Im Term Paper

8/10/2019 Im Term Paper

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ABSTRACTIndian securities market is a highly volatile and sensitive market where portfolio construction

is highly important to get good returns. Thus the main focus of this research is to construct an

optimal equity portfolio with the help of Sharpe index model. Fifteen companies have been

selected and excess to beta ratio has been calculated and ranked the companies based on thatratio. The cut-off point was calculated based on the highest value and cut-off point should be

used to calculate the proportion of money to be invested in each stocks.

INTRODUCTION

Indian securities market came into existence as a most predominant market due to the

globalisation and liberalisation which happened in the year of 1990s. Though it happened to

be a predominant market, only less than 2% of total population invests in stocks. Primarily it

has been divided into two parts, Primary market and secondary market. IPO happens in

primary market and trading of issued shares will happen in secondary market. Security

analysis and portfolio management will help to construct the optimum portfolio for the

equities market and helps to make the right decision for investment.

Generally, Security Analysis is broadly classified into three categories:

Fundamental Analysis

Fundamental Analysis refers to the evaluation of securities with the help of certain

fundamental business factors such as financial statements, current interest rates as well as

competitors products and financial market. Financial statements are nothing but proofs or

written records of various financial transactions of an investor or company. Financialstatements are used by financial experts to study and analyze the profits, liabilities, assets of

an organization or an individual.

Technical Analysis

Technical analysis refers to the analysis of securities and helps the finance professionals to

forecast the price trends through past price trends and market data.

Quantitative Analysis

Quantitative analysis refers to the analysis of securities using quantitative data. There aremany theories present in Security Analysis and Portfolio Management. Harry Markowitz was

the first who had given Modern portfolio theory and he is called as Father of Modern

Portfolio Theory. He provided analytical tools for analysis and selection of optimal portfolio.

This portfolio approach won him Nobel Prize in 1990. There was numerous complex

calculation should be done for the construction of portfolio in Markowitz model. So,

Markowitz work was extended by William Sharpe Model to reduce the complexity.

William Sharpe model will be the best model for Long-term investment and it has been

given as single index model because Individual market return in relation with the market

return is taken into consideration for the construction of optimum portfolio.


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STATEMENT OF PROBLEM

The portfolio should not be constructed based on the brand identity, current performance etc

because that would not help investors in achieving the anticipated return. The main aim of

portfolio construction is diversification and to maintain perfect negative correlation between

the securities. The optimum portfolio gives the investors a better clarity to invest the rightproportion of money in the right stock and it helps the investors to get maximum returns with

minimal risk.

OBJECTIVE OF THE STUDY

To study the relative market performance of 15 companies listed in National Stock

Exchange, India.

To construct an optimal portfolio and analyze its risk and return, for the investments

made by investors.

To calculate the proportion of money to be invested by investors out of their

investment.

SCOPE OF THE STUDY

Scope of the study is to construct the optimum portfolio to reduce its risk and maximise the

profits. Based on the historical performance, risk and return of those companies should be

analysed and top companies should be selected for construction of portfolio.

LIMITATIONS

Portfolio is constructed based only on risk and return.

Stock prices considered only for 5 years so that the real impact cannot be found.

This research is not be suitable for short-term investment.

REVIEW OF LITERATURE

Kwok Wai Yu, Xiao Qi Yang, Heung Wong (2007), explained the applications of the Sharpe

rule in portfolio measurement and management. It proposes that a portion of the portfolio

value should be invested in some other assets for portfolio improvement. With the help of

Sharpe rule they determined that the new stocks are worthy of adding to the old portfolio if

they satisfy a condition, in which the average return rate of these stocks is greater than the

return rate of the old portfolio.


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METHODOLOGY

Descriptive study has been done for the construction of portfolio of stocks where results

obtained on the selected companies. Secondary data is taken for the study and data has been

collected from various sources like National stock exchange website, Reserve Bank of India

website and other databases.Sample Size: 15

The steps in constructing the portfolio using the Sharpe Method are as follows.

Find the excess return to ratio

Arrange the calculated excess return to ration in the descending order.

Find the cut-off points

TOOLS USED

Beta Coefficient

Beta coefficient is the relative measure of non-diversifiable risk. It is an index of the degree

of movement of an assets return in response to a change in the markets return.

=Correlation*(Y)/(X)

Where, (Y) = Standard Deviation of Individual Stock,

(X) = Standard Deviation of Market

Return

The total gain or loss experienced on an investment over a given period of time, calculated by

dividing the assets cash distributions during the period, plus change in value, by its

beginning-of-period investment value is termed as return.

Return = ((Todays market price Yesterdays market price)/Yesterdays marketprice)*100

Efficient Portfolio

A portfolio that maximizes return for a given level of risk or minimizes risk for a given level

of return is termed as an efficient portfolio.

Risk-Free Rate of Return (Rf)

Risk-free rate of return is the required return on a risk free asset, typically a three month

treasury bill.


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Excess Return to Beta Ratio

Excess Return to Beta Ratio = Ri-Rf/i

Where, Ri= the expected return on stock,

Rf = the return on a riskless asset,

i= the expected change in the rate of return on stock associated with one unit changein the market return.

Cut-off Point

Ci = ( (Ri-Rf) /ei)/ (1+

)

Investment to be made in each Security

Xi=Zi/

Where, Xi= the proportion of investment of each stock.

And

Zi=i/ei (Ri-Rf/i-Ci)

Where, Ci = the cut-off point.


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ANALYSIS AND DISCUSSIONS

Table 1: Return, Standard Deviation, Beta and Residual Variance of Individual Stock

Portfolio Scrips IndividualReturn

Unsystematic Risk

ITC 45.15630781 2.48941059 0.561263549 6.197165084

HDFC -8.034497417 3.792903111 1.148901333 14.38611401

INFOSYS 2.956756271 1.923710021 0.692962931 3.700660244

ICICI 72.82353214 3.39112593 1.549568331 11.49973507

ONGC -39.13308354 3.322595538 0.825152399 11.03964111

SBI 62.29244616 2.734717596 1.143667091 7.478680331

TATA MOTORS 60.63047122 4.300381038 1.30728804 18.49327707M&M 69.60074429 3.386513204 1.074686915 11.46847168

NTPC 0.866573602 1.964663737 0.722779541 3.859903601

BHEL -85.35497731 3.593234935 1.032742164 12.9113373

CIPLA 51.13273521 1.938771035 0.498426256 3.758833127

WIPRO 49.03034737 2.803540103 0.886436543 7.85983711

DLF -36.97339488 3.937281052 1.572556532 15.50218208

RANBAXY 49.53198033 2.989680009 0.745920128 8.938186558

SAIL -10.1237203 3.231801617 1.296612145 10.44454169

Table 2: Excess return to beta ratio

Portfolio Scrips (Ri-Rf)/ Rank New Ranking

ITC 65.77357 2 CIPLA

HDFC -14.1653 12 ITC

INFOSYS -7.62414 9 M&M

ICICI 41.6784 7 RANBAXY

ONGC -57.4113 14 SBI

SBI 47.2624 5 WIPRO

TATA MOTORS 40.07569 8 ICICI

M&M 57.09639 3 TATA MOTORS

NTPC -10.2015 10 INFOSYS

BHEL -90.6276 15 NTPC

CIPLA 86.05633 1 SAIL

WIPRO 46.01609 6 HDFC

DLF -28.7515 13 DLF

RANBAXY 55.35711 4 ONGC

SAIL -14.1628 11 BHEL


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CIPLA yielded the maximum return among the companies selected and Bharat Heavy

Electricals Limited yielded lower return following that ONGC and DLF yielded lower return.

Pharma and FMCG have shown a higher return in all the companies chosen for the analysis.

It shows that Pharma is the growing sector and it is most preferred investable securities in

India. Beta is greater than 1 in Mahindra and Mahindra, State Bank of India, ICICI, TataMotors, SAIL, HDFC, DLF and BHEL, which shows that these securities have more risk and

at the same time the reward per unit of risks is also more.

Sharpe has provided a model for the selection of appropriate securities in a portfolio.

The excess return of any stock is directly related to its excess return to beta ratio.

The ratio provides a relationship between potential risk and reward. Ranking of the stocks are

done on the basis of their excess return to beta. Based on the excess return to beta ratio the

scrips are ranked from 1 to 15, with Cipla being in the first rank and BHEL being in the last.

The excess return to beta ratio was calculated using 8.24% as risk free rate of return.

Table 3: Cut-off point calculation for 15 companies

Scrip's (Ri-Rf)/ (Ri-Rf)/ Cumulative

(Ri-Rf)/

(Ri-

Rf)/New USR

CIPLA 86.0533 5.687379398 5.687379398 19.32693481

ITC 65.7735 3.341892869 9.029272267 30.68340342

M&M 57.096 5.749556017 14.77882828 50.22162771

RANBAXY 55.357 3.445805809 18.22463409 61.93121477

SBI 47.262 8.265778228 26.49041232 90.02010172

WIPRO 46.016 4.600165897 31.09057822 105.6524519

ICICI 41.678 8.699877204 39.79045542 135.2165003

TATA MOTORS 40.075 3.703284478 43.4937399 147.8010551

INFOSYS -7.624 -0.989405019 42.50433488 144.4388446

NTPC -10.201 -1.380681883 41.123653 139.7469915

SAIL -14.162 -2.279726714 38.84392628 131.9999913

HDFC -14.165 -1.318923544 37.52500274 127.5180062

DLF -28.7515 -4.586181493 32.93882125 111.9331781ONGC -57.411 -3.541066306 29.39775494 99.8998754

BHEL -90.627 -7.48621515 21.91153979 74.46011096


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Scrip's / Cumulative

/

1+ /

Cut Off Point

(Ci)

CIPLA 0.066085602 0.066085602 1.224573046 15.7825904

ITC 0.050785206 0.116870808 1.397152067 21.96139142M&M 0.100691043 0.217561851 1.739321824 28.87425835

RANBAXY 0.062246653 0.279808504 1.9508493 31.74577082

SBI 0.174891585 0.454700089 2.545168408 35.36901583

WIPRO 0.099964625 0.554664714 2.884869641 36.6229553

ICICI 0.20866171 0.763326424 3.593946876 37.62339982

TATA MOTORS 0.092387723 0.855714147 3.907900171 37.82109281

INFOSYS 0.12975957 0.985473717 4.348851017 33.21310481

NTPC 0.13533938 1.120813097 4.808763253 29.06090073

SAIL 0.160970084 1.281783181 5.355774118 24.64629545

HDFC 0.093039463 1.374822645 5.671942166 22.48224726DLF 0.159522223 1.534344868 6.214032888 18.0129684

ONGC 0.061678823 1.59602369 6.423630754 15.55193305

BHEL 0.082601603 1.678625293 6.704328713 11.10627389

Table 4: Selection of stocks among 15 companies

Scrips Cut Off

CIPLA 15.78259ITC 21.96139

M&M 28.87426

RANBAXY 31.74577

SBI 35.36902

WIPRO 36.62296

ICICI 37.6234

TATA MOTORS 37.82109

Table 5: Proportion of funds invested

Scrips z x

CIPLA 6.395374073 41.96%

ITC 2.530425592 16.60%

M&M 1.806077157 11.85%

RANBAXY 1.463401973 9.60%

SBI 1.443729097 9.47%

WIPRO 0.924188657 6.06%

ICICI 0.519553808 3.41%

TATA MOTORS 0.159321617 1.05%


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FINDINGS & RECOMMENDATIONS

The Pharma and FMCG sectors are the major contributors for the portfolio. Among

the selected 15 stocks, pharmaceutical sector is performing well. The beta values for

those stocks are lesser than 1 which indicates, minimal risk is involved in those

stocks.

The CIPLA forms the major contribution with 42% followed by ITC with 17%.

The recommended proportion investments to the companies according to constructed

portfolio are Cipla 42%, ITC 17%, M&M 12%, Ranbaxy 10%, SBI 9%, Wipro 6%,

ICICI 3%, and Tata Motors 1%.

Investors expecting high return for the minimal risk can go for Cipla (


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CONCLUSION

Though there are 15 stocks that meet the criteria for being included in the Portfolio, the

portfolio is constructed with the top 8 stocks that meet the criteria to be included in the

portfolio according to the Sharpe Index Model. Those stocks are: CIPLA, ITC, Mahindra &Mahindra, Ranbaxy, State Bank of India, Wipro, ICICI and Tata Motors. The portfolio

predominantly consists of stocks from the pharmaceutical sector.

Thus the portfolio construction table would help an investor in investment decisions. And the

investor would select any company among the fifteen companies from the above portfolio

table.

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