“A Study “A Study on Portfolio Hedging using Option with special reference to Sharekhan Ltd, Kochi”
Submitted in partial fulfillment fulfillment of the requirements of the degree of MASTER OF BUSINESS ADMINISTERATION AMRITA UNIVERSITY BY SUVITHA K VIKRAM AM.BU.P2MBA16056
Under the guidance of Snigdha Sasidharan
AMRITA SCHOOL OF BUSINESS AMRITAPURI CAMPUS KOLLAM 2017
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DECLARATION
I hereby, declare that the project report titled ”A study on portfolio on portfolio hedging using option with special reference to Sharekhan Ltd, Kochi”, is Kochi”, is my original work and it was under the supervision of Snigdha Sasidharan, Amrita School of Business, Amritapuri. I also declare that this report has not been submitted by me fully or partially for the award aw ard of any degree,diploma,or any other similar title or recognition before.
Place:
Suvitha K Vikram
Date:
AM.BU.P2MBA16056
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ACKNOWLEDGEMENT I am very thankful to the Almighty God who led me in the right way to complete my m y project work successfully. A deal of time and much much effort have gone into developing and researching researching this project. Many people have helped directly and indirectly for the completion of this project. I would like to take this opportunity to thank the Amrita University for having project as part of MBA curriculum. I would like to express my sincere gratitude to Snigdha Sasidharan, Amrita School of o f Business, my project guide for providing guidance whenever needed. I express my sincere thanks to Mr. Ajith Rao, Branch Manager, Sharekhan Ltd. Kochi Branch and Mr. Boban Mathews, Relationship Manager, Sharekhan Ltd. Kochi Branch and my guide ,for giving me an opportunity to do the project in such an esteemed organization an providing me with all the help and encouragement. I would also like to sincerely thank all members in Sharekhan Ltd. Kochi Branch and the clients for their valuable time and useful insights on my research topic. I am grateful to my parents their never ending support and faith in me. Without their presence, carrying out this research would have been be en rather difficult. In the end, I am thankful to my friends for their constant source of encouragement and being there for me always.
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CONTENTS
CHAPTERS 1 2 3 4 5 6
TITLE INTRODUCTION LITERATURE REVIEW INDUSTRY AND COMPANY PROFILE DATA ANALYSIS AND INTERPRETATION FINDINGS SUGGESTION AND CONCLUSION BIBLIOGRAPHY
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PAGE NO. 6 8 10 13 26 29
EXECUTIVE SUMMARY Sharekhan by BNP PARIBAS is one of the leading brokerage firms in the country with more than eight decades of trust and credibility in the stock market. Asset management, distribution initiatives, core banking and training initiatives are the key areas of products and services provided by Sharekhan. It has one of the largest network of share shops in the country. The service delivery model of Sharekhan includes share shops, online trading (Trade tiger for active traders, web based classic interface for investors, web based applet – fast fast trade for investors). investors ). This study intends to examine the effectiveness of index options as a hedging instrument in Portfolio Risk Management and understanding the perception of active clients in Sharekhan Ltd. towards option trading. The first part of the study is purely based on the secondary data collected from websites of selected companies, moneycontrol.com and trade tiger. The second part of the study is based on the survey done for understanding the active client’s perception towards option trading. The 10 securities selected on the basis of market performance are analyzed by finding out their adjusted rate of return, beta value, alpha value, systematic risk, unsystematic risk, total risk and excess return to beta ratio. An optimal portfolio is constructed by using Sharpe’s S harpe’s optimization model. Cut model. Cut off point is calculated from the market variance, systematic risk and unsystematic risk of the 10 securities. It can be concluded that out of 10 companies 3 companies were selected for investment purpose on the basis of cut-off point which is 25.93. Option trading is looked upon as a strategy for risk f ree profits for investors. Strategies like ‘ buying buying call call’’ and ‘selling put’ put’ is most widely preferred option strategy by the active clients, majority of them are able to hedge their money and thus they feel satisfied with the strategy. Apart from the usual practice of trading construction constructio n of portfolio using Sharpe optimization optimization model is used here. Different tools like Sharpe Sharpe ratio, Treynor ratio and Jensen measure is used for portfolio evaluation. Performance of the optimal portfolio was less compared to the 3 other portfolios. For portfolio hedging, the initial portfolio value is assumed to be ₹ 2500000. Beta values of the securities are assumed to be constant for the hedge period selected. A dynamic hedging strategy is used for this purpose. A long position in portfolio is taken on 2ndJanuary 2017 by investing ₹2500000 in ₹2500000 in the portfolio. A short position in index index option option is simultaneously simultaneously taken taken by calculating calculating the appropriate number of index index options options contracts. nd st The portfolio is then continuously hedged from the period 2 January 2016 to 31 March 2017 by constantly monitoring the movement of the index. A questionnaire is provided to 52 active clients for understanding perception towards option option trading. Constructed 4 portfolios with the 3 selected securities (optimal portfolio, equal weight, and random numbers, P/E ratio). Performance Performance of equal weight portfolio was seen superior superior to that of other portfolio. Hedging nd
efficiency seemed less because the market had no much fluctuation during the 3 months starting from 2 Jan st
2017 to 31 March 2017.
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CHAPTER - 1 INTRODUCTION The concept of risk and return are central to financial investment. They form the major tension faced by investors. In exchange for bearing risk, investors require a higher return. In financial parlance, this is called the risk/return tradeoff and investors choose a risk/return combination based on their attitude towards risk. Determining the right tradeoff between risk and return is a complex process. In an uncertain investment environment, as we have now, determining the right trade-off between risk and return involves application of scientific portfolio management techniques like portfolio optimization models and employing hedging techniques using derivative instruments. Investment risk is of two types: systematic risk and unsystematic risk. Unsystematic risk of a portfolio can be reduced by diversification. The investor, by constructing an optimal portfolio using portfolio optimization models, can reduce the unsystematic risk considerably. Systematic risk can be removed by hedging with a derivative instruments like options and futures. Hedging is a mechanism to counter balance or minimize risk. In hedging an investor takes position in different types of derivative contracts with the aim to either eliminate or minimize the risk. Hedging is like an insurance against price fluctuation. PROBLEM STATEMENT
The project is an outcome of a study undertaken on options as an attempt to study the effectiveness of index options in controlling the risk of a portfolio. The project entitled “A Study on Portfolio Hedging Using Option with Special Reference to Sharekhan Ltd” attempts to study the effectiveness of optimization technique and dynamic hedging with index options in improving portfolio performance. The study first examine the effectiveness of Sharpe’s optimization model in designing and constructing an optimal portfolio for improved risk-return tradeoff. The optimality of the portfolio was then tested against three other portfolios constructed constructed using different criteria with performance measures like Sharpe ratio, Treynor ratio and Jensen ratio. Once the optimal portfolio is structured ,that optimal optimal portfolio is hedged with index options by using a dynamic hedging hedging strategy using index options in order to study the effectiveness of hedging portfolio risk with index options . SCOPE AND SIGNIFICANCE OF THE STUDY
Capital market is inherently volatile. The recent downturn in the global economy has added to the volatility of the capital market. Investor’s major concern in the present scenario is how to achieve an efficient trade-off between risk and return and how to protect their portfolio from the volatility of the market. The study “A Study on Portfolio Hedging Using Option with Special Reference to Sharekhan Ltd” is considered to be significant in the present volatile investment scenario and it focuses on how an efficient trade-off between risk and return can be achieved by employing a portfolio optimization technique and how effectively an investor can use options in protecting the value of her portfolio by undertaking a dynamic hedging strategy. Portfolio optimization and hedging are complex techniques; the scope of the study is limited only to the portfolio that is constructed using Sharpe optimization model and hedging with index options .The scope of the study is also limited to Indian stock market and Indian derivative market. OBJECTIVES
To examine the effectiveness of Index Options as a hedging instrument in Portfolio.
Understanding the perception of active clients in Sharekhan Ltd towards option trading 6
RESEARCH METHODOLOGY METHODOLOGY
The research design is the conceptual structure within which research will be conducted. The first part of the study is purely based on secondary data collected from Websites, Annual Reports, Journals, and Books. Different statistical tools like Sharpe ratio and Treynor ratios are used. Second part of the study purely based upon primary data (questionnaire) for understanding active client’s perception towards option option trading in Sharekhan Sharekhan Ltd. DESIGN OF THE STUDY
(a) Determine return and risk of each security. (b) Determine Beta value, Alpha value and Unsystematic risk (Residual variance) of each security. (c) Constructed 4 portfolios
By using Sharpe’s Sharpe’s optimization model and assigning optimal weight to each security in the portfolio. By giving equal weight to each security in the portfolio. By giving weight to the security on the basis of random numbers. By giving weight to each security based on price earnings ratio of each security. (d) Calculated the return and risk of each portfolio (e) Select best portfolio using Sharpe ratio, Treynor ratio and Jensen measure (f) Hedge the portfolio by adopting a dynamic hedging strategy using hedging options
PERIOD OF STUDY
The study was carried for a period of 10th April 2017 to 10th June 2017 LIMITATION (a)The duration of the study was limited to a period if two months so that an extensive and deep study could not be possible (b)Data is only considered for 1 year (1 st April 2016 to 31 st March 2017) (c) Out of the 10 stock were taken, only three were used to construct the portfolio (d) A well-diversified well-diversified portfolio cannot be constructed due to the time constraint (e) The Beta value taken for risk assessment is static beta. (f) Only dynamic hedging with index options is considered (g) Controlling risk and avoiding losses completely cannot be fully guaranteed.
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CHAPTER – 2 2 LITERATURE REVIEW RISK MANAGEMENT
Diversification always reduces non-systematic risk within a portfolio to a certain extent. Efficient portfolio is one that yields maximum expected returns, given a minimum level of risk given (ESTIMATIO ( ESTIMATION N RISK MODELING IN OPTIMAL PORTFOLIO SELECTION: AN EMPIRICAL STUDY FROM EMERGING MARKETS by Sarayut by Sarayut Nathaphan and Pornchai and Pornchai Chunhachinda ). Optimum portfolio selection within the capital market is primarily dependent on the best risk-return trade-off among the industry sectors. Suggestions from literature about the market volatility can be attributed to substantial increase in sector specific and sub-sector specific risks. Portfolio is the combination of securities such as stocks, bonds and money market instruments. The process of blending together the broad asset classes so as to obtain optimum return with minimum risk is called portfolio construction. Diversification Diversificat ion of investments helps to spread risk over many many assets (CONSTRUCTION OF OPTIMAL PORTFOLIO USING SHARPE INDEX MODEL & CAMP FOR BSE TOP 15 SECURITIES by Chintan A. Shah ). PORTFOLIO OPTIMIZATION
Portfolio theory examines the relationship that exist between risk and return when investing in equities . Obviously, investors are assumed to be risk averse, which means they wish to bear as little risk as possible for a given level of expected return, and the risk reducing benefits make it wiser to invest in a diversified diversified portfolio than in a single asset. Portfolio optimization optimizat ion is a hot topic nowadays, this new type of investment research and analysis begin from the concept concept of Markowitz Markowitz diversification diversification theory. Markowitz Model Model had serious serious practical limitations limitations due to the accuracy involved in the expected returns, standard deviation, variance, covariance of each security to every other security in the portfolio. Sharpe Model has simplified the process by relating the return in a security to a single market index. In the present study 10 companies listed at National National Stock Exchange (NSE) was selected taking Jan 2016 to March 2017 as period of study. The monthly opening and closing prices of the selected securities were used for the above mentioned period. Application of Single Index Model for the empirical analysis identified a portfolio of three companies based on the cut-off point of 25.93(THE SINGLE INDEX MODEL & THE CONSTRUCTION OF OPTIMAL PORTFOLIO: A CASE OF BANKS LISTED ON NSE INDIA by Saurabh Singh and Jayant Gautam). SHARPE’S SHARPE’S OPTIMIZATION OPTIMIZATION MODEL
Excess return is the difference between the expected on the stock and the risk-free rate of interest such as rate of return on the government securities . In the present study 10 companies compani es listed at National Stock Exchange nd st (NSE) was selected taking 2 Jan 2017 to 31 March 2017 as period of study. The monthly closing prices of the selected securities were used for the above mentioned period. It can be concluded that out of 10 companies only 3 companies were selected for investment purpose on the basis of Cut-off point which is 25.93. Application of Single Index Model for the empirical analysis identified a portfolio of three companies based on the cut-off point 25.93 (THE SINGLE INDEX MODEL AND THE CONSTRUCTION OF OPTIMAL PORTFOLIO WITH CNXPHARMA SCRIP by J. Francis Mary and G. Rathika).
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OPTION AND HEDGING
Option is a financial instrument whose value value depend upon the value of the underlying assets. Option itself has no value without underlying underlying assets. Option gives the right to the buyer either to sell or to buy the specified underlying assets for a particular price(Exercise / Strike price) on or before a particular date(expiration date).If the right is to buy, it is known as “call option” and if the right right is to sell, it is called as “put option ”. The buyer of the option has the right but no obligation to buy or to sell. The option buyer has to exercise the option or before the expiration date, otherwise, the option expires automatically at the end of the expiration date. Hence, options are also known as contingent claims. Such an instrument is extensively used in share markets, money markets and commodity market to hedge the investment risks and act as financial leverage investments. The sensitivity of managers’ stock and stock option portfolios to stock price increases, firms tend to hedge more. However, as the sensitivity of managers’ stock option portfolios to stock st ock return volatility increases, increases, firm tend to hedge less (THE VOLATLITY AND PRICE SENSITIVENESS OF MANAGERIAL STOCK OPTION PORTFOLIOS AND CORPORATE CORPORATE HEDGING by John D Knopf, Jouhan Jouhan Nam, and John H. Thornton Jr.). Jr.). Option is a kind of derivative instruments along with forwards, futures and swaps, which are used for managing risk of the investors. Though derivatives are theoretically risk management tools and leverage investment tools, most use them as speculative tools.
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CHAPTER-4 INDUSTRY PROFILE AND COMPANY PROFILE
The Indian capital market is the market for the long-term capital. It refers to all the facilities and institutional arrangements for borrowing and lending short-term funds, medium funds and long-term funds. The requirements of the long-term fund arise from the private and public manufacturing countries, trading and transport units etc. The Central and State Governments raise substantial funds from the capital market. The major fund coming to the capital market is from individual investors, corporate savers, commercial banks, insurance companies, public provident funds and other agencies. The Indian capital market comprises mainly industrial securities market, financial intermediaries, development financial institutions like IFCI,ICICI,IDBI,SIDBI etc. and investment institutions like UTI, LIC, GIC etc. The capital market is a major segment of the financial system of a country. It operates as a switching mechanism for transfer of funds to meet the long-term needs of the private and public enterprises. It is the market that deals in financial assets, which have a long or indefinite maturity. Capital market generally deals with long term securities. The term capital market is used to denote all operations in the new issues and stock market
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FUNCTIONS OF CAPITAL MARKET
To speed up financial disintermediation To mobilize savings, which are scattered To provide different avenues to investors to park their savings depending upon their risk To provide liquidity to different instruments Capital market developments can be taken as a barometer to show the strength or otherwise of the company. Capital market can be divided into 3 categories:
Industrial securities market Government securities market Long term loans market
INDUSTRIAL SECURITIES MARKET
Industrial securities market deals in industrial securities like equity shares, preference shares and debentures or bonds. Industrial organizations mobilize their capital requirements through these securities. Industrial markets are classified as follows:
Primary market and Secondary market
The primary market enables the government as well corporate in raising the capital that is required to meet their requirements of capital expenditure and/or discharge of their obligations such as exit opportunities for venture capitalist/PE firms. The primary market is governed by the provisions of the Companies Act, 1956, which deals with issues, listing, and allotment of securities. Additionally, SEBI prescribes the eligibility and disclosure norms through the ICDR Regulations 2009 that the issuer and the promoter need to comply with for assessing the market.
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FEATURES OF PRIMARY MARKET
It is a market for long term corporate securities that is equit y and debt It is a market where issuers sell shares directly to the investing public
productive purposes Primary market is for channelizing the savings of the public for productive SECONDARY MARKET
Secondary market deals with the buying and selling of securities already issued by the joint stock companies. Securities, which are traded in the secondary stock market, are required to list their securities in a recognized stock exchange. The stock exchanges in India are regulated under the Securities Contract (Regulation) Act, 1956 and SEBI. SEBI formulates the rules, the regulations and the procedures to be followed for trading in the secondary markets. . The stock exchanges in India are regulated under the Securities Contract (Regulation) Act, 1956 and SEBI. SEBI formulates the rules, the regulations and the procedures to be followed for trading in the secondary markets. markets. Stock exchange is a medium of transfer of resources for those securities, which have already been issued. It also plays an important role in the transfer of securities with the companies whose shares being deal with, as the process the registration of shares must be done when they are transferred. Secondary markets do not create financial claims. In this market, funds do not flow between sellers of and buyers of securities. The securities market has essentially three categories of participants- the issuer of the securities, the investors in the securities, and the intermediaries. The issuers are the borrowers or deficit savers, who issue securities to raise funds. The investors, who are surplus savers, deploy their savings by subscribing to these securities. The intermediaries intermediari es are the agents who match the needs of the users and the suppliers of funds for a commission. These intermediaries function to help both the issuers and the investors to achieve their respective goals. There are a large variety and number of intermediaries providing various services in the Indian securities market. This process of mobilizing the resources is carried out under the supervision and overview of the regulators. The regulators develop fair market practices and regulate the conduct of the issuers of securities and the intermediaries. The regulator ensures a high service standard from the intermediaries, as well as the supply of quality securities and non- manipulated demand for them in the market
COMPANY PROFILE ShareKhan is one of the leading brokerage firms in the country. It is the retail brokerage arm of the Mumbai-based SSKI (Shripal, Shewantilal, Kanthilal, Iswarnath Limited). ShareKhan Ltd is a brokerage firm which is established on 8 th February 2000. ShareKhan is India’s third largest stock broker (after ICICI Direct and HDFC securities). ShareKhan provides brokerage service through its online trading web site sharekhan.com and 1800 offices which include branches and franchises in over 550 cities across India. ShareKhan has seen incredible growth over last 10+ years through its very successful online trading platform and the chain of franchises located in almost every part of India. ShareKhan also has international presents in the UAE and Oman. ShareKhan offers its services to all kinds of customers including individual investors and traders, corporate, institutional and NRI’s. As of December 2014, ShareKhan has over 13 lack customers. ShareKhan offers trade execution facilities for equities, cash and derivative segments on BSE and NSE, Commodities trading facilities on MCX and NCDEX. Share/khan also offers depository service (Demat account) and option to invest in mutual funds and IPO’s.
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Sharekhan.com is the finest portal for India stock market. The well designed web sites provides wide range of investment options, share market news ,research reports, stock quotes ,fundamental and statistical information informati on across equity, IPOs and much more. Share khan also offers Sharekhan Trade Tiger one of the most popular trading terminals, for f or retail investors. The trade tiger is quite similar to broker terminal and allows frequent traders to place and execute their orders at a high speed. It also provide live data and other tools on the same screen to help the users with their trades. Sharekhan ‘Share Mobile’ platform offers trading facility through mobile apps are available available for popular iPhone, iPhone, iPad, Blackberry, Blackberry, Android and other phones. Sharekhan offers offers variety of accounts to suit customer requirement. requir ement. These accounts include Sharekhan first step Account, Accoun t, Sharekhan Classic Account, Sharekhan Trade Tiger Account and Portfolio Management Services (PMS) through Sharekhan Platinum Circle Account. SHAREKHAN BUSINESS
1. Brokering business. 2. White feathering house production.
Among the top three (3) branded retail services providers (Rs. 856 cr average daily volume.NO. 2 player in online business. Large network of branded broking outlets in the country servicing around 5, 45, 000 Clients. BENEFITS
Free Depository A/c Secure Order by Voice Tool Dial-n-Trade.
Automated Portfolio to keep track of the value of your actual purchases.
24x7 Voice Tool access to your trading account.
Personalized Price and Account Alerts delivered instantly to your Cell Phone & E-mail address.
Special Personal Inbox for order and trade confirmations. On-line Customer Service via Web Chat. Anytime Ordering. NSDL Account Account
Instant Cash Tranferation.
Multiple Bank Option.
Enjoy Automated Portfolio. Buy or sell even single share
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CHAPTER-4 DATA ANALYSIS AND INTERPRETATION RETURN, RISK AND RISK ADJUSTED RATE OF RETURN
Risk adjusted rate of return = (R i - Rf)/ᴃ Rf)/ᴃ R ᵢ (Return) =Average return of the individual securities in the portfolio Β (Risk) = Beta value of the security
R f f( Risk free rate of return) = 6.91 % ADJUSTED RATE OF RETURN
SECURITY YES BANK KOTAK MAHINDRA BANK CIPLA SUN PHARMA IDEA BHARTI AIRTEL ONGC GAIL BAJAJ AUTO HERO MOTOCORP
R i 57.72 23.16 12.96 -19.92 -11.04 3.84 20.64 35.88 14.64 4.2
R f f 6.91 6.91 6.91 6.91 6.91 6.91 6.91 6.91 6.91 6.91
(R i – R R f f ) ) 50.81 16.25 6.05 -26.83 -17.95 -3.07 13.73 28.97 7.73 -2.71
β 1.41 0.74 0.52 0.73 0.82 0.78 0.51 0.75 0.82 1
(R i – R R f f )β 36.03546099 21.95945946 11.63461538 -36.75342466 -21.8902439 -3.935897436 26.92156863 38.62666667 9.426829268 -2.71
Source: Computed by researcher using secondary data
Inference:
The risk adjusted rate of return is the return the investor can expect while considering the risk associated with it. The above chart shows that Baja auto and Yes bank have the high return with risk adjusted rate of return of 38.62 and 36.03 respectively. respectively. Also negative rate of return is there in the chart. BETA VALUE OF SECURITIES
SECURITY YES BANK KOTAK MAHINDRA BANK CIPLA SUN PHARMA IDEA BHARTI AIRTEL ONGC GAIL BAJAJ AUTO HERO MOTOCORP
β 1.41 0.74 0.52 0.73 0.82 0.78 0.51 0.75 0.82 1
Source: Computed by researcher using secondary data
Inference:
The beta value indicates the measure of systematic risk of security. From the above table it can be inferred that beta value is maximum for Yes bank indicating that it has maximum systematic risk
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ALPHA VALUES OF SECURITIES Inference:
Alpha is used to measure the performance on a risk adjusted basis. Here, the alpha value is maximum for Yes bank and minimum for Sun pharma. SECURITY
R i
YES BANK KOTAK MAHINDRA BANK CIPLA SUN PHARMA IDEA BHARTI AIRTEL ONGC GAIL BAJAJ AUTO HERO MOTOCORP
β
57.72 23.16 12.96 -19.92 -11.04 3.84 20.64 35.88 14.64 4.2
MARKET RETURN 1.29 1.29 1.29 1.29 1.29 1.29 1.29 1.29 1.29 1.29
1.41 0.74 0.52 0.73 0.82 0.78 0.51 0.75 0.82 1
α 57.6 23.71 13.73 -19.35 -10.55 4.35 21.44 36.43 15.11 4.49
Source: Computed by researcher using secondary data
SYSTEMATIC RISK .
SECURITY ᴃ YES BANK KOTAK MAHINDRA BANK CIPLA SUN PHARMA IDEA BHARTI AIRTEL ONGC GAIL BAJAJ AUTO HERO MOTOCORP
1.41 0.74 0.52 0.72 0.8 0.78 0.49 0.74 0.82 1
ᴃ^2 1.9881 0.5476 0.2704 0.5184 0.64 0.6084 0.2401 0.5476 0.6724 1
MARKET STANDARD DEVIATION 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75
MARKET VARIANCE 7.5625 7.5625 7.5625 7.5625 7.5625 7.5625 7.5625 7.5625 7.5625 7.5625
SYSTEMATIC RISK 15.03500625 4.141225 2.0449 3.9204 4.84 4.601025 1.81575625 4.141225 5.085025 7.5625
Source: Computed by researcher using secondary data
Inference:
The systematic risk or market risk is the one which cannot eliminate by portfolio construction. Highest risk is for Yes bank and lowest is for ONGC. RESIDUAL VARIANCE
SECURITY YES BANK KOTAK MAHINDRA BANK CIPLA SUN PHARMA IDEA BHARTI AIRTEL ONGC GAIL BAJAJ AUTO HERO MOTOCORP
(σі)2
(σі) 7.94 4.96 5 5.44 10.35 6 5.36 5.28 4.52 4.56
63 .0436 24.6016 25 29.5936 107.1225 36 28.7296 27.8784 20.4304 20.7936
Source: Computed by researcher using secondary data
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systematic risk 15.0350062 4.141225 2.0449 3.9204 4.84 4.601025 1.81575625 4.141225 5.085025 7.5625
Residual variance(Unsystematic variance(Unsystematic risk) 48.00859375 20.460375 22.9551 25.6732 102.2825 31.398975 26.91384375 23.737175 15.345375 13.2311
Inference:
From the diagram, the highest unsystematic risk is for Idea and the security have the lowest unsystematic risk is for Heromotocorp. Heromotocorp.
COMPOSITION OF TOTAL RISK OF SECURITIES Total Risk = Systematic Risk + Unsystematic Risk SECURITY YES BANK KOTAK MAHINDRA BANK CIPLA SUN PHARMA IDEA BHARTI AIRTEL ONGC GAIL BAJAJ AUTO HERO MOTOCORP
Total risk 63.0436 24.6016 25 29.5936 107.1225 36 28.7296 27.8784 20.4304 20.7936
Source: Computed by researcher using secondary data
Inference:
Risk of a security is the variation of return of that security. Security having higher return will always possess high high risk. Here high risk is in Idea that is 102. 102. PORTFOLIO CONSTRUCTION
It refers to the allocation of funds among a variety of financial assets open for investment. The objective of portfolio construction is to diversification of the risk . SHARPE’S OPTIMIZATION MODEL
Steps in construction of portfolio are given below: A) Calculate the excess return to beta ratio for each stock under consideration and rank them from the highest to the lowest. B) The stocks are ranked on the basis of excess return to beta ratio, it represents the desirability of any stock inclusion. C).After ranking the securities, the next step is to find out the cutoff point with the the use of following formula formula C = σ2m Ʃ (R i – R R f )βi/ σ2e 1+σ2m +Ʃ (βi2/σ2ei) σ2m = market variance, σ2ei = systematic risk, R i = expected return of the stock, R f = risk free rate of return, β = Beta of the stock
D) Calculate the proportion to be invested in each security
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EXCESS RETURN TO BETA RATIO
SECURITY GAIL YES BANK ONGC KOTAK MAHINDRA BANK CIPLA BAJAJ AUTO HEROMOTOCORP HEROMOTOCORP BHARTI AIRTEL IDEA SUN PHARMA
(Ri) 35.88 57.72 20.64 23.16 12.96 14.64 4.2 3.84 -11.04 -19.92
(Rf) 6.91 6.91 6.91 6.91 6.91 6.91 6.91 6.91 6.91 6.91
(Ri - Rf) 28.97 50.81 13.73 16.25 6.05 7.73 -2.71 -3.07 -17.95 -26.83
ᴃ
(Ri - Rf )/ᴃ )/ᴃ 38.62666667 36.55395683 26.92156863 21.38157895 11.63461538 9.426829268 -2.71 -3.935897436 -21.8902439 -36.75342466
0.75 1.39 0.51 0.76 0.52 0.82 1 0.78 0.82 0.73
Rank 1 2 3 4 5 6 7 8 9 10
Source: Computed by researcher using secondary data
STEPS TO CUT OFF RATE AND CALCULATION OF CUT OFF RATE SECURITY GAIL YES BANK ONGC KOTAK MAHINDRA BANK CIPLA BAJAJ AUTO HEROMOTOCORP HEROMOTOCORP BHARTI AIRTEL IDEA SUN PHARMA
(σ2ei) 4.141225 15.03500625 1.81575625 4.141225 2.0449 5.085025 7.5625 4.601025 4.84 3.9204
(R ᵢ-R f f)*βᵢ/σ ) *βᵢ/σ2ei 5.246635959 4.697430704 3.856409692 2.98220937 1.538461538 1.246522878 -0.358347107 -0.520449248 -3.041115702 -4.995893276
(R ᵢ-R f f)βᵢ ) βᵢ 21.7275 70.6259 7.0023 12.35 3.146 6.3386 -2.71 -2.3946 -14.719 -19.5859
Ʃ(R ᵢ-R f f)*βᵢ/σ ) *βᵢ/σ2ei 5.246635959 9.944066664 13.80047636 16.78268573 18.32114726 19.56767014 19.20932304 18.68887379 15.64775808 10.65186481
Source: Computed by researcher using secondary data
SECURITY GAIL YES BANK ONGC KOTAK MAHINDRA BANK CIPLA BAJAJ AUTO HEROMOTOCORP HEROMOTOCORP BHARTI AIRTEL IDEA SUN PHARMA
market variance 7.57 7.57 7.57 7.57 7.57 7.57 7.57 7.57 7.57 7.57
Ʃ(R ᵢ-Rf)*βᵢ/σ^2ei 5.2 9.9 13.8 16.4 18.5 19.9 19.9 18.69 15.76 10.3
Σ(βᵢ^2)/σ^2ei
cut off point (Ci)
0.3 0.8 0.4 0.57 0.64 0.82 0.9 1.01 1.22 1.35
12.03 10.62 25.93 23.35 23.96 20.9 19.28 16.36 11.65 6.94
Source: Computed by researcher using secondary data
RELATIVE INVESTMENT IN EACH SECURITY AND WEIGHT O F SECURITY SECURITY GAIL YES BANK ONGC SUM
market variance 7.57
Ʃ(R ᵢ-Rf)*βᵢ/σ2ei 5.246635959
Σ(βᵢ^2)/σ2ei 0.135829374
cut off point (Ci) 19.58213136
7.57 7.57
9.944066664 13.80047636
0.264336138 0.407582237
25.08362827 25.57146644 Σzi Σzi
Source: Computed by researcher using secondary data
SECURITY GAIL YES BANK ONGC SUM
Zi -0.69616 4.165323 0.076913 3.546071
Weight (Xi) -0.196320009 1.174630474 0.021689535 1
Source: Computed by researcher using secondary data .
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Zi -0.69616 4.165323 0.076913 3.546071
(βᵢ^2)/σ2ei 0.135829374 0.128506764 0.143246099 0.139475638 0.132231405 0.132231405 0.132231405 0.132231405 0.13892562 0.135930007
CRITERIA USED FOR THE CONSTRUCTION OF PORTFOLIO
The first portfolio is constructed constructed by using us ing Sharpe’s optimization model SECURITY GAIL YES BANK ONGC SUM
Weight (Xi) -0.19 1.17 0.02 1
Weight (%) -19.63 117.46 2.16 100
Source: Computed by researcher using secondary data
PORTFOLIO (1) ALPHA, BETA AND RESIDUAL VARIANCE
SECURITY GAIL YES BANK ONGC SUM
Alpha 36.43 23.71 21.44 81.58
Weight(Wi) -0.2 1.17 0.02
Alpha*Weight -7.15 27.85 0.46 21.16
Source: Computed by researcher using secondary data
SECURITY GAIL YES BANK ONGC SUM
Beta 0.74 1.41 0.49 2.64
Weight -0.19632 1.17463 0.02169
beta*weight -0.145 1.65 0.010 1.52
Source: Computed by researcher using secondary data
SECURITY GAIL YES BANK ONGC SUM
Residual variance 4.141225 15.03500625 1.81575625
weight -0.19632 1.17463 0.02169
2
Wi
0.038541546 1.37975675 0.000470436
(Wi2)*Residual variance 0.159609214 20.74465136 0.000854197 20.90511477
Source: Computed by researcher using secondary data
PORTFOLIO (1) RETURN AND RISK
PORTFOLIO 1 Alpha (αp) (αp) Beta (βp) (βp) Average return of index Portfolio Return
21.16357424 1.521580034 1.291334944 23.1284437
Source: Computed by researcher using secondary data
PORTFOLIO 1 β^2p β^2p σ^2m σ^2m ƩWi^2*σ^2ei ƩWi^2*σ^2ei portfolio risk,σp^2 risk,σp^2 σp σp
2.315205799 7.57 20.90511477 38.43122267 6.19929211
Source: Computed by researcher using secondary data
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