CHAPTER I INTRODUCTION

INTRODUCTION:
The financial market is the driver of the economic growth and development of any country. A sound financial market can take the country to the apex. Financial resources were by allocating the resources through one of the ways such as portfolios, which are combinations of various securities. Portfolio analysis includes analyzing the range of possible portfolios that can be constituted from a given set of securities. A combination of securities with different risk- return characteristics will constitute the portfolio of the investor. A portfolio is a combination of various assets and/or instruments of investments. The portfolio is also built up out of the wealth or income of the investor over a period of time with a view to suit his risk and return preferences to that of the portfolio that he holds. The portfolio analysis is an analysis of the risk-return characteristics of individual securities in the portfolio and changes that may take place in combination with other securities due to interactions among themselves and impact of each one of them on others. As individuals are becoming more and more responsible for ensuring their own financial future, portfolio or fund management has taken on an increasingly important role in banks ranges of offerings to their clients. In addition, as interest rates have come down and the stock market has gone up and come down again, clients have a choice of leaving their saving in deposit accounts, or putting those savings in unit trusts or investment portfolios which invest in equities and/or bonds. Investing in unit trusts or mutual funds is one way for individuals and corporations alike to potentially enhance the returns on their saving

Objectives of the study:

To study the role of securities in Indian financial markets To study the investment pattern and its related risks & returns. To find out optimal portfolio, which gave optimal return at a minimize risk to the investor. To understand portfolio selection process. To study the usefulness of efficient frontier technique in portfolio selection process. To see whether the portfolio risk is less than individual risk on whose basis the portfolios are constituted To see whether the selected portfolios is yielding a satisfactory and constant return to the investor To understand, analyze and select the best portfolio.

Limitations of the study:

This study has been conducted purely to understand Portfolio Management for investors. Construction of Portfolio is restricted to two companies based on Markowitz model. Very few and randomly selected scrips / companies are analyzed from BSE listings. Detailed study of the topic was not possible due to limited size of the project. There was a constraint with regard to time allocation for the research study i.e. for a period of 45 days.

RESEARCH METHODOLOGY:
Research design or research methodology is the procedure of collecting, analyzing and interpreting the data to diagnose the problem and react to the opportunity in such a way where the costs can be minimized and the desired level of accuracy can be achieved to arrive at a particular conclusion. The methodology used in the study for the completion of the project and the fulfillment of the project objectives, is as follows: Market prices of the companies have been taken for the years of different dates, there by dividing the companies into 5 sectors. A final portfolio is made at the end of the year to know the changes (increase/decrease) in the portfolio at the end of the year.

Sources of the data:

Primary data: The primary data information is gathered from SMC fin polis by interviewing SMC executives. Secondary data: The secondary data is collected from various financial books, magazines and from stock lists of various newspapers and SMC as part of the training class undertaken for project.

CHAPTER - II INDUSTRY PROFILE

INDUSTRY PROFILE

Bombay Stock Exchange Limited is the oldest stock exchange in Asia with a rich heritage. Popularly known as "BSE", it was established as "The Native Share & Stock Brokers Association" in 1875. BSE has played a pioneering role in the Indian Securities Market - one of the oldest in the world. Much before actual legislations were enacted, BSE had formulated comprehensive set of Rules and Regulations for the Indian Capital Markets. It also laid down best practices adopted by the Indian Capital Markets after India gained its Independence.

Vision:
"Emerge as the premier Indian stock exchange by establishing global benchmarks" BSE is the first stock exchange in the country to obtain permanent recognition in 1956 from the Government of India under the Securities Contracts (Regulation) Act, 1956.The Exchange's pivotal and pre-eminent role in the development of the Indian capital market is widely recognized and its index, SENSEX, is tracked worldwide. SENSEX, first compiled in 1986 was calculated on a "Market Capitalization-Weighted" methodology of 30 component stocks representing a sample of large, well-established and financially sound companies. The base year of SENSEX is 1978-79. From September 2003, the SENSEX is calculated on a free-float market capitalization methodology. The "free-float Market Capitalization-Weighted"

methodology is a widely followed index construction methodology on which majority of global equity benchmarks are based. The launch of SENSEX in 1986 was later followed up in January 1989 by introduction of BSE National Index (Base: 1983-84 = 100). It comprised of 100 stocks listed at five major stock exchanges in India at Mumbai, Calcutta, Delhi, Ahmadabad and Madras. The BSE National Index was renamed as BSE-100 Index from October 14, 1996 and since then it is calculated taking into consideration only the prices of stocks listed at BSE. The Exchange launched dollar-linked version of BSE-100 index i.e. Dollex-100 on May 22, 2006. The Exchange constructed and launched on 27th May, 1994, two new index series viz., the 'BSE-200' and the 'DOLLEX-200' indices. The launch of BSE-200 Index in 1994 was followed by the launch of BSE-500 Index and 5 sectored indices in 1999. In 2001, BSE launched the BSE-PSU Index, DOLLEX-30 and the country's first free-float based index - the BSE TECK Index. The Exchange shifted all its indices to a free-float methodology (except BSE PSU index). The Exchange has a nation-wide reach with a presence in 417 cities and towns of India. The systems and processes of the Exchange are designed to safeguard market integrity and enhance transparency in operations. During the year 2004-2005, the trading volumes on the Exchange showed robust growth. The Exchange provides an efficient and transparent market for trading in equity, debt instruments and derivatives. The BSE's On Line Trading System (BOLT) is a proprietary system of the Exchange and is BS 7799-2-2002 8

certified. The surveillance and clearing & settlement functions of the Exchange are ISO 9001:2000 certified. The Exchange is professionally managed under the overall direction of the Board of Directors. The Board comprises eminent professionals,

representatives of Trading Members and the Managing Director of the Exchange. The Board is inclusive and is designed to benefit from the participation of market intermediaries. BSE as a brand is synonymous with capital markets in India. The BSE SENSEX is the benchmark equity index that reflects the robustness of the economy and finance. It was the First in India to introduce Equity Derivatives First in India to launch a Free Float Index First in India to launch US$ version of BSE Sensex First in India to launch Exchange Enabled Internet Trading Platform First in India to obtain ISO certification for Surveillance, Clearing & Settlement 'BSE On-Line Trading System (BOLT) has been awarded the globally recognized the Information Security Management System standard BS7799-2:2002. First to have an exclusive facility for financial training Moved from Open Outcry to Electronic Trading within just 50 days

In 2002, the name The Stock Exchange, Mumbai, was changed to BSE. BSE, which had introduced securities trading in India, replaced its open outcry system of trading in 1995, when the totally automated trading through the BSE Online trading (BOLT) system was put into practice. The BOLT network was expanded, nationwide, in 1997. It was at the BSE's International Convention Hall that Indias 1st Bell ringing ceremony in the history Capital Markets was held on February 18th, 2002. It was the listing ceremony of Bharti Tele ventures Ltd. BSE with its long history of capital market development is fully geared to continue its contributions to further the growth of the securities markets of the country, thus helping India increase its sphere of influence in international financial markets.

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NATIONAL STOCK EXCHANGE OF INDIA LIMITED

The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company unlike other stock exchanges in the country.

On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June 2000. The national stock exchange of India ltd is the largest stock exchange of the country. NSE is setting the agenda for change in the securities markets in India. For last 5 years it has played a major role in bringing investors from 347 cities and towns online, ensuring complete transparency, introducing financial guarantee to settlements, ensuring scientifically designed and professionally managed indices and by nurturing the dematerialization effort across the country. NSE is a complete capital market prime mover. Its wholly owned subsidiaries, National securities clearing corporation ltd (NSCCL) provides cleaning and 11

settlement of securities, India index services and products ltd (IISL) provides indices and index services with a consulting and licensing agreement with Standard & Poors (S&P), and IT ltd forms the technology strength that NSE works on. Today, NSE is one of the largest exchanges in the world and still forging ahead. At NSE, we are constantly working towards creating a more transparent, vibrant and innovative capital market.

OVER THE COUNTR EXCHANGE OF INDIA

OTCEI was incorporated in 1990 as a section 25 company under the companies Act 1956 and is recognized as a stock exchange under section 4 of the securities Contracts Regulation Act, 1956. The exchange was set up to aid enterprising promotes in raising finance for new projects in a cost effective manner and to provide investors with a transparent and efficient mode of trading Modeled along the lines of the NASDAQ market of USA, OTCEI introduced many novel concepts to the Indian capital markets such as screenbased nationwide trading, sponsorship of companies, market making and scrip less trading. As a measure of success of these efforts, the Exchange today has 115 listings and has assisted in providing capital for enterprises that have gone on to build successful brands for themselves like VIP Advanta, Sonora Tiles & Brilliant mineral water, etc.

Need for OTCEI:

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Studies by NASSCOM, software technology parks of India, the venture capitals funds and the governments IT tasks Force, as well as rising interest in IT, Pharmaceutical, Biotechnology and Media shares have repeatedly emphasized the need for a national stock market for innovation and high growth companies. Innovative companies are critical to developing economics like India, which is undergoing a major technological revolution. With their abilities to generate employment opportunities and contribute to the economy, it is essential that these companies not only expand existing operations but also set up new units. The key issue for these companies is raising timely, cost effective and long term capital to sustain their operations and enhance growth. Such companies, particularly those that have been in operation for a short time, are unable to raise funds through the traditional financing methods, because they have not yet been evaluated by the financial world.

Who would find OTCEI helpful?

High-technology enterprises Companies with high growth potential Companies focused on new product development Entrepreneurs seeking finance for specific business projects

The Indian economy is demonstrating signs of recovery and it is essential that these companies have suitable financing alternative to fund their growth and maintain competitiveness.

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OTCEI, With its entry guidelines and eligibility requirement tailored for such innovative and growth oriented companies, is ideally positioned as the preferred route for raising funds through initial public offer(IPOs) or primary issues, in this country.

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CHAPTER - III COMPANY PROFILE

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COMPANY PROFILE
SMC GLOBAL SECURITIES LIMITED

ABOUT SMC GLOBAL SECURITIES SMC Global is one of the leading integrated financial services groups in the country today, backed by a blue chip promoter pedigree and a proven track record. Our businesses are broadly clubbed across three key verticals, the Retail, Institutional and Wealth spectrums, catering to a diverse and wide base of clients spread across the length and breadth of the country. Structurally, all businesses are operated through various subsidiaries held through the holding company, SMC Global, which recently concluded its resoundingly successful public offer. The company offers a diverse bouquet of services ranging from equities, commodities, insurance broking to wealth management, portfolio management services, personal financial services, investment banking and institutional broking services. SMC Global retail network spreads across the length and breadth of the country with its presence through more than 1300 locations across more than 800 cities and towns. As part of its recent initiatives the group has also started expanding globally. SMC Global has also successfully partnered with Sanlam, one of the global leaders to Wealth Management joint venture.

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The vision is to build SMC Global as a globally trusted brand in the financial services domain and present it as the Investment Gateway of India. All employees of the group, currently more than 15,000 in number, ceaselessly strive to provide financial care driven by the core values of diligence and transparency. GROUP STRUCTURE

SMC

Wealth

Management Services Limited and Financial Services Group of the Macquarie Bank have signed a 50:50 JV now called SMC Wealth Management Limited.

VISION & MISSION Vision - To build SMC Global as a globally trusted brand in the financial services domain and present it as the Investment Gateway of India

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Mission - To provide financial care driven by the core values of diligence & transparency Brand Essence - Diligent, dynamic & ethical processes for wealth creation. BRAND IDENTITY Name SMC Means company chairmans starting characters S stands for Mr.Subhash

Aggarwal M stands for Mr.Mahesh Gupta. Company both are a fellow member of the institute of Charted Accounts of India

Symbol The name is paired with the symbol of a four-leaf clover, a rare mutation of the common three-leaf clover. Traditionally, it is considered good fortune to find a four leaf clover as there is only one four-leaf clover for every 10,000 three-leaf clovers found. Each leaf of the four-leaf clover has a special meaning in the sphere of SMC. The first leaf of the clover represents Hope. The aspirations to succeed. The dream of becoming. Of new possibilities. It is the beginning of every step and the foundations on which a person reaches for the stars.

The second leaf of the clover represents Trust. The ability to place ones own The third leaf To have a relationship Care. The in a team. To accomplish faith in another.of the clover represents as partnerssecret ingredient that is thea cement in every relationship. The truth of feeling to all not in the binding and given goal with the balance that brings satisfaction that underlines sincerity but in the triumph is diligence in every aspect. From it springs true warmth of service the bond that of built. 18

and the ability to adapt to evolving environments with consideration to all.

The fourth and final leaf of the clover represents Good Fortune. Signifying that rare ability to meld opportunity and planning with circumstance to generate those often looked for remunerative moments of success.

Hope. Trust. Care. Good fortune. All elements perfectly combine in the emblematic and rare, four-leaf clover to visually symbolize the values that bind together and form the core of the SMC vision.

Accent usage The diacritical tilde mark () over the letter A in the Smc typeface indicates a palatal emphasis sound of the letter A.

MANAGEMENT TEAM Our Top Management Team Mr. S C Aggarwal Mr. Mahesh C Gupta Mr.D K Aggarwal Chairman & Managing Director Vice Chairman & Managing Director CMD SMC Comtrade Ltd & SMC Capitals Ltd 19

Mr. Pradeep Aggarwal Mr. Anurag Bansal Mr. Ajay Garg Mr. Rakesh Gupta Mr. Tienie van de

Managing Director, SMC Global Securities Ltd Managing Director, SMC Global Securities Ltd Managing Director, SMC Global Securities Ltd Managing Director, SMC Global Securities Ltd CEO, SMC Wealth Management Services Ltd

CLIENT INTERFACE : SERVICES OFFERED Retail Spectrum- To cater to a large number of retail clients by offering all products under one roof through the Branch Network and Online mode

Equity, Commodity & Currency Trading Personal Financial Services

Distribution Insurance Loan Against Securities Equities Derivatives Currency Commodities Clearing Services Wealth Management Research

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Online Investment Portal

Institutional Spectrum- To Forge & build strong relationships with Corporate Client and Institutions

Institutional Equity Broking Investment Banking

Merchant Banking Transaction Advisory Corporate Finance

Wealth Spectrum - To provide customized wealth advisory services to High Net worth Individuals

Wealth Advisory Services Portfolio Management Services International Advisory Fund Management Services Priority Client Equity Services Arts Initiative

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GROUP COMPANIES 1. SMC Global Securities Ltd 2. SMC Comtrade Ltd 3. SMC Insurance Brokers Pvt Ltd 4. SMC Trade Online 5. Nexgen Capitals Ltd 6. SMC Comex INTL DMCC

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CHAPTER - IV REVIEW OF LITERATURE

INTRODUCTION:
A portfolio is a collection of investments held by an institution or a private individual. In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which offers portfolio management services. Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The

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assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value. Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected returns from portfolios, comprised of different asset bundles are compared. The unique goals and circumstances of the investor must also be considered. Some investors are more risk averse than others. Mutual funds have developed particular techniques to optimize their portfolio holdings.

Thus, portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety and numerous other trade-offs encountered in the attempt to maximize return at a given appetite for risk. Aspects of Portfolio Management: Basically portfolio management involves A proper investment decision making of what to buy & sell Proper money management in terms of investment in a basket of assets so as to satisfy the asset preferences of investors. 24

 Reduce the risk and increase returns.

OBJECTIVES OF PORTFOLIO MANAGEMENT:

The basic objective of Portfolio Management is to maximize yield and minimize risk. The other ancillary objectives are as per needs of investors, namely: Regular income or stable return Appreciation of capital Marketability and liquidity Safety of investment Minimizing of tax liability.

NEED FOR PORTFOLIO MANAGEMENT:

The Portfolio Management deals with the process of selection securities from the number of opportunities available with different expected returns and carrying different levels of risk and the selection of securities is made with a view to provide the investors the maximum yield for a given level of risk or ensure minimum risk for a level of return. Portfolio Management is a process encompassing many activities of investment in assets and securities. It is a dynamics and flexible concept and involves regular and systematic analysis, judgment and actions. The objectives of this service are to help the unknown investors with the expertise of professionals in investment Portfolio Management. It involves construction of a portfolio based upon the investors objectives, constrains, preferences for risk and return and liability. The portfolio is reviewed and adjusted from time to

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time with the market conditions. The evaluation of portfolio is to be done in terms of targets set for risk and return. The changes in portfolio are to be effected to meet the changing conditions. Portfolio Construction refers to the allocation of surplus funds in hand among a variety of financial assets open for investment. Portfolio theory concerns itself with the principles governing such allocation. The modern view of investment is oriented towards the assembly of proper combinations held together will give beneficial result if they are grouped in a manner to secure higher return after taking into consideration the risk element. The modern theory is the view that by diversification, risk can be reduced. The investor can make diversification either by having a large number of shares of companies in different regions, in different industries or those producing different types of product lines. Modern theory believes in the perspectives of combination of securities under constraints of risk and return.

ELEMENTS: Portfolio Management is an on-going process involving the following basic tasks. Identification of the investors objective, constrains and preferences which help formulated the invest policy. Strategies are to be developed and implemented in tune with invest policy formulated. This will help the selection of asset classes and securities in each class depending upon their risk-return attributes.

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 Review and monitoring of the performance of the portfolio by continuous overview of the market conditions, companys performance and investors circumstances. Finally, the evaluation of portfolio for the results to compare with the targets and needed adjustments have to be made in the portfolio to the emerging conditions and to make up for any shortfalls in achievements (targets).

Schematic diagram of stages in portfolio management:

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Specification and quantification of investor objectives, constraints, and preferences

Monitoring investor related input factors

Portfolio policies and strategies

Capital market expectations

Portfolio construction and revision asset allocation, portfolio optimization, security selection, implementation and execution

Attainment of investor objectives Performance measurement

Relevant economic, social, political sector and security considerations

Monitoring economic and market input factors

Process of portfolio management: The Portfolio Program and Asset Management Program both follow a disciplined process to establish and monitor an optimal investment mix. This

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six-stage process helps ensure that the investments match investors unique needs, both now and in the future.

1. IDENTIFY GOALS AND OBJECTIVES:

When will you need the money from your investments? What are you saving your money for? With the assistance of financial advisor, the Investment Profile Questionnaire will guide through a series of questions to help identify the goals and objectives for the investments.
2. DETERMINE OPTIMAL INVESTMENT MIX:

Once the Investment Profile Questionnaire is completed, investors optimal investment mix or asset allocation will be determined. An asset allocation represents the mix of investments (cash, fixed income and equities) that match individual risk and return needs. This step represents one of the most important decisions in your portfolio construction, as asset allocation has been found to be the major determinant of long-term portfolio performance. 29

3. CREATE A CUSTOMIZED INVESTMENT POLICY STATEMENT

When the optimal investment mix is determined, the next step is to formalize our goals and objectives in order to utilize them as a benchmark to monitor progress and future updates.
4. SELECT INVESTMENTS

The customized portfolio is created using an allocation of select QFM Funds. Each QFM Fund is designed to satisfy the requirements of a specific asset class, and is selected in the necessary proportion to match the optimal investment mix.
5 MONITOR PROGRESS

Building an optimal investment mix is only part of the process. It is equally important to maintain the optimal mix when varying market conditions cause investment mix to drift away from its target. To ensure that mix of asset classes stays in line with investors unique needs, the portfolio will be monitored and rebalanced back to the optimal investment mix
6. REASSESS NEEDS AND GOALS

Just as markets shift, so do the goals and objectives of investors. With the flexibility of the Portfolio Program and Asset Management Program, when the investors needs or other life circumstances change, the portfolio has the flexibility to accommodate such changes.

RISK: Risk refers to the probability that the return and therefore the value of an asset or security may have alternative outcomes. Risk is the uncertainty

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(today) surrounding the eventual outcome of an event which will occur in the future. Risk is uncertainty of the income/capital appreciation or loss of both. All investments are risky. The higher the risk taken, the higher is the return. But proper management of risk involves the right choice of investments whose risks are compensation. RETURN: Return-yield or return differs from the nature of instruments, maturity period and the creditor or debtor nature of the instrument and a host of other factors. The most important factor influencing return is risk return is measured by taking the price income plus the price change.

PORTFOLIO RISK: Risk on portfolio is different from the risk on individual securities. This risk is reflected by in the variability of the returns from zero to infinity. The expected return depends on probability of the returns and their weighted contribution to the risk of the portfolio. RETURN ON PORTFOLIO: Each security in a portfolio contributes returns in the proportion of its investment in security. Thus the portfolio of expected returns, from each of the securities with weights representing the proportionate share of security in the total investments.

RISK RETURN RELATIONSHIP:

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The risk/return relationship is a fundamental concept in not only financial analysis, but in every aspect of life. If decisions are to lead to benefit maximization, it is necessary that individuals/institutions consider the combined influence on expected (future) return or benefit as well as on risk/cost. The requirement that expected return/benefit be commensurate with risk/cost is known as the "risk/return trade-off" in finance. All investments have some risks. An investment in shares of companies has its own risks or uncertainty. These risks arise out of variability of returns or yields and uncertainty of appreciation or depreciation of share prices, loss of liquidity etc. and the overtime can be represented by the variance of the returns. Normally, higher the risk that the investors take, the higher is the return.

. .

TYPES OF RISKS: risk consists of two components. They are

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1. 2.

Systematic Risk Un-systematic Risk

1. SYSTEMATIC RISK: Systematic risk refers to that portion of total variability in return caused by factors affecting the prices of all securities. Economic, Political and sociological changes are sources of systematic risk. Their effect is to cause prices of nearly all individual common stocks and/or all individual bonds to move together in the same manner. i. Market Risk:

Variability in return on most common stocks that are due to basic sweeping changes in investor expectations is referred to as market risk. Market risk is caused by investor reaction to tangible as well as intangible events. ii. Interest rate-Risk:

Interest rate risk refers to the uncertainty of future market values and of the size of future income, caused by fluctuations in the general level of interest rates. iii. Purchasing-Power Risk:

Purchasing power risk is the uncertainty of the purchasing power of the amounts to be received. In more events everyday terms, purchasing power risk refers to the impact of or deflation on an investment.

2. UNSYSTEMATIC RISK: Unsystematic risk is the portion of total risk that is unique to a firm or industry.

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Factors such as management capability, consumer preferences, and labor strikes Cause systematic variability of return in a firm. Unsystematic factors are largely independent of factors affecting securities markets in general. Because these factors affect one firm, they must be examined for each firm. Unsystematic risk that portion of risk that is unique or peculiar to a firm or an industry, above and beyond that affecting securities markets in general. Factors such as management capability, consumer preferences, and labor strikes can cause unsystematic variability of return for a companys stock.

i.

Business Risk:

Business risk is a function of the operating conditions faced by a firm and the variability these conditions inject into operating income and expected dividends. Business risk can be divided into two broad categories a. Internal Business Risk b. External Business Risk

a. Internal business risk is associated with the operational efficiency of the firm. The operational efficiency differs from company to company. The efficiency of operation is reflected on the companys achievement of its pre-set goals and the fulfillment of the promises to its investors.

b. External business risk is the result of operating conditions imposed on the firm by circumstances beyond its control. The external environments in which it operates exert some pressure on the firm. The external factors are

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social and regulatory factors, monetary and fiscal policies of the government, business cycle and the general economic environment within which a firm or an industry operates. ii. Financial Risk:

Financial risk is associated with the way in which a company finances its activities. Financial risk is avoided risk to the extent that management has the freedom to decide to borrow or not to borrow funds. A firm with no debit financing has no financial risk

MARKOWITZ MODEL
THE MEAN VARIANCE CRITERION: Dr. Harry M. Markowitz is credited with developing the first modern portfolio analysis model in order to arrange for the optimum allocation of assets with in portfolio. To reach these objectives, Markowitz generated portfolio with in a reward risk context. In essence, Markowitz model is a theoretical framework for the analysis of risk return choices. Decisions are based on the concept of efficient portfolios. Markowitz model is a theoretical framework for the analysis of risk, return choices and this approach determines an efficient set of portfolio return through three important variable that is, Return Standard Deviation Coefficient of correlation Markowitz model is also called as a Full Covariance Model. Through this model the investor can find out the efficient set of portfolio by finding out the tradeoff between risk and return, between the limits of zero and infinity.

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According to this theory, the effect of one security purchase over the effects of the other security purchase is taken into consideration and then the results are evaluated. Markowitz had given up the single stock portfolio and introduced diversification. The single stock portfolio would be preferable if the investor is perfectly certain that his expectation of highest return would turn out to be real. In the world of uncertainty, most of the risk averse investors would like to join Markowitz rather than keeping a single stock, because diversification reduces the risk. A portfolio is efficient when it is expected to yield the highest return for the level of risk accepted or, alternatively the smallest portfolio risk for a specified level of expected return level chosen, and asset are substituted until the portfolio combination expected returns, set of efficient portfolio is generated. Assumptions: The Markowitz model is based on several assumptions regarding investor behavior:

1. Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period. 2. Investors maximize one period-expected utility and possess utility curve, which demonstrates diminishing marginal utility of wealth. 3. Individuals estimate risk on the basis of variability of expected return. 4. Investors base decisions solely on expected return and variance of return only.

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5. For a given risk level, investors prefer high returns to lower returns. Similarly for a given level of expected return, investors prefer less risk to more risk.

Under these assumptions, a single asset or portfolio of assets is considered to be efficient if no other asset or portfolio of assets higher expected return with the same expected return. THE SPECIFIC MODEL: In developing this model, Markowitz first disposed of the investor behavior rule that the investor should maximize expected return. This rule implies nondiversified single security analysis portfolio with the highest expected return is the most desirable portfolio. Only by buying that single security portfolio would obviously be preferable if the investor were perfectly certain that this highest expected return would turn out to be the actual return. However, under real world conditions of uncertainty, most risk adverse investors join with Markowitz in discarding the role of calling for maximizing the expected returns. As an alternative, Markowitz offers the expected returns/variance rule. Markowitz has shown the effect of diversification by regarding the risk of securities. According to him, the security with the covariance, which is either negative or low amongst them, is the best manner to reduce risk. Markowitz has been able to show that securities, which have, less than positive correlation will reduce risk without, in any way, bringing the return down. According to his research study a low correlation level between securities in the portfolio will show less risk. According to him, investing in a large number

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of securities is not the right method of investment. It is the right kind of security that brings the maximum results. Henry Markowitz has given the following formula for a two-security portfolio and three security portfolios.

= (x1)2 ( 1)2 + (X2)2 ( 2)2 + 2(X1)(X2)(r12)( 1) ( 2)

= (x1)2( 1)2+(X2)2( 2)2 + (X3)2( 3)2 +2(X1)(X2)(r12)( 1) ( 2)+ 2(X1)(X3)(r13)( 1) ( 3)+ 2(X2)(X3)(r23)( 2) ( 3)
p = Standard deviation of the portfolio return

X1= proportion of the portfolio invested in security 1 X2= proportion of the portfolio invested in security 2 X3= proportion of the portfolio invested in security 3 1= standard deviation of the return on security 1 2= standard deviation of the return on security 2 3= standard deviation of the return on security 3 r12= coefficient of correlation between the returns on securities 1 and 2 r13= coefficient of correlation between the returns on securities 1 and 3 r23= coefficient of correlation between the returns on securities 2 and 3

CAPITAL ASSET PRICING MODEL: (CAPM)

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The CAPM is a model for pricing an individual security (asset) or a portfolio. For individual security perspective, the security market line (SML) is used and its relation to expected return and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. The SML enables us to calculate the reward-to-risk ratio for any security in relation to that of the overall market. Therefore, when the expected rate of return for any security is deflated by its beta coefficient, the reward-torisk ratio for any individual security in the market is equal to the market reward-to-risk ratio, thus: Individual securitys / beta Reward-to-risk ratio = Markets securities (portfolio) Reward-to-risk ratio

, The Security Market Line, seen here in a graph, describes a relation between the beta and the asset's expected rate of return

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The market reward-to-risk ratio is effectively the market risk premium and by rearranging the above equation and solving for E (Ri), we obtain the Capital Asset Pricing Model (CAPM).

Where:

is the expected return on the capital asset is the risk-free rate of interest
(the beta coefficient) the sensitivity of the asset returns to market

returns, or also

is the expected return of the market

is sometimes known as the market premium or risk premium (the difference between the expected market rate of return and the risk-free rate of return). Beta measures the volatility of the security, relative to the asset class. The equation is saying that investors require higher levels of expected returns to compensate them for higher expected risk. We can think of the formula as predicting a security's behavior as a function of beta: CAPM says that if we know a security's beta then we know the value of r that investors expect it to have.

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Assumptions of CAPM:

All investors have rational expectations. There are no arbitrage opportunities. Returns are distributed normally. Fixed quantity of assets. Perfectly efficient capital markets. Investors are solely concerned with level and uncertainty of future wealth

Separation of financial and production sectors. Thus, production plans are fixed.

Risk-free rates exist with limitless borrowing capacity and universal access.

The Risk-free borrowing and lending rates are equal. No inflation and no change in the level of interest rate exists. Perfect information, hence all investors have the same expectations about security returns for any given time period.

Shortcomings Of CAPM:

The model assumes that asset returns are (jointly) normally distributed random variables. It is however frequently observed that returns in equity and other markets are not normally distributed.

The model assumes that the variance of returns is an adequate measurement of risk.

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The model does not appear to adequately explain the variation in stock returns.

The model assumes those given a certain expected return investors will prefer lower risk (lower variance) to higher risk and conversely given a certain level of risk will prefer higher returns to lower ones.

The model assumes that all investors have access to the same information and agree about the risk and expected return of all assets. (Homogeneous expectations assumption)

The model assumes that there are no taxes or transaction costs. The market portfolio consists of all assets in all markets, where each asset is weighted by its market capitalization. This assumes no preference between markets and assets for individual investors, and that investors choose assets solely as a function of their risk-return profile. It also assumes that all assets are infinitely divisible as to the amount which may be held or transacted.

The market portfolio should in theory include all types of assets that are held by anyone as an investment (including works of art, real estate, human capital...)

Unfortunately, it has been shown that this substitution is not innocuous and can lead to false inferences as to the validity of the CAPM, and it has been said that due to the in observability of the true market portfolio, the CAPM might not be empirically testable.

42

The efficient frontier:

The CAPM assumes that the risk-return profile of a portfolio can be optimized - an optimal portfolio displays the lowest possible level of risk for its level of return. Additionally, since each additional asset introduced into a portfolio further diversifies the portfolio, the optimal portfolio must comprise every asset, with each asset value-weighted to achieve the above. All such optimal portfolios, i.e., one for each level of return, comprise the efficient frontier. A line created from the risk-reward graph, comprised of optimal portfolios.

The optimal portfolios plotted along the curve have the highest expected return possible for the given amount of risk.

43

Because the un systemic risk is diversifiable, the total risk of a portfolio can be viewed as beta.

Note 1:

The expected market rate of return is usually measured by

looking at the arithmetic average of the historical returns on a market portfolio. Note 2: The risk free rate of return used for determining the risk premium is usually the arithmetic average of historical risk free rates of return and not the current risk free rate of return. Measuring the Expected Return and Standard Deviation of a Portfolio The expected return on a portfolio is the weighted average of the returns of individual assets, where each asset's weight is determined by its weight in the portfolio.

44

The formula is: E (Rp) = [WaX E (Ra)] + [WaX E (Ra)] Where E= is stands for expected Rp= Return on the portfolio Wa= Weight of asset n where n my stand for asset a, betc. Ra= Return on asset n where n may stand for asset a, betc The portfolio standard deviation (p) measure the risk associated with the expected return of the portfolio. The formula is p = wa2 2 + wa2 2 + 2wawbrab a b

The term rab represents the correlation between the returns of investments a and b. The correlation coefficient, r, will always reduce the portfolio standard deviation as long as it is less than +1.00. Portfolio diversification: Diversification occurs when different assets make up a portfolio.

The benefit of diversification is risk reduction; the extent of this benefit depends upon how the returns of various assets behave over time. The market rewards diversification. We can lower risk without sacrificing expected return, and/or we can increase expected return without having to assume more risk. Diversifying among different kinds of assets is called asset allocation.

45

The diversification can either be vertical or horizontal. In vertical diversification a portfolio can have scripts of different companies within the same industry. In horizontal diversification one can have different scripts chosen from different industries. An important way to reduce the risk of investing is to diversify your investments. Diversification is akin to "not putting all your eggs in one basket." For example: If portfolio only consisted of stocks of technology companies, it would likely face a substantial loss in value if a major event adversely affected the technology industry. There are different ways to diversify a portfolio whose holdings are concentrated in one industry. We can invest in the stocks of companies belonging to other industry groups. We can allocate our portfolio among different categories of stocks, such as growth, value, or income stocks. We can include bonds and cash investments in our asset-allocation decisions. We can also diversify by investing in foreign stocks and bonds. Diversification requires us to invest in securities whose investment returns do not move together. In other words, the investment returns have a low correlation. The correlation coefficient is used to measure the degree to which returns of two securities are related. As we increase the number of securities in our portfolio, we reach a point where likely diversified as much as reasonably possible. Diversification should neither be too much or too less. It should be adequate according to the size of the portfolio. 46

The Efficient Frontier and Portfolio Diversification

The graph on the shows how volatility increases the risk of loss of principal, and how this risk worsens as the time horizon shrinks. So all other things being equal, volatility is minimized in the portfolio. If we graph the return rates and standard deviations for a collection of securities, and for all portfolios we can get by allocating among them. Markowitz showed that we get a region bounded by an upward-sloping curve, which he called the efficient frontier. It's clear that for any given value of standard deviation, we would like to choose a portfolio that gives you the greatest possible rate of return; so we always want a portfolio that lies up along the efficient frontier, rather than lower down, in the interior of the region. This is the first important property of the efficient frontier: it's where the best portfolios are.

47

The second important property of the efficient frontier is that it's curved, not straight. If we take a 50/50 allocation between two securities, assuming that the yearto-year performance of these two securities is not perfectly in sync -- that is, assuming that the great years and the lousy years for Security 1 don't correspond perfectly to the great years and lousy years for Security 2, but that their cycles are at least a little off -- then the standard deviation of the 50/50 allocation will be less than the average of the standard deviations of the two securities separately. Graphically, this stretches the possible allocations to the left of the straight line joining the two securities

48

THE FOUR PILLARS OF DIVERSIFICATION: a. The yield provided by an investment in a portfolio of assets will be closer to the Mean Yield than an investment in a single asset. b. When the yields are independent - most yields will be concentrated around the Mean. c. When all yields react similarly - the portfolio's variance will equal the variance of its underlying assets. d. If the yields are dependent - the portfolio's variance will be equal to or less than the lowest Market portfolio: The efficient frontier is a collection of portfolios, each one optimal for a given amount of risk. A quantity known as the Sharpe ratio represents a measure of the amount of additional return (above the risk-free rate) a portfolio provides compared to the risk it carries. The portfolio on the efficient frontier with the highest Sharpe Ratio is known as the market portfolio, or sometimes the super-efficient portfolio. This portfolio has the property that any combination of it and the risk-free asset will produce a return that is above the efficient frontier - offering a larger return for a given amount of risk than a portfolio of risky assets on the frontier would.

49

PORTFOLIO PERFORMANCE EVALUATION: A Portfolio manager evaluates his portfolio performance and identifies the sources of strengths and weakness. The evaluation of the portfolio provides a feed back about the performance to evolve better management strategy. Even though evaluation of portfolio performance is considered to be the last stage of investment process, it is a continuous process. There are number of situations in which an evaluation becomes necessary and important. Evaluation has to take into account: Rate of returns, or excess return over risk free rate. Level of risk both systematic (beta) and unsystematic and residual risks through proper diversification. Some of the models used to evaluate portfolio performance are: Sharpes ratio Treynors ratio Jensens alpha

50

Sharpes ratio:
A ratio developed by Nobel Laureate William F. Sharpe to measure riskadjusted performance. It is calculated by subtracting the risk-free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.

The Sharpe ratio tells us whether the returns of a portfolio are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its riskadjusted performance has been.

Treynors ratio:
The Treynor ratio is a measurement of the returns earned in excess of that which could have been earned on a risk less investment. The Treynor ratio is also called reward-to-volatility ratio. It relates excess return over the risk-free rate to the additional risk taken; however systematic risk instead of total risk is used. The higher the Treynor ratio, the better is the performance under analysis.

51

Treynors ratio = (Average Return of the Portfolio - Average Return of the Risk-Free Rate) / Beta of the Portfolio Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any, of active portfolio management. It is a ranking criterion only. A ranking of portfolios based on the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, fully diversified portfolio. If this is not the case, portfolios with identical systematic risk, but different total risk, will be rated the same.

Jensens alpha:
An alternative method of ranking portfolio management is Jensen's alpha, which quantifies the added return as the excess return above the security market line in the capital asset pricing model. Jensen's alpha (or Jensen's Performance Index) is used to determine the excess return of a stock, other security, or portfolio over the security's required rate of return as determined by the Capital Asset Pricing Model. This model is used to adjust for the level of beta risk, so that riskier securities are expected to have higher returns. The measure was first used in the evaluation of mutual fund managers by Michael Jensen in the 1970's.

52

To calculate alpha, the following inputs are needed:

The realized return (on the portfolio), The market return, The risk-free rate of return, and The beta of the portfolio.

Rjt - Rft = j + j (RMt - Rft)

Where

Rjt = average return on portfolio j for period oft Rft = risk free rate of return for period oft j = intercept that measures the forecasting ability to the manager j = systematic risk measure RMt = average return on the market portfolio for periodt
Portfolio management in India: In India, portfolio management is still in its infancy. Barring a few Indian banks, and foreign banks and UTI, no other agency had professional portfolio managementuntil1987. After the setting up of public sector Mutual Funds, since 1987, professional portfolio management, backed by competent research staff became the order of the day. After the success of mutual funds

53

in portfolio management, a number of brokers and investment consultants some of whom are also professionally qualified have become portfolio managers. They have managed the funds of clients on both discretionary and non-discretionary basis. The recent CBI probe into the operations of many market dealers has revealed the unscrupulous practices by banks, dealers and brokers in their portfolio operations. The SEBI has then imposed stricter rules, which included their registration, a code of conduct and minimum infrastructure, experience and expertise etc. The guidelines of SEBI are in the direction of making portfolio management a responsible professional service to be rendered by experts in the field.

PORTFOLIO ANALYSIS: Portfolio analysis includes portfolio construction, selection of securities, revision of portfolio evaluation and monitoring the performance of the portfolio. All these are part of subject of portfolio management which is a dynamic concept. Individual securities have risk-return characteristics of their own. Portfolios, which are combinations of securities may or may not take on the aggregate characteristics of their individuals parts. Portfolio analysis considers the determination of future risk and return in holding various blends of individual securities. As we know that expected return from individual securities carries some degree of risk. Various groups of securities when held together behave in a different manner and give interest

54

payments and dividends also, which are different to the analysis of individual securities. A combination of securities held together will give a beneficial result if they are grouped in a manner to secure higher return after taking into consideration the risk element. There are two approaches in construction of the portfolio of securities. They are

Traditional approach Modern approach

TRADITIONAL APPROACH: Traditional approach was based on the fact that risk could be measured on each individual security through the process of finding out the standard deviation and that security should be chosen where the deviation was the lowest. Traditional approach believes that the market is inefficient and the fundamental analyst can take advantage for the situation. Traditional approach is a comprehensive financial plan for the individual. It takes into account the individual needs such as housing, life insurance and pension plans. Traditional approach basically deals with two major decisions. They are a) Determining the objectives of the portfolio b) Selection of securities to be included in the portfolio

55

MODERN APPROACH: Modern approach theory was brought out by Markowitz and Sharpe. It is the combination of securities to get the most efficient portfolio. Combination of securities can be made in many ways. Markowitz developed the theory of diversification through scientific reasoning and method. Modern portfolio theory believes in the maximization of return through a combination of securities. The modern approach discusses the relationship between different securities and then draws inter-relationships of risks between them. Markowitz gives more attention to the process of selecting the portfolio. It does not deal with the individual needs.

56

CHAPTER -V DATA ANALYSIS AND INTERPRETATION

57

CALCULATED EXPECTED RETURNS AND STANDARD DEVIATIONS

Company name CEMENT GACL LNT PHARMACEUTICAL RANBAXY CIPLA TELECOM MTNL BHARTI ARTL BANKING ING VYSYA ICICI I.T. WIPRO SATYAM

Expected return (%)

Standard deviation (%) 56.91 65.12

19.03 63.69

9.02 -8.25

54.82 52.43

13.71 125.18

17.97 126.51

12.46 49.43

68.25 38.83

-13.68 16.82

34.76 40.41

58

Portfolio Returns and Risks of Companies

Company name CEMENT GACL LNT PHARMACEUTICAL RANBAXY CIPLA TELECOM MTNL BHARTI ARTL BANKING ING VYSYA ICICI I.T. WIPRO SATYAM -1.175 28.47 48.3209 38.81 253.99 252.45 -0.6512 48.63 38.2338 44.23 Returns (%) Risks (%)

59

CORRELATION COEFFICIENT BETWEEN THE COMPANIES

Company name CEMENT GACL LNT PHARMACEUTICAL RANBAXY CIPLA TELECOM MTNL BHARTI ARTL BANKING ING VYSYA ICICI I.T. WIPRO SATYAM 0.17 0.54 0.95 0.65 0.66 Correlation coefficient (r)

60

CALCULATION OF AVERAGE RETURN OF COMPANIES:

Average return = R/N GUJARAT AMBUJA CEMENT LTD (GACL): Opening share price (P0) 164.00 306.10 405.00 80.00 144.80 Closing share price (P1) 303.85 401.55 79.60 141.30 119.35

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 139.85 95.45 -325.40 61.30 -25.45

(P1-P0)/ P0*100 85.27 31.18 -80.35 76.63 -17.58

TOTAL RETURN
Average return = 95.15/5 = 19.03 LARSEN AND TOUBRO (LNT): Opening share price (P0) 213.70 530.00 988.70 1845.00 1400.00 Closing share price (P1) 527.35 982.00 1844.20 1442.95 1703.20

95.15

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 313.65 452.00 855.50 -402.05 303.20

(P1-P0)/ P0*100 146.77 85.28 86.53 -21.79 21.66

TOTAL RETURN
Average return = 318.45/5 = 63.69

318.45

RANBAXY LABORATORIES: 61

Year

Opening share price (P0) 597.80 1100.10 1252.00 364.40 393.00

Closing share price (P1) 1098.20 1251.40 362.35 391.85 349.15

(P1-P0) (P1-P0)/ P0*100 500.40 151.30 -889.65 27.45 -43.85 83.71 13.75 -71.06 7.53 11.16

2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

TOTAL RETURN
Average return = 45.09/5 =9.02

45.09

CIPLA: Opening share price (P0) 904.00 1339.00 320.00 445.00 253.40 Closing share price (P1) 1317.25 317.25 443.40 250.70 239.30

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 413.25 -1021.75 123.40 -194.30 -14.10

(P1-P0)/ P0*100 45.71 -76.31 38.56 -43.66 -5.56

TOTAL RETURN
Average return = -41.26/5 = -8.25

-41.26

62

MTNL: Opening share price (P0) 95.15 139.10 156.00 145.20 143.00 Closing share price (P1) 137.70 154.90 144.20 142.85 152.35

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 42.55 15.80 11.80 -2.35 9.35

(P1-P0)/ P0*100 44.72 11.36 7.56 -1.62 6.54

TOTAL RETURN
Average return = 68.56/5 = 13.71 BHARTI ARTL: Opening share price (P0) 23.50 106.25 218.90 348.90 635.00 Closing share price (P1) 105.10 215.60 345.70 628.85 862.80

68.56

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 81.60 109.35 126.80 279.95 227.80

(P1-P0)/ P0*100 347.23 102.92 57.93 80.24 35.87

TOTAL RETURN
Average return = 624.19/5 = 125.18

624.19

ING VYSYA:

63

Year

Opening share price (P0) 252.05 560.00 585.00 164.50 159.00

Closing share price (P1) 549.00 585.75 162.25 157.45 185.15

(P1-P0) (P1-P0)/ P0*100 296.95 25.75 -422.75 -7.05 26.15 117.81 4.60 -72.26 -4.29 16.45

2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

TOTAL RETURN
Average return = 62.31/5 = 12.46

62.31

ICICI: Opening share price (P0) 141.70 299.70 374.85 586.25 889.00 Closing share price (P1) 295.70 370.75 584.70 890.40 950.25

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 154.00 71.05 209.85 304.15 61.25

(P1-P0)/ P0*100 108.68 23.71 55.98 51.88 6.89

TOTAL RETURN
Average return = 247.14/5 = 49.43

247.14

WIPRO:

64

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Opening share price (P0) 1644.40 1744.40 753.00 464.00 607.90

Closing share price (P1) 1737.60 748.00 463.45 604.55 554.35

(P1-P0) 93.2 -996.40 -289.55 140.55 -53.55

(P1-P0)/ P0*100 5.67 -57.12 -38.45 30.29 -8.81

TOTAL RETURN
Average return = -68.42/5 = -13.68 SATYAM COMP: Opening share price (P0) 280.10 370.00 412.00 740.70 486.00 Closing share price (P1) 367.35 409.90 737.80 483.95 474.95

-68.42

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

(P1-P0) 87.25 39.90 325.80 -256.75 -11.05

(P1-P0)/ P0*100 31.15 10.78 79.08 -34.66 -2.27

TOTAL RETURN
Average return = 84.08/5 = 16.82

84.08

CALCULATION OF STANDARD DEVIATION:

65

Standard Deviation = Variance Variance = 1/n-1 (d2)

GUJARAT AMBUJA CEMENT LTD: Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 Return (R) 85.27 31.18 -80.35 76.63 -17.58 TOTAL Avg. Return (R ) 19.03 19.03 19.03 19.03 19.03 d= (R-R) 66.24 12.15 -61.32 57.60 -36.66 d2 4387.74 147.62 3760.14 3317.76 1343.96 d2=12957.22

Variance = 1/n-1 (d2) = 1/5-1 (12957.22) = 56.91 Standard Deviation = LARSEN & TOUBRO: Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 Return (R) 146.77 85.28 86.53 -21.79 21.66 TOTAL Avg. Return (R ) 63.69 63.69 63.69 63.69 63.69 d= (R-R) 83.08 21.59 22.84 -85.48 -42.03 D2 6902.29 466.13 521.67 7306.83 1766.52 d2=16963.44 Variance = 3239.305 = 56.91

Variance = 1/n-1 (d2) = 1/5-1 (16963.44) = 4240.86 Standard Deviation = Variance = 4240.86 = 65.12

RANBAXY LABORATORIES:

66

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Return (R) 83.71 13.75 -71.06 7.53 11.16

Avg. Return (R ) 9.02 9.02 9.02 9.02 9.02

d= (R-R) 74.69 4.73 80.08 -1.49 2.14

D2 5578.60 22.37 6412.81 2.22 4.58 d2=12020.58

TOTAL

Variance = 1/n-1 (d2) = 1/5-1 (12020.58) = 3005.145 Standard Deviation = CIPLA: Avg. Return (R ) -8.25 -8.25 -8.25 -8.25 -8.25 TOTAL d= (R-R) 53.96 -68.06 46.81 -35.41 -2.69 Variance = 3005.145 = 54.82

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Return (R) 45.17 -76.31 38.56 -43.66 -5.56

D2 2911.68 4632.16 2191.18 1253.87 7.24 d2=10996.13

Variance = 1/n-1 (d2) = 1/5-1 (10996.13) = 2749.0325 Standard Deviation = Variance = 2749.0325 = 52.43

MTNL:

67

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Return (R) 44.72 11.36 7.56 -1.62 6.54

Avg. Return (R ) 13.72 13.72 13.72 13.72 13.72

d= (R-R) 31 -2.36 -6.16 -15.34 -7.18

d2 961 5.57 37.95 235.32 51.55 d2=1291.39

TOTAL

Variance = 1/n-1 (d2) = 1/5-1 (1291.39) = 322.8475 Standard Deviation = Variance = 322.8475 = 17.97

BHARTI ARTL: Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 Return (R) 347.23 102.92 57.93 80.24 37.59 TOTAL Avg. Return (R ) 125.18 125.18 125.18 125.18 125.18 d= (R-R) 222.05 -22.26 -67.25 -44.94 -87.59 D2 49306.20 495.51 4522.56 2019.60 7672.01 d2=64015.88

Variance = 1/n-1 (d2) = 1/5-1 (64015.88) = 16003.97 Standard Deviation = Variance = 16003.97 = 126.51

ING VYSYA:

68

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Return (R) 117.81 4.60 -72.26 -4.29 16.45

Avg. Return (R ) 12.46 12.46 12.46 12.46 12.46

d= (R-R) 105.35 -7.86 -84.72 -16.75 3.99

D2 11098.62 61.78 7177.48 280.56 15.92 d2=18634.36

TOTAL

Variance = 1/n-1 (d2) = 1/5-1 (18634.36) = 4658.59 Standard Deviation = ICICI: Avg. Return (R ) 49.43 49.43 49.43 49.43 49.43 TOTAL d= (R-R) 59.25 -25.72 6.55 2.45 -42.54 Variance = 4658.59 = 68.25

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Return (R) 108.68 23.71 55.98 51.88 6.89

d2 3410.56 661.52 42.90 6.00 1809.65 d2=6030.63

Variance = 1/n-1 (d2) = 1/5-1 (6030.63) = 1507.6575 Standard Deviation = Variance = 1507.6575 = 38.83

WIPRO: Year Return (R) Avg. Return d= d2

69

(R ) 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 5.67 -57.12 -38.45 30.29 -8.81 TOTAL -13.68 -13.68 -13.68 -13.68 -13.68

(R-R) 19.35 -43.44 -24.77 43.97 -4.87 374.42 1887.03 613.55 1933.36 23.72 d2=4832.08

Variance = 1/n-1 (d2) = 1/5-1 (4832.08) = 1208.02 Standard Deviation = Variance = 1208.02 = 34.76

SATYAM: Avg. Return (R ) 16.82 16.82 16.82 16.82 16.82 TOTAL d= (R-R) 14.33 -6.04 62.26 51.48 19.09

Year 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Return (R) 31.15 10.78 79.08 -34.66 -2.27

d2 205.55 36.48 3876.31 2050.19 364.43 d2=6532.76

Variance = 1/n-1 (d2) = 1/5-1 (6532.76) = 1633.19 Standard Deviation = Variance = 1633.19 = 40.41

CALCULATION OF CORRELATION BETWEEN TWO COMPANIES:

70

Covariance (COVab) = 1/(n-1) (dx.dy) Correlation of coefficient = COVab / a* b GACL & LNT: Dev. Of GACL (dx) 66.24 12.15 -61.32 57.6 -36.66 Product of dev. (dx)(dy) 5503.2192 262.3185 -1400.5488 -4923.648 1540.8198 dx. dy = 982.1607

YEAR 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Dev. Of LNT (dy) 83.08 21.59 22.84 -85.48 -42.03

TOTAL

COVab =1/(5-1)(982.1607) =245.54 Correlation of coefficient = 245.54/(56.91)(65.12) = 0.066

RANBAXY & CIPLA: YEAR Dev. Of Dev. Of LNT Product of dev.

71

GACL (dx) 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 74.69 4.73 80.08 -1.49 2.14

(dy) 53.96 -68.06 46.81 -35.41 2.69

(dx)(dy) 4030.2724 -321.9238 3748.5448 52.7609 -5.7566 dx. dy = 7503.8977

TOTAL

COVab =1/(5-1)(7503.8977) = 1875.97 Correlation of coefficient = 1875.97/(54.82)(52.43) = 0.65 MTNL & BHARTI ARTL: Dev. Of GACL (dx) 31 -2.36 -6016 -15.34 -7.18 Product of dev. (dx)(dy) 6883.55 52.0616 414.26 689.3796 628.8962 dx. dy = 8668.1474

YEAR 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Dev. Of LNT (dy) 222.05 -22.06 -67.25 -44.94 -87.59

TOTAL

COVab =1/(5-1)(8668.1474) = 2167.04 Correlation of coefficient = 2167.04/(17.97)(126.51)

ING VYSYA & ICICI: YEAR Dev. Of GACL Dev. Of LNT (dy) 72 Product of dev. (dx)(dy)

(dx) 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 105.35 -7.86 -84.72 -16.75 3.99 59.25 -25.72 6.55 2.45 -42.54 6241.9875 202.1592 -554.916 -41.0375 -169.7346 dx. dy = 5678.4586

TOTAL

COVab =1/(5-1)(5678.4586) =1419.61 Correlation of coefficient = 1419.61/(68.25)(38.83) = 0.54 WIPRO & SATYAM: Dev. Of GACL (dx) 19.35 -43.44 -24.77 43.97 -4.87 Product of dev. (dx)(dy) 277.2855 262.3376 -1542.1802 2263.5756 -92.9683 dx. dy = 1168.0802

YEAR 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

Dev. Of LNT (dy) 14.33 -6.04 62.26 51.48 19.09

TOTAL

COVab =1/(5-1)(1168.0802) = 233.62 Correlation of coefficient = 233.62/(34.76)(40.41) = 0.17

CALCULATION OF PORTFOLIO WEIGHTS:

Deriving the minimum risk portfolio, the following formula is used:

73

Wa =
Where,

(b)2 - rab (a) (b)

(a)2 + (b)2 2rab (a) (b)

Xa is the proportion of security A Xb is the proportion of security B a = standard deviation of security A b = standard deviation of security B rab = correlation co-efficient between A&B GACL & LNT: (65.12)2- 0.066(56.91) (65.12) Xa = (56.91)2 + (65.12)2-2 (0.066) (56.91) (65.12) = 0.57 Xb = 1- Xa =1- 0.57 = 0.43 RANBAXY & CIPLA: (52.43)2- 0.65(54.82) (52.43) Xa = (54.82)2 + (52.43)2 -2 (0.65) (54.82) (52.43) = 0.44 Xb = 1-Xa = 1-0.44 = 0.56

MTNL & BHARTI ARTL: (126.51)2 0.95 (17.97) (126.51)

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Xa = (17.97)2 + (126.51)2 2(0.95) (17.97) (126.51) = -1.15 Xb = 1 Xa = 1- (-1.15) = 2.15 ING VYSYA & ICICI: (38.83)2 0.54(68.25) (38.83) Xa = (68.25)2 + (38.83)2 2 (0.54) (68.25) (38.83) = 0.03 Xb = 1 Xa = 1 0.03 = 0.97 WIPRO & SATYAM: (40.41)2 0.17(34.76) (40.41) Xa = (34.76)2 + (40.41)2 2 (0.17) (34.76) (40.41) = 0.59 Xb = 1 Xb = 1 0.59 = 0.41

CALCULATION OF PORTFOLIO RISK:

For two securities:

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P
Where,

a2*(Xa) 2 + b2*(Xb) 2 + 2rab*a*b*Xa*Xb

P = portfolio risk
Xa = proportion of investment in security A Xb = proportion of investment in security B R12 = correlation co-efficient between security 1 & 2 a

= standard deviation of security 1

b = standard deviation of security 2 For three securities:

p =(a)2(Xa)2+(b)2(Xb)2+ (c)2(Xc)2+ 2(Xa)(Xb)(rab)(a)(b) + 2(Xa)(Xc)(rac)(a)(c) + 2(Xb)(Xc)(rbc)(b)(c)

GACL & LNT: p = (0.57)2 *(56.91)2 +(0.43)2 *(65.12)2 +2(0.57)(0.43)(0.066)(56.91)(65.12) = 1956.259145 = 44.23 RANBAXY & CIPLA: p = (0.44)2 *(54.82)2 +(0.56)2 *(52.43)2 +2(0.44)(0.56)(0.65)(54.82)(52.43) = 2364.537348 = 48.63

MTNL & BHARTI ARTL: p =(-1.15)2 *(17.97)2+(2.15)2*(126.51)2+2(-1.15)(2.15)(0.95)(17.97)(126.51)

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= 63729.36593 = 252.45

ING VYSYA & ICICI: p = (0.03)2 *(68.25)2 + (0.97)2 *(38.83)2 +2(0.03)(0.97)(0.54)(68.25)(38.83) = 1506.140849 = 38.81

WIPRO & SATYAM: p = (0.59)2 *(34.76)2 + (0.41)2 *(40.41)2 +2(0.59)(0.41)(0.17)(34.76)(40.41) = 810.6233835 = 28.47

CALCULATION OF PORTFOLIO RETURN: Rp = W1R1 + W2R2 (for two securities) Rp = W1R1+ W2R2 + W3R3 (for three securities)
Where, W1, W2, W3 are the weights of the securities R1, R2, R3 are the Expected returns GACL & LNT: Rp = (0.57)(19.03) + (0.43)(63.69) = 38.2338 RANBAXY & CIPLA: Rp = (0.44)(9.02) + (0.56)(-8.25) = -0.6512

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MTNL & BHARTI ARTL: Rp = (-1.15)(13.17) + (2.15)(125.18) = 253.99 ING VYSYA & ICICI: Rp = (0.03)(12.46) + (0.97)(49.43) = 48.3209 WIPRO & SATYAM: Rp = (0.59)(-13.68) + (0.41)(16.82) = - 1.175

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CHAPTER VI CONCLUSION & SUGGESTIONS

Conclusions for Portfolio Risk, Return & Investments

When we form the optimum of two securities by using minimum variance equation, then the return of the portfolio may decrease in order to reduce the portfolio risk. GACL & LNT

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The prime objective of this combination is to reduce risk of portfolio. Least preference is given to the portfolio returns. As per the calculations GACL, bears a proportion of 0.57 whereas LNT bears a proportion of 0.43. The standard deviations of the companies are 56.91 for GACL and 65.12 for LNT. This combination yields a return of a return of 38.2338 and a risk of 44.23 respectively. RANBAXY & CIPLA As per the calculations RANBAXY, bears a proportion of 0.44 whereas CIPLA bears a proportion of 0.56. The standard deviations of the companies are 54.82 for RANBAXY and 52.43 for CIPLA. This combination yields a return of a return of -.6512 and a risk of 48.63 respectively. The investors shall not invest in this combination as there is negative return and there is not much difference in their standard deviation. MTNL & BHARTI ARTL The proportion of investment for MTNL is -1.15 and for BHARTI ARTL 2.15. BHARTI ARTL bears a major proportion which is dominating one. The standard deviations of the two companies are 67.97 and 126.51 respectively. This combination yields a return of 253.99 and a risk of 252.45. hence investor should invest his major proportion in BHARTI ARTL in order to minimize risk.

ING VYSYA & ICICI In this situation optimum weights of ING VYSYA and ICICI are 0.03 and 0.97 respectively. The portfolio risk is 38.81, which is lesser than the individual risks of two companies. Hence, it is recommended to invest the major proportion of the funds in ICICI, in order to reduce the portfolio risk. 80

WIPRO & SATYAM The proportion of investments for WIPRO is 0.59 and for SATYAM it is 0.41. The standard deviations of the companies are 34.76 and 40.41 respectively. This combination yields a return of -1.175 with a risk of 28.47.

SUGGESTIONS: Select your investments on economic grounds. Public knowledge is no advantage.

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 Buy stock with a disparity and discrepancy between the situation of the firm - and the expectations and appraisal of the public (Contrarian approach vs. Consensus approach). Buy stocks in companies with potential for surprises. Take advantage of volatility before reaching a new equilibrium. Listen to rumors and tips, check for yourself. Dont put your trust in only one investment. It is like putting all the eggs in one basket . This will help lesson the risk in the long term. The investor must select the right advisory body which is has sound knowledge about the product which they are offering. Professionalized advisory is the most important feature to the investors. Professionalized research, analysis which will be helpful for reducing any kind of risk to overcome.

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BIBLIOGRAPHY

BIBLIOGRAPHY Books referred: Security analysis and portfolio management by V.A. Avadhani

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 Security analysis and portfolio management by Fischer & Jordan Investment decisions by V.K. Bhalla Security analysis & portfolio management by Robbins Websites: www.smcindiaonline.com www.geojit.com www.investopedia.com www.capitalmarket.com www.icicidirect.com www.bse.com www.nse.com

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