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The world at present is experiencing a lot of changes of mammoth proportions. The Petroleum Industry in India is one of the harbingers of huge economic growth. The arena for business has now gone global since trade boundaries are fast dissolving. These developments present India with tremendous opportunities in the future to be one of the major players in the export of petrochemical intermediaries. The main problems with the Petroleum Industry in India are related to infrastructural developments. The lack of proper storage facilities, enhancements in refining capacities, and fluctuating import prices plays important role in the development of the sector. The target of improvement for the growth of the economy for India should be in the area of the petrochemical sector. The need for intermediary products for the manufacturing of the end use products is an important sector to tap in. With the per capita consumption for the petrochemical
products in India being low and the production of these products being high, India may become one of the leading exporters of such intermediary products. The long-term energy strategies of India have to emphasize on the methods of using energy effectively and efficiently, and to enhance energy self-sufficiency. To lift the Indian economy to enhanced economic standards innovation, diplomacy, creativity and vision are the need of the hour
1.3 OBJECTIVES
1. The purpose of doing study is to understand the security pricing theories 2. viz, CAPM and SML by practical application 3. To find the pricing status of securities of petroleum firms. 4. Test of asset pricing theories such as CAPM. 5. The study deals with the return and risk of the stocks.
1.4 SCOPE
1. The study is based on the securities listed on the national stock exchange of India Ltd. 2. The studys scope is confined to securities of petroleum and natural gas Firms like: Oil and Natural Gas Corporation. (ONGC) Bharat Petroleum Corporation Ltd. (BPCL) Hindustan Petroleum Ltd (HPL) Reliance Petroleum Ltd.(Rel.Petro.)
1.5 METHODOLOGY
Research design: Research is conducted on the equity shares listed in the National Stock Exchange. Research consists of analyzing the equity shares and calculation of return and betas of the stocks. Data collection methods and techniques: The collection of data is through secondary research. Secondary research: 1. Internal secondary data: The data generated within the organization such as
financial reports, share prices at different time periods. 2. External secondary data: The data generated by sources outside the
ONGC's average gross realization is likely to crash to $61 per barrel, which is nearly half of September '08 quarter. Considering the stagnation in ONGC's crude oil production, it's expected to report a sharp 30% fall in net profit during the quarter. Reliance Industries is expected to post double-digit gross refining margins (GRMs) despite the fall in crude oil prices in the December '08 quarter. Profitability of public sector oil marketing companies could be under pressure from inventory and low GRMs. We expect BPCL to post losses for third consecutive quarter. Gail could take a hit on its petrochemicals and liquid hydrocarbons business, while transmission business is likely to post healthy growth in the December '08 quarter.
2.4 Beta
What Does Beta Mean? A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns.. Also known as "beta coefficient".
RETURNS=
Ending period value- beginning period value dividend beginning period value
The best proxy for return is the future expected return. Therefore the basic equation for measuring return for annual period is given as:
Ri= (Pi-Po) +Di Po Where: Po is the beginning price of the security. Pi is the ending price of the security. Di is the amount of dividend.
Rate of return can be stated semi annually or annually or to compare different investment alternatives available. If the investment alternative is a stock the investor gets a dividend and the capital appreciation. If it is a debt instrument, the investor gets the interest and capital appreciation and the debt instrument is redeemed above the face value.
The square of standard deviation is called variance; hence variance of security returns is the average value of the square of deviations of the observed returns from the expected value of returns. Ex:-A step increase in the crude oil prices is almost certain to affect the entire market adversely hence no amount of diversification can make a portfolio totally free from such risk even though diversification may reduce this risk up to a point. Therefore this level of systematic risk below which the riskness of a portfolio cannot be reduced is called unavoidable risk. The Non-Diversifiable Risk of a Portfolio: - To understand why a certain amount of risk is always present in a portfolio or the nature of the risk that cannot be diversified away, consider the case of n securities, the proportion of investments in each security being 1/n-1. The variance of the portfolio return will be given by 1 Variance (X) = ------------ { (Rx Rx )}
N1
The residual risk in a well diversified portfolio equals the average covariance of the securities in the portfolio representing the market risk. This is the amount of risk that cannot be diversified always no matter how much the reducing risk by diversification.
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Risk Decomposition: - The total risk of a security is measured in terms of variance or standard deviation of its returns. Apart from this we know that the risk comprises of both systematic and unsystematic components. The way or method to split the total risk into the systematic or unsystematic risk components is known as risk decomposition. And this is relatively simple.
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One important implication of the normative approach provided by portfolio theory is pricing of financial assets. If all investors act in a manner that maximized expected returns for a given level of risk. Capital market theory relates to the pricing of financial assets and equilibrium relation between risk and expected return. Capital market theory is an extension of the portfolio theory of markovitz. The portfolio theory explains how rational investors should build efficient portfolio based on their risk return preference. Capital market assets pricing model (capm) incorporates a relationship explaining how assets should be priced in the capital market. The capital market theory provides the following two models to maximize expected return they 1) 2) MARKOWITZ PORTFOLIO THEORY CAPITAL ASSET PRICING MODEL (CAPM)
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dislike for risk this is general behaviors of rational investor, an investor would like to get highest return possible for given risk or would like to minimize the risk for a given expected rate of return 2) Investor act as if they make investment decision on the basis of the expected
return and variance standard deviation about security returns distribution i.e. investors measures their preference and dislike investment through expected return and or standard deviation of security return Markowitz model of portfolio analysis generates an efficient frontier which is a set of efficient portfolios. A portfolio is said to efficient if it offers maximum expected return for a given level of risk or offers minimum risk for a given level of expected returns.
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E (ri) =R+ [E (rm) R] bi Where (bi)= independent variable representing the systematic risk of the ith asset that determines the dependent variable. E (ri) = is the expected rate of return for the ith asset,
The CAPM intersects the vertical axis at the risk less rate, R; and the quantity
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[E (rm) R] is the slope of the CAPM. The risk less interest rate, R is the appropriate rate of return for an asset with zero risk in the CAPM.
Diversifiable risk can easily eliminated by simple diversification. Therefore investors will tend to focus only on assets undiversifiable risk when they search for asset that will minimize their risk exposure at whatever level of expected return they seek. In seeking the most desirable assets investors will bid up the prices of assets with low systematic risk (that is, low beta coefficients). In contrast, assets with high beta coefficients will experience low demand and market prices that are low relative to assets expected income. Stated differently, assets with high levels of systematic risk must also yield high expected returns to induce investors to buy assets with large amount of risk that cannot be eliminated by diversification.
ESTIMATING BETA
The systematic risk cannot be diversified away, unsystematic risk can be. Hence the relevant risk is systematic risk also referred to as non-diversifiable risk. To calculate this systematic risk beta, of a stock we have to calculate the slope of the regression as follows Ri= + Rm + e Where Ri is dependant variable and represents the return on security. Rm is independent variable representing the return on the market portfolio, and e is the error term.
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To calculate beta the following model is used i = im m Where i = estimate of the beta of stock i im = variance between the stock i and the return on the market portfolio. m = variance of the return on market portfolio.
The CAPM or the SML as it is also called. This graphically depicts the result of price adjustments from the risk averse trading described above. In passing, it is interesting to know that the CAPM in the figure is identical to the single factor arbitrage pricing line shown in figure when the only risk factor used to develop arbitrage pricing model as the market portfolio. The CAPM is an extension of Markovitz portfolio theory. The assumptions on which Markovitz is based are also applicable to CAPM also. The assumptions of CAPM are: 1. Investors make their investment decisions on the basis of risk return
assessments measured in terms of expected returns and standard deviation of returns. 2. units. The purchase or sale of a security can be undertaken in infinitely divisible
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3.
Purchases and sales by a single investor cannot affect prices. This means
that there is perfect competition where investors in total determine prices by their actions. 4. There are no transaction costs. Given the fact that transaction costs are
small. They are probably of minor importance in investment decision making, and hence they are ignored. 5. There are no personal income taxes. Alternatively, that tax rates on dividend
income and capital gains are the same, thereby making the investors indifferent to the form in which the returns on the investment is received. 6. The investors can lend or borrow any amount of funds desired at a rate of
interest equal to the rate for risk less securities. 7. The investors can sell short any amount of any share.
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Risk is measured typically in terms of security betas. Ex-post SML: - In the Ex-post (SML) average historical rates of return for security are plotted against their betas for a particular time period. Then a straight line is fitted to the plots by regression and this is called the SML. Hence the SML represents the normal or average trade off between return and risk. The securities which plot above the ex-post SML generate above the normal returns and the securities which plot below this SML generate below average returns. The amount by which a security return differs from the normal returns for its level of risk is simply the vertical distance of SML. The vertical distance is called the securities abnormal return or its alpha . The securities which plot above the ex-post SML generate normal returns for their risk which are measured by their beta for the particular time period used in constructing the SML.
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In case of portfolio involving complete diversification where the unsystematic risk tends to be zero, there is only systematic risk measured by (). The only dimension of a security which concerns us is expected return and betas. The equation of security market line (SML) is Ri= + i (Rm-Rf) Or Ri=Rf + i (Rm-Rf)
Where = Rf = risk free return Rm= market return i= beta Covariance is to be as much as possible negative interactive effect among the securities within the portfolio and co-efficient of correlation to be 1 (negative). So that the overall risk of the portfolio as a whole is nil or neglible. Then the securities have to be combined in a manner that standard deviation is zero.
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For building up an efficient set of portfolio, we need to look into these important parameters: 1. 2. 3. Expected return. Variability of return as measured by standard deviation from the mean. Covariance or variance of one asset return to other asset return.
In general the higher the expected return the lower is the standard deviation or variance and lower is the correlation the better will be the security for the investor choice. Whatever is the risk of the individual securities in isolation, the total risk of all securities may be lower, if the covariance of their returns is negative or neglible. Application: 1. 2. 3. Evaluating the performance of portfolio manager. Test of asset pricing theories such as CAPM. Test of Market efficiency.
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Normal return N (ri) = ro + ri im ro=intercept of Ex-post SML. ri= slope of ex-post SML. = ri- N (ri) + > ri- (ro+ riim) If > 0 then security has above normal returns. < 0 then security has below normal returns.
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Calculation of Returns and Standard deviation of Oil and Natural Gas Corporation
Month Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Opening 880 912 788.05 875 923.85 944.45 906 914 860 962 1268.9 1160 1240 995.05 1024.4 1000 1044 870 829.95 980.2 1019 1064.4 700 724.85 Closing 911.4 788.05 880.8 913.85 922.3 905.55 914.55 860 971 1250 1168.25 1238 1018 1012 986 1031.3 861.6 804 992 1023.75 1034.8 684 687.05 668 Returns 3.568182 -13.591 11.76956 4.44 -0.16778 -4.1188 0.943709 -5.9081 12.90698 29.93763 -7.93207 6.724138 -17.9032 1.703432 -3.74854 3.13 -17.4713 -7.58621 19.52527 4.442971 1.55054 -35.7384 -1.85 -7.843 = -23.216 (Rx-Rx) 26.7842 -13.591 11.76956 4.44 -0.16778 -4.1188 0.943709 -5.9081 12.90698 29.93763 -7.93207 6.724138 -17.9032 1.703432 -3.74854 3.13 -17.4713 -7.58621 19.52527 4.442971 1.55054 -35.7384 -1.85 -7.843 (Rx-Rx) 717.3934 184.7155 138.5225 19.7136 0.028149 16.96451 0.890586 34.9056 166.59 896.2617 62.91769 45.21403 320.5255 2.901681 14.05152 9.7969 305.2451 57.55054 381.2363 19.73999 2.404174 1277.236 3.4225 61.51268 = 4739.741
Table 4.1: Calculation of returns and standard deviation of ONGC Mean return (Rx) = -0.96733 Variance (x) = 174.3417
Standard deviation (x) = 13.203
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Mont h Jan08 Feb0 8 Mar0 8 Apr0 8 May 08 Jun08 Jul08 Aug0 8 Sep08 Oct08 Nov0 8 Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun0 9 Jul09 Aug0 9 sep09 Oct09 Nov0 9
Openi ng 338 355 314.8 302.5 335 355 341 320 310.0 5 361 347.6 393.9 529.7 369.9 451.3 408.4 400.5 5 362.4 232 325 300 358 290
Closin g 360.4 311.2 5 302.7 5 333.2 5 361.2 340.4 5 321.3 311 362 345.9 389 518 357 466.8 5 404 409 362 221.2 326 302 358.8 5 286
Return 6.62721 9 -12.3239 -3.82783 10.1652 9 7.82089 6 -4.09859 -5.77713 -2.8125 16.7553 6 -4.18283 11.9102 4 31.5054 6 -32.6034 26.2097 9 -10.4808 0.14691 5 -9.62427 -38.9625 40.5172 4 -7.07692 19.6166 7 -20.1117
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363 25.1724 1
(RxRx ) 4.573 581 14.37 76 5.881 47 8.111 651 5.767 258 6.152 23 7.830 76 4.866 14 14.70 172 6.236 46 9.856 604 29.45 182 34.65 7 24.15 615 12.53 45 1.906 72 11.67 79 41.01 61 38.46 36 9.130 56 17.56 303 22.16 54 23.11 878
(Rx-Rx) 20.9176 4 206.714 9 34.5916 3 65.7988 9 33.2612 6 37.8499 3 61.3208 6 23.6793 216.140 7 38.8934 8 97.1526 4 867.409 7 1201.10 8 583.519 5 157.113 3.63559 3 136.373 5 1682.32 1 1479.44 9 83.3671 4 308.46 491.303 6 534.477 8
Table 4.2: Calculation of returns and standard deviation of BPCL Mean return (Rx) = 2.0536 Variance (x) = 363.9991
Standard deviation (x) = 19.07876
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Mont h Jan08 Feb0 8 Mar0 8 Apr0 8 May 08 Jun08 Jul08 Aug0 8 Sep08 Oct08 Nov0 8 Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0 9 Sep09 Oct09 Nov0 9 Dec09
Openi ng 280.0 0 311.0 0 273.0 0 250.0 0 273.9 5 294.0 0 265.5 0 254.9 5 237.6 0 255.0 0 241.1 0 277.0 0 356.2 5 255.0 0 300.0 0 252.0 0 260.0 0 247.5 0 184.8 0 218.0 0 197.5 0 241.5 0 193.0 0 239.0 0
Closi ng 312.1 00 271.6 00 247.8 00 270.1 00 294.7 00 270.6 50 257.6 50 235.0 00 266.0 00 239.4 00 272.6 50 364.1 00 252.0 00 301.2 00 256.0 00 256.7 00 247.9 00 172.0 50 220.3 00 202.0 00 242.4 00 190.0 00 238.5 00 238.5 00
Returns 11.4642 9 -12.6688 -9.23077 8.04 7.57437 5 -7.94218 -2.95669 -7.82506 11.9528 6 -6.11765 13.0858 6 31.4440 4 -29.2632 18.1176 5 -14.6667 1.86507 9 -4.65385 -30.4848 19.2099 6 -7.33945 22.7341 8 -21.3251 23.5751 3 -0.20921
(Rx-Rx) 10.86512 -13.268 -9.82994 7.440832 6.975207 -8.54134 -3.55585 -8.42423 11.35369 -6.71682 12.48669 30.84488 -29.8623 17.51848 -15.2658 1.265911 -5.25301 -31.084 18.61079 -7.93862 22.13501 -21.9242 22.97596 -0.80837
((RxRx) 118.050 8 176.039 3 96.6276 7 55.3659 8 48.6535 1 72.9545 7 12.6440 9 70.9676 8 128.906 4 45.1156 1 155.917 4 951.406 3 891.758 5 306.897 1 233.045 7 1.60253 1 27.5941 6 966.216 1 346.361 5 63.0216 5 489.958 6 480.671 4 527.894 8 0.65346 7 =6268. 325
31 =14.38
003
Table 4.3: Calculation of returns and standard deviation of HPL Mean return (Rx) =0.5991 Variance (x) = 272.5359
Standard deviation (x) = 16.50866
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Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0 9 Sep09 Oct09 Nov0 9 Dec09
156.1 201.2 175.05 170.5 164.75 157 143.2 87.3 72.75 87.25
-7.63314 27.9491 3 -14.0226 -16.2574 -3.65497 -4.84848 -8.55683 -39.4171 -19.1667 18.7074 8 =57.91 964
10.0465 25.5358 1 16.4359 18.6707 6.06829 -7.2618 10.9702 41.8304 -21.58 16.2941 6
100.931 2 652.077 5 270.139 2 348.594 5 36.8241 3 52.7337 8 120.344 2 1749.78 2 465.695 8 265.499 8 =10017 .26
Table 4.4: Calculation of returns and standard deviation of Reliance Petroleum Ltd. Mean return (Rx) = 2.4133 Variance (x) = 417.3859
Standard deviation (x) = 20.43002
Muitiply the monthly returns of one stock with that of other companies stock. Covariance has to be calculated for all stocks with that of other stocks.
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Cov (ob) =
1 N-1
( Ro-Ro) ( Rb-Rb)
Correlation of coefficient: = cov (ob) o b Let: Ro= returns of ONGC Rb= returns of BPCL Rh=returns of HPL Rr=returns of REL PETRO.
May 08 Jun08 Jul08 Aug0 8 Sep08 Oct08 Nov0 8 Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0 9 Sep09 Oct-
0.7995 6 -3.1515 0.9437 1 -4.9408 13.874 3 30.905 -6.9647 7.6914 7 -16.936 2.6707 7 -2.7812 4.0973 3 -16.504 -6.6189 20.492 6 5.4103 2.5178 7 -34.771
5.767 26 6.152 2 7.830 8 4.866 1 14.70 17 6.236 5 9.856 6 29.45 18 34.65 7 24.15 61 12.53 4 1.906 7 11.67 8 41.01 6 38.46 36 9.130 6 17.56 3 -
4.61126 19.3885 -7.39 24.0424 203.976 -192.74 -68.649 226.528 586.947 64.5154 34.8609 -7.8125 192.731 271.48 788.219 -49.399 44.2215 770.715
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09 Nov0 9 Dec09
-0.8827 -6.8757
-20.406 -18.348
=3038.69
1 23
(3038.69)
= 132.1168
132.1168 ---------------------------(13.20385)(19.07876)
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0.524
50 40 30 20 10 returns 0 -10 -20 -30 -40 -50 time in months monthlyReturns of ONGC Monthly Returns of BPCL 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Fig 4.1: GRAPH SHOWING MONTHLY RETURNS OF ONGC SECURITIES AND BPCL SECURITIES FROM JAN 2008 TO DEC 2009. 37
38
N-1
1 23
(2337.168)
= 101.616
101.616 ----------------------------
39
(13.20385)( 16.50866)
0.466
Cov (oh)=covariance between ONGC and HPL o = Standard deviation of ONGC h = Standard deviation of HPL.
40 30 20 10 returns 0 1 -10 -20 -30 -40 time in months monthlyReturns of ONGC monthly Returns of HPL 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Figure 4.2: GRAPH SHOWING MONTHLY RETURNS OF SECURITIES OF ONGC AND HPL FROM JAN 2008 TO DEC 2009
40
41
Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0 9 Sep09 Oct09 Nov0 9 Dec09
7.691 472 16.93 59 2.670 766 2.781 2 4.097 334 16.50 39 6.618 87 20.49 261 5.410 305 2.517 874 34.77 11 0.882 67 6.875 67
1.377 379 30.47 41 4.554 146 10.04 65 25.53 581 16.43 59 18.67 07 6.068 29 7.261 8 10.97 02 41.83 04 -21.58 16.29 416
10.59408 516.1058 12.16306 27.94122 104.6287 271.2571 123.5789 -124.355 -39.2886 -27.6215 1454.489 19.04792 -112.033
=4614.077
Calculation of covariance and correlation between stocks ONGC and Rel petroleum:
Cov (or) = 1
(Ro-Ro) (Rr-Rr)
42
N-1
1 23
(4614.077)
= 200.612
200.612 ---------------------------(13.20385)(20.43002)
0.742
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80 60 40 20 0 1 -20 -40 -60 time in months monthlyReturns of ONGC monthly returns of Rel.Petro 3 5 7 9 11 13 15 17 19 21 23 25
Figure 4.3: GRAPHICAL REPRESENTATION OF MONTHLY RETURNS OF SECURITIES OF ONGC AND REL.PETROLEUM LTD FROM JAN 2008 TO DEC 2009.
returns
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Mont h Jan08 Feb0 8 Mar0 8 Apr0 8 May 08 Jun08 Jul08 Aug0 8 Sep08 Oct08 Nov0 8 Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0 9 Sep09 Oct09 Nov0 9
RbRb 4.573 581 14.37 76 5.881 47 8.111 651 5.767 258 6.152 23 7.830 76 4.866 14 14.70 172 6.236 46 9.856 604 29.45 182 34.65 7 24.15 615 12.53 45 1.906 72 11.67 79 41.01 61 38.46 36 9.130 56 17.56 303 22.16 45 54 23.11 878
RhRh 10.86 512 13.26 8 9.829 94 7.440 832 6.975 207 8.541 34 3.555 85 8.424 23 11.35 369 6.716 82 12.48 669 30.84 488 29.86 23 17.51 848 15.26 58 1.265 911 5.253 01 31.08 4 18.61 079 7.938 62 22.13 501 21.92 42 22.97 596
(Rb-Rb)(RhRh) 49.6925 190.7614 57.81443 60.35743 40.22781 52.54831 27.84505 40.99347 166.9189 41.88917 123.0763 908.4377 1034.939 423.179 191.3492 -2.41374 61.3442 1274.945 715.838 72.48403 388.7578 485.9584 531.1761
1 23
(6935.962)
=301.5636 46
301.5636 ---------------------------(19.07876)(16.50866)
= 0.957
Cov (bh)=covariance between BPCL and HPL b = Standard deviation of BPCL h = Standard deviation of HPL
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50 40 30 20 RETURNS 10 0 -10 -20 -30 -40 -50 TIME IN MONTHS Monthly Returns of BPCL monthly Returns of HPL 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Figure 4.4: GRAPHICAL REPRESENTATION OF MONTHLY RETURNS OF SECURITIES OF BPCL AND HPL FROM JAN 2008 AND DEC 2009
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Feb0 8 Mar0 8 Apr0 8 May 08 Jun08 Jul08 Aug0 8 Sep08 Oct08 Nov0 8 Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0
13.26 8 9.829 94 7.440 832 6.975 207 8.541 34 3.555 85 8.424 23 11.35 369 6.716 82 12.48 669 30.84 488 29.86 23 17.51 848 15.26 58 1.265 911 5.253 01 31.08 4 18.61 079 -
0.039 66 4.697 46 10.96 203 20.89 541 8.797 893 2.725 82 2.095 248 26.72 352 58.13 863 15.45 33 1.377 379 30.47 41 4.554 146 10.04 65 25.53 581 16.43 59 18.67 07 6.068 29 -
0.526185 -46.1757 81.56664 145.7498 -75.1458 9.692611 -17.6509 303.4107 -390.506 -192.961 42.4851 910.0271 79.78172 153.3675 32.32607 86.33808 580.3599 -112.936 57.64868
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=1829.32
Calculation of covariance and correlation between stocks HPL and Rel Petroleum:
Cov(hr) = 1 N-1
(Rh-Rh)( Rr-Rr)
1 23
(1829.32)
=79.53563
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79.53563 ---------------------------(16.50866)(20.43002)
= 0.235
Cov (bh) =covariance between HPL and Rel.Petroleum ltd. h = Standard deviation of HPL r = Standard deviation of Rel. Petroleum ltd.
80 60 40 20 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 -20 -40 -60 time in months monthly Returns of HPL monthly returns of Rel.Petro
returns
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Figure 4.5: GRAPHICAL REPRESENTATION OF MONTHLY RETURNS OF SECURITIES OF HPL AND REL.PETROLEUM LTD FROM JAN 2008 TO DEC 2009.
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08 Nov0 8 Dec08 Jan09 Feb09 Mar0 9 Apr0 9 May 09 Jun09 Jul09 Aug0 9 Sep09 Oct09 Nov0 9 Dec09
6.236 46 9.856 604 29.45 182 34.65 7 24.15 615 12.53 45 1.906 72 11.67 79 41.01 61 38.46 36 9.130 56 17.56 303 22.16 54 23.11 878 2.668 584
863 15.45 33 1.377 379 30.47 41 4.554 146 10.04 65 25.53 581 16.43 59 18.67 07 6.068 29 7.261 8 10.97 02 41.83 04 -21.58 16.29 416
-152.317 40.56633 1056.14 110.0106 125.927 -48.6897 191.937 765.7989 -233.408 66.30434 -192.669 927.1861 -498.903 43.48235 =2377.854
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Calculation of covariance and correlation between stocks BPCL and Rel Petroleum:
Cov (br) = 1 N-1
(Rb-Rb) (Rr-Rr)
1 23
(2377.854)
=103.385
= 0.265
Cov (br) =covariance between BPCL and Rel Petroleum b = Standard deviation of BPCL r= Standard deviation of Rel Petroleum.
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80 60 40 RETURNS 20 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 -20 -40 -60 TIME IN MONTHS Monthly Returns of BPCL monthly returns of Rel.Petro
Figure 4.6: GRAPHICAL REPRESENTATION OF MONTHLY RETURNS OF SECURITIES OF BPCL AND REL.PETROLEUM LTD FROM JAN 2008 TO DEC 2009.
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ONGC
BPCL
HPL
Table 4.11: Covariance between the stocks 1. Covariance shows the degree to which the returns of the two securities Vary or change together 2. The stocks which are having high value of covariance are positively covariated means that the returns of the two securities move in the same direction.
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3. The stocks which are having lesser value of covariance or negative covariance imply that the returns of the two securities move in opposite direction. 4. Here the stocks of BPCL and HPL are highly covariated with a covariance of 301.56 between them indicating that the returns of these two stocks move in the same direction. 5. The securities of HPL and Rel.Petroleum ltd are having least value of covariance which implies that the returns of these two stocks do not move in the same direction and hence may be preferred combination to inves
Table 4.12: Correlation of coefficient. 1. Coefficient of correlation reflects the degree of comovement between two variables. Coefficient of correlation indicates the risk aspect of the two stocks. 2. The correlation coefficient can vary between -1.0 and +1.0. A value of -1.0 means perfect negative correlation or comovement; a value of +1.0 means perfect correlation or comovement in the same direction. 57
3. The correlation coefficient between the securities of HPL and Rel Petroleum ltd is the lowest and hence the risk will be least if investment is made in the combination of these two. 4. The correlation coefficient between the securities of BPCL and HPL is the highest indicating high comovement.
4.3. Calculation on market returns (Rm) For the period 2008 and 2009
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Month December'09 November October September August July June May April March February January '09 December'08 November October September August July June May April March February January'08
Opening 2755.15 2885.4 3921.85 4356.1 4331.6 4039.75 4869.25 5265.3 4735.65 5222.8 5140.6 6136.75 5765.45 5903.8 5021.5 4466.65 4528.85 4318.3 4295.8 4087.9 3821.55 3745.3 4082.7 3944.55
Closing 2959.15 2755.1 2885.6 3921.2 4360 4332.95 4040.55 4870.1 5165.9 4734.5 5223.5 5137.45 6138.6 5762.75 5900.65 5021.35 4464 4528.85 4318.3 4295.8 4087.9 3821.55 3745.3 4082.7
Return(Rm ) 7.4 -4.52 -26.42 -9.98 0.66 7.26 -17.02 -7.51 9.09 -9.35 1.61 -16.28 6.47 -2.39 17.51 12.42 -1.43 4.88 0.52 5.09 6.97 2.04 -8.26 3.5 =-17.76
(RmRm) 8.14 -3.78 -25.68 -9.24 1.4 8 -16.28 -6.77 9.83 -8.61 2.35 -15.54 7.21 -1.65 18.25 13.16 -0.69 5.62 1.26 5.83 7.71 2.78 -7.52 4.24
(Rm-Rm)2 66.32832 14.25768 659.5946 85.44777 1.947564 63.96448 265.0105 45.7766 96.53547 74.12326 5.534523 241.6147 52.01409 2.719975 332.9757 173.149 0.4789 31.5357 1.596867 33.93814 59.43777 7.705007 56.6141 17.9963 =2390.29698
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Mean return of market index (Rx) = -0.74 Calculation of variance for market index: m = (Rm-Rm) N-1 m = 2390.30 23 = 103.92
=2506.492
Table 4.14: Calculation of beta of ONGC Calculation of covariance of ONGC & market index: Cov(om) = (Ro-Ro)(Rm-Rm) N-1 61
Cov(om)= 2506.492 = 108.98 24-1 Calculation of beta () for ONGC: = Cov(om) m = 108.98 103.92 = 1.05
Figure 4.8: CHART SHOWING THE MARKET RETURNS AND RETURNS OF SECURITIES OF ONGC FROM JAN 2008 TO DEC 2009.
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Jan08 Feb08 Mar08 Apr08 May08 Jun08 Jul-08 Aug08 Sep08 Oct08 Nov08 Dec08 Jan09 Feb09 Mar09 Apr09 May09 Jun09 Jul-09 Aug09 Sep09 Oct09 Nov09 Dec09
4.573581 -14.3776 -5.88147 8.111651 5.767258 -6.15223 -7.83076 -4.86614 14.70172 -6.23646 9.856604 29.45182 -34.657 24.15615 -12.5345 -1.90672 -11.6779 -41.0161 38.4636 -9.13056 17.56303 -22.1654 23.11878 2.668584
4.24 -7.52 2.78 7.71 5.83 1.26 5.62 -0.69 13.16 18.25 -1.65 7.01 -15.54 2.35 8.61 9.83 -6.77 -16.28 8 1.4 -9.24 -25.68 -3.78 8.14
19.39198 108.1194 -16.3505 62.54083 33.62311 -7.75181 -44.0089 3.357635 193.4747 -113.815 -16.2634 206.4573 538.5698 56.76695 -107.922 -18.7431 79.05941 667.7423 307.7088 -12.7828 -162.282 569.2067 -87.389 21.72228
=2280.432
Table 4.15: Calculation of beta of BPCL Calculation of covariance of BPCL & market index: Cov (bm) = (Rb-Rb)(Rm-Rm) N-1 63
Cov (bm) = 2280.432 = 99.15 24-1 Calculation of beta () for BPCL: = Cov(bm) m = 99.15 103.92 = 0.95
50 40 30 20 10 returns 0 -10 -20 -30 -40 1 2 3 4 5 6 7 8 9 101112131415161718192021222324 time in months Return Return(Rm)
Figure 4.8: CHART SHOWING THE MARKET RETURNS AND THE RETURNS OF BPCL FROM JAN 2008 TO DEC 2009
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Feb08 Mar08 Apr08 May08 Jun08 Jul-08 Aug08 Sep08 Oct08 Nov08 Dec08 Jan09 Feb09 Mar09 Apr09 May09 Jun09 Jul-09 Aug09 Sep09 Oct09 Nov09 Dec09
-13.268 -9.82994 7.440832 6.975207 -8.54134 -3.55585 -8.42423 11.35369 -6.71682 12.48669 30.84488 -29.8623 17.51848 -15.2658 1.265911 -5.25301 -31.084 18.61079 -7.93862 22.13501 -21.9242 22.97596 -0.80837
-7.52 2.78 7.71 5.83 1.26 5.62 -0.69 13.16 18.25 -1.65 7.01 -15.54 2.35 8.61 9.83 -6.77 -16.28 8 1.4 -9.24 -25.68 -3.78 8.14
99.7752 -27.3272 57.36881 40.66546 -10.7621 -19.9839 5.81272 149.4146 -122.582 -20.603 216.2226 464.0605 41.16843 -131.439 12.44391 35.56291 506.0478 148.8863 -11.1141 -204.527 563.014 -86.8491 -6.58016
=1744.744
Table 4.16: Calculation of beta of HPL Calculation of covariance of HPL & market index: Cov (hm) = (Rh-Rh)(Rm-Rm) N-1 Cov (hm) =1744.744 = 75.86
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40 30 20 10 returns 0 -10 -20 -30 -40 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 time in months monthlyReturns of HPL Return(Rm)
Figure 4.9: CHART SHOWING MARKET RETURNS AND RETURNS OF HPL FROM JAN 2008 TO DEC 2009
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Feb08 Mar08 Apr08 May08 Jun08 Jul-08 Aug08 Sep08 Oct08 Nov08 Dec08 Jan09 Feb09 Mar09 Apr09 May09 Jun09 Jul-09 Aug09 Sep09 Oct09 Nov09 Dec09
-0.03966 4.69746 10.96203 20.89541 8.797893 -2.72582 2.095248 26.72352 58.13863 -15.4533 1.377379 -30.4741 4.554146 -10.0465 25.53581 -16.4359 -18.6707 -6.06829 -7.2618 -10.9702 -41.8304 -21.58 16.29416
-7.52 2.78 7.71 5.83 1.26 5.62 -0.69 13.16 18.25 -1.65 7.01 -15.54 2.35 8.61 9.83 -6.77 -16.28 8 1.4 -9.24 -25.68 -3.78 8.14
0.29823 13.05894 84.51727 121.8203 11.08535 -15.3191 -1.44572 351.6816 1061.03 25.49798 9.65543 473.5673 10.70224 -86.5 251.017 111.2711 303.9588 -48.5463 -10.1665 101.3642 1074.204 81.57234 132.6345
=4063.255
Table 4.17: Calculation of beta of Reliance Petroleum ltd Calculation of covariance of Rel Petro & market index: Cov (rm) = (Rr-Rr)(Rm-Rm) N-1 Cov (rm)=4063.26 = 176.66 24-1
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70 60 50 40 30 returns 20 10 0 -10 -20 -30 -40 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 time in months Monthlyreturns of Rel Petro Return(Rm)
Figure 4.10: CHART SHOWING MARKET RETURNS AND RETURNS OF REL.PETROLEUM LTD. FROM JAN 2008 TO DEC 2009.
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r= + (rm-rf) rf = risk free rate, here assuming it to be 9% = beta of individual stock rm = market return, here market return is -0.74.
5.1. FINDINGS
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70
Expected return
Beta
value
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0.2 0 0 -0.2 -0.4 returns -0.6 -0.8 -1 -1.2 -1.4 beta expected returns market return Rf 0.5 1 1.5 2
Figure 6.1: Security market line of the Table 6.1 1. The actual returns of ONGC is -0.97 which is high compared to the expected returns of -0.687, it is under priced, here beta is 1.05, which is high. 2. The actual returns of BPCL is 2.05 when compared to expected returns of-0.613 it is high, it is under priced, here beta is 0.95 which is average. 3. The actual returns of HPL are 0.59 is higher than the expected returns of -0.45, it is also under valued, and here the beta is 0.73 which is low. 4. The actual returns of Relpetroleum is 2.45 which is quite higher than the expected returns of -1.258, and here beta value is 1.70 which is the highest when compared to that of other companys.
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5.2. CONCLUSION
1. The expected returns and the actual returns of the stocks are not equal and there are wide disparities, the market is considered to be aggressive or volatile. 2. The actual returns are better when compared to expected returns of the stocks; hence it would be beneficial for an investor to make investments as all the stocks are under priced. 3. The actual returns of the securities and the beta are directly proportional. The stock with highest beta is also yielding the highest actual returns. 4. Those who want to take less risk must invest in securities which are having less beta value. 5. The stocks of ONGC is having a high beta value and giving negative returns indicating poor performance of the company
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5.3. SUGGESTIONS
1. As the markets are very volatile and the returns for the coming year or two is not certain, an investor seeking to make investment for short period of 1-5 years is advised not to invest in equities. 2. It is a good opportunity for investors looking for a long term investments in stocks as these would be available at low prices, but proper evaluation has to be made. 3. Seeing the current trend the volatility of the market is expected to continue for the next 12-18 months. So even if we buy stocks at lower prices there would not be a notable increase in the values for these 12-18 months. 4. Investors are advised not to make investments in the stocks of ONGC as its actual returns are negative and the beta is als high at 1.05 5. Investors who want to take low risk and are satisfied with low returns can invest in the equities of Hindustan petroleum ltd. 6. Investors who want high returns and are ready to bear high risk can invest in the shares of BPCL and Rel petroleum.
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5.4. LIMITATIONS
1. Future uncertainties: Future changes are largely unpredictable; more so when the economic and business environment is buffeted by frequent winds of changes. In an environment characterized by discontinuities, the past record is poor guide to future performance. 2. Irrational market behavior: The market itself presents a major obstacle to the analyst. On account of neglect of prejudice, undervaluation may persist fore extended periods: likewise, overvaluation arising from unjustified optimism and misplaced enthusiasm may endure for unreasonable lengths of time. The slow correction of under or overvaluation poses a threat to the analyst. Before the market eventually reflects the values established by the analyst, new forces may emerge. 3. Inadequacies or incorrectness of data: An analyst has to often wrestle with inadequacy or incorrect data. While deliberate falsification of data may be rare, subtle misrepresentation and concealment are common. Often an experienced and skilled analyst may be able to detect such ploys and cope with them. However, in some instances, he too is likely to be misled by them into drawing wrong conclusions.
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BIBLIOGRAPHY
1. Prasanna Chandra (2006), Investment Analysis and Portfolio Management (2nd edition) Tata Mc.Graw-Hill Publishing Company limited, New Delhi. 2. Donald E.Fischer & Ronald J.Jordan(2006), Security Analysis and portfolio Management (6th edition) Prentice-Hall of India Pvt limited, New Delhi. 3. ZVI Bodie, Alex Kane, Alan J Marcus, Pitabas Mohanty (2006), Investments (6th edition) Tata Mc.Graw-Hill Publishing Company limited, New Delhi. Websites: www.investopedia.com www.economictimes.com www.investorideas.com
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