Capital Asset Pricing Model of Securities

Sobha P. Joseph MBA(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 + (km-Rf) Kj- required rate of return Km- return on market portfolio Rf- risk free rate of return - 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 January2010 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 + (Rm - Rf) Where: Rf = The risk-free interest rate, is the interest rate the investor would expect to receive from a risk-free investment. = 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 companys 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 + c (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 c - is the consumption beta

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

FORMULAE APPLIED
Beta =

NXY-(X) (Y) ----------------------NX2 (X) 2

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

FORMULAE APPLIED
Estimated return Re = (P1-P0) 100 -------------------P0 Where, Re = Estimated return P1 = Closing share price P0 = Opening share price

Implication
Beta An individual shares 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 1. 2. 3. 4. 5. Infosys ONGC State bank of India SAIL Power Grid Corporation Sector Information Technology Oil and Gas Banking Steel Power

6.
7.

Bharti Airtel
DLF

Telecom
Real estate, retail, sports

ANALYSIS & INTERPRETATION

Sl.No. Company Beta Expected Estimated Standard

name
1. 2. Infosys ONGC 0.45 0.3

return
0.35 0.4

return
31.78 8.94

Deviation
31.43 8.54

3.
4. 5.

SBI
SAIL Power Grid

0.38
0.35 0.34

0.38
0.38 0.39

22.67
-26.47 -12.59

22.29
-26.85 -12.98

6.
7.

Bharti Airtel
DLF

0.16
0.32

0.45
0.4

10.28
-19.94

9.83
-20.34

ANALYSIS & INTERPRETATION

Infosys
Closing Price
4000 3500 3000 2500 2000 1500 1000 500 0 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
1600

Closing Price
1400
1200 1000 800 Closing Price 600 400 200 0

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
4000
3500 3000 2500 2000 1500 1000 Closing Price

Closing Price

500
0

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.

ANALYSIS & INTERPRETATION

SAIL
Closing Price
300 250 200 150 Closing Price 100 50

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.

ANALYSIS & INTERPRETATION

POWERGRID
Closing Price
140 120 100 80 60 40 20 0 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.

ANALYSIS & INTERPRETATION

BHARTI AIRTEL
Closing Price
400 350 300 250 200 150 100 50 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.

ANALYSIS & INTERPRETATION

DLF
Closing Price
450 400 350 300 250 200 150 100 50 0

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