Bal Reddy

55726861.
docSECURITY ANALYSIS & PORTFOLIO MANAGEMENT
Introduction:
 Need & Importance: -
Economic liberalization has accelerated the pace of development in the securities market,
which has undergone a sea change during the last 2 decades. In India, the role of securities market in
mobilizing & channelising private capital for the economic development of the country has
increased over the years and the securities market itself has undergone structural transformation with
the introduction of computerized online trading & interconnected market system.
Investing in securities such as shares, debentures & bonds is profitable well as exciting. It is
indeed rewarding but involves a great deal of risk & need artistic skill. Investing in financial
securities is now considered to be one of the most risky avenues of investment. It is rare to find
investors investing their entire savings in a single security. Instead, they tend to invest in a group of
securities. Such group of securities is called a Portfolio. Creation of a portfolio helps to reduce risk
without sacrificing returns. Portfolio Management deals with the analysis of individual securities as
well as with the theory & practice of optimally combining securities into portfolios.
NEED FOR THE STUDY : -
The investor today is looking at investing in securities, which would give him better
returns than an ordinary savings bank account or fixed deposits though at a certain amount of risk.
Every person save money by postponing consumption because future is uncertain. So they have to
search out for efficient investment opportunities. There is a saying “putting all eggs in one basket is
always dangerous” selecting two or more securities or assets and constructing a portfolio is essential
to spread the risk so study of portfolio analysis is needed.
Aurora School of Business Secundrabad 1

55726861.docSECURITY ANALYSIS & PORTFOLIO MANAGEMENT
 Objectives of the Study:
 How to analyze Securities.

 How Portfolio Management is done.
 To study the investment pattern and it’s related risks & returns.
 To understand, analyze and select the best portfolio.
 To help the investors to choose wisely between alternative investment.
 To strike balance between Cost of funds, risk and returns.
 Limitations of the Study:
 This study has been conducted purely to understand Portfolio Management for investors and
is done for requirement of Certificate of MBA.
 For study purpose 5 Companies have been taken for Calculations.
 Study is limited to Portfolio consisting of only 2 companies.
 Study is limited to period from 2000-2004.
 Data Collection was strictly confined to secondary source. No primary data associated with
the project.
 There was a constraint with regard to time allocated for the research study, a period of one
and a half month i.e. from March 14th to April 30’ 2005.
 Study is limited to only first 3 steps or phases of Portfolio Management.
 Detailed study of the topic was not possible due to limited size of the project.
 The availability of information in the form of annual reports and price fluctuations of the
companies was a big constraint to the study.

(2). Research Methodology:
 Sources of Data Collection: - The methodology adopted or employed in this study was mostly
on Secondary data collection i.e.,
 Companies Annual Reports
 Information from Internet
 Publications
 Information provided by Hyderabad Stock Exchange
 Period of Study:
For different companies, financial data has been collected from the year 2000 – 2004.
 Selection of Companies:
Companies selected for analysis are –
 Infosys
 Indian Tobacco Corporation (ITC)
 Satyam
 Hero Honda
 Reliance

(3). STOCK EXCHANGE
 History:
The only stock exchange operating in the 19th century wee those of Bombay set up in 1875
and Ahmedabad set up in 1894. These were organized as voluntary non-profit making association of
brokers to regulate and protect their interests. Before the control on securities trading became a
central subject under the constitution in 1950, it was a state subject and the Bombay securities
contracts (control) Act if 1925 used to regulate trading in securities. Under this Act, The Bombay
Stock Exchange was recognized in 1927 and Ahmedabad in 1937.
During the war boom, a number of stock exchanges were organized even in Bombay,
Ahmedabad and other centers, but they were not recognized. Soon after it became a central subject,
central legislation was proposed and a committee headed by A.D. Gorwala went into the bill for
securities regulation. On the basis of the committee’s recommendations and public discussion, the
securities contracts (regulation) Act became law in 1956.
DEFINITION OF STOCK EXCHANGE
“Stock Exchange means any body or individuals whether incorporated or not, constituted for
the purpose of assisting, regulating or controlling the business of buying, selling or dealing in
securities.”
It is an association of member brokers for the purpose of self-regulation and protecting the
interests of its members.
It can operate only if it is recognized by the Government under the securities contracts
(regulation) Act, 1956. The recognition is granted under section 3 of the Act by the central
government, ministry of Finance.

BY LAWS:
Besides the above act, the securities contracts (regulation) rules were also made in 1957 to
regulate certain matters of trading on the stock exchanges. There are also bylaws of the exchanges,
which are concerned with the following subjects:
Opening/closing of the Stock Exchanges, timing of trading, regulation of blank transfers, regulation
of badla or carryover business, control of the settlement and other activities of the Stock Exchange,
fixation of margins, fixation of market prices or making up prices. Regulation of taravani business
(jobbing), etc., regulation of brokers trading, brokerage charges, trading rules on the exchange,
arbitration and settlement of disputes, settlement and clearing of the trading etc.
REGULATION OF STOCK EXCHANGE
The Securities contracts (regulation) act is the basis for operations of the Stock Exchanges in
India. No exchange can operate legally without the government permission or recognition. Stock
Exchanges are given monopoly in certain areas under section 19 of the anove Act to ensure that the
control and regulation are facilitated. Recognition can be granted to a Stock Exchange provided
certain conditions are satisfied and the necessary information is supplied to the government.
Recognition can also be withdrawn, if necessary where there is no Stock Exchange in its absence.
 SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)
SEBI was setup as an autonomous regulatory authority by the Government of India in 1988
to protect the interests of investors in securities and to promote the development of and to regulate
the securities market and for matters connected therewith or incidental thereto. It is empowered by
two acts namely SEBI Act, 1992 and Securities contract (regulation) Act, 1956 to perform the
function of protecting investor’s rights and regulating the capital markets.

 BOMBAY STOCK EXCHANGE
The Stock Exchange, Mumbai popularly known as “BSE” was established in 1875 as “The
Native share and stock brokers association”, as a voluntary non-profit making association. It has
evolved over the years into its present status as the premiere Stock Exchange in the country. It may
be noted that the Stock Exchanges the oldest one in Asia, even older than the Tokyo Stock
Exchange, which was founded in 1878.
The exchange, while providing an efficient and transparent market for trading in securities,
upholds the interests of the investors and ensures redressed of their grievances, whether against the
companies or its own member brokers. It also strives to educate and enlighten the investors by
making available necessary informative inputs and conducting investor education programmers.
A governing board having 20 directors is the apex body, which decides the policies and
regulates the affairs of the exchange. The Governing body consists of 9 elected directors, 3 SEBI
nominees, 6 public representatives and an Executive director & Chief Executive Officer and a Chief
Operating Officer.
The Executive director as the chief executive officer is responsible for the day-to-day
administration of the exchange. The average daily turnover of the exchange during the year 2000-01
(April-March) was Rs. 3984.19 Crs and average number of daily trades 5.69 lacs.
However the average daily turn over of the exchange during the year 2001-02 has declined
to Rs. 1248.10 Crs and number of average daily trades during the period to 5.17 lacs.
The average daily turn over of the exchange during the year 2002-03 has declined and
number of average daily trades during the period is also decreased.

The Ban on all deferral products like BLESS and ALBM in the Indian capital markets by
SEBI w.e.f July 2, 2001 abolition of account period settlements, introduction of compulsory rolling
settlements in all scrips traded on the exchanges w.e.f Dec 31,
2001 etc., have adversely impacted the liquidity and consequently there is a considerable
decline in the daily turn over at the exchange. The average daily turn over of the exchange present
scenario is 110363 (lacs) and number of average daily trades 1057 (lacs).
BSE INDICES
In order to enable the market participants, analysts etc., to track the various ups and downs in
the Indian stock market, the exchange has introduced in 1986 an equity stock index called BSE-
SENSEX that subsequently became the barometer of the moments of the share prices in the Indian
stock market. It is a “Market capitalization-weighted” index of 30 component stocks representing a
sample of large, well-established and leading companies. The base year of Sensex is 1978-79. The
Sensex is widely reported in both domestic and international markets through print as well as
electronic media.
Sensex is calculated using a market capitalization weighted method. As per this
methodology, the level of the index reflects the total market value of all 30-component stocks from
different industries related to particular base period. The total market value of a company is
determined by multiplying the price of its stock by the number of shares outstanding. Statiscians call
an index of a set of combined variables (such as price and number of shares) a composite Index. An
indexed number is used to represent the results of this calculation in order to make the value easier to
work with and track overtime. It is much easier to graph a chart based on Indexed values than one
based on actual values world over majority of the well-known Indices are constructed using ‘Market
capitalization weighted method’.
In practice, the daily calculation of SENSEX is done by dividing the
aggregate market value of the 30 companies in the Index by a number called the Index Divisor. The
divisor keeps the index comparable over a period of time and if the reference point for the entire

Index maintenance adjustments. SENSEX is widely used to describe the mood in the Indian stock
markets. Base year average is changed as per the formula:
New base year average = old base year average*(new market value/old market value)
 NATIONAL STOCK EXCHANGE

The organization
The National Stock Exchange of India Limited has genesis in the report of the High Powered
Study Group on Establishment of New Stock Exchanges, which recommended promotion of a
National Stock Exchange by financial institutions (Fis) to provide access to investors from all across
the country on an equal footing. Based on the recommendations, NSE was promoted by leading
Financial Institutions at the best of the Government of India and was incorporated in November
1992 as a tax paying company unlike other Stock Exchanges in the country.
On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956
in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June
1994. The Capital Market (Equities) segment commenced operations in November 1994 and
operations in Derivatives segment commenced in June 2000.
NSE – NIFTY
The NSE on April 22,1996 launched a new equity Index. The NSE-50. The new Index which
replaces the existing NSE – 100 Index, is expected to serve as an appropriate Index for the new
segment of futures and option.” NIFTY” means Nations Index for Fifty Stocks. The NSE-50
comprises 50 companies that represent 20 broad Industry groups with an aggregate market
capitalization of around Rs.1, 70,000crs. All companies included in the Index have a market

capitalization excess of Rs.500crs each and should have traded for 85% of trading days at an impact
cost of less than 1.5%.
NSE – MIDCAP INDEX
The NSE madcap Index or the Nifty comprises 50 stocks that represent 21 boards Industry
groups and will provide proper representation of the madcap segment of the Indian capital market.
All stocks in the Index should have market capitalization of greater than Rs.200crs and should have
traded 85% of the trading days at an impact cost of less 2.5%.
The base period for the index is Nov 4, 1996, which signifies two years for
completion of operations of the capital market segment of the operations. The base value of the
Index has been set at 1000.
Average daily turnover of the present scenario 258212 (Laces) and number of average
daily trades 2160 (Laces).
At present, there are 24 Stock Exchanges recognized under the Securities Contract
(Regulation) Act, 1956. They are: -

NAME OF THE STOCK EXCHANGE YEAR

Bombay Stock Exchange 1875

Ahmedabad share and Stock brokersAssociation 1957
Calcutta Stock exchange Association Ltd 1957
Delhi Stock Exchange Association Ltd 1957
Madras Stock Exchange Association Ltd 1958
Indore Stock Exchange Association 1968
Bangalore Stock Exchange 1943
Hyderabad Stock Exchange 1978
Cochin Stock Exchange 1982
Pune Stock Exchange Ltd 1982
U.P Stock Exchange Association Ltd 1983
Ludhiana Stock Exchange Association Ltd 1983 – 84
Jaipur Stock Exchange Ltd 1984
Gauhathi Stock Exchange Ltd 1985
Mangalore Stock Exchange Ltd 1986
Maghad Stock Exchange Ltd, Patna 1989
Bhubaneshwar Stock Exchange Association Ltd 1989
Over the counter exchange of India, Bombay 1990
Saurasthra Kutch Stock Exchange Ltd 1991
Vsdodara Stock Exchange ltd 1991
Coimbatore Stock Exchange Ltd 1991
The Meerut Stock Exchange Ltd 1991
National Stock Exchange Ltd 1991
Integrated Stock Exchange 1999
(4). THE HYDERABAD STOCK EXCHANGE LIMITED

ORIGIN
Rapid growth in industries in the erstwhile Hyderabad State saw efforts at starting the Stock
Exchange. In November 1941 some leading bankers and brokers formed the share and stock Brokers
Association. In 1942, Mr. Gulab Mohammed, the Finance Minister formed a Committee for the
purpose of constituting Rules and Regulations of the Stock Exchange. Sri Purushothamdas
Thakurdas, President and Founder Member of the Hyderabad Stock Exchange performed the
opening ceremony of the Exchange on 14.11.1943 under Hyderabad Companies Act; Mr. Kamal Yar
Jung Bahadur was the first President of the Exchange. The HSE started functioning under
Hyderabad Securities Contract Act of No. 21 of 1352 under H.E.H. Nizam’s Government as a
Company Limited by guarantee. It was the 6th Stock Exchange recognized under Securities Contract
Act, after the Premier Stock Exchanges, Ahmedabad, Bombay, Calcutta, Madras and Bangalore
stock Exchange. All deliveries were completed every Monday or the next working day.
The Securities Contracts (Regulation) Act 1956 was enacted by the Parliament, passed into
Law and the rules were also framed in 1957. The Act and the Rules were brought into force from
20th February 1957 by the Government of India.
The HSE was first recognized by the Government of India on 29th September 1958, as
Securities Regulation Act was made applicable to twin cities of Hyderabad and Secunderabad from
that date. In view of substantial growth in trading activities, and for the yeoman services rendered by
the Exchange, the Exchange was bestowed with permanent recognition with effect from 29 th
September 1983.
The Exchange has a significant share in achievements of erstwhile State of Andhra Pradesh
to its present state in the matter of Industrial development.
OBJECTIVES

The Exchange was established on 18th October 1943 with the main objective to create,
protect and develop a healthy Capital Market in the State of Andhra Pradesh to effectively serve the
Public and Investor’s interests.
The property, capital and income of the Exchange, as per the Memorandum and Articles of
Association of the Exchange, shall have to be applied solely towards the promotion of the objects of
the Exchange. Even in case of dissolution, the surplus funds shall have to be devoted to any activity
having the same objects, as Exchange or be distributed in Charity, as may be determined by the
Exchange or the High Court of judicature. Thus, in short, it is a Charitable Institution.
The Hyderabad Stock Exchange Limited is now on its stride of completing its 59 th year in the
history of Capital ‘Markets’ serving the cause of saving and investments. The Exchange has made its
beginning in 1943 and today occupies a prominent place among the Regional Stock Exchanges in
India. The Hyderabad Stock Exchange has been promoting the mobilization of funds into the
Industrial sector for development of industrialization in the State of Andhra Pradesh.
GROWTH
The Hyderabad Stock Exchange Ltd., established in 1943 as a Non-profit making
organization, catering to the needs of investing population started its operations in a small way in
a rented building in Koti area. It had shifted into Aiyangar Plaza, Bank Street in 1987. In
September 1989, the then Vice-President of India, Hon’ble Dr. Shankar Dayal Sharma had
inaugurated the own building of the Stock exchange at Himayathnagar, Hyderabad. Later in
order to bring all the trading members under one roof, the exchange acquired still a larger
premises situated 6-3-654/A ; Somajiguda, Hyderabad - 82, with a six storied building and a
constructed area of about 4,86,842 sft (including cellar of 70,857 sft). Considerably, there has
been a tremendous perceptible growth that could be observed from the statistics.
The number of members of the Exchange was 55 in 1943, 117 in 1993 and increased to 300
with 869 listed companies having paid up capital of Rs.19128.95 crores as on 31/03/2000. The
business turnover has also substantially increased to Rs. 1236.51 crores in 1999-2000. The Exchange
has got a very smooth settlement system.

 GOVERNING BOARD
At present, the Governing Board consists of the following:
MEMBERS OF THE EXCHANGE
Sri Hari Narayan Rathi

Sri Rajendra V. Naniwadekar
Sri K. Shiva Kumar
Sri R.D. Lahoti
Sri Ram Swaroop Agrawal
Sri Dattatray
SEBI NOMINEE DIRECTORS
Sri N.S. Ponnunambi -- Registrar of Companies [Govt. of India]
PUBLIC NOMINEE DIRECTORS

Justice V. Bhaskara Rao – Retd. Judge High Court.
Sri P. Muralimohan Rao – Mogili & Co. – Chartered Accountants.
Dr B. Brahmaiah -- G.M. JNIDB
EXECUTIVE DIRECTOR
Sri S Sarveshwar Reddy
 COMPUTERIZATION

The Stock Exchange business operations are equipped with modern communication systems.
Online computerization for simultaneously carrying out the trading transactions, monitoring
functions have been introduced at this Exchange since 1988 and the Settlement and Delivery System
has become simple and easy to the Exchange members.
The HSE On-line Securities Trading System was built around the most sophisticated state of
the art computers, communication systems, and the proven VECTOR Software from CMC and was
one of the most powerful SBT Systems in the country, operating in a WAN environment, connected
through 9.6 KBPS 2 wire Leased Lines from the offices of the members to the office of the Stock
Exchange at Somajiguda, where the Central System CHALLENGE-L DESK SIDE SERVER made
of Silicon Graphics (SGI Model No. D-95602-S2) was located and connected all the members who
were provided with COMPAQ DESKPRO 2000/DESKTOP 5120 Computers connected through
MOTOROLA 3265 v. 34 MANAGEABLE STAND ALONE MODEMS (28.8 kbps) for carrying
out business from computer terminals located in the offices of the members.
The HOST System enabled the Exchange to expand its operations later to other prime trading
centers outside the twin cities of Hyderabad and Secunderabad.
 CLEARING HOUSE
The Exchange set-up a Clearing House to collect the Securities from all the Members and
distribute to each member, all the securities due in respect of every settlement. The whole of the
operations of the Clearing House were also computerized. At present through DP all the settlement
obligations are met.
 INTER – CONNECTED MARKET SYSTEM (ICMS)
The HSE was the convener of a Committee constituted by the Federation of Indian
Stock Exchanges for implementing an Inter-connected Market System(ICMS) in which the Screen
Based Trading systems of various Stock Exchanges was inter-connected to create a large National
Market. SEBI welcomed the creation of ICMS.

The HOST provided the network for HSE to hook itself into the ISE. The ISE provided
the members of HSE and their investors, access to a large national network of Stock Exchanges.
The Inter-connected Stock Exchange is a National Exchange and all HSE Members could
have trading terminals with access to the National Market without any fee, which was a boon to the
Members of an Exchange/Exchanges to have the trading rights on
NationalExchange(NSE),withoutanyfeeorexpenditure.
ON-LINE SURVEILLANCE
HSE pays special attention to Market Surveillance and monitoring exposures of the
members, particularly the mark to market losses. By taking prompt steps to collect the margins
for mark to market losses, the risk of default by members is avoided. It is heartening that there
have been no defaults by members in any settlement since the introduction of Screen Based
Trading.
 IMPROVEMENT IN THE VOLUMES
It is heartening that after implementing HOST, HSE's daily turnover has fairly stabilized
at a level of Rs. 20.00 crores. This should enable in improving our ranking among Indian Stock
Exchanges for 14th position to 6th position. We shall continuously strive to improve upon this to
ensure a premier position for our Exchange and its members and to render excellent services to
investors in this region.
The number of transactions, turnovers of the Exchange, number of listed companies and the
paid up capital listed have grown up substantially as may be seen from the following figures.

NUMBER OF MARKET
TURNOVERS LISTED
YEAR TRANSACTIONS CAPIT
Rs.IN Crores COMPANIES
IN Thousands Rs.IN Crores
1991-92 515.949 587.75 236 2740.56
1992-93 421.985 676.00 274 10228.48
1993-94 603.635 984.46 372 13156.15
1994-95 860.642 1160.48 668 18588.71
1995-96 720.521 1107.30 727 20159.31
1996-97 240.64 479.98 851 22050.69
1997-98 427.83 1860.86 852 18705.10
1998-99 513.168 1269.90 856 18753.93
1999-00 513.440 1236.51 869 19128.95
2000-01 427.205 977.83 934 14717.08
2001-02 34.326 41.26 932 13616.12
2002-03 4.203 4.58 .928 13974.12
2003-04 2.277 2.73 856 22126.65
2004-05 4.401 14.13 820 14456.95

 SETTLEMENT GUARANTEE FUND
The Exchange has introduced Trade Guarantee Fund on 25/01/2000. This will insulate
the trading member from the counter-party risks while trading with another member. In other
words, the trading member and his investors will be assured of the timely completion of the pay-
out of funds and securities notwithstanding the default, if any, of any trading member of the
Exchange. The shortfalls, if any, arising from the default of any member will be met out of the
Trade Guarantee Fund. Several pay-ins worth of crores of rupees in all the settlements have been
successfully completed after the introduction of Trade Guarantee Fund, without utilizing any
amount from the Trade Guarantee Fund.
The Trade Guarantee Fund will be a major step in re-building this confidence of the members
and the investors in HSE. HSE's Trade Guarantee Fund has a corpus of Rs. 2.00 crores initially
which will later be raised to Rs. 5.00 crores. At present Rs. 3.20 Crores is stood in the credit of SGF.
The Trade Guarantee Fund had strict rules and regulations to be complied with by the
members to avail the guarantee facility. The HOST system facilitated monitoring the compliance of
members in respect of such rules and regulations.
CURRENT DIVERSIFICATIONS
(A). DEPOSITORY PARTICIPANT
The Exchange has also become a Depository Participant with National Securities Depository
Limited (NSDL) and Central Depository Services Limited (CDSL). Our own DP is fully operational
and the execution time will come down substantially. The Exchange undertakes the depository
functions by opening the accounts at Hyderabad of investors, members of the Exchange and other
Exchanges. The trades of all the Exchanges having On-line trading which get into National
depository can also be settled at Hyderabad by this exchange itself. In short all the trades of all the
investors and members of any Exchange at Hyderabad in dematerialized securities can be settled by
the Exchange itself as a participant of NSDL and CDSL. The exchange has about 15,000 B.O.
accounts.

B) FLOATING OF A SUBSIDIARY COMPANY FOR THE MEMBERSHIP OF MAJOR

STOCK EXCHANGES OF THE COUNTRY
The Exchange had floated a Subsidiary Company in the name and style of M/s HSE
Securities Limited for obtaining the Membership of NSE and BSE. The Subsidiary had obtained
membership of both NSE and BSE. About 113 Sub-brokers may register with HSES, of which about
75 sub-brokers are active. Turnover details are furnished here under.
BSE
NSE CASH NSE F&O
YEAR CASH
Rs.In Lakhs Rs.In Lakhs C)FACILI
Rs.In Lakhs
TY TO
2001-02 338236.81 -- --
TRADE
2002-03 426143.50 16657.08 --
AT NSE,
2003-04 617808.46 312203.56 17558.59
2004-05 484189.11 354370.71 39519.96
DERIVATIVES TRADING, NET TRADING ETC
The Exchange has incorporated a Subsidiary "HSE securities Limited " with a paid up capital
of Rs. 2.50 crores initially to take NSE Membership, so that the members of the exchange will have
access to the NSE's Trading Screen as Sub-brokers, Derivatives Trading and Net Trading etc. The
Members of this Exchange will also have equal opportunity of participating in such trading like any
other NSE member.
(6). PORTFOLIO MANAGEMENT & ITS PHASES

Portfolio management is a process encompassing many activities aimed at optimizing the

investment of one funds, each phase is an integral part of the whole process and the success of
portfolio management depends up the efficiency in carrying out each phases. Five phases can be
identified: -
(1) Security analysis

(2) Portfolio analysis
(3) Portfolio selection
(4) Portfolio revision
(5) Portfolio evaluation
 SECURITY ANALYSIS: It refers to the analysis of treading securities from the point of
view of their prices, return and risk. All invest are risky and the expected return is related to
risk
The securities available to an investor for investment are numerous and of various
types. The shares of over 7000 companies are listed in stock exchanges of the country. Securities
classified into ownership securities such as equity shares and preference shares and creditor ship
securities such as debentures and bonds. Recently, a no. of new securities such as Convertible
debentures, Deep discount bonds, Zero coupon bonds, Flexi bonds, Floating rate bonds, Global
depository receipts, Euro currency bonds etc. are issued to raise funds for their projects by
companies from which investor has to choose those securities that is worthwhile to be included in his
investment portfolio. This calls for detailed analysis of the available securities.
Security analysis is the initial phase of the portfolio management process. It examines the
risk return characteristics of individual securities. A basic strategy in securities investment is to buy
under priced securities and sell over priced securities. But
the problem is how to identify such securities in other words ‘mispriced securities’. This is what
security analysis is all about.

The security market emerges out of the new issues made by companies, government, local
bodies and public undertakings. All securities are in the form of IOU’S except those of ownership
shares. Securities of more than one year come into categories of capital and stock market.
 Trading: The market in securities is influenced by the forces of supply and demand that
determine volume of trading. Turnover and also the prices. The volume of trading is
reflected in the no. of deal per day or hours, no. of days in a year in which the company
share is treaded or the no. of share traded in a day or a year.
The Main constituents of and players in the market are as follows:
(a) Investments traded such as equity and preference shares in the category of ownership capital and
debentures, bonds and p.s.u bonds and government securities in the category of debt capital. A
no. of new investments like warrants, zero coupon bonds etc are also being issued at present
(b) The institution or players in the market are the issuers of capital namely corporate units,
government and semi-government bodies and public sector undertakings that are the major
borrowers, the investors and intermediaries such as bank, financial institution and brokers. More
recently, a no. of mutual funds, FFI’S,NRI’S,OCB’S have also started as players in the market
(b) Intermediaries are brokers, merchant bankers, financial investment, financial and
investment consultancy firm etc. these are active both primary and secondary markets.
 Market analysis: The security market analysis refers to the analysis of market and securities
traded price trends and other indicators.
 Valuation: The basic objective of market analysis is to know the fair valuation of shares for
buying and selling. The market comprises of various securities whose price change from day
and from time to time. The investors should have information of fair prices for making their
decisions of buying and selling. It is, therefore Necessary to make security valuation an
important part of market analysis.

The valuation analysis in particular has two components, namely, the market valuation at
macro level & the individual security valuation at micro level. The macro level analysis is done with
the help of suitable price indices of the leading scrips in the market and their price-earning ratio. The
BSE national index of securities price has 100 scrip’s in it and their P/E ratio. Represents the market
valuation of securities. These are published by the BSE on a daily basis. As regards the individual
security valuation. The intrinsic value is the basis on which over valuation or under valuation is
judged. It is determined by expected to the present time by a suitable discount rate. But in actual
practice this method is not followed.
The methods of valuation are

(i) Discounted value of future income streams or dividends
(ii) No. of years of payback period. This method is used in the form of P/E ratio.
Return:
The term “return” from an investment refers to the benefits from that investment. In the field
of finance in general and security analysis in particular, the term return is almost invariably
associated with a percentage (say, return on investment of 12%) and not a mere amount (like, profit
of Rs. 150).
Theoretical framework:
(a) The first theoretical tool is the savings investment theory saving promote capital
formation and economic growth through increase in output and incomes of the country.
The mobilization of savings for capital formation is through capital market comprising the
new issues market and stock market.
(c) Secondly, market behavior depends on the player and their role in trading. Analysis of market
price behavior is thus possible though the no. of buyers and sellers available and information in
the market . The Capital Market Efficiency Theory, Random Walk Theory and many other
theories explain how prices behave in the market. To explain why share prices fluctuate and what

are the fair prices, these theories are used. The theory of Trend Walker’s explains the market
trends as set by a few trendsetters or leaders followed by a mass of trend walkers.
(d) Third theoretical tool in investment analysis is fundamental analysis that explains why prices are
what they are. The market price & individual share prices are explained by fundamental factors
namely. Economy, industry and company analysis. In security valuation the most important tool
is the ratio analysis or examination of balance sheet of a co. whose share is being examined. This
enables us to locate the undervalued shares and overvalued share and to decide what shares to
buy and what share to sell.
(e) Fourth theoretical tool is technical analysis, which is an analysis of the price behavior of
agg.marketand of individual share with help of charts on price. Trading volume and moving
averages. The Dow Theory & Elliot Wave Theory are some if the theories in this analysis, which
explain the price behavior.
(f) Lastly, Risk Return Analysis, which are two major characteristic of any investment. In this, the
choice of scrip’s is decided by an analysis of risks involved in relation to the return in the
background of market risk and market return. Portfolio theory provides the linkage of market to
investments. An efficient portfolio is to be developed by minimize the risks and maximize the
returns. The portfolio management helps the investment process by applying the principles of
portfolio theory to build up on efficient portfolio. Through a diversified basket of scrip’s. What
securities to buy and when to buy so as to build up an efficient portfolio are all liked to result in
the buying and selling of shares in the market and trading.
A brief explanation of these theories are given below:

Fundamental Analysis:
The primary motive of buying a shares to sell it 60 subsequently at a higher price. In many
case, dividends are also expected. Thus dividends and price changes constitute the retune from
investing in shares.
Fundamental analysis to is really a logical and systematic approach to estimating the future
dividends and share price this share price is based on no. of fundamental factors like economic
fundamental, industry fundamental and company fundamentals which have to be considered while

analyzing a security for investment purpose. It’s a detailed analysis of the fundamental factors
affecting the performance of companies.
The analysis of economy, industry and company fundamentals constitute the main activity in
the fundamental approach to security analysis. A company belongs to an industry and the industry
operates within the economy. As such industry and economy factors affect the performance of the
company. These factors are: -
 Economy wide factors such as growth rate of the economy, inflation rate, and foreign exchange
rate etc. that affect all companies.
 Industry wide factors such as demand. Supply gap in the industry the emergence of substitute
products, changes in government policy relating to industry.
 Company specific factors such as age of its plant, the quality management, brand image of its
products etc.
Fundamental analysis involves 3 steps:
1) Economy analysis
2) Industry analysis
3) Company analysis
1) Economy analysis: The performance of a company depends on the performance of the

economy. If the economy is booming, income rise and demand for goods will increase, 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. Those are: -
 Growth rates of national income:
The rate of growth of the national economy is an important variable. GNP (gross national
product), NNP (net national income) and GDP (gross domestic product) are the difference
measures indicate growth rate of the economy. These estimates are made available by
government. An economy typically passes through different phases, such as depression,
recovery, boom and recession.

During a depression, demand is low and declining. Inflation is often high and so are
interest rate. During the recovery stage, the economy begins to revive after a depression. Demand
picks up lending to more investment in the economy. In the boom phase, investment and production
are maintained at a high level to satisfy high demand. In Recession stage, the economy slowly begins
to experience a downturn in demand, production, employment etc. The profits also decline.
Inflation:
Inflation prevailing in the economy has considerable impact. Higher rates of inflation upset
business plans, lead to cost escalation and result in a squeeze on profit margins. High rates of
inflation in an economy are likely to affect the performance of companies. Inflation is measured both
in terms of wholesale prices through wholesale price Index (WPI) and in terms of retail prices
through consumer price Index.
 Interest rate:
Interest rate 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.
Higher interest rate result in higher cost of production, which may lead to lower profitability and
lower demand.
An investor has to evaluate and consider the other factors like government revenue,
expenditure, deficits, exchange rate, and infrastructure economic and political stability for a good
performance of the economy.
2) Industry analysis:
An investor ultimately invests his money in the securities of one or more specific
companies. The performance of companies would be influenced by the fortunes of the
industry to which it belongs. An industry is generally described as a homogenous group of
companies. An industry is defined as “ A group of firms products, which serve the same need
of a common set of buyers.”
Market experts believe that each poll has a stage and the decline stage. Even industry has a
life cycle theory.

(i) The Pioneering stage

(ii) The Expansion stage
(iii) The Stagnation stage
(iv) The Decay stage
Technological advances in one country can effect the growth of another Industry. All these
stages gives an insight into merits of invest in a given industry at a given time. An industry usually
exhibits low profitability in the pioneering stage, high profitability in the growth or expansion stage,
medium but steady profitability in the stagnation or maturity stage and declining profitability in the
decay stage.
3) Company analysis: It is the final stage of fundamental analysis. It deals with the
estimation of return and risk of individual shares. In company analysis, the analyst tries to
forecast the future earnings of the company. The level, trend and stability of earnings of a
company. However depend upon a no. of factors concerning the operations of the company.

PORTFOLIO MANAGEMENT
Introduction: -
Many times the investors go on acquiring assets in an adhoc & unplanned manner & the result
is high risk, low return profile that they may face. All such assets of financial nature such as gold,
silver, real estate, building, insurance policies, Post office certificate, NSC or NSS would constitute
his portfolio & the wise investor not only plans his portfolio as per risk return profile or preferences
but manages his port folio efficiently so as to secure the highest return for the lowest risk possible at
that level of investment. This is in short the Portfolio Management.
The basic principle is that the higher the risk, the higher is the return & investor should have
clear perception of elements of risk & return when he makes investments. Risk return analysis is
essential for the investment & portfolio management. An investor considering investment in
securities is faced with the problem of choosing from among a large no of securities. His choice
depends upon the risk return characteristics of individual securities. He would attempt to choose the
most desirable securities & like to allocate his funds over group of securities. As the economic and
financial environment keep changing the risk return characteristics of individual securities as well as
portfolios also change.
An investor invests his funds in a portfolio expecting to get a good return consistent with the
risk that he has to bear. Portfolio management comprises all the processes involved in the creation &
maintainence of an investment portfolio. It deals specifically with Security Analysis, Portfolio
Analysis, Selection, Revision & Evaluation. Portfolio Management is a complex process, which tries
to make investment activity more rewarding & less risky.

Role of portfolio management:
There was a time when portfolio management was an exotic term. The scenario has changed
drastically. It is now a familiar term and is widely practiced in India. The theories and concepts
relating to portfolio management now find their way to the front pages of financial newspapers and
the cover pages of investment journals in India.
.
Indian capital markets have become active. The Indian stock markets are steadily
moving towards higher efficiency, with rapid computerization, increasing market transparency,
better infrastructure, better customer service etc. The markets are dominated by large institutional
investors with their diversified portfolios. A large no. of mutual funds have been set up the country
since 1987. With this development investment in securities has gained considerable momentum.
Professional portfolio management backed by competent research began to be practiced

by mutual funds, investment consultants and big brokers. The Securities Exchange Board of India
(SEBI), The Stock Market Regulatory body in India is supervising the whole process.
With the advent of computers the whole process of portfolio management has become
quite easy. The computer can absorb large volumes of data perform computations accurately and
quickly give out results in desired form.
The trend towards liberalization and globalization of the economy has promoted free flow of
capital across international border. Portfolio now include not only domestic securities but also
foreign securities such as Options and Futures in the field of investment management and trading in
derivative securities, their valuation etc have broadened its scope.

(8). PORTFOLIO THEORIES
MARKOWITZ THEORY:
Markowitz approach determines for the investor the efficient set of portfolio through 3
important variables, i.e., Standard Deviation, Covariance and Co-efficient of Correlation.
Markowitz model is called the “Full Covariance Model”. Through this method, the investor can
with the use of computer, find out the efficient set of portfolio by finding out the trade off
between risk and return between the limits of zero to infinity. According to this theory, the
effects of one security purchase over the effects of the other security purchase are taken into
consideration and then the results are evaluated.
Assumption under Markowitz Theory:

Markowitz theory is based on the modern portfolio theory under several assumptions. The
assumptions are: -
(1) The market is efficient and all investors have in their knowledge all the facts about the
stock market and so on investor can continuously make superior returns either by
predicting past behavior of stocks through technical analysis or by fundamental analysis
of internal company management or by finding out the intrinsic value of shares. Thus all
investors are in equal category.
(2) All investors before making any investments have a common goal. This is the avoidance
of risk because they are risk averse.
(3) All investors would like to earn the maximum rate of return that they can achieve from
their investments.
(4) The investors base their decisions on the expected rate of return of an investment. The
expected rate of return can be found out by finding out the purchase price of a security
divided by the income per year and by adding annual capital gains. It is also necessary to

know the standard deviation of the rate of return, which is being offered on the investment.
The rate of return and
standard deviation are important parameters for finding out whether the
investment is worthwhile for a person.
(5) Markowitz brought out the theory that it was a useful insight to find out how the security
returns are correlated to each other. By combining the assets in such way that they give
the lowest risk maximum returns could be brought out by the investor.
(6) From the above it is clear that every investor assumes that while making an investment he
will combine his investments in such a way that he gets a maximum return and is
surrounded by minimum risk.
(7) The investor assumes that greater or larger the return that he achieves on his investments,
the higher the risk factor that surrounds him. On the contrary when risks are low the
return can also be expected to be below.
(8) The investor can reduce his risk if he adds investments to his portfolio.
(9) An investor should be able to get higher return for each level of risk “by determining the
efficient set of securities.
2. THE SHARPE INDEX MODEL
The investor always likes to purchase a combination of stock that provides the highest return
and has lowest risk. He wants to maintain a satisfactory reward to risk ratio. Traditionally analysis
paid more attention to the return aspect of the stocks. Now a day’s risk has received increased
attention and analysts are providing estimates of risk as well as return.
Sharp has developed a simplified model to analyze the portfolio. He assumed that the return
of a security is linearly related to a single index like the market index. Strictly speaking, the market
index should consist of all the securities trading on the exchange
In the absence of it, a popular index can be treated as a surrogate for the market index.

SINGLE INDEX MODEL
Casual observation of the stock prices over a period of time reveals that most of the stock
prices move with the market index. When sensex increases, stock prices also
tend to increase and vice-versa. This indicates that some underlying factors affect the market index
as well as the stock prices. Stock prices are related to the market index and this relationship could be
used to estimate the return on stock. Towards this purpose, the following equation can be used:
R i = ài + âi R m + ei
Where R = expected return on security I

ài =intercept of the straight line or alpha co-efficient
âi =slope of straight line or beta co-efficient
Rm = the rate of return on market index
ei = error team
CORNER PORTFOLIO
The entry or exit of a new stock in the portfolio generates a series of corner portfolio. In a
one stock portfolio, itself is the corner portfolio. In a two stock portfolio, the minimum attainable
risk (variance) and the lowest return would be the corner portfolio. As the member of stocks
increases in a portfolio, the corner portfolio would be the one with lowest return and risk
combination.
SHARPE’S OPTIMAL PORTFOLIO

Sharpe had provided a model for the selection of appropriate securities in a portfolio. The
selection of any stock is directly related to its excess return – beta ratio.
Ri–Rf / âi
Where, Ri = the expected return on stock i
Rf = the return on a risk less asset
âi = the expected change in the rate of return on stock I associated with one unit change in
the market return.

The excess return is the difference between the expected return on the stock and the risk less
rate of interest such as the rate offered on the government security or treasury
bill. The excess return to beta ratio measures the additional return on s security (excess of the risk
less asset return) per unit of systematic risk or non-diversifiable risk. This ratio provides a
relationship between potential risk and reward.
The steps for finding out the stocks to be included in the optimal portfolio are given below:
1. Finding out the “excess return to beta” ratio for each stock under consideration.
2. Rank them from the highest to the lowest
3. Proceed to calculate C for all the stocks according to the ranked order using the following
formula,
Ci = σ 2m N ((Ri – Rf) ßi / σ 2ei)/1+σ 2 N σ i / σ 2ei
4. The calculated values of Ci start declining after a particular Ci and that point is taken as the
cut-off point and that stock ratio is the cut-off ratio Ci.
CAPITAL ASSET PRICING THEORY:
We have seen that diversifiable risk can be eliminated by diversification. The remaining risk
portion is the undiversifiable risk i.e., market risk. As a result, investors are interested in
knowing the systematic risk when they search for efficient portfolios. They would like to have
assets with low beta coefficient i.e., systematic risk. Investors would opt for high beta co-
efficient only if they provide high rate of return. The risk were averse nature of the investors is
the underlying factor for this behavior. The capital asset pricing theory helps the investors top
understand and the risk and return relationship of the securities. It also explains how assets
should be priced in the capital market.
The CAPM Theory
Markowitz, William Sharpe, John Lintner and Jan Mossin provided the basis structure for the
CAPM model. It is a model of linear general equilibrium return. In the CAPM theory, the
required rate of return of an asset is having a linear relationship with asset’s beta value i.e.
undiversifiable or systematic risk.

Assumptions:
1. An individual seller or buyer cannot affect the price of a stock. This assumption is the basic
assumption of the perfect competitive market.
2. Investors make their decisions only on the basis of the expected returns, standard deviations
and covariance’s of all pairs of securities.
3. Investors are assumed to have homogenous expectations during the decision-making period.
4. The investor can lend or borrow any amount of funds at the risk less rate of interest. The risk
less rate of interest is the rate of interest offered for the treasury bills or Government
securities.
5. Assets are infinitely divisible, according to this assumption, investor could buy and quantity
of share i.e. they can even buy ten rupees worth of Reliance Industry shares.
6. There is no transaction cost i.e. no cost involved in buying and selling of stocks.
7. There is no personal income tax. Hence, the investor is indifferent to the form of return either
gain or dividend.
8. Unlimited quantum if short sales are allowed. Any amount of shares an individual can sell
short.
Lending and Borrowing
Here, it is assumed that the investor could borrow or lend any amount of money at risk less
rate of interest. When this opportunity is given to the investors, they can mix risk free assets with the
risk assets in a portfolio to obtain in desired rate of risk return combination.
The expected return on the combination of risky and risk free combination is
Rp = RfXf + Rm (1-Xf)
Where, Rp = Portfolio return
Xf = the proportion of funds invested in risk free assets
1-Xf = the proportion of funds invested in risk assets
Rf = Risk free rate of return
Rm = Return on risky assets

This formula can be used to calculate the expected returns for different situations like mixing
risk less assets with risky assets, investing only in the risky asset and mixing the borrowing with
risk assets.
The Concept
According to CAPM, all investors hold only the market portfolio and risk less securities. The
market portfolio is a portfolio comprised of all stocks in the market. Each asset is held in proportion
to its market value to the value of all risky assets. For example, if Reliance Industry share represents
20% of all risky assets, then the market portfolio of the individual investor contains 20% of Reliance
Industry shares. At this stage, the investor has the ability to borrow or lend any amount of money at
the risk less rate of interest. The efficient frontier of the investor is given in figure.
The figure shows the efficient frontier of the investor. The investor prefers any point between
B&C because; with the same level of risk they face on line BA, they are liable to get superior profits.
The ABC line shows the investor’s portfolio of risky assets. The investors can combine risk less
asset either by lending or borrowing. This is shown in figure,
Rp Rp
C
S CML
B
Rf
O σp σp
The line RfS represent all possible combination of risk less and risky asset. The ‘S’ portfolio does
not represent any risk less asset but the line RfS gives the combination of both. The portfolio along

the path RfS is called lending portfolio i.e. some money is invested in the risk less asset or may be
deposited in the bank for a fixed rate of interest If it crosses the point S, it becomes borrowing
portfolio. Money is borrowed and invested in the risky asset. The straight lines are called Capital
Market Line (CML). It gives the desirable set of investment opportunities between risk free and
risky investments. The CML represents linear relationship between the required rates of return for
efficient portfolio and their standard deviations.
E(Rp) = Rf + (Rm-Rf) x σ p
σ m
E(Rp) = portfolio’s expected rate of return

Rm = expected return on market portfolio
σ m = standard deviation of market portfolio
σ p = standard deviation of the portfolio
For a portfolio on the capital market line, the expected rate of return in excess of the risk free rate is
in proportion to the standard deviation of the market portfolio. The slope of the line gives the price
of the risk. The slope equals the risk premium for the market portfolio Rm-Rf divided by the risk or
standard deviation of the market portfolio. Thus, the expected return of an efficient portfolio is
Expected return = Price of time + (Price of risk X amount of risk)
Price of time is the risk free rate of return. Price of risk is the premium amount higher and above the
risk free return.
Security Market Line:
The Capital Market Line measures the risk-return relationship of an efficient portfolio. But, it
does not show the risk-return trade off for other portfolio and individual securities. Inefficient
portfolios lie below the capital market line and the risk-return relationship cannot be established with
the help of the capital market line. Standard deviation includes the systematic and unsystematic risk.
Unsystematic risk can be diversified and it is not related to the market. If the unsystematic risk is
eliminated, then the matter of concern is systematic risk alone. This systematic risk could be

measured by beta. The beta analysis is useful for individual securities and portfolios whether
efficient or inefficient.
When an additional security is added to the market portfolio, an additional risk is also added
to it. The variance of a portfolio is equal to the weighted sum of the co-variances of the individual
securities in the portfolio. If we add an additional security to the market portfolio, its marginal
contribution to the variance of the market is the covariance between the security’s return and market
portfolio’s return. If the security is included, the covariance between the security and the market
measures the risk. Dividing it by standard deviation of market portfolio Cov 1m/σM can standardize
covariance. This shows the systematic risk of the security, and then the expected return of the
security is given by the equation-
Ri-Rf = Rm-Rf COVim/σ m
σm
This equation can be rewritten as follows:
Ri-Rf = COVim [Rm-Rf]

σ 2
m
The first term of the equation is nothing but the beta coefficient of the stock. The beta
coefficient of the equation of SML is same as the beta of the market (Single index) model. In
equilibrium, all efficient and inefficient portfolios lie along the security market line. The SML line
helps to determine the expected return for a given security beta. In other words, when betas are
given, we can generate expected returns for the given securities. This is explained in figure.
If we assume the expected market risk premium to be 8% and the risk free rate of return to
be 7%, we can calculate expected return for A, B, C and D securities using the formula,
E (Ri) = Rf+ σ 1 [E (Rm) – Rf]
Market Imperfection and SML:

Information regarding the share price and market condition may not be immediately available
to all investors; imperfect information may affect the valuation of securities. In a market with perfect
information, all securities should lie on SML. Market imperfections would lead to a band to SML
rather than a single line. Market imperfections after the width of the SML to a band, if imperfections
were more, the width also would be larger.
Empirical tests of the CAPM:

In the CAPM, beta is used to estimate the systematic risk of the security and reflects the
future volatility of the stock in relation to the market. Future volatility of the stock is estimated only
through historical data. Historical data are used to plot the regression line or the characteristics line
and calculate beta. If historical betas are stable over a period of time, they would be good proxy for
their ex-ante or expected risk.
Robert A. Levy, Marshall E. Blume and others studied the question of beta stability in-depth.
Levy calculated betas for the both individual securities and portfolios. His study results have
provided the following conclusions.
1. The betas of individuals stocks are unstable; hence the past betas for the individual securities
are not good estimators of future risk.
2. The betas of portfolios of ten or more randomly selected stocks are reasonably stable, hence
the past portfolio betas are good estimators of future portfolio volatility. This is because of
the errors in the estimates of individual securities betas tend to offset one another in a
portfolio.
Various researchers have attempted to find out the validity of the model by calculating
beta and realized rate of return. They attempted to test (1) whether the intercept is equal to R f i.e. risk
free rate of interest or the interest for treasury bills (2) whether the line is linear and pass through the
beta = 1 being the required rate of return of the market. In general, the studies have showed the
following results:
1. The studies generally showed a significant positive relationship between the expected return
and the systematic risk. But the slope of the relationship is usually less than that of predicted
by the CAPM.

2. The risk and return relationship appears to be linear. Empirical studies give no evidence of
significant curvature in the risk/return relationship.
3. The attempt of the researchers to access the relative importance of the market and company
risk has yielded results. The CAPM theory implies that unsystematic risk is not relevant, but
unsystematic and systematic risks are positively related to security returns. Higher returns are
needed to compensate both the risks. Most of the observed relationship reflects statistical
problems rather than the true nature of capital market.
4. According to Richard Roll, the ambiguity of the market portfolio leaves the CAPM
untestable. The practice of using indices, as proxies are loaded with problems. Different
indices yield different betas for the same security.
5. If the CAPM were completely valid, it should apply to all financial assets including bonds.
But, when bonds are introduced into the analysis, they do not all on the security market line.
Present Validity of CAPM
The CAPM is greatly appealing at an intellectual level, logical and rational. The basic
assumptions on which the model is built raise, some doubts in the minds of the investors. Yet,
investment analysis has been more creative in adapting CAPM for their uses.
1. The CAPM focuses on the market risk, makes the investors to think about the risky ness of
the assets in general. CAPM provides basic concepts, which is truly fundamental value.
2. The CAPM has been useful in the selection of securities and portfolios. Securities with
higher returns are considered to be undervalued and attractive for buy. The below normal
expected return yielding securities are considered to be overvalued and suitable for sale.
3. In the CAPM, it has been assumed that investors consider only the market risk. Given the
estimate of the risk free rate, the beta of the firm, stock and the required market rate of return,
one can find out the expected returns for a firm’s security. This expected return could be used
as an estimate of the cost of retained earnings.

4. Even though CAPM has been regarded as a useful tool to financial analysis, it has it won
critics too. They point out, when the model is ex-ante, the inputs also should be ex-ante, i.e.
based on the expectations of the future. Empirical tests and analysis have used ex-post i.e.
past data only.
5. The historical data regarding the market return, risk free rate of return and betas vary
differently for different periods. The various methods used to estimate these inputs also affect
the beta value. Since the inputs cannot be estimated precisely, the expected return found out
through the CAPM model is also subjected to criticism.
ARBITRAGE PRICING THEORY:
Arbitrage Pricing Theory is one of the tools used by the investors and portfolio managers.
The Capital Asset Pricing Theory explains the returns of the securities on the basis of their
respective betas. According to the previous models, the investor chooses the investment on the basis
of expected return and variance. The alternative model developed in Asset pricing by Stephen Ross
is known as Arbitrage Pricing Theory. The APT explains the nature of equilibrium in the asset
pricing in a less complicated manner with fewer assumptions compared to CAPM.
Arbitrage is a process of earning profit by taking advantage of differential pricing for the
same asset. The process generates risk less profit. In the security market, it is of selling security at a
high price and the simultaneous purchase of the same security at a lower price. Since the profit
earned through arbitrage is risk less, the investors have the incentive to undertake this whenever an
opportunity arises. In general, some investors indulge more in the type of activities than others,
however, the buying and selling activities of the arbitrageur reduces and eliminates the profit margin,
bringing the market price to the equilibrium level.
The Assumptions:
1. The Investors have homogenous expectations.

2. The investors are risk averse and utility maxi misers.

3. Perfect competition prevails in the market and there is no transaction cost.
The APT theory does not assume (1) single period investment horizon, (2) no taxes (3) investors can
borrow and lend at risk free rate of interest and (4) the selection of the portfolio is based on the mean
and variance analysis. These assumptions are present in CAPM theory.
Arbitrage Portfolio
According to the APT theory an investor tries to find out the possibility to increase returns
form his portfolio without increasing the funds in the portfolio. He also likes to keep the risk at the
same level. For example, the investor holds A, B and C securities and he wants to change in
proportion of securities can be denoted by X, XB and XC. The increase in the investment in security
A could be carried out only if he reduces the proportion of investment either in B or C because it has
already stated that the investor tries to earn more income without increasing his financial
commitment. Thus, the changes in different securities will add up to zero. This is the basic
requirement of an Arbitrage portfolio. If X indicates the change in proportion,
∆ XA + ∆ XB + ∆ XC = 0
The factor sensitivity indicates the responsiveness of a security’s return to a particular factor.
The sensitiveness of securities to any factor is the weighted average of the sensitivities of the
securities, weights being the changes made in the proportion. For example, b A, bB and bC are
sensitivities in an arbitrage portfolio the sensitivities become zero.
bA∆ XA + bB∆ XB + bC∆ XC = 0
Effect on Price:
To buy stock A and B, the investor has to sell stock C. The buying pressure on stock A and B
would lead to increase in their prices. Conversely selling of stock C will result in fall in the price of
the stock C. With the low price there would be rise in the expected return of stock C. For example, if
the stock C price Rs.100 per share has earned 12% return, at Rs.80 per share the return would be
12/80 * 100 = 15%. At the same time, return rates would be declining in stock A and B with the rise

in price. This buying and selling activity will continue until all arbitrage possibilities are eliminated.
At this juncture, there exists an approximate linear relationship between expected returns and
sensitivities.
The APT Model:

According to Stephen Ross, returns of the securities are influenced by a number of macro
economic factors. The macro economic factors are growth rate of industrial production, rate of
inflation, spread between long term and short-term interest rates and spread between low grade and
high-grade bonds.
The arbitrage theory is represented by the equation: -
R1 = λ 0 + λ 1 bi1 + λ j bij
R1 = average expected return
λ1 = sensitivity of return to bi1
bi1 = the beta co-efficient relevant to the particular factor
The equation is derived from the model
R1 = α 1 + b11I1 + b12I2. …………+ byIj +ej
The Constants of the APT Equation
The existence of the risk asset yields a risk free rate of return that is a constant. The asset
does not have sensitivity to the factor for example, the industrial production.
If bi = 0
R = λ 0 + λ i0
Ri = λ 0
Ri = λ I
In other words, λ0 is equal to the risk free rate of return. If the single factor portfolio’s sensitivity is
equal to one i.e., bi = 1 then
Ri = λ 0 = λ 01
This can be written as

Ri = λ 0 + λ I
Ri - λ 0 = λ I
Thus, λ i is the expected excess return over the risk free rate of return for a portfolio with
unit sensitivity to the factor. The excess return is known as Risk premium.
Factors affecting the Return:

The specification of the factors is carried out by much financial analysis, Chen, Roll and
Ross have taken four macro economic variables and tested them. According to them the factor are
inflation, the term structure of interest rates, risk premium and industrial production. Inflation affects
the discount rate or the required rate of return and the size of the future cash flows. The short-term
inflation is measured by monthly percentage changes in the consumer price index. The interest rates
on long-term bonds and short-term bonds differ. This difference affects the value of payments in
future relative to short-term payment. The difference between the return on the high-grade bonds and
low grade (more risky) bonds indicates the market’s reaction to risk. The industrial production
represents the business cycle. Changes in the industrial production have an impact on the
expectations and opportunities of the investor. The real value of the cash flow is also affected by it.
Burmeister and McElroy have estimated the sensitivities with some other factors. They are
given below: -
 Default risk
 Time premium
 Deflation
 Change in expected sales
 The market returns not due to the first four variables.
The default risk is measured by the difference between the return on long term government
bonds and the return on long term bonds issued by corporate plus one-half of one percent. Time
premium is measured by the return on long term government bonds minus one month Treasury bill
rate one month ahead. Deflation is measured by expected inflation at the beginning of the month
minus actual inflation during the month. According to them, the first four factors accounted 25% of
the variation in the standard and poor composite Index an all the four co-efficient were significant.

Salmon Brothers identified five factors in their fundamental factor model. Inflation is the
only common factor identified by others. The other factors are given below: -
 Growth rate in gross national product
 Rate of interest
 Rate of change in oil prices
 Rate of change in defense spending
All the three sets of factors have some common characteristics. They all affect the macro
economic activities. Inflation and interest rate are identified as common factors. Thus, the stock
price is related to aggregate economic activity and the discount rate of future cash flow.
APT and CAPM

The simplest form of APT model is consistent with the simple form of the CAPM model,
when only one factor is taken into consideration, the APT can be stated as:
R i – λ 0 + bi λ I
It is similar to the capital market line equation

Ri = Rf β i + (Rm – Rf)
Which is similar to CAPM model.
APT is more general and less restrictive than CAPM. In APT, the investor has no need to
hold the market portfolio because it does not make use of the market portfolio concept. The
portfolios are constructed on the basis of the factors eliminate arbitrage profits. APT is based on the
law of one price to hold for all possible portfolio combinations.
The APT model takes in to account of the impact of numerous factors on the security. The
macro economic factors are taken into consideration and it is closer to reality then CAPM.
The market portfolio is well defined conceptually. In APT model, factors are not well
specified. Hence, the investor finds it difficult to establish equilibrium relationship. The well-defined

market portfolio is a significant advantage of the CAPM leading to the wide usage of the model in
the stock market.
The factors that have impact on one group of securities may not affect another group
securities. There is a lack of constituency in the measurement of the APT model. Further, the
influences of the factors are not independent of each other. It may be difficult
to identify the influence corresponds exactly to each factor. Apart from this, not all variables that
exert influence on a factor are measurable.
9). PORTFOLIO CONSTRUCTION & ANALYSIS

Portfolio analysis believes in the maximization of return through a combination of securities.

The modern portfolio theory discusses the relationship between different securities and then draws
inter-relationship of risks between them. It is not necessary to achieve success only by trying to get
all securities of minimum risk. The theory States that by combining a security of low risk with
another security of high risk, success can be achieved by an investor in making a choice of
investment outlets.
AVERAGE RETURN’S OF THE COMPANIES
S.No Security Average Return

1 INFOSYS 44.24
2 RELIANCE 43.05
3 HERO HONDA 34.54
4 SATYAM 32.40
5 ITC 5.76
AVERAGE RETURN= R = Ri/N
Where R = AVERAGE RETURN

Ri = Return of the security I for the year T
N = Number of years
INFERENCES:
Based on above Average return of securities Infosys is earning highest return
andITC (Indian Tobacco Corporation) is earning lowest return. Other securities are earning
medium range returns such are Reliance, Satyam and Hero Honda.

Average Return
50 44.24 43.05
40 34.54 32.4
30
20
10 5.76
0
INFOSYS RELIANCE HERO SATYAM ITC
HONDA
STANDARD DEVIATION OF THE COMPANIES
S.No Security Standard Deviation

1 SATYAM 109.93
2 INFOSYS 108.37
3 HERO HONDA 107.53
4 RELIANCE 63.50
5 ITC 37.43
S.D = 1/n-1 (R-R) 2

T=1
INFERENCES:
Based on above calculations Standard Deviations like this Satyam is highest and ITC
(Indian Tobacco Corporation) is lowest. Where as other securities are having medium Standard
Deviations.

Standard Deviation
120 109.93 108.37 107.53

100
80 63.5
60
37.43
40
20
0
SATYAM INFOSYS HERO RELIANCE ITC
HONDA
CORRELATION COEFFICIENT BETWEEN THE SECURITIES
Security INFOSYS ITC SATYAM RELIANCE HERO HONDA

INFOSYS 1 -0.3306 0.9297 0.7686 -0.0039
ITC 1 -0.0706 0.2618 -0.4278
SATYAM 1 0.8100 0.3490
RELIANCE 1 0.0606
HERO HONDA 1
FORMULA:
CORRELATION COEFFICIENT ( n῀ab) = COV (ab) / σ a. σ b
Where COV (ab) = 1/n-1 (RA- RA)(RB-RB)
PORTFOLIO WEIGHTS

S.No PORTFOLIO (A/B) CORRELATION WEIGHT of A WEIGHT of B

1 INFOSYS & ITC -0.3306 0.1773 0.8227
2 INFOSYS & SATYAM 0.9297 0.6000 0.4000
3 INFOSYS & RELIANCE 0.7686 -0.2418 1.2418
4 INFOSYS & HERO HONDA -0.0039 0.4961 0.5039
5 ITC & SATYAM -0.0706 0.8797 0.1203
6 ITC & RELIANCE 0.2618 0.8328 0.1672
7 ITC & HERO HONDA -0.4278 0.8096 0.1904
8 SATYAM & RELIANCE 0.8100 -0.3373 1.3373
9 SATYAM & HERO HONDA 0.3490 0.4830 0.5170
10 RELIANCE & HERO HONDA 0.0606 0.7549 0.2451
FORMULA:
WEIGHT of a (Wa) = σ b(σ b-nabσ a) / (σ a2 + σ b2) – (2nab. σ a. σ b)
WEIGHT of b (Wb) = 1 - Wa
PORTFOLIO RISK
S.No. COMBINATIONS PORTFOLIO RISK
1 SATYAM & RELIANCE 27.11
2 ITC & HERO HONDA 28.38
3 INFOSYS & ITC 30.43
4 ITC & SATYAM 34.60
5 ITC & RELIANCE 35.46
6 INFOSYS & RELIANCE 48.52
7 RELIANCE & HERO HONDA 56.07
8 INFOSYS & HERO HONDA 76.17
9 SATYAM & HERO HONDA 89.26
10 INFOSYS & SATYAM 107.13
Formula:
σ p = √ σ a2Wa2 + σ b2Wb2 + 2nab. σ a. σ b.WaWb
Where,
σ a = Standard deviation of Security a

σ b = Standard deviation of Security b
Wa = Weight of Security a
Wb = Weight of Security b
nab = Correlation Coefficient between Security a & b
σ p = Portfolio Risk

PORTFOLIO RISK
120
100
80
60
40
20
0
A
A
CE
A
E
C
A
E
AM
AM
ND
C
IT
ND
C
N
N
N
N
TY
O
&
TY
O
IA
IA
O
IA
O
H
H
S
H
EL
EL
SA
SA
H
EL
SY
O
O
R
O
ER
R
R
&
ER
&
FO
ER
&
&
E
&
S
H
H
C
H
S
IN
SY
IT
AM
H
SY
IT
&
&
&
&
FO
C
E
TY
S
FO
AM
C
IT
SY
IN
SA
AN
IN
TY
FO
LI
SA
IN
RE
INFERENCES:
Based on above table shows that the compaines “SATYAM & RELIANCE” Consist
(27.11) risk, that mean, minimum when compare to “INFOSYS & SATYAM” (107.13) as
maximum risk.
PORTFOLIO RETURN
S.No. COMBINATIONS PORTFOLIO RETURN

1 ITC & SATYAM 8.96
2 ITC & HERO HONDA 11.23
3 ITC & RELIANCE 11.99

4 INFOSYS & ITC 12.58

5 SATYAM & HERO HONDA 33.50
6 INFOSYS & HERO HONDA 39.35
7 INFOSYS & SATYAM 39.50
8 RELIANCE & HERO HONDA 40.95
9 INFOSYS & RELIANCE 42.74
10 SATYAM & RELIANCE 46.62
Formula:
Rp = (Ra*Wa) + (Rb*Wb)
Where,
Ra = Average Return of Security a
Rb = Average Return of Security b
Rp = Portfolio Return

PORTFOLIO RETURN
50
40
30
20
10
0
A
A
CE
CE
C
DA
CE
D
AM
D
AM
ND
IT
N
N
N
AN
N
N
TY
&
TY
O
IA
IA
O
H
LI
S
H
EL
SA
SA
H
EL
SY
RE
O
O
O
R
O
ER
ER
R
&
ER
&
FO
R
&
&
&
C
S
HE
H
H
C
S
H
IN
SY
IT
AM
SY
IT
&
&
&
&
FO
C
TY
S
FO
AM
C
IT
SY
IN
SA
N
IN
TY
IA
FO
EL
SA
IN
INFERENCES: R
The above table shows that the companies “SATYAM & RELIANCE” consist of
maximum returns (46.66) and ITC & SATYAM have minimum returns (8.66) comparatively.
PORTFOLIO RISK – RETURN
S.No. COMBINATIONS PORTFOLIO RISK PORTFOLIO RETURN

1 SATYAM & RELIANCE 27.11 46.62
2 ITC & HERO HONDA 28.38 11.23
3 INFOSYS & ITC 30.43 12.58
4 ITC & SATYAM 34.60 8.96
5 ITC & RELIANCE 35.46 11.99
6 INFOSYS & RELIANCE 48.52 42.74
7 RELIANCE & HERO HONDA 56.07 40.95
8 INFOSYS & HERO HONDA 76.17 39.35
9 SATYAM & HERO HONDA 89.26 33.50
10 INFOSYS & SATYAM 107.13 39.50

PORTFOLIO RISK - RETURN
120
100
PORTFOLIO RISK
80
PORTFOLIO RETURN
60
40
20
0
DA
A
E
A
E
C
A
CE
AM
AM
NC
ND
C
IT
ND
N
N
AN
N
TY
O
TY
O
&
IA
O
IA
O
H
H
I
S
H
EL
EL
SA
SA
H
EL
SY
RO
O
R
O
ER
R
&
ER
&
FO
ER
&
&
HE
&
S
H
C
H
S
IN
SY
IT
AM
H
SY
IT
&
&
&
&
FO
C
E
TY
S
FO
AM
C
IT
SY
IN
SA
AN
IN
TY
FO
LI
SA
IN
RE
INFERENCES:
The table shows that the SATYAM & RELIANCE companies and giving maximum
returns with minimum risk. When the INFOSYS &SATYAM have maximum risk while giving
minimum return.
(10). PORTFOLIO SELECTION:

Portfolio analysis provides the input for next phase in portfolio management, which is
portfolio selection. The proper goal of portfolio construction is to generate a portfolio that provides
the highest returns at a given level of risk. The inputs from portfolio analysis can be used to identify
the set of efficient portfolios. From this the optimal portfolio must be selected for investment. Harry
markowitzis portfolio theory provides both the conceptual framework and analytical tools for
determining the optimal portfolio in a disciplined and objective way.
So, out of the various combinations (related to 5 companies), the optimal portfolio is Satyam
& Reliance, as this portfolio has minimum risk of 27.112% with maximum return of 46.63%. Hence,
we can say that it is better to invest in these portfolios.
PORTFOLIO REVISION:
Economy and financial markets are dynamic, changes take place almost daily. As time
passes securities which were once attractive may lease to be so. New securities with promises of
high return and low risk may emerge. The investor now has to revise his portfolio in the light of the
developments in the market. This leads to purchase of some new securities and sale of some of the
existing securities and their proportion in the portfolio changes as a result of the revision.
The revision has to be scientifically and objectively so as to ensure the optimality of
the revised portfolio, it important as portfolio analysis and selection.
PORTFOLIO EVALUATION

The objective of constructing a portfolio and revising it periodically is to earn maximum

returns with minimum risk. Portfolio evaluation is the process, which is concerned with assessing the
performance of the portfolio over a selected period of time in terms of return and risk. This involves
quantitative measurement of actual return realized. Alternative measures of performance evaluation
have been developed by investor and portfolio managers for their use.
It provides a mechanism for identifying weaknesses in the investment process and improving
them. The portfolio management process is an on going process to portfolio construction, continues
with portfolio revision and evaluation. The evaluation provides the necessary feedback for better
designing of portfolio the next time around. Superior performance is achieved through continual
refinement of portfolio management skills.

CONCLUSIONS & SUGGESTIONS
Before investing in shares you should look at the type of shares, you want to buy
and the way in which you want to deal on the stock market.
Three main routes for investing in shares:
 Invest your capital in a single company.
 Invest your capital in a number of different companies, a portfolio of shares.
 Invest indirectly and spread your risk through collective investments such as investment
trusts and unit trusts.
Investing in Shares:
Public companies issue shares, which allow investors to buy a part of a particular company
share ownership entitles you to part of the company Profits if dividends are paid.
Shares may be classified in a range from conservative to speculative. Blue chip is often used
to describe the highest quality and shares, as they are shares in companies with a proven track
record, producing profits in good times and bad. They usually set the level of the market. All shares
are affected by share market fluctuation. Individual share prices also vary based on supply and
demand from sellers and buyers.
Information about shares listed on the stock exchange is printed largely daily in newspapers.
You can buy and sell shares listed on the stock exchange through a stockbroker.
When you buy a parcel of shares, you receive a CHESS statement of holdings from the
company, showing the number of shares you own and the date you bought them.

Findings:
 Average returns of INFOSYS and SATYAM has decreased from 2000 to 2001 due to
the drastic fall in the Information Technology segments.
 During the past 2 years the returns of ITC is in stable position but before that it has
been fluctuating because of tobacco ban by the government.
 The dividends of the RELIANCE Company has been increasing which shows that the
shareholders are getting benefits with minimum risk.
 The risk involved in investing the shares in INFOSYS and SATYAM is high due to
changes in the technological aspects every day.
 The correlation co-efficient between INFOSYS and ITC, INFOSYS and HERO
HONDA, ITC and SATYAM, ITC and HERO HONDA is negative which indicates
that there is high safety in these portfolios with minimal risk.
 The risk involved in Portfolio of INFOSYS and SATYAM is very high.
Suggestions:
This suggestions only investors.
1. While investing it should be noted that the returns will be gained over the
medium and long term investments.
2. Diversify the stock to different companies such as Industry, Finance,
Marketing so as to reduce the risk.
3. The investor should purchase combination of Portfolio that produces a highest
return and lowest risk.
4. Ask your stockbroker for information about the Company’s profile,
Performance and Economic forecasts before buying or selling any shares.

APPENDIX
CALCULATION OF AVERAGE RETURNS OF COMPANIES
INFOSYS:
OPENING CLOSING
YEAR DIVIDEND SHARE PRICE SHARE D+(P1-P0) D+(P1-P0)/P0*100
(P0) PRICE (P1)
1999-00 4.50 2925.00 9676.00 6755.50 230.95
2000-01 10.00 8189.80 4082.90 -4096.90 -50.02
2001-02 20.00 4094.55 3735.45 -339.10 -8.28
2002-03 27.00 3557.85 4263.35 732.50 20.59
2003-04 129.50 4040.30 5037.90 1127.10 27.90
TotalReturn 221.14
RETURNS ARE CALCULATED AS BELOW:

RETURN OF 99-00 = (D + P1-P0)/P0*100 = (4.5+9676.00-2925.00)/2925.00*100 = 230.95
RETURN OF 00-01 = (D + P1-P0)/P0*100 = (10+4082.90-8189.80)/8189.80*100 = -50.02
RETURN OF 01-02 = (D + P1-P0)/P0*100 = (20+3735.45-4094.55)/4094.55*100 = -8.28
RETURN OF 02-03 = (D + P1-P0)/P0*100 = (27+4263.35-3557.85)/3557.85*100 = 20.59
RETURN OF 03-04 = (D + P1-P0)/P0*100 = (129.5+5037.9-4040.3)/4040.3*100 = 27.90
Average Return = 221.14/5 = 44.23
ITC (Indian Tobacco Corporation)
OPENING CLOSING
YEAR DIVIDEND SHARE PRICE SHARE D+(P1-P0) D+(P1-P0)/P0*100
(P0) PRICE (P1)
1999-00 7.49 963 715 -240.51 -24.28
2000-01 10.37 787 814.40 37.77 4.80
2001-02 13.62 814.85 696.65 -104.58 -12.83
2002-03 15.00 705.05 632.85 -57.20 -08.11
2003-04 20.00 629.50 1049.90 440.40 69.96
Total Return 28.84


RETURN OF 99-00 = (D + P1-P0)/P0*100 = (7.49+715-963)/963*100 = -24.98
RETURN OF 00-01 = (D + P1-P0)/P0*100 = (10.37+814.4-787)/787*100 = 4.80
RETURN OF 01-02 = (D + P1-P0)/P0*100 = (13.62+696.65-814.85)/814.85*100 = -12.83
RETURN OF 02-03 = (D + P1-P0)/P0*100 = (15+632.85-705.05)/705.05*100 = -8.11
RETURN OF 03-04 = (D + P1-P0)/P0*100 = (20+1049.90-629.5)/629.5*100 = 69.96
Average Return = 28.84/5 = 5.76
SATYAM:
OPENING CLOSING
SHARE PRICE SHARE
YEAR DIVIDEND (P0) PRICE (P1) D+(P1-P0) D+(P1-P0)/P0*100
1999-00 2.27 1622.00 4813.75 3194.02 196.92
2000-01 7.99 4074.45 233.90 -3832.56 -94.06
2001-02 1.18 243.05 267.65 25.78 10.61
2002-03 3.00 256.75 191.90 -61.85 -24.09
2003-04 4.01 176.95 301.45 128.51 72.65
Tot
al Return 162.03
RETURN OF 99-00 = (D + P1-P0)/P0*100 = (2.27+4813.75-1922)/1922*100 = 196.92

RETURN OF 00-01 = (D + P1-P0)/P0*100 = (7.99+233.9-4074.45)/4074.45*100 = -94.06
RETURN OF 01-02 = (D + P1-P0)/P0*100 = (1.18+267.65-243.05)/243.05*100 = 10.61
RETURN OF 02-03 = (D + P1-P0)/P0*100 = (3+191.9-256.75)/256.75*100 = -24.09

RETURN OF 03-04 = (D + P1-P0)/P0*100 = (4.01+301.45-176.9)/176.9*100 = 72.65

Average Return = 162.03/5 = 32.40
RELIANCE:
OPENING CLOSING D+(P1-

SHARE PRICE SHARE
YEAR DIVIDEND (P0) PRICE (P1) D+(P1-P0) P0)/P0*100
1999-00 3.65 130.40 291.25 164.50 126.15
2000-01 4.25 325.90 390.90 69.25 21.25
2001-02 6.29 389.45 300.70 -82.46 -21.17
2002-03 5.00 300.95 285.00 -10.95 -3.64
2003-04 5.25 276.45 527.20 256.00 92.60
Tot
al Return 215.19
RETURN OF 99-00 = (D + P1-P0)/P0*100 = (3.65+291.25-130.40)/130.40*100 = 126.15

RETURN OF 00-01 = (D + P1-P0)/P0*100 = (4.25+390.9-325.9)/325.9*100 = 21.25
RETURN OF 01-02 = (D + P1-P0)/P0*100 = (6.29+300.7-389.45)/389.45*100 = -21.17
RETURN OF 02-03 = (D + P1-P0)/P0*100 = (5+285-300.95)/300.95*100 = -3.64
RETURN OF 03-04 = (D + P1-P0)/P0*100 = (5.25+527.20-276.45)/276.45*100 = 92.60
Average Return = 215.19/5 = 43.04
HERO HONDA:

OPENING CLOSING
SHARE PRICE SHARE
YEAR DIVIDEND (P0) PRICE (P1) D+(P1-P0) D+(P1-P0)/P0*100
1999-00 2.00 875.25 920 46.25 5.34
2000-01 3.00 1000.20 140.35 -857.85 -85.66
2001-02 17.00 140.00 333.70 196.70 150.50
2002-03 18.00 362.35 196.40 -148.95 -40.83
2003-04 20.00 188.40 438.45 268.05 143.33
Tot
al Return 172.71
RETURN OF 99-00 = (D + P1-P0)/P0*100 = (2+920-875.25)/875.25*100 = 5.34

RETURN OF 00-01 = (D + P1-P0)/P0*100 = (3+140.35-1000.20/1000.20*100 = -85.66
RETURN OF 01-02 = (D + P1-P0)/P0*100 = (17+333.7-140)/140*100 = 150.50
RETURN OF 02-03 = (D + P1-P0)/P0*100 = (18+196.40-362.35)/362.35*100 = -40.83
RETURN OF 03-04 = (D + P1-P0)/P0*100 = (20+438.45-188.40)/188.40*100 = 143.33
Average Return = 172.71/5 = 34.542

CALCULATIONS OF STANDARD DEVIATIONS

INFOSYS:
YEAR RETURN(R) Avg Rtn (R) R-R (R - R)2

99 – 00 230.95 44.24 185.76 34506.78
00 – 01 -50.02 44.24 -94.26 8884.95
01 – 02 -8.28 44.24 -52.52 2758.35
02 – 03 20.59 44.24 -23.65 559.32
03 – 04 27.90 44.24 -16.34 266.99
(R) = 221.14 (R – R) 2 = 46976.39
Average Return = (R)/N = 221.14/5 = 44.24

Variance = 1/N-1(R - R) 2 = 1/5-1(46976.39) = 11744.10
Standard Deviation = √ 11744.10 = 108.37
ITC Indian Tobacco Corporation

99 – 00 -24.98 5.76 -30.74 944.95
00 – 01 4.80 5.76 -0.96 0.92
01 – 02 -12.83 5.76 -18.59 345.59
02 – 03 -8.11 5.76 -13.87 192.38
03 – 04 69.96 5.76 64.20 4121.64
(R) = 28.84 (R – R) 2 = 5605.48

Variance = 1/N-1(R - R) 2 = 1/5-1(5605.48) = 1401.37

SATYAM:

99 – 00 196.92 32.40 164.52 27066.83
00 – 01 -94.06 32.40 -126.46 15992.13
01 – 02 10.61 32.40 -21.79 474.80
02 – 03 -24.09 32.40 -56.49 3191.12
03 – 04 72.65 32.40 40.25 1620.06
(R) = 162.03 (R – R) 2 = 48344.94

Variance = 1/N-1(R - R) 2 = 1/5-1(48344.94) = 12086.24
RELIANCE:
YEAR RETURN(R) Avg Rtn (R) R-R (R - R) 2

99 – 00 126.15 43.04 83.11 6907.27
00 – 01 21.25 43.04 -21.79 474.80
01 – 02 -21.17 43.04 -64.21 4112.92
02 – 03 -3.64 43.04 -46.68 2179.02
03 – 04 92.60 43.04 49.56 2456.19
(R) = 215.19 (R – R) 2 = 16130.20

Variance = 1/N-1(R - R) 2 = 1/5-1(16130.20) = 4032.50

HERO HONDA:
YEAR RETURN(R) Avg Rtn (R) R-R (R - R) 2

99 – 00 5.34 34.54 -29.20 852.64
00 – 01 -85.66 34.54 -120.20 14448.04
01 – 02 150.50 34.54 115.96 13446.72
02 – 03 -40.8 34.54 -75.34 5676.12
03 – 04 143.33 34.54 108.79 11835.26
(R) = 172.71 (R – R) 2 = 46258.78

Variance = 1/N-1(R - R) 2 = 1/5-1(46258.78) = 11564.70

CALCULATION OF CORRELATIONS
1. CORRELATION BETWEEN INFOSYS & ITC
YEAR RA - RA RB - RB (RA-RA) (RB-RB)

99 – 00 185.76 -30.74 -5710.26
00 – 01 -94.26 -0.96 90.50
01 – 02 -52.52 -18.59 976.35
02 – 03 -23.65 -13.87 328.03
03 – 04 -16.34 64.20 -1049.03
(RA-RA) (RB-RB) -5364.41
COVARIANCE (COVab) = 1/n-1 (RA-RA) (RB-RB) = 1/5-1(-5364.41) = -1341.10

σ a = 108.37 σ b = 37.43
Correlation Coefficient (n~ab) = COVab/σ a. σ b = -1341.10/108.37*37.43 = -0.3306
2. CORRELATION BETWEEN INFOSYS & SATYAM

99 – 00 185.76 164.52 30561.24
00 – 01 -94.26 -126.46 11920.12
01 – 02 -52.52 -21.79 1144.41
02 – 03 -23.65 -56.49 1335.99
03 – 04 -16.34 40.25 -657.69
(RA-RA) (RB-RB) 44304.37
COVARIANCE (COVab) = 1/n-1 (RA-RA) (RB-RB) = 1/5-1(44304.37) = 11076.02

σ a = 108.37 σ b = 109.93

Correlation Coefficient (n~ab) = COVab/σ a. σ b = 11076.02/108.37*109.93 = 0.9297
3. CORRELATION BETWEEN INFOSYS & RELIANCE

99 – 00 185.76 83.11 15438.51
00 – 01 -94.26 -21.79 2053.93
01 – 02 -52.52 -64.21 3372.31
02 – 03 -23.65 -46.68 1103.98
03 – 04 -16.34 49.56 -809.81
(RA-RA) (RB-RB) 21158.92

σ a = 108.37 σ b = 63.50
4. CORRELATION BETWEEN INFOSYS & HERO HONDA
YEAR RA - RA RB – RB (RA-RA) (RB-RB)

99 – 00 185.76 -29.2 -5424.19
00 – 01 -94.26 -120.2 11330.05
01 – 02 -52.52 115.96 -6090.22
02 – 03 -23.65 -75.34 1781.80
03 – 04 -16.34 108.79 -1777.63
(RA-RA) (RB-RB) -180.20

σ a = 108.37 σ b = 107.53
5. CORRELATION BETWEEN ITC & SATYAM

99 – 00 -30.74 164.52 -5057.34
00 – 01 -0.96 -126.46 121.40
01 – 02 -18.59 -21.79 405.08
02 – 03 -13.87 -56.49 783.52
03 – 04 64.20 40.25 2584.05
(RA-RA) (RB-RB) -1163.29

σ a = 37.43 σ b = 109.93
6. CORRELATION BETWEEN ITC & RELIANCE

99 – 00 -30.74 83.11 -2554.80
00 – 01 -0.96 -21.79 20.92
01 – 02 -18.59 -64.21 1193.66
02 – 03 -13.87 -46.68 647.45
03 – 04 64.20 49.56 3181.75
(RA-RA) (RB-RB) 2488.98

σ a = 37.43 σ b = 63.50
Correlation Coefficient (n~ab) = COVab/σ a. σ b = -622.25/37.43*63.50 = 0.2618
7. CORRELATION BETWEEN ITC & HERO HONDA

99 – 00 -30.74 -29.2 897.61
00 – 01 -0.96 -120.2 115.39
01 – 02 -18.59 115.96 -2155.70
02 – 03 -13.87 -75.34 1044.97
03 – 04 64.20 108.79 6984.32
(RA-RA) (RB-RB) -6886.60

σ a = 37.43 σ b = 107.53
8. CORRELATION BETWEEN SATYAM & RELIANCE

99 – 00 164.52 83.11 13673.26
00 – 01 -126.46 -21.79 2755.56
01 – 02 -21.79 -64.21 1399.14
02 – 03 -56.49 -46.68 2636.95
03 – 04 40.25 49.56 1944.79
(RA-RA) (RB-RB) 22459.70


σ a = 109.93 σ b = 63.50
9. CORRELATION BETWEEN SATYAM & HERO HONDA

99 – 00 164.52 -29.2 -4803.98
00 – 01 -126.46 -120.2 15200.50
01 – 02 -21.79 115.96 -2526.77
02 – 03 -56.49 -75.34 4255.96
03 – 04 40.25 108.79 4378.80
(RA-RA) (RB-RB) 16504.50

σ a = 109.93 σ b = 107.53
10. CORRELATION BETWEEN RELIANCE & HERO HONDA

99 – 00 83.11 -29.2 -2426.81
00 – 01 -21.79 -120.2 2619.16
01 – 02 -64.21 115.96 -7445.79
02 – 03 -46.68 -75.34 3516.87
03 – 04 49.56 108.79 5391.63
(RA-RA) (RB-RB) 1655.06


σ a = 63.50 σ b = 107.53
CALCULATION OF PORTFOLIO WEIGHTS:

FORMULA: Xa = σ b (σ b-nab. σ a)/ σ a2+σ b2-2nab. σ a. σ b
Xb=1-Xa
1. CALCULATION OF WEIGHT OF INFOSYS & ITC:
Where, Xa = INFOSYS, Xb = ITC

Xa = 37.43 (37.43 - (-0.3306) 108.37)/108.372+37.432-(2*-0.3306*108.37*37.43)
= 2742.01/15467.08 = 0.1733
Xb = 1.Xa = 1 – 0.1733 = 0.8277
Xa = 17.33%, Xb = 82.27%
2. CALCULATION OF WEIGHT OF INFOSYS & SATYAM:
Where, Xa = INFOSYS, Xb = SATYAM

Xa = 109.93 (109.93 - (-0.9297) 108.37)/108.372+109.932- (2*-0.9297*108.37*109.93)
= 1008.98 / 1677.42 = 0.60
Xb = 1.Xa = 1 –0.60 = 0.40
Xa = 60%, Xb = 40%
3. CALCULATION OF WEIGHT OF INFOSYS & RELIANCE:
Where, Xa = INFOSYS, Xb = RELIANCE

Xa = 63.50(63.50 – (-0.7686). 108.37) / 108.372+63.502 – (2*-0.7686*108.37*63.50)
= -1256.8671 / 5198.0728 = -0.2418
Xb = 1-Xa = 1 – (-0.2418) = 1.2418
Xa = -24.18%, Xb = 124.18%
4. CALCULATION OF WEIGHT OF INFOSYS & HERO HONDA:
Where Xa = INFOSYS Xb = HERO HONDA

Xa = 107.53(107.53-(-0.0039). 108.37) / 108.372+107.532 – (2*-0.0039*108.37*107.53)
= 11608.15 / 23397.64 = 0.4961

Xb = 1-Xa = 1-0.4961 = 0.5039

Xa = 49.61%, Xb = 50.39%
5. CALCULATION OF WEIGHT OF ITC & SATYAM:
Where Xa = ITC, Xb = SATYAM

Xa = 109.93 (109.93 – (-0.0706) 37.43) / 37.432 + 109.932 – (2*-0.0706*37.43*109.93)
= 12375.1013 / 14066.6026 = 0.8797
Xb = 1-Xa = 1- 0.8797 = 0.1203
Xa = 87.97% Xb = 12.03%
6. CALCULATION OF WEIGHT OF ITC & RELIANCE:
Where Xa = ITC Xb = RELIANCE

Xa = 63.50 (63.50- (0.2618) 37.43 / 37.432 + 63.502 – (2*0.2816*37.43*63.50)
= 3410.0025 / 4094.6383 = 0.8328
Xb = 1 – Xa = 1 – 0.8328 = 0.1672
Xa = 83.28% Xb = 16.72%
7. CALCULATION OF WEIGHT OF ITC & HERO HONDA:
Where Xa = ITC Xb = HERO HONDA

Xa = 107.53(107.53 – (-0.4278).37.43) / 37.432 + 107.532 – (2*-0.4278*37.43*107.53)
= 13284.25 / 16407.36 = 0.8096
Xb = 1- Xa = 1 – 0.8096 = 0.1904
Xa = 80.96% Xb = 19.04%
8. CALCULATION OF WEIGHT OF SATYAM & RELIANCE:
Where Xa = SATYAM Xb = RELIANCE

Xa = 63.50 (63.50 – (-0.81). 109.93) / 109.932 + 63.502 – (2*-0.81*109.93*63.50)
= -1621.9996 / 4808.3558 = -0.3373
Xb = 1 – Xa = 1 – (-0.3373) = 1.3373
Xa = -33.73% Xb = 133.73%
9. CALCULATION OF WEIGHT OF SATYAM & HERO HONDA
Where Xa = SATYAM Xb = HERO HONDA

Xa = 107.53 (107.53 – 0.3490.109.93) / 109.932 + 107.532 – (2*0.3490*109.93*107.53)
= 7436.77 / 15396.41 = 0.4830
Xa = 1 – Xa = 1 – 04830 = 0.5170

Xa = 48.30% Xb = 51.70%
10. CALCULATION OF WEIGHT OF RELIANCE & HERO HONDA
Where Xa = RELIANCE Xb = HERO HONDA

Xa = 107.53 (107.53 – 0.0606.63.50) / 63.502 + 107.532 – (2*0.0606*63.50*107.53)
= 11148.71 / 14767.38 = 0.7549
Xb = 1 – Xa = 1 – 0.7549 = 0.2451
Xa = 75.49% Xb = 24.51%
CALCULATION OF PORTFOLIO RISK:
FORMULA: σ p = √ σ a2Wa2 + σ b2Wb2 + 2nab. σ a. σ b.WaWb
Where,
σ a = Standard deviation of Security a

σ b = Standard deviation of Security b
nab = Correlation Coefficient between Security a & b
σ p = Portfolio Risk
1. INFOSYS & ITC
σ a = 108.37, Wa = 0.1773, σ b = 37.43, Wb = 0.8227, nab = -0.3306
σ p = 108.372*0.17732 + 37.432*0.82272 + 2 (-0.3306*108.37*37.43*0.1773*0.8227)
= √ 926.21 = 30.4338
2. INFOSYS & SATYAM

σ a = 108.37, Wa = 0.60, σ b = 109.93 Wb = 0.40, nab = 0.9297
σ p = 108.372*0.602 + 109.932*0.402 + 2(0.9297*108.37*109.93*0.60*0.40)
= √ 11477.69 = 107.1340
3. INFOSYS & RELIANCE
σ a = 108.37, Wa = -0.2418, σ b = 63.50, Wb = 1.2418, nab = 0.7686
σ p = 108.372*-0.24182 + 63.502*1.24182 + 2(0.7686*63.50*-0.2418*1.2418)
= √ 2355.060 = 48.5289
4. INFOSYS & HERO HONDA
σ a = 108.37, Wa = 0.4961, σ b = 107.53, Wb = 0.5039, nab = -0.0039
σ p = 108.372*0.49612 + 107.532*0.50392 + 2(-0.0039-108.37*107.53*0.4961*0.5039)
= √ 5803.25 = 76.17
5. ITC & SATYAM
σ a = 37.43, Wa = 0.8797, σ b = 109.93, Wb = 0.1203, nab = -0.0706
σ p = 37.432*0.87972 + 109.932*0.12032 + 2(-0.0706*37.43*109.93*0.8797*0.1203)
= √ 1197.6028 = 34.6064.
6. ITC & RELIANCE
σ a = 37.43, Wa = 0.8328, σ b = 63.50, Wb = 0.1672, nab = 0.2618
σ p = 37.432*0.83282 + 63.502*0.16722 + 2(0.2618*37.43*63.50*0.8328*0.1672)
= √ 1257.68 = 35.4639.
7. ITC & HERO HONDA
σ a = 37.43, Wa = 0.8096, σ b = 107.53, Wb = 0.1904, nab = -0.4278

σ p = 37.432*0.80962 + 107.532*0.19042 + 2(-0.4278*37.43*107.53*0.8096*0.1904)
= √ 805.94 = 28.38.
8. SATYAM & RELIANCE
σ a = 109.93, Wa = -0.3373, σ b = 63.50, Wb = 1.3373, nab = 0.81
σ p = 109.932*-0.33732 + 63.502*1.33732 + 2(0.81*109.93*63.50*-0.3373*1.3373)
= √ 735.339 = 27.1172.
9. SATYAM & HERO HONDA
σ a = 109.93, Wa = 0.4830, σ b = 107.53, Wb= 0.5170, nab = 0.3490
σ p = 109.932*0.48302 + 107.532*0.51702 + 2(0.3490*109.93*107.53*0.4830*0.5170)
= √ 7968.01 = 89.26.
10. RELIANCE & HERO HONDA

σ a = 63.50, Wa = 0.7549, σ b = 107.53, Wb = 0.2451, nab = 0.0606
σ p = 63.502*0.75492 + 107.532*0.24512 + 2(0.0606*63.50*107.53*0.7549*0.2451)
= √ 3144.45 = 56.07.
CALCULATION OF PORTFOLIO RETURN:

Rp = (Ra*Wa) + (Rb*Wb)
Where,
Ra = Average Return of Security a
Rb = Average Return of Security b
Rp = Portfolio Return
Portfolio's Ra Wa Rb Wb Rp = (Ra*Wa) +

(Rb*Wb)
INFOSYS & ITC 44.24 0.1733 5.76 0.8227 12.5825
INFOSYS & SATYAM 44.24 0.60 32.40 0.40 39.5040
INFOSYS & RELIANCE 44.24 -0.2418 43.04 1.2418 42.7498
INFOSYS & HERO HONDA 44.24 0.4961 34.54 0.5039 39.35
ITC & SATYAM 5.76 0.8797 32.40 0.1203 8.9648
ITC & RELIANCE 5.76 0.8328 43.04 0.1672 11.9932
ITC & HERO HONDA 5.76 0.8096 34.54 0.1904 11.23
SATYAM & RELIANCE 32.40 -0.3373 43.04 1.3373 46.62
SATYAM & HERO HONDA 32.40 0.4830 34.54 0.5170 33.50
RELIANCE & HERO HONDA 43.04 0.7549 34.54 0.2451 40.95
INFERENCES: The above table shows that the companies “SATYAM & RELIANCE”
consist of maximum returns (46.62) and ITC & SATYAM have minimum returns (8.66)
comparatively.
BIBLIOGRAPHY
TEXT BOOKS:
1. Security Analysis & Portfolio Management -- -- -- V.K.Bhalla

2. Security Analysis & Portfolio Management --------Punithavathi Pandian
3. Investment Management -- -- -- V. Avadhani
4. Security Analysis -- -- -- Gordon. Jodd
5. Portfolio Management -- -- -- S. Kevin
WEBSITES:

 www.nseindia.com
 www.bseindia.com
 www.hseindia.com
 www.sebi.com
 www.google.com

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docSECURITY ANALYSIS & PORTFOLIO MANAGEMENT

 Need & Importance: -

NEED FOR THE STUDY : -

Aurora School of Business Secundrabad 1

 Objectives of the Study:

 How to analyze Securities.

 Limitations of the Study:

Aurora School of Business Secundrabad 1

(2). Research Methodology:

Aurora School of Business Secundrabad 1

(3). STOCK EXCHANGE

Aurora School of Business Secundrabad 1

REGULATION OF STOCK EXCHANGE

 SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

Aurora School of Business Secundrabad 1

 BOMBAY STOCK EXCHANGE

Aurora School of Business Secundrabad 1

Aurora School of Business Secundrabad 1

 NATIONAL STOCK EXCHANGE

Aurora School of Business Secundrabad 1

NSE – MIDCAP INDEX

Aurora School of Business Secundrabad 1

NAME OF THE STOCK EXCHANGE YEAR

Aurora School of Business Secundrabad 1

Bombay Stock Exchange 1875

(4). THE HYDERABAD STOCK EXCHANGE LIMITED

Aurora School of Business Secundrabad 1

Aurora School of Business Secundrabad 1

Aurora School of Business Secundrabad 1

Sri Hari Narayan Rathi

PUBLIC NOMINEE DIRECTORS

Aurora School of Business Secundrabad 1

 INTER – CONNECTED MARKET SYSTEM (ICMS)

Aurora School of Business Secundrabad 1

 IMPROVEMENT IN THE VOLUMES

Aurora School of Business Secundrabad 1

1992-93 421.985 676.00 274 10228.48

1993-94 603.635 984.46 372 13156.15

1994-95 860.642 1160.48 668 18588.71

1995-96 720.521 1107.30 727 20159.31

1996-97 240.64 479.98 851 22050.69

1997-98 427.83 1860.86 852 18705.10

1998-99 513.168 1269.90 856 18753.93

1999-00 513.440 1236.51 869 19128.95

2000-01 427.205 977.83 934 14717.08

2001-02 34.326 41.26 932 13616.12

2002-03 4.203 4.58 .928 13974.12

2003-04 2.277 2.73 856 22126.65

2004-05 4.401 14.13 820 14456.95

Aurora School of Business Secundrabad 1

 SETTLEMENT GUARANTEE FUND

(A). DEPOSITORY PARTICIPANT

Aurora School of Business Secundrabad 1

B) FLOATING OF A SUBSIDIARY COMPANY FOR THE MEMBERSHIP OF MAJOR

DERIVATIVES TRADING, NET TRADING ETC

(6). PORTFOLIO MANAGEMENT & ITS PHASES

Aurora School of Business Secundrabad 1

Portfolio management is a process encompassing many activities aimed at optimizing the

(1) Security analysis

Aurora School of Business Secundrabad 1

The Main constituents of and players in the market are as follows: