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    SAPM - Portfolio Construction and Comparison for Securities on BSE SAPM - Portfolio Construction and Comparison for Securities on BSE Document Transcript

    • Security Analysis & Portfolio Management PGDM-Exec 2012 Security Analysis and Portfolio Management Portfolio Construction and Comparison for Securities on BSE Bishnu Kumar 11EX-013 Davinder Singh 11EX-015 Prateek Wadhwa 11EX-040 Rajat Goel 11EX-043 Institute of Management Technology Ghaziabad 1
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Table of Contents Introduction ............................................................................................................................................ 3 Factors Impacting the Performance of a Company ................................................................................ 4 Economic Analysis ............................................................................................................................... 4 Industry Analysis ................................................................................................................................. 6 Company Analysis ............................................................................................................................... 7 Literature Review .................................................................................................................................... 9 Statement of Problem........................................................................................................................... 10 Objectives of the Study ......................................................................................................................... 10 Research Methodology ......................................................................................................................... 10 Data Analysis and Interpretation .......................................................................................................... 10 Calculation of Beta ............................................................................................................................ 11 Portfolio Construction using Sharpe’s Single Index Model ................................................................... 12 Determination of Optimal Portfolio.................................................................................................. 15 Comparison of the Portfolios ............................................................................................................ 19 Observations ..................................................................................................................................... 19 Portfolio Construction Worksheet ........................................................................................................ 20 References ............................................................................................................................................ 21 2
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Introduction The foundation of Modern Portfolio Theory was laid by Markowitz in 1951. He began with the simple premise that since almost all investors invest in multiple securities rather than one, there must be some benefit in investing in a portfolio of securities. He measured riskiness of a portfolio through variability of returns and showed that investment in several securities reduced this risk. His work won him the Nobel Prize for Economics in 1990. Markowitz‘s work was extended by Sharpe in 1964, Lintner in 1965 and Mossin in 1966. Sharpe shared the Nobel Prize for Economics in 1990 with Markowitz and Miller for his contribution to the Capital Asset Pricing Model (CAPM). This model breaks up the riskiness of each security into two components - the market related risk which cannot be diversified called systematic risk measured by the beta coefficient and another component which can be eliminated through diversification called unsystematic risk. The Markowitz model is extremely demanding in its data needs for generating the desired efficient portfolio. It requires N (N+3)/2 estimates (N expected returns + N variances of returns + N*(N-1)/2 unique covariance‘s of returns). Because of this limitation the single index model with less input data requirements has emerged. The Single index model requires 3N+2 estimates (estimates of alpha for each stock, estimates of beta for each stock, estimates of variance σei2 for each stock, estimate for expected return on market index and an estimate of the variance of returns on the market index σm2) to use the Markowitz optimization framework. The single index model assumes that co- movement between stocks is due to movement in the index. The basic equation underlying the single index model is: Ri = ai + βi*Rm where Ri = Return on the ith stock ai = component of security i‘s that is independent of market performance βi = coefficient that measures expected change in Ri given a change in Rm Rm = rate of return on market index The term ai in the above equation is usually broken down into two elements ai which is the expected value of ai and ei which is the random element of ai. The single index model equation, therefore, becomes: Ri = αi + βi*Rm + ei Single index model has been criticized because of its assumption that stock prices move together only because of common co-movement with the market. Many researchers have found that there are influences beyond the market, like industry-related factors, that cause securities to move together. 3
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Factors Impacting the Performance of a Company The performance of a company depends on its management, competitive advantages, its competitors, markets etc. Intrinsic value is defined to be the present value of all future net cash flows to the company. The intrinsic value of an equity share depends on a multitude of factors. The earnings of the company, the growth rate and risk exposure of the company have a direct bearing on the price of the share. These factors in turn rely on the host of other factors like economic environment in which they function, the industry which they belong to, and finally company’s own performance. Hence, we can say that the intrinsic value of shares can be appraised through:  Economic Analysis  Industry Analysis  Company Analysis Economic Analysis The level of economic activity has an impact on investment in many ways. If the economy grows rapidly, the industry can also be expected to show rapid growth and vice-versa. When the level of economic activity is low, stock prices are low, and when the level of economic activity is high, stock prices are high reflecting the prosperous outlook for sales and profits of the firms. The analysis of macroeconomic environment is essential to understand the behavior of the stock prices. The commonly analyzed macro-economic factors are as follows:  Gross Domestic Product: GDP indicates the rate of growth of the economy. GDP represents the aggregate value of the goods and services produced in the economy. GDP consists of personal consumption expenditure, gross private domestic investment and government expenditure on goods and services and net export of goods and services. The growth rate of economy points out the prospects for the industrial sector and return investors can expect from investment in shares. The higher growth rate is more favorable to the stock market.  Savings and investment: It is obvious that growth requires investment which in turn requires substantial amount of domestic savings. Stock market is a channel through which the savings of the investors are made available to corporate bodies. Savings are distributed over various assets like equity shares, deposits, mutual fund units, real estate and bullion. The saving and investment patterns of the public affect the stock to a great extent.  Inflation: Along with the growth of GDP, if inflation also increases, then the real rate of growth would be very little. The demand in the consumer product industry is significantly affected. If there is a mid level of inflation, it is 4
    • Security Analysis & Portfolio Management PGDM-Exec 2012 good to the stock market but high rate of inflation is harmful to the stock market.  Interest rates: The interest rate affects the cost of financing to the firms. A decrease in interest rate implies lower cost of finance for firms and more profitability. More money is available at a lower interest rate for the brokers who are doing business with borrowed money. Availability of cheap fund encourages speculation and rise in price of shares.  Budget: The budget draft provides an elaborate account of the government revenues and expenditures. A deficit budget may lead to high rate of inflation and adversely affect the cost of production. Surplus budget may result in deflation. Hence, balanced budget is highly favorable to the stock market.  The tax structure: Concessions and incentives given to a certain industry encourage investment in that particular industry. Tax relief given to savings encourages savings. The type of tax exemption has an impact on the profitability of the industries.  The Balance of payment: BOP is the measure of the strength of rupee on external account. If the deficit increases, the rupee may depreciate against other currencies, thereby, affecting the cost of imports. The volatility of the foreign exchange rate affects the investment of the foreign institutional investors in the Indian Stock Market. A favorable balance of payment renders a positive effect on the stock market.  Monsoon and Agriculture: Agriculture is directly and indirectly linked with the industries. A good monsoon leads to higher demand for input and results in bumper crop. This would lead to buoyancy in the stock market. When the monsoon is bad, Agriculture and hydroelectric production would suffer. They cast a shadow on the share market.  Infrastructure facilities: Infrastructure facilities are essential for the growth of industrial and agricultural sector. A wide network of communication system is a must for the growth of the economy. Regular supply of power without any power cut would boost the production. Banking and financial sectors should also be sound enough to provide adequate support to industry and agriculture.  Demographic factors: The demographic data provides details about the population by age, occupation, literacy and geographic location. This is needed to forecast the demand for the consumer goods. The population by age indicates the availability of able work force. Population, by providing labor and demand for products, affects the industry and stock market. 5
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Industry Analysis Industry analysis is a type of investment research that begins by focusing on the status of an industry or an industrial sector. Each industry has differences in terms of its customer base, market share among firms, industry-wide growth, competition, regulation and business cycles. Learning about how the industry works will give an investor a deeper understanding of a companys financial health. The Industry life cycle analysis and Porter‘s 5 forces model for competitive advantage are common valuation techniques.  Industry Life Cycle Model: This model is a useful tool for analyzing the effects of an industrys evolution on competitive forces. Using the industry life cycle model, we can identify five industry environments, each linked to a distinct stage of an industrys evolution. a. Pioneering development: - During this start up stage, the industry experiences modest sales growth and very small or negative profit margins and profits. The market for the industry‘s product or service during this time period is small, and the firms involved incur major development costs. b. Rapid accelerating growth: - During this rapid growth stage, a market develops for the product or service and demand becomes substantial. The profit margins are very high. The industry builds its productive capacity as sales grow at an increasing rate as the industry attempts to meet excess demands. c. Mature stage: - The success in stage 2 has satisfied most of the demands of the industry goods and services. Thus, further sales growth may be above normal but it no longer accelerates. The rapid growth of sales and the high profit margins attract competitors to the industry, which causes an increase in supply and lower price, which the profit margin begin to decline to normal levels. d. Stabilization and market maturity: - During this stage which is probably the longest stage, the industry growth rate declines to the growth rate of aggregate economy or its industry segment. Competition produces tight profit margins, and the rate of return on capital eventually becomes below the competitive level. e. Deceleration of growth and decline: - At this stage of maturity, the industries sales growth declines because of shifts in demand or growth in substitutes. Profit margins continue to be squeezed, and some firms experiences low profits or even losses.  Porter’s Five Forces Model: This model identifies five competitive forces that shape every single industry and market. These forces help us to analyze everything from the intensity of competition to the profitability and attractiveness of an industry. a. Threat of New Entrants: - The easier it is for new companies to enter the industry, the more cutthroat competition there will be. Factors that can limit the threat of new entrants such as high fixed cost, existing loyalty to major brands, government regulations etc act as barriers to entry. 6
    • Security Analysis & Portfolio Management PGDM-Exec 2012 b. Power of Suppliers: - This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a companys margins and volumes, then they hold substantial power. When there are very few suppliers of a particular product or there are no substitutes or switching to another (competitive) product is very costly, the supplier is powerful and vice versa. c. Power of Buyers: - This is how much pressure customers can place on a business. Some companies serve only a handful of customers, while others serve millions. In general, its a red flag (a negative) if a business relies on a small number of customers for a large portion of its sales because the loss of each customer could dramatically affect revenues. If one customer has a large enough impact to affect a companys margins and volumes, then they hold substantial power. d. Availability of Substitutes: - What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low, then this poses to be a serious threat. The main issue is the similarity of substitutes. If substitutes are similar, then it can be viewed in the same light as a new entrant, which is a threat to the company. e. Competitive Rivalry: - This describes the intensity of competition between existing firms in an industry. A highly competitive market might result from:  Many players of about the same size, no dominant firm.  Little differentiation between competitor‘s products and services.  A mature industry with very little growth. Companies can only grow by stealing customers away from competitors. Company Analysis In the company analysis the investor assimilates the several bit of information related to the company and evaluates the present and future value of stock. The risk and return associated with the purchase of the stock is analyzed to take better investment decision. The present and future are affected by a number of factors. They are:-  Competitive advantage of the company: Competitive advantage (CA) is a position that a firm occupies in its competitive landscape. A companys long-term success is driven largely by its ability to maintain a competitive advantage - and keep it. Competitive advantages vary from situation to situation and from time to time. Some basic examples of CAs can be divided in 4 main global areas: o Cost - Low cost operations o Quality - High quality and consistent quality o Time - delivery speed, on time delivery and development speed o Flexibility - customization, volume flexibility and variety 7
    • Security Analysis & Portfolio Management PGDM-Exec 2012  Earnings of the company: Sales alone do not increase the earnings but the costs and expenses of the company also influence the earnings of the company. Further, earnings do not always increase with the increase in sales. The company‘s sales might have increased but its earnings may decline due to the rise in costs.  Capital structure: The equity holder’s return can be increased manifold with the help of financial leverage, i.e. using debt financing along with equity financing. The effect of financial leverage is measured by computing leverage ratios. The debt may be in the form of debentures and term loans from financial institutions.  Management: Good and capable management generates profit to the investors. The management of the firm should efficiently plan, organize, actuate and control the activities of the company. The basic objective of management is to attain the stated objectives of the company for the good of the equity share holders, the public and the employers. Good management depends on the quality of the manager. Some believe that management is the most important aspect for investing in a company. It makes sense - even the best business model is doomed if the leaders of the company fail to properly execute the plan.  Operating efficiency: The operating efficiency of a company directly affects the earnings of a company. An expanding company that maintains high operating efficiency with a low break-even point earns more than the company with high break-even points. If a firm has stable operating ratio, the revenue will also be stable. Efficient use of fixed assets with a raw materials, labor and management would lead to more income from sales. This leads to internal fund generation for the expansion of the firm. A growing company should have low operating ratio to meet the growing demand for its product.  Business Model: Even before an investor looks at a companys financial statements or does any research, one of the most important questions that should be asked is: What exactly does the company do? This is referred to as a companys business model – its how a company makes money. You can get a good overview of a companys business model by checking out its website. Unless you understand a companys business model, you dont know what the drivers are for future growth, and you leave yourself vulnerable to being blindsided.  Corporate Governance: Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors and stakeholders. These policies are defined and determined in the company charter and its bylaws, along with corporate laws and regulations. The purpose of corporate governance policies is to 8
    • Security Analysis & Portfolio Management PGDM-Exec 2012 ensure that proper checks and balances are in place, making it more difficult for anyone to conduct unethical and illegal activities Good corporate governance is a situation in which a company complies with all of its governance policies and applicable government regulations in order to look out for the interests of the companys investors and other stakeholders.  Financial analysis: The best source of financial information about a company is its own financial statements. This is a primary source of information for evaluating the investments prospects in the particular company‘s stock. Financial statement analysis is the study of a company‘s financial statement from various viewpoints. The statement gives the historical and current information about the company‘s operations. Historical financial statements help to predict the future. The current information aids to analyze the present status of the company. The two main statements used in analysis are:- o Balance sheet o Profit and loss account Literature Review Elton, Edwin J (1977), is among the prominent researchers, who have worked on Sharpes Single Index Model. They presented a new method for selecting optimal portfolios when upper bound constraints on investments in individual stocks were present and when the variance-covariance matrix of returns possessed a special structure such as that implied by standard single index model. Extending their previous work, more commonly called as EPG approach to portfolio optimization, it was shown that upper bounds could be dealt within a more complex fashion that shares many of the features of ranking procedures of standard single index model. Bawa, Vijay S (1979), showed that the construction of optimal portfolio could be simplified by using simple ranking procedures when returns followed a stable distribution and the dependence structure had any of several standard forms. The ranking procedures simplified the computations necessary to determine an optimum portfolio. Faaland, Bruce H. and Jacob, Nancy l (1981), examined alternative solution procedure to achieve the objective of choosing n securities from a universe of m securities in order to maximize the portfolios excess-return-to Beta ratio. Mulvey, John M (2003), observed that a multi-period portfolio model provides significant advantages over traditional single-period approaches-especially for long-term investors. Such a framework can enhance risk adjusted performance and help investors evaluate the probability of reaching financial goals by linking asset and liability policies. 9
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Statement of Problem Investors generally hold a portfolio of securities to take advantage of diversification, while individual return and risks are important, what matters finally is the return and risk of the portfolio. In constructing a portfolio fundamental analysis can be used to select securities or Sharpe single index model can be used to construct an optimal portfolio. In many cases it is seen that securities trade above their intrinsic value especially in the recent times because of boom in stock market, as a result investors pay more to purchase them and the returns are not up to the mark. Objectives of the Study  To undertake study of Banking Index as Compared to Information Technology Index in Sensex (BSE)  To construct a portfolio of banking index stocks and IT index stocks on BSE  To construct a portfolio of banking stocks using Sharpe single index model  To find the return difference in optimal portfolio constructed using stocks from these indexes Research Methodology Type of Study The research conducted is basically a statistical analysis of historical stock price on Sensex. It involves univariate regression of historical data against the historical market data. In this project a study is conducted to determine the level of significance in portfolio mean returns constructed through fundamental analysis and Sharpe single index model. Type of Data Data required for this study was secondary data collected from BSE portal for last 3 years. Sample Size The sample consists of companies of the banking and IT industry selected from the respective industry index on Sensex. Data Analysis and Interpretation The process starts by selecting stocks to construct an optimum portfolio using past share price data through the Sharpe‘s optimization model for both the industries on Sensex. The return and risk aspects are then compared between the two portfolios. Then the level of significance between the return of portfolios is determined. 10
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Companies used for Analysis – Banking Companies Information Technology Companies Axis Bank Infosys Technologies Bank of India HCL Technologies Canara Bank Hexaware Technologies Federal Bank mPhasis HDFC Bank Oracle Financial Services ICICI Bank Tata Consultancy Services IDBI Bank Tech Mahindra IndusInd Bank Wipro Technologies Kotak Bank Fintech Punjab National Bank State Bank of India Union Bank Yes Bank Calculation of Beta Beta is a measure of a stocks volatility in relation to the market. The beta coefficient is a key parameter in the capital asset pricing model (CAPM). It measures the part of the assets 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. The formula for the Beta of an asset within a portfolio is, For the analysis, we have regressed the historical prices of given securities against the Sensex value for last 3 years. Banking Securities Security Return (1 Day) Variance Beta HDFC Bank 0.0053 234.1810 1.2595 IndusInd Bank 0.0022 6.6013 1.1826 Yes Bank 0.0016 6.4847 1.3314 Federal Bank 0.0010 4.2658 0.9435 Canara Bank 0.0009 5.4607 1.0837 Axis Bank 0.0006 5.1921 1.3298 SBI 0.0005 4.3828 1.2307 PNB 0.0004 3.5339 0.9162 ICICI Bank 0.0005 5.0845 1.5054 Kotak Bank 0.0003 7.2809 1.1216 Bank of India 0.0003 5.7607 1.0850 Union Bank 0.0002 5.2375 0.9745 IDBI Bank 0.0001 5.4580 1.3846 11
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Information Technology Securities Security Return (1 Day) Variance Beta Hexaware Technologies 0.0022 15.3188 0.9982 TCS 0.0018 3.7571 0.9982 HCL Technologies 0.0015 5.0972 1.0524 Oracle Financial Services 0.0011 3.7010 0.6392 Infosys 0.0006 2.7709 0.8302 Wipro 0.0004 5.1139 0.7742 mPhasis 0.0002 6.6170 0.7564 Tech Mahindra 0.0002 5.9242 0.7550 FinTech -0.0004 7.2675 0.8669 Portfolio Construction using Sharpe’s Single Index Model Every investor faces the dilemma, of which scrip‘s to select for his portfolio to get adequate return. Besides, the investor has to decide how much to invest in each script. Simple Sharpe Portfolio Optimization model enables the investor to find a portfolio that best meets the goals, objectives and risk tolerance of the investor. The method also stresses on portfolio optimization, which is an important component of the portfolio selection process. It helps to select a set of script‘s, which provides the highest rate of return for the lowest risk that the investor is willing to take. Steps for finding the stocks to be included in the optimal portfolio are: 1. Find out the ―excess return to beta‖ ratio for each stock under consideration. 2. Rank them from the highest to the lowest. 3. Proceed to calculate Ci for all stocks according to the ranked order using the following formula- The cumulative values of Ci start declining after a particular Ci and that point is taken as the cut-off point and that stock ratio is the cut-off ratio C. 12
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Sharpe’s Excess Return to Beta Ratio It is a single number that measures the desirability of any stock to be included in the optimal portfolio. The excess return to beta ratio measures the additional return on a security (excess of the risk free asset return) per unit of systematic risk or non-diversifiable risk. Excess return to beta = (Ri – RF) / Bi Where: Ri = expected return on stock i Rf = return on risk free asset Bi = expected change in the rate of return on stock i associated with a 1% change in the market return. Stocks are ranked by excess return to beta (from the highest to the lowest). The higher the excess return to beta ratio, the more is the desirability of the stock to be included in the portfolio. Ranking of Securities According to Excess Return to Beta Banking Securities SN Rank Security Return Variance Beta ERTB 1 5 HDFC Bank 0.0053 234.1810 1.2595 0.393% 2 8 IndusInd Bank 0.0022 6.6013 1.1826 0.159% 3 13 Yes Bank 0.0016 6.4847 1.3314 0.097% 4 4 Federal Bank 0.0010 4.2658 0.9435 0.073% 5 3 Canara Bank 0.0009 5.4607 1.0837 0.054% 6 1 Axis Bank 0.0006 5.1921 1.3298 0.024% 7 11 SBI 0.0005 4.3828 1.2307 0.018% 8 10 PNB 0.0004 3.5339 0.9162 0.011% 9 6 ICICI Bank 0.0005 5.0845 1.5054 0.010% 10 9 Kotak Bank 0.0003 7.2809 1.1216 0.002% 11 2 Bank of India 0.0003 5.7607 1.0850 -0.005% 12 12 Union Bank 0.0002 5.2375 0.9745 -0.016% 13 7 IDBI Bank 0.0001 5.4580 1.3846 -0.017% Information Technology Securities SN Rank Security Return Variance Beta ERTB 5 1 Hexaware Technologies 0.0022 15.3188 0.9982 0.190% 8 2 TCS 0.0018 3.7571 0.9982 0.149% 11 3 HCL Technologies 0.0015 5.0972 1.0524 0.113% 1 4 Oracle Financial Services 0.0011 3.7010 0.6392 0.124% 6 5 Infosys 0.0006 2.7709 0.8302 0.033% 2 6 Wipro 0.0004 5.1139 0.7742 0.007% 4 7 mPhasis 0.0002 6.6170 0.7564 -0.012% 12 8 Tech Mahindra 0.0002 5.9242 0.7550 -0.015% 9 9 FinTech -0.0004 7.2675 0.8669 -0.087% 13
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Combined Portfolio Rank SN Security Return Variance Beta ERTB 1 19 TCS 0.0018 3.7571 0.8867 0.168% 2 8 IndusInd Bank 0.0022 6.6013 1.1826 0.159% 3 13 Yes Bank 0.0016 6.4847 1.3314 0.097% 4 15 HCL Technologies 0.0015 5.0972 1.0524 0.113% 5 4 Federal Bank 0.0010 4.2658 0.9435 0.073% 6 18 Oracle Financial 0.0011 3.7010 0.6392 0.124% 7 16 Hexaware 0.0022 15.3188 0.9982 0.190% 8 3 Canara Bank 0.0009 5.4607 1.0837 0.054% 9 14 Infosys 0.0006 2.7709 0.8302 0.033% 10 1 Axis Bank 0.0006 5.1921 1.3298 0.024% 11 11 SBI 0.0005 4.3828 1.2307 0.018% 12 6 ICICI Bank 0.0005 5.0845 1.5054 0.010% 13 10 PNB 0.0004 3.5339 0.9162 0.011% 14 5 HDFC Bank 0.0053 234.1810 1.2595 0.393% 15 21 Wipro 0.0004 5.1139 0.7742 0.007% 16 9 Kotak Bank 0.0003 7.2809 1.1216 0.002% 17 2 Bank of India 0.0003 5.7607 1.0850 -0.005% 18 17 mPhasis 0.0002 6.6170 0.7564 -0.012% 19 20 Tech Mahindra 0.0002 5.9242 0.7550 -0.015% 20 12 Union Bank 0.0002 5.2375 0.9745 -0.016% 21 7 IDBI Bank 0.0001 5.4580 1.3846 -0.017% 22 22 FinTech -0.0004 7.2675 0.8669 -0.087% 14
    • Determination of Optimal PortfolioRisk Free Rate Rf (1 Day) 0.0321%Market Variance 1.5088Banking Portfolio ERTB (Rs-Irf)*Beta Cumm. Beta^2 Cumm. Cut-off Xi Rank SN Security Return Variance Beta Zi (Rs-Irf)/Beta /Variance Summ. /Variance Summ. (B) Weight 1 5 HDFC Bank 0.0053 234.1810 1.2595 0.393% 0.0000266 0.00027 0.0068 0.0068 0.004% 0.002% 5.72% 2 8 IndusInd Bank 0.0022 6.6013 1.1826 0.159% 0.0003360 0.00363 0.2119 0.2186 0.041% 0.018% 57.48% 3 13 Yes Bank 0.0016 6.4847 1.3314 0.097% 0.0002643 0.00627 0.2734 0.4920 0.054% 0.008% 25.66% 4 4 Federal Bank 0.0010 4.2658 0.9435 0.073% 0.0001526 0.00779 0.2087 0.7007 0.057% 0.004% 11.15% 5 3 Canara Bank 0.0009 5.4607 1.0837 0.054% 0.0001170 0.00897 0.2151 0.9157 0.057% 6 1 Axis Bank 0.0006 5.1921 1.3298 0.024% 0.0000817 0.00082 0.3406 0.3406 0.008% 7 11 SBI 0.0005 4.3828 1.2307 0.018% 0.0000624 0.00144 0.3456 0.6862 0.011% 8 10 PNB 0.0004 3.5339 0.9162 0.011% 0.0000269 0.00171 0.2376 0.9237 0.011% 9 6 ICICI Bank 0.0005 5.0845 1.5054 0.010% 0.0000431 0.00214 0.4457 1.3694 0.011% 10 9 Kotak Bank 0.0003 7.2809 1.1216 0.002% 0.0000034 0.00218 0.1728 1.5422 0.010% 11 2 Bank of India 0.0003 5.7607 1.0850 -0.005% -0.0000095 0.0208 0.2044 1.7466 0.009% 12 12 Union Bank 0.0002 5.2375 0.9745 -0.016% -0.0000289 0.00179 0.1813 1.9279 0.007% 13 7 IDBI Bank 0.0001 5.4580 1.3846 -0.017% -0.0000606 0.00118 0.3513 2.2792 0.004% Cut-off 0.057% 0.032% Weight Return Beta Weighted Return Weighted Beta Excess return on Beta 5.716% 0.53% 1.2595 0.0003015 0.0720 0.393% 0.0002 57.479% 0.22% 1.1826 0.0012628 0.6797 0.159% 0.0009 25.656% 0.16% 1.3314 0.0004127 0.3416 0.097% 0.0002 11.149% 0.10% 0.9435 0.0001127 0.1052 0.073% 0.0001 100.000% 0.00209 1.19851 0.00147 15
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Information Technology Portfolio ERTB (Rs-Irf)*Beta Cumm. Beta^2 Cumm. Cut-off Xi Rank SN Security Return Variance Beta Zi (Rs-Irf)/Beta /Variance Summ. /Variance Summ. (B) Weight 5 1 Hexaware Tech. 0.0022 15.3188 0.9982 0.190% 0.0001 0.0001 0.0650 0.0650 0.017% 0.008% 16.380% 8 2 TCS 0.0018 3.7571 0.9982 0.149% 0.0004 0.0005 0.2652 0.3303 0.052% 0.021% 44.328% 11 3 HCL Technologies 0.0015 5.0972 1.0524 0.113% 0.0002 0.0008 0.2173 0.5476 0.063% 0.009% 19.313% 1 4 Oracle Financial 0.0011 3.7010 0.6392 0.124% 0.0001 0.0009 0.1104 0.6580 0.068% 0.010% 19.980% 6 5 Infosys 0.0006 2.7709 0.8302 0.033% 0.0001 0.0010 0.2487 0.9067 0.063% 2 6 Wipro 0.0004 5.1139 0.7742 0.007% 0.0000 0.0010 0.1172 1.0239 0.059% 4 7 mPhasis 0.0002 6.6170 0.7564 -0.012% 0.0000 0.0010 0.0865 1.1103 0.055% 12 8 Tech Mahindra 0.0002 5.9242 0.7550 -0.015% 0.0000 0.0010 0.0962 1.2066 0.052% 9 9 FinTech -0.0004 7.2675 0.8669 -0.087% -0.0001 0.0009 0.1034 1.3100 0.044% Cut-off 0.068% 0.048% Weight Return Beta Weighted Return Weighted Beta Excess return on Beta Summary 16.380% 0.22% 0.9982 0.0003629 0.1635 0.190% 0.0003 Portfolio Return (1 Day) 0.168% 44.328% 0.18% 0.9982 0.0008014 0.4425 0.149% 0.0007 Portfolio Return (Annual) 42.331% 19.313% 0.15% 1.0524 0.0002927 0.2033 0.113% 0.0002 Portfolio Beta 0.9370 19.980% 0.11% 0.6392 0.0002228 0.1277 0.124% 0.0002 100.000% 0.0016798 0.9370 0.0014 16
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Portfolio using combination of securities from both the indexes (Rs- ERTB Cumm. Beta^2 Cumm. Cut-off Xi Rank SN Security Return Variance Beta Irf)*Beta Zi (Rs-Irf)/Beta Summ. /Variance Summ. (B) Weight /Variance 1 19 TCS 0.0018 3.7571 0.8867 0.168% 0.0004 0.0004 0.2093 0.2093 0.040% 0.020% 34.058% 2 8 IndusInd Bank 0.0022 6.6013 1.1826 0.159% 0.0003 0.0007 0.2119 0.4211 0.063% 0.014% 23.119% 3 13 Yes Bank 0.0016 6.4847 1.3314 0.097% 0.0003 0.0010 0.2734 0.6945 0.070% 0.003% 5.009% 4 15 HCL Technologies 0.0015 5.0972 1.0524 0.113% 0.0002 0.0012 0.2173 0.9118 0.076% 0.006% 10.904% 5 4 Federal Bank 0.0010 4.2658 0.9435 0.073% 0.0002 0.0014 0.2087 1.1205 0.076% 6 18 Oracle Financial 0.0011 3.7010 0.6392 0.124% 0.0013709 0.00149 0.1104 1.2308 0.079% 0.007% 12.245% 7 16 Hexaware 0.0022 15.3188 0.9982 0.190% 0.0012342 0.00161 0.0650 1.2959 0.082% 0.007% 11.838% 8 3 Canara Bank 0.0009 5.4607 1.0837 0.054% 0.0011705 0.00173 0.2151 1.5110 0.079% 9 14 Infosys 0.0006 2.7709 0.8302 0.033% 0.0008177 0.00181 0.2487 1.7597 0.075% 10 1 Axis Bank 0.0006 5.1921 1.3298 0.024% 0.0008173 0.00189 0.3406 2.1003 0.068% 11 11 SBI 0.0005 4.3828 1.2307 0.018% 0.0006242 0.00195 0.3456 2.4459 0.063% 12 6 ICICI Bank 0.0005 5.0845 1.5054 0.010% 0.0004308 0.00200 0.4457 2.8916 0.056% 13 10 PNB 0.0004 3.5339 0.9162 0.011% 0.0002690 0.00202 0.2376 3.1291 0.053% 14 5 HDFC Bank 0.0053 234.1810 1.2595 0.393% 0.0002664 0.00205 0.0068 3.1359 0.054% 0.002% 2.826% 15 21 Wipro 0.0004 5.1139 0.7742 0.007% 0.0000819 0.00206 0.1172 3.2531 0.053% 16 9 Kotak Bank 0.0003 7.2809 1.1216 0.002% 0.0000342 0.00206 0.1728 3.4259 0.050% 17 2 Bank of India 0.0003 5.7607 1.0850 -0.005% -0.0000949 0.00205 0.2044 3.6302 0.048% 18 17 mPhasis 0.0002 6.6170 0.7564 -0.012% -0.0001050 0.00204 0.0865 3.7167 0.047% 19 20 Tech Mahindra 0.0002 5.9242 0.7550 -0.015% -0.0001460 0.00203 0.0962 3.8129 0.045% 20 12 Union Bank 0.0002 5.2375 0.9745 -0.016% -0.0002894 0.00200 0.1813 3.9943 0.043% 21 7 IDBI Bank 0.0001 5.4580 1.3846 -0.017% -0.0006065 0.00194 0.3513 4.3455 0.039% 22 22 FinTech -0.0004 7.2675 0.8669 -0.087% -0.0008999 0.00185 0.1034 4.4489 0.036% Cut-off 0.082% 0.059% 17
    • Security Analysis & Portfolio Management PGDM-Exec 2012 Portfolio Securities Weights Return Beta Weighted Return Beta Excess Return to Beta TCS 34.058% 0.18% 0.8867 0.0006 0.3020 0.168% 0.0006 IndusInd Bank 23.119% 0.22% 1.1826 0.0005 0.2734 0.159% 0.0004 Yes Bank 5.009% 0.16% 1.3314 0.0001 0.0667 0.097% 0.0000 HCL Technologies 10.904% 0.15% 1.0524 0.0002 0.1148 0.113% 0.0001 Oracle Financial 12.245% 0.11% 0.6392 0.0001 0.0783 0.124% 0.0002 Hexaware 11.838% 0.22% 0.9982 0.0003 0.1182 0.190% 0.0002 HDFC Bank 2.826% 0.53% 1.2595 0.0001 0.0356 0.393% 0.0001 100.000% 0.0019 0.9889 0.0016 Summary Portfolio Return (Day) 0.192% Portfolio Return (Annual) 48.318% Portfolio Beta 0.9889 18
    • Once the securities to be included in the portfolio are decided, the next step is todetermine the weight of each security to be included in the portfolio as follows –In the above formula the second expression determines the relative investmentin each security. The first determines the weight of each security in the portfolioso that they sum to 1. This ensures full investment.Comparison of the Portfolios Number of Included in Weighted Weighted Industry Securities Portfolio Return Beta Banking 13 4 52.661% 1.1985 IT 9 4 42.331% 0.9370 Combined 22 7 48.318% 0.9889 Equation of SML: y = 2.996x + 8.1Observations  Banking Portfolio has higher return than IT Portfolio and at the same time is riskier than the other.  We see that, the return is directly proportional to the risk incurred by the portfolio means greater the risk, higher is the return.  Banking Portfolio is more volatile than IT Portfolio because it has higher beta value hence there are chances to get more return. 19
    • Security Analysis & Portfolio Management PGDM-Exec 2012  All our portfolios lies above the SML Line hence are undervalued. So, we can invest on any of the given portfolios depending on our risk and return requirement.  When combining both the industries into one portfolio, we can work out our risk and return equation to obtain required results. Portfolio Construction Worksheet Banking Index.xlsx IT Index.xlsx Combined Portfolio.xlsx 20
    • Security Analysis & Portfolio Management PGDM-Exec 2012 References  Portfolio Construction Using Fundamental Analysis, Alliance Business Academy  Investopedia  Wikipedia  bseindia.com  in.finance.yahoo.com  money.rediff.com 21