1. Security Analysis and Portfolio Management Power Points by Aditi Rode

2. Some Important Formulas Expected Return = ∑ Prob * Return Variance = ∑ ( r – Er )^2* Prob Standard Deviation = Square root Variance

3. Coefficient of Variation = Standard deviation/expected return Beta = Cov (Market and stock ) / Var of Market

4. Capital Asset Pricing Model (CAPM) Require Rate of Return as per CAPM Model R = Rf + Beta * ( Rm – Rf ) Risk Premium = Beta * ( Rm – Rf )

5. Relationship Between Risk & Expected Return – Security Market Line Expected return  1.0

6. Some important Concepts Correlation Coefficient Market Risk or Systematic Risk Diversifiable Risk or Unsystematic Risk Efficient Frontier Capital Market Line

7. Correlation Coefficient Two stocks can be combined to form a risk less portfolio if  = -1.0. Risk is not reduced at all if the two stocks have  = +1.0. In general, stocks have   0.65, so risk is lowered but not eliminated. Investors typically hold many stocks. What happens to the risk where the portfolio has many stocks?

8. Stand Alone Risk = Market Risk + Diversifiable Risk Market Risk Political Risk Inflation Risk Interest Rate Risk Diversifiable Risk Default Risk Operational Risk Financial Risk Business Risk

9. The Efficient Set for Many Securities The section of the opportunity set above the minimum variance portfolio is the efficient frontier. return PP minimum variance portfolio efficient frontier Individual Assets

10. Portfolios Involving Riskless Borrowing and Lending With a risk-free asset available and the efficient frontier identified, we choose the capital allocation line with the steepest slope return PP efficient frontier rfrf CML

11. 11 Practice Problems

12. Calculate the Risk and Beta for Zee

13. Steps Step 1 Calculate the expected return Step 2 Calculate the Variance Step 3 Calculate the Beta

14. Expected Return

15. Risk for Zee

16. Risk for Market

17. Risk V/s Return

18. Calculation of Covariance of Market and stock

19. Calculation of Beta Beta = Cov (Market and stock ) / Var of Market Beta = 210.4 / 161 Beta = 1.31

20. 20 Should the investor liquidate his holding in A and B or make fresh investments in A and B ? Risk free return is 7%. The assumptions of CAMP hold good.

21. Steps Step 1 – Calculate the expected return of stock A, B and Market and, Variance and SD of market Step 2 – Calculate the covariance of the stocks with the market Step 3 – Calculate the Beta for the stocks Step 4 – Use the CAPM model to determine the required rate of return Step 5 – Calculate the alpha and determine whether the stocks are overpriced or under priced 21

22. Expected Return Σr*P 22

23. Expected Return Σr*P 23

24. Expected Return Σr*P 24

25. Variance of Market 25

26. Covariance of A with Market 26

27. Covariance of B with Market 27

28. Beta = Cov sm / Var M Beta for A = 57.34/62.51 = 0.92 28

29. Calculation of require rate of return as per CAPM model R = Rf + Beta ( Rm – Rf ) A = 7 +.92* ( 12.3 – 7 ) A = 7 +.92 * 5.3 A = 7 + 4.88 A = 11.88 Alfa = Expected Rate – Require Rate of Return Alfa = 14.05 – 11.88 = 2.17 29

30. Decision Making Alfa is positive 2.17. That means as per the risk of the stock the return should be 11.88 but as the expected return is 14.05 the stock is giving higher return in proportion to its risk. Thus an positive Alfa denotes that stock is undervalued.

31. Beta = Cov sm / Var M Beta for B = 50.37/62.51 = 0.81 31

32. Calculation of require rate of return as per CAPM model R = Rf + Beta ( Rm – Rf ) B = 7 +.81* ( 12.3 – 7 ) A = 7 +.81 * 5.3 A = 7 + 4.29 A = 11.29 Alfa = Expected Rate – Require Rate of Return Alfa = 11.95 – 11.29 = 0.66 32

33. Decision Making Alfa is positive.66. That means as per the risk of the stock the return should be 11.29 but as the expected return is 11.95 the stock is giving higher return in proportion to its risk. Thus an positive Alfa denotes that stock is undervalued.

34. What is the Market Risk for A? Total Risk = Variance = Systematic Risk + Unsystematic Risk Market Risk = Var Market * (Beta)^2 Market Risk A = 62.51*(.92)^2 Market / Systematic Risk A = 52.91

35. What is the Unsystematic Risk for a ? Total risk = Variance = 54.85 Total Risk = Systematic + Unsystematic 54.85 = 52.91 + Unsystematic Unsystematic = 54.85 – 52.91 = 1.94

36. Proportion of Systematic and Unsystematic Risk % of Systematic Risk in Total Risk 52.91/54.85*100 = 96.47% % of Systematic Risk in Total Risk 1.94/54.85*100 = 3.53%

37. Conclusion The stock specific risk of the stock stands as low as 3.53 %.

38. What is the Market Risk for B? Total Risk = Variance = Systematic Risk + Unsystematic Risk Market Risk = Var Market * (Beta)^2 Market Risk B = 62.51*(.81)^2 Market / Systematic Risk B = 41

39. What is the Unsystematic Risk for a ? Total risk = Variance = 46.15 Total Risk = Systematic + Unsystematic 46.15 = 41 + Unsystematic Unsystematic = 46.15 – 41 = 5.15

40. Proportion of Systematic and Unsystematic Risk % of Systematic Risk in Total Risk 41/46.15*100 = 88.85% % of Unsystematic Risk in Total Risk 11.16/46.15*100 = 11.16%

41. Conclusion The stock specific risk of the stock stands at 11.16% and is B is higher than stock A..

42. Consider the following data Find the missing data

43. Beta for A Beta = Cov / Market Var Beta = 205 / 225 Beta = 0.91

44. Covariance of B with Market Beta = Cov / Market Var 1.2 = Cov / 225 Cov = 1.2 * 225 = 270

45. Assignment Analysis of stocks in different industries using the following approaches.

46. Approaches EIC – Economy, Industry and Company Structural Analysis / Michael Porter Analysis Calculation of Var, SD and CV Calculation of Beta of the various stock and comparison of the same Calculation of Expected Return using CAPM

47. Structural Analysis Threat of Entry Bargaining Power of Buyers Bargaining Power of Suppliers Threat of Substitute Intensity of Competition among the existing players

48. Industry Automobile Aviation Telecommunication Capital Goods Industry Insurance Media

49. Industry Infrastructure Pharmaceutical FMCG Petroleum Banking