“A CASE STUDY ON PORT FOLIO MANAGEMENT”

CONTENTS

1. COMPANY PROFILE
2. INTRODUCTION
3. PORTFOLIO ANALYSIS
4. ANALYSIS & INTERPRETION
5. CALCULATION OF AVERAGE RETURN OF COMPANIES
6. CALCULATION OF PORTFOLIO RISK
7. CALCULATION OF PORTFOLIO WEIGHTS
8. CONCLUSION
9. BIBILOGRAPHY

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 COMPANY PROFILE

Inter-connected stock exchange of India limited [ISE] has been promoted by 14

Regional stock exchanges to provide cost-effective trading linkage/connectivity to
all the members of the participating Exchanges, with the objective of widening
the market for the securities listed on these Exchanges. ISE aims to address the
needs of small companies and retail investors with the guiding principle of
optimizing the existing infrastructure and harnessing the potential of regional
markets, so as to transform these into a liquid and vibrant market through the use
of state-of-the-art technology and networking.

The participating Exchanges of ISE in all about 4500 stock brokers, out
of which more than 200 have been currently registered as traders on ISE. In order
to leverage its infrastructure and to expand its nationwide reach, ISE has also
appointed around 450 Dealers across 70 cities other than the participating
Exchange centers. These dealers are administratively supported through the
regional offices of ISE at Delhi [north], kolkata [east], Coimbatore, Hyderabad
[south] and Nagpur [central], besides Mumbai.

ISE has also floated a wholly-owned subsidiary, ISE securities and

services limited [ISS], which has taken up corporate membership of the National
Stock Exchange of India Ltd. [NSE] in both the Capital Market and Futures and
Options segments and The Stock Exchange, Mumbai In the Equities segment, so

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that the traders and dealers of ISE can access other markets in addition to the ISE
markets and their local market. ISE thus provides the investors in smaller cities a
one-stop solution for cost-effective and efficient trading and settlement in
securities.
With the objective of broad basing the range of its services, ISE has
started offering the full suite of DP facilities to its Traders, Dealers and their
clients.

OBJECTIVES OF THE COMPANY:

1. Create a single integrated national level solution with access to multiple
markets for providing high cost-effective service to millions of investors across
the country.
2. Create a liquid and vibrant national level market for all listed companies in
general and small capital companies in particular.
3. Optimally utilize the existing infrastructure and other resources of participating
Stock Exchanges, which are under-utilized now.
4. Provide a level playing field to small Traders and Dealers by offering an
opportunity to participate in a national markets having investment-oriented
business.
5. Reduce transaction cost.
6. Provide clearing and settlement facilities to the Traders and Dealers across the
Country at their doorstep in a decentralized mode.
7. Spread demat trading across the country

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 SAILENT FEATURES

Network of intermediaries:
As at the beginning of the financial year 2003-04, 548 intermediaries
(207 Traders and 341 Dealers) are registered on ISE. A broad of members forms
the bedrock for any Exchange, and in this respect, ISE has a large pool of
registered intermediaries who can be tapped for any new line of business .

Robust Operational Systems:

The trading, settlement and funds transfer operations of ISE and ISS are
completely automated and state-of-the-art systems have been deployed. The
communication network of ISE, which has connectivity with over 400 trading
members and is spread across46 cities, is also used for supporting the operations of
ISS. The trading software and settlement software, as well as the electronic funds
transfer arrangement established with HDFC Bank and ICICI Bank, gives ISE and
ISS the required operational efficiency and flexibility to not only handle the
secondary market functions effectively, but also by leveraging them for new
ventures.

Skilled and experienced manpower:

ISE and ISS have experienced and professional staff, who have wide
experience in Stock Exchanges/ capital market institutions, with in some cases, the
experience going up to nearly twenty years in this industry. The staff has the skill-
set required to perform a wide range of functions, depending upon the
requirements from time to time.

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Aggressive pricing policy:
The philosophy of ISE is to have an aggressive pricing policy for the
various products and services offered by it. The aim is to penetrate the retail
market and strengthen the position, so that a wide variety of products and services
having appeal for the retail market can be offered using a common distribution
channel. The aggressive pricing policy also ensures that the intermediaries have
sufficient financial incentives for offering these products and services to the end-
clients.

Trading, Risk Management and Settlement Software Systems:

The ORBIT (Online Regional Bourses Inter-connected Trading) and
AXIS (Automated Exchange Integrated Settlement) software developed on the
Microsoft NT platform, with consultancy assistance from Microsoft, are the most
contemporary of the trading and settlement software introduced in the country. The
applications have been built on a technology platform, which offers low cost of
ownership, facilitates simple maintenance and supports easy up gradation and
enhancement. The soft wares are so designed that the transaction processing
capacity depends on the hardware used; capacity can be added by just adding
inexpensive hardware, without any additional software work.

Vibrant Subsidiary Operations:

ISS, the wholly owned subsidiary of ISE, is one of the biggest Exchange
subsidiaries in the country. On any given day, more than 250 registered
intermediaries of ISS traded from 46 cities across the length and breadth of the
country.

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 Name of the Board of directors

1. Prof. P. V. Narasimham Public Interest Director

2. Shri V. Shankar Managing Director
3. Dr. S. D. Israni Public Interest Director
4. Dr. M. Y. Khan Public Interest Director
5. Mr. P. J. Mathew Shareholder Director
6. M. C. Rodrigues Shareholder Director
7. Mr. M. K. Ananda Kumar Shareholder Director
8. Mr. T.N.T Nayar Shareholder Director
9. Mr. K. D. Gupta Shareholder Director
10. Mr. V. R. Bhaskar Reddy Shareholder Director
11. Mr. Jambu Kumar Jain Trading Member Director

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 INTRODUCTION

Investment may be defined as an activity that commits funds in any financial

form in the present with an expectation of receiving additional return in the future.
The expectations bring with it a probability that the quantum of return may vary
from a minimum to a maximum. This possibility of variation in the actual return is
known as investment risk. Thus every investment involves a return and risk.

Investment is an activity that is undertaken by those who have savings.

Savings can be defined as the excess of income over expenditure. An investor
earns/expects to earn additional monetary value from the mode of investment that
could be in the form of financial assets.

 The three important characteristics of any financial asset are:

Return-the potential return possible from an asset.

 Risk-the variability in returns of the asset form the chances of its value going
down/up.

 Liquidity-the ease with which an asset can be converted into cash.

Investors tend to look at these three characteristics while deciding on their

individual preference pattern of investments. Each financial asset will have a
certain level of each of these characteristics.

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 Investment avenues
There are a large number of investment avenues for savers in India. Some of
them are marketable and liquid, while others are non-marketable. Some of them
are highly risky while some others are almost risk less.
Investment avenues can be broadly categorized under the following head.

1. Corporate securities
2. Equity shares.
3. Preference shares.
4. Debentures/Bonds.
5. Derivatives.
6. Others.

Corporate Securities

Joint stock companies in the private sector issue corporate securities. These
include equity shares, preference shares, and debentures. Equity shares have
variable dividend and hence belong to the high risk-high return category;
preference shares and debentures have fixed returns with lower risk.The
classification of corporate securities that can be chosen as investment avenues can
be depicted as shown below:

Equity Preference Bonds Warrants Derivatives

Shares shares

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METHODOLOGY OF THE STUDY

OBJECTIVES OF THE STUDY:

The objectives of the study are as follows:

 To study the investment pattern and its related risks & returns.
 To find out optimal portfolio, which gave optimal return at a minimize risk
to the investor.
 To see whether the portfolio risk is less than individual risk on whose basis
the portfolios are constituted.
 To see whether the selected portfolios is yielding a satisfactory and constant
return to the investor.
 To understand, analyze and select the best portfolio.

SCOPE OF STUDY:

This study covers the Markowitz model. The study covers the calculation of
correlations between the different securities in order to find out at what percentage
funds should be invested among the companies in the portfolio. Also the study
includes the calculation of individual Standard Deviation of securities and ends at
the calculation of weights of individual securities involved in the portfolio. These
percentages help in allocating the funds available for investment based on risky
portfolios.

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 DATA COLLECTION METHODS

The data collection methods include both the primary and secondary collection
methods.
 Primary collection methods: This method includes the data collection from the
personal discussion with the authorized clerks and members of the exchange.
 Secondary collection methods: The secondary collection methods includes the
lectures of the superintend of the department of market operations and so on,
also the data collected from the news, magazines of the ISE and different books
issues of this study

LIMITATIONS OF THE STUDY

The study confines to the past 2-3 years and present system of the trading
procedure in the ISE and the study is confined to the coverage of all the related
issues in brief. The data is collected from the primary and secondary sources and
thus is subject to slight variation than what the study includes in reality.
Hence accuracy and correctness can be measured only to the extend of what the
sample group has furnished.

This study has been conducted purely to understand Portfolio Management

for investors.

 Construction of Portfolio is restricted to two companies based on Markowitz

model.
 Very few and randomly selected scripts / companies are analyzed from BSE
listings.

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  Data collection was strictly confined to secondary source. No primary data is
associated with the project.
 Detailed study of the topic was not possible due to limited size of the
project.
There was a constraint with regard to time allocation for the research study
i.e. for a period of two months.

PORT FOLIO MANAGEMENT

MEANING:
A portfolio is a collection of assets. The assets may be physical or financial
like Shares, Bonds, Debentures, Preference Shares, etc. The individual investor or
a fund manager would not like to put all his money in the sares of one company,
that would amount to great risk. He would therefore, follow the age old maxim
that one should not put all the egges into one basket. By doing so, he can achieve
objective to maximize portfolio return and at the same time minimizing the
portfolio risk by diversification.

 Portfolio management is the management of various financial assets which

comprise the portfolio.
 Portfolio management is a decision – support system that is designed with a
view to meet the multi-faced needs of investors.
 According to Securities and Exchange Board of India Portfolio Manager is
defined as: “portfolio means the total holdings of securities belonging to any
person”.
 PORTFOLIO MANAGER means any person who pursuant to a contract
or arrangement with a client, advises or directs or undertakes on behalf of
the client (whether as a discretionary portfolio manager or otherwise) the
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 management or administration of a portfolio of securities or the funds of the
client.
 DISCRETIONARY PORTFOLIO MANAGER means a portfolio
manager who exercises or may, under a contract relating to portfolio
management exercises any degree of discretion as to the investments or
management of the portfolio of securities or the funds of the client.

FUNCTIONS OF PORTFOLIO MANAGEMENT:

 To frame the investment strategy and select an investment mix to achieve

the desired investment objectives

 To provide a balanced portfolio which not only can hedge against the
inflation but can also optimize returns with the associated degree of risk

 To make timely buying and selling of securities

 To maximize the after-tax return by investing in various tax saving

investment instruments.

STRUCTURE / PROCESS OF TYPICAL PORTFOLIO MANAGEMENT

In the small firm, the portfolio manager performs the job of security analyst.
In the case of medium and large sized organizations, job function of portfolio
manager and security analyst are separate.

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 RESEARCH OPERATIONS
(e.g. Security PORTFOLIO
MANAGERS (e.g. buying and
Analysis) selling of Securities)

CLIENTS

CHARACTERISTICS OF PORTFOLIO MANAGEMENT:

Individuals will benefit immensely by taking portfolio management services

for the following reasons:

 Whatever may be the status of the capital market, over the long period
capital markets have given an excellent return when compared to other
forms of investment. The return from bank deposits, units, etc., is much less
than from the stock market.

 The Indian Stock Markets are very complicated. Though there are thousands
of companies that are listed only a few hundred which have the necessary
liquidity. Even among these, only some have the growth prospects which are
conducive for investment. It is impossible for any individual wishing to
invest and sit down and analyze all these intricacies of the market unless he
does nothing else.

 Even if an investor is able to understand the intricacies of the market and

separate chaff from the grain the trading practices in India are so
complicated that it is really a difficult task for an investor to trade in all the

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 major exchanges of India, look after his deliveries and payments. This is
further complicated by the volatile nature of our markets which demands
constant reshuffing of portfolios.

TYPES OF PORTFOLIO MANAGEMENT:

1. DISCRETIONARY PORTFOLIO MANAGEMENT SERVICE (DPMS):

In this type of service, the client parts with his money in favour of the
manager, who in return, handles all the paper work, makes all the decisions and
gives a good return on the investment and charges fees. In the Discretionary
Portfolio Management Service, to maximise the yield, almost all portfolio
managers park the funds in the money market securities such as overnight market,
18 days treasury bills and 90 days commercial bills. Normally, the return of such
investment varies from 14 to 18 percent, depending on the call money rates
prevailing at the time of investment.

2. NON-DISCRETIONARY PORTFOLIO MANAGEMENT SERVICE

(NDPMS):

The manager functions as a counsellor, but the investor is free to accept or

reject the manager‘s advice; the paper work is also undertaken by manager for a
service charge. The manager concentrates on stock market instruments with a
portfolio tailor-made to the risk taking ability of the investor.

IMPORTANCE OF PORTFOLIO MANAGEMENT:

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  Emergence of institutional investing on behalf of individuals. A number of
financial institutions, mutual funds and other agencies are undertaking the
task of investing money of small investors, on their behalf.

 Growth in the number and size of investigable funds – a large part of

household savings is being directed towards financial assets.

 Increased market volatility – risk and return parameters of financial assets

are continuously changing because of frequent changes in government‘s
industrial and fiscal policies, economic uncertainty and instability.

 Greater use of computers for processing mass of data.

 Professionalization of the field and increasing use of analytical methods (e.g.

quantitative techniques) in the investment decision – making

 Larger direct and indirect costs of errors or shortfalls in meeting portfolio

objectives – increased competition and greater scrutiny by investors.

STEPS IN PORTFOLIO MANAGEMENT:

 Specification and qualification of investor objectives, constraints, and

preferences in the form of an investment policy statement.

 Determination and qualification of capital market expectations for the

economy, market sectors, industries and individual securities.

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  Allocation of assets and determination of appropriate portfolio strategies for
each asset class and selection of individual securities.

 Performance measurement and evaluation to ensure attainment of investor

objectives.

 Monitoring portfolio factors and responding to changes in investor

objectives, constrains and / or capital market expectations.

Rebalancing the portfolio when necessary by repeating the asset allocation,

portfolio strategy and security selection.

CRITERIA FOR PORTFOLIO DECISIONS:

 In portfolio management emphasis is put on identifying the collective

importance of all investors holdings. The emphasis shifts from individual
assets selection to a more balanced emphasis on diversification and risk-
return interrelationships of individual assets within the portfolio. Individual
securities are important only to the extent they affect the aggregate portfolio.
In short, all decisions should focus on the impact which the decision will
have on the aggregate portfolio of all the assets held.

 Portfolio strategy should be moulded to the unique needs and characteristics

of the portfolio‘s owner.
 Diversification across securities will reduce a portfolio‘s risk. If the risk and
return are lower than the desired level, leverages (borrowing) can be used to
achieve the desired level.

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  Larger portfolio returns come only with larger portfolio risk. The most
important decision to make is the amount of risk which is acceptable.

 The risk associated with a security type depends on when the investment
will be liquidated. Risk is reduced by selecting securities with a payoff close
to when the portfolio is to be liquidated.

Competition for abnormal returns is extensive, so one has to be careful in

evaluating the risk and return from securities. Imbalances do not last long and one
has to act fast to profit from exceptional opportunities.

QUALITIES OF PORTFOLIO MANAGER:

1. SOUND GENERAL KNOWLEDGE: Portfolio management is an

exciting and challenging job. He has to work in an extremely uncertain and
confliction environment. In the stock market every new piece of information
affects the value of the securities of different industries in a different way. He
must be able to judge and predict the effects of the information he gets. He must
have sharp memory, alertness, fast intuition and self-confidence to arrive at quick
decisions.

2. ANALYTICAL ABILITY: He must have his own theory to arrive at the

instrinsic value of the security. An analysis of the security‘s values, company, etc.
is s continuous job of the portfolio manager. A good analyst makes a good
financial consultant. The analyst can know the strengths, weaknesses,
opportunities of the economy, industry and the company.

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3. MARKETING SKILLS: He must be good salesman. He has to
convince the clients about the particular security. He has to compete with the stock
brokers in the stock market. In this context, the marketing skills help him a lot.

4. EXPERIENCE: In the cyclical behaviour of the stock market history is

often repeated, therefore the experience of the different phases helps to make
rational decisions. The experience of the different types of securities, clients,
market trends, etc., makes a perfect professional manager.

PORTFOLIO BUILDING:

Portfolio decisions for an individual investor are influenced by a wide

variety of factors. Individuals differ greatly in their circumstances and therefore, a
financial programme well suited to one individual may be inappropriate for
another. Ideally, an individual‘s portfolio should be tailor-made to fit one‘s
individual needs.

Investor‘s Characteristics:
An analysis of an individual‘s investment situation requires a study of
personal characteristics such as age, health conditions, personal habits, family
responsibilities, business or professional situation, and tax status, all of which
affect the investor‘s willingness to assume risk.

Stage in the Life Cycle:

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 One of the most important factors affecting the individual‘s investment
objective is his stage in the life cycle. A young person may put greater emphasis
on growth and lesser emphasis on liquidity. He can afford to wait for realization of
capital gains as his time horizon is large.

Family responsibilities:
The investor‘s marital status and his responsibilities towards other members of the
family can have a large impact on his investment needs and goals.

Investor‘s experience:
The success of portfolio depends upon the investor‘s knowledge and
experience in financial matters. If an investor has an aptitude for financial affairs,
he may wish to be more aggressive in his investments.

Attitude towards Risk:

A person‘s psychological make-up and financial position dictate his ability to
assume the risk. Different kinds of securities have diffferent kinds of risks. The
higher the risk, the greater the opportunity for higher gain or loss.

Liquidity Needs:
Liquidity needs vary considerably among individual investors. Investors
with regular income from other sources may not worry much about instantaneous
liquidity, but individuals who depend heavily upon investment for meeting their
general or specific needs, must plan portfolio to match their liquidity needs.
Liquidity can be obtained in two ways:

1. by allocating an appropriate percentage of the portfolio to bank deposits, and

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2. by requiring that bonds and equities purchased be highly marketable.

Tax considerations:
Since different individuals, depending upon their incomes, are subjected to
different marginal rates of taxes, tax considerations become most important factor
in individual‘s portfolio strategy. There are differing tax treatments for investment
in various kinds of assets.

Time Horizon:
In investment planning, time horizon become an important consideration. It is
highly variable from individual to individual. Individuals in their young age have
long time horizon for planning, they can smooth out and absorb the ups and downs
of risky combination. Individuals who are old have smaller time horizon, they
generally tend to avoid volatile portfolios.

Individual‘s Financial Objectives:

In the initial stages, the primary objective of an individual could be to
accumulate wealth via regular monthly savings and have an investment programme
to achieve long term capital gains.

Safety of Principal:
The protection of the rupee value of the investment is of prime importance to
most investors. The original investment can be recovered only if the security can
be readily sold in the market without much loss of value.

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Assurance of Income:
`Different investors have different current income needs. If an individual is
dependent of its investment income for current consumption then income received
now in the form of dividend and interest payments become primary objective.

Investment Risk:
All investment decisions revolve around the trade-off between risk and
return. All rational investors want a substantial return from their investment. An
ability to understand, measure and properly manage investment risk is fundamental
to any intelligent investor or a speculator. Frequently, the risk associated with
security investment is ignored and only the rewards are emphasized. An investor
who does not fully appreciate the risks in security investments will find it difficult
to obtain continuing positive results.

RISK AND EXPECTED RETURN:

There is a positive relationship between the amount of risk and the amount of
expected return i.e., the greater the risk, the larger the expected return and larger
the chances of substantial loss. One of the most difficult problems for an investor is
to estimate the highest level of risk he is able to assume.

 Risk is measured along the horizontal axis and increases from the left to
right.

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  Expected rate of return is measured on the vertical axis and rises from
bottom to top.

 The line from 0 to R (f) is called the rate of return or risk less investments
commonly associated with the yield on government securities.

 The diagonal line form R (f) to E(r) illustrates the concept of expected rate
of return increasing as level of risk increases.

TYPES OF RISKS:
Risk consists of two components. They are

1. Systematic Risk
2. Un-systematic Risk

1. Systematic Risk:

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 Systematic risk is caused by factors external to the particular company and
uncontrollable by the company. The systematic risk affects the market as a whole.
Factors affect the systematic risk are

 economic conditions
 political conditions
 sociological changes

The systematic risk is unavoidable. Systematic risk is further sub-divided into three
types. They are

a) Market Risk
b) Interest Rate Risk
c) Purchasing Power Risk

a). Market Risk:

One would notice that when the stock market surges up, most stocks post higher
price. On the other hand, when the market falls sharply, most common stocks will
drop. It is not uncommon to find stock prices falling from time to time while a
company‘s earnings are rising and vice-versa. The price of stock may fluctuate
widely within a short time even though earnings remain unchanged or relatively
stable.

b). Interest Rate Risk:

Interest rate risk is the risk of loss of principal brought about the changes in the
interest rate paid on new securities currently being issued.

c). Purchasing Power Risk:

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 The typical investor seeks an investment, which will give him current income and /
or capital appreciation in addition to his original investment.

2. Un-systematic Risk:

Un-systematic risk is unique and peculiar to a firm or an industry. The nature and
mode of raising finance and paying back the loans, involve the risk element.
Financial leverage of the companies that is debt-equity portion of the companies
differs from each other. All these factors Factors affect the un-systematic risk and
contribute a portion in the total variability of the return.
 Managerial inefficiently
 Technological change in the production process
 Availability of raw materials
 Changes in the consumer preference
 Labour problems

The nature and magnitude of the above mentioned factors differ from industry to
industry and company to company. They have to be analyzed separately for each
industry and firm. Un-systematic risk can be broadly classified into:
a) Business Risk
b) Financial Risk

a. Business Risk:

Business risk is that portion of the unsystematic risk caused by the operating
environment of the business. Business risk arises from the inability of a firm to
maintain its competitive edge and growth or stability of the earnings. The
volatibility in stock prices due to factors intrinsic to the company itself is known as

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 Business risk. Business risk is concerned with the difference between revenue and
earnings before interest and tax. Business risk can be divided into.

i). Internal Business Risk

Internal business risk is associated with the operational efficiency of the

firm. The operational efficiency differs from company to company. The efficiency
of operation is reflected on the company‘s achievement of its pre-set goals and the
fulfillment of the promises to its investors.

ii). External Business Risk

External business risk is the result of operating conditions imposed on the

firm by circumstances beyond its control. The external environments in which it
operates exert some pressure on the firm. The external factors are social and
regulatory factors, monetary and fiscal policies of the government, business cycle
and the general economic environment within which a firm or an industry operates.

b. Financial Risk:

It refers to the variability of the income to the equity capital due to the debt capital.
Financial risk in a company is associated with the capital structure of the company.
Capital structure of the company consists of equity funds and borrowed funds.

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 PORTFOLIO ANALYSIS:

Various groups of securities when held together behave in a different

manner and give interest payments and dividends also, which are different to the
analysis of individual securities. A combination of securities held together will
give a beneficial result if they are grouped in a manner to secure higher return after
taking into consideration the risk element.

There are two approaches in construction of the portfolio of securities. They

are

 Traditional approach
 Modern approach

TRADITIONAL APPROACH:

Traditional approach was based on the fact that risk could be measured on
each individual security through the process of finding out the standard deviation
and that security should be chosen where the deviation was the lowest. Traditional
approach believes that the market is inefficient and the fundamental analyst can
take advantage fo the situation. Traditional approach is a comprehensive financial
plan for the individual. It takes into account the individual needs such as housing,
life insurance and pension plans. Traditional approach basically deals with two
major decisions. They are

a) Determining the objectives of the portfolio

Selection of securities to be included in the portfolio

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MODERN APPROACH:
Modern approach theory was brought out by Markowitz and Sharpe. It is the
combination of securities to get the most efficient portfolio. Combination of
securities can be made in many ways. Markowitz developed the theory of
diversification through scientific reasoning and method. Modern portfolio theory
believes in the maximization of return through a combination of securities. The
modern approach discusses the relationship between different securities and then
draws inter-relationships of risks between them. Markowitz gives more attention to
the process of selecting the portfolio. It does not deal with the individual needs.

MARKOWITZ MODEL:
Markowitz model is a theoretical framework for analysis of risk and return
and their relationships. He used statistical analysis for the measurement of risk and
mathematical programming for selection of assets in a portfolio in an efficient
manner. Markowitz apporach determines for the investor the efficient set of
portfolio through three important variables i.e.

 Return
 Standard deviation
 Co-efficient of correlation

Markowitz model is also called as an “Full Covariance Model“. Through this

model the investor can find out the efficient set of portfolio by finding out the trade
off between risk and return, between the limits of zero and infinity. According to
this theory, the effects of one security purchase over the effects of the other
security purchase are taken into consideration and then the results are evaluated.
Most people agree that holding two stocks is less risky than holding one stock. For

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example, holding stocks from textile, banking and electronic companies is better
than investing all the money on the textile company‘s stock.
Markowitz had given up the single stock portfolio and introduced diversification.
The single stock portfolio would be preferable if the investor is perfectly certain
that his expectation of highest return would turn out to be real. In the world of
uncertainity, most of the risk adverse investors would like to join Markowitz rather
than keeping a single stock, because diversification reduces the risk.

ASSUMPTIONS:
 All investors would like to earn the maximum rate of return that they can
achieve from their investments.
 All investors have the same expected single period investment horizon.
 All investors before making any investments have a common goal. This is
the avoidance of risk because Investors are risk-averse.
 Investors base their investment decisions on the expected return and
standard deviation of returns from a possible investment.
 Perfect markets are assumed (e.g. no taxes and no transation costs)
 The investor assumes that greater or larger the return that he achieves on his
investments, the higher the risk factor surrounds him. On the contrary when
risks are low the rerturn can also be expected to be low.
 The investor can reduce his risk if he adds investments to his portfolio.
 An investor should be able to get higher return for each level of risk “by
determining the efficient set of securities“.

 An individual seller or buyer cannot affect the price of a stock. This

assumption is the basic assumption of the perfectly competitive market.

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  Investors make their decisions only on the basis of the expected returns,
standard deviation and covariances of all pairs of securities.
 Investors are assumed to have homogenous expectations during the decision-
making period
 The investor can lend or borrow any amount of funds at the riskless rate of
interest. The riskless rate of interest is the rate of interest offered for the
treasury bills or Government securities.
 Investors are risk-averse, so when given a choice between two otherwise
identical portfolios, they will choose the one with the lower standard
deviation.
 Individual assets are infinitely divisible, meaning that an investor can buy a
fraction of a share if he or she so desires.
 There is a risk free rate at which an investor may either lend (i.e. invest)
money or borrow money.
 There is no transaction cost i.e. no cost involved in buying and selling of
stocks.
There is no personal income tax. Hence, the investor is indifferent to the form of
return either capital gain or dividend.

THE EFFECT OF COMBINING TWO SECURITIES:

It is believed that holding two securities is less risky than by having only one
investment in a person‘s portfolio. When two stocks are taken on a portfolio and if
they have negative correlation then risk can be completely reduced because the
gain on one can offset the loss on the other. This can be shown with the help of
following example:

33
INTER- ACTIVE RISK THROUGH COVARIANCE:

Covariance of the securities will help in finding out the inter-active risk.
When the covariance will be positive then the rates of return of securities move
together either upwards or downwards. Alternatively it can also be said that the
inter-active risk is positive. Secondly, covariance will be zero on two investments
if the rates of return are independent.

Holding two securities may reduce the portfolio risk too. The portfolio risk
can be calculated with the help of the following formula:

CAPITAL ASSET PRICING MODEL (CAPM):

Markowitz, William Sharpe, John Lintner and Jan Mossin provided the basic
structure of Capital Asset Pricing Model. It is a model of linear general equilibrium
return. In the CAPM theory, the required rate return of an asset is having a linear
relationship with asset‘s beta value i.e. undiversifiable or systematic risk (i.e.
market related risk) because non market risk can be eliminated by diversification
and systematci risk measured by beta. Therefore, the relationship between an assets
return and its systematic risk can be expressd by the CAPM, which is also called
the Security Market Line.

Rp= Rf Xf+ Rm(1- Xf)

Rp = Portfolio return
Xf = The proportion of funds invested in risk free assets
1- Xf = The proportion of funds invested in risky assets
Rf = Risk free rate of return

34
 Rm = Return on risky assets

Formula can be used to calculate the expected returns for different situtions, like
mixing riskless assets with risky assets, investing only in the risky asset and
mixing the borrowing with risky assets.

THE CONCEPT:

According to CAPM, all investors hold only the market portfolio and risk
less securities. The market portfolio is a portfolio comprised of all stocks in the
market. Each asset is held in proportion to its market value to the total value of all
risky assets.

For example, if Satyam Industry share represents 15% of all risky assets, then the
market portfolio of the individual investor contains 15% of Satyam Industry
shares. At this stage, the investor has the ability to borrow or lend any amount of
money at the risk less rate of interest.
Eg.: assume that borrowing and lending rate to be 12.5% and the return from
the risky assets to be 20%. There is a trade off between the expected return and
risk. If an investor invests in risk free assets and risky assets, his risk may be less
than what he invests in the risky asset alone. But if he borrows to invest in risky
assets, his risk would increase more than he invests his own money in the risky
assets. When he borrows to invest, we call it financial leverage. If he invests 50%
in risk free assets and 50% in risky assets, his expected return of the portfolio
would be

Rp= Rf Xf+ Rm(1- Xf)

= (12.5 x 0.5) + 20 (1-0.5)
35
 = 6.25 + 10 = 16.25%

if there is a zero investment in risk free asset and 100% in risky asset, the return is
Rp= Rf Xf+ Rm(1- Xf)
= 0 + 20%
= 20%

if -0.5 in risk free asset and 1.5 in risky asset, the return is

Rp= Rf Xf+ Rm(1- Xf)

= (12.5 x -0.5) + 20 (1.5)
= -6.25+ 30
= 23.75%

EVALUATION OF PORTFOLIO:
Portfolio manager evaluates his portfolio performance and identifies the
sources of strengths and weakness. The evaluation of the portfolio provides a feed
back about the performance to evolve better management strategy. Even though
evaluation of portfolio performance is considered to be the last stage of investment
process, it is a continuous process. There are number of situations in which an
evaluation becomes necessary and important.

i. Self Valuation: An individual may want to evaluate how well he has done.
This is a part of the process of refining his skills and improving his
performance over a period of time.

36
ii. Evaluation of Managers: A mutual fund or similar organization might
want to evaluate its managers. A mutual fund may have several managers
each running a separate fund or sub-fund. It is often necessary to compare
the performance of these managers.

iii. Evaluation of Mutual Funds: An investor may want to evaluate the

various mutual funds operating in the country to decide which, if any, of
these should be chosen for investment. A similar need arises in the case of
individuals or organisations who engage external agencies for portfolio
advisory services.

Evaluation of Groups: Academics or researchers may want to evaluate the

performance of a whole group of investors and compare it with another group of
investors who use different techniques or who have different skills or access to
different information.

NEED FOR EVALUATION OF PORTFOLIO:

 We can try to evaluate every transaction. Whenever a security is brought or

sold, we can attempt to assess whether the decision was correct and
profitable.

 We can try to evaluate the performance of a specific security in the portfolio

to determine whether it has been worthwhile to include it in our portfolio.
 We can try to evaluate the performance of portfolio as a whole during the
period without examining the performance of individual securities within the
portfolio.

37
NEED & IMPORTANCE:

Portfolio management has emerged as a separate academic discipline in

India. Portfolio theory that deals with the rational investment decision-making
process has now become an integral part of financial literature.

Investing in securities such as shares, debentures & bonds is profitable well

as exciting. It is indeed rewarding but involves a great deal of risk & need artistic
skill. Investing in financial securities is now considered to be one of the most risky
avenues of investment. It is rare to find investors investing their entire savings in a
single security. Instead, they tend to invest in a group of securities. Such group of
securities is called as PORTFOLIO. Creation of portfolio helps to reduce risk
without sacrificing returns. Portfolio management deals with the analysis of
individual securities as well as with the theory & practice of optimally combining
securities into portfolios.

The modern theory is of the view that by diversification, risk can be reduced.
The investor can make diversification either by having a large number of shares of
companies in different regions, in different industries or those producing different
types of product lines. Modern theory believes in the perspective of combinations
of securities under constraints of risk and return.

PORTFOLIO REVISION:

The portfolio which is once selected has to be continuously reviewed over a

period of time and then revised depending on the objectives of the investor. The
care taken in construction of portfolio should be extended to the review and
38
revision of the portfolio. Fluctuations that occur in the equity prices cause
substantial gain or loss to the investors.

The investor should have competence and skill in the revision of the
portfolio. The portfolio management process needs frequent changes in the
composition of stocks and bonds. In securities, the type of securities to be held
should be revised according to the portfolio policy.

An investor purchases stock according to his objectives and return risk

framework. The prices of stock that he purchases fluctuate, each stock having its
own cycle of fluctuations. These price fluctuations may be related to economic
activity in a country or due to other changed circumstances in the market.

If an investor is able to forecast these changes by developing a framework for the

future through careful analysis of the behavior and movement of stock prices is in
a position to make higher profit than if he was to simply buy securities and hold
them through the process of diversification. Mechanical methods are adopted to
earn better profit through proper timing. The investor uses formula plans to help
him in making decisions for the future by exploiting the fluctuations in prices.

FORMULA PLANS:

The formula plans provide the basic rules and regulations for the purchase
and sale of securities. The amount to be spent on the different types of securities is
fixed. The amount may be fixed either in constant or variable ratio. This depends
on the investor‘s attitude towards risk and return. The commonly used formula
plans are

39
 i. Average Rupee Plan
ii. Constant Rupee Plan
iii. Constant Ratio Plan
iv. Variable Ratio Plan

ADVANTAGES:

 Basic rules and regulations for the purchase and sale of securities are
provided.

 The rules and regulations are rigid and help to overcome human emotion.

 The investor can earn higher profits by adopting the plans.

 A course of action is formulated according to the investor‘s objectives.

 It controls the buying and selling of securities by the investor.

 It is useful for taking decisions on the timing of investments.

DISADVANTAGES:

 The formula plan does not help the selection of the security. The selection of
the security has to be done either on the basis of the fundamental or
technical analysis.

 It is strict and not flexible with the inherent problem of adjustment.

40
  The formula plans should be applied for long periods, otherwise the
transaction cost may be high.

Even if the investor adopts the formula plan, he needs forecasting. Market
forecasting helps him to identify the best stocks.

ANALYSIS & INTERPRETION

CALCULATION OF AVERAGE RETURN OF COMPANIES:

Average Return = (R)/N

ITC LTD:

Opening Closing
share price share price (P1-P0)/
ear (P0) (P1) (P1-P0) P0*100
2002-2003 696.70 628.25 -68.45 -9.82
2003-2004 628.25 1043.10 414.85 66.03
2004-2005 1043.10 1342.05 298.95 28.66
2005-2006 1342.05 2932 1589.95 118.47
2006-2007 195.15 151.15 -44 -22.55

TOTAL RETURN 180.79

Average Return = 180.79/5 = 36.16

41
DR REDDY LABORATORIES LTD:

Opening Closing
share price share price (P1-P0)/
Year (P0) (P1) (P1-P0) P0*100
2002-2003 1090.95 916.30 -174.65 -16.00
2003-2004 916.30 974.35 58.2 6.33
2004-2005 974.35 739.15 23.52 -24.14
2005-2006 739.15 1,421.40 682.25 92.30
2006-2007 1,421.40 1456.55 35.15 2.47

TOTAL RETURN 60.96

Average Return = 60.96/5 = 12.19

ACC:

Opening Closing
share price share price (P1-P0)/
Year (P0) (P1) (P1-P0) P0*100
2002-2003 153.40 138.50 -14.19 -9.7
2003-2004 138.50 254.65 116.15 83.86
2004-2005 254.65 360.55 105.9 41.58
2005-2006 360.55 782.20 421.61 116.95
2006-2007 782.20 735.25 -46.95 -6.00

TOTAL RETURN 226.8

Average Return = 226.8/5 = 45.36

42
BHARAT HEAVY ELECTRICALS LTD:

Opening Closing
share price share price (P1-P0)/
Year (P0) (P1) (P1-P0) P0*100
2002-2003 169.00 223.15 54.15 32.04
2003-2004 223.15 604.35 38.12 170.83
2004-2005 604.35 766.40 162.05 26.81
2005-2006 766.40 2241.95 1475.55 192.53
2006-2007 2241.95 2261.35 19.4 0.87

TOTAL RETURN 423.08

Average Return = 423.08/5 = 84.62

HEROHONDA AUTOMOBILES LIMITED:

Opening Closing
share price share price (P1-P0)/
Year (P0) (P1) (P1-P0) P0*100
2002-2003 338.55 188.20 -150.35 -44.40
2003-2004 188.20 490.60 302.40 160.68
2004-2005 490.60 548.00 57.40 11.70
2005-2006 548.00 890.45 342.45 62.50
2006-2007 890.45 688.75 -20.17 -22.65

TOTAL RETURN 167.82

Average Return = 167.82/5 = 33.56

43
WIPRO:

Opening Closing
share price share price (P1-P0)/
Year (P0) (P1) (P1-P0) P0*100
2002-2003 1,700.60 1233.45 -467.15 -27.47
2003-2004 1,233.45 1361.20 127.75 10.36
2004-2005 1,361.20 2,012 650.8 47.87
2005-2006 670.95 559.7 -111.25 -16.58
2006-2007 559.70 559.40 -0.3 -0.05

TOTAL RETURN 14.13

Average Return = 14.13/5 = 2.83

CALCULATION OF STANDARD DEVIATION:

Standard Deviation = Variance

Variance = 1/n (R-R)2

ITC LTD:

Return Avg.
Year (R) Return (R) (R-R) (R-R)2
2002-2003 -9.82 36.16 -45.98 2114.16
2003-2004 66.03 36.16 29.87 892.22
2003-2004 28.66 36.16 -7.5 56.25
2004-2005 118.47 36.16 82.31 6775
2005-2006 -22.55 36.16 -58.71 3447

TOTAL 13284

Variance = 1/n (R-R)2 = 1/5 (13284) = 2656.8

Standard Deviation = Variance = 2656.8 = 51.54

44
DR. REDDY:

Return Avg.
Year (R) Return (R) (R-R) (R-R)2
2002-2003 -16.00 12.19 -28.19 795
2003-2004 6.33 12.19 -5.86 34
2004-2005 -24.14 12.19 -36.33 1320
2005-2006 92.30 12.19 80.11 6418
2006-2007 2,47 12.19 -9.72 94

TOTAL 8,661

Variance = 1/n-1 (R-R)2 = 1/5 (8,661) = 1732.2

Standard Deviation = Variance = 1732.2= 41.62

ACC:

Return Avg.
Year (R) Return (R) (R-R) (R-R)2
2002-2003 -9.7 45.36 -55.06 3032
2003-2004 83.86 45.36 38.5 1482
2004-2005 41.58 45.36 -3.78 13.69
2005-2006 116.95 45.36 71.59 5125
2006-2007 -6.00 45.36 -51.36 2638

TOTAL 12,291

Variance = 1/n-1 (R-R)2 = 1/5 (12,291) = 2458

Standard Deviation = Variance = 2458 = 49.58

45
WIPRO:

Return Avg.
Year (R) Return (R) (R-R) (R-R)2
2002-2003 -27.47 2.83 -30.29 917
2003-2004 10.36 2.83 7.53 57
2004-2005 47.87 2.83 45.04 2029
2005-2006 -16.58 2.83 -19.41 377
2006-2007 -0.05 2.83 -2.88 8

TOTAL 3388

Variance = 1/n-1 (R-R)2 = 1/5 (3388) = 847

Standard Deviation = Variance = 847

=33.09

BHEL:

Return Avg.
Year (R) Return (R) (R-R) (R-R)2
2002-2003 32.04 84.62 -52.58 2765
2003-2004 170.83 84.62 86.21 7432
2004-2005 26.81 84.62 -57.81 3342
2005-2006 192.53 84.62 107.91 11645
2006-2007 0.87 84.62 -83.75 7014

TOTAL 32,198

Variance = 1/n-1 (R-R)2 = 1/5 (32198) = 6440

Standard Deviation = Variance = 6440 = 80.25

46
HERO HONDA:

Return Avg.
Year (R) Return (R) (R-R) (R-R)2
2002-2003 -44.40 33.56 -77.97 6079
2002-2003 160.68 33.56 127.12 16160
2004-2005 11.70 33.56 -21.86 478
2005-2006 62.50 33.56 28.94 838
2006-2007 -22.65 33.65 -56.21 3160

TOTAL 26,715

Variance = 1/n-1 (R-R)2 = 1/5 (26,715) = 5343

Standard Deviation = Variance = 5343 = 73.09

CALCULATION OF CORRELATION:

Covariance (COV ab) = 1/n (RA-RA)(RB-RB)

Correlation Coefficient = COV ab/a*b

i. ACC (RA) & ITC (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -55.06 -45.98 2532
2003-2004 38.5 29.87 1149.99
2004-2005 -3.78 -7.5 28.35
2005-2006 71.59 82.31 5892.57
2006-2007 -51.36 -58.71 3015
TOTAL 12617.9

Covariance (COV ab) = 1/5 (12617.9) = 2523.58

Correlation Coefficient = COV ab/a*b

a = 49.57 ; b = 51.54
= 2523.58/(49.57)(51.54) = 0.98

47
ii) ACC (RA) & WIPRO (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -52.58 -77.97 4099.66
2003-2004 86.21 127.12 10959.01
2004-2005 -57.81 -21.86 1263.72
2005-2006 107.91 28.94 3122.91
2006-2007 -83.75 -56.21 4707.58

TOTAL 24152.88

Covariance (COV ab) = 1/5 (24152.88) = 4830.57

Correlation Coefficient = COV ab/a*b

a = 26 ; b = 41.62
= 4830.57/(80.25)(73.09) = 0.82

iii. WIPRO (RA) & DR REDDY (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -30.29 -28.19 853.87
2003-2004 7.53 -5.86 -44.12
2004-2005 44.98 -36.33 -1634.12
2005-2006 -19.41 80.11 -1554.93
2006-2007 -2.88 -9.72 27.99

TOTAL -2351.31

Covariance (COV ab) = 1/5 (-2351.31) = 470.26

Correlation Coefficient = COV ab/a*b
a = 26.00 ; b = 41.62
= -470.26/(26.00)(41.62) = -0.43

48
 v. ITC (RA) & BHEL (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -45.98 -52.58 2417.63
2003-2004 -29.87 86.21 -2575.09
2004-2005 -7,5 -57.81 -433.58
2005-2006 82.31 107.91 8882.07
2006-2007 -58.71 -83.75 4916.96

TOTAL 14075.15

Covariance (COV ab) = 1/5 (14075.15) = 2815.03

Correlation Coefficient = COV ab/a*b

a = 51.54 ; b = 80.25
= 2815.03/(51.54)(80.25) = 0.68

v. ACC (RA) & BHEL (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -55.06 -52.58 2895.05
2003-2004 38.5 86.21 3319.08
2004-2005 -3.7 -57.81 213.89
2005-2006 71.59 107.91 7725.27
2006-2007 -51.3 -83.75 4296.37

TOTAL 18449.66

Covariance (COV ab) = 1/5 (18449.66) = 3689.93

Correlation Coefficient = COV ab/a*b

a = 49.57 ; b = 80.25
49
= 18449.66/(49.57)(80.25) = 0.92

2. Correlation between ACC & other Companies:

i. ACC (RA) & HEROHONDA (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -55.06 -77.97 4293.02
2003-2004 38.5 127.12 4894.12
2004-2005 -3.78 -21.86 82.63
2005-2006 71.59 28.94 2071.81
2006-2007 -51.36 -56.21 2886.95

TOTAL 14228.53

Covariance (COV ab) = 1/5 (14228.53) = 2845.70

Correlation Coefficient = COV ab/a*b

a = 49.58 ; b = 73.04
= 2845.70/(49.57)(26.00) = 0.78

ii. ACC (RA) & WIPRO (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -55.06 -30.29 1667.77
2003-2004 38.5 7.53 289.90
2004-2005 -3.78 44.98 -170.02
2005-2006 71.59 -19.41 -1389.56
2006-2007 -51.36 -2.88 147.91

TOTAL 546

Covariance (COV ab) = 1/5 (546) = 109.2

Correlation Coefficient = COV ab/a*b

50
 a = 49.57; b = 26.00
= 109.2/(49.57)(26.00) = 0.08

iii. ACC (RA) & DR REDDY (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -55.06 -28.19 552.14
2003-2004 38.5 -5.86 -225.61
2004-2005 -3.78 -36.33 137.33
2005-2006 71.59 80.11 5735.07
2006-2007 -51.36 -9.72 499.21

TOTAL 7698.14

Covariance (COV ab) = 1/5 (7698.14) = 1539.63

Correlation Coefficient = COV ab/a*b

a = 49.57 ; b = 41.62
= 1539.63/(49.57)(41.62) = 0.74

iv. ITC (RA) & HERO HONDA (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -45.98 -77.97 3585.06
2003-2004 29.87 127.12 3797.07
2004-2005 -7.5 -21.86 163.95
2005-2006 82.31 28.94 2382.05
2006-2007 -58.71 -56.21 3300.08

TOTAL 13228.21

Covariance (COV ab) = 1/5 (13228.21) = 2645.64

Correlation Coefficient = COV ab/a*b

a = 51.54 ; b = 73.09

51
 = 2645.64/(51.54)(73.09) = 0.70

3. Correlation Between DR REDDY & Other Companies

i. ITC(RA) & WIPRO:

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -16.024 -10.89 174.50
2002-2003 -26.574 -46.94 1,247.38
2003-2004 -3.684 -8.7 32.05
2004-2005 -34.724 -26.98 936.85
2005-2006 81.006 93.53 7,576.49

TOTAL 9,967.28

Covariance (COV ab) = 1/5-1 (9967.28) = 2491.82

Correlation Coefficient = COV ab/a*b


a = 46.75 ; b = 54.48
= 2491.82/(46.75)(54.48) = 0.978

ii. DR. REDDY (RA) & &ITC (RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -28.19 -45.98 1296.17
2003-2004 -5.86 29.87 -175.03
2004-2005 -36.33 -7.5 272.47
2005-2006 80.11 82.31 6593.85
2006-2007 -9.72 -58.71 570.66

TOTAL 8558.12

Covariance (COV ab) = 1/5 (8558.12) = 1711.62

Correlation Coefficient = COV ab/a*b

a = 41.62 ; b = 51.54
52
 = 1711.62/(41.62)(51.54) = 0.79

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -28.19 -77.97 2197.97
2003-2004 -5.86 127.12 744.92
2004-2005 -36.33 -21.86 794.17
2005-2006 80.11 28.94 2318.38
2006-2007 -9.72 -56.21 546.36

TOTAL 6601.8

iv. DR REDDY (RA) &HEROHONDA(RB)

Covariance (COV ab) = 1/5 (6601.8) = 1320.36

Correlation Coefficient = COV ab/a*b

a = 41.62 ; b = 73.09
= 1320.36/(41.62)(73.09)
= 0.43
4. Correlation Between HLL & Other Companies

i. HEROHONDA (RA) & WIPRO(RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -77.97 -30.29 2361.71
2003-2004 127.12 7.53 957.21
2004-2005 -21.86 45.04 -984.57
2005-2006 28.94 -19.41 -561.72
2006-2007 -56.21 -2.88 161.88

TOTAL 1934.51

Covariance (COV ab) = 1/5 (1934.51) = 386.90

53
Correlation Coefficient = COV ab/a*b
  a = 73.09; b = 26.00
= 386.90/(73.09)(26.00) = 0.20
ii. DR REDDY (RA) & BHEL(RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -28.19 -52.58 1482.23
2003-2004 -5.86 86.21 -505.19
2004-2005 -36.33 -57.81 2100.24
2005-2006 80.11 107.91 8644.67
2006-2007 -9.72 -83.75 814.05

TOTAL 12536

Covariance (COV ab) = 1/5 (12536) = 386.90

Correlation Coefficient = COV ab/a*b

a = 41.62; b = 80.25
= 2507.2/(41.62)(80.25) = 0.93

5. CORRELATION BETWEEN BHEL(RA) & WIPRO(RB)

YEAR (RA-RA) (RB-RB) (RA-RA) (RB-RB)

2002-2003 -52.58 -30.29 1592.65
2003-2004 86.21 7.53 649.16
2004-2005 -57.81 45.04 -2603.76
2005-2006 107.91 -19.41 -2094.53
2006-2007 -83.75 -2.88 241.2

TOTAL -2215.28

Covariance (COV ab) = 1/5 (-2215.28) = -443.05

Correlation Coefficient = COV ab/a*b

54
 a = 80.25; b = 26.00
= -443.05/(80.25)(26.00) = -0.21

CALCULATION OF PORTFOLIO WEIGHTS:

FORMULA :

Wa = b [b-(nab*a)]
a2 + b2 - 2nab*a*b

Wb = 1 – Wa

CALCULATION OF WEIGHTS OF ITC & OTHER COMPANIES:

i. ITC(a) & WIPRO (b)

a = 51.54
b = 26.00
nab = -0.02

Wa = 26.00 [26.00-(-0.02*51.54)]
2 + 2 – 2(-0.02)**
Wa = 690
3386
Wa = 0.20

Wb = 1 – Wa
Wb = 1-0.20 = 0.8

ii. HEROHONDA(a) & WIPRO(b)

a = 73.09

55
 b = 26.00
nab = 0.20

Wa = 26.00 [26.00-(0.20*73.09)]
2 + 2 – 2(0.20)**
Wa = 296
5258
Wa = 0.05

Wb = 1 – Wa
Wb = 1-0.05 = 0.95

CALCULATION OF WEIGHTS OF BHEL & WIPRO:

a = 80.25
b = 26.00
nab = -0.21

Wa = 26.00 [26.00-(-0.21*80.25)]
2 + 2 – 2(-0.21)**
Wa = 1114
7992
Wa = 0.14

Wb = 1 – Wa
Wb = 1-0.14 = 0.86

CALCULATION OF WEIGHTS OF WIPRO & OTHE COMPANIES:

i. ACC (a) & ITC (b):

a = 49.57
b = 51.54
56
 nab = 0.98

Wa = 51.54 [-(0.98*)]
2 + 2 – 2(0.98)**
Wa = 152
106
Wa = 1.43

Wb = 1 – Wa
Wb = 1-1.43 = - 0.43

ii. BHEL (a) & HEROHONDA (b)

a = 80.25
b = 73.09
nab = 0.82

Wa = 73.09 [73.09-(0.82*)]
2 + 2 – 2(0.82)**

Wa = 533
2163
Wa = 0.24

Wb = 1 – Wa
Wb = 1-0.24 = 0.76

iii. WIPRO (a) & DR REDYY (b)

a = 26.00
b = 41.62
nab = -0.43

Wa = 41.62 [-(-0.43*)]
57
 2 + 2 – 2(-0.43)**
Wa = 2198
1477
Wa = 1.49

Wb = 1 – Wa
Wb = 1-1.49 = -0.49

iv. ITC (a) & BHEL (b)

a = 51.54
b = 80.25
nab = 0.68

Wa = 80.25 [80.25-(0.68*)]
 + 2 – 2(0.68)**
2

Wa = 3628
3471
Wa = 1.04

Wb = 1 – Wa
Wb = 1-1.04 =0.04

v. ACC (a) & BHEL (b)

a = 49.57
b = 80.25
nab = 0.92

Wa = 80.25 [80.25-(0.92*)]
2 + 2 – 2(0.92)**
58
 Wa = 2781
1577
Wa = 1.76

Wb = 1 – Wa
Wb = 1-1.76 = -0.76

CALCULATION OF WEIGHTS OF ACC & OTHER COMPANIES:

iii. ACC (a) & HEROHONDA (b)

a = 49.57
b = 73.09
nab = 0.78

Wa = 73.09 [73.09-(0.78*49.57)]
 + 2 – 2(0.78)**
2

Wa = 2516
2148
Wa = 1.17

Wb = 1 – Wa
Wb = 1-1.17 = -0.17

iv. ACC(a) & WIPRO (b)

a = 49.57
b = 26.00
nab = 0.08

Wa = 26.00 [26.00-(0.08*49.57)]
2 + 2 – 2(0.08)**
Wa = 573
59
 2927
Wa = 0.19

Wb = 1 – Wa
Wb = 1-0.19 = 0.81

v. ACC (a) & DR REDDY (b)

a = 49.57
b = 41.62
nab = 0.74

Wa = 41.62 [41.62-(0.74*49.57)]
 + 2 – 2(0.74)**
2

Wa = 206
1136
Wa = 0.18

Wb = 1 – Wa
Wb = 1-0.18 = 0.82

vi. ITC(a) & HERO HONDA (b)

a = 51.54
b = 73.09
nab = 0.70

Wa = 73.09 [73.09-(0.70*51.54)]
2 + 2 – 2(0.70)**
Wa = 2706
2724
Wa = 0.99
60
 Wb = 1 – Wa
Wb = 1-0.99 = 0.01

CALCULATION OF WEIGHTS OF DRREDDY & OTHER

COMPANIES:

vii. DRREDDY (a) & ITC (b)

a = 41.62
b = 51.54
nab = 0.79

Wa = 51.54 [51.54-(0.79*41.62)]
2 + 2 – 2(0.79)**
Wa = 962
999
Wa = 0.96
Wb = 1 – Wa
Wb = 1-0.96 = 0.04

viii. DRREDDY (a) & HEROHONDA (b)

a = 41.62
b = 73.09
nab = 0.43

Wa = 73.09 [73.09-(0.43*41.62)]
2 + 2 – 2(0.43)**
Wa = 4034
4458
Wa = 0.90

Wb = 1 – Wa
Wb = 1-0.90 = 0.10
61
 ix. DRREDDY (a) & BHEL (b)

a = 41.62
b = 80.25
nab = 0.75

Wa = 80.25 [80.25-(0.75*41.62)]
 + 2 – 2(0.75)**
2

Wa = 3935
3162
Wa = 1.24

Wb = 1 – Wa
Wb = 1-1.24 = -0.24

CALCULATION OF PORTFOLIO RISK:

RP = a2*Wa2 + b2*Wb2 + 2nab*a*b*Wa*Wb

CALCULATION OF PORTFOLIO RISK OF WIPRO & OTHER

COMPANIES:

i. Wipro (a) & ITC (b):

a = 33.09
b = 56.09
= 2/3
= 1/3
Nab = 0.98

RP = (2/3)2(49.57)2+(2(0.51.54)2+2(49.57)**(2/3)*(1/3)
62

 2505 = 50.04


ii. BHEL (a) & HEROHONDA (b):

a = 80.25
b = 73.09
= 2/3
= 1/3
nab = 0.82

RP = (2/3)2(80.25)2+(1/32(73.09)2+2(80.25)**(2/3)*(1/3)

 5613 = 74.91

iii. WIPRO (a) & DR REDDY (b):

a = 41.62
b = 26.00
= 2/3
= 1/3
nab = 0.43

RP = (2/3)2(41.62)2+(1/32(26.00)2+2(41.62)**(2/3)*(1/3)

 647 = 25.43

iv. ITC (a) & BHEL (b):



a = 51.54
b = 80.25
= 1/3
= 2/3
nab = 0.68

63
 RP = (1/3)2(51.54)2+(2/32(80.25)2+2(51.54)**(2/3)*(1/3)

 4434 = 66.58

v. ACC (a) & BHEL (b):



a = 49.57
b = 80.25
= 2/3
=1/3
nab = 0.92

RP = (2/3)2(49.57)2+(1/32(80.25)2+2(49.57)**(2/3)*(1/3)

 4786 = 69.18

I. CALCULATION OF PORTFOLIO RISK OF ACC & OTHER

COMPANIES
vi. ACC(a) & HEROHONDA(b):


a = 49.57
b = 73.09
= 2/3
= 1/3
nab = 0.78

RP = (2/3)2(49.57)2+(1/32(73.09)2+2(49.57)**(2/3)*(1/3)

 2944 = 54.25

vii. ACC (a) & WIPRO (b):

64
 

a = 49.57
b = 26.00
= 2/3
= 1/3
nab = 0.08

RP = (2/3)2(49.57)2+(1/32(26.00)2+2(49.57)**(2/3)*(1/3)

 1226 = 35.01

viii. ACC (a) & DR REDDY (b):



a = 49.57
b = 41.62
= 2/3
= 1/3
nab = 0.74

RP = (2/3)2(49.57)2+(1/32(41.62)2+2(49.57)**(2/3)*(1/3)

 1972 = 44.40

ix. ITC (a) & HEROHONDA (b):



a = 51.54
b = 73.09
= 2/3
= 1/3
nab = 0.70

RP = (2/3)2(51.54)2+(1/32(73.09)2+2(51.54)**(2/3)*(1/3)

 2949 = 54.30
65
 II. CALCULATION OF PORTFOLIO RISK OF DR REDDY &
OTHER COMPANIES

x. DRREDDY (a) & ITC (b):



a = 41.62
b = 51.54
= 1/3
= 2/3
nab = 0.79

RP = (1/3)2(41.62)2+(2/32(51.54)2+2(41.62)**(2/3)*(1/3)

 2135 = 46.2

xi. DRREDDY (a) & HEROHONDA (b):



a = 41.62
b = 73.09
= 1/3
= 2/3
nab = 0.43

RP = (1/3)2(41.62)2+(2/32(73.09)2+2(41.62)**(2/3)*(1/3)

 3172 = 56.32

xii. DRREDDY (a) & BHEL (b):



a = 41.62
b = 80.25
= 1/3
= 2/3
66
 nab = 0.878

RP = (1/3)2(41.62)2+(2/32(80.25)2+2(41.62)**(2/3)*(1/3)

 4197 = 64.78

III. CALCULATION OF PORTFOLIO RISK OF ITC & OTHER

COMPANIES

xiii. ITC (a) & WIPRO (b):



a = 51.54
b = 26.00
= 2/3
= 1/3
nab = -0.02

RP = (2/3)2(51.54)2+(1/32(26.00)2+2(51.54)**(2/3)*(1/3)

 1281 = 35.79

xiv. HEROHONDA (a) & WIPRO (b):



a = 73.09
b = 26.00
= 2/3
= 1/3
nab = 0.20

RP = (2/3)2(73.09)2+(1/32(26.00)2+2(73.09)**(0.67)*(0.33)


67
  2646 = 51.44

IV. CALCULATION OF PORTFOLIO RISK OF BHEL (a) &WIPRO

(b)

a = 80.25
b = 26.00
=2/3
=1/3
nab = -0.21

RP = (2/3)2(80.25)2+(1/32(26.00)2+2(80.25)**(2/3)*(1/3)

 2778 = 52

68
 CONCLUSION

For any investment the factors to be considered are the return

on the investment and the risk associated with that investment.

Diversification in the investment into different assets can

reduce the risk. There fore by following modern portfolio theorem,
risk can be reduced for a required return

69