module 6 sapm

8/3/2019 Module 6 SAPM

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MODULE-6


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In 1953, Moeverice Kendall a Statistician

presented a paper. Where, he made an

observation of various stock and commodity

prices for almost 30 years and out come wasthat their was any trend observed. Every

observation applied to flow a random walk

that is price changes are independent of one

another.The stock price behavior do not have any

relationship with its past price behavior.


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The accuracy and the quickness in which the

market translates the expectation into prices

is considered to be the market efficiency.

EX: Today the closing price of TCS is 100. Ifcompany announces that it will issue 1:1

bonus share then market opens with price

coat of Rs. 200 for TCS


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Operational Efficiency and

Informational Efficiency.


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Efficiency of day today market. It evaluate

an order settlement procedure etc.,


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It is the measure of the swiftness or the

market reaction to new information. The

security prices adjust themselves very rapidly

and accurately to any new information theynever take a long time to adjust to the new

information.

EX: Announcement of a bonus issue will

definitely lead to increase in the price of thestock.


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Weak Form of Efficiency

Semi-Strong Form of Efficiency

Strong Form of Efficiency


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According to the weak form of efficiency

future prices cannot be predicated by

analyzing the prices from the fast. Because,

every one has excess to past information andnobody can take advantage to predict the

future price. Current prices reflect all

information found in the past prices.


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According to Semi-Strong Form of Efficiency the

security prices adjust rapidly to all publicly

available information. According to it the prices

not only reflect past information but also reflect

the current publicly available information.Hence, available of past and current information

cannot be a source of prediction of future price.

When new information is available it is

transmitted very fast to the entire market.Hence nobody can take advantage of information

available.

EX: News related to NPA of SBI.


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Strong Form of Efficiency states that current

price reflect the past current and even

confidential information which is available

on that shares. Information whether it ispublic or inside cannot be used to earn

superior returns.


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Weak Form of Efficiency

Past Information and Data

Semi-Strong Form of Efficiency

Past, current information Strong Form of Efficiency

Past, current and confidential information


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Hypothesis test for weak for efficiency

Filter Roll, Runs test and Serial co-relation

Hypothesis test for Semi-strong efficiency

Regression, coefficient, abnormal return test.Hypothesis test for Strong efficiency

Test prove that mutual funds who are suppose to

have confidential information never given

superior than compare to the market.


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Strong

Semi-Strong

Weak


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1. According to Efficient Market Hypothesis

behavior of prices are random in nature.

2. Technical analysis represent useless

analysis. 3. Uncommon techniques will help to earn

superior returns.

4. According to Efficient Market Hypothesis

active portfolio management will not helpinggenerating superior return but a passive

portfolio management strategy will deliver

superior return.


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CAPM explains the behavior of security pricesand provides a mechanism where byinvestors could assess the impact of aproposed security investment on the over all

portfolio risk and return. A risk-averseinvestor prefers to invest in risk-freesecurities.

An investor who prefers to invest in portfolio

has to bear the systematic risk but, he candiversify the unsystematic risk which isrelated to the individual company orindustry.


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Rp

Rp

Rf

SDSD

C

B

A

S

CML

Lending

Borrowing

Risk free asset

Any asset can be borrowed or lent at risk free rate.

Efficient Frontier


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CAPM concept here it is assumed that investors hold only

market portfolio and risk less securities and also investor

has the ability to borrow or lend any amount at risk less

rate of interest. It we look at the diagram (I) ABC line

shows the efficient frontier which is representing risky

assets. Any point between B and C gives superior rate of

return compared to B and A. Investors can combine risk

less asset and risky assets by lending or borrowing. So Rfs

represents a lending portfolio and Beyond Sit is

borrowing portfolio. The straight Rfs is called Capital

market line. It gives the Desirable set of investment

opportunities between risk free and risky invests. CML

represents a linear relationship between return and

standard deviations.

E(Rp)= Rf+(Rm-Rf)

M


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The slope of CML is risk premium of the

market portfolio divided by S.D.

E(Rp)= Rf+(Rm-Rf)

M

Rp=Expected return

Rf=Risk free rate of interest

Rm=Market return

= SD of the portfolioM


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The Capital market line measures risk return

relationship of the efficient portfolio. It

does not show the risk return relationship of

other portfolio which are inefficient. The

inefficient portfolio lie below the CML line.

We already know that unsystematic risk can

be diversified or eliminated, then the

remaining risks systematic risk. So as ainvestor our main interest is what is the

amount of systematic risk? This is measured

by Beta and the line Rfs is called as Security

Market line.

Security Market Line.


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Rp

Rf

S

1 Beta

Security Market Line


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module 6 sapm

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