manjunath thunga

7/28/2019 Manjunath Thunga

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PORTFOLIO MANAGEMENT AND INVESTMENT DECISIONS

EXAM NO: MBA04004011 ROLL NO: 419

KARNATAK UNIVERSITY

DHARWAD

B.V.V.SANGHAS

INSTITUTE OF MANGEMENT STUDIES

BAGALKOT

A PROJECT REPORT ON


AT HYDERABAD STOCK EXCHANGE

HYDERABAD

Submitted in partial fulfillment for the degree of Master of Business Administration.

COMPANY GUIDE INSTITUTE GUIDE

T.S.V.PRASAD Prof. PRAMOD. S.G.

Submitted by

THUNGA MANJUNATHMBA IIYEAR

B.V.V. SANGHAS INSTITUTE OF MANAGEMENT STUDIES,BAGALKOT


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DECLARATION

I, THUNGA MANJUNATH declare that this project titled PORTFOLIO

MANAGEMENT AND INVESTMENT DECISIONS at Hyderabad Stock

Exchange, is my original work & is being submitted to Karnatak University for the

partial fulfillment for the award of M. B. A. During the year 2004 2006.

I also declare that this project is not copied and is not submitted by any other person

before.

Yours faithfully

Place:

Date:(THUNGA MANJUNATH)


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ACKNOWLEDGEMENT

I take this opportunity to express my sincere thanks to Mr S.SARVESWAR REDDY, EXECUTIVE DIRECTOR ofHyderabad Stock Exchange Ltd for giving me an opportunity to dothis project.

I thank Mr. CHANDRAMOULI. CEO of Hyderabad Stock

Exchange Ltd and Mr.T.S.V. PRASAD, Program Co-ordinationfaculty for giving me valuable information. And would speciallylike to thank Mr. MALLESWAR, for his co-operation in

providing various materials for my project.

I thank Director of our Institute Mr.A.V. KAPILESHWAR forhelping me in this project.

My special thanks to Mr. RAJA SHEKAR, for his motivation,guidance and assistance in completion of this project.

Also, I express thanks to my internal guide Prof: Pramod.S.G forhis valuable suggestion in completion of this project.

Finally, I thank all my friends who shared the valuableinformation, views and their ideas.


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CONTENTS

1. Executive summary.

2. Introduction to Portfolio Management

3. Stock Exchange in India

4. Company profile of HSE

5. Portfolio Management

Objectives

Need for portfolio management

Elements of portfolio management

6. Investment Decisions and process

7. Markowitz model

8. Analysis

9. Pie diagrams

10. Recommendations

11. Conclusions

12. Bibliography


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EXECUTIVE SUMMARY

Investment is one of the most fruitful, ever-changing and exciting dimensions of our

lives. Investment is an activity by which we employ our savings in a profitable venture to

earn a higher and regular return.

Portfolio is a combination of securities. Portfolio is constructed in such a manner to

meet the investors goals and objectives. Investors should decide how best to reach the goals

with the securities available and try to maximum return with minimum risk by diversifyinghis portfolio and allocate funds among the securities.

Purpose of the Study:

The purpose of the study is to find out at what percentage of investment should be

invested between two companies, on the basis of risk and return of each security in

comparison. These percentages help in allocating the funds available for investment based on

risky portfolios.

OBJECTIVES:

The main objective of the study is to diversify from different securities to maximize

the return to the investors and to minimize the risk involved in investment.

The secondary objectives are:

a) Regular returnb) Appreciation of capital

c) More liquidity

d) Safety of investment


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Methodology of the study:

For methodology of the study, ten securities or stocks constituting the Senses Market

are selected of one month closing share movement prices data from websites dated from 1st

June 2005 to 30th June 2005.

In order to know the risk of the stock or security, I used the standard deviation, and for the

comparison of the stocks or securities of two companies with each other by using the

correlation co-efficient, and for the construction of the optimal portfolio on the basis of whatpercentage of investment should be invested when two securities are combined i.e.

calculation of two assets portfolio by using minimum variance equation. And final step is to

calculate the portfolio risk that shows how much is the risk is reduced by combining two

stocks.

Some of the important findings of my study are:

According to the study on portfolio management and investment decisions, I find out

that BHEL and RELIANCE Securities are having more returns with higher portfolio

risk.

And SBI and JINDAL, SBI and WIPRO Securities having moderate returns with the

moderate portfolio risk.

Finally the RAYMOND and HLL Securities having low returns with the low

portfolio risk.


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INTRODUCTION TO PORTFOLIO MANAGEMENT

Portfolio is a combination of securities that have return and risk characteristics of

their own; portfolio may not take on the aggregate characteristics of their individual parts.

Thus, a portfolio is a combination of various assets and/or instruments of investments. The

combination may have different features of risk and return separate from those of the

components. The portfolio is also built up of the wealth or income of the investor over a

period of time with a view to suit is return or risk preferences to that of the portfolio that he

holds. The portfolio analysis is thus an analysis of risk return characteristics of individualsecurities in the portfolio and changes that may take place in combination with other

securities due interaction among them and impact of each one them on others.

Security analysis is only a tool for efficient portfolio management; both of them go

together and cannot be dissociated. Portfolios are combination of assets held by the investors.

These combinations may be various assets classed like equity and debt or of different issues

like Govt. bonds and corporate debts are of various instruments like discount bonds,

debentures and blue chip equity nor scripts of emerging blue chip companies.

Portfolio analysis includes portfolio constructions, selection of securities, and

revision of portfolio evaluation and monitoring of the performance of the portfolio. All these

are part of the portfolio management.


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STOCK EXCHANGES

The investor wants liquidity for their investments. The securities, which they hold

should easily be sold when they need cash. Similarly, there are others who want to invest in

new securities. There should be a place where the securities need to be sold and purchased.

Stock Exchanges provide a place where securities of different companies can be purchased

and sold. Stock Exchange is a body of persons, whether incorporated or not, formed, with a

view to help, regulate and control the business of buying and selling securities.

Stock Exchanges are organized and regulated markets for various securities issued by

corporate sector and other institutions. The Stock Exchanges enable flexible purchase and

sale of securities as commodity exchanges allow trading in commodities.

Stock Exchanges are an integral part of nations economic life. By virtue of holding

the responsibility of mobilizing savings of small and big investors and allocating them to the

business firms and for the entrepreneurs, towards productive investment. The following

definitions explain the meaning and scope of Stock Exchanges.

DEFINITION:

According to the securities contract act, 1956

Stock Exchange means any body of individuals, whether incorporated or not,

constituted for the purpose of assisting, regulating or controlling the business of buying and

selling in securities


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CHARACTERISTICS OF STOCK EXCHANGES:

The following are some of the salient features of Stock Exchange:

It is a place where securities are purchased and sold.

A Stock Exchange is an association of persons whether incorporated or not.

The trading in an exchange is strictly regulated and rules and regulations are

prescribed for various transactions.

Both genuine investors and speculators buy and shell shares.

The securities of corporations, trusts, governments, municipal corporations, etc., are

allowed to deal at Stock Exchanges.

LISTING OF SECURITIES:

The term listing means admission of securities of a company to dealing on a

recognized Stock Exchange. Listed securities are also known as quoted securities. With

effect from 13th February 1989, any company can list, de-list and re-list its securities by

paying a stipulated fee, provided its equity capital is at least Rs. 3 crore, and at least Rs.1.8

crore (i.e., 60%) of its capital is offered for public subscription.

The main purpose for listing requirement is:

To ensure proper supervision and control of dealing in securities.

To protect the interests of shareholders and general investors

To avoid the concentration of economic power

To give promoters an opportunity to invest sufficiently in the company for their self-

benefit To require promoters to have a reasonable stake in the company.


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The securities of an entity may be listed at any of the following stages:

At the time of public issue of shares/debentures At the time of right issue of shares/debentures

At the time of bonus issue

Shares issued on amalgamations/mergers.

ROLE AND FUNCTIONS OF STOCK EXCHANGE

The Stock Exchange plays important role in the economic development of a country. Theimportance of Stock Exchange will be clear from the functions they perform:

1. Ensures liquidity of capital:

The exchanges provide a ready market where buyers and sellers are always available

and those who are in need of hard cash can sell their holdings. Had this not been possible

then many persons would have feared for blocking their savings in securities. It is because of

exchanges that many persons invest in securities and they can again convert them into cash.

Continuous market for securities:

The securities once listed continue to be traded at the exchange irrespective of the fact that

their owners changing, thus it provides a regular market for trading securities.

Evaluation of securities:

The investors can evaluate the worth of their holdings from the prices quoted at differentStock Exchanges for those securities. The securities are quoted under the free atmosphere of

demand and supply and the prices are set on the basis of free market.


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Mobilizing surplus savings:The investors do not have any difficulty in investing their savings by purchasing shares,

bonds etc., from the exchange. If this facility was not there then many persons who want to

invest their savings will not find avenues to do so. In this way, Stock Exchanges play an

important role in mopping up surplus funds of investors.

Safety in dealings:

The dealings at Stock Exchanges are governed by well-defined rules and regulations ofsecurities contract (regulation) Act 1956. There is no scope for manipulating transactions.

The safety in dealings brings confidence in the minds of all concerned parties and helps in

increasing various dealings.

Listing of securities:

Only listed securities can be purchased and sold at Stock Exchanges. The listing is allowed

only after a critical examination of capital structure, management and prospects of the

company. The listing of securities gives privilege to the company. The investors can form

their own views about the securities because listing a security does not guarantee the

financial stability of the company.

Helpful in raising capital:

The new and existing concerns need capital for their activities. The new concerns raise

capital for the first time and existing units increase their capital for expansion and

diversification purposes. The exchanges are helpful in raising capital both by new and old

concerns.


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Clearing house of business information:The companies listing securities with exchange have to provide financial statements, annual

reports and other reports to ensure maximum publicity of corporation operations and

working. The economic and other informations provide at Stock Exchanges help companies

to decide their policies.

ORGANISATION OF STOCK EXCHANGES

Some of the recognized Stock Exchanges in Mumbai, Ahmedabad and Indoor are

voluntary non-profit making organizations where those situated in Kolkata, Delhi and

Bangalore function as joint Stock Exchanges limited by shares and Stock Exchanges

functioning in Chennai and Hyderabad are formed as companies limited by guarantee.

Uniformly in their organization is ensured through Articles of Association, which define the

constitution of the recognized Stock Exchanges. The Stock Exchange Mumbai was the first

to get permanent recognition followed by Kolkata, Hyderabad, Indoor and Bangalore. The

other exchanges were given, at the first instance, official recognition for a period of five

years and at the end of each term the recognition has been renewed for another five-year

period.

At, present there are more than 24 Stock Exchanges in India. As per the present

guidelines, the proposed region in which the Stock Exchange is to be set up must be

industrially developed with a sizable number of industrial units and should be able to attract

at least 50 companies independently.


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SECURITIES CONTROL (REGULATION) ACT (SCR ACT) 1956

The Securities Control (regulation) Act is formed in 1956 with the main objective of

controlling and regulating the activities of Stock Exchanges in India. The Act sets up a

general framework of control, which makes government influence all pervasive. Any Stock

Exchange has to be recognized under the SCR before it starts its operations.

Stock Exchange is an association of member brokers for the purpose of self-regulation and

protecting the interests of its members.

The central government, ministry of Finance, and Stock Exchange Division grant the

recognition to Stock Exchanges under section 3 of the Act.

Bye-laws:

Besides the above Act, the Securities Contracts (regulation) Rules were also made in 1957 to

regulate certain matters of trading on the Stock Exchanges. There are also byelaws of the

Exchanges, which are concerned with the following subjects: Opening/closing of the Stock Exchanges.

Tuning of trading

Regulation of blank transfers

Regulation of badla or carryover business

Control of the settlement and other activities of the Stock Exchanges

Fixation of margins, market prices or making up prices (Havala rates)

Regulation of taravani business (jobbing) etc

Regulation of brokers trading

Brokerage charges, trading rules on the exchange

Arbitration and settlement of disputes


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Settlement and clearing of the trading

Regulation of Stock Exchanges

The SCR Act is the basis for operation of the Stock Exchanges inIndia.

RECOGNITION BY GOVERNMENT

Stock Exchange is recognized only after the Government is satisfied that its Rules

and Byelaws conform to the conditions prescribed for ensuring fair dealings and protection toinvestors. Government has also to be satisfied that it would be in the interest of the trade and

public interest to grant such recognition. Mumbai, Calcutta, Delhi, Chennai, Ahmedabad,

Hyderabad, Indore, Bangalore etc have so far been granted permanent recognition. Others are

granted temporary recognition from time to time.

The rules can be amended, varied or rescinded only after with the approval of

Government. Likewise, the byelaws of the recognized exchanges in detail for the regulationand control of contracts in securities and for eve of the trading activities of members must

also be sanctioned by Government amendments or modifications must be similarly approved.

The Act empowered the Government with power to make enquiries into the affairs of

a recognized stock exchanges members, to suspend its business, and lastly, to withdraw the

recognition to an exchange should such steps be deemed indispensable in the public interest.


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SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

SEBI was given statutory status by an Act of Parliament on April 4, 1992. SEBI was

authorized

a) To regulate all merchant banks on issue activity

b) To lay guidelines, and supervise and regulate the working of mutual funds andc) To oversee the working of Sock Exchanges in India.

FUNCTIONS OF SEBI:

Under the SEBI Act, SEBI has been assigned the following main functions:

1. Regulating the business in Stock Exchanges and other securities markets.

2. Registering and regulating the working of stock-brokers, sub-brokers, share transfer

agents, bankers to an issue, trustees of trust deals, registrars to an issue, merchant

bankers, underwriters, portfolio managers, and other intermediaries associated with the

securities markets.

3. Registering and regulating of collective investment schemes including mutual funds

4. Promoting and regulating the working of self-regulatory organizations

5. Prohibiting fraudulent and unfair trade practices relating to securities market.

6. Promoting investors education and training of intermediaries of Securities market

7. Prohibiting insiders trading in securities


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8. Regulating substantial acquisition of shares and takeover of companies.

RECENT DEVELOPMENTS IN SECONDARY MARKET ANDROLE OF SEBI IN REGULATING THE MARKETS:

The century-old Indian capital market is two steps forward and one step back, or vice-versa,

but whatever may be the phrase, according to some surveys made recently, it is found that

though Indian capital marker is firmly on the road to renewed growth, the investors

confidence is totally shattered and the SEBIs reformists will did not find much favor with

investors, in restoring their faith in the capital market. Since 1995-96, SEBI has been

showing its reformist will in more than one way. Several measures in conjunction with the

stock exchanges were introduced by SEBI, for safeguarding the investors interests by

ensuring better transparency and efficiency of markets. Some note worthy reforms in the

capital market introduced by SEBI are as follows:

Electronic trading

De-mat trading

Stock watch surveillance system

Fast clearance of investigation

Levy of heavy penalty on defaulting brokers

Buy back of shares by the corporate

Compulsory rolling settlement


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Swadeshi EDGAR (Electronic Data Gathering, Analysis and Retrieval) etc

The constitution of SEBI has heralded a new era in the Indian

Capital Market with its heavy agenda

To protect the interests of investors

To promote and regulate the securities market by regulating the business in stock

exchanges

To regulate the working of stock brokers, merchant bankers & other intermediaries

To regulate the working of depositories and participants

To regulate the working of venture capital funds and mutual funds

To prohibit the fraudulent and unfair trade practices

To promote investors education and to train intermediaries


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Company Profile

ORIGIN

Rapid growth in industries in the erstwhile Hyderabad State saw efforts at starting the

Stock Exchange. In November 1941 some leading bankers and brokers formed the share and

stock Brokers Association. In 1942, Mr. Gulab Mohammed, the Finance Minister formed a

Committee for the purpose of constituting Rules and Regulations of the Stock Exchange. Sri

Purushothamdas Thakurdas, President and Founder Member of the Hyderabad Stock

Exchange performed the opening ceremony of the Exchange on 14.11.1943 under Hyderabad

Companies Act, Mr. Kamal Yar Jung Bahadur was the first President of the Exchange. The

HSE started functioning under Hyderabad Securities Contract Act of No. 21 of 1352 under

H.E.H. Nizams Government as a Company Limited by guarantee. It was the 6 th Stock

Exchange recognized under Securities Contract Act, after the Premier Stock Exchanges,Ahmedabad, Bombay, Calcutta, Madras and Bangalore stock Exchange. All deliveries were

completed every Monday or the next working day.

The Securities Contracts (Regulation) Act 1956 was enacted by the Parliament,

passed into Law and the rules were also framed in 1957. The Government of India brought

the Act and the Rules into force from 20th February 1957.

The HSE was first recognized by the Government of India on 29th September 1958 asSecurities Regulation Act was made applicable to twin cities of Hyderabad and

Secunderabad from that date. In view of substantial growth in trading activities, and for the


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yeoman services rendered by the Exchange, the Exchange was bestowed with permanent

recognition with effect from 29th September 1983.

The Exchange has a significant share in achievements of erstwhile State of Andhra

Pradesh to its present state in the matter of Industrial development.

OBJECTIVES

The Exchange was established on 18 th October, 1943 with the main objective to create

, protect and develop a healthy Capital Market in the State of Andhra Pradesh to effectively

serve the Public and Investors interests.

The property, capital and income of the Exchange, as per the Memorandum and

Articles of Association of the Exchange, shall have to be applied solely towards the

promotion of the objects of the Exchange. Even in case of dissolution, the surplus funds shall

have to be devoted to any activity having the same objects, as Exchange or be distributed in

Charity, as may be determined by the Exchange or the High Court of judicature. Thus, in

short, it is a Charitable Institution.

The Hyderabad Stock Exchange Limited is now on its stride of completing its 62nd

year in the history of Capital Markets serving the cause of saving and investments. The

Exchange has made its beginning in 1943 and today occupies a prominent place among the

Regional Stock Exchanges in India. The Hyderabad Stock Exchange has been

promoting the mobilization of funds into the Industrial sector for development of


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industrialization in the State of Andhra Pradesh.

GROWTH

The Hyderabad Stock Exchange Ltd., established in 1943 as a Non-profit making

organization, catering to the needs of investing population started its operations in a small

way in a rented building in Koti area. It had shifted into Aiyangar Plaza, Bank Street in 1987.

In September 1989, the then Vice-President of India, Honble Dr. Shankar Dayal Sharma

had inaugurated the own building of the Stock exchange at Himayathnagar, Hyderabad.

Later in order to bring all the trading members under one roof, the exchange acquired still a

larger premises situated 6-3-654/A ; Somajiguda, Hyderabad - 82, with a six storied building

and a constructed area of about 4,86,842 sft (including cellar of 70,857 sft). Considerably,

there has been a tremendous perceptible growth which could be observed from the statistics.

The number of members of the Exchange was 55 in 1943, 117 in 1993 and increased

to 300 with 869 listed companies having paid up capital of Rs.19128.95 crores as on

31/03/2000. The business turnover has also substantially increased to Rs. 1236.51 crores in

1999-2000. The Exchange has got a very smooth settlement system.

GOVERNING BOARD

At present, the Governing Board consists of the following:

MEMBERS OF THE EXCHANGE


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Sri Hari Narayan Rathi Sri R.D. Lahoti

Sri Rajendra V. Naniwadekar Sri Ram Swaroop Agrawal

Sri K. Shiva Kumar Sri Dattatray

SEBI NOMINEE DIRECTORS

Sri. N.S. Ponnunambi -- Registrar of Companies [Govt. of India.]

PUBLIC NOMINEE DIRECTORSDr. N.R. Sivaswamy (Chairman, HSE) -- FormarCBDT ChairmanJustice V. Bhaskara Rao -- Retd. Judge High Court.

Sri P. Muralimohan Rao -- Mogili&Co.-Chartered Accountants

Dr B. Brahmaiah -- G.M. JNIDB

EXECUTIVE DIRECTOR

Sri S SARVESHWAR REDDY

COMPUTERIZATION

The Stock Exchange business operations are equipped with modern communication

systems. Online computerization for simultaneously carrying out the trading transactions,

monitoring functions have been introduced at this Exchange since 1988 and the Settlement

and Delivery System has become simple and easy to the Exchange members. The HSE On-

line Securities Trading System was built around the most sophisticated state of the artcomputers, communication systems, and the proven VECTOR Software from CMC and was

one of the most powerful SBT Systems in the country, operating in a WAN environment,

connected through 9.6 KBPS 2 wire Leased Lines from the offices of the members to the

office of the Stock Exchange at Somajiguda, where the Central System CHALLENGE-L


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DESK SIDE SERVER made of Silicon Graphics(SGI Model No. D-95602-S2) was located

and connected all the members who were provided with COMPAQ DESKPRO

2000/DESKTOP 5120 Computers connected through MOTOROLA 3265 v. 34

MANAGEABLE STAND ALONE MODEMS (28.8 kbps) for carrying out business from

computer terminals located in the offices of the members.

INTER CONNECTED MARKET SYSTEM (ICMS)

The HSE was the convener of a Committee constituted by the Federation of Indian

Stock Exchanges for implementing an Inter-connected Market System(ICMS) in which the

Screen Based Trading systems of various Stock Exchanges was inter-connected to create a

large National Market. SEBI welcomed the creation of ICMS.

The HOST provided the net-work for HSE to hook itself into the ISE. The ISE

provided the members of HSE and their investors, access to a large national network of Stock

Exchanges.

The Inter-connected Stock Exchange is a National Exchange and all HSE Members

could have trading terminals with access to the National Market without any fee, which was a

boon to the Members of an Exchange/Exchanges to have the trading rights on National

Exchange (ISE), without any fee or expenditure.

ON-LINE SURVEILLANCE

HSE pays special attention to Market Surveillance and monitoring exposures of the

members, particularly the mark to market losses. By taking prompt steps to collect the

margins for mark to market losses, the risk of default by members is avoided. It is heartening

that there have been no defaults by members in any settlement since the introduction of

Screen Based Trading.


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IMPROVEMENT IN THE VOLUMES

It is heartening that after implementing HOST, HSE's daily turnover has fairly

stabilized at a level of Rs. 20.00 crores. this should enable in improving our ranking amongIndian Stock Exchanges for 14th position to 6th position. We shall continuously strive to

improve upon this to ensure a premier position for our Exchange and its members and to

render excellent services to investors in this region.

The number of transactions, turnovers of the Exchange, number of listed companies

and the paid up capital listed have grown up substantially as may be seen from the following

figures.


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YEARNUMBER OF

TRANSACTIONS

IN Thousands

TURNOVERS

Rs.IN CroresLISTED

COMPANIES

MARKET

CAPIT

Rs.IN Crores

1991-92 515.949 587.75 236 2740.56

1992-93 421.985 676.00 274 10228.48

1993-94 603.635 984.46 372 13156.15

1994-95 860.642 1160.48 668 18588.71

1995-96 720.521 1107.30 727 20159.31

1996-97 240.64 479.98 851 22050.69

1997-98 427.83 1860.86 852 18705.10

1998-99 513.168 1269.90 856 18753.93

1999-00 513.440 1236.51 869 19128.95

2000-01 427.205 977.83 934 14717.08

2001-02 34.326 41.26 . .

2002-03 4.203 4.58 . .

2003-04 2.277 2.73 856 22126.65

2004-05 4.401 14.13 820 14456.95


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SETTLEMENT GUARANTEE FUND

The Exchange has introduced Trade Guarantee Fund on 25/01/2000. This will

insulate the trading member from the counter-party risks while trading with another member.

In other words, the trading member and his investors will be assured of the timely completion

of the pay-out of funds and securities notwithstanding the default, if any, of any trading

member of the Exchange. The shortfalls, if any, arising from the the default of any member

will be met out of the Trade Guarantee Fund. several pay-ins worth of crores of rupees in all

the settlements have been successfully completed after the introduction of Trade Guarantee

Fund ,without utilizing any amount from the Trade Guarantee Fund.

The Trade Guarantee Fund will be a major step in re-building this confidence of the

members and the investors in HSE. HSE's Trade Guarantee Fund has a corpus of Rs. 2.00

crores initially which will later be raised to Rs. 5.00 crores. At present Rs. 3.20 Crores is

stood in the credit of SGF.

The Trade Guarantee Fund had strict rules and regulations to be complied with by

the members to avail the guarantee facility. The HOST system facilitated monitoring the

compliance of members in respect of such rules and regulations.


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CURRENT DIVERSIFICATIONS

A) DEPOSITORY PARTICIPANT

The Exchange has also become a Depository Participant with National Securities

Depository Limited (NSDL) and Central Depository Services Limited (CDSL). Our own DPis fully operational and the execution time will come down substantially. The depository

functions are undertaken by the Exchange by opening the accounts at Hyderabad of

investors, members of the Exchange and other Exchanges. The trades of all the Exchanges

having On-line trading which get into National depository can also be settled at Hyderabad

by this exchange itself. In short all the trades of all the investors and members of any

Exchange at Hyderabad in dematerialized securities can be settled by the Exchange itself as a

participant of NSDL and CDSL. The exchange has about 15,000 B.O. accounts.

B) FLOATING OF A SUBSIDIARY COMPANY FOR THE

MEMBERSHIP OF MAJOR STOCK EXCHANGES OF THE

COUNTRY.

The Exchange had floated a Subsidiary Company in the name and style of M/s HSE

Securities Limited for obtaining the Membership of NSE and BSE. The Subsidiary had

obtained membership of both NSE and BSE. About 113 Sub-brokers may registered with

HSES, of which about 75 sub-brokers are active. Turnover details are furnished here under.


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YEAR NSE CASH

Rs.In Lakhs

NSE F&O

Rs.IN Lakhs

BSE

CASH

Rs.IN Lakhs

2001-02 338236.81 -- --

2002-03 426143.50 16657.08 --

2003-04 617808.46 312203.56 17558.59

2004-05 484189.11 354370.71 39519.96

C) FACILITY TO TRADE AT NSE,DERIVATIVES TRADING, NET

TRADING ETC

The Exchange has incorporated a Subsidiary "HSE securities Limited " with a paid up capital

of Rs. 2.50 crores initially to take NSE Membership, so that the members of the exchange

will have access to the NSE's Trading Screen as Sub-brokers, Derivatives Trading and Net

Trading etc. The Members of this Exchange will also have equal opportunity of participating

in such trading like any other NSE member.


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PORTFOLIO MANAGEMENT

PORTFOLIO:

A portfolio is a collection of securities. Since it is really desirable to invest the entire

funds of an individual or an institution or a single security, it is essential that every security

be viewed in a portfolio context. Thus it seems logical that the expected return of the

portfolio should depend on the expected return of each of the security contained in the

portfolio. Portfolio analysis considers the determine of future risk and return in holding

various blends of individual securities.

Portfolio expected return is a weighted average of the expected return of the

individual securities but portfolio variance, in short contrast, can be something reduce

portfolio risk by adding security with greater individual risk than any other security in the

portfolio. This is because risk depends greatly on the co-variance among returns of individual

securities. Portfolios, which are combinations of

Since portfolios expected return is a weighted average of the expected return of its

securities, the contribution of each security to the portfolios expected returns depends on its

expected returns and its proportionate share of the initial portfolios market value. It follows

that an investor who simply wants the greatest possible expected return should hold one

security; the one, which is considered to have a greatest, expected return. Very few investors

do this, and very few investment advisors would counsel such and extreme policy instead,

investors should diversity, meaning that their portfolio should include more than one

security.


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OBJECTIVES OF PORTFOLIO MANAGEMENT:

The main objective of the investment portfolio management is to maximize the return from

the investment and to minimize the risk involved in investment. Moreover, risk in prices or

inflation erodes the value of money and hence investment must provide a protection against

inflation.

The secondary objectives are:

e) Regular return

f) Stable income

g) Appreciation of capital

h) More liquidity

i) Safety of investment

j) Tax benefits

NEED FOR PORTFOLIO MANAGEMENT:

Portfolio management is a process encompassing many activities of investment in

assets and securities. It is a dynamic and flexible concept and involves regular and systematic

analysis, judgment and actions. The objective of this service is to help the unknown and

investors with the expertise of professionals in investment portfolio management. It involves

construction of a portfolio based upon the investors objectives, constraints, preferences forrisk and returns and tax liability. The portfolio is reviewed and adjusted from time to time in

tune with the market conditions. The evaluation of portfolio is to be done in terms of targets

set for risk and return. The changes in the portfolio are to be effected to meet the changing

conditions.


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Portfolio construction refers to the allocation of surplus funds in hand among a

variety of financial assets open for investment. Portfolio theory concerns itself with the

principles governing such allocation. The modern view of investments is oriented more

toward the assembly of proper combinations of individual securities to form investment

portfolios. A combination of securities held together will give a beneficial result if they

grouped in a manner to secure higher return after taking into consideration the risk element.

The modern theory is of the view that by diversification risk can be reduce. The

investors 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 combination of securities under constraints of

risk and return.

ELEMENTS OF PORTFOLIO MANAGEMENT:

Portfolio management is on-going process involving the following basic

tasks:

Identification of the investors objectives, constraints and preferences.

Strategies are to be developed and implemented in tune with investment policy

formulated.

Review and monitoring of the performance of the portfolio.

Finally the evaluation of the portfolio.


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RISK:

Risk is uncertainty of the income/capital appreciation or loss or both. All investments

are risky. The higher the risk taken, the higher is the return. But proper management of risk

involves the right choice of investments whose risks are compensating. The total risks of two

companies may be different and even lower than the risk of a group of two companies if their

risks are offset by each other.

The two major types of risks are:

Systematic or market related risks and

Unsystematic or company related risks.

The Systematic risks affected from the entire market are (the market problems, rawmaterials availability, tax policy or Govt. policy, inflation risk, interest risk and financial

risk). It is managed by the use of Beta of different company shares.

The Unsystematic risks are mismanagement, increasing inventory, wrong financial policy,

defective marketing etc. This is diversifiable or avoidable because it is possible to eliminate

or diversify away this component of risk to a considerable extent by investing in a large

portfolio of securities. The unsystematic risk stems from managerial inefficiency

technological change in the production processes, labour problems etc, the nature and

magnitude of those factors differ from one company to another.


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RETURN ON PORTFOLIO:

Each security in a portfolio contributes return in the proportion of its investments in

security. Thus the portfolio expected return is the weighted average of the expected return,

from each of the securities, with weights representing the proportions share of the security in

the total investment. Why does an investor have so many securities in his portfolio? If the

security ABC gives the maximum return why not he invest in that security all his funds and

thus maximize return? The answer to this question lie in the investors perception of risk

attached to investments, his objectives of income, safety, appreciation, liquidity and hedgeagainst loss of value of money etc. This pattern of investment in different asset categories,

types of investments, etc., would all be described under the caption of diversification, which

aims at the reduction or even elimination of non-systematic risks and achieve the specific

objectives of investors.

RISK ON PORTFOLIO:

The expected return from individual securities carries some degree of risk. Risk on

the portfolio is different from the risk on individual securities. This risk is reflected in the

variability of the returns from zero to infinity. Risk of the individual asset or a portfolio is

measured by the variance of its return. The expected return depends on the probability of the

returns and their weighted contribution to the risk of the portfolio. There are two measures of

risk in this context one is the absolute deviation and other standard deviation.

Most investors invest in a portfolio of assets, because as to spread risk by not putting

all eggs in one basket. Hence, what really matters to them is not the risk and return of stocks

in isolation, but the risk and return of the portfolio as a whole. Risk is mainly reduced by

Diversification.


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PORTFOLIO DIVERSIFICATION:

Diversification is a technique of reducing the risk involved in investment and in portfolio

management. This is a process of conscious selection of assets instruments and splits of

companies/ Govt. securities, in a manner that the total risks are brought down. This process

helps in the reduction of risk and promotes the optimization of returns for a given level of

risks in portfolio management.

Traditional form of diversification is concentrated upon holding a number of security

types across industry lines (utility, mining, manufacturing groups). Holding one stock each

from mining, utility, manufacturing groups is superior to holding three mining stocks. The

best diversification comes through holding large number of securities scattered across

industries.

Risk of a portfolio is determined by the degree of covariance (correlation) between

the returns of assets in the portfolio.

ELEMENTS OF PORTFOLIO MANAGEMENT:

Portfolio Management is on-going process involving the following basic tasks:

1. Identification of the investors objectives, constraints and preferences.

2. Strategies are to be developed and implemented in tune with investment policy

formulated.

3. Review and monitoring of the performance of the portfolio.

4. Finally the evaluation of the portfolio.


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RISK-RETURN ANALYSIS:

All investments have some risks. Investments in shares of companies have its own

risks or uncertainty. These risks arise out of variability of returns or yields and uncertainty ofappreciation or depreciation of share prices, loss of liquidity etc. The Risk over time can be

represented by the variance of the returns. While the return over time is capital appreciation

plus payout, divided by the purchase price of the share.

Y (SML)

Security Market Line

EXPECTED

RETURN

Variablereturn

} Risk Free Return

0 RISK X

Normally, the higher the risk that the investor takes, the higher is the return. There is,however, a risk less return on capital of about 12%, which is the bank rate charged by the

R.B.I or long-term, yielded on Government securities at around 13% to 14%. This risk less

return refers to lack of variability of return and no uncertainty in the repayment or capital.

But other risks such as loss of liquidity due to parting with money etc., may, however, remain

but are rewarded by the total return on the capital. Risk-return is subject to variation and the

objective of the portfolio manager is to reduce that variability and thus reduce the risky by

choosing an appropriate portfolio. Traditional approach advocates that one securities holdsthe better it is according to the modern approach diversification should not be quantity that

should be related to the quality of scripts which leads to quality of portfolio. Experience has

shown that beyond the certain securities by adding more securities expensive.


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Simple Diversification reduces risk:

An assets total risk can be divided into systematic plus unsystematic risk, as shown

below.

Systematic risk (undiversifiable risk) +Unsystematic risk (diversifiable risk) =Total risk=Var

(r)

Unsystematic risk is that portion of the risk that is unique to the firm (for example, risk due

to strikes and management errors). Unsystematic risk can be reduced to zero by simple

diversification. Simple diversification is the random selection of securities that are to be

added to a portfolio. As the number of randomly selected securities added to a portfolio is

increased, the level of unsystematic risk approaches zero. However, market-related

systematic risk cannot be reduced by simple diversification. This risk is common to all

securities.


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CAPITAL ASSET PRICING MODEL (CAPM)

The relevant risk for an individual asset is systematic risk (or market-market risk) because

non market risk can be eliminated by diversification, the relationship between an assets

return and its systematic risk can be expressed by the CAPM, which is also called the

security market (SML). The equation for the CAPM is as follows:

E (ri) =R+ [E (rm)-R] bi

Where E (ri) is the expected return for an asset,

Ris the risk-free rate (usually assumed to be a short-term T-bill rate),E (rm) equals the expected market return (usually assumed to be theS&P500),

Bi denotes for the assets beta.

The CAPM is an equilibrium model for measuring the risk return tradeoff for all assets

including both inefficient and efficient portfolios. A graph of the CAPM is given below:\

E(rj)

CAPM or SMLu

Eo

E(rm)

Eu

R o bi=beta

Capm or security market line


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Assumptions underlying CAPM

The capital Asset Pricing Model [CAPM] is an equilibrium model. The derivation of

the model is based on several assumptions about investors and the market, which we present

below for completeness. Investors are assumed to take into account only two parameters of

return distribution, namely the mean the mean and the variance, in making a choice of

portfolio. In other words, it is assumed that a security can be completely represented in terms

of its expected return and variance and those investors behave as if a security were a

commodity with two attributes, namely, expected return which is a desirable attribute and

variance, which is an undesirable attribute. Investors are supposed to be risk averse and for

every additional unit of risk they take, they demand compensation in terms of expectedreturn.

Again, the capital market is assumed to be efficient. An efficient market implies that

all new information that could possibly affect the share prices becomes available to all the

investors quickly and more or less simultaneously. Thus in an efficient market no single

investor has an edge over another in terms of the information possessed by him since all

investors are supposedly well informed and rational, meaning that all of them process the

available information more or Less alike. And finally in an efficient market, all investors are

price takers, i.e., no investor are so big as to effect the price of security significantly by virtue

of his trading in that security.

Capital Asset Pricing Model also assumes that the difference between lending and

borrowing rates are negligibly small for investors. Also, the investors are assumed to make a

single period investment decisions. The cost of transactions and information are assumed to

be negligibly small. The model also ignores the existence of taxes, which may influence the

investors behavior.


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The fact that some of the above assumptions are some what restrictive has attracted

considerable criticism of the model. This, however, need not distract us from the main thrust

of the model. The Capital Asset Pricing Model merely implies that in a reasonably well-

functioning market where a large number of knowledgeable financial analysts operate, all

securities will yield returns consistent with their risk, since if this were not is, the

knowledgeable analysts will be able to take advantage of the opportunities for

disproportionate returns and thereby reduce such opportunities. Hence, according to CAPM,

in an efficient market, returns disproportionate to risk are difficult to come by. Assumptions

concerning the investor behavior, market efficiency, lending and borrowing rates, etc., are to

be taken not in their literal sense, but rather as approximate conditions. Factors such as taxes,

transaction cost, etc., can be easily incorporated into the model for greater rigor.


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INVESTMENT DECISIONS

Definition of Investment:

According to F. Amling, Investment may be defined as the purchase by an

individual or institutional investor of a financial or real asset that produces a return

proportional to the risk assumed over some future investment period. According to D. E.

Fisher and R.J Jordan, Investment is a commitment of funds made in the expectation of

some positive rate of return. If the investment is properly undertaken, the return will be

commensurate with the risk the investor assumes.

Concept of Investment:

Investment will generally be used in its financial sense and as such investment is the

allocation of monetary resources to assets that are expected to yield some gain or positive

return over a given period of time. Investment is a commitment of a persons funds to derive

future income in the form of interest, dividends, rent, premiums, pension benefits or the

appreciation of the value of his principal capital.

Any investor would like to know the media or range of investments so that he can use

his discretion and save in those investments, which will give him both security and stable

return. The ultimate objective of the investor is to derive a variety of investments that meet

his preference for risk and expected return. The investor will select the portfolio, which will

maximize his utility. Another important consideration is the temperament and psychology of

the investor. It is not only the construction of a portfolio that will promise the highestexpected return, but it is the satisfaction of the need of the investor.


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Many types of investment media or channels for making investments are available.

Securities ranging from risk free instruments to highly speculative shares and debentures are

available for alternative investments.

All investments are risky, as the investor parts with his money. An efficient investor

with proper training can reduce the risk and maximize returns. He can avoid pitfalls and

protect his interests.

Money and information are the basis and the first requirement of investment is the

availability of money or savings. But, money is not enough, as investments are generally

made on the basis of information of the companies, instruments, industry and economy. Both

money and information flow do help making investment management.

There are different methods of classifying the investment avenues. A major

classification is Physical Investments and Financial Investments. They are physical, if

savings are used to acquire physical assets, useful for consumption or production. Some

physical assets like ploughs, tractors or harvesters are useful in agricultural production. A

few useful physical assets like cars, jeeps etc., are useful in business. Many items of physicalassets are not useful for further production or goods or create income as in the case of

consumer durables, gold, silver etc. Among different types of investments, some are

marketable and transferable and others are not. Examples of marketable assets are shares and

debentures of public limited companies, particularly the listed companies on Stock

Exchange, bonds of P.S.U., Government Securities etc. Non-marketable securities or

investments in bank deposits, provident fund and pension funds, insurance certificates, post

office deposits, national savings certificate, company deposits, private limited companies

shares etc.


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Investment Process:

The investment process may be described in the following stages:

1. Investment Policy: The first stage determines and involves personal financial affairs

and objectives before making investment. It may also be called the preparation of

investment policy stage. The investor has to see that he should be able to create an

emergency fund, an element of liquidity and quick convertibility of securities into cash.

This stage may, therefore, be called the proper time of identifying investment assets and

considering the various features of investments.

2. Investment Analysis: After arranging a logical order of types of investment

preferred, the next step is to analyze the securities available for investment. The investor

must make a comparative analysis of type of industry, kind of securities etc. the primary

concerns at this stage would be to form beliefs regarding future behavior of prices and

stocks, the expected return and associated risks.

3. Investment valuation: Investment value, in general, is taken to be the present worth to

the owners of future benefits from investments. The investor has to bear in mind the

value of these investments. An appropriate set of weights have to be applied with the use

of forecasted benefits to estimate the value of the investment assets such as stocks,

debentures and bonds and other assets. Comparison of the value with the current market

price of the asset allows a determination of the relative attractiveness of the asset. Each

asset must be value on its individual merit.


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4. Portfolio Construction and Feed-back: Portfolio construction requires knowledge of

the different aspects of securities in relation to safety and growth of principal, liquidity of

assets etc. In this stage, we study, determination of diversification level, consideration of

investment timing, selection of investment assets, allocation of invest able wealth to

different investments, evaluation of portfolio for feed-back.

INVESTMENT DECISIONS-GUIDELINES FOR EQUITY

INVESTMENT

Equity shares are characterized by price fluctuations, which can

produce substantial gains or inflict severe losses. Given the volatility and

dynamism of the stock market, investor requires greater competence and

skill-along with a touch of good luck too-to invest in equity shares. Here

are some general guidelines to play to equity game, irrespective of

whether you are aggressive or conservative.

Adopt a suitable formula plan

Establish value anchors

Assets market psychology

Combine fundamental and technical analyze

Diversify sensibly Periodically review and revise your portfolio


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Requirement of Portfolio:

1. Maintain adequate diversification when relative values of various securities in theportfolio change.

2. Incorporate new information relevant for risk return assessment

3. Expand or contract the size of portfolio to absorb funds or with draw funds and

4. Reflect changes in investor risk disposition.

Types of Investors and Factors Influence on Investors on

Investors DecisionThere are four types of Investors in a market. They are as follows:

Types of Investors:

Type A Investor: No Market Timing and No stock-picking skills

If the investor does not believe that he has any special skills in picking undervalued stocks or

in predicting the movement of the market, then the portfolio design problem becomes

relatively simple. The Investor simply choices a diversified portfolio (in the mannerdescribed above) and then adjusts its beta to the desired level. If he weighs the chooses

securities in proportion to market capitalization, he can expect to get a portfolio beta close to

one. To achieve a higher or lower beta, he can shift the weights towards high or low beta

stocks. He can achieve the same effects by increasing or decreasing the allocation to the

equity portfolio in the overall portfolio.

The type A investor would hold a passive, diversified portfolio with the constant betaequal to the target beta. He may also prefer to invest his money in a mutual fund and let it do

the portfolio management for him.


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Type B Investor: Only Stock-Picking Skills

An investor who has and wishes to exploit his stock picking skills should start with a

base portfolio similar to that of the type A investor. He should then adjust the weights of the

stocks, which are in his opinion mis-priced. Specifically, he should overweight the stocks

which are overvalued and underweight those which are under valued. For example, the base

portfolio may have 2% in stock X and 1.5% in stock Y. The investor who finds X

undervalued and Y overvalued may change the weights to 3% to X, he may have a problem

as he would then have to short sell Y to the extent of 0.5% of the portfolio. This may not be

legally or practically possible. The investor then has to raise the weight of X to 4%, eliminateY from the portfolio and reduce the weight of some other stocks by 0.5%.

The investor can deal with this problem in a slightly different manner. He can put, say

90%, of his equity investment in the diversified portfolio and reserve the remaining 10% for

the mis-priced stocks. How large a fraction he should devote to mis-priced scripts depends on

how good analyst may choose a larger fraction. What we are doing in this decision is to

balance the profit potential of investing in undervalued stocks against the benefit of

diversification. Unless we are confident about our analysis, we should give primacy to the

need for diversification.

Since the average beta of the undervalued and overvalued stocks is likely to be close to one,

the overall beta is likely to remain close to the target value, unless the target beta is

substantially different from one and the percentage of the portfolio devoted to mis-priced

stocks is large. If, for some reason, this is not so, the investor would have to take further

action to maintain to the beta at the target value. The portfolio of the type B investor is

concentrated but has a constant beta.


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Type C Investor: Only Market-timing Skills

The type C investor holds a well-diversified portfolio but switches actively betweendefensive and offensive portfolios to take advantage of the market timing. If he expects the

market to rise, he should push his portfolio beta above his target level by any of the

techniques described in the section on market timing. The converse should be done if the

investor is bearish about the market. In either case, the portfolio would remain diversified all

through. The portfolio of this investor is diversified, but its beta is managed and not constant.

Type D Investor: Both Stock-picking and Market-timing Skills

This type of investor would use the techniques used by both the type B and type C

investor. These investors would have the most active and aggressive portfolio management

strategies. Using their superior ability to predict booms and busts in the market as a whole

and their skills in identifying undervalued scripts, they should hold highly concentrated

portfolios and let the beta fluctuate quite sharply around the long run target value.

A pitfall to be very strenuously avoided is that of assuming that one has a skill which

one in reality does not have. For example, an investor who does not have very good abilitiesin scrip selection may still think that he does have such skills. He would then end up with an

ill-diversified portfolio, which earns mediocre returns; he would have been better off with a

passive portfolio.

Qualities For Successful Investing:

Contrary thinking

Patience

Composure

Flexibility and

Openness


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INVESTORS PORTFOLIO CHOICE

An investor tends to choose that portfolio, which yield maximum return by applying utility

theory. Utility theory is the foundation for the theory of choice under uncertainty. Cardinal

and ordinal theories are the two alternatives, which is used by economists to determine how

people and societies choose to allocate scare resources and to distribute wealth among one

another.

The former theory implies that a consumer is capable of assigning to every

commodity or combination of commodities a number representing the amount of degree of

utility associated with it. Were as the latter theory, implies that a consumer needs not be

liable to assign numbers that represent the degree or amount of utility associated with

commodity or combination of commodity. The consumer can only rank and order the amount

or degree of utility associated with commodity.

In explaining how investment decisions or portfolio choices are made utility theory is

used here not to imply that individual actually make decision using a utility curve, but rather

as an expository vehicle that helps explain how investors presumable act.

In an uncertain environment it becomes necessary to ascertain how different

individual will react to risky situation. The risk is defined as the probability of success or

failure or risk could be described as variability of outcomes, payoffs or returns. This implies

that there is a distribution of outcomes associated with each investment decision. Therefore

we can say that there is a relationship between the expected utility and risk. Expected utility

has been defined as the numerical value assigned to the probability distribution associatedwith a particular portfolio return. This numerical value is calculated by taking a weighted

average of the utilities of the various possible returns. The weights are the probabilities of

occurrence associated with each of the possible returns.


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LINEAR UTILITY FUNCTION AND RISK

The shape of an individuals utility function affects his or her reaction to risk suppose

an individual has Rs.50,000 and whose behavior is linear utility function is offered a chance

to gain Rs.1,00,000 with a probability of 1|2 or to lose Rs.1,00,000 with a probability of 1|2.

This individual would be no better or worse off accepting or rejecting this opportunity his

wealth would remain at Rs.50000 with utility UI. Any payment for this chance could reduce

his wealth and therefore be undesirable because the expected value of the fair game is zero.

CONCAVE UTILITY FUNCTION AND RISK

In case of a concave utility function, if an individual participants and wins his or her utility or

if he/she loses, than expected value of this fair game, having a 50 percent chance of winning

and a 50 percent chance of losing. If the utility of winning is less than the utility of losing,

than the utility of doing nothing is greater than the expected utility of accepting the fair

game. In fact the individual should be willing to pay up to the difference in this situation.

Hence, an investor with concave utility functions are said to be risk averse.

That is, they would reject a fair game because the utility derived from winning is less

than the utility lost should they lose the game [i.e., the expected utility of participating in a

fair game is negative. Hence the convex utility function is not realistic in real world decision;

therefore it is not worth exploring.


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UNCERTAIN OUTCOMES, INSURANCE AND EXPECTED

RETURNS

The below figure plots the utility of wealth curve for an individual who prefers more

wealth to less but it can be characterized as having decreasing marginal utility. An extra

rupee increases his utility but not by as much as a loss of a rupee would decrease his utility.

Assume that this individual is a fairly well off person with a current wealth [Wo] of

Rs.1000000 which provides a correspondence utility of wealth [Uo]. If he is offered by

broker to play a usual coin-tossing game. If head comes, the individual will pay the odds of

winning or losing are identical since it is a fair count but still the individual declines to

expose himself to a risk without a corresponding return.

The individual has two choices; to play the game or not to play the game. If he

decides not to play the game, his wealth remains the same and his utility remains at Uo. If he

plays the game, his wealth will be either Rs. 950000 or Rs.1050000 with respective utility of

UI and UW. If he decides to play the game with a fair coin, his expected utility is less than uo

lies in the fact that individual has decreasing marginal utility of wealth. The increasedsatisfaction obtained by a Rs.50000 increase in his wealth is more than offset by the

decreased satisfaction associated with a Rs.50000 loss. Individuals with decreasing marginal

utility are risk averse.

When deciding whether to buy or sell securities, however, one consciously accepts

risks, and a possible expected return is required in order for the expected utility of wealth not

to fall [and, one hopes, to increase]. To illustrate, assume that an individual has fully insuredthe risks in his wealth, resulting in a current certain wealth of C and corresponding utility of

Uc.


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Now if a broker offers to play the game again. If he plays, the outcomes would result

in wealth levels WI, and Ww. Clearly, the individual will play only if his expected utility

does not fall if his expected wealth is equal to E [W]. The individual will demand an

expected return to freely take on the change outcome. The broken can provide this return

either by changing the odds of winning and losing or by paying him to play. The form of

return is unimportant. The important fact is that the individual demands a positive expected

return simply because he has a decreasing marginal utility of wealth curve.

The return, which must be paid to induce people to accept the uncertain outcomes

associated with securities, is known as the risk premium. The risk premium will depend upon

both the risk aversion of an individual and the size of the risk.


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MARKOWITZ MODEL

THE MEAN-VARIANCE CRITERION

Dr. Harry M. Markowitz is credited with developing the first modern portfolio

analysis in order to arrange for the optimum allocation of assets within portfolio. To reach

this objective, Markowitz generated portfolios within a reward risk context. In essence,

Markowitzs model is a theoretical framework for the analysis of risk return choices.

Decisions are based on the concept of efficient portfolios.

A portfolio is efficient when it is expected to yield the highest return for the level of

risk accepted or, alternatively, the smallest portfolio risk for a specified level of expected

return. To build an efficient portfolio an expected return level is chosen, and assets aresubstituted until the portfolio combination with the smallest variance at the return level is

found. At this process is repeated for other expected returns, set of efficient portfolio is

generated.


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ASSUMPTIONS:

The Markowitz model is based on several assumptions regarding investor

behavior:

1. Investors consider each investment alternative as being represented by a probability

distribution of expected returns over some holding period.

2. Investors maximize one period-expected utility and posses utility curve, which

demonstrates diminishing marginal utility of wealth.

3. Individuals estimate risk on the basis of the variability of expected returns.

4. Investors base decisions solely on expected return and variance of returns only.

5. For a given risk level, investors prefer high returns to lower returns. Similarly for a

given level of expected return, investor prefer less risk to more risk.

Under these assumptions, a single asset or portfolio of assets is considered to be

efficient if no other asset or portfolio of assets offers higher expected return with the same

risk or lower risk with the same expected return.


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THE SPECIFIC MODEL

In developing his model, Markowitz first disposed of the investment behavior rule

that the investor should maximize expected return. This rule implies that the non-diversified

single security portfolio with the highest return is the most desirable portfolio. Only by

buying that single security can expected return be maximized. The single-security portfolio

would obviously be preferable if the investor were perfectly certain that this highest expected

return would turn out to be the actual return. However, under real world conditions of

uncertainty, most risk adverse investors join with Markowitz in discarding the role of calling

for maximizing expected returns. As an alternative, Markowitz offers the expected

returns/variance of returns rule.

Markowitz has shown the effect of diversification by reading the risk of securities.

According to him, the security with covariance which is either negative or low amongst

themselves is the best manner to reduce risk. Markowitz has been able to show that securities

which have less than positive correlation will reduce risk without, in any way, bringing the

return down. According to his research study a low correlation level between securities in the

portfolio will show less risk. According to him, investing in a large number of securities is

not the right method of investment. It is the right kind of security which bring the maximum

results.


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Henry Markowitz has given the following formula for a two-security

portfolio.

p2 = x12 12 + x22 22 + 2 (x1) (x2) (12) 12

p = x12 12 + x22 22 + 2 (x1) (x2) (12) 12

Where

p2 = variance of the portfolio return

p = standard deviation of the portfolio return

X1 = proportion of the portfolio invested in security 1

X2= proportion of the portfolio invested in security 2

1 = standard deviation of the return on security 1

2 = standard deviation of the return on security 2

12= coefficient of correlation between the returns on securities 1 and 2


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Practical study of selected scripts

Purpose of the Study:

The purpose of the study is to find out at what percentage of investment should be invested

between two companies, on the basis of risk and return of each security in comparison.

These percentages helps in allocating the funds available for investment based on risky

portfolios.

Implementation of Study:

For implementing the study, ten securities or stocks constituting the Sensex Market are

selected of one month closing share movement prices data from websites dated from 1st June

2005 to 30th June 2005.

In order to know the risk of the Stock or Security, we use the formula, which is given below.

Standard Deviation = variance

nVariance =1/n-1 (R-R)2

t=1Where

(R-R)2 = squares of difference between sample and mean.

n = number of sample observations.

After that, we need to compare the Stocks or Securities of two companies with each other by

using the formula or Correlation Co-Efficient as given below:


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SL.NO. SECTOR COMPANY

1 ENERGY RELIANCE

2 OIL INDIAN OIL CORP.

3 PHARMA CIPLA

4 STEEL JINDAL STEEL

5 ELECTRONIC BHEL

6 TEXTILE RAYMOND

7 FMCG HLL

8 BANKING SBI

9 AUTOMOBILE HERO HONDA

10 SOFTWARE WIPRO

Calculated Average And Standard Deviation


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CALCULATED CORRELATION CO-EFFICIENT AND PORTFOLIORISKBETWEEN TWO COMPANIES


Company Name Average Standard Deviation

Reliance 593.5456 44.7922

Indian Oil 445.6374 13.4126

Cipla 297.1196 10.7145

Jindal Steel 898.0435 18.4243

Bhel 869.5652 11.8100

Raymond 343.6717 05.8073

HLL 151.8435 06.6868

SBI 674.3639 11.3606

Hero Honda 560.8609 15.3432

Wipro 737.7630 17.4849

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Company Name Correlation coefficientRisk(%)

Portfolio

BHEL & Reliance -0.6442 15.8189

Reliance & Indian Oil -0.9343 6.6600

SBI & JINDAL Steel -0.1194 9.1266

BHEL & Indian Oil +0.6318 11.2473

Raymond & HLL -0.4335 3.8885

SBI & WIPRO +0.0130 9.5838

CIPLA & BHEL -0.7349 4.1158

Hero Honda & Raymond -0.4182 4.4160

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STANDARD DEVIATION

CORRELATION COEFFICIENT


60

STANDARD DEVIATION

29%

9%

7%12%8%

4%4%

7%

10%10%

RELIANCE INDIAN OIL CORP

CIPLA JINDAL STEEL

BHEL RAYMOND

HLL SBI

HERO HONDA WIPRO


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CORRELATION COEFFICIENT

16%

24%

3%16%

10%

2%

19%

10%

RELIANC E & BHELRELIANC E & IOCSB I & J INDALBHEL &IOCRAYMOND & HLL

SB I & WIPROCIPLA & BHELHERO HONDA & RAYMOND


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R 10249.6500Average(R) = = = 445.6374

N 23n _

Variance = 1/n-1 (R-R) 2t=1

Variance = 1/23-1(3958.0283)Variance = 179.8981

_______________Standard deviation = Variance

________________Standard deviation = 179.8981 = 13.4126

CALCULATION OF STANDARD DEVIATION OF CIPLA


R R R-R [R-R] 2

DATESHAREPRICE

AVERAGE DEVIATIONSSQUAREDEVIATIONS

01/06/05 463.6500 445.6374 18.0126 324.453702/06/05 461.5000 445.6374 15.8626 251.62203/06/05 461.6000 445.6374 15.9626 254.804504/06/05 459.5500 445.6374 13.9126 193.560406/06/05 459.0500 445.6374 13.4126 179.897807/06/05 458.8500 445.6374 13.2126 174.572808/06/05 458.6000 445.6374 12.9626 168.02909/06/05 457.2500 445.6374 11.6126 134.852410/06/05 453.5500 445.6374 7.9126 62.609213/06/05 453.2500 445.6374 7.6126 57.951714/06/05 450.9000 445.6374 5.2626 27.9649

15/06/05 450.1000 445.6374 4.4626 19.914816/06/05 444.2000 445.6374 -1.4374 2.066117/06/05 440.3500 445.6374 -5.2874 27.956620/06/05 437.2500 445.6374 -8.3874 70.348521/06/05 431.2500 445.6374 -14.3874 206.997322/06/05 430.1000 445.6374 -15.2374 232.178423/06/05 429.3500 445.6374 -16.2874 265.279424/06/05 432.0500 445.6374 -13.5874 184.617427/06/05 433.1000 445.6374 -12.5374 157.186428/06/05 431.0000 445.6374 -14.6374 214.253529/06/05 429.7500 445.6374 -15.8874 252.4095

30/06/05 423.4000 445.6374 -22.2374 494.502TOTAL 10249.6500 3958.0283

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R 6833.7500Average (R) = = = 297.1196

N 23n _

Variance = 1/n-1 (R-R) 2t=1

Variance = 1/23-1(2525.6037)

Variance = 114.8002 _______________Standard deviation = Variance

________________Standard deviation = 114.8002 =10.7145


RR R-R ( R-R )

DATESHAREPRICE AVERAGE DEVIATIONS

SQUAREDEVIATIONS

01/06/05 292.2000 297.1196 -4.9196 24.202502/06/05 289.3000 297.1196 -7.8196 61.146103/06/05 290.7500 297.1196 -6.3696 40.571804/06/05 289.5000 297.1196 -7.6196 58.058306/06/05 289.8500 297.1196 -7.2696 52.847107/06/05 289.8000 297.1196 -7.3196 53.576508/06/05 295.4000 297.1196 -1.7196 2.95709/06/05 293.6000 297.1196 -3.5196 12.387610/06/05 291.4500 297.1196 -5.6696 32.144413/06/05 290.1000 297.1196 -7.0196 49.2748

14/06/05 290.4000 297.1196 -6.7196 45.153015/06/05 288.2000 297.1196 -8.9196 79.559316/06/05 285.9500 297.1196 -11.1696 124.760017/06/05 284.9500 297.1196 -12.1696 148.099220/06/05 284.7500 297.1196 -12.3696 153.007021/06/05 304.8500 297.1196 7.7304 59.759122/06/05 312.4500 297.1196 15.3304 235.021123/06/05 310.7000 297.1196 13.5804 184.427324/06/05 314.3000 297.1196 17.1804 295.166127/06/05 310.7000 297.1196 13.5804 184.427328/06/05 310.9000 297.1196 13.7804 189.8994

29/06/05 310.0000 297.1196 12.8804 165.904730/06/05 313.6500 297.1196 16.5304 273.2541TOTAL 6833.7500 2525.6037

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CALCULATION OF STANDARD DEVIATION OF JINDAL STEEL

R 20654.9000Average(R) = = = 898.0435

N 23n _

Variance = 1/n-1 (R-R) 2

t=1

Variance = 1/23-1(7468.0298)Variance = 339.4559 _______________Standard deviation = Variance

________________


R R R-R [R-R] 2

DATESHAREPRICE AVERAGE DEVIATIONS

SQUAREDEVIATIONS

01/06/05 905.6000 898.0435 7.5565 57.100602/06/05 898.6500 898.0435 0.6065 0.367803/06/05 900.6000 898.0435 2.5565 6.535704/06/05 903.0500 898.0435 5.0065 25.065006/06/05 905.0500 898.0435 7.0065 49.091007/06/05 901.9000 898.0435 3.8565 14.872608/06/05 899.5500 898.0435 1.5065 2.269509/06/05 900.0000 898.0435 1.9565 3.827910/06/05 900.0500 898.0435 2.0065 4.0260

13/06/05 900.0000 898.0435 1.9565 3.827914/06/05 886.5500 898.0435 -11.4935 132.100515/06/05 899.3000 898.0435 1.2565 1.578816/06/05 879.5500 898.0435 -18.4935 342.009517/06/05 886.0000 898.0435 -12.0435 145.045920/06/05 895.3000 898.0435 -2.7435 7.526821/06/05 897.8500 898.0435 -0.1935 0.037422/06/05 914.0000 898.0435 15.9565 254.609923/06/05 920.3000 898.0435 22.2565 495.351824/06/05 922.4000 898.0435 24.3565 593.239127/06/05 922.7500 898.0435 24.7065 610.4111

28/06/05 897.8500 898.0435 -0.1935 0.037429/06/05 888.6000 898.0435 -9.4435 89.179730/06/05 830.0000 898.0435 -68.0435 4629.9179TOTAL 20654.9000 7468.0298

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Standard deviation = 339.4559 = 18.4243CALCULATION OF STANDARD DEVIATION OF BHEL

RR R-R ( R-R ) 2

DATE SHARE PRICE AVERAGE DEVIATIONS SQUARE DEVIATIONS01/06/05 880.1500 869.5652 10.5848 112.038002/06/05 870.3500 869.5652 0.7848 0.615903/06/05 869.4500 869.5652 -0.1152 0.013304/06/05 865.8500 869.5652 -3.7152 13.802706/06/05 870.3000 869.5652 0.7348 0.539907/06/05 872.7500 869.5652 3.1848 10.143008/06/05 880.4000 869.5652 10.8348 117.392909/06/05 888.2000 869.5652 18.6348 347.255810/06/05 876.3000 869.5652 6.7348 45.357513/06/05 881.0000 869.5652 11.4348 130.754714/06/05 883.1000 869.5652 13.5348 183.190815/06/05 881.1000 869.5652 11.5348 133.051616/06/05 879.7000 869.5652 10.1348 102.714217/06/05 874.7500 869.5652 5.1848 26.882220/06/05 873.0000 869.5652 3.4348 11.797921/06/05 866.7500 869.5652 -2.8152 7.925422/06/05 853

manjunath thunga

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