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Study of Top 30 Companies of Bombay
Stock Exchange through
Capital Asset Pricing Model
Project Report submitted in partial fulfillment of the requirements for the Degree
of Masters of International Business

Under the guidance of

Ms. Sunanina Kanojia

Submitted by
Saurabh Chhabra
Batch of 2011
Department of Commerce
Delhi School of Economics
March 25,

University of Delhi

This is to certify that the dissertation titled “Portfolio Management: Study of Capital Asset
Pricing Model on the Stocks of BSE Sensex” submitted in partial fulfillment of the requirements
of the award of the degree of Masters of International Business program is based on original
research work carried out by Saurabh Chhabra, conducted under the guidance of Ms Sunaina
Kanojia, for submission to the Department of Commerce, Delhi University.

It is further certified that the project report, or any part thereof, has not been submitted elsewhere
for any other purpose, and no part of this work has been copied from any source. All references,
wherever used, have been duly acknowledged.

( ) ( )
Saurabh Chhabra Ms. Sunaina Kanojia
Master of International Business Department of Commerce
Roll No:44, IVth Semester University of Delhi

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“No man is an island entire of itself” (John Donne, 1572-1631).
The completion of this study would not have been possible without the help, encouragement and
support of many individuals to whom I would like to express my deepest gratitude.

I would take this opportunity to express my sincere gratitude to Ms. Sunaina Kanojia for her
invaluable inspiration, guidance and support through out this project. I truly appreciate her inputs
and count it a privilege to have worked under the supervision. This dissertation report has given
me immense knowledge about the institution of Capital Asset Pricing Model in a broader sense,
its problems and its road ahead.

Thanks also to all the professors and teaching faculty for providing necessary guidance and
valuable inputs. I would also like to extend my thanks to my friends in the Commerce
Department (from Delhi School of Economics) who have helped me in the better understanding
of the subject. Their insightful feedback about the project work helped a long way in shaping this
final report.

Saurabh Chhabra

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Chapter 1: Introduction……….

1.1 Scope of the dissertation….………………….…………………………………….….


1.2 Objectives of the Study………………….……………………………………………….



1.4 Organization of the dissertation………………..…….


1.5 Limitations……………………………………………...….….

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Chapter 2: Conceptual Framework of Capital Asset Pricing Model

Review of Literature..……..……………………………………………….

2.1 Introduction of Portfolio Management…………..


2.2 Selection of Portfolios…………………………..………………………………………….


2.3 Evolution of Portfolio Management……………………………………………..


2.4 Literature in Capital Asset Pricing Model…………………………………….….


2.5 Background….……………………………………………………………………………….

2.6 Security Market Line…………..………………………………………………………….


2.7 Risk & Diversification………….


2.8 Market Portfolio……………………………………………….


2.9 Assumptions of CAPM……………………………………….


2.10 Limitations of CAPM………...


2.11 Summary………………………....

Chapter 3: CAPM: Conceptual Research

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3.1 Introduction & Background of


3.2 Portfolio Theory, Riskless Lending and Borrowing and Fund


3.3 Capital Asset Pricing


3.4 Is CAPM

Chapter 4: Use of CAPM in BSE Sensex: An Empirical Study

4.1 Empirical Study of Applicabilty of CAPM in BSE

4.2 Inferences of Empirical

4.3 Application of CAPM in Strategic Planning…………………………………..


4.4 Building A


Chapter 5

5.1 Conclusion…………………...

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The proposition of this dissertation is that an optimal portfolio can be built by making an
extensive analysis of various stock in correlation with market index as a whole using Capital
Asset Pricing Model as the basis whereby we can not only diversify the risk but maximize the
overall return of the portfolio.

The dissertation starts with historical background and concepts involved in need for
diversification, the systematic and unsystematic risks involved, the technical and fundamental
analysis. Finally, shifting the focus on the historical background of CAPM, evolution of CAPM
model and the basic concepts on which it is based upon.

The dissertation extends into analysis of CAPM in BSE Sensex and to interpret whether CAPM
can be used as a true reflector of the returns as provided by the stocks over a period of time.
The dissertation concludes with Strategic implication of CAPM and with the conclusions drawn
from the analysis for building the optimum portfolio.

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Chapter 1
Many modern financial applications such as portfolio construction and risk management, require
estimates of the asset returns. The finance literature in the past paid less attention to the
estimation. This lack of attention is due to two factors. First, there was limited computing
technology to practically handle large amount of cross-sectional information for covariance
estimation. Second, it was generally believed that in a mean-variance optimization process,
compared to expected returns, covariance is more stable and causes fewer problems; hence it is

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less important to have good estimations for it. Recently, with development in both optimization
and computational technologies and renewed interests in portfolio risk management, there
has been increasing attention on CAPM.

This dissertation studies the applicability of CAPM in Indian Stock market. The need for
diversification arises from the concept of having higher returns with lower risk involved and for
that return on equity has to be considered. The cost of capital DCF model was used. Since it had
certain loopholes many models have been developed to calculate return on portfolio and stocks
with CAPM being the earliest model. Since then models like Efficient Market hypothesis, three
factor model have been developed but CAPM has still its stronghold for such estimation. Thus, it
becomes imperative to analyze it as an estimator. In this study, we focus on that very aspect and
try to evaluate its sustainability in Indian Stock market by undertaking an empirical study.

1.1 Scope of the study

The dissertation consists of five essays. The first essay is an empirical study on the need of
diversification, history of Capital asset pricing model. We contribute to the literature by
providing an up-to-date analysis of both old and new estimation methods. We compare these
methods using the conventional comparison criteria.

We need to find a more powerful measure to compare the performance of alternative models. For
portfolio risk management purposes, we want a more robust assessment criterion where the risks
of any portfolios can be measured. This leads to the second part of our thesis, where we propose

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to use the applicability of Capital Asset Pricing model in order to determine if this model can be
used as a true reflector of the actual returns provided by the stocks considered.

 Understanding the various dimensions of Portfolio Management

 Need for building Optimal Portfolios

 Use of CAPM as a means to determine the optimal Portfolio

1.2 Objectives of the Study

The core idea behind undertaking the dissertation is to attain following objectives:-

Various Models have been developed over a period of time for the very purpose of calculating
the “Return on Equity”. The earliest model was based on the concept of Cost of Capital. Since

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there were certain loopholes in this model, the first model for calculating return on Equity is
considered to be developed by Markowitz. However, since model like Du Pont, Arbitrage
Pricing theory, Three factor model have become more prominent this study has been undertaken
to authenticate that CAPM is still one of the most important model for the analysis on return on
equity and no analysis would be complete without it.

i. Study the concept of Portfolio Management with the focus on Capital Asset Pricing

ii. To sketch the conceptual framework used for the analysis of Capital Asset Pricing

iii. To highlight the relation and sustainability of Capital Asset pricing Model in Indian
Stock Market by doing the analysis of top 30 companies of Bombay Stock Exchange
during a period of 10 years

iv. To draw the conclusions and give recommendations about the applicability.

1.3 Research Methodology

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The cornerstones of my approach to study the Applicability of risk analysis in listed companies
of NSE and recommending a sustainable roadmap for building a portfolio using Markowitz
The study is related to obtaining a better estimation of the returns of a reasonably large number
of stocks for portfolio risk management. To set the stage for our analysis, we examine the returns
offered by companies . Next, as part of exploring the best way to examine the risk involved in
different stocks, we calculated co-relation between these companies and finally studied the risk
involved in all this exercise using Markowitz model.
Extensive interactions were held with certain corporate, representatives from the banking
and financial industry based in Delhi to have a better analysis of the subject.

Case study based approach:

All through the text my endeavor has been to study Markowitz Model as case study and
try and draw out how it has been applied to calculate Return and risk on Equity, which in
turn has helped me analyze the sector in a better way.

Extensive Secondary Research:

Applicability of Markowitz Model in Indian Stock Market is not extensively researched
in India. Moreover empirical records of Markowitz Model are quite less. Models like
discounted cash flow, Du Pont analysis, arbitrage pricing theory, three factor model are
used. Hence, I have focused on CAPM and used it to determine as a means. I have relied
to a large extent on the publications and reports published in the international domain.
Along with that journals have been also considered. The data for empirical study is
basically collected from the various software like Prowess etc. The additional
information about individual stock performances likes returns have been collected from
financial journals as well as by studying of the Annual reports of the companies. To
ensure the relevance in the Indian markets, research based out of the emerging markets
has been considered.

Conceptual Analysis:
In order to lay out a roadmap for CAPM, it was necessary to analyze the conceptual
framework. Hence, key concepts and bases with respect to CAPM have been analyzed.

1.4 The organization of the dissertation

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Following the introduction of the dissertation report in Chapter 1, the rest of the dissertation is
organized in the following way.

Chapter 2 reviews the literature on the Capital Asset Pricing Model. It focuses on the portfolio
management, evolution of portfolio management, history of CAPM Model, various risk
involved, need for diversification and CAPM as model to diversify the portfolio, assumptions
and limitations Along with this, the usefulness of CAPM is also factored in.

Chapter 3 conducts a comprehensive empirical analysis of estimating the return on equity of

various stocks of BSE Sensex using the CAPM Model. We examine how much CAPM is
applicable in real life and if CAPM is a true reflector of the market value as reflected in prices of
Stocks. This chapter extends as a tool for finding if CAPM could be used as a strategic planning.
These comparisons helps in finding the optimal portfolio management, where the returns are
maximized and the risk diversified.

In Chapter 4, we analyse the CAPM model as a whole robust optimal portfolio measurement
means. This chapter draws the final implication of the objectives of the study and the concepts of
CAPM and the inferences drawn from the empirical study. Finally, we conclude and describes
potential future research of CAPM model in Portfolio Management.

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1.5 Limitations of the Study

The following dissertation has following limitations..

➢ Using CAPM as the only model for determining the optimal portfolio.

➢ Limiting the scope of Stock to blue chip companies or heavy weights only in which case
the risk is already diversified and lesser risk factor involved thus a skewed result has high

➢ Time frame of data for analysis limited to a period of 10 years.

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Chapter 2
Conceptual Framework of Capital Asset Pricing Model

Literature Review
Estimation of return on the asset returns plays an important role in both the theory and practice
of modern portfolio analysis and financial risk management.

Markowitz's (1952) mean-variance portfolio optimization theory shows that we can construct
optimal portfolios if accurate estimation of expected returns, variance and covariance of every
asset could be obtained. Following the work of Markowitz, numerous studies have been
searching for methods that can provide the best estimates. Therefore, there has been considerable
progress in the design of optimal portfolios.

This chapter provides a brief review of the literature on estimating a return of an asset and
portfolio as a whole with Capital Asset Pricing model as the basis.

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2.1 Introduction to Portfolio Management

Investing in securities such as shares, debentures, and bonds is profitable as well as exciting. It is
indeed rewarding, but involves a great deal of risk and calls for scientific knowledge as well
artistic skill. In such investments both rationale and emotional responses are involved. Investing
in financial securities is now considered to be one of the best avenues for investing one savings
while it is acknowledged to be one of the best avenues for investing one saving while it is
acknowledged 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 a group of securities is called 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 and practice of
optimally combining securities into portfolios. An investor who understands the fundamental
principles and analytical aspects of portfolio management has a better chance of success.

Portfolio Management:
An investor considering investment in securities is faced with the problem of choosing from
among a large number of securities and how to allocate his funds over this group of securities.
Again he is faced with problem of deciding which securities to hold and how much to invest in
each. The risk and return characteristics of portfolios. The investor tries to choose the optimal
portfolio taking into consideration the risk return characteristics of all possible portfolios. As the
risk return characteristics of individual securities as well as portfolios also change. This calls for
periodic review and revision of investment portfolios of investors.

An investor invests his funds in a portfolio expecting to get good returns consistent with the risk
that he has to bear. The return realized from the portfolio has to be measured and the
performance of the portfolio has to be evaluated. It is evident that rational investment activity
involves creation of an investment portfolio. Portfolio management comprises all the processes
involved in the creation and maintenance of an investment portfolio. It deals specifically with the
security analysis, portfolio analysis, portfolio selection, portfolio revision & portfolio evaluation.
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Portfolio management makes use of analytical techniques of analysis and conceptual theories
regarding rational allocation of funds. Portfolio management is a complex process which tries to
make investment activity more rewarding and less risky. The selection of portfolio depends upon
the objectives of the investor.


The selection of portfolio under different objectives are dealt subsequently Objectives and asset
mix If the main objective is getting adequate amount of current income, sixty percent of the
investment is made in debt instruments and remaining in equity. Proportion varies according to
individual preference. Here the investor requires a certain percentage of growth as the income
from the capital he has invested. The proportion of equity varies from 60 to 100 % and that of
debt from 0 to 40 %. The debt may be included to minimize risk and to get tax exemption. It
means that value of the investment made increases over the year. Investment in real estate can
give faster capital appreciation but the problem is of liquidity. In the capital market, the value of
the shares is much higher than the original issue price. Safety of principle and asset mix Usually,
the risk adverse investors are very particular about the stability of principal. Generally old people
are more sensitive towards safety.

Risk and return analysis

The traditional approach of portfolio building has some basic assumptions. An investor wants
higher returns at the lower risk. But the rule of the game is that more risk, more return. So while
making a portfolio the investor must judge the risk taking capability and the returns desired.
Diversification Once the asset mix is determined and risk – return relationship is analyzed the
next step is to diversify the portfolio. The main advantage of diversification is that the
unsystematic risk is minimized.

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2.3 Evolution of Portfolio Management

Portfolio management is essentially a systematic method of maintaining one‘s investment
efficiently. Many factors have contributed to the existence and development of the concept. In
the early years of the century analyst used financial statements to find the value of the securities.
The first to be analyzed using this was Railroad Securities of the USA. A booklet entitled ―The
Anatomy of the Railroad was published by Thomas F. Woodlock in 1900. As the time
progressed this method became very important in the investment field, although most of the
writers adopted different ways to publish their data. They generally advocated the use of
different ratios for this purpose. John Moody in his book ―The Art of wall Street Investing‖,
strongly supported the use of financial ratios to know the worth of the investment. The proposed
type of analysis later on became the ―common-size analysis.

The other major method adopted was the study of stock price movement with the help of price
charts. This method later on was known as Technical Analysis. It evolved during 1900-1902
when Charles H. Dow, the founder of the Dow Jones and Co. presented his view in the series of
editorials in the Wall Street Journal in USA. The advocates of technical analysis believed that
stock prices movement is ordered and systematic and the definite pattern could be identified.
There investment strategy was build around the identification of the trend and pattern in the
stock price movement.

Another prominent author who supported the technical analysis was Ralph N. Elliot who
published a book in the year 1938 titled ―The Wave Principle. After analyzing 75 years data of
share price, he concluded that the market movement was quite orderly and followed a pattern of
waves. His theory is known as Elliot Wave Theory. According to J.C. Francis the development
of investment management can be traced chronologically through three different phases. First

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phase is known as Speculative Phase. Investment was not a wide spread activity, but a cake of
few rich people. The process is speculative in nature. Investment management was an art and
needed skills. Price manipulation was resorted to by the investors. During this time period pools
and corners were used for manipulation. The result of this was the stock exchange crash in the
year 1929. Finally the daring speculative ventures of investors were declared illegal in the US by
the Securities Act of 1934. Second phase began in the year 1930. The phase was of
professionalism. After coming up of the Securities Act, the investment industry began the
process of upgrading its ethics, establishing standard practices and generating a good public
image. As a result the investments market became safer place to invest and the people in
different income group started investing. Investors began to analyze the security before
investing. During this period the research work of Benjamin Graham and David L. Dood was
widely publicized and publicly acclaimed. They published a book ―Security Analysis in 1934,
which was highly sought after. There research work was considered first work in the field of
security analysis and acted as the base for further study. They are considered as pioneers of
security analysis as a discipline. Third phase was known as the scientific phase.

The foundation of modern portfolio theory was laid by Markowitz. His pioneering work on
portfolio management was described in his article in the Journal of Finance in the year 1952 and
subsequent books published later on.
He tried to quantify the risk. He showed how the risk can be minimized through proper
diversification of investment which required the creation of the portfolio. He provided technical
tools for the analysis and selection of optimal portfolio. For his work he won the Noble Prize for
Economics in the year 1990. The work of Markowitz was extended by the William Sharpe, John
Linter and Jan Mossin through the development of the Capital Asset Pricing Model (CAPM). If
we talk of the present the last two phases of Professionalism and Scientific Analysis are currently
advancing simultaneously with investment in various financial instruments becoming safer, with
proper knowledge to each and every investor.

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2.4 Literature on Capital Asset Pricing Model

The literature on estimating a return on portfolio is quite extensive. We focus our review on
methods that use mostly historical stock return data but limited stock fundamental information
such as the industry classifications in the estimation process.

A fundamental question in finance is how the risk of an investment should affect its expected
return. The Capital Asset Pricing Model (CAPM) provided the first coherent framework for
answering this question. The CAPM was developed in the early 1960s by William Sharpe
(1964), Jack Treynor (1962), John Lintner (1965) and Jan Mossin (1966). The CAPM is based
on the idea that not all risks should affect asset prices. In particular, a risk that can be diversified
away when held along with other investments in a portfolio is, in a very real way, not a risk at
all. The CAPM gives us insights about what kind of risk is related to return. This paper lays out
the key ideas of the Capital Asset Pricing Model, places its development in a historical context,
and discusses its applications and enduring importance to the field of finance. After all, stock and
option markets had been in existence at least since 1602 when shares of the East India Company
began trading in Amsterdam (de la Vega, 1688); and organized insurance markets had become
well developed by the 1700s (Bernstein, 1996). By 1960, insurance businesses had for centuries
been relying on diversification to spread risk. But despite the long history of actual risk-bearing
and risk-sharing in organized financial markets, the Capital Asset Pricing Model was developed

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at a time when the theoretical foundations of decision making under uncertainty were relatively
new and when basic empirical facts about risk and return in the capital markets were not yet

Rigorous theories of investor risk preferences and decision-making under uncertainty emerged
only in the 1940s and 1950s, especially in the work of von Neumann and Morgenstern (1944)
and Savage (1954). Portfolio theory, showing how investors can create portfolios of individual
investments to optimally trade off risk versus return, was not developed until the early 1950s by
Harry Markowitz (1952, 1959) and Roy (1952). Equally noteworthy, the empirical measurement
of risk and return was in its infancy until the 1960s, when sufficient computing power became
available so that researchers were able to collect, store and process market data for the purposes
of scientific investigation. The first careful study of returns on stocks listed on the New York
Stock Exchange was that of Fisher and Lorie (1964) in which they note: "It is surprising to
realize that there have been no measurements of the rates of return on investments in common
stocks that could be considered accurate and definitive." In that paper, Fisher and Lorie report
average stock market returns over different holding periods since 1926, but not the standard
deviation of those returns. They also do not report any particular estimate of the equity risk
premium that is, the average amount by which the stock market outperformed risk-free
investments although they do remark that rates of return on common stocks were "substantially
higher than safer alternatives for which data are available."

Measured standard deviations of broad stock market returns did not appear in the academic
literature until Fisher and Lorie (1968). Carefully constructed estimates of the equity risk
premium did not appear until Ibbotson and Sinquefield (1976) published their findings on long-
term rates of return. They found that over the period 1926 to 1974, the (arithmetic) average
return on the Standard and Poor's 500 index was 10.9 percent per annum, and the excess return
over U.S. Treasury bills was 8.8 percent per annum.

The first careful study of the historical equity risk premium for UK stocks appeared in Dimson
and Brealey (1978) with an estimate of 9.2 percent per annum over the period 1919-1977. In the
1940s and 1950s, prior to the development of the Capital Asset Pricing Model, the reigning
paradigm for estimating expected returns presupposed that the return that investors would
require (or the "cost of capital") of an asset depended primarily on the manner in which that asset
was financed (for example, Bierman and Smidt, 1966). There was a "cost of equity capital" and a
"cost of debt capital," and the weighted average of these based on the relative amounts of debt
and equity financing represented the cost of capital of the asset. The costs of debt and equity
capital were inferred from the long-term yields of those instruments. The cost of debt capital was
typically assumed to be the rate of interest owed on the debt, and the cost of equity capital was
backed out from the cash flows that investors could expect to receive on their shares in relation
to the current price of the shares. A popular method of estimating the cost of equity this way was
the Gordon and Shapiro (1956) model, in which a company's dividends are 1. These are
arithmetic average returns. Ibbotson and Sinquefield (1976) were also the first to report the term
premium on long-term bonds: 1.1 percent per annum average return in excess of Treasury bills
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over the period 1926-1974 assumed to grow in perpetuity at a constant rate g. In this model, if a
firm's current dividend per share is D, and the stock price of the firm is P, then the cost of equity
capital r is the dividend yield plus the dividend growth rate: r = D/P + g.1

From the perspective of modern finance, this approach to determining the cost of capital was
anchored in the wrong place. At least in a frictionless world, the value of a firm or an asset more
broadly does not depend on how it is financed, as shown by Modigliani and Miller (1958). This
means that the cost of equity capital likely is determined by the cost of capital of the asset, rather
than the other way around. Moreover, this process of inferring the cost of equity capital from
future dividend growth rates is highly subjective. There is no simple way to determine the
market's forecast of the growth rate of future cash flows, and companies with high dividend
growth rates will be judged by this method to have high costs of equity capital. Indeed, the
Capital Asset Pricing Model will show that there need not be any connection between the cost of
capital and future growth rates of cash flows. In the pre-CAPM paradigm, risk did not enter
directly into the computation of the cost of capital. The working assumption was often that a firm
that can be financed mostly with debt is probably safe and is thus assumed to have a low cost of
capital; while a firm that cannot support much debt is probably risky and is thus assumed to
command a high cost of capital. These rules-of-thumb for incorporating risk into discount rates
were ad hoc at best. As Modigliani and Miller (1958) noted: "No satisfactory explanation has yet
been provided as to what determines the size of the risk [adjustment] and how it varies in
response to changes in other variables."

In short, before the arrival of the Capital Asset Pricing Model, the question of how expected
returns and risk were related had been posed, but was still awaiting an answer.

Diversification, Correlation and Risk

The notion that diversification reduces risk is centuries old. In eighteenth-century English
language translations of Don Quixote, Sancho Panza advises his master, "It is the part of a wise
man to ... not venture all his eggs in one basket." According to Herbison (2003), the proverb "Do
not keep all your eggs in one basket" actually appeared as far back as Torriano's (1666) Common
Place of Italian Proverbs. However, diversification was typically thought of in terms of spreading
your wealth across many independent risks that would cancel each other if held in sufficient
number (as was assumed in the new ventures example). Harry Markowitz (1952) had the insight
that, because of broad economic influences, risks across assets were correlated to a degree. As a
result, investors could eliminate some but not all risk by holding a diversified portfolio.
Markowitz wrote: "This presumption that the law of large numbers applies to a portfolio of
securities, cannot be accepted. The returns from securities are too inter correlated.
Diversification cannot eliminate all variance." Markowitz (1952) went on to show analytically

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how the benefits of diversification depend on correlation. The correlation between the returns of
two assets measures the degree to which they fluctuate together. Correlation coefficients range
between 1.0 and -1.0. When the correlation is 1.0, the two assets are perfectly positively
correlated. They move in the same direction and in fixed proportions (plus a constant). In this
case, the two assets are substitutes for one another. When the correlation is -1.0, the returns are
perfectly negatively correlated meaning that when one asset goes up, the other goes down and in
a fixed proportion (plus a constant). In this case, the two assets act to insure one another. When
the correlation is zero, knowing the return on one asset does not help you predict the return on
the other.

These are Harry Markowitz's important insights: 1) that diversification does not rely on
individual risks being uncorrelated, just that they be imperfectly correlated; and 2) that the risk
reduction from diversification is limited by the extent to which individual asset returns are
correlated. If Markowitz were restating Sancho Panza's advice, he might say: It is safer to spread
your eggs among imperfectly correlated baskets than to spread them among perfectly correlated

In finance, the capital asset pricing model (CAPM) is used to determine a theoretically
appropriate required rate of return of an asset, if that asset is to be added to an already well-
diversified portfolio, given that asset's non-diversifiable risk. The model takes into account the
asset's sensitivity to non-diversifiablerisk(also known as systematic risk or market risk), often
represented by the quantity beta (β) in the financial industry, as well as the expected return of the
market and the expected return of a theoretical risk-free asset.

2.5 Background:
The model was introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John
Lintner (1965) and Jan Mossin (1966) independently, building on the earlier work of Harry
Markowitz on diversification and modern portfolio theory.
One of the fundamental tenants in financial theory is the CAPM as developed by Sharpe (1964),
Lintner (1965) and Black (1972). The CAPM’s impact over the decades on the financial
community has led several authors inclusive of Fama and French (2004) to suggest that the
development of the CAPM marks “the birth of Asset Pricing models”.

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The CAPM is an ex-ante, static (one period) model. The model’s main prediction is that a market
portfolio of invested wealth is mean-variance efficient resulting in a linear cross-sectional
relationship between mean excess returns and exposures to the market factor. The model draws
on the portfolio theory as developed by Harry Markowitz (1959).

Estimation of the CAPM and the Security Market Line (purple) for the Dow Jones Industrial Average over the last 3 years for monthly data.

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

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


 is the expected return on the capital asset

 is the risk-free rate of interest such as interest arising from government bonds

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 (the beta) is the sensitivity of the expected excess asset returns to the expected excess

market returns, or also ,

 is the expected return of the market

 is sometimes known as the market premium or risk premium (the

difference between the expected market rate of return and the risk-free rate of return).

Note 1: the expected market rate of return is usually estimated by measuring the Geometric
Average of the historical returns on a market portfolio (e.g. S&P 500, BSE Sensex ).
Note 2: the risk free rate of return used for determining the risk premium is usually the arithmetic
average of historical risk free rates of return and not the current risk free rate of return.

The CAPM model assumes a linear relationship between the expected return in a risky asset and
its β and further assumes that β is an applicable and sufficient measure of risks that captures the
cross section of average returns, that is, the model assumes that assets can only earn a high
average return if they have a high market β. β drives average returns because β measures how
much the inclusion of additional stock to a well diversified portfolio increases the inherent risk
and volatility of the portfolio.

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2.6 Security Market Line

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula.
The x-axis represents the risk (beta), and the y-axis represents the expected return. The market
risk premium is determined from the slope of the SML.
The relationship between β and required return is plotted on the securities market line (SML)
which shows expected return as a function of β. The intercept is the nominal risk-free rate
available for the market, while the slope is the market premium, E(Rm)− Rf. The securities
market line can be regarded as representing a single-factor model of the asset price, where Beta
is exposure to changes in value of the Market. The equation of the SML is thus:

It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable
expected return for risk. Individual securities are plotted on the SML graph. If the security's
expected return versus risk is plotted above the SML, it is undervalued since the investor can
expect a greater return for the inherent risk. And a security plotted below the SML is overvalued
since the investor would be accepting less return for the amount of risk assumed.

Once the expected/required rate of return, E(Ri), is calculated using CAPM, we can compare this
required rate of return to the asset's estimated rate of return over a specific investment horizon to
determine whether it would be an appropriate investment. To make this comparison, you need an
independent estimate of the return outlook for the security based on either fundamental or
technical analysis techniques, including P/E, M/B etc.

Assuming that the CAPM is correct, an asset is correctly priced when its estimated price is the
same as the present value of future cash flows of the asset, discounted at the rate suggested by
CAPM. If the observed price is higher than the CAPM valuation, then the asset is overvalued
(and undervalued when the estimated price is below the CAPM valuation). When the asset does
not lie on the SML, this could also suggest mis-pricing. Since the expected return of the asset at

time t is , a higher expected return than what CAPM suggests

indicates that Pt is too low (the asset is currently undervalued), assuming that at time t + 1 the
asset returns to the CAPM suggested price.

March 25,

The CAPM returns the asset-appropriate required return or discount rate—i.e. the rate at which
future cash flows produced by the asset should be discounted given that asset's relative riskiness.
Betas exceeding one signify more than average "riskiness"; betas below one indicate lower than
average. Thus, a more risky stock will have a higher beta and will be discounted at a higher rate;
less sensitive stocks will have lower betas and be discounted at a lower rate. Given the accepted
concave utility function, the CAPM is consistent with intuition—investors (should) require a
higher return for holding a more risky asset.

Since beta reflects asset-specific sensitivity to non-diversifiable, i.e. market risk, the market as a
whole, by definition, has a beta of one. Stock market indices are frequently used as local proxies
for the market—and in that case (by definition) have a beta of one. An investor in a large,
diversified portfolio (such as a mutual fund), therefore, expects performance in line with the

2.7 Risk & Diversification

The risk of a portfolio comprises systematic risk, also known as undiversifiable risk,
and unsystematic risk which is also known as idiosyncratic risk or diversifiable risk. Systematic
risk refers to the risk common to all securities—i.e. market risk. Unsystematic risk is the risk
associated with individual assets. Unsystematic risk can be diversified away to smaller levels by
including a greater number of assets in the portfolio (specific risks "average out"). The same is
not possible for systematic risk within one market. Depending on the market, a portfolio of
approximately 30-40 securities in developed markets such as UK or US will render the portfolio
sufficiently diversified such that risk exposure is limited to systematic risk only. In developing
markets a larger number is required, due to the higher asset volatilities.

A rational investor should not take on any diversifiable risk, as only non-diversifiable risks are
rewarded within the scope of this model. Therefore, the required return on an asset, that is, the
return that compensates for risk taken, must be linked to its riskiness in a portfolio context - i.e.
its contribution to overall portfolio riskiness - as opposed to its "stand alone riskiness." In the
CAPM context, portfolio risk is represented by higher variance i.e. less predictability. In other
words the beta of the portfolio is the defining factor in rewarding the systematic exposure taken
by an investor.

March 25,

The (Markowitz) efficient frontier. CAL stands for the capital allocation line.

The CAPM assumes that the risk-return profile of a portfolio can be optimized—an optimal
portfolio displays the lowest possible level of risk for its level of return. Additionally, since each
additional asset introduced into a portfolio further diversifies the portfolio, the optimal portfolio
must comprise every asset, (assuming no trading costs) with each asset value-weighted to
achieve the above (assuming that any asset is infinitely divisible). All such optimal portfolios,
i.e., one for each level of return, comprise the efficient frontier.
Because the unsystematic risk is diversifiable, the total risk of a portfolio can be viewed as beta.

2.8 Market Portfolio

An investor might choose to invest a proportion of his or her wealth in a portfolio of risky assets
with the remainder in cash—earning interest at the risk free rate (or indeed may borrow money
to fund his or her purchase of risky assets in which case there is a negative cash weighting).
Here, the ratio of risky assets to risk free asset does not determine overall return—this
relationship is clearly linear. It is thus possible to achieve a particular return in one of two ways:

1. By investing all of one's wealth in a risky portfolio,

2. or by investing a proportion in a risky portfolio and the remainder in cash (either
borrowed or invested).

For a given level of return, however, only one of these portfolios will be optimal (in the sense of
lowest risk). Since the risk free asset is, by definition, uncorrelated with any other asset, option 2
will generally have the lower variance and hence be the more efficient of the two.
This relationship also holds for portfolios along the efficient frontier: a higher return portfolio
plus cash is more efficient than a lower return portfolio alone for that lower level of return. For a

March 25,

given risk free rate, there is only one optimal portfolio which can be combined with cash to
achieve the lowest level of risk for any possible return. This is the market portfolio.


All investors:
• Aim to maximize economic utilities.

• Are rational and risk-averse.

• Are broadly diversified across a range of investments.

• Are price takers, i.e., they cannot influence prices.

• Can lend and borrow unlimited amounts under the risk free rate of interest.

March 25,

• Trade without transaction or taxation costs.

• Deal with securities that are all highly divisible into small parcels.

• Assume all information is available at the same time to all investors.


➢ The model assumes that either asset returns are (jointly) normally
distributed random variables or that investor’s employ a quadratic form of utility. It is
however frequently observed that returns in equity and other markets are not normally
distributed. As a result, large swings (3 to 6 standard deviations from the mean) occur in
the market more frequently than the normal distribution assumption would expect.

➢ The model assumes that the variance of returns is an adequate measurement of risk. This
might be justified under the assumption of normally distributed returns, but for general
return distributions other risk measures (like coherent risk measures) will likely reflect
March 25,

the investors' preferences more adequately. Indeed risk in financial investments is not
variance in itself, rather it is the probability of losing: it is asymmetric in nature.

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

➢ The model assumes that the probability beliefs of investors match the true distribution of
returns. A different possibility is that investors' expectations are biased, causing market
prices to be informationally inefficient. This possibility is studied in the field
of behavioral finance, which uses psychological assumptions to provide alternatives to
the CAPM such as the overconfidence-based asset pricing model of Kent Daniel, David
Hirshleifer, and Avanidhar Subrahmanyam (2001).

➢ The model does not appear to adequately explain the variation in stock returns. Empirical
studies show that low beta stocks may offer higher returns than the model would predict.
Some data to this effect was presented as early as a 1969 conference in Buffalo, New
York in a paper by Fischer Black, Michael Jensen, and Myron Scholes. Either that fact is
itself rational (which saves the efficient-market hypothesis but makes CAPM wrong), or
it is irrational (which saves CAPM, but makes the EMH wrong – indeed, this possibility
makes volatility arbitrage a strategy for reliably beating the market).

➢ The model assumes that given a certain expected return investors will prefer lower risk
(lower variance) to higher risk and conversely given a certain level of risk will prefer
higher returns to lower ones. It does not allow for investors who will accept lower returns
for higher risk. Casino gamblers clearly pay for risk, and it is possible that some stock
traders will pay for risk as well.

➢ The model assumes that there are no taxes or transaction costs, although this assumption
may be relaxed with more complicated versions of the model.

➢ The market portfolio consists of all assets in all markets, where each asset is weighted by
its market capitalization. This assumes no preference between markets and assets for
individual investors, and that investors choose assets solely as a function of their risk-
return profile. It also assumes that all assets are infinitely divisible as to the amount
which may be held or transacted.
➢ The market portfolio should in theory include all types of assets that are held by anyone
as an investment (including works of art, real estate, human capital...) In practice, such a
market portfolio is unobservable and people usually substitute a stock index as a proxy
for the true market portfolio. Unfortunately, it has been shown that this substitution is not
innocuous and can lead to false inferences as to the validity of the CAPM, and it has been
said that due to the inobservability of the true market portfolio, the CAPM might not be
empirically testable. This was presented in greater depth in a paper by Richard Roll in
1977, and is generally referred to as Roll's critique.
March 25,

➢ The model assumes just two dates, so that there is no opportunity to consume and
rebalance portfolios repeatedly over time. The basic insights of the model are extended
and generalized in the intertemporal CAPM (ICAPM) of Robert Merton, and the
consumption CAPM (CCAPM) of Douglas Breeden and Mark Rubinstein.

➢ CAPM assumes that all investors will consider all of their assets and optimize one
portfolio. This is in sharp contradiction with portfolios that are held by individual
investors: humans tend to have fragmented portfolios or, rather, multiple portfolios: for
each goal one portfolio — see behavioral portfolio theory and Maslowian Portfolio

The Capital Asset Pricing Model is a fundamental contribution to our understanding of the
determinants of asset prices. The CAPM tells us that ownership of assets by diversified investors
lowers their expected returns and raises their prices. Moreover, investors who hold undiversified
portfolios are likely to be taking risks for which they are not being rewarded. As a result of the
model, and despite its mixed empirical performance, we now think differently about the
relationship between expected returns and risk; we think differently about how investors should
allocate their investment portfolios; and we think differently about questions such as
performance measurement and capital budgeting.

Chapter 3

March 25,

Capital Asset Pricing Model:

Conceptual Research
There has been a lot of theoretical research already undertaken on Capital Asset Pricing Model.
This dissertation throws a brief light on the various aspects that have been covered in the
research undertaken till now.

March 25,

3.1 Introduction & Background of Research

While relationships described by the CAPM have been the context of numerous empirical studies
by many academics, its use in many present day applications by fund managers and in finance
based course curricula, provides an insight on the significance of this finance model. Fama and
French (2000) summarize the popularity of the CAPM by their statement:

“The attraction of the CAPM is that it offers powerful and intuitively pleasing predictions about
how to measures risk and the relation between expected return and risk.”

Fama and French (2000) also offer their opinion on its relevance:
“Unfortunately the empirical record of the model is poor – poor enough to invalidate the way it
is used in applications.”

Whether the basic CAPM or one of its multifactor extensions is the "correct" model of asset
prices is ultimately an empirical question, one that is discussed in detail by Fama and French in
their companion paper in this journal. Initial tests of the CAPM by Black, Jensen and Scholes
(1972) and Fama and MacBeth (1973) supported the theory in that high beta stocks were found
to have had higher returns than low beta stocks. However, the relationship between beta and
average returns was not as steep as indicated by the theoretical Securities Market Line. Since this
early work, a vast body of research has looked for additional risk factors that affect expected
returns. Most notably, Fama and French (1992) find that adding a "value" factor and a "size"
factor (in addition to the overall market) greatly improves upon the explanatory power of the
CAPM. The pervasiveness of these findings in follow-up research across time and other
countries provides strong evidence that more than one systematic risk factor is at work in
determining asset prices. However, the value and size factors are not explicitly about risk; at
best, they are proxies for risk. For example, size per se cannot be a risk factor that affects
expected returns, since small firms would then simply combine to form large firms.

Another criticism of the Fama-French findings is that their value effect is based on giving equal
weight to small and large companies and is much stronger than observed in capitalization-
weighted value indexes. Until the risks that underlie the Fama-French factors are identified, the
forecast power of their model will be in doubt and the applications will be limited.

During the 1980’s several studies resulted in the identification of additional factors that provide
explanatory power other than β for average stock returns. Variables that have no special standing
in asset pricing theory were shown to have reliable power in explaining the cross section of
returns (these variables are referred to as anomalies by Fama and French (1993, 1996)). Banz
(1981) finds that Market Equity (ME) adds to the cross section of expected returns provided by
the market β. Basu (1983) finds that low earnings-price ratios (E/P) stocks help explain the cross
section of US stocks returns while high (E/P) stocks experiencing lower returns could be
explained by the CAPM. DeBondt and Thaler (1985) find that stocks with abnormally low long

March 25,

term returns (average returns in three years) experience abnormally high long term future returns
(average returns in the next three years) and vice versa. Bhandari (1988) finds a positive
relationship between leverage and the cross section of average return. Rosenberg, Reid and
Lanstein (1985) find a positive relationship between the average return and the ratio of a firm’s
book value to market equity (BE/ME). Lakonishok, Sheifer and Vishny (1994) find a strong
positive relationship between average returns and BE/ME and cashflow/price ratio (C/P). These
relationships could not be explained by the CAPM.

One of the major empirical arguments against the CAPM model is presented by Fama and
French (1992). They find that the cross section of average equity returns in the US market shows
little statistical relation to the βs of the original CAPM model. The authors evaluate the joint
roles of the market β, firm Size (ME), (E/P), financial leverage and BE/ME in the cross section
of average returns on the New York Stock Exchange (NYSE), American Stock Exchange
(AMEX), and National Association of Securities Dealers Automated Quotations (NASDAQ)
stocks. They find that the Size and BE/ME variables capture the cross sectional variation in
average stock returns associated and conclude that the CAPM model is violated in its predication
of a cross sectional relationship between mean excess returns and exposures to the market factor.
Fama and French (1993) find that five (5) common risk factors explain the returns in both stocks
and bonds. In testing the relationship between risk factors and stocks returns, the authors use the
Black, Jensen and Scholes (1972) time series regression model to identify these factors. They
find that two (2) factors, namely; firm Size and BE/ME portfolios explain the differences in the
average cross section returns of stocks. Fama and French (1996) also observe that abnormal
patterns of asset returns experienced during the 1980’s and 1990’s could not be explained by the
CAPM but are however due to mis-specification in the expected returns model. They find that
two other variables, SMB (Small Minus Big - the Size proxy) and HML (High Minus Low - the
BE/ME proxy), inclusive of the market factor, explains significant return patterns on
Lakonishok, Shleifer, and Vishny (1994) portfolios. The resultant model is being coined the
Fama and French Three Factor Model (TFM) in financial literature.

March 25,

3.2 Portfolio Theory, Riskless Lending and Borrowing and Fund

To arrive at the CAPM, we need to examine how imperfect correlation among asset returns
affects the investor's tradeoff between risk and return. While risks combine nonlinearly (because
of the diversification effect), expected returns combine linearly. That is, the expected return on a
portfolio of investments is just the weighted average of the expected returns of the underlying

Imagine two assets with the same expected return and the same standard deviation of return. By
holding both assets in a portfolio, one obtains an expected return on the portfolio that is the same
as either one of them, but a portfolio standard deviation that is lower than any one of them
individually. Diversification thus leads to a reduction in risk without any sacrifice in expected
return. Generally, there will be many combinations of assets with the same portfolio expected
return but different portfolio risk; and there will be many combinations of assets with the same
portfolio risk but different portfolio expected return. Using optimization techniques, we can
compute what Markowitz coined the "efficient frontier." For each level of expected return, we
can solve for the portfolio combination of assets that has the lowest risk. Or for each level of
risk, we can solve for the combination of assets that has the highest expected return.

The efficient frontier consists of the collection of these optimal portfolios, and each investor can
choose which of these best matches their risk tolerance. The initial development of portfolio
theory assumed that all assets were risky. James Tobin (1958) showed that when investors can
borrow as well as lend at the risk-free rate, the efficient frontier simplifies in an important way.
(A "risk-free" instrument pays a fixed real return and is default free. U.S. Treasury bonds that
adjust automatically with inflation called Treasury inflation-protected instruments, or TIPS and
short-term U.S. Treasury bills are considered close approximations of risk-free instruments.) To
see how riskless borrowing and lending affects investors' decision choices, consider investing in
the following three instruments: risky assets M and H, and the riskless asset, where the expected
returns and risks of the assets. Suppose first that you had the choice of investing all of your
wealth in just one of these assets. Which would you choose? The answer depends on your risk

You would choose the riskless asset has no risk but also the lowest expected return. You would
choose to lend at the risk-free rate if you had a very low tolerance for risk. An Asset may have

March 25,

an intermediate risk and expected return, and you would choose this asset if you had a moderate
tolerance for risk. Suppose next that you can borrow and lend at the risk-free rate,that you wish
to invest some of your wealth and the balance in riskless lending or borrowing.3

3.3 Capital Asset Pricing Model

The rule for improving the Sharpe Ratio of a portfolio allows us to derive the Capital Asset
Pricing Model in a straightforward and intuitive way. We begin with four assumptions. First,
investors are risk averse and evaluate their investment portfolios using the Capital Asset Pricing
Model The rule for improving the Sharpe Ratio of a portfolio allows us to derive the Capital
Asset Pricing Model in a straightforward and intuitive way.

We begin with four assumptions.

 Investors are risk averse and evaluate their investment portfolios solely in terms of
expected return and standard deviation of return measured over the same single
holding period.

 Capital markets are perfect in several senses: all assets are infinitely divisible; there
are no transactions costs, short selling restrictions or taxes; information is costless
and available to everyone; and all investors can borrow and lend at the risk-free rate.

 Investors all have access to the same investment opportunities.

 Investors all make the same estimates of individual asset expected returns, standard
deviations of return and the correlations among asset returns.

These assumptions represent a highly simplified and idealized world, but are needed to obtain
the CAPM in its basic form. The model has been extended in many ways to accommodate some
of the complexities manifest in the real world. But under these assumptions, given prevailing
prices, investors all will determine the same highest Sharpe Ratio portfolio of risky assets.
Depending on their risk tolerance, each investor will allocate a portion of wealth to this optimal
portfolio and the remainder to risk-free lending or borrowing. Investors all will hold risky assets
in the same relative proportions. For the market to be in equilibrium, the price (that is, the
expected return) of each asset must be such that investors collectively decide to hold exactly the
supply of the asset. If investors all hold risky assets in the same proportions, those proportions
March 25,

must be the proportions in which risky assets are held in the market portfolio the portfolio
comprised of all available shares of each risky asset. In equilibrium, therefore, the portfolio of
risky assets with the highest Sharpe Ratio must be the market portfolio. If the market portfolio
has the highest attainable Sharpe Ratio, there is no way to obtain a higher Sharpe Ratio by
holding more or less of any one asset.

This formula is the one that Sharpe, Treynor, Lintner and Mossin successfully set out to find. It
is the relationship between expected return and risk that is consistent with investors behaving
according to the prescriptions of portfolio theory. If this rule does not hold, then investors will be
able to outperform the market (in the sense of obtaining a higher Sharpe Ratio) by applying the
portfolio improvement rule, and if sufficiently many investors do this, stock prices will adjust to
the point where the CAPM becomes true. Another way of expressing the CAPM equation is

Sharpe Ratio of Asset S= p X Sharpe Ratio of the Market Portfolio

In other words, in equilibrium, the Sharpe Ratio of any asset is no higher than the Sharpe Ratio
of the market portfolio (since p < 1). Moreover, assets having the same correlation with the
market portfolio will have the same Sharpe Ratio. The Capital Asset Pricing Model tells us that
to calculate the expected return of a stock, investors need know two things: the risk premium of
the overall equity market (assuming that equities are the only risky assets) and the stock's beta
versus the market. The stock's risk premium is determined by the component of its return that is
perfectly correlated with the market that is, the extent to which the stock is a substitute for
investing in the market. The component of the stock's return that is uncorrelated with the market
can be diversified away and does not command a risk premium.

The Capital Asset Pricing Model has a number of important implications:-

First, perhaps the most striking aspect of the CAPM is what the expected return of an
asset does not depend on. In particular, the expected return of a stock does not depend on
its stand-alone risk. It is true that a high beta stock will tend to have a high stand-alone
risk because a portion of a stock's stand-alone risk is determined by its beta, but a stock
need not have a high beta to have a high stand-alone risk. A stock with high stand-alone
risk therefore will only have a high expected return to the extent that its stand-alone risk
is derived from its sensitivity to the broad stock market.

Second, beta offers a method of measuring the risk of an asset that cannot be diversified
away. We saw earlier that any risk measure for determining expected returns would have
to satisfy the requirement that the risk of a portfolio is the weighted average of the risks
of the holdings in the portfolio. Beta satisfies this requirement. For example, if two stocks
have market betas of 0.8 and 1.4, respectively, then the market beta of a 50/50 portfolio
of these stocks is 1.1, the average of the two stock betas. Moreover, the capitalization
weighted average of the market betas of all stocks is the beta of the market versus itself.
The average stock therefore has a market beta of 1.0. On a graph where the risk of an
March 25,

asset as measured by beta is on the horizontal axis and return is on the vertical axis, all
securities lie on a single line the so-called Securities Market Line. If the market is in
equilibrium, all assets must lie on this line. If not, investors will be able to improve upon
the market portfolio and obtain a higher Sharpe Ratio. In contrast, presented earlier
measured risk on the horizontal axis as stand-alone risk, the standard deviation of each
stock, and so stocks were scattered over the diagram. But remember that not all of the
stand-alone risk of an asset is priced into its expected return, just that portion of its risk,
pas, that is correlated with the market portfolio.

Third, in the Capital Asset Pricing Model, a stock's expected return does not depend on
the growth rate of its expected future cash flows. To find the expected return of a
company's shares, it is thus not necessary to carry out an extensive financial analysis of
the company and to forecast its future cash flows. According to the CAPM, all we need
to know about the specific company is die beta of its shares, a parameter that is usually
much easier to estimate than the expected future cash flows of the firm.4

3.4 Is CAPM Useful

The Capital Asset Pricing Model is an elegant theory with profound implications for asset
pricing and investor behavior. But how useful is the model given the idealized world that
underlies its derivation. There are several ways to answer this question.

First, we can examine whether real world asset prices and investor portfolios conform to die
predictions of the model, if not always in a strict quantitative sense, and least in a strong
qualitative sense.

Second, even if the model does not describe our current world particularly well, it might predict
future investor behavior for example, as a consequence of capital market frictions being lessened
through financial innovation, improved regulation and increasing capital market integration.

Third, the CAPM can serve as a benchmark for understanding the capital market phenomena that
cause asset prices and investor behavior to deviate from die prescriptions of the model.
Suboptimal Diversification Consider the CAPM prediction that investors all will hold the same
(market) portfolio of risky assets. One does not have to look far to realize that investors do not
hold identical portfolios, which is not a surprise since taxes alone will cause idiosyncratic
investor behavior.

On one hand, popular index funds make it possible for investors to obtain diversification at low
cost. On the other hand, many workers hold concentrated ownership of company stock in
employee retirement savings plans and many executives hold concentrated ownership of
company stock options. Common explanations are that obtaining broad diversification can be
costly, in terms of direct expenses and taxes, and that investors are subject to behavioral biases

March 25,

and lack of sophistication. None of these reasons, if valid, would mean that the CAPM is not
useful. The CAPM tells us that investors pay a price for being undiversified in that they are
taking risks for which they are not being compensated. Thus, there exists the potential for port?
folio improvement, which in turn creates opportunities for investor education and financial
innovation. Indeed, foreign ownership of equities in many countries has more than doubled over
the last 20 years, most likely due to the increased availability of low-cost vehicles to invest
globally and greater investor appreciation of the need for diversification. Investors today seem to
be much better diversified than in decades past, a trend that appears likely to continue.

Performance Measurement
One of the earliest applications of the Capital Asset Pricing Model was to performance
measurement of fund managers. Consider two funds, A and B, that are actively managed in the
hope of outperforming the market. Suppose that the funds obtained returns of 12 percent and 18
percent, respectively, during a period when the risk-free rate was 5 percent and the overall
market returned 15 percent.

Assume further that the standard deviation of funds A and B were 40 percent per annum and 30
percent per annum, respectively. Which fund had the better performance. At first glance, fund A
had greater risk and a lower return than fund B, so fund B would appear to have been the better
performing fund. However, we know from the CAPM that focusing on stand-alone risk is
misleading if investors can hold diversified portfolios. To draw a firmer conclusion, we need to
know how these funds are managed: Suppose that fund A consists of a high-risk but "market-
neutral" portfolio that has long positions in some shares and short positions in others, with a
portfolio beta of zero. Fund B, on the other hand, invests in selected high beta stocks, with a
portfolio beta of 1.5. Instead of investing in funds A and/or B, investors could have held corre
sponding mimicking or "benchmark" portfolios. For fund A, since its beta is zero, the benchmark
portfolio is an investment in the risk-free asset; for fund B, the benchmark is a position in the
market portfolio leveraged 1.5:1 with borrowing at the risk-free rate. The benchmark portfolios
respectively would have returned 5 percent and 20 percent (= 5 percent + 1.5 X (15 percent 5
percent)). Fund A thus outperformed its benchmark by 7 percent, while fund B underperformed
its benchmark by 2 percent.

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In terms of the CAPM framework, funds A and B had alphas of 7 percent and 2 percent,
respectively, where alpha is the difference between a fund's performance and that predicted
given the beta of the fund. Appropriately risk adjusted, fund A's performance (alpha = 7 percent)
exceeded that of fund B (alpha = 2 percent). An investor who held the market portfolio would,
at the margin, have obtained a higher return for the same risk by allocating money to fund A
rather than to fund B.

The key idea here is that obtaining high returns by owning high beta stocks does not take skill,
since investors can passively create a high beta portfolio simply through a leveraged position in
the market portfolio. Obtaining high returns with low beta stocks is much harder, however, since
such performance cannot be replicated with a passive strategy. Investors therefore need to assess
performance based on returns that have been appropriately risk adjusted. The CAPM and
Discounted Cash Flow Analysis According to the CAPM, the appropriate discount rate for
valuing the expected future cash flows of a company or of a new investment project is
determined by the risk-free rate, the market risk premium and the beta versus the market of the
company or project. Accuracy in estimating these parameters matters greatly for real world
decisionmaking since, for long-dated cash flows, an error in the discount rate is magnified
manyfold when calculating the net present value. Beta is usually estimated with use of linear
regression analysis applied to historical stock market returns data. Beta can in many
circumstances be accurately measured this way even over a relatively short period of time,
provided that there is sufficient high-frequency data. When die company or project being valued
is not publicly traded or there is no relevant return history, it is customary to infer beta from
comparable entities whose betas can be estimated.

The hardest of all parameters to estimate is usually the market risk premium. The historical risk
premium is estimated from the average of past returns and, unlike variance-related measures like
beta, average returns are very sensitive to the beginning and ending level of stock prices. The
risk premium must therefore be measured over long periods of time, and even this may not be
sufficient if the risk premium varies over time. None of these measurement questions poses a
problem for the CAPM per se, however. The market risk premium is common to all models of
cash flow valuation, and its estimation needs to be performed regardless of the difficulty of the

Provided that the CAPM is the "right" model, beta too needs to be estimated, irrespective of
difficulty. Extensions of the CAPM The Capital Asset Pricing Model has been extended in a
variety of ways. Some of the best-known extensions include allowing heterogeneous beliefs;
eliminating the possibility of risk-free lending and borrowing; having some assets be
nonmarketable; allowing for multiple time periods and investment opportunities that change
from one period to the next; extensions to international investing ; and employing weaker
assumptions by relying on arbitrage pricing. In most extensions of the CAPM, no single portfolio
of risky assets is optimal for everyone. Rather, investors allocate their wealth differentially
among several risky portfolios, which across all investors aggregate to the market portfolio. To
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illustrate, consider the International Capital Asset Pricing Model. This model takes into account
that investors have consumption needs particular to the country in which they are resident. Thus,
British investors will worry about the purchasing power of pounds while American investors
worry about the purchasing power of dollars, which means that British and American investors
will differently assess the incremental contribution that any particular asset makes to portfolio
risk. As a result, they will hold somewhat different portfolios.

In the basic CAPM, investors care about only one risk factor the overall market. In this
international version of the model, they are also concerned about real currency fluctuations. This
insight leads to a model of expected returns involving not only the beta of an asset versus the
overall market, but also the betas of the asset versus currency movements and any other risk that
is viewed differently by different investor segments. Almost all variants of the CAPM have a
multi-beta expression. 5

Chapter 4
Core Chapter: Use of CAPM in BSE Sensex: An Empirical Study
The objective of this chapter is to make a comprehensive research on the application of CAPM
as a true reflector of returns as shown by the stock over a period of time and not just he stock but
the returns of the portfolio.

In this particular case, the top heavy weights of BSE Sensex (30 Companies) from diversified
sectors are considered and their return over a period of time is calculated using Risk free return,
Risk Premium and Beta( Correlation of the market risk and security risk).

March 25,



March 25,

Table 1:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Rate Cost of Equity
Auto Ltd.
2000 10.10% -10.10% 0.91 0.90900%
2001 7.35% -7.35% 0.91 0.66150%
2002 5.62% -5.62% 0.91 0.50580%
2003 4.55% -4.55% 0.91 0.40950%
2004 5.79% -5.79% 0.91 0.52110%
2005 5.60% -5.60% 0.91 0.50400%
2006 7.22% -7.22% 0.91 0.64980%
2007 6.07% -6.07% 0.91 0.54630%
2008 7.06% 20.05% 12.99% 0.91 18.88090%
2009 3.24% 279.44% 276.20% 0.91 254.58200%
2010 7.68% 60.48% 52.80% 0.91 55.72757%

March 25,

Table 2:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Rate Cost of Equity
2000 10.10% 0.82% -9.28% 1.01 0.727200%
2001 7.35% 5.63% -1.72% 1.01 5.612800%
2002 5.62% 22.04% 16.42% 1.01 22.204200%
2003 4.55% 124.77% 120.22% 1.01 125.972200%
2004 5.79% 39.88% 34.09% 1.01 40.220900%
2005 5.60% 42.80% 37.20% 1.01 43.172000%
2006 7.22% 20.39% 13.17% 1.01 20.521700%
2007 6.07% 79.70% 73.63% 1.01 80.436300%
2008 7.06% 5.62% -1.44% 1.01 5.605600%
2009 3.24% -2.65% -5.89% 1.01 -2.708900%
2010 7.68% -19.86% -27.54% 1.01 -20.135352%

Table 3:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Rate Cost of Equity
2000 10.10% -10.10% 0.68 3.23200%
2001 7.35% -7.35% 0.68 2.35200%
2002 5.62% -51.66% -57.28% 0.68 -33.33040%
2003 4.55% 286.06% 281.51% 0.68 195.97680%
2004 5.79% 82.62% 76.83% 0.68 58.03440%
2005 5.60% 19.52% 13.92% 0.68 15.06560%
2006 7.22% 35.43% 28.21% 0.68 26.40280%
2007 6.07% 11.01% 4.94% 0.68 9.42920%
2008 7.06% 26.39% 19.33% 0.68 20.20440%
March 25,

Risk Free Market Risk

Rate Rate Premium BETA CAPM
364 T- Bill Rate Cost of Equity
2000 10.10% -3.93% -14.03% 0.51 2.944700%
2001 7.35% 27.35% 20.00% 0.51 17.550000%
2002 5.62% -23.53% -29.15% 0.51 -9.246500%
2003 4.55% -24.79% -29.34% 0.51 -10.413400%
2004 5.79% 7.33% 1.54% 0.51 6.575400%
2005 5.60% -0.20% -5.80% 0.51 2.642000%
2006 7.22% -4.68% -11.90% 0.51 1.151000%
2007 6.07% -61.43% -67.50% 0.51 -28.355000%
2008 7.06% 41.57% 34.51% 0.51 24.660100%
2009 3.24% -0.20% -3.44% 0.51 1.485600%
2010 7.68% -6.24% -13.92% 0.51 0.578448%

Table 4:

March 25,

Table 5:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Rate Cost of Equity
2000 10.10% -10.10% 1.63 -6.36300%
2001 7.35% -7.35% 1.63 -4.63050%
2002 5.62% -5.62% 1.63 -3.54060%
2003 4.55% -4.55% 1.63 -2.86650%
2004 5.79% -5.79% 1.63 -3.64770%
2005 5.60% -5.60% 1.63 -3.52800%
2006 7.22% -7.22% 1.63 -4.54860%
2007 6.07% 42.21% 36.14% 1.63 64.97820%
2008 7.06% -21.06% -28.12% 1.63 -38.77560%
2009 3.24% -52.32% -55.56% 1.63 -87.32280%
2010 7.68% -36.13% -43.81% 1.63 -63.72728%

Table 6:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Rate Cost of Equity
Bank Ltd
2000 10.10% 59.42% 49.32% 0.92 55.474400%
2001 7.35% 19.71% 12.36% 0.92 18.721200%
2002 5.62% -4.96% -10.58% 0.92 -4.113600%
2003 4.55% -3.43% -7.98% 0.92 -2.791600%
2004 5.79% 31.34% 25.55% 0.92 29.296000%
2005 5.60% -7.24% -12.84% 0.92 -6.212800%
March 25,

Table 9:

March 25,

Risk Free
7: Market Risk BETA CAP
Rate Free Rate Premium
364 T- Bill Rate Cost of Equity
2000 10.10% 13.55% 3.45% 0.47 11.721500%
2001 364 7.35%
T- Bill Rate 28.50% 21.15% 0.47Cost17.290500%
of Equity
2002 5.62% -21.06% -26.68% 0.47 -6.919600%
Hero 2003 4.55% -55.20% -59.75% 0.47 -23.532500%
Honda2004 5.79% -41.13% -46.92% 0.47 -16.262400%
Ltd 5.60% -2.71% -8.31% 0.47 1.694300%
2006 10.10%
7.22% -1.24%
-34.33% -11.34%
-41.55% 0.44 5.110400%
0.47 -12.308500%
2007 7.35%
6.07% 67.70%
-43.84% 60.35%
-49.91% 0.44 33.904000%
0.47 -17.387700%
2008 5.62%
7.06% 9.60%
70.50% 3.98%
63.44% 0.44 7.371200%
0.47 36.876800%
2009 4.55%
3.24% 4.87%
-72.40% 0.32%
-75.64% 0.44 4.690800%
0.47 -32.310800%
2010 5.79%
7.68% 19.26%
3.30% 13.47%
-4.38% 0.44
0.47 11.716800%
2005 5.60% 12.69% 7.09% 0.44 8.719600%
2006 Table7.22%
10: Market -55.37% Risk-62.59% BETA 0.44 CAPM
2007 6.07% -53.31% -59.38% 0.44 -20.057200%
Risk Free
Rate 70.41%
63.35% 0.44 34.934000%
2009 Rate 3.24% 35% 31.76% 0.44 17.214400%
2010 364 T- Bill
7.68% Rate 4.98% -2.70% 0.44Cost of Equity
Development Market Risk BETA CAPM
Finance Rate Premium
Corpn. Ltd.Table 8:
2000 Risk10.10%
Free 114.49% 104.39% 0.92 106.138800%
2001 7.35% 42.55% 35.20% 0.92 39.734000%
Rate 5.62% 8.90% 3.28% 0.92 8.637600%
364 T- Bill Rate Cost of Equity
2003 4.55% 11.96% 7.41% 0.92 11.367200%
2004 5.79% 9.93% 4.14% 0.92 9.598800%
2005 5.60% 18.50% 12.90% 0.92 17.468000%
Ltd. 2006 7.22% -12.12% -19.34% 0.92 -10.572800%
2000 6.07%
10.10% 31.85%
12.91% 25.78%
2.81% 0.92 29.787600%
1.33 13.837300%
2001 7.06%
7.35% 4.06%
5.87% -3.00%
-1.48% 0.92
1.33 4.300000%
2002 3.24%
5.62% 1.28%
-8.62% -1.96%
-14.24% 0.92 -13.319200%
1.33 1.436800%
March 25,

March 25,

Table 12:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
2000 10.10% 135.72% 125.62% 1.38 183.455600%
2001 7.35% -22.89% -30.24% 1.38 -34.381200%
2002 5.62% 58.70% 53.08% 1.38 78.870400%
2003 4.55% 47.67% 43.12% 1.38 64.055600%
2004 5.79% 14.64% 8.85% 1.38 18.003000%
2005 5.60% 19.32% 13.72% 1.38 24.533600%
2006 7.22% 9.97% 2.75% 1.38 11.015000%
2007 6.07% -7.21% -13.28% 1.38 -12.256400%
2008 7.06% -10.45% -17.51% 1.38 -17.103800%
2009 3.24% 17.15% 13.91% 1.38 22.435800%
2010 7.68% 15.17% 7.49% 1.38 18.018024%
Table 13:

March 25,

Risk Free Market Risk

Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
gies Ltd.
2000 10.10% -10.10% 0.45 5.55500%
2001 7.35% -10.40% -17.75% 0.45 -0.63750%
2002 5.62% 14.39% 8.77% 0.45 9.56650%
2003 4.55% -55.29% -59.84% 0.45 -22.37800%
2004 5.79% 40.40% 34.61% 0.45 21.36450%
2005 5.60% 2.95% -2.65% 0.45 4.40750%
2006 7.22% 4.51% -2.71% 0.45 6.00050%
2007 6.07% -67.70% -73.77% 0.45 -27.12650%
2008 7.06% 17.80% 10.74% 0.45 11.89300%
2009 3.24% 55.02% 51.78% 0.45 26.54100%
2010 7.68% 17.31% 9.63% 0.45 12.01086%

March 25,

Table 14:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
Ass. Ltd.
2000 10.10% -10.10% 1.7 -7.0700%
2001 7.35% -7.35% 1.7 -5.1450%
2002 5.62% -5.62% 1.7 -3.9340%
2003 4.55% -4.55% 1.7 -3.1850%
2004 5.79% -5.79% 1.7 -4.0530%
2005 5.60% 68.15% 62.55% 1.7 111.9350%
2006 7.22% 46.89% 39.67% 1.7 74.6590%
2007 6.07% 148.02% 141.95% 1.7 247.3850%
2008 7.06% -27.86%
Market Risk-34.92% BETA 1.7 -52.3040%
2009 3.24% 86.13% 82.89% 1.7 144.1530%
2010 Table7.68%
15: Rate-45.03% Premium
-52.71% 1.7 -81.9236%
Risk Free
364 T- Bill Cost of
Rate Equity
Steel &
2000 10.10% -19.41% -29.51% 1.45 -32.689500%
2001 7.35% 6.46% -0.89% 1.45 6.059500%
2002 5.62% 127.14% 121.52% 1.45 181.824000%
2003 4.55% 195.66% 191.11% 1.45 281.659500%
2004 5.79% 30.84% 25.05% 1.45 42.112500%
2005 5.60% 32.52% 26.92% 1.45 44.634000%
2006 7.22% 0.89% -6.33% 1.45 -1.958500%
2007 6.07% 533.76% 527.69% 1.45 771.220500%
2008 7.06% -17.58% -24.64% 1.45 -28.668000%
2009 3.24% 282.88% 279.64% 1.45 408.718000%
2010 7.68% -15.94% -23.62% 1.45 -26.566840%
March 25,

Table 16:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
Larsen &
2000 10.10% -43.43% -53.53% 1.2 -54.13600%
2001 7.35% 18.66% 11.31% 1.2 20.92200%
2002 5.62% 12.68% 7.06% 1.2 14.09200%
2003 4.55% 80.82% 76.27% 1.2 96.07400%
2004 5.79% 24.96% 19.17% 1.2 28.79400%
2005 5.60% 45.70% 40.10% 1.2 53.72000%
2006 7.22% 14.11% 6.89% 1.2 15.48800%
2007 6.07% 144.49% 138.42% 1.2 172.17400%
2008 7.06% -9.95% -17.01% 1.2 -13.35200%
2009 3.24% 37.37% 34.13% 1.2 44.19600%
2010 7.68% 1.24% -6.44% 1.2 -0.04704%

March 25,

Table 17:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
2000 10.10% -44.06% -54.16% 1.1 -49.47600%
2001 7.35% -19.27% -26.62% 1.1 -21.93200%
2002 5.62% 28.63% 23.01% 1.1 30.93100%
2003 4.55% 186.33% 181.78% 1.1 204.50800%
2004 5.79% 29.77% 23.98% 1.1 32.16800%
2005 5.60% 52.11% 46.51% 1.1 56.76100%
2006 7.22% 35.95% 28.73% 1.1 38.82300%
2007 6.07% -50.73% -56.80% 1.1 -56.41000%
2008 7.06% -14.96% -22.02% 1.1 -17.16200%
2009 3.24% 217.65% 214.41% 1.1 239.09100%
2010 7.68% 28.65% 20.97% 1.1 30.74748%

March 25,

Table 18:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
2000 10.10% -10.10% 0.74 2.62600%
2001 7.35% -7.35% 0.74 1.91100%
2002 5.62% -5.62% 0.74 1.46120%
2003 4.55% 56.49% 51.94% 0.74 42.98560%
2004 5.79% 11.87% 6.08% 0.74 10.28920%
2005 5.60% -4.37% -9.97% 0.74 -1.77780%
2006 7.22% 0.75% -6.47% 0.74 2.43220%
2007 6.07% -39.76% -45.83% 0.74 -27.84420%
2008 7.06% 5.32% -1.74% 0.74 5.77240%
2009 3.24% 119.65% 116.41% 0.74 89.38340%
March 25,

Market Risk BETA CAPM

Rate Premium

Table 19:
Table 20:
Risk Free Market Risk
Risk Free
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
364 T- Bill
Rate Cost of
Rate Equity
Videsh2000 10.10% -10.10% 0.69 3.13100%
Ltd. 2001 7.35% -7.35% 0.69 2.27850%
2002 10.10%
5.62% -17.68% -27.78%
-5.62% 0.69 10.100%
2003 7.35%
4.55% 37.82% 30.47%
-4.55% 0.69 7.350%
2004 5.62%
5.79% 166.74%
4% 161.12%
-1.79% 0.69 5.620%
2005 4.55%
5.60% 70.72%
-10.20% 66.17%
-15.80% 0.69 4.550%
2006 5.79%
7.22% -5.80%
-21.41% -11.59%
-28.63% 0.69 5.790%
2007 5.60%
6.07% 5.79%
40.16% 0.19%
34.09% 0.69 5.600%
2008 7.22%
7.06% -34.02%
24.18% -41.24%
17.12% 0.69 7.220%
2009 6.07%
3.24% -0.71%
-48.38% -6.78%
-51.62% 0.69 6.070%
2010 7.06%
7.68% 8.01%
-30.71% 0.95%
-38.39% 0.69 7.060%
2009 3.24% 0.20% -3.04% 3.240%
2010 7.68% -3.65% -11.33% 7.675%

March 25,

Table 22:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
ations Ltd.
2000 10.10% -10.10% 1.31 -3.13100%
2001 7.35% -7.35% 1.31 -2.27850%
2002 5.62% -5.62% 1.31 -1.74220%
2003 4.55% -4.55% 1.31 -1.41050%
2004 5.79% -5.79% 1.31 -1.79490%
2005 5.60% -5.60% 1.31 -1.73600%
2006 7.22% 14.17% 6.95% 1.31 16.32450%
2007 6.07% 11.39% 5.32% 1.31 13.03920%
2008 7.06% -16.79% -23.85% 1.31 -24.18350%
2009 3.24% -104.73% -107.97% 1.31 138.2000%
2010 7.68% -33.07% -40.75% 1.31 -45.70101%

March 25,

Market Risk BETA CAPM

Risk Free Market
Rate Risk
Rate Rate Premium
364 T- Bill Cost of
Rate Equity
Table 21:
Risk Free
ure Ltd. 364 T- Bill Cost of
2000 Rate 10.10% 26.12% 16.02% 1.54 Equity
2001 7.35% 19.94% 12.59% 1.54 26.738600%
2002 5.62% 10.75% 5.13% 1.54 13.520200%
2003 4.55% 62.22% 57.67% 1.54 93.361800%
Ltd. 2004 5.79% -8.56% -14.35% 1.54 -16.309000%
2005 10.10%
5.60% 67.31%
-28.02% 57.21%
-33.62% 1.03 69.026300%
1.54 -46.174800%
2006 7.35%
7.22% 9%
-60.46% 1.65%
-67.68% 1.03 -97.007200%
1.54 9.049500%
2007 5.62%
6.07% -2.46%
267.30% -8.08%
261.23% 1.03 -2.702400%
1.54 408.364200%
2008 4.55%
7.06% 23.15%
-21.88% 18.60%
-28.94% 1.03 23.708000%
1.54 -37.507600%
2009 5.79%
3.24% -16.82%
17.95% -22.61%
14.71% 1.03
1.54 -17.498300%
2010 5.60%
7.68% 28.29%
-43.48% 22.69%
-51.16% 1.03 -71.103808%
1.54 28.970700%
2006 7.22% 74.04% 66.82% 1.03 76.044600%
2007 6.07% 81.51% 75.44% 1.03 83.773200%
2008 7.06% -4.10% -11.16% 1.03 -4.434800%
2009 3.24% -2.89% -6.13% 1.03 -3.073900%
2010 7.68% -19.66% -27.34% 1.03 -20.480056%

March 25,

Market Risk BETA CAPM

Rate Premium

Table 24:
Risk Free
364 T- Bill Cost of
Rate Equity
Bank Of
200023: 10.10% 7.34% -2.76% 1.08 7.119200%
2001 7.35% 14.95% 7.60% 1.08 15.558000%
2002 5.62% 55.27% 49.65% 1.08 59.242000%
2003 4.55% 21.81% 17.26% 1.08 23.190800%
2004 5.79% 6.87% 1.08% 1.08 6.956400%
2005 5.60% 1.88% -3.72% 1.08 1.582400%
2006 7.22% -5.63% -12.85% 1.08 -6.658000%
2007 6.07% 45.22% 39.15% 1.08 48.352000%
2008 7.06% 10.56% 3.50% 1.08 10.840000%
2009 3.24% -1.96% -5.20% 1.08 -2.376000%
2010 7.68% 8.18% 0.50% 1.08 8.220384%

March 25,

Table 25:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
(India) Ltd.
2000 10.10% 49.11% 39.01% 1.41 65.104100%
2001 7.35% 33.51% 26.16% 1.41 44.235600%
2002 5.62% 13.87% 8.25% 1.41 17.252500%
2003 4.55% 852.23% 847.68% 1.41 1199.77880%
2004 5.79% -28.11% -33.90% 1.41 -42.009000%
2005 5.60% 24.55% 18.95% 1.41 32.319500%
2006 7.22% 118.43% 111.21% 1.41 164.026100%
2007 6.07% 43.28% 37.21% 1.41 58.536100%
2008 7.06% -22.14% -29.20% 1.41 -34.112000%
2009 3.24% 151.03% 147.79% 1.41 211.623900%
2010 7.68% -30.30% -37.98% 1.41 -45.869832%

March 25,

Table 26:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
y Services
2000 10.10% -10.10% 0.49 5.15100%
2001 7.35% -7.35% 0.49 3.74850%
2002 5.62% -5.62% 0.49 2.86620%
2003 4.55% -4.55% 0.49 2.32050%
2004 5.79% 23.97% 18.18% 0.49 14.69820%
2005 5.60% -11.49% -17.09% 0.49 -2.77410%
2006 7.22% -3.54% -10.76% 0.49 1.94760%
2007 6.07% -57.26% -63.33% 0.49 -24.96170%
2008 7.06% -1.32% -8.38% 0.49 2.95380%
2009 3.24% 138.80% 135.56% 0.49 69.66440%
March 25,

Table 27:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
2000 10.10% -35.62% -45.72% 1.16 63.13520%
2001 7.35% 54.52% 47.17% 1.16 47.36720%
2002 5.62% 58.15% 52.53% 1.16 55.31480%
2003 4.55% 113.11% 108.56% 1.16 121.3796%
2004 5.79% 1.60% -4.19% 1.16 10.65040%
2005 5.60% -8.84% -14.44% 1.16 22.35040%
2006 7.22% -8.09% -15.31% 1.16 24.97960%
2007 6.07% -63.06% -69.13% 1.16 86.26080%
2008 7.06% -25.37% -32.43% 1.16 44.67880%
2009 3.24% 324.23% 320.99% 1.16 369.1084%
2010 7.68% 49.96% 42.28% 1.16 41.37516%

March 25,

Table 28:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
Co. Ltd.
2000 10.10% 65.03% 54.93% 1.01 65.579300%
2001 7.35% 43.93% 36.58% 1.01 44.295800%
2002 5.62% -1.98% -7.60% 1.01 -2.056000%
2003 4.55% 119.81% 115.26% 1.01 120.962600%
2004 5.79% 13.31% 7.52% 1.01 13.385200%
2005 5.60% -27.22% -32.82% 1.01 -27.548200%
2006 7.22% -15.98% -23.20% 1.01 -16.212000%
2007 6.07% 119.33% 113.26% 1.01 120.462600%
2008 7.06% 1.28% -5.78% 1.01 1.222200%
2009 3.24% 5.10% 1.86% 1.01 5.118600%
2010 7.68% -17.42% -25.10% 1.01 -17.670952%

March 25,

Table 29:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
Steel Ltd.
2000 10.10% 12.53% 2.43% 1.45 13.623500%
2001 7.35% -12.73% -20.08% 1.45 -21.766000%
2002 5.62% 83.79% 78.17% 1.45 118.966500%
2003 4.55% 135.26% 130.71% 1.45 194.079500%
2004 5.79% 22.48% 16.69% 1.45 29.990500%
2005 5.60% -41.52% -47.12% 1.45 -62.724000%
2006 7.22% -14.40% -21.62% 1.45 -24.129000%
2007 6.07% 77.96% 71.89% 1.45 110.310500%
2008 7.06% -23.66% -30.72% 1.45 -37.484000%
2009 3.24% 115.27% 112.03% 1.45 165.683500%
2010 7.68% -5.73% -13.41% 1.45 -11.762340%

March 25,

Table 30:
Risk Free Market Risk
Rate Rate Premium BETA CAPM
364 T- Bill Cost of
Rate Equity
2000 10.10% 13.19% 3.09% 0.75 12.417500%
2001 7.35% -15.52% -22.87% 0.75 -9.802500%
2002 5.62% -1.70% -7.32% 0.75 0.130000%
2003 4.55% -66.22% -70.77% 0.75 -48.527500%
2004 5.79% 18.40% 12.61% 0.75 15.247500%
2005 5.60% -18.99% -24.59% 0.75 -12.842500%
2006 7.22% -15.92% -23.14% 0.75 -10.135000%
2007 6.07% -58.94% -65.01% 0.75 -42.687500%
2008 7.06% -1.82% -8.88% 0.75 0.400000%
2009 3.24% 112.94% 109.70% 0.75 85.515000%
2010 7.68% 3.89% -3.79% 0.75 4.836300%


Sector Wise Analysis:-
Information Technology:- Companies like TCS, Infosys & Wipro provided a very low return
on Equity during the period of 2000- 2003 period. The revenue & profit margins were deeply
affected by Dot Com bubble which is basically reflected in the return provided by these stocks
providing negative and returns close to zero and using the CAPM parameters this is reflected
truly in the actual returns. Companies like TCS provide return 5%, 3% & 2% in ’00, ’01 & ’02.
Stocks like Infosys provided return as 5%, 0%, 9% & -22% during dot com bubble. These
companies seemed to have revived post ’04 posting higher return with Infosys as the market
leader in return. The returns were 21% for year ’04 in case of Infosys and the returns of Wipro &
TCS were close to that Infosys. However in ’07 due to US Subprime crisis the return were
affected. But since the revival of economy all these stocks have shown robust performance
which is reflected in the returns of CAPM model. Wipro posted a return of 85% by Wipro, 69%
by TCS & 26% by Infosys in ’09.

Telecommunication:- Telecommunications companies like Reliance Communication & Bharti

Airtel have always driven on lower margins and higher cost. With introduction of more
March 25,

companies the telecom space has become more competitive. These stocks have been below
average performer with a few exceptional year around ’03-’04 where they experienced high
growth opportunities. Return on reliance communication has been consistently been around
-1%.Recession had its own toll over telecom sector. Reliance provided heft return as 138%
during ’09 period otherwise it has been below average performer. Bharti Airtel has performed
well during growth years and provide returns as high as 159% in ’03 & followed it with return of
58% & 26% in subsequent years. During recent years they have experienced a better surge but
that has been a consistent growth and so the returns by CAPM reflect the situation of companies
like Reliance Communication & Bharti Airtel, though Airtel has shown a better performance
compared to Reliance simply because of company fundamentals being better.

Banking & Financial Sector:- The banking and financial sector was booming in the period of
2000. The performance was sustained till the period of ’04 for the growing demand of ever
expanding Indian economy. Stocks like SBI, HDFC, HDFC Bank, ICICI outperformed many of
the other stocks and the returns through CAPM show the kind of hefty returns provided by these
stocks. Stocks like SBI provided returns like 15%, 59% & 23& before ’05. Another heavyweight
ICICI provided returns as high as 183%, 78%, 64% during the same period. However in post ’05
there was a decline in their return and post recession these stocks provided negative returns due
to the coupling effect of economies of recession. Moreover, it was the financial crisis so the
banking sector was hit the hardest. However, these stocks seemed to have revived and provided
average returns since then a bit higher than to returns on government securities. The performance
of these stocks is shown in returns on CAPM. SBI provided return close to 10%, -2% in ’08 &
’09. It revived to 8% in ’10 showing signs of recovery. HDFC provided returns as 4%, 1% in 08
& ’09 respectively & provided higher return in ’10 with returns close to 19%. Same was the case
with HDFC bank providing returns as 10%, -8% & 20% during the same period.

FMCG:- This sector provides average returns. In the period of ’00 the returns were higher than
average return but since then the returns have been quite low even negative for HUL
consistently. HUL returns were -6%, -23% & -16%. ITC returns were close to 1%, 0% & -7%.A
better performance during the period of ’04-’05 was shown by both the stocks HUL &ITC due to
growing economic demand. ITC returns were hovering around 13% but slipped to -5% & -8%
again and so was the case with HUL with returns as -12% & -17%. However, the demand
slipped again and these sector have provided a negative returns with an exception of ’08 year
and in last financial year. ITC returns in ’08 were 19% & in ’10 close to 16%.The performance
of FMCG sector as a whole in the particular year has never been inspiring and government
securities seems to be a safer bet. The Cost of Equity (return on stocks) using CAPM shows the

March 25,

kind of return thus ascertaining the position of FMCG sector as not a safe bet for investment and
diversification of portfolio.

Automobile:- Companies like Bajaj Auto, Hero Honda, Maruti Suzuki have been providing low
returns with the sole exception of Hero Honda & Tata Motors. The sales of Tata Motors have
outperformed Indian car segment. Maruti Suzuki returns have hovered around 2% & 1% in
00’-’04 and same is the case with Bajaj Auto. Tata Motors returns were 63%,47%,55% 121%
during ’00-’04 period. On the other hand, Hero Honda Motors have been providing par
performance with the industry. The automobiles sales domestic and export market was hit hard
because of recession and all companies sales declined resulting in negative returns. Maruti
Suzuki returns were -27% in ’07 but seemed to have recover and gave returns as close to 89% in
‘09 However, the spurt in demand for automobiles in India because of higher disposable income
post recession has ensured higher volumes for all companies & impressive growth for these
companies and this is reflected in return calculated by CAPM model. Like in case of Tata Motors
despite recessionary period it provided returns of 86%, 44% in ’07 & ’08 and a 369% return in ‘
post recession ’09 period.

Manufacturing Sector:- Manufacturing Sector has been one of the strong hold of the Indian
economy thus substantiating the point of India being one of the fastest growing economies. This
sector has been outperforming with a high growth post ’00. Sterlite have performed well with
65% & 44% returns in ’00 &’01. M&M posted a return of around 200% in ’03 and has been
consistently hovering around 30%-50% return to pre-recession period. Companies have posted
higher sales revenue and higher margins resulting in higher returns in not only stock returns but
higher dividends as well. Companies faced a slight turbulence in ’04-’06 where certain stocks
posted losses and their performance revived in first half of ’07 before they were affected by
recession whose effect was felt in ’08. Sterlite again posted a good performance return in ’07
before being hit by recessionary phase. Larsen Toubro return in ’07 were 172%. But these
companies fundamentals have been strong and they were able to quickly recover from it and
again posted huge profit margins and higher returns for investor. Companies like Sterlite have
provided as high as 1192% return in ’03 and a high returns as 200% after recession along with
M&M whose return were close to 240%. L&T , Hindalco, BHEL &Reliance Industries have
performed in correlation with Manufacturing Sector. RIL provided returns of around 34 & 26%
in ’00-’01 with a high of 93% in ’03. It showed negative returns since’04 before a high of 408%
in ’07. Snce then it has gradually recovered and provided average returns at par with industry.

Steel & Power Sector:- Steel & Power is another sector like Manufacturing sector that has been
the stronghold of Indian economy. Again companies like Tata Steel, Tata Power, Jindal Steel &
Power, Jaiprakash Associates have performed outstandingly with return as high as more than

March 25,

100% in the financial year of ’03-’04. Tata Steel returns have been 118%, 194% & 29% form
’02-’04 along with Tata Power return as 120% in ‘03. Jindal Steel returns were 181 &281%
during the same years These stocks have performed consistently well even before this period like
Tata Power returns were 65% & 44& in ’00 & ‘01. However, they faced slight decline during
the period of ’05-’06 where Tata Steel returns declined 62% & 24%. But they again performed
exceedingly well in ’07 when the economy was at its high before the Subprime crisis hit the
world. Stocks like Jindal Steel returns were outstanding like 707% returns, Tata Steel returns
were 110% ,Tata Power returns were 120% in ’07 and JP Associates returns were 247% in the
same year. The effects of which were felt in subsequent year. These stock being fundamentally
strong with huge demand potential recovered by’09 and have performed well after that. Jindal
Steel was the market leader with 408% return. Tata steel again outperformed the market with
returns of 165% despite a -37% return in ’08. Tata Power return post Subprime crisis were 5%
and 1%. Stocks of PSU like NTPC, ONGC have been providing returns at par with the
benchmark rate of government securities. This is reflected in the CAPM return of these stocks.

Infrastructure Sector:- The need for infrastructure has been growing with economy expanding.
Infrastructure has been booming and a robust performance was shown during the period of
’00-’04 but since then there has been a considerable slowdown in demand. These stocks
correlated with market risk and market return have given positive returns till ’04 but the slow
down has resulted in negative returns. Reliance Infrastructure provided return with 34%, 26% ,
13% and as high as 93%. After ’04 these stocks seemed to decline with returns as -46% & -97%
in ‘05 & ‘06 period. As an exception to recession the sector became a safer investment haven as
compared to financial instruments and so outperformed the market return. Both DLF and
Reliance Infra provided much higher return. Reliance Infra provided return close to 408% in ‘08
However, this phenomena was short lived and due to credit crunch problem these sectors again
declined and have slightly reviewed after ’08-’09 and a better performance is expected. These
performance are reflected in CAPM returns.

Pharmaceutical:- This sector has been a laggard. The performance of Indian generic industry
was average in ’00-’01. The sales further declined post this period with below average margins
of pharma companies. Return on Cipla were 2%, 17%, -9% & -10% during the period of
2000-’04. The recession didn’t help the situation further as the generic version exports from
Indian market as well domestic competition reduced margins for the companies. The regulations
of patents and constant scrutiny of the generic version was another hinderance in the
performance. They seemed to have revived but that even a slightly bit. These are shown in the
result of CAPM return of pharmaceutical companies like Cipla in this case. In ’08 returns were
28% but post recession they have touched the lows of 1% & 0%.

March 25,


The strategic portfolio planning problem of the firm involves two interdependent decisions. First,
management must decide which businesses in the portfolio should be retained and which should
be removed (divested). Second, for those businesses retained in or added to the portfolio,
management must determine the amount to invest in each business. Under the CAPM
March 25,

framework, the primary strategic objective of management in making these two interdependent
decisions is to maximize Vz, the expected value of the firm's common stock.

The first point to note about is that the company's management wields little or no influence over
the risk-free interest rate i and the market price of risk p.

The three parameters over which management has at least partial control are the company's profit
stream , the standard deviation of the company's rate of return and the correlation coefficient
between the company's rate of return and the market rate of return.

The company's return from its entire portfolio of businesses depends not only on the variance of
the returns of the businesses constituting the portfolio but also on the relationship between these
businesses, which is denoted by the covariance . By diversifying its portfolio to include
businesses with low positive covariances or even possibly negative covariances, a conglomerate
can reduce the dispersion of the probability distribution of possible returns

In summary, in building a portfolio of businesses, a company should strive for high profits in
each business, low variances of return , negative covariances of returns , and values of that are
close to zero or negative.6

4.4 Building A Portfolio:-

Year Higher Return Stocks
March 25,

2000 HDFC,HDFC Bank, Hindalco HUL,ITC, ICICI, ONGC,

RIL Reliance Infra, Tata Power, Tata Motors, Sterlite
2001 HDFC, HDFC Bank, Hero Honda, HUL, L& T, Reliance
Infra, SBI, Tata Power, Tata Motors, Sterlite
2002 BHEL,ICICI,JSPL,M&M, Tata Motors, Tata Steel, SBI
2003 BHEL, Bharti Airtel, Hindalco, ICICI, JSPL, L&T,
M&M, Maruti Suzuki, RIL, SBI, Reliance Infra, Sterlite,
Tata Power, Tata Motors, Tata Steel
2004 BHEL, Bharti Airtel, HDFC Bank, Hero Honda, Infosys,
JSPL, L&T, M&M, TCS, Tata Power, Tata Steel Wipro
2005 BHEL, HDFC, ITC, ICICI, Jai prakash Associates, JSPL,
L&T, M&M, RIL, Sterlite, Tata Motors
2006 Bharti Airtel, Jai prakash Associates, M&M, RIL,
Reliance Communication, Sterlite, Tata Motor

2007 BHEL, DLF, HDFC Bank, Hero Honda, HDFC, Jai

prakash Associates, JSPL, L&T, RIL, Reliance Infra, SBI,
Sterlite, Tata Power, Tata Motor, Tata Steel
2008 Bharti Airtel, Cipla, HUL, ITC, Tata Motor
Bajaj Auto, Hindalco, ICICI, Infosys, Jai prakash
Associates, JSPL, M&M, Maruti Suzuki, Reliance
2009 Communication, Reliance Infra, Sterlite, TCS, Tata
Motor, Tata Steel, Wipro
2010 Bajaj Auto, HDFC Bank, Hindalco, HDFC, ICICI, M&M,
TCS, Tata Motor

March 25,

Although it has certain limitations, the capital asset pricing model appears to offer a company
that owns a portfolio of risky businesses a useful conceptual framework for long-term strategic
planning. However, the CAPM is merely one of several options available to strategic planners.
Among the other options available are competitive strategy models, deterministic portfolio
optimization models and corporate simulation models.

Competitive strategy models of the type proposed by the Boston Consulting Group, Arthur D.
Little, McKinsey and more recently by Michael Porter all have a quite different focus. Whereas
the capital asset pricing model concentrates on risk, return and the value of a business, the
competitive strategy models apply such well-known concepts as the growth-share matrix and the
experience curve to the overall problem of competitive strategy. That is, competitive strategy
models emphasize the interdependence of a business with its competitors, not the
interdependence of businesses within a multidivisional firm. Clearly, competitive strategy is an
important element in a company's overall strategic plan.

On the other hand, corporate simulation models enable management to examine a variety of
strategic options, and to evaluate their consequences on a multiplicity of financial marketing and
production indicators. To be useful to management, capital asset pricing models must be linked
to some type of corporate simulation model. That is, one can envisage a series of business
simulation models, one for each business in the company's portfolio, each of which generates a
value for the stream of profits, and the variability of return for that business as well as other
output variables of interest to management. A corporate consolidation model that computes the
value of the company would also be needed. This consolidated model must in addition treat the
interdependencies among the businesses in the company's portfolio.

March 25,

Chapter 5
Summary & Conclusion from the Study
The following summarizes the various concepts that are understood in the dissertation and the
Conclusion about CAPM as an effective tool for measurement of returns on stocks and

March 25,

This study discussed the basic framework for applicability of Capital Asset Pricing Model in
Indian stock Market. Better return can be obtained by diversification and using CAPM as a
means for estimating the return can be effectively used. The major findings of the study as

i. Among the various model for estimating the return, CAPM emphasis the strategy of
incorporating both risk free return, the return premium for risk undertaken & correlation
of return on individual stock & Market return (Beta).
ii. Higher risk does not always guarantee higher return. The optimal portfolio selection
results from a well balanced multi-criteria approach rather than a single variable factor.
iii. The contribution of fundamental analysis for selecting a stock in a portfolio is a pivotal
factor in selecting appropriate mix of stocks.

However, the study had certain limitations like limiting the kind of stocks for determining the
portfolio and the time frame considered. Given these limitations, future research can concentrate
on this model to evaluate risk and return of portfolios. Another aspect that can be researched in
depth is considering the correlation of market return and individual stock return considering the
actual returns provided by the companies over a period of time. This information will further
substantiate the robustness of CAPM model. A further area of research can be the application of

March 25,

approach to other decision making situations like merger & acquisition and other corporate
decision like capital structure & dividends distribution.

The value of the model lies in the benefits that the integration of various techniques and
approaches offer. The multi criterion function provides the company with a tool that optimizes
its choices regarding selection of stocks. The model thereby enables to take appropriate
investment decision after taking into account its impact on the portfolio as a whole. By using this
model, even firms can improve their capital structure.

The development of this integrated model should not be seen as a once- off task with the aim of
finding optimal portfolios. Once the optimal portfolio has been identified, the model should be
used on regular basis to identify the changes to be incorporated. The model should be used when
following situation take place because they would affect the company’s performance

i. Strategic:- Strategic changes can reflect in numerous ways. A company may declare
dividends, go for a right issue/ bonus issue, stock split, merger & acquisition, change in
capital structure can affect the returns provided by the company and can affect the overall
return on portfolio.

ii. Financial:- Changes in the financial performance must be incorporated. Such changes
can affect the availability of profits for distribution. The financial fundamentals if are
brighter in the future would help in inject more & more capital and thus rising the overall
market value of the stocks.

iii. Economic:- A fundamental change in economy ( e.g. exchange rate, inflation, business
cycle etc.) may result in changes to optimal portfolio.

Considering such factors a stock should be selected. The model by incorporating “Beta” helps in
bringing correlation to economic factors and so it remains as a powerful means for decision
making process.

March 25,


Brigham, E.F (1989). Fundamental of Financial Management, 5th edition, Dryden Press, Chicago

Elton, E.J. and Grubber M.J. (1987) Modern Portfolio theory and Investment Analysis, 3rd
edition., Wiley, New York

Richard A. DeFusco, Jerald E. Pinto and David E. Runkle, 2001 edition, Quantitative
Techniques in Portfolio Management, Aimr Publication

Reilly & Brown Investment Analysis & Portfolio Management, 7th edition, South Western
College Publication

March 25,

Rustagi R.P. Financial Management, 3rd edition, Galgotia Publications

Chandra Prassana, Investment Analysis & Portfolio management, 3rd edition , Tata McGraw Hill

Pandey I.M. Financial Management, 9th edition, Vikas Publication

Edwin J. Elton, Martin J. Gruber, Stephen J. Brown, William N. Goetzmann, 8th edition, Modern
Portfolio Theory & Investment Analysis

Charles P. Jones, 9th edition Investments: Analysis and Management

Prasad G B R K, How to Choose Winning Stocks: Rewriting Formulas for Investment

Bhalla V. K., 2008 edition, Portfolio Analysis and Management, S. Chand Publications

Khan M.Y. & Jain P.K.,11th edition, Financial Management, Tata McGraw Hill Publication

Fisher & Jordan, 6th edition, Security Analysis & Portfolio Management, Prentice Hall

Kevin S., 2nd edition, Security Analysis & Portfolio Management, Prentice Hall

Pandian Punithavathy, 6th edition, Security Analysis & Portfolio Management, Vikas Publication

Annual reports of top 30 BSE Sensex Companies

March 25,

Research Papers & Journals from JStore

(i) CAPM Research paper – Andre F. Perold
(ii) CAPM Model: Theory & Evidence - Eugene F. Fama and Kenneth R.
(iii) CAPM vs. Three Factor Model - Riad Ramlogan
(iv) CAPM – Lan Liu
(v) Market Imperfections, Capital Market Equilibrium &
Corporate Finance – R.C. Stapleton & M.G. Subhramanyam
(vi) CAPM as a Strategic Planning tool - Francis Tapon
(vii) Benchmark Beta, CAPM & Pricing Anomalies – Eun
(viii) Growth Options, Beta & Cost of Capital – Antonio E. Bernardo, Bhagwan
Chaudhary & Amit Goyal
(ix) The Value Premium & CAPM – Fama & French



March 25,

Beta for top 30 Companies of BSE Sensex


No. No. No. No. No. No. No. No. No. No. No.
Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10
Company Name Beta Beta Beta Beta Beta Beta Beta Beta Beta Beta Beta
Bajaj Auto Ltd. 0.91 0.91 0.91
Bharat Heavy Electricals Ltd. 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01
Bharti Airtel Ltd. 0.68 0.68 0.68 0.68 0.68 0.68 0.68 0.68 0.68
Cipla Ltd. 0.51 0.51 0.51 0.51 0.51 0.51 0.51 0.51 0.51 0.51 0.51
D L F Ltd. 1.63 1.63 1.63 1.63
H D F C Bank Ltd. 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92
Hero Honda Motors Ltd. 0.44 0.44 0.44 0.44 0.44 0.44 0.44 0.44 0.44 0.44 0.44
Hindalco Industries Ltd. 1.33 1.33 1.33 1.33 1.33 1.33 1.33 1.33 1.33 1.33 1.33
Hindustan Unilever Ltd. 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47
Housing Development Finance Corpn. Ltd. 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92 0.92
I C I C I Bank Ltd. 1.38 1.38 1.38 1.38 1.38 1.38 1.38 1.38 1.38 1.38 1.38
I T C Ltd. 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47
Infosys Technologies Ltd. 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45
Jaiprakash Associates Ltd. 1.7 1.7 1.7 1.7 1.7 1.7 1.7
Jindal Steel & Power Ltd. 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45
Larsen & Toubro Ltd. 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2
Mahindra & Mahindra Ltd. 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1
Maruti Suzuki India Ltd. 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74
N T P C Ltd. 0.69 0.69 0.69 0.69 0.69 0.69 0.69
Oil & Natural Gas Corpn. Ltd. 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9
Reliance Communications Ltd. 1.31 1.31 1.31 1.31 1.31
Reliance Industries Ltd. 1.03 1.03 1.03 1.03 1.03 1.03 1.03 1.03 1.03 1.03 1.03
Reliance Infrastructure Ltd. 1.54 1.54 1.54 1.54 1.54 1.54 1.54 1.54 1.54 1.54 1.54
State Bank Of India 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08 1.08
Sterlite Industries (India) Ltd. 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41 1.41
Tata Consultancy Services Ltd. 0.49 0.49 0.49 0.49 0.49 0.49 0.49
Tata Motors Ltd. 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16
Tata Power Co. Ltd. 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01 1.01
Tata Steel Ltd. 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45 1.45
Wipro Ltd. 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75

March 25,



(%) (%) (%) (%) (%) (%) (%) (%) (%) (%) (%)
Dec-00 Dec-01 Dec-02 Dec-03 DEC '04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10
Company Name
Bajaj Auto Ltd. 20.05 279.44 60.48
Bharat Heavy Electricals Ltd. 0.82 5.63 22.04 124.77 39.88 42.8 20.39 79.7 5.62 -2.65 -19.86
Bharti Airtel Ltd. -51.66 286.06 82.62 19.52 35.43 11.01 26.39 -88.85 -8.08
Cipla Ltd. -3.93 27.35 -23.53 -24.79 7.33 -0.2 -4.68 -61.43 41.57 -0.2 -6.24
D L F Ltd. 42.21 -21.06 -52.32 -36.13
H D F C Bank Ltd. 59.42 19.71 -4.96 -3.43 31.34 -7.24 4.47 15.46 10.5 -9.48 21.43
Hero Honda Motors Ltd. -1.24 67.7 9.6 4.87 19.26 12.69 -55.37 -53.31 70.41 35 4.98
Hindalco Industries Ltd. 12.91 5.87 -8.62 71.48 -8.22 -36.92 -21.37 -22.12 -20.75 133.78 36.83
Hindustan Unilever Ltd. 13.55 28.5 -21.06 -55.2 -41.13 -2.71 -34.33 -43.84 70.5 -72.4 3.3
Housing Development Finance Corpn. Ltd. 114.49 42.55 8.9 11.96 9.93 18.5 -12.12 31.85 4.06 1.28 20.18
I C I C I Bank Ltd. 135.72 -22.89 58.7 47.67 14.64 19.32 9.97 -7.21 -10.45 17.15 15.17
I T C Ltd. 56.88 -6.65 -4.05 -20.84 23.01 23.26 -19.88 -25.22 32.97 -32.15 26.71
Infosys Technologies Ltd. -0.68 -10.4 14.39 -55.29 40.4 2.95 4.51 -67.7 17.8 55.02 17.31
Jaiprakash Associates Ltd. 58.08 68.15 46.89 148.02 -27.86 86.13 -45.03
Jindal Steel & Power Ltd. -19.41 6.46 127.14 195.66 30.84 32.52 0.89 533.76 -17.58 282.88 -15.94
Larsen & Toubro Ltd. -43.43 18.66 12.68 80.82 24.96 45.7 14.11 144.49 -9.95 37.37 1.24
Mahindra & Mahindra Ltd. -44.06 -19.27 28.63 186.33 29.77 52.11 35.95 -50.73 -14.96 217.65 28.65
Maruti Suzuki India Ltd. 56.49 11.87 -4.37 0.75 -39.76 5.32 119.65 -25.9
N T P C Ltd. 4 -10.2 -21.41 40.16 24.18 -48.38 -30.71
Oil & Natural Gas Corpn. Ltd. -17.68 37.82 166.74 70.72 -5.8 5.79 -34.02 -0.71 8.01 0.2 -3.65
Reliance Communications Ltd. 14.17 11.39 -16.79 -104.73 -33.07
Reliance Industries Ltd. 67.31 9 -2.46 23.15 -16.82 28.29 74.04 81.51 -4.1 -2.89 -19.66
Reliance Infrastructure Ltd. 26.12 19.94 10.75 62.22 -8.56 -28.02 -60.46 267.3 -21.88 17.95 -43.48
State Bank Of India 7.34 14.95 55.27 21.81 6.87 1.88 -5.63 45.22 10.56 -1.96 8.18
Sterlite Industries (India) Ltd. 49.11 33.51 13.87 852.23 -28.11 24.55 118.43 43.28 -22.14 151.03 -30.3
Tata Consultancy Services Ltd. 23.97 -11.49 -3.54 -57.26 -1.32 138.8 41.9
Tata Motors Ltd. -35.62 54.52 58.15 113.11 1.6 -8.84 -8.09 -63.06 -25.37 324.23 49.96
Tata Power Co. Ltd. 65.03 43.93 -1.98 119.81 13.31 -27.22 -15.98 119.33 1.28 5.1 -17.42
Tata Steel Ltd. 12.53 -12.73 83.79 135.26 22.48 -41.52 -14.4 77.96 -23.66 115.27 -5.73
Wipro Ltd. 13.19 -15.52 -1.7 -66.22 18.4 -18.99 -15.92 -58.94 -1.82 112.94 3.89

CAPM Research paper – Andre F. Perold

2 CAPM Research paper – Andre F. Perold

3 CAPM Research paper – Andre F. Perold

4 CAPM Model: Theory & Evidence - Eugene F. Fama and Kenneth R. French

5 Market Imperfections, Capital Market Equilibrium & Corporate Finance – R.C. Stapleton & M.G. Subhramanyam

6 CAPM as a Strategic Planning tool - Francis Tapon