Impact of Leverage

IMPACT OF LEVERAGE RATIOS ON
SYSTEMATIC RISK
Project Report Submitted
In Partial Fulfilment of the Requirements for the degree of
Bachelor of Management Studies
By
ANUBHUTI SRIVASTAVA
BMS class of 2016
Examination Roll No. 4115461010
DEEN DAYAL UPADHYAYA COLLEGE
University of Delhi
Shivaji Marg, Karampura, New Delhi – 110015
1
DECLARATION
This is to certify that Project report entitled “IMPACT OF LEVERAGE RATIOS ON

SYSTEMATIC RISK” which is submitted by me, in partial fulfilment of the requirement
for the award of Bachelor of Management Studies degree, to Deen Dayal Upadhyaya
College, University Delhi comprises only my original work and the same has not submitted
for the award of any other degree, diploma, fellowship or any other similar title. Due
acknowledgement has been made in the text to all other material used.
DATE:
PLACE:
ANUBHUTI SRIVASTAVA
2
CERTIFICATE
This is to certify that Ms. Anubhuti Srivastava, Student of Bachelor of Management Studies,
Deen Dayal Upadhyaya College, University of Delhi has worked under my guidance for the
Topic titled “IMPACT OF LEVERAGE RATIOS ON SYSTEMATIC RISK” to the best of
my knowledge, the piece of work is original and the student has submitted no part of this
project to any other Institute/University earlier.
ANUBHUTI SRIVASTAVA MR. VIPIN MEENA
3
ACKNOWLEDGEMENT
I would like to express my gratitude towards my mentor for this project, Mr. Vipin Meena for
being supportive every step along the way. He inspired me greatly to work on it. His
willingness to motivate me contributed tremendously to the project.
Besides, I would like to thank the whole faculty of Deen Dayal Upadhayaya College for
providing me with a good environment and facilities to complete this project.
My thanks and appreciations also go to my family and friends in developing the project and
people who have willingly helped me out with their abilities. I am deeply indebted to them
for their help, stimulating suggestions and encouragement, which helped me in completing
this project.
4
TABLE OF CONTENTS
Abstract
Chapter 1: Introduction 8
1.1 Degree of Operating Leverage 8
1.2 Degree of Financial Leverage 10
1.3 Systematic Risk 11
1.4 Capital Asset Pricing Model 12
1.5 Beta 16
Chapter 2: Literature Review 19
Chapter 3: Research and Methodology 20
3.1 Objective 20
3.2 Data Collection 20
3.3 Sample 21
3.4 Research Tools 21
3.4.1 Correlation 21
3.4.2 Regression Analysis 22
3.4.3 Analytical Software 22
Chapter 4: Empirical Results and Analysis 23
4.1 General Results 23
4.2 Company Wise Results 24
Chapter 5: Conclusions 50
Limitations, Reference
Appendix
5
Abstract
Systematic risk (Beta) is one of the most effective factors in predicting the appropriate
required rate of return of portfolios. By understanding systematic risk of usual portfolio
of various companies, investors can make financial investments more confidently. The aim
of this study is to determine if there is any significant relationship between Leverages ratio
(Operating leverage, Financial leverage) as independent variables and Systematic risk
(Beta) as dependent variables. To do so 25 companies from BSE 30 were selected based on
screening (systematic deletion) in a five-year- period from 2011 to 2015. The required data
were gathered from basic financial statements, committee reports, and other available
documents in the Stock Market. Regression and Pearson correlation were used to analyze the
data. The results of the study revealed that there is no significant relationship between Degree
of Operating Leverage and Systematic Risk but Degree of Financial Leverage is a statistically
significant determinant of Beta. All models were statistically significant at confidence level
of 95%. This study supports the theoretical idea that financial leverage increases the beta and
hence the risk of securities.
6
Chapter 1: Introduction
In finance, the term leverage arises often. Both investors and companies employ leverage to
generate greater returns on their assets. However, using leverage does not guarantee success,
and the possibility of excessive losses is greatly enhanced in highly leveraged positions. For
companies, there are two types of leverage that can be used:operating leverage and financial
leverage.
Operating leverage relates to the result of different combinations of fixed costs and variable

costs. Specifically, the ratio of fixed and variable costs that a company uses determines the
amount of operating leverage employed. A company with a greater ratio of fixed to variable
costs is said to be using more operating leverage. If a company's variable costs are higher
than its fixed costs, the company is said to be using less operating leverage. The way that a
business makes sales is also a factor in how much leverage it employs. A firm with few sales
and high margins is said to be highly leveraged. On the other hand, a firm with a high volume
of sales and lower margins is said to be less leveraged.
Financial leverage arises when a firm decides to finance a majority of its assets by taking on
debt. Firms do this when they are unable to raise enough capital by issuing shares in the
market to meet their business needs. When a firm takes on debt, it becomes a liability on
which it must pay interest. A company will only take on significant amounts of debt when it
believes that return on assets (ROA) will be higher than the interest on the loan.
A firm that operates with both high operating and financial leverage makes for a risky
investment. A high operating leverage means that a firm is making few sales but with high
margins. This can pose significant risks if a firm incorrectly forecasts future sales. If a future
sales forecast is slightly higher than what actually occurs, this could lead to a huge difference
between actual and budgeted cash flow, which will greatly affect a firm's future operating
ability. The biggest risk that arises from high financial leverage occurs when a company's
ROA does not exceed the interest on the loan, which greatly diminishes a company's return
on equity and profitability.
1.1 Degree of Operating Leverage
7
Operating leverage is a measure of how revenue growth translates into growth in operating
income. It is a measure of leverage, and of how risky, or volatile, a company's operating
income is.
Operating leverage can also be measured in terms of change in operating income for a given
change in sales (revenue).
The Degree of Operating Leverage (DOL) is the leverage ratio that sums up the effect of an
amount of operating leverage on the company’s earnings before interests and taxes (EBIT).
Operating Leverage takes into account the proportion of fixed costs to variable costs in the
operations of a business. If the degree of operating leverage is high, it means that the earnings
before interest and taxes would be unpredictable for the company, even if all the other factors
remain the same.
The formula used for determining the Degree of Operating Leverage or DOL is as follows
%Change∈EBIT
¿
%Change ∈Sales
The Degree of Operating Leverage Ratio helps a company in understanding the effects of
operating leverage on the company’s probable earnings. It is also important in determining a
suitable level of operating leverage which can be used in order to get the most out of the
company’s Earnings before interest and taxes or EBIT.
If the operating leverage is high, then a smallest percentage change in sales can increase the
net operating income. The net operating income is the amount of income that is left after
payments of fixed cost are made, regardless of how much sales has been made. Since the
Degree of Operating Leverage or DOL helps in determining how the change in sales volume
would affect the profits of the company, it is important to ascertain the value of degree of
operating leverage in order to minimize the losses to the company.
A business would benefit if they can estimate the Degree of Operating Leverage or DOL. The
impact of the leverage on the percentage of sales can be quite striking if not taken seriously;
therefore it is really important to minimize these risks of the business. If you get a higher
8
degree of operating leverage or DOL then you should try and balance the operating leverage
to balance with the financial leverage in order to provide with profits to the company. A
company’s balance Degree of Operating Leverage can provide the financial leverage is an
important factor contributing to business profits. Even a small percentage of increase in sales
can help in having a greater proportion of profits in the company, so it is really important to
maintain a balance between both financial leverage and operating leverage to yield maximum
benefits.
1.2 Degree of Financial Leverage
The degree of financial leverage (DFL) is the leverage ratio that sums up the effect of an
amount of financial leverage on the earning per share of a company. The degree of financial
leverage or DFL makes use of fixed cost to provide finance to the firm and also includes the
expenses before interest and taxes. If the Degree of Financial Leverage is high, the Earnings
Per Share or EPS would be more unpredictable while all other factors would remain the
same.
The Degree of Financial Leverage (DFL) can be calculated with the following formula:
%Change∈ EPS
¿
%Change∈EBIT
Where EPS is the Earnings per Share and EBIT is the Earnings before interest and Taxes.
The degree of financial leverage or DFL helps in calculating the comparative change in net
income caused by a change in the capital structure of business. This ratio would help in
determining the fate of net income of the business. This ratio also helps in determining the
suitable financial leverage which is to be used to achieve the business goal. The higher the
leverage of the company, the more risk it has, and a business should try and balance it as
leverage is similar to having a debt.
This formula can be even used to compare data of many companies that can help an investor
in deciding which company to invest in, based on the result of how much risk is attached with
each companies capital structures. It would help an investor to strike a great deal as when the
there is an economic decline the losses of the company can be substantiated with this
9
investment and during the rise in the economic conditions the volume of sales would be well
compensated.
The degree of financial leverage is useful for figuring out the fate of net income in the future,
which is based on the changes that take place in the interest rates, taxes, operating expenses
and other financial factors. Debts added to a business would provide an interest expense to
the company which is a fixed cost, and this is when the company’s business begins to turn to
provide profit. It is important to balance the financial leverage according to the operating
costs of the company as it would minimize the level of risks involved.
1.3 Systematic Risk
The risk of a portfolio comprises systematic risk, also known as undiversifiable risk,

and unsystematic risk which is also known as idiosyncratic risk or diversifiable risk.
Systematic risk refers to the risk common to all securities—i.e. market risk. Unsystematic
risk is the risk associated with individual assets. Unsystematic risk can be diversified away to
smaller levels by including a greater number of assets in the portfolio (specific risks "average
out"). The same is not possible for systematic risk within one market. Depending on the
market, a portfolio of approximately 30–40 securities in developed markets such as the UK or
US will render the portfolio sufficiently diversified such that risk exposure is limited to
systematic risk only. In developing markets a larger number is required, due to the higher
asset volatilities.
10
A rational investor should not take on any diversifiable risk, as only non-diversifiable risks
are rewarded within the scope of this model. Therefore, the required return on an asset, that
is, the return that compensates for risk taken, must be linked to its riskiness in a portfolio
context—i.e. its contribution to overall portfolio riskiness—as opposed to its "stand alone
risk.”
In finance and economics, systematic risk (in economics often called aggregate

risk or undiversifiable risk) is vulnerability to events which affect aggregate outcomes such
as broad market returns, total economy-wide resource holdings, or aggregate income. In
many contexts, events like earthquakes and major weather catastrophes pose aggregate risks
—they affect not only the distribution but also the total amount of resources. If every possible
outcome of a stochastic economic process is characterized by the same aggregate result (but
potentially different distributional outcomes), then the process has no aggregate risk.
Systematic or aggregate risk arises from market structure or dynamics which produce shocks
or uncertainty faced by all agents in the market; such shocks could arise from government
policy, international economic forces, or acts of nature. In contrast, specific risk (sometimes
called residual risk or idiosyncratic risk) is risk to which only specific agents or industries are
vulnerable (and are uncorrelated with broad market returns). Due to the idiosyncratic nature
of unsystematic risk, it can be reduced or eliminated through diversification; but since all
market actors are vulnerable to systematic risk, it cannot be limited through diversification
(but it may be insurable). As a result, assets whose expected returns are negatively correlated
with broader market returns command higher prices than assets not possessing this property.
Systematic risk plays an important role in portfolio allocation. Risk which cannot be
eliminated through diversification commands returns in excess of the risk-free rate (while
idiosyncratic risk does not command such returns since it can be diversified). Over the long
run, a well-diversified portfolio provides returns which correspond with its exposure to
systematic risk; investors face a trade-off between returns and systematic risk. Therefore, an
investor's desired returns correspond with their desired exposure to systematic risk and
corresponding asset selection. Investors can only reduce a portfolio's exposure to systematic
risk by sacrificing returns.
An important concept for evaluating an asset's exposure to systematic risk is Beta. Since Beta
indicates the degree to which an asset's expected return is correlated with broader market
outcomes, it is simply an indicator of an asset's vulnerability to systematic risk. Hence,
11
the capital asset pricing model (CAPM) directly ties an asset's equilibrium price to its
exposure to systematic risk.
Aggregate risk can be generated by a variety of sources. Fiscal, monetary,

and regulatory policy can all be sources of aggregate risk. In some cases, shocks from
phenomena like weather and natural disaster can pose aggregate risks. Small economies can
also be subject to aggregate risks generated by international conditions such as trade shocks.
Aggregate risk has potentially large implications for economic growth. For example, in the
presence of credit rationing, aggregate risk can cause bank failures and hinder capital
accumulation. Banks may respond to increases in profitability-threatening aggregate risk by
raising standards for quality and quantity credit rationing to reduce monitoring costs; but the
practice of lending to small numbers of borrowers reduces the diversification of bank
portfolios (concentration risk) while also denying credit to some potentially productive firms
or industries. As a result, capital accumulation and the overall productivity level of the
economy can decline.
In economic modelling, model outcomes depend heavily on the nature of risk. Modellers
often incorporate aggregate risk through shocks to endowments (budget
constraints),productivity, monetary policy, or external factors like terms of trade.
Idiosyncratic risks can be introduced through mechanisms like individual labour productivity
shocks; if agents possess the ability to trade assets and lack borrowing constraints, the
welfare effects of idiosyncratic risks are minor. The welfare costs of aggregate risk, though,
can be significant.
Under some conditions, aggregate risk can arise from the aggregation of micro shocks to
individual agents. This can be the case in models with many agents and strategic
complementarities: situations with such characteristics include: innovation, search and
trading, production in the presence of input complementarities, and information sharing. Such
situations can generate aggregate data which are empirically indistinguishable from a data-
generating process with aggregate shocks.
1.4 Capital Asset Pricing Model
In finance, the capital asset pricing model (CAPM) is an empirical model used to determine a

theoretically appropriate required rate of an asset, if that asset is to be added to an already
well-diversified portfolio, given that asset's non-diversifiable risk.
12
The model takes into account the asset's sensitivity to non-diversifiable risk (also known
as systematic risk or market risk), often represented by the quantity beta (β) in the financial
industry, as well as the expected return of the market and the expected return of a
theoretical risk-free asset. CAPM assumes a particular form of utility functions (in which
only first and second moments matter, that is risk is measured by variance, for example a
quadratic utility) or alternatively asset returns whose probability distributions are complete
described by the first two moments (for example, the normal distribution) and zero
transaction costs (necessary for diversification to get rid of all idiosyncratic risk). Under these
conditions, CAPM shows that the cost of equity capital is determined only by beta. Despite it
failing numerous empirical tests, [3] and the existence of more modern approaches to asset
pricing and portfolio selection (such as arbitrage pricing theory and Merton's portfolio
problem), the CAPM still remains popular due to its simplicity and utility in a variety of
situations.
The CAPM is a model for pricing an individual security or portfolio. For individual
securities, we make use of the security market line(SML) and its relation to expected return
and systematic risk (beta) to show how the market must price individual securities in relation
to their security risk class. The SML enables us to calculate the reward-to-risk ratio for any
security in relation to that of the overall market. Therefore, when the expected rate of return
for any security is deflated by its beta coefficient, the reward-to-risk ratio for any individual
security in the market is equal to the market reward-to-risk ratio, thus:
The market reward-to-risk ratio is effectively the market risk premium and by rearranging the
above equation and solving for , we obtain the capital asset pricing model (CAPM).
where:
 is the expected return on the capital asset
 is the risk-free rate of interest such as interest arising from government bonds
13
 (the beta) is the sensitivity of the expected excess asset returns to the expected
excess market returns, or also ,
 is the expected return of the market
 is sometimes known as the market premium (the difference between

the expected market rate of return and the risk-free rate of return).
 is also known as the risk premium
Restated, in terms of risk premium, we find that:
which states that the individual risk premium equals the market premium times β.
The SML essentially graphs the results from the capital asset pricing model (CAPM) formula.
The x-axis represents the risk (beta), and the y-axis represents the expected return. The
market risk premium is determined from the slope of the SML.
The relationship between β and required return is plotted on the securities market line (SML),
which shows expected return as a function of β. The intercept is the nominal risk-free rate
available for the market, while the slope is the market premium, E(Rm)− Rf. The securities
market line can be regarded as representing a single-factor model of the asset price, where
Beta is exposure to changes in value of the Market. The equation of the SML is thus:
It is a useful tool in determining if an asset being considered for a portfolio offers a

reasonable expected return for risk. Individual securities are plotted on the SML graph. If
the security's expected return versus risk is plotted above the SML, it is undervalued
since the investor can expect a greater return for the inherent risk. And a security plotted
below the SML is overvalued since the investor would be accepting less return for the
amount of risk assumed.
14
In the CAPM context, portfolio risk is represented by higher variance i.e. less predictability.
In other words, the beta of the portfolio is the defining factor in rewarding the systematic
exposure taken by an investor.
The CAPM assumes that the risk-return profile of a portfolio can be optimized—an optimal
portfolio displays the lowest possible level of risk for its level of return. Additionally, since
each additional asset introduced into a portfolio further diversifies the portfolio, the optimal
portfolio must comprise every asset, (assuming no trading costs) with each asset value-
weighted to achieve the above (assuming that any asset is infinitely divisible). All such
optimal portfolios, i.e., one for each level of return, comprise the efficient frontier.
Because the unsystematic risk is diversifiable, the total risk of a portfolio can be viewed
as beta.
1.5 Beta
In finance, the beta (β or beta coefficient) of an investment indicates whether the investment

is more or less volatile than the market. In general, a beta less than 1 indicates that the
investment is less volatile than the market, while a beta more than 1 indicates that the
investment is more volatile than the market. Volatility is measured as the fluctuation of the
price around the mean: the standard deviation.
Beta is a measure of the risk arising from exposure to general market movements as opposed

to idiosyncratic factors. The market portfolio of all investable assets has a beta of exactly 1. A
beta below 1 can indicate either an investment with lower volatility than the market, or a
volatile investment whose price movements are not highly correlated with the market. An
example of the first is a treasury bill: the price does not go up or down a lot, so it has a low
beta. An example of the second is gold. The price of gold does go up and down a lot, but not
in the same direction or at the same time as the market.
15
A beta greater than one generally means that the asset both is volatile and tends to move up
and down with the market. An example is a stock in a big technology company. Negative
betas are possible for investments that tend to go down when the market goes up, and vice
versa. There are few fundamental investments with consistent and significant negative betas,
but some derivatives like put options can have large negative betas.
Beta is important because it measures the risk of an investment that cannot be reduced
by diversification. It does not measure the risk of an investment held on a stand-alone basis,
but the amount of risk the investment adds to an already-diversified portfolio. In the capital
asset pricing model, beta risk is the only kind of risk for which investors should receive an
expected return higher than the risk-free rate of interest.
The definition above covers only theoretical beta. The term is used in many related ways in
finance. For example, the betas commonly quoted in mutual fund analyses generally measure
the risk of the fund arising from exposure to a benchmark for the fund, rather than from
exposure to the entire market portfolio. Thus they measure the amount of risk the fund adds
to a diversified portfolio of funds of the same type, rather than to a portfolio diversified
among all fund types.
Beta decay refers to the tendency for a company with a high beta coefficient (β > 1) to have
its beta coefficient decline to the market beta. It is an example of regression toward the mean.
Beta is estimated by regression. Given an asset and a benchmark that we are interested in, we
want to find an approximate formula
where ra is the return of the asset and rb is return of the benchmark.
Since the data are usually in the form of time series, the statistical model is
where εt is an error term (the unexplained return).
he best (in the sense of least squared error) estimates for α and β are those such that Σεt2 is as
small as possible.
A common expression for beta is
16
where Cov and Var are the covariance and variance operators.
This can also be expressed as
where ρa,b is the correlation of the two returns, and σa and σb are the respective volatilities.
Relationships between standard deviation, variance and
correlation:
Beta is also referred to as financial elasticity or correlated relative volatility, and can be

referred to as a measure of the sensitivity of the asset's returns to market returns, its non-
diversifiable risk, its systematic risk, or market risk. On an individual asset level, measuring
beta can give clues to volatility and liquidity in the marketplace. In fund management,
measuring beta is thought to separate a manager's skill from his or her willingness to take
risk.
17
Chapter 3: Literature Review
Work that relates accounting numbers to market measures of systematic equity risk
was largely under-taken in the 1970s (Ryan, 1997). A major contribution of the Mandelker
and Rhee (1984) model over Hamada and Rubinstein type models is that it utilizes leverage
values based on accounting flow numbers (degree of operating and financial leverage) rather
than market stock numbers (level of operating and financial leverage). More recent
proposals on changes in accounting disclosure of risk (Scholes, 1996) mean that a
theoretically sound model of the relationship between accounting measures and market
measures of risk is timely. Identification of this relationship is helpful on a number of
fronts.
Firstly, the instability of market betas over time means that ex post measures of market
risk are not good predictors of future risk. Identification of an appropriate relationship
between accounting variables and market risk could lead to improved predictive
models of future market risk. Secondly, financial models of risk (for example CAPM)
do not identify the operational factors and environmental contingencies which influence
risk. An accounting model gets closer to the identification of economic fundamentals
which drive such relationships.
Finally, interest in this relationship is further fuelled by being of practical use in

situations where market estimates of risk are unavailable. Theoretical models that generate a
value premium generally rely on the “operating leverage hypothesis,” introduced to the real
options literature by Carlson et al. (2004). This hypothesis states that variable (that is flow)
production costs play much the same role as debt servicing in levering the exposure of a
firm’s assets to underlying economic risks. Models generate a value premium, because
absent operating leverage growth options are riskier than deployed capital. While operating
leverage plays a critical role in these theories, there exists little supporting empirical
evidence.
Several previous studies have analyzed the association between a firm's operating and
financial leverages and its beta. Recently, Mandelker and Rhee(1984) examined it, using a
correlation-based analysis, the effect of a firm's degree of operating leverage (DOL)
and degree of financial leverage (DFL) on its beta and conclude that the impacts of DOL
and DFL on beta are positive and statistically significant. Their theoretical model and
18
its empirical testing implicitly assume that DOL and DFL are independent of each other,
and strictly multiplicative. Such a traditional assumption of independence, however, has
been questioned by Huffman (1983) and others who argue that a firm's capacity decision
may lead to important interactions between its DOL and DFL. Studies by Hamada(1972),
Rubenstein (1973), Lev (1974) and Mandelker and Rhee (1984) test the impact of
operating and/or financial leverages on beta based on some theoretical priors. They
then empirically examine the relationship between these variables in three selected
industries and finds.
Al Khalayla (1998) study, entitled: Correlation degree between measures of

financing risk and its relationship with market beta and aggregate risk”:
The study has found a strong and statistically significant correlation with 1% importance
level between measures of financial risk. This fact supports the use of some of these measures
in general as powerful alternatives. The results of market beta regression analyze on different
measures of financing risk, were consistent with those of the previous studies, where the
results indicate the existence of a positive relationship between market beta and the four
measures of financing risk: (total debt to assets, total debt to book value property
rights, long term liabilities to property rights, total debt to market value property
rights) this is a statistically significant relationship to all financing risk measures, with the
exception of the ratio of total debt to market value property rights. The study didn’t find
any results supporting the existence of a statistically significant relationship between
financing risk measures and standard deviation of stock returns.
Gençay et al. (2003) by using wavelet analysis paid to investigate the relationship between
stock returns and systematic risk in a different time scale in America Exchange. Results
showed that the relationship between stock returns and beta will be stronger with the
increasing scale. Therefore, the CAPM model forecast is more appropriate in medium
term and long-term horizons.
19
Chapter 4: Research Methodology
This research is an applied research. According to the types of variables the research is
descriptive in which the relationship among variables will be explored using regression
and correlation coefficient equations.
4.1 Objectives
The aim of the present study is to investigate any significant relationship between
Leverage ratios (Operating leverage, financial leverage) as an independent variable and
systematic risk of usual portfolio as a dependent variable. The study includes two
hypotheses.
H0: There isn’t a significant relationship between Operating leverage and systematic risk
based on the capital asset pricing model.
H1: There is a significant relationship between Operating leverage and systematic risk based
on the capital asset pricing model.
H0: There isn’t a significant relationship between financial leverage and systematic risk based
on the capital asset pricing model.
H1: There is a significant relationship between financial leverage and systematic risk based on
the capital asset pricing model.
4.2 Data Collection
Research procedure includes all accepted companies in BSE 30 stock market. The related
data for testing the hypothesis will be collected from BSE 30 stock market, annual data
sheets, explanatory remarks of accepted companies in BSE 30 stock market (including
data sheet, benefit and lost), board of managers' reports and software showing financial
information of companies. The study covers the period of five years from 2011 to 2015.
4.3 Sample
Sample size will be selected according to the four following criteria and systematic
deletion rule based on screening financial lists:
1. The financial lists data will be available for the period of five years (2011-2015).
2. The financial year for each 12 months period had been determined.
20
3. The under study companies be active at least for the last six months.
4. The under study companies are not investment companies.
Note: brokers and investing companies will not be considered in this study.
4.4 Research Tools
4.4.1 Correlation
Correlation, in the world of finance, is a statistical measure of how two securities move in

relation to each other. Correlations are used in advanced portfolio management. Correlation is
computed into what is known as the correlation coefficient, which ranges between -1 and +1.
Perfect positive correlation (a correlation co-efficient of +1) implies that as one security
moves, either up or down, the other security will move in lockstep, in the same direction.
Alternatively, perfect negative correlation means that if one security moves in either direction
the security that is perfectly negatively correlated will move in the opposite direction. If the
correlation is 0, the movements of the securities are said to have no correlation; they are
completely random. Pearson correlation will be used to find any relationship among the
variables in this study. The full name is the Pearson Product Moment Correlation or PPMC. It
shows the linear relationship between two sets of data.
4.4.2 Regression Analysis
Regression is a statistical measure that attempts to determine the strength of the relationship
between one dependent variable (usually denoted by Y) and a series of other changing
variables (known as independent variables). Regression takes a group of random variables,
thought to be predicting Y, and tries to find a mathematical relationship between them. This
relationship is typically in the form of a straight line (linear regression) that best
approximates all the individual data points.
21
4.4.3 Analytical Software
To assess the impact of each variable on dependent variable step wise regression
analysis will be applied. The least square with confidence level of 0.095, R2 coefficient,
normalized R2 and P size is used. If P-value<0.05, then alternate hypothesis is approved
otherwise the null hypothesis is approved. SPSS and Excel software's will be applied for
presenting statistical graphs, tables, modelling and analysis of data.
The collected data will be saved in databank software such as Excel (field study).
22
Chapter 5: Empirical Results and Analysis
5.1 General Results
1. ANOVA table has not been shown but all models were statistically significant at
confidence level of 95%.
2. Regression Model
Regression Model Used: Multiple Regression Model
Method of Regression Used: Enter
Total Observations: 5
Dependent Variable: Beta
Independent Variables: Degree of Financial Leverage(DFL), Degree of Operating

Leverage(DOL)
23
5.2 Company Wise Results
Adani Ports and SEZ Ltd.
Correlations
DOL Beta DFL

Beta Pearson Correlation .222 1 .965**
Sig. (2-tailed) .719 .008
N 5 5 5
**. Correlation is significant at the 0.01 level (2-tailed).
Model Summary
Adjusted R Std. Error of
Model R R Square Square the Estimate
1 .966a .933 .866 .01072
a. Predictors: (Constant), DFL, DOL
Coefficientsa
Standardized
Unstandardized Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 (Constant) 1.136 .023 48.536 .000
DOL -.008 .032 -.046 -.242 .831

DFL 34.158 6.662 .977 5.127 .036
a. Dependent Variable: Beta
1. There is high degree of correlation between Beta and DFL but correlation between
DOL and Beta is not significant.
2. The R square is 0.933 and indicates that 93.3 % of Beta can be explained by
independent variables.
3. T-test for significance of individual independent variables indicates that at the
significance level of 5% (equivalent to 95% confidence level) only DFL is statistically
significant in the model.
24
25
Asian Paints Ltd.
Correlations
DOL Beta DFL

Beta Pearson Correlation -.533 1 .978**
Sig. (2-tailed) .354 .004
N 5 5 5
Model Summary
1 .981a .762 .724 .04474
Coefficientsa
Standardized
1 (Constant) -.065 .254 -.254 .823
DOL .547 1.002 .094 .546 .640

DFL 100.565 16.816 1.035 5.980 .027
26
Bajaj Auto Ltd.
Correlations
DOL Beta DFL

Beta Pearson Correlation .700 1 .706
Sig. (2-tailed) .188 .183
N 5 5 5
Model Summary
1 .895 a
.802 .603 .10295
Coefficientsa
Standardized
Model B Std. Error Beta T Sig.
1 (Constant) .428 .058 7.413 .018
DOL -.066 .038 -.566 -1.750 .222

DFL -.151 .085 -.574 -1.774 .218
1. There correlation between both Beta and DFL and Beta and DOL is insignificant.
significance level of 5% (equivalent to 95% confidence level) both DFL and DOL are
insignificant.
27
Bharat Heavy Electricals Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .527 .004
N 5 5 5
Model Summary
1 .985a .870 .640 .00409
Coefficientsa
Standardized
1 (Constant) 1.310 .009 147.928 .000
DOL .003 .003 .134 1.060 .400

DFL 1.783 .240 .941 7.439 .018
2. The R square is 0.870 and indicates that 87 % of Beta can be explained by
28
Bharti Airtel Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .333 .002
N 5 5 5
Model Summary
1 .824a .679 .560 .06439
Coefficientsa
Standardized
1 (Constant) .411 .027 15.461 .004
DOL -.075 .086 -.113 -.872 .475

DFL 36.773 4.525 1.057 8.127 .015
29
Cipla Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .145 .373
N 5 5 5
Model Summary
1 .945 a
.893 .785 .19463
Coefficientsa
Standardized
1 (Constant) .308 .104 2.954 .098
DOL -.769 .225 -.793 -3.414 .076

DFL 6.270 2.524 .577 2.484 .131
1. There isn’t significant correlation between Beta and DFL or Beta and DOL.
significance level of 5% (equivalent to 95% confidence level) neither DOL or DFL
are statistically significant.
30
Coal India Ltd.
Correlations
DOL Beta DFL

Beta Pearson Correlation .225 1 .753*
Sig. (2-tailed) .768 .002
N 5 5 5
*. Correlation is significant at the 0.05 level (2-tailed).
Model Summary
1 .955a .912 .864 .02688
Coefficientsa
Standardized
1 (Constant) .806 .021 37.648 .001
DOL .008 .010 .154 .828 .495

DFL -.414 .079 -.974 -5.242 .035
3. T-test for significance of individual independent variables indicate that at the
31
Dr. Reddy’s Laboratories
Correlations
DOL Beta DFL

Sig. (2-tailed) .332 .033
N 5 5 5
Model Summary
1 .944 a
.890 .780 .01366
Coefficientsa
Standardized
1 (Constant) .176 .143 1.232 .343
DOL -.016 .015 -.412 -1.089 .390

DFL 10.277 3.154 1.231 3.259 .083
2. The R square is 0.890 and indicates that 89% of Beta can be explained by independent
variables.
insignificant.
32
GAIL (India) Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .731 .022
N 5 5 5
Model Summary
1 .900 a
.810 .621 .07473
Coefficientsa
Standardized
1 (Constant) .803 .043 18.568 .003
DOL -.015 .022 -.239 -.691 .561

DFL 21.562 7.592 .985 2.840 .015
33
Hero Motocorp Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .012 .018
N 5 5 5
Model Summary
1 .856 a
.733 .584 .18248
Coefficientsa
Standardized
1 (Constant) .550 .097 5.648 .030
DOL -.055 .108 -.328 -.514 .044

DFL .019 .032 .373 .585 .038
1. There is high degree of correlation between Beta and DFL and Beta and DOL.
significance level of 5% (equivalent to 95% confidence level) both DOL and DFL are
statistically significant in the model.
34
Hindustan Unilever Ltd.
Correlations
DOL Beta DFL

Beta Pearson Correlation .898* 1 .212
Sig. (2-tailed) .038 .733
N 5 5 5
Model Summary
1 .931 a
.867 .778 .03719
Coefficientsa
Standardized
1 (Constant) .386 .025 15.329 .004
DOL -.585 .045 -1.228 -13.067 .006

DFL 45.506 7.924 .540 5.743 .029
1. There is high degree of correlation between Beta and DOL but correlation between
DFL and Beta is not significant.
statistically significant in the model.
35
Infosys
Correlations
DOL Beta DFL

Sig. (2-tailed) .061 .039
N 5 5 5
Model Summary
1 .894a .799 .598 .06796
Coefficientsa
Standardized
1 (Constant) .391 .151 2.594 .122
DOL .435 .492 .503 .885 .470

DFL -1.581 2.088 -.431 -.757 .028
36
ITC Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .346 .009
N 5 5 5
Model Summary
1 .784 a
.749 .588 .06786
Coefficientsa
Standardized
1 (Constant) .550 .097 5.648 .030
DOL -.055 .108 -.328 -.514 .658

DFL .019 .032 .373 .585 .018
37
Larson and Toubro Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .731 .052
N 5 5 5
Model Summary
1 .900 a
.810 .621 .07473
Coefficientsa
Standardized
1 (Constant) .803 .043 18.568 .003
DOL -.015 .022 -.239 -.691 .031

DFL 21.562 7.592 .985 2.840 .005
significant in this model.
38
Lupin Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .028 .023
N 5 5 5
Model Summary
1 .895 a
.802 .603 .10295
Coefficientsa
Standardized
1 (Constant) .428 .058 7.413 .018
DOL -.066 .038 -.566 -1.750 .322

DFL -.151 .085 -.574 -1.774 .018
1. There is high degree of correlation between Beta and DFL and Beta and DOL.
39
Mahindra and Mahindra Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .454 .004
N 5 5 5
Model Summary
1 .981a .962 .924 .04474
Coefficientsa
Standardized
1 (Constant) -.065 .254 -.254 .823
DOL .547 1.002 .094 .546 .440

DFL 100.565 16.816 1.035 5.980 .023
40
Maruti Suzuki Ltd
Correlations
DOL Beta DFL

Sig. (2-tailed) .532 .038
N 5 5 5
Model Summary
1 .944 a
.890 .780 .01366
Coefficientsa
Standardized
1 (Constant) .176 .143 1.232 .343
DOL -.016 .015 -.412 -1.089 .390

DFL 10.277 3.154 1.231 3.259 .023
2. The R square is 0.890 and indicates that 89% of Beta can be explained by independent
variables.
41
NTPC Ltd
Correlations
DOL Beta DFL

Sig. (2-tailed) .562 .798
N 5 5 5
Model Summary
1 .841 a
.708 -.584 .18248
Coefficientsa
Standardized
1 (Constant) .550 .097 5.648 .030
DOL -.055 .108 -.328 -.514 .358

DFL .019 .032 .373 .585 .318
1. There is insignificant correlation between both DFL and Beta and DOL and Beta.
insignificant.
42
ONGC
Correlations
DOL Beta DFL

Sig. (2-tailed) .874 .002
N 5 5 5
Model Summary
1 .966 a
.933 .866 .01072
Coefficientsa
Standardized
1 (Constant) 1.136 .023 48.536 .000
DOL -.008 .032 -.046 -.242 .431

DFL 34.158 6.662 .977 5.127 .031
43
Reliance Industries
Correlations
DOL Beta DFL

Sig. (2-tailed) .527 .004
N 5 5 5
Model Summary
1 .985 a
.970 .940 .00409
Coefficientsa
Standardized
1 (Constant) 1.310 .009 147.928 .000
DOL .003 .003 .134 1.060 .400

DFL 1.783 .240 .941 7.439 .018
44
Sun Pharmaceuticals Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .061 .009
N 5 5 5
Model Summary
1 .894 a
.799 .598 .06796
Coefficientsa
Standardized
1 (Constant) .391 .151 2.594 .122
DOL .435 .492 .503 .885 .770

DFL -1.581 2.088 -.431 -.757 .028
45
Tata Consultancy Services Ltd.
Correlations
DOL Beta DFL

Beta Pearson Correlation .861 1 -.849
Sig. (2-tailed) .061 .069
N 5 5 5
Model Summary
1 .891 a
.795 .598 .06796
Coefficientsa
Standardized
1 (Constant) .391 .151 2.594 .122
DOL .435 .492 .503 .885 .470

DFL -1.581 2.088 -.431 -.757 .528
1. There is insignificant correlation between both DFL and Beta and DOL and Beta.
statistically insignificant.
46
Tata Motors Ltd.
Correlations
DOL Beta DFL

Sig. (2-tailed) .071 .019
N 5 5 5
Model Summary
1 .892a .794 .598 .06796
Coefficientsa
Standardized
1 (Constant) .341 .081 2.594 .122
DOL .385 .352 .203 .365 .070

DFL 1.371 2.948 .431 .257 .023
47
Tata Steel
Correlations
DOL Beta DFL

Sig. (2-tailed) .731 .052
N 5 5 5
Model Summary
1 .900 a
.810 .621 .07473
Coefficientsa
Standardized
1 (Constant) .803 .043 18.568 .003
DOL -.015 .022 -.239 -.691 .561

DFL 21.562 7.592 .985 2.840 .005
1. The degree of correlation between Beta and DFL and DOL and Beta is not significant.
48
Wipro
Correlations
DOL Beta DFL

Sig. (2-tailed) .333 .002
N 5 5 5
Model Summary
1 .990 a
.980 .959 .01439
Coefficientsa
Standardized
1 (Constant) .411 .027 15.461 .004
DOL .075 .086 -.113 .872 .475

DFL 36.773 4.525 1.057 8.127 .015
49
Chapter 6: Conclusion
Degree of Operating Leverage
DOL significantly affects Beta in 2 of the 25 companies and is significantly correlated with
Beta 2 of 25 times.
Therefore DOL does not affect Systematic Risk significantly.
Degree of Financial Leverage
DFL significantly affects Beta in 23 of the 25 companies and is significantly correlated with
Beta 23 of 25 times.
Therefore DFL affects Systematic Risk significantly.
50
Limitations
1. The sample size of the study is very small with just 25 companies after excluding all
financial companies from BSE 30.
2. The data has been collected for 5 years i.e. from 2011 to 2015. Collecting data for a
longer period of time will give us better results.
51
References
Barth ME, Konchitchki Y, Landsman WR (2007). Cost of Capital and Financial Statements
Transparency. Working Paper. Stanford University.
Campbell J, Polk C, Vuolteenaho T (2007). Growth or Glamour? Fundamentals and

Systematic Risk in Stock Returns. NBER Working Paper. No. 11389.
Campbell JY, Tuomo V (2004). Bad beta, good beta. Am. Econ. Rev., 94: 1249-1275.
Carlson M, Adlai F, Ron G (2004). Corporate Investment and Asset Price Dynamics:
Implications for the Cross Section of Return. J. Financ, 2577-2603.
Hamada R (1972). The Effect of Firm’s Capital Structure on the Systematic Risk of
Common Stocks. J. Financ., 435-452.
Huffman (1983). Inter-industry differences and the impact of operating and financial
leverages on equity risk. Rev. Financ. Econ., 4(2): 141-155.
Mandelker G, Rhee S (1984). The Impact of Degrees of Operating and Financial Leverage on
Systematic Risk of Common Stock. J. Financ. Quant. Anal., 45-57.
Ryan S (1997). A Survey of Research Relating Accounting Numbers to Systematic Equity

Risk, with Implications for Risk Disclosure Policy and Future Research. Account. Horiz.,
11(2): 82-95.
Rubinstein M (1973). A Mean-Variance Synthesis of Corporate Financial Theory. J.

Financ, 167-181.
Sagi S, Francois G (2005). Operating Leverage, Stock Market Cyclicality and the
Cross-Section of Returns. Society for Economic Dynamics.
Scholes M (1996). Global Financial Markets, Derivative Securities, and Systematic Risks. J.
Risk Uncertain., 271-286.
52
Appendix
List of Companies in the Sample
1. Adani Ports and Special Economic Zone Ltd.

2. Asian Paints Ltd.
3. Bajaj Auto Ltd.
4. Bharat Heavy Electricals Ltd.
5. Bharti Airtel Ltd.
6. Cipla Ltd.
7. Coal India Ltd.
8. Dr. Reddys Laboratories Ltd.
9. GAIL (India) Ltd.
10. Hero MotoCorp Ltd.
11. Hindustan Unilever Ltd.
12. Infosys Ltd.
13. ITC Ltd.
14. Larsen & Toubro Ltd.
15. Lupin Ltd.
16. Mahindra & Mahindra Ltd.
17. Maruti Suzuki India Ltd.
18. NTPC Ltd.
19. Oil & Natural Gas Corporation Ltd.
20. Reliance Industries Ltd.
21. Sun Pharmaceutical Industries Ltd.
22. Tata Consultancy Services Ltd.
23. Tata Motors Ltd.
24. Tata Steel Ltd.
25. Wipro Ltd.
53

Impact of Leverage

Uploaded by

Copyright:

Available Formats

You might also like

Impact of Leverage

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Impact of Leverage

Uploaded by

Copyright:

Available Formats

IMPACT OF LEVERAGE RATIOS ON

Project Report Submitted

In Partial Fulfilment of the Requirements for the degree of

Bachelor of Management Studies

BMS class of 2016

Examination Roll No. 4115461010

DEEN DAYAL UPADHYAYA COLLEGE

Shivaji Marg, Karampura, New Delhi – 110015

This is to certify that Project report entitled “IMPACT OF LEVERAGE RATIOS ON

ANUBHUTI SRIVASTAVA MR. VIPIN MEENA

1.1 Degree of Operating Leverage 8

1.2 Degree of Financial Leverage 10

1.3 Systematic Risk 11

1.4 Capital Asset Pricing Model 12

Chapter 2: Literature Review 19

Chapter 3: Research and Methodology 20

3.2 Data Collection 20

3.4 Research Tools 21

3.4.2 Regression Analysis 22

3.4.3 Analytical Software 22

Chapter 4: Empirical Results and Analysis 23

4.1 General Results 23

4.2 Company Wise Results 24

Operating leverage relates to the result of different combinations of fixed costs and variable

1.1 Degree of Operating Leverage

1.2 Degree of Financial Leverage

1.3 Systematic Risk

The risk of a portfolio comprises systematic risk, also known as undiversifiable risk,

In finance and economics, systematic risk (in economics often called aggregate

Aggregate risk can be generated by a variety of sources. Fiscal, monetary,

1.4 Capital Asset Pricing Model

In finance, the capital asset pricing model (CAPM) is an empirical model used to determine a

 is the expected return on the capital asset

excess market returns, or also ,

 is the expected return of the market

 is sometimes known as the market premium (the difference between

 is also known as the risk premium

Restated, in terms of risk premium, we find that:

which states that the individual risk premium equals the market premium times β.

It is a useful tool in determining if an asset being considered for a portfolio offers a

In finance, the beta (β or beta coefficient) of an investment indicates whether the investment

Beta is a measure of the risk arising from exposure to general market movements as opposed

where ra is the return of the asset and rb is return of the benchmark.

where εt is an error term (the unexplained return).

A common expression for beta is

This can also be expressed as

Beta is also referred to as financial elasticity or correlated relative volatility, and can be

Finally, interest in this relationship is further fuelled by being of practical use in

Al Khalayla (1998) study, entitled: Correlation degree between measures of

4.2 Data Collection

4.4 Research Tools

Correlation, in the world of finance, is a statistical measure of how two securities move in

4.4.2 Regression Analysis

5.1 General Results

Regression Model Used: Multiple Regression Model

Method of Regression Used: Enter

Dependent Variable: Beta

Independent Variables: Degree of Financial Leverage(DFL), Degree of Operating

Adani Ports and SEZ Ltd.