Bottom-up beta analysis

Of
Bankex and
its listed institutions
Date: March 22,2015

Business Communication
Group 3
Abhishek Ghosh
Akshat Garg
Chitra Sharma
Sreejith A.S
Udhayarajan

INTRODUCTION
Banks are a major part of any economic system. They provide a strong base to
Indian economy too. Even in share markets, the performance of bank shares is
of great importance. This is justified by the proof that in both BSE and NSE we
have separate index for Banking Sector Shares. But for our study we have taken
only BSE BANKEX. Thus, the performance of share market, the rise and the
fall of market is greatly affected by the performance of Banking Sector Shares
and this paper revolves around some of those factors, their understanding and a
theoretical and technical analysis of the same. By declaring that, we have made
a thorough understanding of the factors through the Beta estimation.
Risk measurement and analysis has been a critical issue for any investment
decision because risk can be transferred but cannot be eliminated from the
system. The nature and degree of risk varies from industry to industry. The risk
can be categorized into two parts:
a> Risk-Free Rate
b> Market Risk Premium
Beta is used by all categories of investors for measurement of market risk of
individual companies, portfolios and sectors.
In finance, the beta () of an investment is a measure of the risk arising from
exposure to general market movements as opposed to idiosyncratic factors. The
market portfolio of all investable assets has a beta of exactly 1. A beta below 1
can indicate either an investment with lower volatility than the market, or a
volatile investment whose price movements are not highly correlated with the
market. An example of the first is a treasury bill: the price does not go up or
down a lot, so it has a low beta. An example of the second is gold. The price of
gold does go up and down a lot, but not in the same direction or at the same
time as the market.
A beta above one generally means that the asset both is volatile and tends to
move up and down with the market. An example is a stock in a big technology
company. Negative betas are possible for investments that tend to go down
when the market goes up, and vice versa. There are few fundamental
investments with consistent and significant negative betas, but some derivatives
like equity put options can have large negative betas.
Beta is important because it measures the risk of an investment that cannot be
diversified away. It does not measure the risk of an investment held on a standalone basis, but the amount of risk the investment adds to an already-diversified

portfolio. In the capital asset pricing model, beta risk is the only kind of risk for
which investors should receive an expected return higher than the risk-free rate
of interest.
Internal or External conditions both are involved in measuring the sensitivity of
returns of stocks. Industrial Production, money Supply ,Foreign Exchange Rate,
Interest rate, Gold prices, GDP and oil prices in the world economy are involved
in external conditions whereas dividend policy, earning per share, etc. are the
contributors of internal factors. The paper studies the impact of Macro
(External) factors on BSE BANKEX. Macroeconomic indicators are already
exhibiting signs of deterioration as Rupee is depreciating against dollar,
inflation is mounting, interest rates and gold prices are increasing and industrial
production has started to decline. The study which measures the impact of
macroeconomic forces on various sectors of stock exchange index is rare in the
literature so this study provides a new way in the extending line of literature.
BANKEX
BANKEX Index Bombay Stock Exchange Limited launched "BSE BANKEX
Index" on 23 June 2003. This index consists of major Public and Private Sector
Banks listed on BSE. The BSE BANKEX Index is displayed online on the
BOLT trading terminals nationwide.
Objective:
a. An Index to track the performance of listed equity of Banks.
b. A suitable benchmark for the Central Government to monitor its wealth
on the bourses.
Features:
BANKEX tracks the performance of the leading banking sector stocks listed
on the BSE
BANKEX is based on the free float methodology of index construction
The base date for BANKEX is 1st January 2002
The base value for BANKEX is 1000 points
BSE has calculated the historical index values of BANKEX since 1st January
2002.

 14 stocks which represent 90 percent of the total market capitalization of all

banking sector stocks listed on BSE are included in the Index
The Index is disseminated on a real time basis through BSE Online Trading
(BOLT) terminals.
Stocks forming part of the BANKEX along with the particulars of their freefloat adjusted market capitalization are listed below.
Script Selection Criteria for BSE BANKEX: Eligible Universe Scripts classified
under the banking sector which are present constituents of BSE-500 index form
the eligible universe.
Trading Frequency Scripts should have a minimum trading frequency of 90% in
preceding three months. Market capitalization Scripts with minimum market
capitalization coverage of 90% in banking sector based on free-float final rank
form the index. Buffers Buffer of 2% both for inclusion and exclusion in the
index is considered so that movements in and out of the index are minimized.
For example, a company can be included in the index only if it falls within 88%
coverage and an existing index constituent cannot be excluded unless it falls
above 92% coverage. However, the above buffer criterion is applied only after
the minimum 90% market coverage is satisfied.
Listed below are the today's Top Scrips traded in ``S&P BSE BANKEX`` with
respect to Total Turnover. (20th March, 2015).

Scrip Name

Scrip
Group

Open

High

Low

LTP

No. of
Shares
Traded

Total
Turnover
(Lac)

No. of
Trades

532215.0
0
532174.0
0

AXISBANK

562.70

565.00

553.20

556.75

881262.00

4921.23

28760.00

ICICIBANK

329.00

329.50

318.00

319.10

4032.49

28423.00

500112.00

SBIN

281.55

282.30

277.00

278.35

3921.66

27980.00

532648.0
0
500180.0
0
532461.0
0
532149.0
0
500247.0
0
532187.0

YESBANK

827.90

841.25

816.90

832.25

398049.00

3303.82

19513.00

HDFCBANK

1052.00

1059.05

1045.25

1055.55

309916.00

3262.76

10223.00

PNB

162.00

163.75

159.40

162.95

1078868.0
0

1750.67

10717.00

BANKINDIA

214.80

217.90

210.65

212.80

598411.00

1280.46

11560.00

KOTAKBANK

1334.90

1343.85

1308.50

1339.25

85431.00

1130.84

7523.00

INDUSINDBK

871.50

895.05

871.50

887.45

106642.00

945.74

8029.00

Scrip
Code

1248169.0
0
1401237.0
0

0
532134.0
0

BANKBAROD
A

177.30

177.30

172.00

172.90

504686.00

879.26

9952.00

532483.0
0

CANBK

390.00

390.00

380.30

382.05

167195.00

641.97

6851.00

500469.0
0

FEDERALBN
K

138.65

140.30

137.00

137.65

100876.00

139.25

2623.00

Macro factors
This paper studies the impact of Macro (External) factors on BSE BANKEX
and some of the factors that are considered are explained below:
Inflation
The control of inflation has become one of the dominant objectives of
government economic policy in many countries. Monetary policy can control
the growth of demand to tame inflation through an increase in interest rates and
a contraction in the real money supply. This higher interest rates reduce
aggregate demand by discouraging borrowing by both households and
companies and by increasing the rate of saving (the opportunity cost of
spending has increased) Inflation is usually measured based on certain indices.
Broadly, there are two categories of indices for measuring inflation i.e.
Wholesale Prices and Consumer Prices.
Exchange rate
Exchange Rate is the price of one country's currency expressed in another
country's currency. If there is depreciation in the exchange rate, this
depreciation will cause cost-push inflation and demand pull inflation.
Controlling inflation will lead to increase in interest rates by RBI thereby
affecting the profitability of banks.
GDP
GDP represents the total Rupee value of all goods and services produced over a
specific time period. If the GDP growth rate is speeding up too fast, RBI may
raise interest rates to stem inflation or the rising of prices for goods and
services. As GDP growth slows down, and, in particular, during recessions,
credit quality deteriorates, and defaults increase, thus resulting into reduced

bank returns. Unlike nominal GDP, real GDP can account for changes in the
price level, and provide a more accurate figure.
Gold prices
Of all the precious metals, gold is the most popular as an investment. Investors
generally buy gold as a hedge or harbour against economic, political, or social
fiat currency crises (including investment market declines, burgeoning national
debt, currency failure, inflation, war and social unrest). The gold market is
subject to speculation as are other markets.

LITERATURE REVIEW
Aswath Damodrans textbook on valuation with security analysis for investment
and corporate finance, helped the report with in-depth coverage of different
distinct valuation approaches and key models within reach, the beta estimation
with the support of regression model paved a way for better understanding and
furthermore to analyse the firm as levered or unlevered.
Manisha Luthra and Shikha Mahajans journal (2014), The Impact of Macro
Factors on BSE BANKEX, cemented the report with elaboration of MacroEconomic factors like Inflation, GDP rates, Gold Prices and Exchange Rates,
helped us to understand the effect on overall Beta in the BANKEX.
Reddy and Prasad (2011) analyses the effect of announcements made by RBI
and S&P ratings on public and private bank stocks and BANKEX respectively.
After the announcement of RBIs credit policy, the stock price of BANKEX is
affected more, when compared to public or private sector banks individually.
There is no impact of S&P ratings on public sector banks.
Ghosh et al. estimates the relationship between BSE Sensex and some important
Economic factors like Oil prices, Gold price, Cash Reserve Ratio, Food price
inflation, Call money rate, Dollar price, FDI, Foreign Portfolio Investment and
Foreign Exchange Reserve (Forex) using multiple regression model and Factor
Analysis.
Neha Sainis Measuring The Profitability And Productivity Of
Banking Industry: A Case Study Of Selected Commercial Banks
In India is used as a reference to understand the profitability
and productivity of banking industry.

RESEARCH PROBLEM
1. Responsiveness of the stock to its Sectorial Index rather than BSE/NSE?
2. Classification of those stock into aggressive or defensive stock as per
their responsiveness as per their responsiveness to Sectorial Index?
3. Calculation of Alpha (Abnormal Return) whether it prevails in any of the
stocks?
4. Whether the market (S&P BSE BANKEX) performed in accordance to
the expected return of the investors (Expected return as per the CAPM)?
5. Bottom-Up Beta i.e., convert the Raw Beta into Adjusted Beta to take
both systematic and the unsystematic risk?

VARIABLE IDENTIFICATION

Estimating Beta
The standard procedure for estimating betas is to regress stock returns (Rj)
against market returns (Rm) Rj = a + b Rm
where a is the intercept and b is the slope of the regression.
The slope of the regression corresponds to the beta of the stock, and measures
the riskiness of the stock.
This beta has three problems:
1. It has high standard error

2. It reflects the firms business mix over the period of the regression, not
the current mix
3. It reflects the firms average financial leverage over the period rather than
the current leverage.

Solutions to the Regression Beta Problem

Modify the regression beta by:
Changing the index used to estimate the beta
Adjusting the regression beta estimate, by bringing in information
about the fundamentals of the company

Estimate the beta for the firm using:

The standard deviation in stock prices instead of a regression
against an index
Accounting earnings or revenues, which are less noisy than market
prices.

Estimate the beta for the firm from the bottom up without employing the
regression technique. This will require:
Understanding the business mix of the firm
Estimating the financial leverage of the firm

Steps involved in estimating bottom-up betas

There are four steps:
Step 1:
Break your company down into the businesses that it operates in. A firm like GE
operates in 26 businesses but Walmart is a single business company. Do not
define your business too narrowly or you will run into trouble in step 2.

Step 2:
Estimate the risk (beta) of being in each business. This beta is called an asset
beta or an unlevered beta.
Step 3:
Take a weighted average of the unlevered betas of the businesses you are in,
weighted by how much value you get from each business.
Step 4:
Adjust the beta for your company's financial leverage (Debt to equity ratio)
Using beta as a measure of relative risk has its own limitations. Most analyses
consider only the magnitude of beta. Beta is a statistical variable and should be
considered with its statistical significance (R-Square value of the regression
line). Higher R-Square value implies higher correlation and a stronger
relationship between returns of the asset and benchmark index

Comparable firms
While the narrow version of comparable firm defines it to be another firm in the
same business that the firm is in, the broader definition of comparable firm
includes any firm whose fortunes are tied to the firm's success and failure (or
vice versa).
i.
Define comparable more broadly (all software as opposed to
entertainment software).
ii.

Look for global listings of companies in the same business; all

entertainment companies listed globally would be an example.

iii.

Look up and down the supply chain for other companies that feed
into your company and that your company feeds into. Thus, you may
start looking for software retailers that get the bulk of their revenues
from entertainment software.

How big a sample of firms required?

Any sample size greater than one is an improvement on a regression beta.
However, the more firms that we have in the sample, the greater the potential
savings in error. With a sample of 4, the standard error will be cut by half; with
a sample of 9, by two-thirds; with a sample of 16, by 75%.

Its better to get to double digits for the sample size, if you can. If you cannot,
settle for 6-8 firms and you are still saving a substantial amount in terms of
estimation error.
There is clearly a trade-off between how tightly defining "comparable firm" and
the sample size. If the comparable narrowly (firms like just like in terms of size
and what they do), one will get a smaller sample. If one can get to double digits
with a narrow definition, stay with it.
.

After having comparable firms, how do we estimate the

unlevered (asset) betas?
Simply average their regression betas and cleaning up those betas for financial
leverage and cash holdings. In practical terms, here are some issues that one
will face:

Do the regression betas for the comparable firms all have to be over the
same time period and against the same index?
In a perfect world, YES! However, as the sample size increases, one can afford
to get sloppy with these details, hoping that the law of large numbers bails you
out. Thus, if we have 100 global firms in the sample, with betas estimated
against local indices, one can get away using an average of these 100 betas
since some are likely to be over-estimated and some under-estimated.
Once we have the regression betas for the firms, should we use simple or
weighted averages?
Use simple averages. Otherwise, one will be attaching the beta of the largest
firm or firms in the group to all of the firms in the sample.
Why do we need to correct for financial leverage?
The company can have a very different policy on how much debt to use than the
typical firm in the sample. Regression betas are levered betas but they reflect
the financial leverage of the companies in the sample (and not the company).
Its necessary to take out the financial leverage effect (un-lever the beta) to
come up with a pure play or business beta.
Unlevered beta = Levered Beta / (1 + (1-tax rate) D/E)

 Should we un-lever each firm's beta and then average or average and then
un-lever?
We prefer to average first and then un-lever. Individual firm regression betas are
noisy (have large standard error) and un-levering them only compounds the
noise. Averaging first should reduce the noise, leading to better beta estimates.

What tax rate and debt to equity ratio should be used for the
sector?
To be safe, its better to go with a marginal tax rate and use either the median
D/E ratio or the aggregate D/E ratio for the sector. (There are always strange
outliers with D/E ratios that make simple averages go haywire.)

Is it possible to adjust the unlevered betas for operating

leverage?
It is possible, but only if we want to know what costs are fixed and what are
variable not only for the firm but for all of the firms in the sample. If we do
have that information, one can break the unlevered beta down into a business
component (reflecting the elasticity of demand for your company) and an
operating leverage component:
Business Risk beta = Unlevered beta/ (1 +Fixed Costs/ Variable Costs)
The problem from a practical standpoint is getting the fixed and variable cost
breakdown.

How do we weight these unlevered betas to arrive at the beta

for the company?
The weights should be market value weights of the individual businesses that
the firm operates in. However, these businesses do not trade (GE Capital does
not have its own listing) and one have to estimate the market values. One can
use weight based on revenues or earnings from each business but we are
assuming that a dollar in revenues (earnings) has the same value in every
business. An alternative is to apply a multiple of revenues (earnings) to the

revenues (earnings) from each business to arrive at an estimated value. This

multiple can be estimated for the comparable firms (from which we have
estimated the betas). Since we are interested in the value of the business (and
not the value of equity), we should look at EV multiples (and not equity
multiples). If we use revenues, we have to use an EV/ Sales multiple.

How do we adjust for financial leverage?

The standard adjustment for financial leverage is to assume that debt has no
market risk (a beta of zero) and to use what is called the "Hamada" adjustment:
Levered Beta = Unlevered beta (1 + (1- tax rate) (Debt/Equity))
We can use the current debt to equity ratio for the firm we are analysing or even
a target debt to equity (if a feeling of change is on the horizon) in making this
computation.
If we feel uncomfortable about the assumption that debt has no market risk,
estimate a beta for debt and compute the levered beta as follows
Levered Beta = Unlevered Beta (1 + (1-t)*(D/E)) Beta of debt (1-t)*(D/E)
The tricky part is estimating the beta of debt.

Can bottom-up betas change over time for a company?

Yes, and for two reasons. One is that the mix of businesses can change over
time, leading to a different unlevered beta. The other is that the debt to equity
ratio for the firm can change over time, leading to changes in the levered beta.

Why is a bottom-up beta better than a regression beta?

Bottom up betas are better than a regression beta for three reasons
They are more precise. The standard error in a bottom-up beta estimate is
more precise because you are averaging across regression betas. The
savings will approximate 1/ Square root of number of firms in the sample.
Thus, even if there is only one firm is the business and has not changed
its debt to equity ratio over time, we will be better off using bottom up
betas.

 If a firm has changed its business mix, one can reflect that more easily in
a bottom-up beta because you set the weights on the different businesses.
A regression beta reflects past business mix choices.
If a firm has changed its debt to equity ratio, the bottom up beta can be
easily adjusted to reflect those changes. A regression beta reflects past
debt to equity choices.

Research Methodology
Objectives
To investigate the impact of Bottom-up Beta Analysis on Banking Index.

Methodology
Sample selection
The sample selection for this study will include all the banking companies listed
on the BSE Bankex.

Hypothesis
There is positive relationship between the bankex and individual stocks;
assuming certain risk associated with each security with respect to the market;
and Return from all securities are equal, i.e. r1 = r2 = r3=..= r15; i.e. here as
null hypothesis, as against the alternative hypothesis that all returns
are not equal.
H01: > 0 (Positive risk of overall Beta)
H02: r1 = r2 = r3=..= r15 (Return from all security are equal)

Source and collection of the data

Data required was collected in the form of secondary data on fundamental
variables from March 20012- March 2014 taken from BSE Index website for
the analysis purposes.

The following fundamental variables were collected and computed (with

Natural Logarithm and Regression Model):

Market prices of the stock (Close Price)

Beta of Stock
Daily Return on Stock
Daily Return on Sensex
Risk free rate
Average Daily Market Return
Annualised Market returns

Period of the study

The present study is an attempt to test the impact of various macro factors on
the BSE BANKEX during the period from 2012 to 2014.

Tools used for analysis

In this research, linear regression model has been used to determine the
explanatory power of each valuation model. A linear regression line has an
equation of the form Y = a + bX, where X is the explanatory variable and Y is
the dependent variable. The slope of the line is b, and a is the intercept (the
value of y when x = 0).
Tests include the estimation of linear regressions with dependent variable the
bank stock price and several components of financial statements as the
independent variables. For comparing the explanatory power of research models
in valuing the stock of companies listed on Indian stock exchange, we use
adjusted R-square of the models.
In another expression, we can show that which valuation models, results are
closer to real stock prices. To do so, different regression models must be tested.
In this section, first the significance of impacts of independent variables on the
dependent variable and determining R in each model will be regarded and in
the second place the relative importance of each independent variable will be
discussed.
The integrity of regression assumptions can be determined by considering
residuals distribution and its relationships with other variables. Residuals
include the difference between the observed values of a dependent variable and
the predicted values by regression line. The assumptions of these models should

be regarded. In regression analysis considering linearity, normality, stability of

variance and independence of observations is of vital importance. In this
research, these assumptions were considered, but not mentioned here for
brevity.
Since in this research we intend to review 6 valuation models
a. Levered Beta
b. Unlevered Beta
c. Cost of Equity
d. Total Unlevered Beta
e. Levered Total Beta
f. Total Cost Unlevered Beta
g. Debt-Equity Ratio

Individual Firms: Alpha Value, Beta Estimation,

P-Value & R-Square
Name

Type of
Bank

Axis Bank

Private
Sector
Public
Sector
Public
Sector
Public
Sector
Private
Sector
Private
Sector
Private
Sector
Private
Sector
Private
Sector
Public
Sector
Public
Sector
Private
Sector

Bank of Baroda
Bank of India
Canara Bank
Federal Bank
HDFC Bank
ICICI Bank
IndusInd Bank
Kotak
Mahindra Bank
Punjab National
Bank
State Bank of
India
Yes Bank

Intercept
X(Alpha) Variable
(Beta)
0.00
1.21

PValue

RSquare

0.00

0.70

-0.06

1.10

0.00

0.53

-0.14

1.22

0.00

0.47

-0.16

1.19

0.00

0.50

-0.34

0.91

0.00

0.04

0.04

0.79

0.00

0.67

0.02

1.12

0.00

0.81

0.04

1.10

0.00

0.61

0.81

0.81

0.00

0.54

-0.09

1.12

0.00

0.56

-0.06

0.94

0.00

0.63

-0.04

1.45

0.00

0.63

Note: Federal Bank has a R-Square of 0.03820428, which is quite not

acceptable. This is because of Stock-Split.

Debt Equity Ratio of the Firms

Banks
Axis Bank
Bank of Baroda
Bank of India
Canara Bank
Federal Bank
HDFC Bank
ICICI Bank
IndusInd Bank
Kotak Mahindra
PNB
SBI
Yes Bank

Equity

Debt

Rat
io

38,220.
49
35,985.
58
29,923.
08
29,620.
11
6,860.7
1
43,478.
63
73,213.
32
9,030.1
9
19,084.
54
38,516.
33
1,18,28
2.25
7,115.2
2

2,80,944
.57
5,68,894
.39
4,76,974
.05
4,20,722
.82
59,729.0
4
3,67,337
.48
3,31,913
.66
60,502.2
9
56,929.7
5
4,61,203
.53
13,94,40
8.51
74,185.6
3

7.3
5
15.
81
15.
94
14.
20
8.7
1
8.4
5
4.5
3
6.7
0
2.9
8
11.
97
11.
79
10.
43

Average Beta, Average Debt-Equity Ratio &

Average R-Square
BET
A

Axis

1.20

7.49

0.696258759

DEBT
EQUIT
Y
RATIO

R
SQ
UA
RE

Bank
Bank
of
Baroda
Bank
of
India
Canara
Bank
Federa
l Bank
HDFC
Bank
ICICI
Bank
IndusI
nd
Bank
Kotak
Mahind
ra
Bank
Punjab
Nation
al
Bank
State
Bank
of
India
Yes
Bank
AVERA
GE

8958
812
1.09
8264
434
1.22
0476
653
1.19
0616
604
0.90
8005
105
0.79
3590
929
1.12
2456
1.09
6498

15.32

0.534453942

15.95

0.468494047

14.25

0.504452098

8.82

0.038204284

8.32

0.670829371

4.64

0.805553

6.9

0.611049

0.80
8344

5.11

0.541481

1.11
5365

0.561559

0.94
4480

0.631300

0.629042

7.2333
33333

0.557723038

1.45
3794
1.08
007
077
9
SQUARE ROOT
R SQUARE

OF AVG 0.746808569

Axis Bank
Bank of
Baroda
Bank of India
Canara Bank
Federal Bank
HDFC Bank
ICICI Bank
IndusInd
Bank
Kotak
Mahindra
Bank
Punjab
National
Bank
State Bank of
India
Yes Bank
AVERAGE
SQUARE ROOT

BETA
1.21

DEBT
EQUITY
RATIO
7.35

R
SQUAR
E
0.70

1.10
1.22
1.19
0.91

15.81
15.94
14.20
8.71

0.53
0.47
0.50
0.04

0.79
1.12

8.45
4.53

0.67
0.81

1.10

6.70

0.61

0.81

2.98

0.54

1.12

11.97

0.56

0.94
11.79
1.45
10.43
1.08
9.91
OF AVG R SQUARE

0.63
0.63
0.56
0.75

Estimated Discounted Rates

Estimated Valuation Models
UNLEVERED BETA

Rates
0.14

TOTAL UNLEVERED BETA0.18

LEVERED BETA

1.08

TOTAL LEVERED BETA

1.45

LEVERED COST OF CAPITAL

0.11

TOTAL LEVERED COST OF

CAPITAL

0.11

Note: Rates which are used for determination of the calculation of the above
estimated valuation models
MARGINAL TAX RATE

0.30

MARKET RETURN (Rm)

RISK FREE RETURN (Rf)
RISK PREMIUM (Rm - Rf)

0.10
0.08
0.02

The empirical tests that are applied to equity valuation for Banks in the
examined banking sector are based on the following models: a) Levered Beta,
b) Unlevered Beta, c) Cost of Equity, c) Total Unlevered Beta, d) Levered Total
Beta, f) Total Cost Unlevered Beta, and g) Debt-Equity Ratio which captures
the spirit of the value relevance of linear regression analysis. The valuation
models are introduced and tested empirically, using the estimation method on a
sample of 14 Indian bank stocks included in BSE BANKEX. These tests include
the estimation of linear regressions with the various banks market price as the
dependent variable and various components taken from the financial statements
as independent variables. Overall, the results of the empirical analysis indicate
that the linear accounting-based valuation model (EBO Model) that incorporates
both stock and flow components, provides greater explanatory power and thus
better captures the different aspects of equity values of bank stocks in the Indian
banking sector .

SUGGESTION
A fairer way to compute alpha would be to add back a reasonable expense ratio
(something in the 1.0% range) to the funds return. This seems only fair since a
funds expected returns should actually be less than its benchmark, given the
same risk level as the index. A funds expected returns should be less than its
benchmark because an index has no expense ratio, does not factor in trading
costs when securities are bought or sold, and does not provide shareholder
services. This fairer way would be used when comparing a fund or ETF
against its peer group. A potential shortcoming of alpha is it may not reflect
management skill in selecting securities. Instead, a low alpha might simply
mean the fund has high expensessomething largely beyond the control of the
people selecting fund securities. A second flaw with alpha is that a positive or
negative number could be the result of good or bad luck. By reviewing a funds
alpha over several periods, the impact of luck becomes less and less.
Remember, alpha is considered a valid measurement only if the portfolio has a
high or very high R-squared number (75100).

If a lot of debt is used to finance increased operations, the company could

potentially generate more earnings than it would have without this outside
financing. If this were to increase earnings by a greater amount than the debt
cost (interest), then the shareholders benefit as more earnings are being spread
among the same amount of shareholders. However, the cost of this debt
financing may outweigh the return that the company generates on the debt
through investment and business activities and become too much for the
company to handle. This can lead to bankruptcy, which would leave
shareholders with nothing.
For a suggestion to have a more control debt-equity ratio then Optimal debtto-equity ratio is considered to be about 1, i.e. liabilities =
equity, but the ratio is very industry specific because it
depends on the proportion of current and non-current assets.
The more non-current the assets (as in the capital intensive
industries), the more equity is required to finance these long
term investments.

CONCLUSION
On an overall, the null hypothesis is accepted. After computation, out of 14
banks listed in BANKEX, 8 of them has a significance value of more than one,
which represent the stock is aggressive and quite volatile. For example, YES
BANK has an estimation of Beta around 1.45, indicates that the stock is 45
percent more volatile than the market beta of Sensex 1. The stated stock will
deliver 14.5 percent return if the market has delivered 10 percent return in same
time period. Its opposite is also true if Sensex delivers 10 percent negative
return then the stated stock will fall by 14.5 percent in the same time period. A
beta of less than 1 implies lesser volatility. But on an average after formulation
and computation the overall return is 1.08 percent, therefore slightly volatile of
8 percent as the remaining banks are of less risky i.e., under 1.
The desirable value of beta depends upon the individual risk bearing capacity.
So, one can expect a high return from a stock that has a beta of 2, but will have
to expect it to drop much more when the market falls.

R-squared is a statistical measure of how close the data are to the fitted
regression line. It is also known as the coefficient of determination, or the
coefficient of multiple determination for multiple regression.
The definition of R-squared is fairly straight-forward; it is the percentage of the
response variable variation that is explained by a linear model. Or:
R-squared = Explained variation / Total variation
R-squared is always between 0 and 100%:
0% indicates that the model explains none of the variability of the
response data around its mean.
100% indicates that the model explains all the variability of the response data
around its mean.
In general, the higher the R-squared, the better the model fits the data.
Furthermore, if R-squared value is low but have statistically significant
predictors, one can still draw important conclusions about how changes in the
predictor values are associated with changes in the response value. Regardless
of the R-squared, the significant coefficients still represent the mean change in
the response for one unit of change in the predictor while holding other
predictors in the model constant. Obviously, this type of information can be
extremely valuable. Such in the cases of the banks which have above 0.50 rsquare value, which is meeting 50 percent of the explained variation with total
variation.
Higher R-Square depends on the decision-making situation, and it depends on
the objectives or needs, and it depends on how the dependent variable is
defined. In some situations it might be reasonable to hope and expect to explain
99% of the variance, or equivalently 90% of the standard deviation of the
dependent variable. In other cases, one might consider it to be doing very well
if there is a proper explanation of 10% of the variance, or equivalently 5% of
the standard deviation, or perhaps even less.
The overall debt-equity ratio is high, for BOI it is around 15.94 and overall
nearly 10 %. Therefore it generally means that this sector is very aggressive in
financing its growth with debt. This can result in volatile earnings as a result of
the additional interest expense. Only Kotak Mahindra Bank has the lowest debt
in terms of equity and similarly ICICI stands seconds in terms of lower D/E
ratio.

With reference to Neha Sainis article, MEASURING THE

PROFITABILITY AND PRODUCTIVITY OF BANKING INDUSTRY: A
CASE STUDY OF SELECTED COMMERCIAL BANKS IN INDIA,
about the profitability, there is a significant difference between
the selected banks of public and private sector. And when
productivity is concerned, there is no significant difference
between the selected banks of public and private sector.
Although both sectors show increasing trend in productivity
ratios but in comparison private sector banks are having high
productivity and high profitability. Public sector bank shows low
productivity, the reason may be high staffing. Staff needs to be
managed according tothe business and forecasting of human
resource planning can be done accordingly.
Alpha is one of five technical risk ratios; the others are beta, standard deviation,
R-squared, and the Sharpe ratio. These are all statistical measurements used in
modern portfolio theory (MPT). All of these indicators are intended to help
investors determine the risk-reward profile of a mutual fund. Simply stated,
alpha is often considered to represent the value that a portfolio manager adds to
or subtracts from a fund's return.
A positive alpha of 1.0 means the fund has outperformed its benchmark index
by 1%. Correspondingly, a similar negative alpha would indicate an
underperformance of 1%. Most of the Firms under BANKEX is
underperforming.
If a CAPM analysis estimates that a portfolio should earn 10% based on the risk
of the portfolio but the portfolio actually earns 15%, the portfolio's alpha would
be 5%. This 5% is the excess return over what was predicted in the CAPM
model.
The cost of equity is very difficult to estimate, partly because it as an implicit
cost and partly because it varies across equity investors. For publicly traded
firms, we estimate it from the perspective of the marginal investor in the equity,
who we assume is well diversified. This assumption allows us to consider only
the risk that cannot be diversified away as equity risk, and to measure it with a
beta (in the CAPM) or betas (in the arbitrage pricing and multi-factor models).
We also presented three different ways in which we can estimate the cost of
equity: by entering the parameters of a risk and return model, by looking and
computing at return differences across stocks over long periods, and by backing
out an implied cost of equity from stock prices.

The Cost of Debt is the rate at which a firm can borrow money today and will
depend on the default risk embedded in the firm. This default risk can be
measured using a bond rating (if one exists) or by looking at financial ratios. In
addition, the tax advantage that accrues from tax-deductible interest expenses
will reduce the after tax cost of borrowing.

REFERENCES
Damodaran on Valuation :Estimating Discount Rates
Manisha Luthra and Shikha Mahajans journal (2014), The Impact of Macro
Factors on BSE BANKEX,
Reddy and Prasad (2011) analyses the effect of announcements made by RBI
and S&P ratings on public and private bank stocks and BANKEX respectively.
Ghosh et al. paper Determinants of BSE Sensex: A Factor Analysis Approach
Neha Sainis paper MEASURING THE PROFITABILITY AND
PRODUCTIVITY OF BANKING INDUSTRY: A CASE STUDY OF
SELECTED COMMERCIAL BANKS IN INDIA