BETA ESTIMATION OF TATA

MOTORS
PGDM PT 20-23 GROUP_3

JAGMOHAN SAINI (E202007)

RODLEY NUNES (E2020020)
HARSHDA GHOLVE (E202005)
PARVEZ CHALIL (E2020015)
AMEY VERNEKAR (E202002)
FARHA SHEIKH(E202003)
 Estimation of Beta of a Stock and
Computation of Cost of Equity (Required
Rate of Return) Using CAPM Model

Objective: -. The study is carried out to calculate the beta of TATA motors
and Cost of equity by collecting the historical 84-month data.

To perform the risk return analysis of the TATA MOTORS Share with NSE
Index the report prepared by taking Monthly share prices of TATA MOTORS
of last 84 months and compare with the last 84 months prices of NSE INDEX.
To calculate the monthly return of Stock as well as Market index, used the
Adjusted closing price and monthly return % calculated.

The study includes the Beta and Alpha of the stock and tried to show the
reliability of Beta and Alpha values by calculating the R-squared. Further in
study showed the model used (Sharpe’s Single index model) for calculation of
beta and its limitations and assumption. Also tried to explain the issues and
problems in estimation of beta value.
The study also includes the concept of adjustment of beta and calculated our
report adjusted beta. At last explained the CAPM model and utility of beta for
calculating Cost of equity.

Theoretical framework/background: -

General Statistical Regression Model: -When comparing two different

variables, two questions come to mind: “Is there a relationship between two
variables?” and “How strong is that relationship?” These questions can be
answered using regression and correlation. Regression answers whether there is
a relationship and correlation answers how strong the linear relationship is.

The aim of regression is to find the linear relationship between two variables.
There is two variable one is Independent variable, and another is dependent
variable, the independent variable is also called the caused factor. Its value
is independent of other variables in study.

The dependent variable is the effect factor, its value depends upon on
changes in the independent variable.
 The independent variable, also called the explanatory variable or predictor
variable, this shown by the x-value in the equation. The dependent variable is
the y-value in the equation depends on what independent value you pick. It also
responds to the explanatory variable and is sometimes called the response
variable.
The process of regression is used to find the line that best fits the data
(sometimes called the best fitting line).

Let us for example we consider the scatter plot between two variables, and one
possible line of best fit has been drawn on the diagram. Some of the points lie
above the line and some lie below it.

The vertical distance each point is above or below the line are called residuals
ε1
or deviations or errors – they are symbolized as d 1 , d 2 ,...,d n .
When drawing in a regression line, the aim is to make the line fit the points as
closely as possible. We do this by making the total of the squares of the
deviations as small as possible, i.e., we minimize d i
2
.

If a line of best fit is found using this principle, it is called the least-squares
regression line. The regression line is the line that makes the square of the
residuals as small as possible, so the regression line is also sometimes called
the least squares line. Regression also allows us to determine how well one
variable can be used to predict another.

The specific equation for the line of best fit can be derived.
the regression equation is
ˆy = a + bx

where the slope = b = SSxy ÷ SSx

SSxy =∑(x - xbar )(y - ybar )

SSx =∑(x -xbar )^2
SSy = (y - ybar )2

SS stands for sum of squares.

Slope b measures the estimated change in y as a result of a one-unit change

in x.

and y-intercept = a = y bar – b xbar

Intercept a is the estimated value of y when x is 0

The residuals are the difference between the actual values and the estimated
values.
residual = y - ˆy

Measures of Variation: -

Sums of Squares

Total sum of squares = Regression sum of squares + Error sum of squares

SST =SSR+SSE
(Total variation = Explained variation + Unexplained variation)
2
Total sum of squares (Total Variation): SST =∑ ( Y i−Ȳ )
Regression sum of squares (Explained Variation by the Regression):
2
SSR=∑ ( Y^ i−Ȳ )
SSE= ∑ ( Y − ^ i )2
Y
Error sum of squares (Unexplained Variation): i

IMPORTANT OUT PUT OF REGRESSION ANLYSIS

Coefficients of Determination– it is a measure of the regression goodness-of-

fit. Several measures of the goodness-of-fit of the regression model to the data
have been proposed, but most popular is R^2 or R-Squared. R^2, officially
known as the coefficient of determination, is defined as the sum of squares due
to the regression divided by the adjusted total sum of squares of Y. It is the
proportion of the variation in Y that is accounted or explained by the
variation in X.

The formula for R^2is

SSR
R2 =
SST ; 0≤R 2≤1
its values range from zero to one. A value of R2 near zero
indicates no linear relationship, while a value near one indicates a perfect linear
fit.
R Square is highly sensitive to the number of observations. The smaller the
sample size, the larger its value.
 Coefficient of Non-Determination: - It tells about the amount of unexplained,
or unaccounted, variance between two variables, or between a set of variables
(predictors) in an outcome variable. Where the Coefficient of Non-
Determination is representing by 1 – R^2

Correlation Coefficient: -
The co relation coefficient is a statical measure of the relationship between the
relative movement between two variables.
Facts about the Correlation Coefficient
1. The range of r is between -1 and 1.
2. If r = 1, the observations fall on a straight line with positive slope.
3. If r = -1, the observations fall on a straight line with negative slope.
4. If r = 0, there is no linear relationship between the two variables.
5. r is a measure of the linear (straight-line) association between two variables.

Way to calculate Correlations coefficient.

1. If both Y and X are standardized by subtracting their means and dividing by

their standard deviations, it provides value of r.
2. correlation is the slope of the regression of the standardized Y on the
standardized X.
3. The correlation is the standardized covariance between Y and X.
4. The correlation is the square root of R-squared,
The corresponding formulas for the calculation of the correlation coefficient
are.

r=
∑ ( x− x̄ )( y − ȳ ) = S XY = n ∑ xy−∑ x ∑ y
√[ ∑ ( x− x̄ )2 ][ ∑ ( y− ȳ )2 ] √ S XX S YY √[ n( ∑ x2 )−( ∑ x )2 ][ n(∑ y 2 )−( ∑ y)2 ]
Regression Analysis – Linear model assumptions: -

Linear regression analysis is based on six fundamental assumptions:

1. The dependent and independent variables show a linear relationship

between the slope and the intercept.
2. The independent variable is not random.
3. The value of the residual (error) is zero.
4. The value of the residual (error) is constant across all observations.
5. The value of the residual (error) is not correlated across all observations.
6. The residual (error) values follow the normal distribution.
Sharps Single index model (SIM) -

There are many investors who want to invest their savings in various Investment
Product to gain a return and those who are risk takers they invest their savings
in the stock Market. It is a volatile market which moves towards up and down
based on simple economic concept demand and supply.

This volatility is known as the risk of the market and to save the investors
against these volatilities of the market, stock exchanges introduce a new concept
i.e., Portfolio where the investors get the opportunity to reduce the risk through
the segmenting the total investment amount in the bunch of securities.

To determine the variance of the portfolio, the covariance between each

possible pair of securities must be computed, which is represented in a
covariance matrix.
Thus, increase in the number of securities results in a large covariance matrix,
which in turn, results in a more complex computation.
If there are n securities in a portfolio, requires n average (or expected) returns, n
variance terms and n*(n-1)/2covariance terms.

Due to these difficulties analysts did not like to perform their task and they
searched a simplified model to perform their tasks which is known as Sharp
single Index Model given by William F.Sharp in 1963

Important concepts in SIM:

a) Systematic and Unsystematic Risk

b) Characteristic Line

Market Risk or Systematic Risk:

The systematic risk represents that portion of total risk which arises on account
of market wide factors. These risks are caused due to fluctuations in the market
and are also called as market risk. Because the market is inherently
unpredictable, the systematic risk always exists and is unavoidable. The
systematic risk can affect all investment avenues at the same time. The
systematic part of the total risk cannot be reduced through diversification.
This type of risk accounts for most of the risk in a well-diversified portfolio.

Components of market/ systematic risk are- equity risk, interest rate risk,
currency risk and commodity risk. Each investment you make will face one or
more of these components of risk.
Unique Risk or Unsystematic Risk:

The unsystematic risk represents such component of total portfolio risk that
arises on account of companywide factors. These risks are firm specific and
are also called as unique risk. These firm specific factors may include events
such as development of a new product, labor strikes, emergence of a new
competitor, etc. Since, these events primarily affect the specific firms and not
all firms in general; this type of risk can be either eliminated completely or
reduced through diversification. In a well-diversified portfolio, the unique
risk of most of the stocks tends to cancel each other resulting in minimum
nonmarket risk.

As Shown in figure, that as more and more securities are combined, the firm
specific risk is diversified away, and this reduces the total portfolio risk. But the
systematic risk remains although the securities in a portfolio increase to a large
number n. The systematic risk is non-diversifiable, since all the securities are
exposed to common factors.

Characteristic Line: -
The risk and return, whether of an individual security or of a portfolio, are based
on two broad factors: the systematic and nonsystematic. Such a bifurcation can
be presented with the help of a graph. The line that decomposes the risk and
return into its components is called the Characteristic Line. It is regression
line that represents the relation between return on portfolio security and return
on market portfolio, over time. It can be used to calculate estimated return of a
security or portfolio.
The return and risk of the security is bifurcated into the following:

a) Systematic Component –

This represents the market wide component of return and risk. It represents the
association of security with the general market index and is depicted with the
help of beta (β). Mathematically,
Systematic Return = βi*Rm
Systematic Risk = βi2 σm2

b) Non- Systematic Component -

This represents the company wide components of return and risk. The non-
systematic return (𝛼𝑖) depends upon the performance of the company.
Mathematically,
Residual Return (𝛼𝑖) = Ṝ𝑖− 𝛽𝑖Ṝ𝑀
Residual Risk ( 𝜎𝑒𝑖2) = 𝜎𝑖2− βi2 σm2

c) Random Returns –
These are generated due to random factors affecting the company such as
mergers, acquisitions, extraordinary profits, etc. It is generally assumed to be
zero (0). Due to this, alpha (𝛼𝑖) can be calculated as residual return or residual
component of risk.

Formula for Characteristic Line:

Ri = αi + βi*Rm + ei

Any security return having These component = Individual Performance return +

Market Return + Error term. If security doing good but market is not good than
problem is there also if market is good, but security is not doing good than also
having problem. So αi is intercept component is due to individual performance
return means if market giving 0 return than due to security individual
performance at least get some return and that is unsystematic component or
Alpha, which is not connected to market.

Also, second component Market return is βi*Rm, where βi means how the
security is co related with market, means higher the beta higher the relation.

Also, third component is error term also known as Residual return ei

So in In the Equation

Ri =The Return of the Security i

αi = Alpha Component or non systematic return( Part of security return
independent of market performance), Intercept of characteristic line

βi = Beta of security( A constant measuring the expected change in

dependent variable), Slope of Characteristic line

Rm = The return of Market index

ei =Random Residual return error

Same as return risk also having two component one is individual risk and
another is market related risk.

Risk is Denoted either by Standred deviation or Variance(σ or σ2)

Total risk or Variance of Security(σi2) = Market Risk(Systematic risk) +

Individual Risk or company specific risk (Unsystematic Risk)= Variance of
systematic risk + Variance of Unsystematic Risk

Characteristic Line showing Risk Component is:

σi2 = βi2 σm2 + σ ei2

Vi=Vm* βi2 + Vei2
σi2 = Variance of individual
σm2 = Variance of market index Return
σ ei2 = Variance of residual returns of individual security
βi = Beta coefficient of individual security
Characteristic Line can be presented with the help of a graph.

In the figure, X-axis measures the return on market portfolio and Y-axis
measures the return on individual securities. The above graph shows the
characteristic line. The intercept alpha (α) is positive, represents the non-
systematic component of the security’s return. It is that part of the security’s
return that is realized even if the market return is ‘zero’. The slope of the
characteristic line is beta (β). It measures the risk of a security relative to the
movements in market i.e. the degree to which the security’s return reacts to
changes in the market return. The greater the slope of the characteristic line i.e.
beta coefficient, the greater is the systematic risk for an individual security.

In summery Characteristic line has:

1. Return Component:- Systematic Return = 𝛽𝑖Ṝ𝑀 + Residual Return (𝛼𝑖) =

Ṝ𝑖− 𝛽𝑖Ṝ𝑀
2. Risk Component: - Systematic Risk = 𝛽𝑖2𝜎𝑀2 + Residual Risk ( 𝜎𝑒𝑖2) =
𝜎𝑖2− 𝛽𝑖2𝜎𝑀
Assumption/Limitation of Single Index Model: -

1. Covariance of two Stock I and j depend upon market risk that is stocks co
vary together only b/o their common relation to the market. In other
words, there are no influence on stocks beyond the market, such as
industry effect. This is the assumption as well as limitation of single
index model.
2. The basic notion underlying the single index model is that all stocks are
affected by movement in the stock market.
3. Expected excess return of the individual stock due to firm specifies factor
commonly denoted by its Alpha Coefficient, which is the return that
exceeds the risk-free rate.

Operationalizing the Model: In our study we took TATA MOTORS 84

monthly share prices and calculated monthly returns. Also Taken NIFFTY as
Market Index and collected data for 84 months. We obtained the values from
yahoo finance Beta is dependent on the time period and reporting frequency
(daily, weekly or monthly). The following table shows relevant stock values,
index values and associated returns calculated using the holding period return
formula.

Followings are the findings of the Study: -

  TATA MOTORS(84 NIFFTY TATA MOTOR NSE RETURN(%)

months) RETURN(%) (N)
(T)

Date Adj Close Adj Close    

01-01-2014 344.23 6,089.50    
01-02-2014 410.60 6,276.95 19.28 3.08
01-03-2014 392.58 6,704.20 -4.39 6.81
01-04-2014 408.44 6,696.40 4.04 -0.12
01-05-2014 408.73 7,229.95 0.07 7.97
01-06-2014 424.74 7,611.35 3.92 5.28
01-07-2014 439.95 7,721.30 3.58 1.44
01-08-2014 519.27 7,954.35 18.03 3.02
01-09-2014 496.62 7,964.80 -4.36 0.13
01-10-2014 529.95 8,322.20 6.71 4.49
01-11-2014 527.62 8,588.25 -0.44 3.20
01-12-2014 490.09 8,282.70 -7.11 -3.56
01-01-2015 578.71 8,808.90 18.08 6.35
01-02-2015 568.82 8,844.60 -1.71 0.41
01-03-2015 544.14 8,491.00 -4.34 -4.00
01-04-2015 508.04 8,181.50 -6.63 -3.65
01-05-2015 481.46 8,433.65 -5.23 3.08
01-06-2015 433.97 8,368.50 -9.86 -0.77
01-07-2015 383.69 8,532.85 -11.59 1.96
01-08-2015 340.01 7,971.30 -11.38 -6.58
01-09-2015 298.48 7,948.90 -12.22 -0.28
01-10-2015 384.79 8,065.80 28.92 1.47
01-11-2015 423.33 7,935.25 10.01 -1.62
01-12-2015 391.14 7,946.35 -7.60 0.14
01-01-2016 336.76 7,563.55 -13.90 -4.82
01-02-2016 299.58 6,987.05 -11.04 -7.62
01-03-2016 386.44 7,738.40 29.00 10.75
01-04-2016 408.18 7,849.80 5.63 1.44
01-05-2016 459.46 8,160.10 12.56 3.95
01-06-2016 459.06 8,287.75 -0.09 1.56
01-07-2016 503.00 8,638.50 9.57 4.23
01-08-2016 537.70 8,786.20 6.90 1.71
01-09-2016 534.85 8,611.15 -0.53 -1.99
01-10-2016 537.00 8,638.00 0.40 0.31
01-11-2016 459.30 8,224.50 -14.47 -4.79
01-12-2016 472.00 8,185.80 2.77 -0.47
01-01-2017 523.55 8,561.30 10.92 4.59
01-02-2017 456.75 8,879.60 -12.76 3.72
01-03-2017 465.85 9,173.75 1.99 3.31
01-04-2017 458.90 9,304.05 -1.49 1.42
01-05-2017 476.15 9,621.25 3.76 3.41
01-06-2017 432.55 9,520.90 -9.16 -1.04
01-07-2017 444.60 10,077.10 2.79 5.84
01-08-2017 376.55 9,917.90 -15.31 -1.58
01-09-2017 401.50 9,788.60 6.63 -1.30
01-10-2017 428.40 10,335.30 6.70 5.59
01-11-2017 404.15 10,226.55 -5.66 -1.05
01-12-2017 431.85 10,530.70 6.85 2.97
01-01-2018 399.50 11,027.70 -7.49 4.72
01-02-2018 369.90 10,492.85 -7.41 -4.85
01-03-2018 326.85 10,113.70 -11.64 -3.61
01-04-2018 340.40 10,739.35 4.15 6.19
01-05-2018 282.50 10,736.15 -17.01 -0.03
01-06-2018 269.30 10,714.30 -4.67 -0.20
 01-07-2018 264.10 11,356.50 -1.93 5.99
01-08-2018 267.50 11,680.50 1.29 2.85
01-09-2018 223.70 10,930.45 -16.37 -6.42
01-10-2018 179.10 10,386.60 -19.94 -4.98
01-11-2018 171.95 10,876.75 -3.99 4.72
01-12-2018 172.70 10,862.55 0.44 -0.13
01-01-2019 181.20 10,830.95 4.92 -0.29
01-02-2019 177.45 10,792.50 -2.07 -0.36
01-03-2019 174.25 11,623.90 -1.80 7.70
01-04-2019 214.30 11,748.15 22.98 1.07
01-05-2019 172.60 11,922.80 -19.46 1.49
01-06-2019 162.55 11,788.85 -5.82 -1.12
01-07-2019 135.60 11,118.00 -16.58 -5.69
01-08-2019 116.70 11,023.25 -13.94 -0.85
01-09-2019 117.45 11,474.45 0.64 4.09
01-10-2019 177.70 11,877.45 51.30 3.51
01-11-2019 161.50 12,056.05 -9.12 1.50
01-12-2019 185.15 12,168.45 14.64 0.93
01-01-2020 176.60 11,962.10 -4.62 -1.70
01-02-2020 128.95 11,201.75 -26.98 -6.36
01-03-2020 71.05 8,597.75 -44.90 -23.25
01-04-2020 93.25 9,859.90 31.25 14.68
01-05-2020 87.00 9,580.30 -6.70 -2.84
01-06-2020 98.25 10,302.10 12.93 7.53
01-07-2020 104.65 11,073.45 6.51 7.49
01-08-2020 143.20 11,387.50 36.84 2.84
01-09-2020 133.30 11,247.55 -6.91 -1.23
01-10-2020 132.65 11,642.40 -0.49 3.51
01-11-2020 180.35 12,968.95 35.96 11.39
01-12-2020 183.85 13,981.75 1.94 7.81

RESULT OF ANALYSIS: -
BETA 1.903

ALPHA -1.880

Multiple R 0.660

R Square 0.436

Systematic Risk 0.436

Unsystematic Risk 0.564

Standard Error 11.077

R square came 0.436 , This means 43.6% variation or movement in Tata motors
Share price can be explained by movement of BSE Sensex or market, rest of
57.26% is actually then explained by non-market or firm specific
facts(unsymmetric risk).

Estimated Beta came 1.90 means it’s very aggressive stock, will provide more
return when market is bullish. Also Means if BSE Sensex up by 10 % Tata
motors share moves by 19.03%.

Co relation Coefficient came 0.660 means Tata motors having 66% liner
relationship with NIFFTY market index.

Tata motors Alphs is -1.88% Per month but its not statically significant due to p
value is greater than 5%. So, we will consider it 0
Issues with the Beta Estimate

1. Choice of market index: -

The Index used in practice never come close to market portfolio.
Because these index does not include all companies so beta estimation with a
particular index may not provide accurate result. For beta to provide any useful
insight, the market that is used as a benchmark should be related to the stock.
For example, calculating a bond or T-Bill's beta using the NIFFTY as the
benchmark would not provide helpful insight for an investor because bonds and
stocks are too dissimilar.

2. Impact of return interval: -

The choice of return interval also affects beta estimates. As in our study when
we take the data daily, weekly, and monthly basis than beta values show
variation. The beta coefficient of the security varies across return frequencies.
Assets are not traded on a continuous basis, and because of such a non-trading
problem, the beta estimate can be affected – non-trading during a return period
can reduce the measured correlation with the market index.

Betas calculated during shorter intervals are likely to show a significant bias due
to the non-trading problem..

3.The beta metric has its uses in the management of well-diversified

portfolios but is inappropriate for forecasting the performance of
individual equities over periods of time in which correlations may change.

4. The beta coefficient theory assumes that stock returns are normally

distributed from a statistical perspective. However, financial markets are prone
to large surprises. Returns aren’t always normally distributed. Therefore, what a
stock's beta might predict about a stock’s future movement is not always true.

5. Beta is useful in determining a security's short-term risk, and for analyzing

volatility to arrive at equity costs when using the CAPM. However, since beta is
calculated using historical data points, it becomes less meaningful for investors
looking to predict a stock's future movements.

6. Beta is also less useful for long-term investments since a stock's volatility can
change significantly from year to year, depending upon the company's growth
stage and other factors.
Adjustment of Historical Beta: -

Betas calculated purely based on historical data are unadjusted betas. However,
this beta estimate based on historical estimates is not a good indicator of the
future. This is also called the beta instability problem. Statistically, over time
betas may exhibit mean reverting properties as extended periods significantly
above 1 (one) may eventually decline and betas below one may revert toward 1.

Therefore, analysts may apply models to create an adjustment calculation for

the historical beta and use this adjusted beta to calculate the expected return for
the security.

Adjusted Beta: -

Adjusted beta tends to estimate a security’s future beta. It is a historical beta

adjusted to reflect the tendency of beta to be mean reverting.

The beta estimate based purely on historical data – known as the unadjusted

beta – is not a good indicator of the future.

over time, there is a general tendency for betas of all companies to converge
towards one. The reason behind it is that, because most companies tend to
grow in size, become more diversified, and own more assets, over time,
their beta values fluctuate less, resulting in beta mean reversion.

One researcher Bloomberg reports both the Adjusted Beta and Raw Beta. The
adjusted beta is an estimate of a security's future beta. It uses the historical data
of the stock but assumes that a security’s beta moves toward the market average
over time. The formula is as follows:

Adjusted beta = (.67) * Raw beta + (.33) * 1.0

As Per Our Study RAW beta came 1.90 so According to equation Adjusted beta
will be = 0.67*1.90+0.33*1
Adjusted Beta = 1.60.
As per Money Control data the Actual beta of TATA MOTORS of Last 5 year is
1.58, which is close to our findings.

CAPM Model and Utility of Beta:

The Capital Asset Pricing Model (CAPM) is a model developed in an attempt to

explain variation in yield rates on various types of investments.

CAPM is based on the idea that investors demand additional expected return
(called the risk premium) if they are asked to accept additional risk.

The CAPM model says that this expected return that these investors would
demand is equal to the rate on a risk-free security plus a risk premium.

The model Starts with the idea that individual investment contains two type of
risk.

Systematic risk (Market risk

Unsystematic risk (Specific risk)

CAPM consider only systematic risk and assume unsystematic risk can be
diversified.

When a investor holds a market portfolio, each individual assets in that portfolio
entails specific risk, but through diversification the investor net exposure to
systematic risk of market portfolio.

The CAPM assumes that investors hold fully diversified portfolios. This means
that investors are assumed by the CAPM to want a return on an investment
based on its systematic risk alone, rather than on its total risk. The measure of
risk used in the CAPM, which is called ‘beta’, is therefore a measure of
systematic risk.

The minimum level of return required by investors occurs when the actual
return is the same as the expected return, so that there is no risk of the
investment's return being different from the expected return. This minimum
level of return is called the ‘risk-free rate of return’.
The formula for the CAPM, is as follows:

E(ri ) = Rf + βi(E(rm) – Rf)

E(ri) = return required on financial asset 
Rf = risk-free rate of return
βi = beta value for financial asset 
E(rm) = average return on the capital market

This formula expresses the required return on a financial asset as the sum of the
risk-free rate of return and a risk premium – βi (E(rm) – Rf) – which
compensates the investor for the systematic risk of the financial asset. If shares
are being considered, E(rm) is the required return of equity investors,
usually referred to as the ‘cost of equity’.
The formula is that of a straight line, y = a + bx, with βi as the independent
variable, Rf as the intercept with the y axis, (E(r m ) – Rf) as the slope of the
line, and E(ri) as the values being plotted on the straight line. The line itself is
called the security market line (or SML), as shown in Figure.

The risk-free rate of return

In the real world, there is no such thing as a risk-free asset. Short-term
government debt is a relatively safe investment, however, and in practice, it can
be used as an acceptable substitute for the risk-free asset.

To ensure consistency of data, the yield on India treasury bills is used as a

substitute for the risk-free rate of return when applying the CAPM to shares that
are traded on the Indian capital market.

Because the CAPM is applied within a given financial system, the risk-free rate
of return (the yield on short-term government debt) will change depending on
which country’s capital market is being considered. The risk-free rate of return
is also not fixed but will change with changing economic circumstances.

The equity risk premium

Rather than finding the average return on the capital market, E(rm), research has
concentrated on finding an appropriate value for (E(rm) – Rf), which is the
difference between the average return on the capital market and the risk-free
rate of return. This difference is called the equity risk premium, since it
represents the additional return required for investing in equity (shares on the
capital market as a whole) rather than investing in risk-free assets.

What is Beta

Beta is an indirect measure which compares the systematic risk associated with
a company’s shares with the systematic risk of the capital market.

Beta values are found by using regression analysis to compare the returns on a
share with the returns on the capital market.

Formula for the Beta Coefficient of a Stock

Beta Coefficient of Stock = Cov(rs, rm)/ σ2m

rs = Stock Return

rm = Market Return
σ2m = Market Variance
Types of Beta Values

1.Beta Value Equal to 1.0

If a stock has a beta of 1.0, it indicates that its price activity is strongly
correlated with the market. A stock with a beta of 1.0 has systematic risk.
However, the beta calculation can’t detect any unsystematic risk. Adding a
stock to a portfolio with a beta of 1.0 doesn’t add any risk to the portfolio, but it
also doesn’t increase the likelihood that the portfolio will provide an excess
return.

2.Beta Value Less Than One

A beta value that is less than 1.0 means that the security is theoretically less
volatile than the market. Including this stock in a portfolio makes it less risky
than the same portfolio without the stock. For example, utility stocks often have
low betas because they tend to move more slowly than market averages.

3.Beta Value Greater Than One

A beta that is greater than 1.0 indicates that the security's price is theoretically
more volatile than the market. For example, if a stock's beta is 1.2, it is assumed
to be 20% more volatile than the market. Technology stocks and small cap
stocks tend to have higher betas than the market benchmark. This indicates that
adding the stock to a portfolio will increase the portfolio’s risk, but may also
increase its expected return.

4.Negative Beta Value

Some stocks have negative betas. A beta of -1.0 means that the stock is
inversely correlated to the market benchmark. This stock could be thought of as
an opposite, mirror image of the benchmark’s trends.  There are also a few
industry groups, like gold miners, where a negative beta is also common.

There are three types of beta coefficients: equity beta (also called levered or
geared beta), debt beta and asset beta (also called unlevered or ungeared beta

Unlevered beta (or asset beta) measures the market risk of the company without
the impact of debt.
Unlevering a beta removes the financial effects of leverage thus isolating the
risk due solely to company assets. In other words, how much did the company's
equity contribute to its risk profile.

A key determinant of beta is leverage, which measures the level of a company’s

debt to its equity. Levered beta measures the risk of a firm with debt and equity
in its capital structure to the volatility of the market.

Unlevering the beta removes any beneficial or detrimental effects gained by

adding debt to the firm's capital structure. Comparing companies' unlevered
betas gives an investor clarity on the composition of risk being assumed when
purchasing the stock.

Betaunlevrage = Betalevrage / [1 + ((1 - Tax Rate) x Debt/Equity)]

Bassets = BEquity / [1 + ((1 - Tax Rate) x Debt/Equity)]

Equity betas reflect not only the business risk of a company’s operations, but
also the financial risk of a company. The systematic risk represented by equity
betas, therefore, includes both business risk and financial risk.

Use full ness of CAPM in calculating the project-specific discount rate: -

The CAPM can also be used to calculate a project-specific cost of equity. Once
values have been obtained for the risk-free rate of return, and either the equity
risk premium or the return on the market, these can be put into the CAPM
formula along with the equity beta:

The project-specific cost of equity can be used as the project-specific discount

rate or project-specific cost of capital.
Cost of Equity of TATA MOTORS:-

NIFTY RETURN % 1+Ri G-Sec Return%

Jan-14 -0.034 0.966 -0.57%

Feb-14 0.0308 1.0308 1.05%

Mar-14 0.0681 1.0681 -0.65%

Apr-14 -0.0012 0.9988 0.27%

May-14 0.0797 1.0797 -2.07%

Jun-14 0.0528 1.0528 1.15%

Jul-14 0.0144 1.0144 -0.30%

Aug-14 0.0302 1.0302 -1.82%

Sep-14 0.0013 1.0013 -0.56%

Oct-14 0.0449 1.0449 -2.74%

Nov-14 0.032 1.032 -2.31%

Dec-14 -0.0356 0.9644 -2.87%

Jan-15 0.0635 1.0635 -2.09%

Feb-15 0.0106 1.0106 0.43%

Mar-15 -0.0462 0.9538 0.18%

Apr-15 -0.0365 0.9635 1.58%

May-15 0.0308 1.0308 -0.57%

Jun-15 -0.0077 0.9923 0.59%

Jul-15 0.0196 1.0196 -0.70%

Aug-15 -0.0658 0.9342 -0.28%

Sep-15 -0.0028 0.9972 -3.15%

Oct-15 0.0147 1.0147 1.34%

Nov-15 -0.0162 0.9838 1.91%

Dec-15 0.0014 1.0014 -0.36%

Jan-16 -0.0482 0.9518 0.27%

Feb-16 -0.0762 0.9238 -2.01%

Mar-16 0.1075 1.1075 -2.15%

Apr-16 0.0144 1.0144 -0.32%

May-16 0.0395 1.0395 0.48%

Jun-16 0.0156 1.0156 -0.31%

Jul-16 0.0423 1.0423 -3.83%

Aug-16 0.0171 1.0171 -0.74%

Sep-16 -0.0199 0.9801 -2.14%

Oct-16 0.0017 1.0017 -1.05%

Nov-16 -0.0465 0.9535 -9.32%

Dec-16 -0.0047 0.9953 4.31%

Jan-17 0.0459 1.0459 -1.61%

Feb-17 0.0372 1.0372 7.23%

Mar-17 0.0331 1.0331 -3.09%

Apr-17 0.0142 1.0142 4.55%

May-17 0.0341 1.0341 -4.31%

Jun-17 -0.0104 0.9896 -2.25%

Jul-17 0.0584 1.0584 -0.71%

Aug-17 -0.0158 0.9842 0.93%

Sep-17 -0.013 0.987 2.11%

Oct-17 0.0559 1.0559 2.99%

Nov-17 -0.0105 0.9895 2.86%

Dec-17 0.0297 1.0297 3.80%

Jan-18 0.0472 1.0472 1.42%

Feb-18 -0.0485 0.9515 3.98%

Mar-18 -0.0361 0.9639 -4.25%

Apr-18 0.0619 1.0619 4.99%

May-18 -0.0003 0.9997 0.76%

Jun-18 -0.002 0.998 0.98%

Jul-18 0.0599 1.0599 -1.66%

Aug-18 0.0285 1.0285 2.30%

Sep-18 -0.0642 0.9358 0.92%

Oct-18 -0.0498 0.9502 -2.13%

Nov-18 0.0472 1.0472 -3.13%

Dec-18 -0.0013 0.9987 -3.12%

Jan-19 -0.0029 0.9971 1.53%

Feb-19 -0.0036 0.9964 1.44%

Mar-19 0.077 1.077 -3.23%

Apr-19 0.0107 1.0107 0.93%

May-19 0.0149 1.0149 -5.15%

Jun-19 -0.0112 0.9888 -2.18%

Jul-19 -0.0569 0.9431 -7.41%

Aug-19 -0.0085 0.9915 2.94%

Sep-19 0.0409 1.0409 2.12%

Oct-19 0.0351 1.0351 -0.78%

Nov-19 0.015 1.015 -2.75%

Dec-19 0.0093 1.0093 1.46%

Jan-20 -0.017 0.983 0.69%

Feb-20 -0.0636 0.9364 -3.46%

Mar-20 -0.2325 0.7675 -3.66%

Apr-20 0.1468 1.1468 -0.46%

May-20 -0.0284 0.9716 -1.59%

Jun-20 0.0753 1.0753 -2.08%

Jul-20 0.0749 1.0749 -0.87%

Aug-20 0.0284 1.0284 4.13%

 Sep-20 -0.0123 0.9877 -1.04%

Oct-20 0.0351 1.0351 -2.23%

Nov-20 0.1139 1.1139 0.51%

NSE 50 Geo MEAN RETURN 0.87%  

Expected Market return (E(Rm)

Government Security Arithmetic MEAN RETURN (Risk Free -0.44%

return ( Rf)

Cost of equity = Rf + βi(E(rm) – Rf)

Beta 1.9
E(Rm) 0.87%
Rf -0.44%

= -0.44 + 1.90(0.87-(-0.44)

Cost of equity = -0.44 +2.849

Cost of equity =2.049

THANK YOU