CAPITAL ASSET PRICING MODEL WITH REFERENCE TO BANKING STOCKS OF BSE INDEX AT MONARCH NETWORTH CAPITAL LIMITED

 CAPITAL ASSET PRICING MODEL WITH REFERENCE TO BANKING STOCKS OF BSE INDEX AT MONARCH NETWORTH CAPITAL LIMITED SYNOPSIS

ABSTRACT

The Study on capital asset pricing model in equity shares of Banking industries was undertaken with an objective of getting an insight into the concept of investments, market risk,  security market line, undervalued overvalued stocks, the risks and the returns. The study aims to determine the market risk involved in the investments and the factors affecting the market risk and to determine required rate of returns. The other objectives of the study are to observe the security market line and the degree of volatility of the Banking industry and undervalued and overvalued stocks. The study is confined to the banking sector and analyzed six companies – STATE BANK OF INDIA, ICICI, HDFC, ANDHRA BANK, AXIS BANK and BANK OF BARODA. The study is done using the SENSEX values and other related data from the Stock Exchanges. The data of the only one sector – STATE BANK OF INDIA, ICICI, HDFC, ANDHRA BANK, AXIS BANK and BANK OF BARODA are collected. The entire study is based on the secondary data only. The analytical tools used for the study are risk and return analysis. The study is done at Hyderabad for a period of 45 days. The study had few limitations which were taken care of.

The information collected during the year 2017-2018 was analyzed using appropriate techniques – Study on capital asset pricing model. From the analysis, it was found that the investors should sell their shares of STATE BANK OF INDIA, and BANK OF BARODA to safe their investments in market loss because they are overvalued. That means the required rate of return is greater than the expected returns. The remaining four banks ICICI, HDFC, ANDHRA BANK, AXIS BANK, it is suggested to the investors to hold their shares with these companies to protect their money even in the market losses because stocks are undervalued. 

1.1 INTRODUCTION

The Capital asset pricing model, in essence, predicts the relationship between the risk of an asset and its expected return. This relationship is very useful in two important ways. First, it produces a benchmark for evaluating various investments. For example, when we are analyzing a security we are interested in knowing whether the expected return from it is in line with its fair return as per the CAPM. Second, it helps us to make an informed guess about the return that can be expected from an asset that has not yet been traded in the market.

The capital asset pricing model is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset’s sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by quantity beta in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.Modern portfolio theory shows that specific risk can be removed through diversification. The trouble is that diversification still doesn't solve the problem of systematic risk; even a portfolio of all the shares in the stock market can't eliminate that risk. Therefore, when calculating a deserved return, systematic risk is what plagues investors most. CAPM, therefore, evolved as a way to measure this systematic risk.

Beta:
According to CAPM, beta is the only relevant measure of a stock's risk. It measures a stock's relative volatility - that is, it shows how much the price of a particular stock jumps up and down compared with how much the stock market as a whole jumps up and down. If a share price moves exactly in line with the market, then the stock's beta is 1. A stock with a beta of 1.5 would rise by 15% if the market rose by 10%, and fall by 15% if the market fell by 10%. 

Security Market Line:

Security market line (SML) is the representation of the Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk (its beta).

RISK AND RETURN

According to Kevin, Return and risk are two important characteristics of every investment. Investors base their investment decision on the expected return and risk of investments. Risk is measured by the variability in returns.

Investors attempt to reduce the variability of returns through diversification of investment. This results in the creation of a portfolio. With a given set of securities, any number of portfolios may be created by altering the proportion of funds invested in each security. Among these portfolios some dominate others or some are more efficient than the vast majority of portfolios because of lower risk or higher returns.

Diversification helps to reduce risk, but even a well diversified portfolio does not become risk free. If we construct a portfolio including all the securities in the stock market, that would be the most diversified portfolio. Even such a portfolio would be subject to considerable variability. This variability is undiversifiable and is known as the market risk or systematic risk because it   affects all he securities in the market.

The real risk of a security is the market risk which cannot be eliminated through diversification. This is indicated by the sensitivity of a security to the movements of the market and is measured by the beta coefficient of the security.

A rational investor would expect the return on a security to be commensurate with its risk. The higher the risk of security, the higher would be the return expected from it. And since the relevant risk of a security is its market risk or systematic risk, the return is correlated with this risk only. The capital asset pricing model gives the nature of the relationship between the expected return and the systematic risk of a security.

1.2 NEED FOR THE STUDY

The need of the study is to find the Security market line (SML) which represents Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk (beta).

The Study on capital asset pricing model in equity shares of banking industries will be undertaken with an objective of getting an insight into the concept of investments, market risk, security market line, undervalued overvalued stocks, the risks and the returns. The study aims to determine the market risk involved in the investments and the factors affecting the market risk and to determine required rate of returns. The other objectives of the study are to observe the security market line and the degree of volatility of the Banking industry and undervalued and overvalued stocks.

1.4 SCOPE OF THE STUDY

The study covers the information related to the equities share of banking sector. It also covers the systematic risk and unsystematic risk of banking companies. The study is confined only one Sector i.e., banking industry and the entire study is based upon their Stock prices for a period of last two years. Companies need to invest in diverse areas in order to minimize their risk and get optimum returns. However, a company cannot blindly invest in everything in order to reduce its risk since it involves huge money and effort. So, it is important for a company to properly decide its portfolio and invest carefully. The present study gives an insight into this issue by analyzing the capital asset pricing model Analysis in Equity share prices of the Banking industry.

 1.3 OBJECTIVES OF THE STUDY

·         To observe the risk free rate and evaluate the relationship between risk and return involved in equity share prices of banking industry.

·         To observe the significant risk of shares (market risk or systematic risk).

·         To observe the relationship between security market line and capital market line

·         To develop the inputs required for applying the capital asset pricing model.

·         To produce a benchmark for evaluating various investments and finding out whether the stocks are under or overvalued.

 1.5 RESEARCH METHODOLOGY

Method of data collection:

 The Historical data of share prices of 2017-18 was collected from BSE index for the study.

Source of data

Secondary data was collected from the respective web sites like bseindia.com, Moneycontrol.com and other financial Journals of the selected banking Stocks.

The stocks of the Six Major Banks to be taken under study are as follows

1. STATE BANK OF INDIA
2. ICICI
3. HDFC
4. ANDHRA BANK
5. AXIS BANK
6. BANK OF BARODA

Data analysis tools:

Appropriate data tools like Beta, Mean, S.D, Correlation and Covariance were used for Analysis. 

 1.6 LIMITATIONS OF THE STUDY

·         The study is based on the secondary data.

·         The study is limited to banking stocks only.

·         The time for the project is limited to 40 days approximately.

·         The study is confined to BSE index.

·         The study is based on CAPM model.