ESTIMATION OF BETA & IT’S SIGNIFICANCE

STUDY GROUP A9:SRITAM KUMAR DASHTAPABRATA BANERJEEDEBARATI RAYANURADHA KUMARI

OUTLINES

•Introduction•Theoretical background of the concept•Objectives•Companies Profile•Methodology•Analysis•Conclusion •References

INTRODUCTION

• A financial decision typically involves risk. For example, a company that borrows money faces the risk that interest rates may change, and a company that builds a new factory faces the risk that product sales may be lower than expected. These and many other decisions involve future cash flows that are risky. Investors generally dislike risk, but they are also unable to avoid it . To make effective financial decisions, managers need to understand what causes risk, how it should be measured and the effect of risk on the rate of return required by investors. These issues are discussed using the framework of portfolio theory, which shows how investors can maximize the expected return on a portfolio of risky assets for a given level of risk.

THEORETICAL BACK GROUND OF THE CONCEPT

• A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual fund, exchange-traded fund and closed-fund counterparts.

• A portfolio is planned to stabilize the risk of non-performance of various pools of investment.

• Portfolio Management (PM) guides the investor in a method of selecting the best available securities that will provide the expected rate of return for any given degree of risk and also to mitigate (reduce) the risks. It is a strategic decision which is addressed by the top-level managers.

BETA

• In finance, the beta (β) of a stock or portfolio is a number describing how the return of an asset is predicted by a benchmark. This benchmark is generally the overall financial market and is often, estimated via the use of representative indices. Beta measures systematic risk based on how returns co-move with the overall market.

Interpretations of beta

Value of Beta Interpretations

• β < 0

• β = 0

• 0 < β < 1

• β = 1

• β > 1

• Asset generally moves in the opposite direction as compared to the index

• Movement of the asset is uncorrelated with the movement of the benchmark

• Movement of the asset is generally in the same direction as, but less than the movement of the benchmark

• Movement of the asset is generally in the same direction as, and about the same amount as the movement of the benchmark

• Movement of the asset is generally in the same direction as, but more than the movement of the benchmark

Interpretations of beta

• β < 0

• β = 0

• 0 < β < 1

• β = 1

• β > 1

• An inverse exchange traded fund or a short position

• Fixed-yield asset, whose growth is unrelated to the movement of the stock market

• Stable, "staple" stock such as a company that makes soap. Moves in the same direction as the market at large, but less susceptible to day-to-day fluctuation.

• A representative stock, or a stock that is a strong contributor to the index itself.

• Stocks which are very strongly influenced by day-to-day market news, or by the general health of the economy.

OBJECTIVE

• The beta or betas that measure risk in models of risk in finance have two basic characteristics that we need to keep in mind during estimation.

• The first is that they measure the risk added on to a diversified portfolio, rather than total risk. Thus, it is entirely possible for an investment to be high risk, in terms of individual risk, but to below risk, in terms of market risk.

• The second characteristic that all betas share is that they measure the relative risk of an asset, and thus are standardized around one.

COMPANY PROFILE

STATE BANK OF INDIA:

• State Bank of India (SBI) is a multinational banking and financial services company based in India. It is a government-owned corporation with its headquarters in Mumbai, Maharashtra. As of December 2013, it had assets of US$388 billion and 16,000 branches, including 190 foreign offices, making it the largest banking and financial services company in India by assets

• SBI is a regional banking behemoth and has 20% market share in deposits and loans among Indian commercial banks.

• SBI had 14,816 branches in India, as on 31 March 2013, of which 9,851 (66%) were in Rural and Semi-urban areas. In the financial year 2012-13, its revenue was INR 200,560 Crores (US$ 36.9 billion), out of which domestic operations contributed to 95.35% of revenue. Similarly, domestic operations contributed to 88.37% of total profits for the same financial year.

 

INFOSYS LTD:• Infosys (formerly Infosys Technologies) is an Indian multinational provider of

business consulting, information technology, software engineering and outsourcing services.

• Infosys is the third-largest India-based IT services company by 2012 revenues, and the second largest employer of H-1B visa professionals in the United States, as of 2012. On 28 March 2013, its market capitalisation was $30.8 billion, making it India's sixth largest publicly traded company.

• During July 2003, June 2005 and November 2006, it made secondary ADS issues of US $294 million, US $1.07 billion and US $ 1.605 billion respectively.

• In December 2012, Infosys transferred the listing of its American Depositary Shares (ADS) from the NASDAQ to the NYSE.

• The credit rating of the company is A- (given by Standard & Poor's on 13-Dec-2013).

METHODOLOGY

At first we estimated the risk and return of the two companies.

Then we formed 5 portfolios using the stocks of two companies and estimated the risk and return of the portfolios.

Beta of the two companies was determined using graphical analysis.

Minimum risk portfolio was found out using beta portfolio method.

 

Company Expected Return Risk

•SBI -0.099935723 1.98237

•Infosys 0.198421317 2.235288

•Correlation -0.050470076

Portfolio Risk and Return

Beta calculationBeta for SBI:Beta-1.1266

-10 -5 0 5 10 15

-10

-5

0

5

10

15

f(x) = 1.12659092513161 x − 0.1460890803453

Beta SBI

Beta(Infosys)=0.5361

-25 -20 -15 -10 -5 0 5 10 15 20

-25

-20

-15

-10

-5

0

5

10

15

20

f(x) = 0.536067111500166 x + 0.176460110003434

Beta Infosys

Portfolio Beta• Beta(SBI)=1.126591

• Beta(Infy)=0.536067

• W1(Beta(SBI))+W2(Beta(Infy))=1

• W1(1.12659)+W2(0.536067)=1

• We know W1+W2=1

• So Putting W2=1-W1 we get,

• W1=0.785629=79%

• W2=1-W2=0.214371=21%

Portfolio Beta

-8 -6 -4 -2 0 2 4 6 8

-8

-6

-4

-2

0

2

4

6

8

f(x) = 1.00258092426901 x − 0.0783537503720655

Portfolio Beta

ANALYSIS

State Bank Of India Stock Risk and return:

• The average return percentage is -0.10 % and the risk percentage is 1.990369369% with a C.V of -19.83650951.

• SBI witnessing a negative average return, losing on the revenue growth over the last 5 years and it has lost 3.5% market share to its competitors. SBI is also missing on targets sets.

Infosys Ltd Stock Risk and return

• The average return percentage is 0.198% which is negative and a risk percentage of 2.235% with a C.V of 11.265.Infosys had been in loss for more than 2 to 3 consecutive years. But now with the return of its founder Dr. Naryan Murthy it has started to rise again and gaining profit and will retain its top position what it had previously in the IT sector.

RISK AND RETURN IN CASE OF THE PORTFOLIO

• Portfolio reduces the effect of risk associated with the individual stocks. Here the portfolio is prepared by investing 50% of SBI and 50% of INFOSYS ; portfolio of 40% of SBI and 60 % of INFOSYS; portfolio of 60% of SBI and 40 % of INFOSYS; portfolio of 80% of SBI and 20 % of INFOSYS; portfolio of 20% of SBI and 80 % of INFOSYS.

• So in this case the 40% of SBI and 60% of INFOSYS shows that it has a C.V of 19.26% higher than the portfolio of 20 % SBI and 80 % INFOSYS (13.05%). Always a least C.V is preferred as portfolio. Portfolio doesn’t fluctuate as like individual assets. The entire risk can’t be eliminated altogether but the risk of a portfolio would be less as compared to individual securities risk. So, the 5th portfolio is preferred.

BETA FOR SBI STOCK BETA FOR INFOSYS STOCK

• The beta value for SBI is 1.12, so a beta greater than 1 shows that the stock has high systematic risk and will on average go up by a larger percentage than the market goes up and of course will on average go down by greater percentage when the market goes down.

• The beta value for INFOSYS is 0.53 and a beta value of less than 1 show that it has less systematic risk less than the market and an expected return less than the market.

PORTFOLIO BETA

• Using the beta of SBI and beta of INFOSYS the portfolio beta found out which is found out to be 79% of SBI and 21% INFOSYS stock which is the optimal portfolio where to be invested which has minimum systematic risk.

CONCLUSION• The present project work has been undertaken to study the risk-return

relationship of individual securities, risk and return relationship of a portfolio as well as beta. As this project work is done by studying two individual stocks of Sensex, there is much scope for the analysis, interpretation and conclusion. When there is higher risk associated with a stock there is always higher return and when beta is greater than 1 the stock moves in the same direction as of market. As the economy fluctuates very badly, the stock prices are affected by these fluctuations and the market has become so volatile in this situation investors should be very careful.