A PROJECT REPORT

on

A STUDY OF THE OPTIMAL PORTFOLIO CONSTRUCTION USING

SHARPES SINGLE INDEX MODEL WITH SPECIAL REFERENCE TO
BSE 100 SHARES

Undertaken by

PRATIK UDAY

(Reg No CUJ/I/2013/IMBA/021)

Under the guidance of

Dr. Rishi Dwivedi

CENTRE FOR BUSINESS ADMINISTRATION

CENTRAL UNIVERSITY OF JHARKHAND

 ACKNOWLEDGEMENT

This project would have been complete without acknowledging my sincere gratitude
to all the persons who have applied me in carrying out study and in preparation of
this project.
I owe my sincere gratitude to Prof. Ashok Kumar Sarkar, Head of Department,
Centre for Business Administration, Central University of Jharkhand for providing
me the opportunity to take up this project work.
I wish to thank Dr. Rishi Dwivedi, Project guide who provided expert guidance
throughout this project.
I wish to thank all faculty members of Centre for Business Administration, Central
University of Jharkhand who provided expert guidance throughout my project.
I express my sincere thanks to my family and friends for their support in completing
project on time.
I thank the God, Almighty and most benevolent for giving me the courage and
wisdom to complete this project as per schedule.

ii
 Table of Contents
Chapter Title Page No
1 Introduction 1-2
2 Industry Profile 3-15
i) Stock Market 3-4
ii) Stock Exchange 5-8
iii) History of Indian Stock Exchange 9
iv) Major Stock Exchanges in India 10-13
3 Literature Review 14-15
4 Research Methodology 16-17
i) Problem Statement 16
ii) Need for the Study 16
iii) Objective of the Study 16
iv) Research Design 17
v) Data Collection 17
vi) Methodology 17
vii) Limitations of the Study 17
5 Theoretical Framework 18-45
i) Portfolio Construction 18
ii) Approaches to Portfolio Constructions 18
iii) Traditional Approach 18
iv) Security Analysis 19-33
v) Portfolio Analysis 34
vi) Portfolio Selection 34
vii) Portfolio Revision 34
viii) Portfolio Evaluation 34
ix) Return and Risk Analysis of Portfolio 34-36
x) Modern Approaches to Portfolio 37-44
Selection
xi) Portfolio Evaluation Methods 44-45

iii
 6 Data Analysis and Interpretations 47-74
i) List of BSE 100 Index Shares 48-49

ii) Analysis of Securities 50

iii) Risk Analysis of Securities 51-66
iv) Construction of Optimal Portfolio using 67-68
Sharpes Single Index Model
v) Measuring Return and Risk of Optimal 69-74
Portfolio
7 Conclusion 75-76
i) Findings 75
ii) Suggestions 76
8 References 77

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Introduction

Portfolio is a bundle of or a combination of individual assets or securities. The

portfolio theory provides normative approach to investors to make decisions to
invest their wealth in assets or securities under risk (See Mullins 1982 and Butters
et. al.). It is based on the assumption that investors are risk-averse. This implies that
investors hold well diversified portfolios instead of investing their entire wealth in a
single or few assets. Investors who are risk-averse reject investment portfolios that
are fair games or worse. Risk-averse investors are willing to consider only risk-free
or speculative prospects with positive risk premiums. Loosely speaking, risk-averse
investors penalize the expected return of the risky portfolio by certain percentage
to account for risk involved. Greater the risk, greater the penalty. A rational investor
is a person that desires to maximize their return with less risk on his investment in a
portfolio. For this purpose investor has to construct a portfolio of assets which is an
efficient portfolio (minimum risk for a given expected return) which comprises of
different classes of assets. Determining efficient portfolios within an asset class (e.g.,
stocks) can be achieved with the single index (beta) model proposed by Sharpe. In
the early 1960s, the investment community talked about risk, but there was no
specific measure for the term. To measure risk or to avoid risk investor had to
quantify their risk variable by building a basic portfolio model. The basic portfolio
model was developed by Harry Markowitz (1952, 1959), who derived the expected
rate of return. Markowitz showed that the variance of the rate of return was a
meaningful measure of portfolio risk under reasonable set of assumptions, and he
derived the formula for computing the variance of a portfolio as variance is a
measure of risk. The Markowitz model is based on several assumptions regarding
investor behavior. (1) Investor considers 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 their utility curves
demonstrate diminishing marginal utility of wealth. (3) Investors estimate the risk
of the portfolio on the basis of the variability of expected return. (4) Investors base
decisions solely on expected return and risk, so their utility curves are a function of
expected return and the expected variance of returns only. (5) For a given level of
risk, investor prefers higher 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 assets offers
higher expected return with the same (or lower) risk or lower risk with the same (or
higher) expected return. Harry Markowitz model has certain drawbacks. These are:
The model requires huge number of estimates to fill the covariance matrix. The
model does not provide any guidelines to the forecasting of the security risk
1
premiums that are essential to construct the efficient frontier of risky assets.
Identification of this, several studies and research had been done to develop simple
index model for portfolio. William Sharpe is among many who tried to simplify the
Markowitz model and developed Sharpe index model which reduces substantially
its data and computational requirements. The simplified model assumed that the
fluctuations in the value of stock relative to other stocks do not depend on the
characteristics of those two securities alone. The two securities are more suitable or
appropriate to describe business condition. Relationship between securities occurs
only through their individual relationships with some indexes of business activity.
The reduction in the number of covariance estimates needed eases considerably he
job of security analysis and portfolio- analysis computation. Thus the covariance
data requirement reduces from (N2 N)/2 under the Markowitz technique to only N
measures of each security as it relates to the index.

2
 Industry Profile
2.1 Stock Market

Capital Market is the financial market for equity instruments and debt instruments
with a maturity greater than one year. The Capital market includes both primary
market and secondary markets.

The Primary market is the market that deals with new securities, i.e., the securities
that are offered to the investing public for the first time. So it is a market for new
issues. Because of that, it is also called the new issues market.

The Secondary market is the market in which existing securities are traded. This
market also known as stock market. A stock market, equity market or share
market is the aggregation of buyers and sellers (a loose network of economic
transactions, not a physical facility or discrete entity) of stocks (also called shares),
which represent ownership claims on businesses; these may include securities listed
on a public stock exchange as well as those only traded privately. Examples of the
latter include shares of private companies which are sold to investors through equity
crowd funding platforms. Stock exchanges list shares of common equity as well as
other security types, e.g. corporate bonds and convertible bonds.

3
2.1.1 History of Stock Market

In 12th-century France, the courtiers de change were concerned with managing and
regulating the debts of agricultural communities on behalf of the banks. Because
these men also traded with debts, they could be called the first brokers.

In the middle of the 13th century, Venetian bankers began to trade in government
securities. In 1351 the Venetian government outlawed spreading rumors intended to
lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence
also began trading in government securities during the 14th century. This was only
possible because these were independent city-states not ruled by a duke but a council
of influential citizens. Italian companies were also the first to issue shares.
Companies in England and the Low Countries followed in the 16th century.

The Dutch East India Company (founded in the year of 1602) was the first joint-
stock company to get a fixed capital stock and as a result, continuous trade in
company stock occurred on the Amsterdam Exchange. Soon thereafter, a lively trade
in various derivatives, among which options and repos, emerged on the Amsterdam
market. Dutch traders also pioneered short selling a practice which was banned by
the Dutch authorities as early as 1610.[19]

There are now stock markets in virtually every developed and most developing
economies, with the world's largest markets being in the United States, United
Kingdom, Japan, India, China, Canada, Germany (Frankfurt Stock Exchange),
France, South Korea and the Netherlands.

4
2.2 Stock Exchange

A stock exchange is a place where, or an organization through which, individuals

and organizations can trade stocks. Many large companies have their stock listed on
a stock exchange. This makes the stock more liquid and thus more attractive to many
investors. It may also act as a guarantor of settlement. Other stocks may be traded
"over the counter" (OTC), that is, through a dealer. Some large companies will have
their stock listed on more than one exchange in different countries, so as to attract
international investors.

Stock exchanges may also cover other types of securities, such as fixed interest
securities (bonds) or (less frequently) derivatives, which are more likely to be traded
OTC.

2.2.1 Functions and Purpose of Stock Market

(1) Providing Liquidity and Marketability to Existing Securities:

Stock exchange is a market place where previously issued securities are traded.
Various types of securities are traded here on regular basis. Whenever required, an
investor can invest his money through this market into securities and can reconvert
this investment into cash. Availability of ready market for sale and purchase of
securities increases their marketability and enhances liquidity.

(2) Pricing of Securities:

A stock exchange provides platform to deal in securities. The forces of demand and
supply work freely in the stock exchange. In this way, prices of securities are
determined.

(3) Safety of Transactions:

Stock exchanges are organized markets. They fully protect the interest of investors.
Each stock exchange has its own laws and bye-laws. Each member of stock
exchange has to follow them and if any member is found violating them, his
membership is cancelled.

For instance, if any broker working in stock exchange charges more commission
than stipulated from any investor or misleads him in any other way, then the
management committee of the stock exchange can fine the broker and even his
membership can be cancelled.

5
(4) Contributes to Economic Growth:
A stock exchange provides liquidity to securities. This gives the investor a double
benefit-first, the benefit of the change in the market price of securities can be taken
advantage of, and secondly, in case of need for money they can be sold at the existing
market price at any time.

These advantages provided by the share market encourage the people to invest their
money in securities. In this way, peoples money gets invested in industries and
economic development becomes possible.

2.2.2 Physical and Electronic Exchanges

Some exchanges are physical locations where transactions are carried out on a
trading floor, by a method known as open outcry. An example of such an exchange
is the New York Stock Exchange. The outer type of stock exchange is a virtual kind,
composed of network of computers where traders are made electronically by traders.
An example of such an exchange is the National Stock Exchange of India (NSE).

The National Stock Exchange of India (NSE) is a virtual listed exchange, where all
of the trading is done over a computer network. The buyers and sellers are
electronically matched. One or more market makers will always provide a bid and
ask price at which they will always purchase or sell their stock. People trading in
big exchanges get greater number of potential counterparties (buyers for a seller,
sellers for a buyer), and probably the best price.

2.2.3 Size of the Market

Stocks can be categorized in various way. One way is by the country where the
company is domiciled. For example, Nestl and Novartis are domiciled in
Switzerland, so they may be considered as part of the Swiss stock market, although
their stock may also be traded on exchanges in other countries, for example, as
American Depository Receipts (ADRs) on U.S. stock markets.

At the close of 2012, the size of the world stock market (total market capitalization)
was about US$55 trillion.[1] By country, the largest market was the United States
(about 34%), followed by Japan (about 6%) and the United Kingdom (about
6%).These numbers increased in 2013.

As of 2015, there are a total of 60 stock exchanges in the world with a total market
capitalization of $69 trillion. Of these, there are 16 exchanges with a market
capitalization of $1 trillion or more, and they account for 87% of global market
6
capitalization. Apart from the Australian Securities Exchange, these 16 exchanges
are based in one of three continents: North America, Europe and Asia.
The Table below represents the list of largest stock exchanges around the world.
New York Stock Exchange (NYSE) is the biggest stock exchange in the world in
terms of market capitalization. Bombay Stock Exchange (BSE) holds the 11th place
and National Stock Exchange of India (NSE) holds 12th place.

Table Ranking of Stock Exchanges based on Market Capitalization

Rank Stock Exchange Market Cap (in US$ trillion)

1 New York Stock Exchange 19,223
2 NASDAQ 6,831
3 London Stock Exchange 6,187
4 Japan Stock Exchange 4,485
5 Shanghai Stock Exchange 3,986
6 Hong Kong Stock Exchange 3,325
7 Euronext 3,321
8 Shenzhen Stock Exchange 2,285
9 TMX Group 1,939
10 Deutsche Borse 1,762

2.2.4 Behavior of Stock Market

Investors may temporarily move financial prices away from market equilibrium.
Over-reactions may occurso that excessive optimism (euphoria) may drive prices
unduly high or excessive pessimism may drive prices unduly low. Economists
continue to debate whether financial markets are generally efficient.

According to one interpretation of the efficient-market hypothesis (EMH), only

changes in fundamental factors, such as the outlook for margins, profits or dividends,
ought to affect share prices beyond the short term, where random 'noise' in the
system may prevail. The 'hard' efficient-market hypothesis does not explain the
cause of events such as the crash in 1987, when the Dow Jones Industrial Average
plummeted 22.6 percentthe largest-ever one-day fall in the United States.
7
This event demonstrated that share prices can fall dramatically even though no
generally agreed upon definite cause has been found: a thorough search failed to
detect any 'reasonable' development that might have accounted for the crash. (Note
that such events are predicted to occur strictly by chance, although very rarely.) It
seems also to be the case more generally that many price movements (beyond that
which are predicted to occur 'randomly') are not occasioned by new information; a
study of the fifty largest one-day share price movements in the United States in the
post-war period seems to confirm this.

A 'soft' EMH has emerged which does not require that prices remain at or near
equilibrium, but only that market participants not be able to systematically profit
from any momentary market 'inefficiencies'. Moreover, while EMH predicts that all
price movement (in the absence of change in fundamental information) is random
(i.e., non-trending), many studies have shown a marked tendency for the stock
market to trend over time periods of weeks or longer. Various explanations for such
large and apparently non-random price movements have been promulgated. For
instance, some research has shown that changes in estimated risk, and the use of
certain strategies, such as stop-loss limits and value at risk limits, theoretically could
cause financial markets to overreact. But the best explanation seems to be that the
distribution of stock market prices is non-Gaussian (in which case EMH, in any of
its current forms, would not be strictly applicable).

2.2.5 Stock Market Index

The movements of the prices in a market or section of a market are captured in price
indices called stock market indices, of which there are many, e.g., the S&P, the FTSE
and the Euronext indices. Such indices are usually market capitalization weighted,
with the weights reflecting the contribution of the stock to the index. The
constituents of the index are reviewed frequently to include/exclude stocks in order
to reflect the changing business environment.

2.2.6 Derivative Instruments

Financial innovation has brought many new financial instruments whose pay-offs or
values depend on the prices of stocks. Some examples are exchange-traded funds
(ETFs), stock index and stock options, equity swaps, single-stock futures, and stock
index futures. These last two may be traded on futures exchanges (which are distinct
from stock exchangestheir history traces back to commodity futures exchanges),
or traded over-the-counter. As all of these products are only derived from stocks,
they are sometimes considered to be traded in a (hypothetical) derivatives market,
rather than the (hypothetical) stock market.
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2.3 History of Indian Stock Market
The stock exchange or market is a place where stocks, shares and other long-term
commitments or investment are bought and sold. The first organized stock exchange
in India was started in 1875 at Bombay and it is stated to be the oldest in Asia. In
1894 the Ahmedabad Stock Exchange was started to facilitate dealings in the shares
of textile mills there. The Calcutta stock exchange was started in 1908 to provide a
market for shares of plantations and jute mills. Then the madras stock exchange was
started in 1920. At present there are 24 stock exchanges in the country, 21 of them
being regional ones with allotted areas. Two others set up in the reform era, viz., the
National Stock Exchange (NSE) and Over the Counter Exchange of India (OICEI),
have mandate to have nation-wise trading.

They are located at Ahmedabad, Vadodara, Bangalore, Bhubaneswar, Mumbai,

Kolkata, Kochi, Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur Kanpur,
Ludhiana, Chennai Mangalore, Meerut, Patna, Pune, Rajkot.

The Stock Exchanges are being administered by their governing boards and
executive chiefs. Policies relating to their regulation and control are laid down by
the Ministry of Finance. Government also Constituted Securities and Exchange
Board of India (SEBI) in April 1988 for orderly development and regulation of
securities industry and stock exchanges.

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2.4 Major Stock Exchanges in India
The Major Stock Exchanges in India are mention below:

2.4.1 Bombay Stock Exchange

The Bombay Stock Exchange is the oldest exchange in Asia. Its history dates back
to 1855, when five stockbrokers would gather under banyan trees in front of
Mumbai's Town Hall. The location of these meetings changed many times to
accommodate an increasing number of brokers. The group eventually moved to
Dalal Street in 1874 and became an official organization known as "The Native
Share & Stock Brokers Association" in 1875.
On August 31, 1957, the BSE became the first stock exchange to be recognized by
the Indian Government under the Securities Contracts Regulation Act. In 1980, the
exchange moved to the Phiroze Jeejeebhoy Towers at Dalal Street, Fort area. In
1986, it developed the BSE SENSEX index, giving the BSE a means to measure the
overall performance of the exchange. In 2000, the BSE used this index to open its
derivatives market, trading SENSEX futures contracts. The development of
SENSEX options along with equity derivatives followed in 2001 and 2002,
expanding the BSE's trading platform.
Historically an open outcry floor trading exchange, the Bombay Stock Exchange
switched to an electronic trading system developed by CMC Ltd. in 1995. It took the
exchange only 50 days to make this transition. This automated, screen-based trading
platform called BSE On-Line Trading (BOLT) had a capacity of 8 million orders per
day. The BSE has also introduced a centralized exchange-based internet trading
system, BSEWEBx.co.in to enable investors anywhere in the world to trade on the
BSE platform.
At present BSE has 5,749 listed companies with market capitalization of US$ 1.43
trillion.

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2.4.2 Calcutta Stock Exchange
Calcutta Stock Exchange, also abbreviated to CSE, located at the Lyons Range,
Kolkata, India, is the oldest stock exchange in South Asia. It was incorporated in
1908 and is the second largest bourse in India.
In 1830, the bourse activities in Kolkata were conducted under a neem tree. The
earliest record of dealings in securities in India is the British East India Companys
loan securities. In 1908, the stock exchange was incorporated and consisted of 150
members. The present building at the Lyons Range was constructed in 1928. The
Calcutta Stock Exchange Ltd was granted permanent recognition by the Government
of India with effect from April 14, 1980, under the relevant provisions of the
Securities Contracts (Regulation) Act, 1956. The Calcutta Stock Exchange followed
the familiar outcry system for stock trading until 1997, when it was replaced by an
electronic (eTrading) system known as C-STAR (CSE Screen Based Trading and
Reporting). The full form of CSE is Calcutta Stock Exchange.

2.4.3 National Stock Exchange

The National Stock Exchange of India Limited (NSE) is the leading stock exchange
of India, located in Mumbai. NSE was established in 1992 as the first demutualized
electronic exchange in the country. NSE was the first exchange in the country to
provide a modern, fully automated screen-based electronic trading system which
offered easy trading facility to the investors spread across the length and breadth of
the country.

NSE was set up by a group of leading Indian financial institutions at the behest of
the government of India to bring transparency to the Indian capital market. Based on
the recommendations laid out by the government committee, NSE has been
established with a diversified shareholding comprising domestic and global
investors. The key domestic investors include Life Insurance Corporation of India,
State Bank of India, IFCI Limited IDFC Limited and Stock Holding Corporation of
India Limited. And the key global investors are Gagil FDI Limited, GS Strategic
Investments Limited, SAIF II SE Investments Mauritius Limited, Aranda
Investments (Mauritius) Pvt. Limited and PI Opportunities Fund I.

The exchange was incorporated in 1992 as a tax-paying company and was

recognized as a stock exchange in 1993 under the Securities Contracts (Regulation)
Act, 1956, when P. V. Narasimha Rao was the Prime Minister of India and
Manmohan Singh was the Finance Minister. NSE commenced operations in the
Wholesale Debt Market (WDM) segment in June 1994. The capital market (equities)

11
segment of the NSE commenced operations in November 1994, while operations in
the derivatives segment commenced in June 2000.

National Stock Exchange has a total market capitalization of more than US$1.41
trillion, making it the worlds 12th-largest stock exchange as of March 2016.[1]
NSE's flagship index, the NIFTY 50, the 51 stock index (50 companies with 51
securities inclusive of DVR), is used extensively by investors in India and around
the world as a barometer of the Indian capital markets.

The National Stock Exchange of India Limited (NSE) commenced trading in

derivatives with the launch of index futures on 12 June 2000. The futures and options
segment of NSE has made a global mark. In the Futures and Options segment,
trading in NIFTY 50 Index, NIFTY IT index, NIFTY Bank Index, NIFTY Next 50
index and single stock futures are available. Trading in Mini Nifty Futures & Options
and Long term Options on NIFTY 50 are also available. The average daily turnover
in the F&O Segment of the Exchange during the financial year April 2013 to March
2014 stood at 1.52236 trillion (US$23 billion).

NSEs trading systems, is a state of-the-art application. It has an up time record of

99.99% and processes more than 450 million messages every day with sub
millisecond response time.

Today NSE can handle 1, 60,000 orders/messages per second, with infinite ability
to scale up at short notice on demand, NSE has continuously worked towards
ensuring that the settlement cycle comes down. Settlements have always been
handled smoothly. The settlement cycle has been reduced from T+3 to T+2/T+1.

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2.4.4 OTCEI
The OTC Exchange of India (OTCEI), also known as the Over-the-Counter
Exchange of India, is based in Mumbai, Maharashtra. It is India's first exchange for
small companies, as well as the first screen-based nationwide stock exchange in
India.[4] OTCEI was set up to access high-technology enterprising promoters in
raising finance for new product development in a cost-effective manner and to
provide a transparent and efficient trading system to investors.

OTCEI is promoted by the Unit Trust of India, the Industrial Credit and Investment
Corporation of India, the Industrial Development Bank of India, the Industrial
Finance Corporation of India, and other institutions, and is a recognized stock
exchange under the SCR Act.

The OTC Exchange of India was founded in 1990 under the Companies Act 1956
and was recognized by the Securities Contracts Regulation Act, 1956 as a stock
exchange. The OTCEI is no longer a functional exchange as the same has been de-
recognized by SEBI vide its order dated 31 Mar 2015.

2.4.5 Inter-Connected Stock Exchange of India

Started in the year 1998 with the main objective to interlink the 15 odd regional stock
Exchanges throughout the country [Bangalore, Bhubaneswar, Chennai, Kochi,
Coimbatore, Guwahati, Hyderabad, Jaipur, Ludhinana, Indore, Magadh, Mangalore,
Saurastra (Kutch), Uttar Pradesh (Kanpur) and Vadodara to ensure liquidity.

The total cost of ISE was 15 crores that were shaded equally by participating stock
exchanges. The membership fees to ISE costs Rs. 16000/- along with the capital
adequacy deposit of Rs. 4 lakhs as stipulated by SEBI. Another important objective
of ISE is to minimize the cost of regional exchanges as they are incurring huge costs
by supporting a very liquid market.

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3. Literature Review
Markowitz (1952 and 1959) performed the pioneer work on portfolio analysis. The
major assumption of the Markowitzs approach to portfolio analysis is that investors
are basically risk averse. This means that investors must be given higher returns in
order to accept higher risk. Markowitz then developed a model of portfolio analysis.
Markowitz (1952) and Tobin (1958) showed that it was possible to identify the
composition of an optimal portfolio of risky securities, given forecasts of future
returns and an appropriate covariance matrix of share returns. Sharpe (1963)
attempted to simplify the process of data input, data tabulation, and reaching a
solution. He also developed a simplified variant of the Markowitz model that reduces
data and computational requirements. William Sharpe (1964) has given model
known as Sharpe Single Index Model which laid down some steps that are required
for construction of optimal portfolios. Elton and Gruber (1981), and Elton, Grube
and Padberg [1976, 1977A, l978A, 1978B, 1979] have established simple criteria
for optimal portfolio selection using a variety of models, such as single index, multi-
index, and constant correlation models. These models are used to provide solution
to portfolio problems by disallowing short sales of risky securities in portfolios and
this can be done by using simple ranking procedures. Elton, Grube, Padberg (1977B)
have also extended their analysis using a constant correlation model, as well as a
single index model incorporate upper limits on investment in individual securities.
Haugen (1993) stated that Index models can handle large population of stocks. They
serve as simplified alternatives to the full-covariance approach to portfolio
optimization. Although the Single Index Model offers a simple formula for portfolio
risk, it also makes an assumption about the process generating security returns.
According to Terol et al. (2006) Markowitz model is a conventional model proposed
to solve the portfolio selection problems by assuming that the situation of stock
markets in the future can be characterized by the past asset data. In addition, Briec
& Kerstens (2009) stated that Markowitz model contributes in geometric mean
optimization advocated for long term investments. On the other hand, the Simple
Index Model is no longer good approximations to multi period. As seen by
Frankfurter et al. (1976) according to this study, under conditions of certainty, the
Markowitz and Simple Index Model approaches will arrive at the same decision set
in the experiment. These results demonstrate that under conditions of uncertainty,
Simple Index Model approach is advantageous over the Markowitz approach. It was
found that variation in performance is explained in terms of the two essential
differences in the models. First, fewer and different estimators are used in the Simple
Index Model to summarize past history. Second, the linear assumption of the Simple
Index Model does not necessarily hold. They finally found that in experiments, the
Simple Index Model process performs worse than Markowitz process,
14
and gives superior results when only short data histories are available. Omet (1995)
argued that the two models are similar. Simple Index Model can be used, which is
more practical than the Markowitz model in generating ASE efficient frontier. Dutt
(1998) used Sharpe single index model in order to optimize a portfolio of 31
companies from BSE (Bombay Stock Exchange). Nanda, Mahanty, and Tiwari
(2012) selected stocks from the clusters to build a portfolio, minimizing portfolio
risk and compare the returns with that of the benchmark index i.e. Sensex. Saravanan
and Natarajan (2012) used Sharpe single index model in order to construct an
optimal portfolio of 4 companies from NSE (National Stock Exchange of India) and
used NSE NIFTY as market index. Meenakshi and Sarita (2012) stated that Sharpe's
single index model is of great importance and the framework of Sharpe's single index
model for optimal portfolio construction is very simple and useful.

15
4. Research Methodology

4.1 Problem Statement

High Inflation rate prevailing in the economy erodes the value of investments in risk
free assets such as bank deposits and debt instruments. Hence, an investor has to
allocate some portion of his savings to high return instruments such as equity for
achieving his long term goals. However, the volatility of stock market makes the
decision making a complex process.

Hence, the problem under the study is to construct an optimal Portfolio using
Sharpes performance model and conduct an evaluation of the portfolio with other
portfolios of same return or risk to prove that this optimization model is simple and
highly effective for portfolio construction.

4.2 Need for the Study

The effectiveness of a portfolio is decided the collection of assets under portfolio
and their proportions. There for an investor who want to invest his own shall be
thorough with the methods of security analysis, portfolio analysis, portfolio
selection, portfolio evaluation and revision.

Since this study attempts to touch almost all the points required to reach optimal
portfolio it has very significance for an investor

4.3 Objectives of Study

1) To perform the risk and return analysis of the BSE 100 Index Shares.

2) To Construct an Optimal Portfolio using Sharpes Optimization Model and

find out risk and return.

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4.4 Research Design
This project is based on analytical research design.

4.5 Sources of Data

The price movement of BSE 100 index and stock prices are the fundamental data
for the study. Secondary data are used for this purpose.

4.6 Tools for Data Analysis

The data collected from sources has been analyzed using ratios and formulas. Tools
like Arithmetic Mean, Standard deviation, Alpha, Beta, Covariance, Sharpe Index
Model.
The Microsoft Excel package is used for performing calculations and analysis.

4.7 Limitations of Study

Duration of the study is limited hence extensive and deep such as fundamental
analysis and technical analysis could not be possible.

The beta value changes from time to time. It may not reflect the future voltality of
returns. Hence the portfolio needs to be revised periodically.

An optimized portfolio cannot reduce systematic risk affecting the entire market.
Hence, the return from the portfolio varies with the general trend in the market.

17
 5. Theoretical Framework

5.1 Portfolio Construction

Portfolio is a combination of securities such as stocks bonds and money market

instruments. Diversification of investments over different assets helps to reduce risk
without sacrificing return. When determining a proper asset allocation one aims at
maximizing the expected return and minimizing the risk.The process of blending
together the broad asset classes so as to obtain optimum return with minimum risk
is called portfolio construction.

5.2 Approaches to portfolio Construction

There are two approaches to portfolio construction of the portfolio of securities viz,
Traditional Approach
Modern Approach

In Traditional approach, investors needs in terms of income and capital appreciation

are evaluated and appropriate securities are selected to meet the needs of the
investor. The common practice in the traditional approach is to evaluate the entire
financial plan of the individual.

In modern approach portfolios are constructed to maximize the expected return for
a given level of risk. It views on portfolios construction in terms of the expected
return and the risk associated with obtaining the expected return.

5.3 Traditional Approach of portfolio construction

The Construction of portfolio by traditional method is carried out in 5 steps.

The five steps
1) Security Analysis
2) Portfolio Analysis
3) Portfolio Selection
4) Portfolio Revision
5) Portfolio Evaluation

These steps are detailed below under separate headings.

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5.4 Security Analysis

Security Analysis is the initial step of portfolio management. Security analysis is

method which helps to calculate the value of various assets. There are two alternate
approaches to security analysis namely fundamental analysis and technical analysis.

5.4.1 Fundamental Analysis

Fundamental analysis is a method of evaluating a security in an attempt to measure
its intrinsic value, by examining related economic, financial and other qualitative
and quantitative factors. Fundamental analysts study anything that can affect the
security's value, including macroeconomic factors such as the overall economy and
industry conditions, and microeconomic factors such as financial conditions and
company management. The end goal of fundamental analysis is to produce a
quantitative value that an investor can compare with a security's current price, thus
indicating whether the security is undervalued or overvalued.

5.4.1.1 Economic Analysis

The performance of the company depends on the performance of the economy. If
the economy is booming, incomes rise, demand for goods increases and hence the
industries and companies in general tend to be prosperous. On the other hand, if the
economy is in recession, the performance of the company will be generally bad.
Investors are concerned with those variables in the economy which affect the
performance of the company in which they tend to invest. Study of these economic
variables would give an idea about future corporate earnings and payment of
dividends and interest to investors.
Some of the key economic variables that an investor must monitor as a part of his/her
fundamental analysis.
a) Inflation:
Inflation prevailing in the economy has considered impact on the performance of
companies. Higher rates of inflation upset business planes, lead to cost escalation
and result in a squeeze on profit margins. On the other hand inflation leads to erosion
of purchasing power in the hands of consumers. This will result lower demand for
products. Thus higher inflation in an economy are likely to affect the performance
of companies adversely. Industries and companies prosper during times of low
inflation.
b) Interest Rates:
Interest rates determine the cost and availability of credit for companies operating in
an economy. A low interest rate stimulates investment by making credit available
easily and cheaply. Moreover it implies lower cost of finance for companies and
19
thereby assures higher profitability. On the contrary, higher interest rates result in
higher cost of production which may lead to lower profitability and lower demand.
The interest rates in the organized financial sector of the economy are determined
by the monetary policy of the government and the trends in the money supply. These
rates are thus controlled and vary within certain ranges. But the interest rates in the
unorganized financial sector are controlled and may fluctuate widely depending
upon the demand and supply of funds in the market.
c) Government revenues, expenditure and deficits:
As the government is the largest investor and spender of money, the trends in
government revenue, expenditure and deficits have a signifying impact on the
performance of industries and companies. Expenditure by govt stimulates the
economy by creating jobs and generating demand. Since a major portion of demand
in the economy is generated by govt spending, the nature of govt spending is of great
importance in determining the fortunes of many an industry.
However, when the govt expenditure exceeds its revenue, there occurs a deficit. This
is known as fiscal deficit. All developing countries suffer from fiscal deficits as govt
spend large amounts of money to build up infrastructure.
d) Exchange rates:
The performance and profitability of industries and companies that are major
importers and exporters are considerably affected by the exchange rates of the rupee
against major currencies of the world. A depreciation of rupee improves the
competitive position of Indian products in foreign markets, thereby stimulating
exports. But it would also make imports more expensive.
The exchange rates of the rupee are influenced by the balance of trade deficit, the
balance of payments deficit and also the foreign exchange reserves of the country.
The excess of imports over exports is called balance of trade deficit. A country needs
foreign exchange reserves to meet several commitments such as payment for imports
and servicing of foreign debts. Balance of payment deficit typically leads to decline
in foreign exchange reserves as the deficit has to be met from reserve.
e) Monsoon:
The Indian economy essentially an agrarian economy and agriculture forms a very
important sector of Indian economy. Because of the strong forward and backward
linkages between agriculture and industry, performance of several companies and
industries are dependent on the performance of agriculture. Moreover, as agriculture
incomes rise, the demand for industrial products and services will be good and
industry will prosper.
f) Economic and political stability:
A stable political environment is necessary for steady and balanced growth. No
industry or company can grow and prosper in the midst of political turmoil. Stable
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long term economic policies are what needed for industrial growth. Stable govt with
clear cut long term economic policies will be conducive to good performance of the
economy.

5.4.1.2 Industry Analysis

Industry analysis is a tool that facilitates a company's understanding of its position
relative to other companies that produce similar products or services. Understanding
the forces at work in the overall industry is an important component of effective
strategic planning. Industry analysis enables small business owners to identify the
threats and opportunities facing their businesses, and to focus their resources on
developing unique capabilities that could lead to a competitive advantage.

"Many small business owners and executives consider themselves at worst victims,
and at best observers of what goes on in their industry. They sometimes fail to
perceive that understanding your industry directly impacts your ability to succeed.
Understanding your industry and anticipating its future trends and directions gives
you the knowledge you need to react and control your portion of that industry,"
Kenneth J. Cook wrote in his book The AMA Complete Guide to Strategic Planning
for Small Business. "However, your analysis of this is significant only in a relative
sense. Since both you and your competitors are in the same industry, the key is in
finding the differing abilities between you and the competition in dealing with the
industry forces that impact you. If you can identify abilities you have that are
superior to competitors, you can use that ability to establish a competitive
advantage."

An industry analysis consists of three major elements: the underlying forces at work
in the industry; the overall attractiveness of the industry; and the critical factors that
determine a company's success within the industry.

One way in which to compare a particular business with the average of all
participants in the industry is through the use of ratio analysis and comparisons.
Ratios are calculated by dividing one measurable business factor by another, total
sales divided by number of employees, for example. Many of these ratios may be
calculated for an entire industry with data available from many reports and papers
published by the U.S. Departments of Commerce and Labor.

By comparing a particular ratio for one company with that of the industry as a whole,
a business owner can learn much about where her business stands in comparison
with the industry average. For example, a small nursing home business can compare
21
its "payroll per employee" ratio with the average for all residential care operators in
the U.S. in order to determine if it is within a competitive range. If her business's
"payroll per employee" figure is higher than the industry average, she may wish to
investigate further. Checking the "employees per establishment" ratio would be a
logical place to look next. If this ratio is lower than the industry average it may
justifying the higher per-employee payroll figure. This sort of comparative analysis
is one important way in which to assess how one's business compares with all others
involved in the same line of work. There are various sources for the industry average
ratios, among them is the industry analysis series published by Thomson Gale as the
USA series.

Another premier model for analyzing the structure of industries was developed by
Michael E. Porter in his classic 1980 book Competitive Strategy: Techniques for
Analyzing Industries and Competitors. Porter's model shows that rivalry among
firms in industry depends upon five forces: 1) the potential for new competitors to
enter the market; 2) the bargaining power of buyers; 3) the bargaining power of
suppliers; 4) the availability of substitute goods; and 5) the competitors and nature
of competition. These factors are outlined below.

a) Industry forces
The first step in performing an industry analysis is to assess the impact of Porter's
five forces. "The collective strength of these forces determines the ultimate profit
potential in the industry, where profit potential is measured in terms of long term
return on invested capital," Porter stated. "The goal of competitive strategy for a
business unit in an industry is to find a position in the industry where the company
can best defend itself against these competitive forces or can influence them in its
favor." Understanding the underlying forces determining the structure of the industry
can highlight the strengths and weaknesses of a small business, show where strategic
changes can make the greatest difference, and illuminate areas where industry trends
may turn into opportunities or threats.

b) Ease of Entry
Ease of entry refers to how easy or difficult it is for a new firm to begin competing
in the industry. The ease of entry into an industry is important because it determines
the likelihood that a company will face new competitors. In industries that are easy
to enter, sources of competitive advantage tend to wane quickly. On the other hand,
in industries that are difficult to enter, sources of competitive advantage last longer,
and firms also tend to benefit from having a constant set of competitors.

22
The ease of entry into an industry depends upon two factors: the reaction of existing
competitors to new entrants; and the barriers to market entry that prevail in the
industry. Existing competitors are most likely to react strongly against new entrants
when there is a history of such behavior, when the competitors have invested
substantial resources in the industry, and when the industry is characterized by slow
growth. Some of the major barriers to market entry include economies of scale, high
capital requirements, switching costs for the customer, limited access to the channels
of distribution, a high degree of product differentiation, and restrictive government
policies.
c) Power of Suppliers
Suppliers can gain bargaining power within an industry through a number of
different situations. For example, suppliers gain power when an industry relies on
just a few suppliers, when there are no substitutes available for the suppliers' product,
when there are switching costs associated with changing suppliers, when each
purchaser accounts for just a small portion of the suppliers' business, and when
suppliers have the resources to move forward in the chain of distribution and take
on the role of their customers. Supplier power can affect the relationship between a
small business and its customers by influencing the quality and price of the final
product. "All of these factors combined will affect your ability to compete," Cook
noted. "They will impact your ability to use your supplier relationship to establish
competitive advantages with your customers."

d) Power of Buyers
The reverse situation occurs when bargaining power rests in the hands of buyers.
Powerful buyers can exert pressure on small businesses by demanding lower prices,
higher quality, or additional services, or by playing competitors off one another. The
power of buyers tends to increase when single customers account for large volumes
of the business's product, when a substitutes are available for the product, when the
costs associated with switching suppliers are low, and when buyers possess the
resources to move backward in the chain of distribution.

e) Availability of Substitutes
"All firms in an industry are competing, in a broad sense, with industries producing
substitute products. Substitutes limit the potential returns of an industry by placing
a ceiling on the prices firms in the industry can profitably charge," Porter explained.
Product substitution occurs when a small business's customer comes to believe that
a similar product can perform the same function at a better price. Substitution can
be subtlefor example, insurance agents have gradually moved into the investment
field formerly controlled by financial plannersor suddenfor example, compact
23
disc technology has taken the place of vinyl record albums. The main defense
available against substitution is product differentiation. By forming a deep
understanding of the customer, some companies are able to create demand
specifically for their products.

f) Competitors
"The battle you wage against competitors is one of the strongest industry forces with
which you contend," according to Cook. Competitive battles can take the form of
price wars, advertising campaigns, new product introductions, or expanded service
offeringsall of which can reduce the profitability of firms within an industry. The
intensity of competition tends to increase when an industry is characterized by a
number of well-balanced competitors, a slow rate of industry growth, high fixed
costs, or a lack of differentiation between products. Another factor increasing the
intensity of competition is high exit barriersincluding specialized assets,
emotional ties, government or social restrictions, strategic interrelationships with
other business units, labor agreements, or other fixed costswhich make
competitors stay and fight even when they find the industry unprofitable.
INDUSTRY ATTRACTIVENESS AND INDUSTRY SUCCESS FACTORS
"Industry attractiveness is the presence or absence of threats exhibited by each of the
industry forces," Cook explained. "The greater the threat posed by an industry force,
the less attractive the industry becomes." Small businesses, in particular, should
attempt to seek out markets in which the threats are low and the attractiveness is
high. Understanding what industry forces are at work enables small business owners
to develop strategies to deal with them. These strategies, in turn, can help small
businesses to find unique ways to satisfy their customers in order to develop a
competitive advantage over industry rivals.
Success factors are those elements that determine whether a company succeeds or
fails in a given industry. They vary greatly by industry. Some examples of possible
success factors include quick response to market changes, a complete product line,
fair prices, excellent product quality or performance, knowledgeable sales support,
a good record for deliveries, solid financial standing, or a strong management team.
"The reason for identifying success factors is that it will help lead you to areas where
you can establish competitive advantages," Cook noted. The first step is to determine
whether or not the company possesses each success factor identified. Then the small
business owner can decide whether the company can and should develop additional
success factors.

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THE IMPORTANCE OF INDUSTRY ANALYSIS
A comprehensive industry analysis requires a small business owner to take an
objective view of the underlying forces, attractiveness, and success factors that
determine the structure of the industry. Understanding the company's operating
environment in this way can help the small business owner to formulate an effective
strategy, position the company for success, and make the most efficient use of the
limited resources of the small business. "Once the forces affecting competition in an
industry and their underlying causes have been diagnosed, the firm is in a position
to identify its strengths and weaknesses relative to the industry," Porter wrote. "An
effective competitive strategy takes offensive or defensive action in order to create
a defendable position against the five competitive forces." Some of the possible
strategies include positioning the firm to use its unique capabilities as defense,
influencing the balance of outside forces in the firm's favor, or anticipating shifts in
the underlying industry factors and adapting before competitors do in order to gain
a competitive advantage.
5.4.1.3 COMPANY ANALYSIS:
Company analysis is the first stage of fundamental analysis. The economy analysis
provides the investor a broad outline of the prospects of growth in the economy. The
industry analysis helps the investor to select the industry in which investment would
be rewarding. Now he has decide the company in which he should invest his money.
Company analysis provides answer to this question.
Company analysis deals with the estimation of return and risk of individual shares.
In company analysis he may evaluating short and long term financial position by
applying various ratios. The prosperity of a company would depend upon its
profitability and financial health. For knowing profitability of the company the
investor may calculate profitable ratios, operating ratios etc.

In company analysis, the investor analyses information related to the company and
evaluates the present and future values for the stock. The present and future values
are affected by a number of factors and they are given below.

Factors that affect present share values are

Historic Stock Price
Price/Equity Ratio
Economic Condition
Stock Market Condition

Factors that affect the Future share prices are

Competitive Edge of the company
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 Earnings of the company
Capital Structure of the company
Management quality of the company
Operating Efficiency of the company
Financial Performance of the company

The competitive edge of the company could be measured with the companys market
share, growth and stability of sales.

The financial statement reveals information about the financial state of the company.
Fund flow and cash flow statement is used to analyze the financial health of the
company.

The ratio analysis helps the investor to study the individual parameters like
profitability, liquidity, leverage and the value of stock.

5.4.2 Technical Analysis

It is the process identifying trend reversals at an earlier stage to formulate the buying
and selling strategy. With the help of several indicators, the analyst analyses the
relationship between price-volume and supply demand for overall market and
individual stock.

The Generally used technical tools are

Dow theory
Volume of trading
Short selling
Bars and Charts
Moving Averages
Oscillators

5.4.2.1 Dow Theory

The market moves in a general direction called trend. According to Dow Theory
the trend is divided in to primary, intermediate and short term trend. The primary
trend may be the broad upward or downward movement that may last for a year or
two. The intermediate trends are corrective movements that may last for three weeks
or three months. The Short term trend refers to day-to day price movement.
26
Dow gives special emphasis on volume. Volume expands along with the bull market
along with the bear market. Large volume with rise in price indicators bull markets.
Large volume with fall in price indicates bear market.

5.4.2.2 Breadth of the market

The net difference between the number of stocks advanced and number of stocks
declined is the breadth of the marke. A ratio of 0.75 indicates short-term buying
opppotunity and there will be an intermediate rally in the beginning of bearish
trend. A risk above 1.25 indicates selling opportunities.

5.4.2.3 Short Selling

Short selling is a technical indicator referring to selling of shares that are not owned.
If the short selling ratio is less than 1 it indicates that the market is overbrought and
a decline can be expected. Value above 1 indicates bullish trend and if the market is
above 2 is oversold.

27
5.4.2.4 Moving Average
Moving Averages indicates the underlying trend in the scrip. For identify short term
trend 10 to 30 day moving averages are used. In the case of medium term trend, 50
to 125 day are adopted, 200-day moving average is used to identify long-term trend.

The Chart below shows the morning averages for 50 and 200 days.

5.4.2.5 Oscillators
Oscillators such as Relative Strength Index (RSI) and Rate of change (ROC) indicate
the market momentum or scrip momentum. The oscillators indicate over brought
and oversold conditions, possible trend reversal, rise or decline in stock momentum.

5.4.2.6 Relative Strength Index

A technical momentum indicator that compares the magnitude of recent gains to

recent losses in an attempt to determine overbought and oversold conditions of an
assets. It is calculated using the following formula :
RSI = 100 100/ (1+RS*)
*Where RS = Average of x days up closes/ Average of x days down closes.
28
From the chart, the RSI ranges from 0 to 100. An asset is deemed to be over brought
once the RSI approaches the 70 level, meaning that it may be getting overvalued and
is good candidate for a pullback. Likewise, if the RSI approaches 30, it is an
indication that the asset may be getting oversold and therefore likely to become
undervalued.

5.4.2.7 Rate of Change (ROC) Indicator

Rate of Change (ROC) Indicator, which is also referred to as simply Momentum, is
a pure momentum oscillator that measures the percent change in price from one
Period to the next. The ROC calculations compares the current price with the price
n periods ago. The Plot forms an oscillator that fluctuates above and below the
zero line as the Rate-of-Change moves from positive to negative. As a momentum
oscillator, ROC signals overbought-oversold conditions.

5.4.2.8 Charts
Charts are valuable and easiest tools in the technical analysis. The graphic prsentaion
of the data helps the investor to find out the trend of the price without difficulty. The
29
charts indicate past historic price movement, current trend, important support and
resistance, and probable future action of the market by projection.

There are four main types of charts that used by investors and traders depending on
the information that they are seeking and their individual skill levels. The Chart types
are: the line chart, the bar chart, the candlestick chart and the point and figure chart.

a) Line Charts

The line chart is the most basic chart type and it uses only one data point to form the
chart. When it comes to technical analysis, a line chart is formed by plotting the
closing prices of a stock or an index. A dot is placed for each closing price and the
various dots are then connected by a line. If we are looking 60 day data then the line
chart is formed by connecting the dots of the closing prices for 60 days.

b) Bar Chart
The line charts can be plotted for various time frames namely monthly, weekly,
hourly etc. So, if you wish to draw a weekly line chart, you can use weekly closing
prices of securities and likewise for the other time frames as well. The advantage of
the line chart is its simplicity. With one glance, the trader can identify the generic
trend of the security. However the disadvantage of the line chart is also its simplicity.
Besides giving the analysts a view on the trend, the line chart does not provide any
additional detail. Plus the line chart takes into consideration only the closing prices

30
ignoring the open, high and low. For this reason traders prefer not to use the line
charts.

The bar chart on the other hand is a bit more versatile. A bar chart displays all the
four price variables namely open, high, low, and close. A bar has three components.

1. The central line The top of the bar indicates the highest price the security has
reached. The bottom end of the bar indicates the lowest price for the same period.
2. The left mark/tick indicates the open
3. The right mark/tick indicates the close
For example assume the OHLC data for a stock as follows:
Open 65 High 70
Low 60 Close 68
For the above data, the bar chart would look like this:

As you can see, in a single bar, we can plot four different price points. If you wish
to view 5 days chart, as you would imagine we will have 5 vertical bars. So on and
so forth.
Note the position of the left and right mark on the chart varies based on how the
market has moved for the given day. If the left mark, which represents the opening
price is placed lower than the right mark, it indicates that the close is higher than the
open (close > open), hence a positive day for the markets.

For example consider this: O = 46, H = 51, L = 45, C = 49. To indicate it is a bullish
day, the bar is represented
In blue color.

31
Likewise if the left mark is placed higher than the right mark it indicates that the
close is lower than the open (close <open), hence a negative day for markets. For
example consider this: O = 74, H=76, L=70, C=71. To indicate it is a bearish day,
the bar is represented in red color. The length of the central line indicates the range
for the day. A range can be defined as the difference between the high and low.
Longer the line, bigger the range, shorter the line, smaller is the range.

While the bar chart displays all the four data points it still lacks a visual appeal.
This is probably the biggest disadvantage of a bar chart. It becomes really hard to
spot potential patterns brewing when one is looking at a bar chart. The complexity
increases when a trader has to analyze multiple charts during the day.
Hence for this reason the traders do not use bar charts.

c) Candlestick Chart
Similar to the bar chart, the candlestick also has a thin vertical line showing the
period's trading range. The difference comes in the formation of a wide bar on the
vertical line, which illustrates the difference between the open and close. A major
problem with the candlestick color configuration, however, is that different sites use
different standards; therefore, it is important to understand the candlestick
configuration used at the chart site you are working with. There are two color
constructs for days up and one for days that the price falls. When the price of the
stock is up and closes above the opening trade, the candlestick will usually be white
or clear. If the stock has traded down for the period, then the candlestick will usually
be red or black, depending on the site. If the stock's price has closed above the
previous day's close but below the day's open, the candlestick will be black or filled
with the color that is used to indicate an up day.

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 d) Point Figure Chart
The point and figure chart is not well known or used by the average investor but it
has had a long history of use dating back to the first technical traders. This type of
chart reflects price movements and is not as concerned about time and volume in the
formulation of the points. The point and figure chart removes the noise, or
insignificant price movements, in the stock, which can distort traders' views of the
price trends. These types of charts also try to neutralize the skewing effect that time
has on chart analysis.

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5.5 Portfolio Analysis
Security analysis provides a set of securities suitable for investment. From these
securities a large number of portfolios can be constructed by choosing different set
of securities and also by varying weight of securities. The diversification has the
effect of reducing the portfolio risk by minimizing the unsystematic risk which
affects individual security or industry. Whereas over diversification reduces the
return from portfolio. A rational investor has to find out the most efficient portfolio
by choosing appropriate trade-off between risk and return.

5.6 Portfolio Selection

Portfolio analysis gives different portfolios available for investment. From these
portfolios an optimal portfolio is selected for investment.

5.7 Portfolio Revision

As the economy and business environment changes the return from securities also
changes. The portfolio has to include new securities which promises high return and
exclude securities which has become underperformer. Hence, after constructing an
optimal portfolio the investor has to periodically monitor the portfolio to ensure that
it remains optimal.

5.8 Portfolio Evaluation

The evaluation of portfolio provides feedback about the performance to evolve better
management strategy. The return and risk of portfolio over a period of time is
evaluated. These values are compared with standard values such as market index to
assess the relative performance of the portfolio.

5.9 Return and Risk Analysis of Portfolio

Portfolios Performance analysis consists of examine the risk-return characteristics
of the portfolio

5.9.1 Return
The Return of a portfolio is measured by its average total return over a standard
holding period, usually one year. The total return consists of investment income such
as dividends plus capital gain/loss. The rate of return earned by the portfolio is
calculated compared with the benchmark like market index.

34
The return of a portfolio is given by

5.9.2 Risk
Risk is the possibility of not realizing return less than expected. The risk is broadly
classified into two types;

1) Systematic Risk
2) Unsystematic Risk

Systematic Risk
Systematic risk refers to that portion of variation in return caused by factors that
affect the price of all securities. The effect of systematic risk is to move prices of all
individual securities in same direction. The systematic risk arises due to following
reasons.

a) Market Risk: Variation in prices arises out of changes in demand and supply
pressures in the market following the changing flow of news and expectations.
b) Interest Rate risk: The market perception is influenced by changes in interest
rates which in-turn affects the riskiness of investments due to their effects on
Returns expectations and the total principal amount due to be refunded.
c) Purchasing Power risk: Purchasing power risk is the uncertainty of the
purchasing power of the amounts to be received due to both inflation and
deflation.

35
Unsystematic Risk
Unsystematic Risk refers to that portion of risk which is caused due to factors unique
or related to firm or industry. This type of risk can be divided further in to the
following types.

a) Business Risk: Business risk may be due to internal factors or external factors.
Internal factors is caused by factors such as improper product mix, non-
availability of raw material, incompetence to face competence etc. External
risks arise due to factors which are beyond the control of the firm.
b) Financial Risk: Financial risk is associated with the capital structure of the
company. The extent of risk depends on the leverage of the firms capital
structure.
c) Credit Risk: Credit risk is associated with probability of a buyer will default.
The borrowers credit rating might have fallen suddenly and he may become
default prone.
d) Other Risks: In addition to above risk there are many more risks particularly
associated with the foreign securities. These are monetary value risk, political
risk, and foreign government indebtedness risk.

Calculation of Risk on a Portfolio

Risk on a portfolio is not same as risk on individual securities. Portfolios standard
deviation is a good indicator of the risk of the portfolio. The portfolio risk of a
portfolio of 2 securities can be calculated using the following formula:

36
5.10 Modern Approaches to Portfolio Selection

In modern approach of portfolio selection the stocks are not selected based on the
need for income or appreciation. The selection is based on the risk and return
analysis. Modern Portfolio Theory (MPT) approaches investing by examining the
entire market and the whole economy. The theory is an alternative to the older
method of analyzing each investments individual merits. MPT places a large
emphasis on the correlation between investments. Correlation is the amount we can
expect various investments and various asset classes to change in value compared
with each other. The commonly used models are given below.

Sharpes single index model

Markowitz mean- variance optimization model
Capital Asset Pricing Model (CAPM)
Arbitrage Pricing theory

Sharpes Single Index Model

Sharpes Single Index Model was developed by William Sharpe for the construction
of optimal portfolio using less number of inputs. The simplicity is the most important
feature of the Sharpes single index model over Markowitz model. Markowitz
model uses large number of covariance. Taking idea from Markowitz, suggested
that index to which securities are related can be used for covariance generation,
William Sharpe formulated single index model.

The Regression equation is

ei = error term
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The key assumptions are

1) The error term ei is zero mean and had finite variance.

2) The Securities are related through common response to return of market index.
Meaning the error term of one security is not correlated with error term of any
other security. COV (ei, ej) = 0
3) There is no correlation between error term and return on market index.
COV (ei, Rm) = 0

The expected return of security is

As ei zero in value so,

The variance of the return of the security is

The major assumption of Sharpes single model is that the co-variation of the
security can be explained by one single factor known as index.

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Steps in Construction of Optimal Portfolio Using Single Index Model

This model firstly ranks the securities based on their excess to beta ratio. After that
all securities are arranged according to their ranks. Then cutoff rate is calculated and
it is compared with excess return to beta for deciding whether to select the security
for investment or not. The model explains the weight that should be allocated to each
security to obtain optimal portfolio.

Step 1: Calculate excess return to beta ratio for each security under consideration
Excess return to beta ratio = (Ri - Rf)/i

Step 2: Rank the securities based on the excess return to beta ratio.

Step 3: Calculate the cut of rate using the formulae. Highest cut off rate will be
regarded as C*.

Step 4: Selection of securities for investment. If (Ri - Rf)/i is greater than cut off rate
then the security will be included in the portfolio.

Step 5: Calculate the proportion to be invested in each security is calculated.

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Markowitz Mean Variance Optimization Model (Tangency Model)

Harry Markowitz developed algorithms to minimize portfolio risk. His Study was
first published in journal of finance in March 1952. Markowitz indicated the
importance of correlation among the returns of different stocks in construction of a
stock portfolio.

Markowitz Model

The theory assumes that investors prefer to minimize risk. The theory assumes that
given the choice of two portfolios with equal returns, investors will choose the one
with the least risk. If investors take on additional risk, they will expect to be
compensated with additional return. According to MPT, risk comes in two major
categories:

Systematic Risk the possibility that the entire market and economy will
show losses negatively affecting nearly every investment; also called market
risk.
Unsystematic Risk- the possibility than an investment or a category of
investments will decline in value without having a major impact upon the
entire market.
Diversification generally does not protect against systematic risk because a drop in
the entire market and economy typically affects all investments. However,
40
diversification is designed to decrease unsystematic risk. Since unsystematic risk is
the possibility that one single thing will decline in value, having a portfolio invested
in a variety of stocks, a variety of asset classes and a variety of sectors will lower the
risk of losing much money when one investment type declines in value.

The Efficient Frontier

In order to compare investment options, Markowitz developed a system to describe

each investment or each class with math, using unsystematic risk statistics. Then he
further applied that to the portfolios that contain the investment options. He looked
at the expected rate-of-return and the expected volatility for each investment. He
named his risk-reward equation The Efficient Frontier. The graph below is an
example of what the efficient Frontier equations looks like when plotted. The
purpose of The Efficient Frontier is to maximize returns while minimizing volatility.

Capital Asset Pricing Model (CAPM)

William F. Sharpe developed CAPM. He emphasized that the risk factor in portfolio
theory is a combination of two risks, the systematic risk and unsystematic risk. The
total risk of the portfolio is reduced with increase in number of securities in a
portfolio. This is due in the unsystematic risk distributed over a number of securities.
41
Beta Coefficient

CAPM calculates required return based on a risk measurement. To do this, the model
relies on a risk multiplier called the beta coefficient. Beta coefficient is a measure of
the volatility or systematic risk, of a security or a portfolio in comparison to the
market as a whole. Beta is the tendency of a securitys returns to respond to swings
in the market.
A beta of 1 includes that the securitys price will move with the market. A security
with beta of less than 1 will be less volatile than the market. For example, if a stocks
beta is 1.2, its theoretically 20% more volatile than the market.

Assumptions of CAPM
The CAPM depends on certain assumptions. All investors are
1) Aim to maximize economic utilities (Asset quantities are given and fixed).
2) Are rational and risk-averse.
3) Are broadly diversified across a range of investments.
4) Are price takers, i.e., they cannot influence prices.
5) Can lend and borrow unlimited amounts under the risk free rate of interest.
6) Trade without transaction or taxation costs.
7) Deal with securities that are all highly divisible into small parcels (All assets
are perfectly divisible and liquid).
8) Have homogeneous expectations.
9) Assume all information is available at the same time to all investors.
CAPM Formula
The CAPM formula is sometime called the Security Market Line formula and
consists of the following equation:

It is basically the equation of a line where :

r* = required return, Rf = the risk-free rate, Rm = the average market return
= the beta coefficient of the security

42
The Rm- Rf term is called the market risk premium.

The risk-free rate (Rf) is the return that an investment with no risks should earn,
commonly returns on Treasury Securities is used as risk-free rate.

Arbitage Pricing Theory (APT)

Arbitage Pricing theory (APT) was developed by Stephen Ross in 1976. It is a

method of estimating the price of an asset. The theory assumes an assets return is
dependent on various macroeconomic, market and security-specific factors.

The APT formula is:

There are an infinite number of security-specific influences for any given security
including inflation, production measures, investor confidence, exchange rates,

43
market indices or change in interest rates. It is up to the analyst to decide which
influences are relevant to the asset being analyzed.

Once the analyst derives the assets expected rate of return from the APT Model, he
or she can determine what the correct price of the asset by using discounted cash
flow model.

The APT allows the user to adapt the model to the security being analyzed. And as
with other pricing models, it helps the user decide whether a security is undervalued
or overvalued and so he or she can profit from this information. APT is also very
useful for building portfolios because it allows managers to test whether their
portfolios are exposed to certain factors.
5.11 Portfolio Evaluation Methods

The different evulation methods commonly used for portfolio evaluation are

1) Sharpes Ratio
2) Treynors Ratio
3) Jensons Performance Index

Sharpes Ratio
Sharpes performance index or Sharpes ratio was developed by William Sharpe and
gives a single value to be used for the performance ranking of various portfolios.
The index assigns highest value to the portfolio which has best risk-adjusted average
rate of return.

Sharpes ratio measures risk premium of the portfolio relative to the total amount of
risk in the portfolio. The risk premium is the difference between the portfolios
average rate of return and riskless rate of return. The standard deviation of the
portfolio indicates the risk.

44
Treynors Ratio

Treynors ratio was developed by Jack Treynor. It is the ratio of risk premium to the
volatility of return. The risk Premium is the difference between average return of
the portfolio riskless rate of return. Volatility of portfolio is measured by the
portfolio beta.

Jensens Measure

This absolute risk adjusted return measure was developed by Michael Jenson. This
ratio attempts to measure the differential between actual return of the portfolio and
the expected return of the portfolio.

45
 Data Analysis and Interpretations

46
BSE 100 INDEX SHARES
The BSE 100 index compromises of 100 companies from various sectors, which
rank high in market capitalization. The weight of stocks in the index is determined
by the market capitalizations of free floating shares of the respective companies.

BSE 100 Index is used a barometer of India stock market and economy. The list of
100 shares which constitutes the index is shown in the table below.

S No Security S No Security
1 ABB India 51 IOC
2 ACC Ltd 52 ITC
3 Adani Ports 53 JP Associates
4 Adani Power 54 Jindal Steel
5 Ambuja Cements 55 JSW Steel
6 Ashok Leyland 56 Kotak Mahindra
7 Asian Paints 57 Larsen
8 Axis Bank 58 LICHF
9 Bajaj Auto 59 Lupin
10 Bajaj Finance 60 M&M Finance
11 Bank of Baroda 61 M&M
12 Bank of India 62 Maruti Suzuki
13 Bharat Forge 63 Mothersom Sumi
14 Bharti Airtel 64 Nestle
15 BHEL 65 NHPC
16 BOSCH 66 NMDC
17 BPCL 67 NTPC
18 Cadilla HealthCare 68 ONGC
19 Canara Bank 69 PNB
20 CG Power 70 Power Finance
21 Cipla 71 PowerGrid
22 Coal India 72 REC

47
 23 Colgate 73 Rel Capital
24 Cummins 74 Reliance Communications
25 Dabur India 75 Reliance Infra
26 Divis Lab 76 Reliance Power
27 DLF 77 Reliance
28 Dr. Reddy 78 SAIL
29 Eicher Motors 79 SBIN
30 Exide India 80 Shriram Transport
31 Federal Bank 81 Siemens
32 Glenmark 82 Sun Pharma
33 GMR Infra 83 Tata Chemical
34 Godrej Consumer 84 Tata Global Bev
35 Grasim 85 Tata Motors
36 HCL Tech 86 Tata Power
37 HDFC Bank 87 Tata Steel
38 HDFC 88 TCS
39 HDIL 89 Tech Mahindra
40 Hero MotorCorp 90 Titan Company
41 Hindalco 91 Ultratech Cement
42 Hindustan Zinc 92 Uninon Bank
43 HPCL 93 Unitech
44 HUL 94 United Brew
45 ICICI Bank 95 United Spirits
46 IDBI Bank 96 UPL
47 Idea Cellular 97 Vedanta
48 IDFC 98 Wipro
49 Induslnd Bank 99 Yes Ban
50 Infosys 100 Zeel

48
Analysis of Securities
Here all the BSE 100 index stocks are used for the study. Security analysis involves
calculation of average return, variance alpha and beta of the securities. These values
from the basic secondary data for the formation for optimal portfolio.

Security Analysis on all the BSE 100 shares were conducted and average return,
variance, alpha and beta of the security of the shares were calculated using Microsoft
Excel.

Microsoft Excel work sheet was prepared with above formulae and calculations were
done using it. A sample calculation of ABB India is shown in the Appendix. The
table below shows the summary of calculation of all shares.

49
Summary Table Showing Return and Risk

The Table given shows the return, alpha beta and variance of BSE 100 Shares
Name of Returns Alpha Beta Returns Alpha Beta
Security (Ri) () () i Name of Security (Ri) () () i
ABB India 0.01 -0.04 0.55 2.42 IOC 0.09 0.04 0.62 13.56
ACC Ltd 0.02 -0.07 1.05 1.84 ITC -0.04 -0.1 0.76 6.13
Adani Ports 0.16 0.03 1.66 5.55 JP Associates 0.28 0.14 1.79 18.65
Adani Power 0.08 -0.04 1.57 5.48 Jindal Steel 0.31 0.15 1.89 9.81
Ambuja
Cements 0.02 -2.97 1.23 2.4 JSW Steel -0.19 -0.29 1.26 35.8
Ashok Leyland -0.09 -0.17 1.05 3.67 Kotak Mahindra 0.11 0.04 0.8 1.49
Asian Paints 0.1 0.02 0.92 2.26 Larsen 0.11 0.01 1.22 2.48
Axis Bank 0.05 -0.04 1.18 3.21 LICHF 0.11 -0.01 1.55 3.38
Bajaj Auto 0.07 -0.01 0.91 1.7 Lupin 0.01 -0.06 0.8 2.52
Bajaj Finance -0.13 0.24 1.35 38.37 M&M Finance 0.13 0.01 1.51 5.5
Bank of Baroda 0.08 -0.04 1.43 5.79 M&M 0.04 -0.05 1.05 2.01
Bank of India 0.16 0.03 1.6 5.12 Maruti Suzuki 0.21 0.1 1.28 2.36
Bharat Forge 0.09 0 1.19 3.69 Mothersom Sumi 0.17 0.03 1.68 4.73
Bharti Airtel 0.03 -0.03 0.81 2.95 Nestle 0.08 0.05 0.38 1.9
BHEL 0.16 0.04 1.44 4.94 NHPC 0.13 0.06 0.92 3.25
BOSCH 0.07 -0.02 1.07 2.53 NMDC 0.15 0.05 1.19 4.27
BPCL -0.03 -0.11 0.96 13.5 NTPC 0.11 0.04 0.8 1.99
Cadilla
HealthCare 0.16 0.09 0.87 5.27 ONGC -0.01 -0.07 0.73 6.39
Canara Bank 0.2 0.07 1.57 5.15 PNB 0.25 0.11 1.68 6.41
CG Power 0.22 0.11 1.28 6.01 Power Finance 0.05 -0.07 1.38 14.96
Cipla 0.07 0.02 0.58 1.93 PowerGrid 0.15 0.09 0.79 1.68
Coal India 0.02 -0.03 0.57 1.94 REC 0.14 0.02 1.41 14.55
Colgate 0.08 0.04 0.48 1.38 Rel Capital 0.22 0.06 1.99 5.06
Reliance
Cummins 0.05 -0.01 0.77 2.37 Communications -0.08 -0.21 1.62 6.82
Dabur India 0.05 0 0.62 1.93 Reliance Infra 0.03 -0.12 1.92 4.89
Divis Lab -0.16 -0.23 0.86 6.64 Reliance Power 0 -0.12 1.45 2.89
DLF 0.12 -0.06 2.2 7.76 Reliance 0.11 0.06 0.64 1.89
Dr. Reddy -0.04 -0.08 0.47 2.2 SAIL 0.16 0.03 1.66 5.02
Eicher Motors 0.13 0.04 1.11 3.25 SBIN 0.18 0.06 1.45 3.6
Exide India 0.2 0.1 1.23 3.02 Shriram Transport 0.09 -0.03 1.42 5.32
Federal Bank 0.29 0.16 1.58 4.44 Siemens 0.06 -0.02 0.99 1.97
Glenmark 0.04 -0.03 0.84 2.16 Sun Pharma -0.06 -0.02 0.99 1.97
GMR Infra 0.14 0 1.71 5.35 Tata Chemical 0.21 0.11 1.2 3.27

50
 Godrej
Consumer 0.09 -0.01 1.17 2.73 Tata Global Bev 0.1 0 1.16 3.17
Grasim -0.19 -0.31 1.4 28.54 Tata Motors 0.11 -0.03 1.74 5.12
HCL Tech 0.04 0 0.49 2.03 Tata Power 0.14 0.06 1.02 2.43
HDFC Bank 0.13 0.07 0.71 0.84 Tata Steel 0.19 0.06 1.63 4.51
HDFC 0.13 0.04 1.12 2.01 TCS 0.01 -0.04 0.51 2.06
HDIL 0.06 -0.11 2.12 7.68 Tech Mahindra 0.01 -0.07 0.97 2.85
Hero
MotorCorp 0.05 -0.03 0.98 2 Titan Company 0.14 0.04 1.16 3.29
Hindalco 0.36 0.22 1.77 6.43 Ultratech Cement 0.1 0.01 1.16 2.39
Hindustan Zinc 0.21 0.11 1.15 5.46 Uninon Bank 0.08 -0.06 1.72 6.46
HPCL 0.03 -0.07 1.15 22.11 Unitech 0.1 -0.04 1.69 15.89
HUL 0.03 -0.02 0.58 1.24 United Brew -0.02 -0.07 0.63 2.22
ICICI Bank 0.08 -0.05 1.62 3.97 United Spirits -0.04 -0.11 0.9 3.51
IDBI Bank 0.03 -0.08 1.43 4 UPL 0.2 0.11 1.03 3.78
Idea Cellular -0.04 -0.11 0.87 9.77 Vedanta 0.49 0.33 1.96 6.91
IDFC 0.15 0.02 1.56 5.35 Wipra -0.03 -0.07 0.49 1.41
Induslnd Bank 0.17 0.08 1.09 2.03 Yes Ban 0.26 0.14 1.41 3.1
Infosys -0.06 -0.11 0.59 1.89 Zeel 0.15 0.06 1.07 3.13

Inferences:

From the above table following inferences are made:

Vedanta has the highest return (49%) and Grasim and JSW Steel has lowest
return (-19%)
Vedanta has the highest Alpha (33%) and Reliance communication has lowest
return (-21%)
HDIL has the highest Beta (2.12) and HCL has lowest Beta (0.49)
Bajaj Finance has the highest Variance (38.37%) and HDFC Bank has lowest
(0.84%)

RISK ANALYSIS OF SECURITIES

The total risk of securities is divided in to two; the systematic risk which cannot be
diversified and unsystematic or specify risk which can be reduced by diversification.
These are calculated by Sharpes Index Model.

51
Systematic Risk of Securities

The systematic risk indicates non diversifiable part of the risk of security. It is
calculated using the following formule.

Market is represented by BSE 100, from the above table = 65%

The calculations are performed using Microsoft excel software. The result of
calculation of systematic risk of securities is given in the table below

Beta m2 Systematic Beta m2 Systematic

Security () (%) Risk Security () (%) Risk
ABB India 0.55 65% 19.66 IOC 0.62 65% 24.99
ACC Ltd 1.05 65% 71.66 ITC 0.76 65% 37.54
Adani Ports 1.66 65% 179.11 JP Associates 1.79 65% 208.27
Adani Power 1.57 65% 160.22 Jindal Steel 1.89 65% 232.19
Ambuja Cements 1.23 65% 98.34 JSW Steel 1.26 65% 103.19
Ashok Leyland 1.05 65% 71.66 Kotak Mahindra 0.8 65% 41.60
Asian Paints 0.92 65% 55.02 Larsen 1.22 65% 96.75
Axis Bank 1.18 65% 90.51 LICHF 1.55 65% 156.16
Bajaj Auto 0.91 65% 53.83 Lupin 0.8 65% 41.60
Bajaj Finance 1.35 65% 118.46 M&M Finance 1.51 65% 148.21
Bank of Baroda 1.43 65% 132.92 M&M 1.05 65% 71.66
Bank of India 1.6 65% 166.40 Maruti Suzuki 1.28 65% 106.50
Bharat Forge 1.19 65% 92.05 Mothersom Sumi 1.68 65% 183.46
Bharti Airtel 0.81 65% 42.65 Nestle 0.38 65% 9.39
BHEL 1.44 65% 134.78 NHPC 0.92 65% 55.02
BOSCH 1.07 65% 74.42 NMDC 1.19 65% 92.05
BPCL 0.96 65% 59.90 NTPC 0.8 65% 41.60
Cadilla HealthCare 0.87 65% 49.20 ONGC 0.73 65% 34.64
Canara Bank 1.57 65% 160.22 PNB 1.68 65% 183.46
CG Power 1.28 65% 106.50 Power Finance 1.38 65% 123.79
Cipla 0.58 65% 21.87 PowerGrid 0.79 65% 40.57
Coal India 0.57 65% 21.12 REC 1.41 65% 129.23
Colgate 0.48 65% 14.98 Rel Capital 1.99 65% 257.41
52
 Reliance
Cummins 0.77 65% 38.54 Communications 1.62 65% 170.59
Dabur India 0.62 65% 24.99 Reliance Infra 1.92 65% 239.62
Divis Lab 0.86 65% 48.07 Reliance Power 1.45 65% 136.66
DLF 2.2 65% 314.60 Reliance 0.64 65% 26.62
Dr. Reddy 0.47 65% 14.36 SAIL 1.66 65% 179.11
Eicher Motors 1.11 65% 80.09 SBIN 1.45 65% 136.66
Exide India 1.23 65% 98.34 Shriram Transport 1.42 65% 131.07
Federal Bank 1.58 65% 162.27 Siemens 0.99 65% 63.71
Glenmark 0.84 65% 45.86 Sun Pharma 0.99 65% 63.71
GMR Infra 1.71 65% 190.07 Tata Chemical 1.2 65% 93.60
Godrej Consumer 1.17 65% 88.98 Tata Global Bev 1.16 65% 87.46
Grasim 1.4 65% 127.40 Tata Motors 1.74 65% 196.79
HCL Tech 0.49 65% 15.61 Tata Power 1.02 65% 67.63
HDFC Bank 0.71 65% 32.77 Tata Steel 1.63 65% 172.70
HDFC 1.12 65% 81.54 TCS 0.51 65% 16.91
HDIL 2.12 65% 292.14 Tech Mahindra 0.97 65% 61.16
Hero MotorCorp 0.98 65% 62.43 Titan Company 1.16 65% 87.46
Hindalco 1.77 65% 203.64 Ultratech Cement 1.16 65% 87.46
Hindustan Zinc 1.15 65% 85.96 Uninon Bank 1.72 65% 192.30
HPCL 1.15 65% 85.96 Unitech 1.69 65% 185.65
HUL 0.58 65% 21.87 United Brew 0.63 65% 25.80
ICICI Bank 1.62 65% 170.59 United Spirits 0.9 65% 52.65
IDBI Bank 1.43 65% 132.92 UPL 1.03 65% 68.96
Idea Cellular 0.87 65% 49.20 Vedanta 1.96 65% 249.70
IDFC 1.56 65% 158.18 Wipro 0.49 65% 15.61
Induslnd Bank 1.09 65% 77.23 Yes Ban 1.41 65% 129.23
Infosys 0.59 65% 22.63 Zeel 1.07 65% 74.42

Inference:

From the above table it is inferred that Nestle has minimum systematic risk (9.39)
and DLF has highest systematic risk (314.60)

It means Nestle is less affected by Ups and downs in market and DLF share price is
highly influenced by volatility in the market.

53
Unsystematic Risk of the securities

Unsystematic risk refers to that portion of risk which is caused due to factors unique
or related to a firm or industry.

The total Risk of the security is the sum of systematic and non-systematic risk, the
unsystematic risk is fond out by deducting systematic risk from total risk i.e.

Unsystematic Risk = Variance of Security Systematic Risk

The Unsystematic Risk is calculated using the formula

Market is represented by BSE 100 INDEX

From the above table m2 = 65%

The table given in the next page shows the calculations of unsystematic
risk of securities

54
 Unsystematic Risk of the securities
Systematic Unsystematic Systematic Unsystematic
Security m2 Risk Risk Security m2 Risk Risk
ABB India 2.42 19.66 222.34 IOC 13.56 24.99 1331.01
ACC Ltd 1.84 71.66 112.34 ITC 6.13 37.54 575.46
Adani Ports 5.55 179.11 375.89 JP Associates 18.65 208.27 1656.73
Adani Power 5.48 160.22 387.78 Jindal Steel 9.81 232.19 748.81
Ambuja Cements 2.4 98.34 141.66 JSW Steel 35.8 103.19 3476.81
Ashok Leyland 3.67 71.66 295.34 Kotak Mahindra 1.49 41.60 107.40
Asian Paints 2.26 55.02 170.98 Larsen 2.48 96.75 151.25
Axis Bank 3.21 90.51 230.49 LICHF 3.38 156.16 181.84
Bajaj Auto 1.7 53.83 116.17 Lupin 2.52 41.60 210.40
Bajaj Finance 38.37 118.46 3718.54 M&M Finance 5.5 148.21 401.79
Bank of Baroda 5.79 132.92 446.08 M&M 2.01 71.66 129.34
Bank of India 5.12 166.40 345.60 Maruti Suzuki 2.36 106.50 129.50
Bharat Forge 3.69 92.05 276.95 Mothersom Sumi 4.73 183.46 289.54
Bharti Airtel 2.95 42.65 252.35 Nestle 1.9 9.39 180.61
BHEL 4.94 134.78 359.22 NHPC 3.25 55.02 269.98
BOSCH 2.53 74.42 178.58 NMDC 4.27 92.05 334.95
BPCL 13.5 59.90 1290.10 NTPC 1.99 41.60 157.40
Cadilla
HealthCare 5.27 49.20 477.80 ONGC 6.39 34.64 604.36
Canara Bank 5.15 160.22 354.78 PNB 6.41 183.46 457.54
CG Power 6.01 106.50 494.50 Power Finance 14.96 123.79 1372.21
Cipla 1.93 21.87 171.13 PowerGrid 1.68 40.57 127.43
Coal India 1.94 21.12 172.88 REC 14.55 129.23 1325.77
Colgate 1.38 14.98 123.02 Rel Capital 5.06 257.41 248.59
Reliance
Cummins 2.37 38.54 198.46 Communications 6.82 170.59 511.41
Dabur India 1.93 24.99 168.01 Reliance Infra 4.89 239.62 249.38
Divis Lab 6.64 48.07 615.93 Reliance Power 2.89 136.66 152.34
DLF 7.76 314.60 461.40 Reliance 1.89 26.62 162.38
Dr. Reddy 2.2 14.36 205.64 SAIL 5.02 179.11 322.89
Eicher Motors 3.25 80.09 244.91 SBIN 3.6 136.66 223.34
Exide India 3.02 98.34 203.66 Shriram Transport 5.32 131.07 400.93
Federal Bank 4.44 162.27 281.73 Siemens 1.97 63.71 133.29
Glenmark 2.16 45.86 170.14 Sun Pharma 1.97 63.71 133.29
GMR Infra 5.35 190.07 344.93 Tata Chemical 3.27 93.60 233.40
Godrej Consumer 2.73 88.98 184.02 Tata Global Bev 3.17 87.46 229.54
Grasim 28.54 127.40 2726.60 Tata Motors 5.12 196.79 315.21
HCL Tech 2.03 15.61 187.39 Tata Power 2.43 67.63 175.37
55
 HDFC Bank 0.84 32.77 51.23 Tata Steel 4.51 172.70 278.30
HDFC 2.01 81.54 119.46 TCS 2.06 16.91 189.09
HDIL 7.68 292.14 475.86 Tech Mahindra 2.85 61.16 223.84
Hero MotorCorp 2 62.43 137.57 Titan Company 3.29 87.46 241.54
Hindalco 6.43 203.64 439.36 Ultratech Cement 2.39 87.46 151.54
Hindustan Zinc 5.46 85.96 460.04 Uninon Bank 6.46 192.30 453.70
HPCL 22.11 85.96 2125.04 Unitech 15.89 185.65 1403.35
HUL 1.24 21.87 102.13 United Brew 2.22 25.80 196.20
ICICI Bank 3.97 170.59 226.41 United Spirits 3.51 52.65 298.35
IDBI Bank 4 132.92 267.08 UPL 3.78 68.96 309.04
Idea Cellular 9.77 49.20 927.80 Vedanta 6.91 249.70 441.30
IDFC 5.35 158.18 376.82 Wipro 1.41 15.61 125.39
Induslnd Bank 2.03 77.23 125.77 Yes Ban 3.1 129.23 180.77
Infosys 1.89 22.63 166.37 Zeel 3.13 74.42 238.58

Inference:

From the table it is inferred that the Bajaj Finance has highest unsystematic risk
(3718.54%) and HDFC Bank has the lowest unsystematic risk (51.23%)

Total Risk of Securities

Total Risk of a security is the sum of systematic risk and unsystematic risk.

Total Risk = Systematic Risk + Unsystematic Risk

The table given below shows the total risk of securities.

56
 Total Risk of Securities
Security SR UR Total Risk Security SR UR Total Risk
ABB India 19.66 222.34 242.00 IOC 24.99 1331.01 1356.00
ACC Ltd 71.66 112.34 184.00 ITC 37.54 575.46 613.00
Adani Ports 179.11 375.89 555.00 JP Associates 208.27 1656.73 1865.00
Adani Power 160.22 387.78 548.00 Jindal Steel 232.19 748.81 981.00
Ambuja
Cements 98.34 141.66 240.00 JSW Steel 103.19 3476.81 3580.00
Ashok Leyland 71.66 295.34 367.00 Kotak Mahindra 41.60 107.40 149.00
Asian Paints 55.02 170.98 226.00 Larsen 96.75 151.25 248.00
Axis Bank 90.51 230.49 321.00 LICHF 156.16 181.84 338.00
Bajaj Auto 53.83 116.17 170.00 Lupin 41.60 210.40 252.00
Bajaj Finance 118.46 3718.54 3837.00 M&M Finance 148.21 401.79 550.00
Bank of Baroda 132.92 446.08 579.00 M&M 71.66 129.34 201.00
Bank of India 166.40 345.60 512.00 Maruti Suzuki 106.50 129.50 236.00
Bharat Forge 92.05 276.95 369.00 Mothersom Sumi 183.46 289.54 473.00
Bharti Airtel 42.65 252.35 295.00 Nestle 9.39 180.61 190.00
BHEL 134.78 359.22 494.00 NHPC 55.02 269.98 325.00
BOSCH 74.42 178.58 253.00 NMDC 92.05 334.95 427.00
BPCL 59.90 1290.10 1350.00 NTPC 41.60 157.40 199.00
Cadilla
HealthCare 49.20 477.80 527.00 ONGC 34.64 604.36 639.00
Canara Bank 160.22 354.78 515.00 PNB 183.46 457.54 641.00
CG Power 106.50 494.50 601.00 Power Finance 123.79 1372.21 1496.00
Cipla 21.87 171.13 193.00 PowerGrid 40.57 127.43 168.00
Coal India 21.12 172.88 194.00 REC 129.23 1325.77 1455.00
Colgate 14.98 123.02 138.00 Rel Capital 257.41 248.59 506.00
Reliance
Cummins 38.54 198.46 237.00 Communications 170.59 511.41 682.00
Dabur India 24.99 168.01 193.00 Reliance Infra 239.62 249.38 489.00
Divis Lab 48.07 615.93 664.00 Reliance Power 136.66 152.34 289.00
DLF 314.60 461.40 776.00 Reliance 26.62 162.38 189.00
Dr. Reddy 14.36 205.64 220.00 SAIL 179.11 322.89 502.00
Eicher Motors 80.09 244.91 325.00 SBIN 136.66 223.34 360.00
Exide India 98.34 203.66 302.00 Shriram Transport 131.07 400.93 532.00
Federal Bank 162.27 281.73 444.00 Siemens 63.71 133.29 197.00
Glenmark 45.86 170.14 216.00 Sun Pharma 63.71 133.29 197.00
GMR Infra 190.07 344.93 535.00 Tata Chemical 93.60 233.40 327.00
Godrej
Consumer 88.98 184.02 273.00 Tata Global Bev 87.46 229.54 317.00
Grasim 127.40 2726.60 2854.00 Tata Motors 196.79 315.21 512.00

57
 HCL Tech 15.61 187.39 203.00 Tata Power 67.63 175.37 243.00
HDFC Bank 32.77 51.23 84.00 Tata Steel 172.70 278.30 451.00
HDFC 81.54 119.46 201.00 TCS 16.91 189.09 206.00
HDIL 292.14 475.86 768.00 Tech Mahindra 61.16 223.84 285.00
Hero MotorCorp 62.43 137.57 200.00 Titan Company 87.46 241.54 329.00
Hindalco 203.64 439.36 643.00 Ultratech Cement 87.46 151.54 239.00
Hindustan Zinc 85.96 460.04 546.00 Uninon Bank 192.30 453.70 646.00
HPCL 85.96 2125.04 2211.00 Unitech 185.65 1403.35 1589.00
HUL 21.87 102.13 124.00 United Brew 25.80 196.20 222.00
ICICI Bank 170.59 226.41 397.00 United Spirits 52.65 298.35 351.00
IDBI Bank 132.92 267.08 400.00 UPL 68.96 309.04 378.00
Idea Cellular 49.20 927.80 977.00 Vedanta 249.70 441.30 691.00
IDFC 158.18 376.82 535.00 Wipra 15.61 125.39 141.00
Induslnd Bank 77.23 125.77 203.00 Yes Ban 129.23 180.77 310.00
Infosys 22.63 166.37 189.00 Zeel 74.42 238.58 313.00

Inference:
From the table it is inferred that the Bajaj Finance has highest total risk (3837%) and
HDFC Bank has the lowest unsystematic risk (84%)

Construction of optimal portfolio using Sharpes optimization model

The construction of optimal portfolio using Sharpes single index model involves
following steps.

1) Ranking of the securities based on excess return over risk i.e. (Ri - Rf )/ ratio.
2) Calculation of Cut- off point.
3) Selection of securities based on the cut-off point.
4) Calculation of Weight of each security in the portfolio.

Ranking of Securities

The BSE 100 securities are ranked based on (Ri - Rf )/ ratio.

Where;

Ri = Return of the security

Rf = the risk free rate

58
The latest MIBOR (Mumbai Inter Bank Offer Rate) is taken as risk free rate Rf . The
present rate is 6%. Hence, 6% is taken as risk free calculation.

The table given in the next page shows the rank of securities based on (R i - Rf )/
ratio.

Ranking of Securities
Security Ri Rf (Ri - Rf ) (Ri - Rf )/ Ranking
ABB India 0.01 6 -5 0.55 -9.09 42
ACC Ltd 0.02 6 -4 1.05 -3.81 38
Adani Ports 0.16 6 10 1.66 6.02 14
Adani Power 0.08 6 2 1.57 1.27 24
Ambuja Cements 0.02 6 -4 1.23 -3.25 36
Ashok Leyland -0.09 6 -15 1.05 -14.29 46
Asian Paints 0.1 6 4 0.92 4.35 17
Axis Bank 0.05 6 -1 1.18 -0.85 29
Bajaj Auto 0.07 6 1 0.91 1.10 26
Bajaj Finance -0.13 6 -19 1.35 -14.07 45
Bank of Baroda 0.08 6 2 1.43 1.40 23
Bank of India 0.16 6 10 1.6 6.25 12
Bharat Forge 0.09 6 3 1.19 2.52 21
Bharti Airtel 0.03 6 -3 0.81 -3.70 37
BHEL 0.16 6 10 1.44 6.94 10
BOSCH 0.07 6 1 1.07 0.93 27
BPCL -0.03 6 -9 0.96 -9.38 43
Cadilla HealthCare 0.16 6 10 0.87 11.49 5
Canara Bank 0.2 6 14 1.57 8.92 9
CG Power 0.22 6 16 1.28 12.50 4
Cipla 0.07 6 1 0.58 1.72 22
Coal India 0.02 6 -4 0.57 -7.02 41
Colgate 0.08 6 2 0.48 4.17 18
Cummins 0.05 6 -1 0.77 -1.30 31
Dabur India 0.05 6 -1 0.62 -1.61 32
Divis Lab -0.16 6 -22 0.86 -25.58 50
DLF 0.12 6 6 2.2 2.73 19
Dr. Reddy -0.04 6 -10 0.47 -21.28 49
Eicher Motors 0.13 6 7 1.11 6.31 11
Exide India 0.2 6 14 1.23 11.38 6
Federal Bank 0.29 6 23 1.58 14.56 2
Glenmark 0.04 6 -2 0.84 -2.38 34
GMR Infra 0.14 6 8 1.71 4.68 16
59
 Godrej Consumer 0.09 6 3 1.17 2.56 20
Grasim -0.19 6 -25 1.4 -17.86 47
HCL Tech 0.04 6 -2 0.49 -4.08 39
HDFC Bank 0.13 6 7 0.71 9.86 8
HDFC 0.13 6 7 1.12 6.25 13
HDIL 0.06 6 0 2.12 0.00 28
Hero MotorCorp 0.05 6 -1 0.98 -1.02 30
Hindalco 0.36 6 30 1.77 16.95 1
Hindustan Zinc 0.21 6 15 1.15 13.04 3
HPCL 0.03 6 -3 1.15 -2.61 35
HUL 0.03 6 -3 0.58 -5.17 40
ICICI Bank 0.08 6 2 1.62 1.23 25
IDBI Bank 0.03 6 -3 1.43 -2.10 33
Idea Cellular -0.04 6 -10 0.87 -11.49 44
IDFC 0.15 6 9 1.56 5.77 15
Induslnd Bank 0.17 6 11 1.09 10.09 7
Infosys -0.06 6 -12 0.59 -20.34 48
IOC 0.09 6 3 0.62 4.84 40
ITC -0.04 6 -10 0.76 -13.16 92
JP Associates 0.28 6 22 1.79 12.29 10
Jindal Steel 0.31 6 25 1.89 13.23 6
JSW Steel -0.19 6 -25 1.26 -19.84 97
Kotak Mahindra 0.11 6 5 0.8 6.25 31
Larsen 0.11 6 5 1.22 4.10 45
LICHF 0.11 6 5 1.55 3.23 48
Lupin 0.01 6 -5 0.8 -6.25 81
M&M Finance 0.13 6 7 1.51 4.64 42
M&M 0.04 6 -2 1.05 -1.90 70
Maruti Suzuki 0.21 6 15 1.28 11.72 11
Mothersom Sumi 0.17 6 11 1.68 6.55 29
Nestle 0.08 6 2 0.38 5.26 39
NHPC 0.13 6 7 0.92 7.61 25
NMDC 0.15 6 9 1.19 7.56 26
NTPC 0.11 6 5 0.8 6.25 31
ONGC -0.01 6 -7 0.73 -9.59 86
PNB 0.25 6 19 1.68 11.31 15
Power Finance 0.05 6 -1 1.38 -0.72 64
PowerGrid 0.15 6 9 0.79 11.39 13
REC 0.14 6 8 1.41 5.67 38
Rel Capital 0.22 6 16 1.99 8.04 21

60
 Reliance
Communications -0.08 6 -14 1.62 -8.64 83
Reliance Infra 0.03 6 -3 1.92 -1.56 68
Reliance Power 0 6 -6 1.45 -4.14 78
Reliance 0.11 6 5 0.64 7.81 24
SAIL 0.16 6 10 1.66 6.02 35
SBIN 0.18 6 12 1.45 8.28 20
Shriram Transport 0.09 6 3 1.42 2.11 54
Siemens 0.06 6 0 0.99 0.00 62
Sun Pharma -0.06 6 -12 0.99 -12.12 90
Tata Chemical 0.21 6 15 1.2 12.50 8
Tata Global Bev 0.1 6 4 1.16 3.45 46
Tata Motors 0.11 6 5 1.74 2.87 49
Tata Power 0.14 6 8 1.02 7.84 23
Tata Steel 0.19 6 13 1.63 7.98 22
TCS 0.01 6 -5 0.51 -9.80 87
Tech Mahindra 0.01 6 -5 0.97 -5.15 79
Titan Company 0.14 6 8 1.16 6.90 28
Ultratech Cement 0.1 6 4 1.16 3.45 46
Uninon Bank 0.08 6 2 1.72 1.16 59
Unitech 0.1 6 4 1.69 2.37 53
United Brew -0.02 6 -8 0.63 -12.70 91
United Spirits -0.04 6 -10 0.9 -11.11 88
UPL 0.2 6 14 1.03 13.59 5
Vedanta 0.49 6 43 1.96 21.94 1
Wipra -0.03 6 -9 0.49 -18.37 96
Yes Ban 0.26 6 20 1.41 14.18 4
Zeel 0.15 6 9 1.07 8.41 19

Calculation of Cut-Off Point

The securities are rearranged based on the rank of (Ri - Rf)/ ratio.

Then the cut of rate is calculated using the formulae.

61
The Calculation Cut-off point is shown in the below table.
From the table it seen that the cut-off point Ci shows a character of increasingly
gradually and after reaching a peak value it starts decreasing gradually. This Point
is highest cut off rate and it will be denoted as C*.

The cut-off point determines which securities are to be included in the portfolio. The
securities with (Ri - Rf )/ values up to cut off point C* () are included in the portfolio.
Securities with (Ri - Rf )/ values beyond cut off point are excluded.

62
 (Ri- (Ri-
(Ri- Rf)* Rf)*
Rank Security Rf) ei2 /ei2 /ei2 m2 2/ei (2/ei) Ci Status
1 Vedanta 43 1.96 441.3 0.19 0.19 65 0.009 0.009 7.79 IN
2 Hindalco 30 1.77 439.36 0.12 0.31 65 0.007 0.016 9.86 IN
3 Federal Bank 23 1.58 281.73 0.13 0.44 65 0.009 0.025 10.89 IN
4 Yes Bank 20 1.41 180.77 0.16 0.60 65 0.011 0.036 11.60 IN
5 UPL 14 1.03 309.04 0.05 0.64 65 0.003 0.039 11.72 IN
6 Jindal Steel 25 1.89 748.81 0.06 0.71 65 0.005 0.044 11.84 IN
7 Hindustan Zinc 15 1.15 460.04 0.04 0.74 65 0.003 0.047 11.90 IN
8 Tata Chemical 15 1.2 233.4 0.08 0.82 65 0.006 0.053 11.95 IN
9 CG Power 16 1.28 494.5 0.04 0.86 65 0.003 0.057 11.98 IN
10 JP Associates 22 1.79 1656.7 0.02 0.89 65 0.002 0.058 11.99 IN
11 Maruti Suzuki 15 1.28 129.5 0.15 1.03 65 0.013 0.071 11.95 IN
Cadilla
12 Healthcare 10 0.87 477.8 0.02 1.05 65 0.002 0.073 11.94 IN
13 Power Grid 9 0.79 127.43 0.06 1.11 65 0.005 0.078 11.91 IN
14 Exide India 14 1.23 203.66 0.08 1.19 65 0.007 0.085 11.87 IN
15 PNB 19 1.68 457.54 0.07 1.26 65 0.006 0.091 11.84 OUT
16 Indulsnd Bank 11 1.09 125.77 0.10 1.36 65 0.009 0.101 11.70 OUT
17 HDFC Bank 7 0.71 51.23 0.10 1.45 65 0.010 0.111 11.55 OUT
18 Canara Bank 14 1.57 354.78 0.06 1.52 65 0.007 0.117 11.41 OUT
19 Zeel 9 1.07 238.58 0.04 1.56 65 0.005 0.122 11.31 OUT
20 SBIN 12 1.45 223.34 0.08 1.63 65 0.009 0.132 11.12 OUT
21 Rel Capital 16 1.99 248.59 0.13 1.76 65 0.016 0.148 10.82 OUT
22 Tata Power 8 1.02 175.37 0.05 1.81 65 0.006 0.154 10.71 OUT
23 Tata Steel 13 1.63 278.3 0.08 1.89 65 0.010 0.163 10.56 OUT
24 Reliance 5 0.64 162.38 0.02 1.91 65 0.003 0.166 10.53 OUT
25 NHPC 7 0.92 269.98 0.02 1.93 65 0.003 0.169 10.48 OUT
26 NMDC 9 1.19 334.95 0.03 1.96 65 0.004 0.173 10.41 OUT
27 BHEL 10 1.44 359.22 0.04 2.00 65 0.006 0.179 10.31 OUT
28 Titan Company 8 1.16 241.54 0.04 2.04 65 0.006 0.184 10.21 OUT
MotherSom
29 Sumi 11 1.68 289.54 0.06 2.10 65 0.010 0.194 10.04 OUT
30 Eicher Motors 7 1.11 244.91 0.03 2.13 65 0.005 0.199 9.95 OUT
31 Kotak Mahindra 5 0.8 107.4 0.04 2.17 65 0.006 0.205 9.85 OUT
32 NTPC 5 0.8 157.4 0.03 2.20 65 0.004 0.209 9.79 OUT
33 HDFC 7 1.12 119.46 0.07 2.26 65 0.011 0.220 9.63 OUT
34 Bank of India 10 1.6 166.4 0.10 2.36 65 0.015 0.235 9.42 OUT
35 SAIL 10 1.66 322.89 0.05 2.41 65 0.009 0.244 9.31 OUT
36 Adani Ports 10 1.66 375.89 0.04 2.45 65 0.007 0.251 9.22 OUT

63
 37 IDFC 9 1.56 376.82 0.04 2.49 65 0.006 0.257 9.14 OUT
38 REC 8 1.41 1325.8 0.01 2.50 65 0.001 0.259 9.12 OUT
39 Nestle 2 0.38 180.81 0.00 2.50 65 0.001 0.260 9.11 OUT
40 IOC 3 0.62 1331 0.00 2.51 65 0.000 0.260 9.10 OUT
41 GMR Infra 8 1.71 344.93 0.04 2.55 65 0.008 0.268 8.97 OUT
42 M&M Finance -2 1.05 129.34 -0.02 2.53 65 0.009 0.277 8.65 OUT
43 Asian Paints 4 0.92 170.98 0.02 2.55 65 0.005 0.282 8.58 OUT
44 Colgate 2 0.48 172.88 0.01 2.56 65 0.001 0.283 8.56 OUT
45 Larsen 5 1.22 151.25 0.04 2.60 65 0.010 0.293 8.42 OUT
Tata Global
46 Bevg 4 1.16 229.54 0.02 2.62 65 0.006 0.299 8.33 OUT
Ultratech
47 Cement 4 1.16 151.54 0.03 2.65 65 0.009 0.308 8.19 OUT
48 LICHF 5 1.55 181.84 0.04 2.69 65 0.013 0.321 8.00 OUT
49 Tata Motors 5 1.74 315.21 0.03 2.72 65 0.010 0.331 7.86 OUT
50 DLF 6 2.2 461.6 0.03 2.75 65 0.010 0.341 7.71 OUT
Godrej
51 Consumer 3 1.17 184.02 0.02 2.77 65 0.007 0.349 7.60 OUT
52 Bharat Forge 3 1.19 276.95 0.01 2.78 65 0.005 0.354 7.53 OUT
53 Unitech 4 1.69 1403.4 0.00 2.78 65 0.002 0.356 7.50 OUT
Shriram
54 Transport 3 1.42 400.93 0.01 2.79 65 0.005 0.361 7.43 OUT
55 CIPLA 1 0.58 171.13 0.00 2.80 65 0.002 0.363 7.40 OUT
56 Bank of Baroda 2 1.43 446.08 0.01 2.80 65 0.005 0.367 7.33 OUT
57 Adani Power 2 1.57 387.78 0.01 2.81 65 0.006 0.374 7.23 OUT
58 ICICI Bank 2 1.62 226.41 0.01 2.83 65 0.012 0.385 7.06 OUT
59 Union Bank 2 1.72 453.7 0.01 2.83 65 0.007 0.392 6.96 OUT
60 Bajaj Auto 1 0.91 116.17 0.01 2.84 65 0.007 0.399 6.86 OUT
61 BOSCH 1 1.07 178.58 0.01 2.85 65 0.006 0.405 6.77 OUT
62 Siemens 0 0.99 133.29 0.00 2.85 65 0.007 0.413 6.65 OUT
63 HDIL 0 2.12 475.86 0.00 2.85 65 0.009 0.422 6.51 OUT
64 Power Finance -1 1.38 1372.2 0.00 2.85 65 0.001 0.423 6.49 OUT
65 Axis Bank -1 1.18 230.49 -0.01 2.84 65 0.006 0.429 6.39 OUT
Hero
66 MotorCorp -1 0.98 137.57 -0.01 2.83 65 0.007 0.436 6.27 OUT
67 Cummins -1 0.77 198.46 0.00 2.83 65 0.003 0.439 6.22 OUT
68 Reliance Infra -3 1.92 249.38 -0.02 2.81 65 0.015 0.454 5.98 OUT
69 Dabur India -1 0.62 168.01 0.00 2.80 65 0.002 0.457 5.94 OUT
70 M&M -2 1.05 129.34 -0.02 2.79 65 0.009 0.465 5.80 OUT
71 IDBI Bank -3 1.43 267.08 -0.02 2.77 65 0.008 0.473 5.68 OUT
72 Glenmark -2 0.84 170.14 -0.01 2.76 65 0.004 0.477 5.61 OUT
73 HPCL -3 1.15 2125 0.00 2.76 65 0.001 0.477 5.60 OUT
64
 Ambuja
74 Cements -4 1.23 141.66 -0.03 2.73 65 0.011 0.488 5.41 OUT
75 Bharti Airtel -3 0.81 252.35 -0.01 2.72 65 0.003 0.491 5.37 OUT
76 ACC Ltd -4 1.05 112.34 -0.04 2.68 65 0.010 0.501 5.19 OUT
77 HCL Tech -2 0.49 187.39 -0.01 2.67 65 0.001 0.502 5.17 OUT
78 Reliance Power -6 0.45 152.34 -0.02 2.66 65 0.001 0.503 5.12 OUT
79 Tech Mahindra -5 0.97 223.84 -0.02 2.63 65 0.004 0.507 5.04 OUT
80 HUL -3 0.58 102.13 -0.02 2.62 65 0.003 0.511 4.97 OUT
81 Lupin -5 0.8 210.4 -0.02 2.60 65 0.003 0.514 4.91 OUT
82 Coal India -4 0.57 172.88 -0.01 2.58 65 0.002 0.516 4.87 OUT
Reliance
83 Communcations -14 1.62 511.41 -0.04 2.54 65 0.005 0.521 4.74 OUT
84 ABB India -5 0.55 222.34 -0.01 2.53 65 0.001 0.522 4.70 OUT
85 BPCL -9 0.96 1290.1 -0.01 2.52 65 0.001 0.523 4.68 OUT
86 ONGC -7 0.73 604.36 -0.01 2.51 65 0.001 0.524 4.66 OUT
87 TCS -5 0.51 189.09 -0.01 2.50 65 0.001 0.525 4.62 OUT
88 United Spirits -10 0.9 298.35 -0.03 2.47 65 0.003 0.528 4.55 OUT
89 Idea Cellular -10 0.87 927.8 -0.01 2.46 65 0.001 0.529 4.52 OUT
90 Sun Pharma -12 0.99 133.29 -0.09 2.37 65 0.007 0.536 4.30 OUT
91 United Brew -8 0.63 196.2 -0.03 2.34 65 0.002 0.538 4.24 OUT
-
92 ITC -10 0.76 575.46 0.01 2.36 65 0.001 0.539 4.25 OUT
93 Bajaj Finance -19 1.35 3718.5 -0.01 2.35 65 0.000 0.539 4.24 OUT
94 Ashok Leyland -15 1.05 295.34 -0.05 2.30 65 0.004 0.543 4.11 OUT
95 Grasim -25 1.4 2726.8 -0.01 2.28 65 0.001 0.544 4.09 OUT
96 Wipro -9 0.49 125.39 -0.04 2.25 65 0.002 0.546 4.01 OUT
97 JSW Steel -25 1.26 3476.8 -0.01 2.24 65 0.000 0.546 3.99 OUT
98 Infosys -12 0.59 166.37 -0.04 2.20 65 0.002 0.548 3.90 OUT
99 Dr. Reddy -10 0.47 205.64 -0.02 2.18 65 0.001 0.549 3.85 OUT
100 Divis Lab -22 0.86 615.93 -0.03 2.14 65 0.001 0.551 3.79 OUT

Inference:
14 shares up to cut point 14 corresponding to highest cut-off point of 11.87 are
included in the portfolio.

65
Calculation of Optimal portfolio

The proportion to be invested in each security (weightage) is calculated using the

following equation.

The Calculation of optimal portfolio is shown in the table below.

Security (Ri-Rf) B UR (Ri-Rf)/B C* b/UR Zi Ezi Xi=Zi/Ezi

Vedanta 43 1.96 441.3 21.94 7.79 0.004 -7.7 -158.543 0.0488
Hindalco 30 1.77 439.36 16.95 9.86 0.004 -9.8 -158.543 0.0620
Federal Bank 23 1.58 281.73 14.56 10.89 0.006 -10.8 -158.543 0.0684
Yes Bank 20 1.41 180.77 14.18 11.60 0.008 -11.5 -158.543 0.0727
UPL 14 1.03 309.04 13.59 11.72 0.003 -11.7 -158.543 0.0737
Jindal Steel 25 1.89 748.81 13.23 11.84 0.003 -11.8 -158.543 0.0746
Hindustan Zinc 15 1.15 460.04 13.04 11.90 0.002 -11.9 -158.543 0.0749
Tata Chemical 15 1.2 233.4 12.50 11.95 0.005 -11.9 -158.543 0.0751
CG Power 16 1.28 494.5 12.50 11.98 0.003 -12.0 -158.543 0.0754
JP Associates 22 1.79 1656.73 12.29 11.99 0.001 -12.0 -158.543 0.0756
Maruti Suzuki 15 1.28 129.5 11.72 11.95 0.010 -11.9 -158.543 0.0748
Cadilla
Healthcare 10 0.87 477.8 11.49 11.94 0.002 -11.9 -158.543 0.0752
Power Grid 9 0.79 127.43 11.39 11.91 0.006 -11.8 -158.543 0.0746
Exide India 14 1.23 203.66 11.38 11.87 0.006 -11.8 -158.543 0.0745
-
Total zi 158.543 Wi 1.00

Inference:
The JP Associates has the highest weight in the portfolio (7.56%) and Vedanta has
lowest weight in the portfolio (4.88 %).

66
 Weightage

Exide India Vedanta

7% 5% Hindalco
Power Grid 6%
7%
Federal Bank
7%
Cadilla Healthcare
8%
Yes Bank
7%

Maruti Suzuki
7%
UPL
7%

JP Associates
8%
Jindal Steel
7%

CG Power
8%
Hindustan Zinc
8%
Tata Chemical
8%

Vedanta Hindalco Federal Bank Yes Bank UPL

Jindal Steel Hindustan Zinc Tata Chemical CG Power JP Associates
Maruti Suzuki Cadilla Healthcare Power Grid Exide India

67
Measuring Risk and Return of Optimal Portfolio

The return and risk of optimal portfolio is required for evaluation of portfolio with
other portfolios.

Calculation of Portfolio Alpha in Optimal Portfolio

The portfolio alpha is the weighted average of the specific returns (alpha) of the
invidual securities. The portfolio alpha is calculated using the equation

The table below shows the calculation of alpha of Optimal Portfolio.

Alpha* Weight
Security Alpha (i) Weight (wi) (i*wi)
Cadilla Healthcare 9 0.08 0.72
CG Power 7 0.08 0.56
Exide India 10 0.07 0.70
Federal Bank 16 0.07 1.12
Hindalco 22 0.06 1.32
Hindustan Zinc 11 0.07 0.77
Jindal Steel -29 0.07 -2.03
JP Associates 14 0.08 1.12
Maruti Suzuki 10 0.07 0.70
Power Grid 9 0.07 0.63
Tata Chemical 11 0.08 0.88
UPL 11 0.07 0.77
Vedanta 33 0.05 1.65
Yes Bank 14 0.07 0.98
Total 9.89

Inference:
68
From the above table, it is inferred that the alpha (excess return over the market) of
optimal portfolio is 9.89%.

Calculation of Portfolio Beta in Optimal Portfolio

The Portfolio Beta is the weighted average of the beta coefficient of the individual
securities. The portfolio beta is calculated using the equation.

The table below shows the calculation of beta of optimal portfolio.

Beta*Weight
Security Beta (i) Weight (wi) (i* wi)
Cadilla Healthcare 0.87 0.08 0.0696
CG Power 1.28 0.08 0.1024
Exide India 1.23 0.07 0.0861
Federal Bank 1.58 0.07 0.1106
Hindalco 1.77 0.06 0.1062
Hindustan Zinc 1.15 0.07 0.0805
Jindal Steel 1.89 0.07 0.1323
JP Associates 1.79 0.08 0.1432
Maruti Suzuki 1.28 0.07 0.0896
Power Grid 0.79 0.07 0.0553
Tata Chemical 1.2 0.08 0.096
UPL 1.41 0.07 0.0987
Vedanta 1.96 0.05 0.098
Yes Bank 1.03 0.07 0.0721
Total 1.3406

Inference:
From the above table it is inferred that beta of the portfolio is 1.3406, i.e. for 1%
variation in value of market index, the risk in portfolio will be only 0.45%.

69
Calculation of Return of Optimal Portfolio

The expected return of a portfolio is calculated using the formulae

The table below shows the calculation of return of optimal portfolio.

Portfolio Alpha Portfolio Beta Market Return Portfolio Return

Portfolio (p) () (Rm) (Rp)= p + + Rm

Optimal Portfolio 9.89 1.34 8 20.61

Inference
From the Above table it is inferred that, the average return of the optimal portfolio
for the 1 year from 2016-2017 is 20.61%.

70
Calculation of Residual Variance (Unsystematic Risk) in Optimal Portfolio

Unsystematic risk or residual variance of a portfolio is given by the equation

The table given below shows the calculation of unsystematic risk of optimal
portfolio.

Residual Variance RV*Weight

Security (ei2) Weight(Wi) Wi2 (ei2* Wi2)
Cadilla Healthcare 477.8 0.08 0.0064 3.05792
CG Power 494.5 0.08 0.0064 3.1648
Exide India 203.66 0.07 0.0049 0.997934
Federal Bank 281.73 0.07 0.0049 1.380477
Hindalco 439.36 0.06 0.0036 1.581696
Hindustan Zinc 460.04 0.07 0.0049 2.254196
Jindal Steel 748.81 0.07 0.0049 3.669169
JP Associates 1656.73 0.08 0.0064 10.603072
Maruti Suzuki 129.5 0.07 0.0049 0.63455
Power Grid 127.43 0.07 0.0049 0.624407
Tata Chemical 233.4 0.08 0.0064 1.49376
UPL 309.04 0.07 0.0049 1.514296
Vedanta 441.3 0.05 0.0025 1.10325
Yes Bank 180.77 0.07 0.0049 0.885773
Total 32.97

Inference:
From the above table, it is inferred that the residual variance of the optimal portfolio
is 32.97 %.

71
Calculation of Systematic Risk of Optimal Portfolio

Systematic Risk of a portfolio is calculated using the equation given below

The table below shows the calculation of systematic risk of optimal portfolio.

Systematic Risk
Portfolio p p2 m2 (p2* m2) %

Optimal Portfolio 1.3406 1.797208 65 116.82

Inference
From the above table it is inferred that the systematic risk of optimal portfolio is
116.82 %.

72
Calculation of total risk of Optimal Portfolio

The total risk of a portfolio is sum of systematic risk and unsystematic risk of a
portfolio.
This may be expressed as:

The table below shows the calculation of total risk of optimal portfolio.

Portfolio Systematic Risk Unsystematic Risk Total Risk (%)

Optimal Portfolio 116.82 32.97 149.79

Inference:
From the above table it is inferred that the total risk of of optimal portfolio is
149.79%.

73
Findings
1) The risk can be reduced if the portfolio is diversified. The point of diversity
is to achieve a given level of expected return while bearing the least possible
risk.

2) The 14 securities ranking from 1 to 14 based on the Ci values were identified

along with the proportion of investment is too made.

3) Bajaj Finance stock return has highest unsystematic risk (3718.54%) and that
of HDFC Bank has the lowest unsystematic risk (51.23%).It is unique risk
affecting the firm due to certain factors affecting only the company issuing
such security. It is avoidable risk.

4) The stock return of Vedanta has the highest return (49%) and Grasim and JSW
Steel has lowest return (-19%). If the investor wants to earn a maximum return
without considering the risk aspect then investment can be made on those
securities which yield high returns. Even though the return is high, the risk
involved in the stock return should be considered while taking investment
decision.

5) The return from HDIL has the highest Beta (2.12) which means this stock is
less volatile.

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Recommendations

1) Financial Advisor have to study and analyze companies future prospects,

quality of management, past record etc. and take informed decisions by
fundamental analysis of a company which can benefit the investor before
investing into the stocks.

2) The investors should invest for longer term rather than investing for shorter
duration to maximize returns.

3) If the investor is aggressive investor or High risk taker, then the advisors have
to suggest investors to invest in high risk and high return earning stocks.

4) All investments carry risk of some kind. Investors should understand the risk
they are taking and invest in manner that matches their tolerance. The return
(Ri) gives an idea of the risk involved in making any investment.

5) Statistical tools such ast-test can be used for providing the superiority of
optimal portfolio constructed using Sharpes single index model.

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References
Chandra, D. P. (2004). Investment Analysis and Portfolio Management. Tata McGraw- Hill Publishing
Company Limited.

Gupta, S. K. (2013). Financial Management. Ludhiana: Kalyani Publishers.

Historical Data. (n.d.). Retrieved from Bombay Stock Exchange Website: http://www.bseindia.com

Kevin, S. (2003). Portolio Management. New Delhi: Printice Hall of India Pvt Ltd.

Kothari, C. (2004). Research Methodolgy: Methods and Techiniques. New Delhi: New Age International
Pvt. Ltd.

Portfolio Evaluation. (2017). Retrieved from Investopedia Website: http://www.investopedia.com

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