis Bank Returns Estimation for year 2007-2011
49
3.1.4 OVERVIEW OF HINDUSTAN LEVER LIMITED:

Hindustan Lever Limited (HLL) is Indias largest fast moving consumer goods company, with leadership in Home & Personal Care Products and Foods & Beverages. HLLs brands, spread across 20 distinct consumer categories, touch the lives of two out of three Indians. They endow the company with a scale of combined volumes of about 4 million tonnes and sales of Rs. 10,000 crores. The mission that inspires HLLs 36,000 employees, including about 1,350 managers, is to add vitality to life. With 35 Power Brands, HLL meets everyday needs for nutrition, hygiene, and personal care with brands that help people feel good, look good and get more out of life. It is a mission HLL shares with its parent company, Unilever, which holds 51.55% of the equity. A fortune 500 transnational, Unilever sells Foods and Home and Personal Care brands in about 100 countries worldwide. Unilevers mission is to add Vitality to life. We meet everyday needs for nutrition, hygiene, and personal care with brands that help people feel good, look good and get more out of life.
50
CALAULATIONS OF HINDUSTAN UNILEVER LIMITED FOR THE YEAR 2007
DATE
OPENING PRICE 217.8 208.1 177.9 202 203.8 205 190 220 207 219.65 208 207
CLOSING PRICE 208.25 176.35 205.2 199.3 203.4 188.6 206.75 208.3 220.6 207.05 206.75 213.7
RETURNS -0.04385 -0.15257 0.153457 -0.01337 -0.00196 -0.08 0.088158 -0.05318 0.0657 -0.05736 -0.00601 0.032367
MARKET RETURN 0.02936 -0.08279 0.02033 0.07013 0.05046 0.00518 0.04873 -0.01432 0.12419 0.17508 -0.02389 0.06472
Table 3.19: HUL Returns Estimation for year 2007
51
DATE
OPENING PRICE 213.25 208 223 232 252 238 207.55 238 245.4 255 225.4 236.5
CLOSING PRICE 208.75 227.5 228.8 250.25 237.1 207.15 239.65 245.4 252.25 221.75 236.4 250.3
RETURNS -0.0211 0.09375 0.026009 0.078664 -0.05913 -0.12962 0.154662 0.031092 0.027914 -0.13039 0.048802 0.058351
MARKET RETURN -0.16283 0.01612 -0.09340 0.09085 -0.07505 -0.17019 0.07258 0.00656 -0.09984 -0.26422 -0.04516 0.07404
52
DATE
OPENING PRICE 251 259 248.1 235 236 228.55 266.15 291 260 262 279 286
CLOSING PRICE 261.65 253.05 237.5 234.75 230.8 267.5 291.5 259.95 262.6 283.5 285.2 264.8
RETURNS 0.04243027 -0.02297297 -0.04272470 -0.00106383 -0.02203389 0.17042222 0.09524704 -0.10670103 0.01000000 0.08206106 0.02222222 -0.074125874
MARKET RETURN -0.029865 -0.037843 0.0927258 0.148849 0.278911 -0.035794 0.080178 0.006107 0.090461 -0.073812 0.067912 0.032015
53
DATE
OPENING PRICE 264.8 243.8 234
CLOSING PRICE 242.3 236.2 239.55 239.8 237.2 267.55 251.45 264.5 309.05 294.7 298.25 312.9
RETURNS -0.084970 -0.031173 0.023718
MARKET RETURN -0.06130 0.00824 0.06352
240.4 240.9 237.95 267 250 264.5 309 296 297
-0.002496 -0.015359 0.124396 -0.058240
0.00548 -0.03639 0.04448 0.01046
0.058 0.16843 -0.046278 0.007601
0.00612 0.11603 -0.00209 -0.03768
0.053535 0.04488
Dec-10 Table 3.22: HUL Returns Estimation for year 2010
54
DATE
OPENING PRICE 310.05 271.15 283.5
CLOSING PRICE 271.15 282 287.1 285.2 304.55 343.65 324 320.4 340.6 375.8 397.15 407.4
RETURNS -0.125463 0.040014 0.012698
MARKET RETURN -0.10871 -0.03685 0.083937
286 286.8 304.85 342.4 325.5 330 338 371.4 403
-0.002797 0.061890 0.127276 -0.053738
-0.014653 -0.035851 0.0155276 -0.039215
-0.015668 0.032121 0.111834 0.069332
-0.095251 -0.032594 0.0927704 -0.084596
0.010918 -0.069716
Dec-11 Table 3.23: HUL Returns Estimation for year 2011
55
Year 2007 2008 2009 2010 2011 HUL RETURN (%)
Return -0.10076 0.14628 0.12818 0.18130 0.27041
Relative Return 0.89924 1.14628 1.12818 1.18130 1.27041 6.48484
Table 3.24: Overalls HUL Returns Estimation for year 2007-2011
56
3.1.5 OVERVIEW OF MARUTI SUZUKI LIMITED:

Maruti Suzuki India Limited (MSIL, formerly Maruti Udyog( Limited), a subsidiary of Suzuki Motor Corporation of Japan, is India's largest passenger car company, accounting for over 50 per cent of the domestic car market Maruti Suzuki's facility in Gurgoan houses three fully integrated plants. While the three plants have a total installed capacity of 350,000 cars per year, several productivity improvements or shop floor Kaizens over the years have enabled the company to manufacture nearly 700,000 cars/ annum at the Gurgoan facilities. The entire facility is equipped with more than 150 robots, out of which 71 have been developed in-house. More than 50 per cent of our shop floor employees have been trained in Japan.
Vision and core value:

Customer and obsession Fast, Flexible and first mover Innovation and creativity Net working and partnership Openness and learning
Milestones:
Msil adopts voluntary fuel disclosure First shipment of A-star leaves mundra port jan-10 A-star bags, zigwheels car of the year award A-star rated best small car of the year Autocar-UTVi
57
CALCULATION OF MARUTI SUZUKI RETURNS FOR THE YEAR 2007
DATE
OPENING PRICE 939 939.9 848 795 817.5 820 745 831.1 876.7 1,008.80 1,100.00 1,030.00
CLOSING PRICE 924.9 841.7 820.2 806.1 817.1 744.15 844.55 867.7 998.75 1,073.85 1,014.15 994.5
RETURNS
MARKET RETURN 0.02936 -0.08279 0.02033 0.07013 0.05046 0.00518 0.04873 -0.01432 0.12419 0.17508 -0.02389 0.06472
-0.01502 -0.10448 -0.03278 0.013962 -0.00049 -0.0925 0.133624 0.044038 0.139215 0.064483 -0.07805 -0.03447
Table 3.25: MARUTI SUZUKI Returns Estimation for year 2007
58
DATE
OPENING PRICE
CLOSING PRICE
RETURNS
MARKET RETURN
1,000.00 833.15 859.7 840 751.1 765.5 616.55 564.9 649.6 695.35 565.5 540.5
850.2 868.2 827 742.1 763.05 616.55 575.65 649.6 690.2 563.2 533.55 520.2
-0.1498 0.042069 -0.03804 -0.11655 0.01591 -0.19458 -0.06634 0.149938 0.0625 -0.19005 -0.0565 -0.03756
-0.16283 0.01612 -0.09340 0.09085 -0.07505 -0.17019 0.07258 0.00656 -0.09984 -0.26422 -0.04516 0.07404
59
DATE
OPENING PRICE 521.00 561.00 698.70 780.00 821.35 1,025.00 1,078.00 1,411.00 1,447.00 1,715.00 1,403.00 1,565.00
CLOSING PRICE 568.30 677.30 779.85 814.00 1,027.10 1,068.95 1,414.45 1,437.75 1,701.40 1,403.30 1,557.35 1,560.10
RETURNS
MARKET RETURN -0.029865 -0.037843 0.0927258 0.148849 0.278911 -0.035794 0.080178 0.006107 0.090461 -0.073812 0.067912 0.032015
0.09078 0.20730 0.11614 0.04358 0.25050 0.04287 0.31210 0.01895 0.17581 -0.18174 0.11001 -0.00313
CALCULATION OF MARUTI SUZUKI RETURNS 60
FOR THE YEAR 2010 OPENING PRICE 1,565.00 1,389.00 1,472.00 1,425.00 1,275.00 1,235.00 1,424.30 1,211.00 1,262.00 1,456.00 1,560.00 1,420.00 CLOSING PRICE 1,389.45 1,459.95 1,417.95 1,279.70 1,236.85 1,423.75 1,198.60 1,257.50 1,440.90 1,551.60 1,422.00 1,421.60 MARKET RETURN -0.06130 0.00824 0.06352 0.00548 -0.03639 0.04448 0.01046 0.00612 0.11603 -0.00209 -0.03768 0.04488
DATE
RETURNS
-0.11217 0.05107 -0.03671 -0.10196 -0.02992 0.15283 -0.15846 0.03839 0.14175 0.06565 -0.08846 0.00112
61
CALCULATION OF MARUTI SUZUKI RETURNS FOR THE YEAR 2011 OPENING PRICE 1430 1266 1209.1 1251.65 1320 1220 1154 1210.1 1072.05 1083.9 1122 992 CLOSING PRICE 1252.85 1208.2 1262.15 1317.65 1230.15 1159.9 1206.65 1091.55 1083 1125.3 972.15 918.3 MARKET RETURN -0.10871 -0.03685 0.083937 -0.014653 -0.035851 0.0155276 -0.039215 -0.095251 -0.032594 0.0927704 -0.084596 -0.069716
DATE
RETURNS -0.12388 -0.045656 0.043876 0.052730 -0.068068 -0.049262 0.045624 -0.097967 0.010214 0.038195 -0.133556 -0.074294
62
Year
Return 2007 0.00250 2008 -0.48311 2009 1.84724 2010 -0.12407 2011 -0.35407
Relative Return 1.00250 0.51689 2.84724 0.87593 0.64593 -3.54766
MARUTI SUZUKI RETURN
Table 3.30: Overall MARUTI SUZUKI Returns Estimation for year 2007-2011
63
3.1.6 OVERVIEW OF SUN PHARMACEUTICALS:
Sun Pharmaceutical (or Sun Pharmaceutical Industries Limited) (BSE 524715 and scrip ID SUNPHARMA) is an international pharmaceutical company based in Mumbai, India. It makes many generic and brand name drugs that are distributed in the United States, Europe, Asia and worldwide. Sun manufactures both pharmaceuticals and active pharmaceutical ingredients (API), in essence, ingredients to be used in finished pharmaceutical products. Its products are in several therapeutic areas, including psychiatry, neurology, cardiology, dialectology, gastroenterology, respiratory, and orthopedics.
Established in 1983, Sun Pharma was a start-up company with five products. Since 1996, Sun has grown largely through a combination of internal growth, and acquisition of other pharmaceutical companies. For example, it bought US-based Caraco Pharm Labs, and ICN Hungary. A planned acquisition of Israeli Taro Pharmaceuticals initiated in March 2007 was terminated by the Taro board in May 2008; this was subsequently followed by an unsolicited tender offer in June 2008, the outcome of which remains to be determined. As of 2008, it has grown to become an international specialty pharma company with more than 7000 employees, 17 manufacturing locations worldwide, two research centers, and a presence in 30 countries. It is one of the leading Indian-based pharma companies in India.
Sun Pharma was listed on the main stock exchanges in India in 1994; and the Rs. 55 crores issue of a Rs. 10 face value equity share at a premium of Rs. 140/- was oversubscribed 55 times. The minimum 25% that was required under the regulations then for listing was offered to the public, the owner family continues to hold a majority stake in Sun Pharma. We used this money to build a Greenfield site for API manufacture, as well as for acquisitions.
64
For the acquisitions, typically companies or assets that could be turned around and brought on track were identified. By 1997, our headquarters were shifted to Mumbai, the commercial capital of the country. We began on the first of our international acquisitions with an initial $7.5 million investment in Caraco Pharm Labs, Detroit. By 2000, we had completed 8 acquisitions, each such move adding new therapy areas or offering an entry to important international markets. A new research center was set up in Mumbai for generic product development for the US market. In India, as new therapy areas were entered into post acquisition; customer attention, product selection and focused marketing helped us gain a foothold in areas like orthopedics, gynecology, oncology, etc. From a ranking at 38th in 1994, by 2000 we were ranked 5th with a leadership in 8 of the 11 therapy areas that we are present in. The year 2000 was the year of turnaround at the US subsidiary, Caraco, as it began to receive approvals after successful inspection by the USFDA. In December 2004, a research center spread over 16 acres was inaugurated by the President of India, with special lab space for drug discovery and innovation. The post 2005 years have witnessed important acquisitions to strengthen our US business- the purchase of manufacturing assets for controlled substances in Cranbury,NJ; that of a site to make creams and lotions in Bryan, that of Alkaloida, a Hungary based API and dosage form manufacturer , and recently, Chattem Ltd., a Tennessee-based controlled substance API manufacturer.
65
CALAULATIONS OF SUNPHARMA RETURNS FOR THE YEAR 2007
DATE
OPENING PRICE 983.9 1,034.80 920
CLOSING PRICE 1,030.55 929.3 1,056.45 1,026.25 1,119.30 1,025.50 931.65 929.4 964.8 1,054.95 1,102.60 1,203.75
RETURNS 0.0474134 -0.1019521 0.1483152
MARKET RETURN 0.02936 -0.08279 0.02033
1,046.00 1,048.00 1,129.00 1,026.10 900 923 975 1,055.00 1,112.00
-0.0188815 0.0680344 -0.091674 -0.0920476
0.07013 0.05046 0.00518 0.04873
0.0326667 0.0452871 0.082 0.0451185
-0.01432 0.12419 0.17508 -0.02389
0.082509 0.06472
Dec-07 Table 3.31: SUN PHARMA Returns Estimation for year 2007
66
DATE
OPENING PRICE 1,226.90 1,133.00 1,208.00
CLOSING PRICE 1,132.80 1,227.00 1,229.35 1,447.80 1,402.70 1,400.95 1,411.00 1,472.30 1,483.35 1,118.25 1,082.15 1,064.15
RETURNS -0.0766974 0.0829656 0.0176738
MARKET RETURN -0.16283 0.01612 -0.09340
1,248.00 1,465.00 1,429.50 1,409.95 1,419.80 1,466.05 1,480.50 1,124.00 1,035.05
0.1600962 -0.0425256 -0.019972 0.0007447
0.09085 -0.07505 -0.17019 0.07258
0.036977 0.0118004 -0.2446809 -0.0372331
0.00656 -0.09984 -0.26422 -0.04516
0.0281146 0.07404
67
DATE
OPENING PRICE 1078 1083 1022
CLOSING PRICE 1074.45 1017.5 1111.45 1278.4 1213.75 1090.55 1174.75 1190.55 1407.65 1378.65 1451.8 1508.8
RETURNS -0.00329313 -0.06048014 0.08752446
MARKET RETURN -0.029865 -0.037843 0.0927258
1101.05 1290 1230.05 1099.9 1198.75 1198 1400 1375 1453.55
0.161073521 -0.05910852 -0.11341002 0.068051641
0.148849 0.278911 -0.035794 0.080178
-0.00684045 0.1750000 -0.01525000 0.05585454
0.006107 0.090461 -0.073812 0.067912
0.03801038 0.032015
68
DATE
OPENING PRICE 1538 1446.25 1547 1795 1547 1669 1780 1770 1750 2023 2169.5 450
CLOSING PRICE 1473.05 1539.7 1792 1571.2 1664.15 1785.1 1768.6 1762.4 2020.5 2110.05 447.55 484.95
RETURNS -0.042230 0.064615 0.158371 -0.124680 0.057274 0.069563 -0.006404 -0.004294 0.154571 0.043030 -0.793708 0.077667
MARKET RETURN -0.06130 0.00824 0.06352 0.00548 -0.03639 0.04448 0.01046 0.00612 0.11603 -0.00209 -0.03768 0.04488
Table 3.34: SUN PHARMA Returns Estimation for year 2010
69
DATE
OPENING PRICE 495 445.7 426.3 442.3 467.4 473.7 500 518.5 502.7 455.25 500 531
CLOSING PRICE 440.85 423.5 442.5 465.75 477.45 497.9 518.2 491.6 462.5 504.45 525.5 497.65
RETURNS -0.109394 -0.049809 0.038001 0.053014 0.021501 0.051087 0.0364 -0.051880 -0.079968 0.108072 0.051 -0.062806
MARKET RETURN -0.10871 -0.03685 0.083937 -0.014653 -0.035851 0.0155276 -0.039215 -0.095251 -0.032594 0.0927704 -0.084596 -0.069716
Table 3.35: SUN PHARMA Returns Estimation for year 2011
70
Year 2007 2008 2009 2010 2011 SUNPHARMA RETURNS (%)
Return 0.23342 -0.13042 0.32683 -0.69034 -0.02006
Relative Return 1.23342 0.86958 1.32683 0.30966 0.97994 -15.4596
Table 3.36: Overall SUN PHARMA Returns Estimation for year 2007-2011
3.2 Beta Estimation

71
The formula for the Beta of an asset within a portfolio is
, Where
ra measures the rate of return of the asset,

rp measures the rate of return of the portfolio, Cov (ra, rp) is the covariance between the rates of return.
In the CAPM formulation, the portfolio is the market portfolio that contains all risky assets, and so the rp terms in the formula are replaced by rm, the rate of return of the market.
Betas for the selected stocks have been calculated for the years 2005-2009.Based on the betas calculated the expected returns are also calculated.
Calculation of beta and the expected return with beta consideration is as follows:
72
MARUT DATE Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 MARKET ACC 0.02936 -0.06897810 -0.08279 -0.12765957 0.02033 -0.18491214 0.16555555 0.07013 0.05046 0.00518 0.04873 -0.01432 0.12419 0.17508 -0.02389 0.06472 -0.16283 0.01612 6 0.00336084 9 0.07465517 2 0.13780748 7 0.00622142 6 0.12214098 2 -0.10597510 -0.00868221 -0.07157093 -0.25787439 0.02044871 8 0.03794208 AXIS 0.133107 -0.13968 0.05022 -0.00372 0.223298 0.043966 0.001921 0.018118 0.204094 0.196179 0.006108 0.036639 0.155107 -0.10303 -0.1815 0.141595 -0.1516 -0.21929 0.071967 0.112923 0.000278 -0.22029 -0.29847 0.223515 -0.14709 -0.19653 0.20977 0.32690 0.35469 0.05214 HUL -0.04385 -0.15257 0.153457 -0.01337 -0.00049 -0.00196 -0.0925 -0.08 0.133624 0.088158 0.044038 -0.05318 0.139215 0.0657 -0.05736 -0.00601 0.032367 -0.04385 -0.15257 -0.03804 0.153457 -0.01337 -0.00196 -0.08 0.088158 -0.05318 0.0657 -0.05736 -0.00601 0.032367 0.04243 -0.02297 -0.04272 0.04358 0.148849 0.278911 -0.035794 0.134448 0.185606 -0.030696 -0.00106 -0.02203 0.170422 0.25050 0.04287 0.31210 -0.11655 0.01591 -0.19458 -0.06634 0.149938 0.0625 -0.19005 -0.0565 -0.03756 0.09078 0.20730 0.11614 0.0176738 0.1600962 -0.0425256 -0.019972 0.0007447 0.036977 0.0118004 -0.2446809 -0.0372331 0.0281146 -0.0032931 -0.0604801 0.0875244 6 0.1610735 73 2 -0.0591085 -0.11341 0.0680516 0.064483 -0.07805 -0.03447 -0.1498 0.042069 0.0452871 0.082 0.0451185 0.082509 -0.0766974 0.0829656 0.0326667 -0.0920476 -0.091674 0.0680344 I -0.01502 -0.10448 -0.03278 0.013962 SUN 0.0474134 -0.1019521 0.1483152 -0.0188815
-0.09340 2 0.09085 -0.08491647 -0.07505 -0.16280541 -0.17019 -0.20499243 0.07258 0.11018078 0.00656 -0.022 0.10801801 -0.09984 8 -0.26422 -0.20234248 -0.04516 -0.21849711 0.16824817 0.07404 -0.029865 -0.037843 0.0927258 5 0.05467 0.06309 0.083262
Table 3.37: Beta Estimation using Stock return
3.3 Market model

The Market model is got by drawing the characteristic line which is nothing but a regression line that represents the relationship between the returns on the stock and the returns on the market over a period of time. The slope of the Characteristic Line is the Beta Coefficient. The degree to which the characteristic line explains the variability in the dependent variable (returns on the stock) is measured by the coefficient of determination. (Also known as the R2 r-squared or coefficient of determination)). To estimate Beta, one needs a list of returns for the asset and returns for the index; these returns can be daily, weekly or any period. Monthly returns were used in this case. Next, a plot is made, with the index returns on the x-axis and the asset returns on the y-axis, in order to check that there are no serious violations of the linear regression model assumptions. The slope of the fitted line from the linear least-squares calculation is the estimated Beta. The y-intercept is the alpha. The market model is thus an ex-post model.
74
Figure 3.1 ACC Characteristic Lines The market model equation for ACC is Y=0.002 + 0.810X +0.0006841 Now for X = 20.48173747 Y=0.002 + 0.810*(20.48173747) + 0.0006841 Y= 16.593
75
Figure 3.2 SBI Characteristic Lines The market model equation for SBI is Y=-0.001+1.149X-0.00293456 Now for X = 20.48173747 Y= -0.001 + 1.149*(20.48173747) - 0.00293456 Y= 23.5295818
76
Figure 3.3 HUL Characteristic Lines The market model equation for HUL is Y= 0.006 + 0.361X + 0.000422847 Now for X = 20.48173747 Y= 0.006 + 0.361*(20.48173747) + 0.000422847 Y= 7.4003307
77
Figure 3.4 RIL Characteristic Lines
The market model equation for RIL is Y=-0.002+0.958X+0.001794518 Now for X = 20.48173747 Y=-0.002 + 0.958*(20.48173747) +0.001794518 Y=19.621299
78
Figure 3.5 SUN PHARMA Characteristic Lines The market model equation for SUN is Y=0.007+0.548X+0.000799345 Now for X = 20.48173747 Y= 0.007 + 0.548*(20.48173747) + 0.000799345 Y = 11.231791
79
3.4 Security Market Line

In Modern Portfolio Theory, the Security Market Line (SML) is the graphical representation of the Capital Asset Pricing Model. It displays the expected rate of return for an overall market as a function of systematic, non-diversifiable risk (its beta). The Y-Intercept (beta=0) of the SML is equal to the risk-free interest rate. The slope of the SML is equal to the Market Risk Premium and reflects investors' degree of risk aversion at a given time. The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML. The security market line is a useful tool in determining whether an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security's risk versus expected return is plotted above the SML, it is undervalued because the investor can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because the investor would be accepting less return for the amount of risk assumed. The required rate of return on a stock is determined by individual investors after considering other investment opportunities (market conditions) and the stocks risk. According to CAPM, this is expressed in the following equation, which is the formula for the Security Market Line (SML):
Ri = rf + i (Rm - rf) Where:Ri = required rate of return (RRR) on stock i rf = risk-free interest rate Bi = beta of stock i Rm = expected return on the market 80
Note: Ri represents the required rate of return on stock i, not the predicted (or expected) return. The required return will equal the predicted return only if the stock price equals its intrinsic value.
SECURITY E(r) BETA MARKET MODEL RETURN RETURN CAPM EXPECTED
MARKET 0.019523969 1
ACC 0.01849848 0.81
SBI 0.0210864 1.149
HUL 0.013471 0.361
RIL 0.01611 0.958
SUN 0.01829836 0.548
16.593
23.5295818
7.4003307
19.621299
11.231791
20.48173747 20.48
14.230308 17.730207
16.817937 22.639516
11.978776 11.227907
8.506282 19.873504
19.568746 13.935992
Table 3.38: Beta values with CAPM Returns
Figure 3.6: SML line (CAPM returns v/s Beta) 81
Figure 3.7: Identifying Over/Under Valued Securities using SML
It was observed from the above figure that SBI is undervalued security as it lies above SML line while ACC, HUL, RIL and SUN are Overvalued Securities as they fall below SML line.
82
Figure 3.8: SML line plotted with Market model return of ACC security
Return on CAPM and MARKET MODEL CAPM MARKET MODEL RM 0.82 RF 8 BETA() 0.825787 Ri = RF + (RM - RF) Ri= 2.070849 Ri = + RM + ei Ri=0.6882
Since the Market model Returns are slightly less than the expected return ACC is overvalued.
83
Figure 3.9: SML line plotted with Market model return of SBI security
Return on CAPM and MARKET MODEL CAPM MARKET MODEL RM 0.82 RF 8 BETA() 1.814431 Ri = RF + (RM - RF) Ri = - 5.02761 Ri = + RM + ei Ri= 1.4801
Since the Market model Returns are slightly less than the expected return SBI is undervalued.
84
Figure 3.10: SML line plotted with Market model return of HUL security
Return on CAPM and MARKET MODEL CAPM MARKET MODEL RM 0.82 RF 8 BETA() 1.21287 Ri = RF + (RM - RF) Ri = -0.70841 Ri = + RM + ei Ri= 0.97740
Since the Market model Returns are slightly less than the expected return HUL is overvalued.
85
Figure 3.11: SML line plotted with Market model return of RELIANCE security
Return on CAPM and MARKET MODEL CAPM MARKET MODEL RM 0.82 RF 8 BETA() 1.44389 Ri = RF + (RM - RF) Ri = -2.36715 Ri = + RM + ei Ri= 1.1912
Since the Market model Returns are slightly less than the expected return RIL is overvalued.
86
Figure 3.12: SML line plotted with Market model return of SUN PHARMA security
Return on CAPM and MARKET MODEL CAPM MARKET MODEL RM 0.82 RF 8 BETA() 1.0924 Ri = RF + (RM - RF) Ri= 0.155994 Ri = + RM + ei Ri= 0.89697
Since the Market model Returns are slightly less than the expected return SUN is overvalued.
87
3.5 REGRESSSION OUT PUT

3.5.1 ACC Regression
Output Regression Statistics Multiple R 0.603745 R Square 0.364508 Adjusted R Square 0.353551 Standard Error 0.096835 Observations ANOVA df Regression Residual Total 1 58 59 SS 0.31195 6 0.54387 2 0.85582 9 Standar d Error 0.01281 3 0.14375 5 MS 0.311956 0.009377 F 33.26787 Significanc eF 3.28E-07 60
Coefficients Intercept X Variable 1 0.00231 0.829156
t Stat 0.180291 5.767831
P-value 0.857553 3.28E-07
Lower 95% -0.02334 0.541398
Upper 95% 0.02795 7 1.11691 3
Lower 95.0% -0.02334 0.54139 8
Upper 95.0% 0.02795 7 1.11691 3
88
3.5.2 SBI Regression Output
Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations ANOVA df Regression Residual Total 1 58 59 Coefficient s Intercept X Variable 1 -0.00134 1.148662 SS 0.59869 6 0.39481 1 0.99350 6 Standar d Error 0.01091 6 0.12248 1 MS 0.59869 6 0.00680 7 F 87.9519 2 Significanc eF 3.17E-13 0.776279 0.602609 0.595757 0.082505 60
t Stat
-0.12276 9.37826 9 3.17E-13
P-value 0.90272 5
Lower 95% -0.02319 0.903489
Upper 95% 0.02051 2 1.39383 5
Lower 95.0% -0.02319 0.90348 9
Upper 95.0% 0.020512 1.393835
89
3.5.3 HUL Regression

Output Regression Statistics Multiple R 0.150006 R Square 0.022502 Adjusted R Square 0.005649 Standard Error 0.086666 Observations 60 ANOVA df Regression Residual Total 1 58 59 Coefficient s Intercept X Variable 1 0.010568 0.148663 SS 0.01002 8 0.43563 5 0.44566 4 Standar d Error 0.01146 7 0.12865 8 MS 0.01002 8 0.00751 1 F 1.33515 5 Significanc eF 0.252628
t Stat 0.92163 6 1.15548 9
P-value 0.36053 7 0.25262 8
Lower 95% -0.01239 -0.10887
Upper 95% 0.03352 2 0.4062
Lower 95.0% 0.0123 9 0.1088 7
Upper 95.0% 0.03352 2 0.4062
90
3.5.4 RELIANCE Regression

Output
Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations ANOVA df Regression Residual Total 1 58 59 Coefficient s Intercept X Variable 1 -0.00259 0.957997 SS 0.41643 7 0.59750 8 1.01394 5 Standar d Error 0.01343 0.15067 7 MS 0.41643 7 0.01030 2 F 40.4235 2 Significanc eF 3.48E-08 0.640867 0.41071 0.40055 0.101498 60
t Stat
-0.19318 6.35794 9 3.48E-08
P-value 0.84749 6
Lower 95% -0.02948 0.656384
Upper 95% 0.02428 8 1.25960 9
Lower 95.0% -0.02948 0.65638 4
Upper 95.0% 0.02428 8 1.25960 9
91
3.5.5 SUNPHARMA Regression

Output
Regression Statistics Multiple R 0.591815 R Square 0.350245 Adjusted R Square Standard Error 0.339043 0.06605
Observations 60 ANOVA Significanc df Regression Residual Total 1 58 59 Coefficient s Intercept 0.007594 SS 0.13639 3 0.25302 8 0.38942 Standar d Error 0.00873 9 t Stat 0.86897 7 P-value 0.38844 2 Lower 95% -0.0099 Upper 95% 0.02508 8 Lower 95.0% -0.0099 92 Upper 95.0% 0.02508 8 MS 0.13639 3 0.00436 3 F 31.2644 5 eF 6.36E-07
0.09805 X Variable 1 0.548258 3
5.59146 2 6.36E-07 0.351984
0.74453 1
0.35198 4
0.74453 1
CHAPTER FOUR- SUMMARY OF FINDINGS

4.1 Summary:
The Capital Asset Pricing Model, or CAPM, is a theory of the relationship between risk and return and explains how financial assets are priced under certain conditions. The standard deviation of a securitys returns is a measure of the total risk of that security. According to CAPM, however, standard deviation is not the relevant measure of a securitys risk, because part of the total risk is eliminated by diversification. Only that part of risk that remains after diversifying is important to diversified investors.
93
The required rate of return on a stock is determined by individual investors after considering other investment opportunities (market conditions) and the stocks risk. According to CAPM, this is expressed in the following equation, which is the formula for the Security Market Line (SML): Ri = rf + i(Rm- rf) Where Ri = required rate of return on stock i rf = risk-free interest rate Bi = beta of stock i Rm= expected return on the market For stocks that are in equilibrium, the return indicated by CAPM represents both the required rate of return and the expected return. If the stock market is efficient, stock prices tend to be in equilibrium, and move to the new equilibrium level very quickly when investors receive new information that causes them to revise their view of the stocks intrinsic value. In any case, while some stocks might be undervalued and others might be overvalued at a particular time, on average, market prices are probably close to intrinsic values.
SECURITY
CAPM
BETA
MARKET MODEL RETURN
MARKET ACC SBI HUL RELIANCE SUN PHARMA
20.48 17.730207 22.639516 11.227907 19.873504 13.935992
1 0.81 1.149 0.361 0.958 0.548 16.593 23.5295818 7.4003307 19.621299 11.237791
94
Table 3.39: Summary of Findings
Table 3.40: Summary of stocks
The findings were as detailed below:
AGGRESSIVE STOCKS
DEFENSIVE STOCKS ACC HUL RELIANCE SUN PHARMA
SBI
Stocks of ACC, HUL, RELIANCE &SUN PHARMA were found to be defensive stocks with lower beta value as compared to the market performance. Stocks of SBI were aggressive on their pricing with higher beta values.
CHAPTER FIVE- CONCLUSION & SUGGESTIONS

5.1CONCLUSION
95
This paper examined the validity of the CAPM for the selected stocks of National Stock Exchange. The study used monthly stock returns from five selected companies listed on the NSE from 1.1.2005to 31.12.2009 In our analysis of Capital Asset Pricing Model, we analyze the pricing of the stocks using this model. As we know that the unsystematic risk can be eliminated by the diversification, the only risk to be accounted is the systematic risk. In Order to consider the systematic risk for analysis we have taked the CAPM. Even though the can be calculated as per the formula. We have used Market Model for its plot. The reason for this is it will be cumbersome once the number of securities used for the analysis increases. Thus we can also use the Market Model or Sharpes Index Model for calculating . In Market Model, we regress the historical data of stocks with the historical data of the market. The Market model equation thus falls in the line with the linear Regression wherein we can also find the dependency of stock return to the market return. The thus got, is used for the Capital Asset Pricing Model, in fact the forms the central figure in the model. The only thing to accounted or calculated in the CAPM is the calculation of the . Thus the return depends on the factor which accounts for the systematic risk of the portfolio. The direct relationship between a securitys expected return & its is called the security Market Line (SML). The Security Market Line is thus plotted with the expected return got by CAPM. The CAPM states that the expected return on a security above that of the risk-free rates equals the securitys multiplied by the expected excess return on the market by which the expected return is the linear function of its . All said there are two points that is always present for the plot of the graph, the one is the zero & the other of the value of which is equal to zero is the risk-free rate and the market value of is the equal to one. Both the points are used to plot the SML. The CAPM states that the expected return increases with increase in the risk. The Regression model used will only define how good is the data for analysis when considered for the stock and market return .The best is the one which is near to one as the dependent data is suitably explained by the independent data by coefficient of determination. The forming the linear relationship of the CAPM equation define the stock variation with that of the market .The market model in place of the expected return is gives 96
the return based on the past price behavior .The important point here is that the market model dose not account for the risk bearing of the investor accordingly the equation does not include any notation which gives the proper bearing of risk bearing of investor. The market model only gives the measure the sock return on the historical data ,but the question is still remains as to what should be the investor return on the future date of he/she is ready to bear the risk for any price fall. The answer for this is provided by incorporating or taking into account the risk free rate. The market model is an ex post model, which means it describes past portfolio price behavior. The CAPM model is an ex ante model, which means it predicts what the portfolio value should be.
5.2 SUGGESTIONS
In empirically testing of CAPM, it cannot be fully rejected since the market index used in this test is surely not the market portfolio of what CAPM says. And the securities betas used are all estimated betas and not the true betas.
97
As pointed out in the literature survey, one of the shortcomings of any ex-post test of CAPM is the difficulty in defining the market portfolio. The assumptions of CAPM imply that the market portfolio reflects the universally preferred combination of risky assets. The market portfolio in CAPM should ideally include all assets. Naturally, for testing purposes only a reasonable proxy for the market portfolio has to be used. Thus, if the market proxy is not properly defined tests of CAPM may give misleading results. Moreover the efficient market assumptions behind CAPM is likely to be less valid in India compared to the developed country markets, where the securities trading is much more efficient in terms of greater transparency in transactions, faster and easier availability of information related to the market, shorter settlement periods, less transaction cost, greater liquidity and depth of the market, etc. Insider trading is believed to be rampant in the Indian market. The lack of transparency in the trading system facilitates insider trading. Earlier there was virtually no law against insider trading. After SEBI was formed, it has taken several steps to protect the small investors and prevent insider trading. In specific cases it can carry out investigations on alleged insider trading. Greater transparency in transactions will make insider trading more difficult to hide. The only factor considered for the model is beta. The influence of other factors are not considered for analysis, this has however lead to question the validity of the model as the significant effects of the price variation and the company policies which play a vital role as the new information in the market is not considered for the analysis. Factors like size, various ratios and price momentum provide clear cases of diversion from the model's premise. This ignores too many other asset classes to be considered a viable option.
BIBILIOGRAPHY: 1. Portfolio construction and management &Protection - ROBERT STRONGS, CFA 2. Practical Investment management
98
ROBERT A STRONG 3. Security analysis and Portfolio management - BODIE & KANE 4. Investments - WILLIAM SHARPE 5. Security analysis and Portfolio management PRASANNA CHANDRA
Websites: www.bseindia.com www.nseinia.com www.economictimes.com www.google.com
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INTRODUCTION

CHAPTER ONE: INTRODUCTION:

1.1 PROBLEM STATEMENT:

1.2 Objectives of the study:

1.3 Scope of the study:

Sample Design Methodology

SEGMENT Cement Banking Pharmaceutical Industry Automobiles FMCG

1.6 COMPANY PROFILE:

Strive to keep all stake-holders proud and satisfied.

CAPM SML Beta

CHAPTER TWO LITERATURE REVIEW

2.1 The classic theory - CAPM

2p = n t=1 Xi2 + (n t=i Xi i)2 2m

Examples of Systematic risk:

Examples of unsystematic risks:

= [(1+R1) (1+R2) (1+Rn)]^ (1/n) - 1

2.1.3 Market model

2.1.4 The Security Market Line

2.2 The support of the theory

2.2.1 The classic support of the theory

2.3 Challenges to the theory

2.4 Empirical method of CAPM testing

2.4.2 Data Selection

2.4.3 Procedure of CAPM testing

Calculation of Returns Beta estimation SML line Plot Regression Outputs

CHAPTER THREE EMPIRICAL ANALYSIS

3.1 Empirical analysis of the CAPM

3.1.1 S&P CNX Nifty Index

CALCULATIONS OF MARKET RETURN FOR THE YEAR 2007

Table 3.1: Market Returns Estimation for year 2007

CALCULATIONS OF MARKET RETURN FOR THE YEAR 2008

Table 3.2: Market Returns Estimation for year 2008

CALCULATIONS OF MARKET RETURN FOR THE YEAR 2009

Table 3.3: Market Returns Estimation for year 2009

CALCULATIONS OF MARKET RETURN FOR THE YEAR 2010

Table 3.4: Market Returns Estimation for year 2010

CALCULATIONS OF NIFTY MARKET RETURN FOR THE YEAR 2011

Table 3.5: Market Returns Estimation for year 2011

Year 2007 2008 2009 2010 2011 MARKET RETURN %

Return 0.54482 -0.5265 0.74796 0.15967 -0.29747

Relative Return 1.54482 0.4735 1.74796 1.15967 0.70253 0.81986

Table 3.6: Overall Market Returns Estimation for year 2007-2011

3.1.2 OVERVIEW OF ACC LIMITED:

CALCULATION OF ACC LIMITED RETURNS FOR THE YEAR 2007

OPENING PRICE 1,096.00 1,034.00 902.05

RETURNS -0.068978102 -0.127659574 -0.184912145

MARKET RETURN 0.02936 -0.08279 0.02033

720 848 870 935 1,060.85 1,066.80 1,205.00 1,099.95 1,103.80

0.165555556 0.003360849 0.074655172 0.137807487

0.07013 0.05046 0.00518 0.04873

0.006221426 0.122140982 -0.105975104 -0.008682213

-0.01432 0.12419 0.17508 -0.02389

Dec-07 Table 3.7: ACC Returns Estimation for year 2007

CALCULATION OF ACC LIMITED RETURNS FOR THE YEAR 2008

Table 3.8: ACC Returns Estimation for year 2008

CALCULATION OF ACC LIMITED RETURNS FOR THE YEAR 2009

Table 3.9: ACC Returns Estimation for year 2009

CALCULATION OF ACC LIMITED RETURNS 40

FOR THE YEAR 2010

Table 3.10: ACC Returns Estimation for year 2010

CALCULATION OF ACC LIMITED RETURNS 41

FOR THE YEAR 2009

Table 3.11: ACC Returns Estimation for year 2011

Year 2007 2008 2009 2010 2011 ACC RETURN (%)