capital asset pricing model of securities.1

Capital Asset Pricing Model of Securities

Sobha P. JosephMBA(IB)

Reg. No.85490021

Acumen Capital Market (I) Ltd

• Stock broking firm• Peninsular Capital Market Ltd.• Subsidiary of Acumen group.• Products and services include equity,

commodity, depository services and wealth management

Departments and functions

• Trading• Research• Surveillance• Depository• Accounts• Customer care• Technical• Business development• Business acquisition

CAPM

• Establishes a linear relationship between the required rate of return on a security and its systematic or non diversifiable risk as measured by beta.

• Kj=Rf + ß (km-Rf)• Kj- required rate of return• Km- return on market portfolio• Rf- risk free rate of return• ß- measure of systematic risk

IMPORTANCE OF THE STUDY

• CAPM model is used for evaluating the pricing of securities. This project aims to study the risk, return and pricing of securities from different sectors for the period of January 2010 to December 2010.

OBJECTIVES OF THE STUDY

• To compare and study the difference between

expected return and actual return of 7 companies during the period 2010 January-2010 December.

• To identify whether various securities are overpriced, correctly priced or under priced.

• To study the perception of investors about CAPM model.

RESEARCH METHODOLOGY

Data Collection• Based on primary and secondary data. • Primary data - survey • secondary data from journals, books and

websites.

RESEARCH METHODOLOGY

Sampling• To conduct the CAPM analysis, the sample size under the study

consisted of 7 shares of BSE. Six scrips were taken from six different sectors and seventh one is taken having a diversified strategy. Six sectors selected for study are Information technology, Banking, Oil, Power, Steel and Telecom sector. Securities from different sectors were taken based on market capitalization. Systematic random sampling was done.

• To study the perception of investors, a survey was conducted using questionnaire. Population consist of the investors who invested in the above 7 scrips through ACUMEN. Sample selected were the clients of the company Acumen. Stratified random sampling done. Data collected from company records.

Tools used for analysis

• CAPM (Relationship between risk and return).• Expected Rate of Return = r = Rf + ß (Rm - Rf) Where: Rf = The risk-free interest rate, is the interest rate the

investor would expect to receive from a risk-free investment. ß = A stock beta, is used to mathematically describe the

relationship between the movements of an individual stock versus the market itself. Investors can use a stock's beta to measure the risk of a security versus the market.

Rm = The expected market return, is the return the investor would expect to receive from a broad stock market.

LIMITATIONS OF THE STUDY

• The study was based on the return factor, which was computed on the basis of difference between the opening and the closing price of the stock. Other factors like details about the company’s performance, profitability, industry etc, have not been taken into consideration. But those factors also play an important role for selecting the company.

• The investors population selected for the awareness study was those who invested through ACUMEN. Other investors are taken into consideration.

• Time limit was also one of the limitations of the study.

ANALYSIS AND INTERPRETATION

FORMULAE APPLIED

• Expected return r= Rf + βc (Rm - Rf) Where, r - is the expected return on risky asset Rf - is the risk free rate Rm - is the return on the market (Rm – Rf) - is the market risk premium βc - is the consumption beta

• Rf = 6/12% = 0.5%Where,Rf = Risk free rate for the month of January• Rm = (Q1-Q0) 100 ------------------------ Q0Where,Rm = Market return Q1= Closing nifty price Q0 = Opening nifty price

FORMULAE APPLIED

• Beta β = NΣXY-(ΣX) (ΣY) ----------------------- NΣX2 – (ΣX) 2

Where,N = Number of days taken X = Share Price Return percentageY = Nifty Return percentage

FORMULAE APPLIED

• Estimated return Re = (P1-P0) 100 -------------------- P0Where,Re = Estimated return P1 = Closing share price P0 = Opening share price

FORMULAE APPLIED

Implication

Beta • An individual share’s beta shows how it compares to the market as a

whole:• = 1 means equal risk with the market• > 1 means more risky than the market• < 1 means less risky than the market Return • Expected return = Estimated return means stock is correctly priced• Expected return> Estimated return means stock is overvalued• Expected return< Estimated return means stock is undervalued

SELECTED SECURITIES AND SECTORS

Sl. No. Security name Sector

1. Infosys Information Technology

2. ONGC Oil and Gas

3. State bank of India Banking

4. SAIL Steel

5. Power Grid Corporation Power

6. Bharti Airtel Telecom

7. DLF Real estate, retail, sports

ANALYSIS & INTERPRETATION

Sl.No. Company

name

Beta Expected

return

Estimated

return

Standard

Deviation

1. Infosys 0.45 0.35 31.78 31.43

2. ONGC 0.3 0.4 8.94 8.54

3. SBI 0.38 0.38 22.67 22.29

4. SAIL 0.35 0.38 -26.47 -26.85

5. Power Grid 0.34 0.39 -12.59 -12.98

6. Bharti Airtel 0.16 0.45 10.28 9.83

7. DLF 0.32 0.4 -19.94 -20.34

ANALYSIS & INTERPRETATION

Infosys

4-Jan-10

20-Jan-10

5-Feb-10

21-Feb-10

9-Mar-

10

25-Mar-

10

10-Apr-1

0

26-Apr-1

0

12-May

-10

28-May

-10

13-Jun-10

29-Jun-10

15-Jul-1

0

31-Jul-1

0

16-Aug-1

0

1-Sep-10

17-Sep-10

3-Oct-

10

19-Oct-

10

4-Nov-1

0

20-Nov-1

0

6-Dec-

10

22-Dec-

100

500

1000

1500

2000

2500

3000

3500

4000

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

Infosys• Beta of the company is 0.45. A stock with beta less than

1 would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is 31.43 (estimated return – expected return). Therefore, total risk of the company is 31.88 (beta + standard deviation).Here, expected return is less than estimated return. This implies that the company is undervalued.

ANALYSIS & INTERPRETATION

ONGC

4-Jan-10

20-Jan-10

5-Feb-10

21-Feb-10

9-Mar-

10

25-Mar-

10

10-Apr-1

0

26-Apr-1

0

12-May

-10

28-May

-10

13-Jun-10

29-Jun-10

15-Jul-1

0

31-Jul-1

0

16-Aug-1

0

1-Sep-10

17-Sep-10

3-Oct-

10

19-Oct-

10

4-Nov-1

0

20-Nov-1

0

6-Dec-

10

22-Dec-

100

200

400

600

800

1000

1200

1400

1600

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

ONGC• Beta of the company is 0.3. A stock with beta less than 1

would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is 8.54 (estimated return – expected return). Therefore, total risk of the company is 8.84 (beta + standard deviation).Here, expected return is less than estimated return. This implies that the company is undervalued.

ANALYSIS & INTERPRETATION

SBI

4-Jan-10

22-Jan-10

9-Feb-10

27-Feb-10

17-Mar-

10

4-Apr-1

0

22-Apr-1

0

10-May

-10

28-May

-10

15-Jun-10

3-Jul-1

0

21-Jul-1

0

8-Aug-1

0

26-Aug-1

0

13-Sep-10

1-Oct-

10

19-Oct-

10

6-Nov-1

0

24-Nov-1

0

12-Dec-

10

30-Dec-

100

500

1000

1500

2000

2500

3000

3500

4000

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

SBI• Beta of the company is 0.38. A stock with beta less than

1 would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is 22.29 (estimated return – expected return). Therefore, total risk of the company is 22.67 (beta + standard deviation).Here, expected return is less than estimated return. This implies that the company is undervalued.

• SAIL

ANALYSIS & INTERPRETATION

4-Jan-10

19-Jan-10

3-Feb-10

18-Feb-10

5-Mar-

10

20-Mar-

10

4-Apr-1

0

19-Apr-1

0

4-May

-10

19-May

-10

3-Jun-10

18-Jun-10

3-Jul-1

0

18-Jul-1

0

2-Aug-1

0

17-Aug-1

0

1-Sep-10

16-Sep-10

1-Oct-

10

16-Oct-

10

31-Oct-

10

15-Nov-1

0

30-Nov-1

0

15-Dec-

10

30-Dec-

100

50

100

150

200

250

300

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

SAIL• Beta of the company is 0.35. A stock with beta less than

1 would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is -26.85 (estimated return – expected return). Therefore, total risk of the company is 26.5 (beta + standard deviation).Here, expected return is more than estimated return. This implies that the company is overvalued.

• POWERGRID

ANALYSIS & INTERPRETATION

4-Jan-10

23-Jan-10

11-Feb-10

2-Mar-

10

21-Mar-

10

9-Apr-1

0

28-Apr-1

0

17-May

-10

5-Jun-10

24-Jun-10

13-Jul-1

0

1-Aug-1

0

20-Aug-1

0

8-Sep-10

27-Sep-10

16-Oct-

10

4-Nov-1

0

23-Nov-1

0

12-Dec-

10

31-Dec-

100

20

40

60

80

100

120

140

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

POWER GRID • Beta of the company is 0.34. A stock with beta less than 1

would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is -12.98 (estimated return – expected return). Therefore, total risk of the company is 12.64 (beta + standard deviation).

• Here, expected return is more than estimated return. This implies that the company is overvalued.

• BHARTI AIRTEL

ANALYSIS & INTERPRETATION

4-Jan-10

21-Jan-10

7-Feb-10

24-Feb-10

13-Mar-

10

30-Mar-

10

16-Apr-1

0

3-May

-10

20-May

-10

6-Jun-10

23-Jun-10

10-Jul-1

0

27-Jul-1

0

13-Aug-1

0

30-Aug-1

0

16-Sep-10

3-Oct-

10

20-Oct-

10

6-Nov-1

0

23-Nov-1

0

10-Dec-

10

27-Dec-

100

50

100

150

200

250

300

350

400

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

BHARTI AIRTEL• Beta of the company is 0.16. A stock with beta less than 1

would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is 9.83 (estimated return – expected return). Therefore, total risk of the company is 9.99(beta + standard deviation).

• Here, expected return is less than estimated return. This implies that the company is undervalued.

• DLF

ANALYSIS & INTERPRETATION

4-Jan-10

22-Jan-10

9-Feb-10

27-Feb-10

17-Mar-

10

4-Apr-1

0

22-Apr-1

0

10-May

-10

28-May

-10

15-Jun-10

3-Jul-1

0

21-Jul-1

0

8-Aug-1

0

26-Aug-1

0

13-Sep-10

1-Oct-

10

19-Oct-

10

6-Nov-1

0

24-Nov-1

0

12-Dec-

10

30-Dec-

100

50

100

150

200

250

300

350

400

450

Closing Price

Closing Price

ANALYSIS & INTERPRETATION

DLF• Beta of the company is 0.32. A stock with beta less than 1

would have below average risk. Variability in its return would be comparatively lesser than the market variability. Therefore the investment in the company will have below average risk.

• Standard deviation of the company is -20.34 (estimated return – expected return). Therefore, total risk of the company is 20.02(beta + standard deviation).

• Here, expected return is less than estimated return. This implies that the company is undervalued.

FINDINGS

• Among the 7 scrips, Infosys, ONGC, SBI, Bharti Airtel, are underpriced. SAIL, POWER GRID and DLF are over priced.

• All 7 scrips are having below average risk.• Comparing the beta value of DLF with others, it seems that

the DLF share is not highly fluctuating with the market. It is overvalued because of the speculation in market. Analyzing the variance, DLF is having a medium variance compared to others. That means it is having a medium risk among the group under study. So investing in company with diversified strategy is good avenue for investment.

• Investors are not aware of CAPM analysis.

CONCLUSION

• This project gave me immense opportunity and exposure to trading practiced in the stock market.

• To study and apply the analysis technique used by most of the investment analyst.

• And to study the perception of investors about CAPM