Risk 133 d on the past return of the stock sei : ability distribution) one canfind tthe probability of Then, using the standard normal probability distribution, ¥ OF return on that stock falling below that mean or expected return, If try Price is not normally distributed, subjective estimates of probabilities of returns are needed. ising 1 investor can find out the expected return of that stock. Then the calculation of variance gives risk of the expected stock return, The other statistical tool often used to Measure and used as a proxy for risk is the standard deviation, dard deviation It is a measu square root of the sum of the Standard deviation - Excel the Excel spread sheet; type the monthly return in Column A. Click the a egy eee Ot lian A and pcs = automatically you will get the Tear mean ofthe returns may be same fortwo companies, the returns may vary widely. This deena enc compenies A and Bo calculate te expected turns.14 prrttchio Maniaiyerriortt ay analysis ond Porn 6 0.10 0 4 ? 025 175 6 62 4 030 aA 6 04 9 025 226 10 02 id 10 010 1,00 12 iy % cE El) = 800 — In the example given above the expected means are the same in both the varies from 6% to 10% while the B company’s return varies standard deviation technique is applied. a N a= |) PE)? ‘al é Ny fariance =D -E(n il Companies, 6 12%, Tota He ence o= (Variance (a?) For Company ADP -EP fat o=/480 =219 The expected returns are the same for A and B companies but the variations in expected returns different. Company A's expected return is stable compared to Company B's expected return. The stand a deviation helps to measure the variability of return. The variability in return includes both systematic and ‘ unsystematic risks. Characteristic Regression Line (CRL) The characteristic regression line or CRL is a simple linear regression model estimated for a particular ; stock against the market index return to measure its diversifiable and undiversifiable risks. The model is R, =o, + BR 6, Return of the i® stock Intercept Slope of the i* stock 7" Return of the market index ‘The error term iF a, 8 R, ¢ The security return is Today's price - Yesterday's price Yesterday’s price Today's security return = x 100 Today's index = Yesterday's index Yesterday’s index ‘Today’s market return = 100 Like ss, weekly returns can be calculated by using this week's and last in the above-mentioned formula. Monthly returns also496 Security Analysis and Portfolio Managoment Let us consider the daily prices of the Shaji Auto stock and the index for the period 5 October illustrate the computation of beta, Usy. 16 October 2012, The objective of this example is only 10 Se 5 values have to be calculated from data of a fairly long period to minimize the sampling error, ‘To calculate the beta, the returns have to be calculated. Then using the formula below, the beta ang co-efficient can be calculated. Z nD X¥-(ZH (ZY) nox? (EX) -& “The calculations are given below.iad vor b es n&x? ~| =249132=(-7.09)0.78) 9x82.75—(—7.09) B=119 a=Y-& 12 on 7.09 > 0.79 =0.086-(1.19x— 0,79) a=102 >sI The manual calculation seems to be laborious, At Present beta can be calculated with the help of . When an investor has to calculate for a period, a co f would be of great use. Along with beta, other information also can be obtained, chen spreadsheet for the previous example, i.e., for Shaji Auto stock return on NSE index return. R=0,+B8R +e, @, = 1.02 B, = 1.19 standard crror is 0.0266 Standard deviation of stock return Variance of stock return Standard deviation of index return Variance of the index return Correlation coefficient 20.795 Beta: Beta is the slope of the characteristic regression line. Beta describes the relationship between the stock’s return and the index returns. In the above example, beta indicates that one per cent change in NSE _ index return would cause 1.19 per cent change in the Shaji Auto stock return. 1) Beta= + 1.0 One per cent change in market index return causes exactly 1 per cent change in the stock return. indicates that the stock moves in tandem with the market. 2) Beta= + 0.5 f One per cent change in market index return causes 0.5 per cent change in the stock re & ge in market index return causes 2 per cent change in the stock re _ When there is a decline of 10 per cent in the market return, return of 20 per cent. The stocks with more than that the stock return moves in the opposite direction to t , of -1 would provide a return of 10 per cent, if the marketK 0 Market Return Figure 7.3 (a) Systematic risk same as market Y x Market Return ° Figure 7.3 (b) High systematic risk Figure 7.3 (c) Low Alpha The intercept of the characteristic regression line is alpha i.e, the and the horizontal axis. It indicates that the stock return is i ee sign. Positive alpha values would yield Portfolio theory, in a well-diversified portfolio, ane me!re -_enry M2 - x) Indy? ove : 9x9132-(-109)(0.78) z 9%82.75~(7,09 i 9 «17336-(078)" _ 2741 10407379 ‘The square of the correlation co-efficient i it The i is the co-efficient of determination, It gi ion in the stock's return explained by the variation in the markets remmm, a € P = (0.79 = 0.62 The interpretation is that 62 per cent of i i i — Variations in stock's return is explained by the Case: Is This the Right Stock...? Mr Mohan, after considering many stocks in the banking sector, has selected the HDFC Bank stock. I He has downloaded the stock price and the Sensex values from the BSE website www. bseindia.com and, as usual, he is concerned with market upswings and downswings. He knows that was able to withstand the global financial crisis. Yet he wants to know how much market can affect the HDFC stock price. What will happen to the stock return if there is a downturn in the market? Will the uptrend reward him more than the market return? He turns to you, an MBA student — with specialization in finance, for help. How will you help him? He has downloaded the price data for HDFC stock and the Sensex value as given in Table 7.3 from the BSE website. Price of HDFC Bank stock and Sensex value € 114l2012 514.15 16/4/2012 17,466..2 a7 aiai201e 17,636.8 5183 sg/are0t2 17,27337 498.65 ad gyalent2 17,636.99 5189 24/2012 17,316.18 : s1ale0t2 17,362.87 5113 212012 17,601.71 6/4/2012 17,173.29 507.6 2214/2012 17,196.47 TIN2012 515.3 23/4/2012 17,361.740 Secu Anaiyen and Revttsio Management the market-related risk. Normally, jp, _ sampling error. To case Mr Moteyy ‘aloes are calculated from data over along period to minimize ‘understanding, here itis calculated for a month. ptt NTN ale Ey) o-7- “i "s price ~ Yesterday's price F Yesterday's price ce EAT purposes nly log vale ae wed. In hat cas, al prices and index values ap SSaverted into log values and the return is calculated as follows, x = InP,-inP_, x 100 BP, = log of today’s price AMP... = log of yesterday's price a it es he mat Sk a his eatin, eg ‘method is used. The calculated returns : and other calculations are given below: i. a ane 0807 +a oa | et | 0.116 x 100 e 013 0 4155 a i = e ae 1.188 0724 ny ie zn an 1517 ee _ 2006 4353 1.465 27 aa - = ao 0574 i 1205 vs ta 3s ite 0184 ~ e 1407 91391BS a OTe? 610 0917 041 ; As O88 “0807 0.267 0.106 2.008 4104 1.831 3.382 4700 LX LNs 99.235 LY= 1.97 Ls 46.225 LY = 93,304 pat XTE MEN aLXx* -(2X) pet x33234-(-0.86)(137) _ 1,006 21x33235-(-0.86) a=¥-X 7-157 -o0ss x-2*__oon @=0.065— (1.006 x - 0.041)=0.106 This is written as an equation + BR, +5 (0106 +°1.006 R, Excel | Mr Moti can use the Excel programme to find the beta value. Open the Excel spreadsheet. Enter | Sensex data in column A and HDFC Bank data in column B. | To obtain return cell C2, write = (A2-A1)/A1*100. Press Enter, Drag cursor to other cells. | In cell D2 write = (B2-B1)/B1*100. Press Enter. Drag cursor to other cells. | Now click Data on the Excel menu and then click Data Analysis to view analysis tools. Select Regression Analysis. Select the input Y (dependent, HDFC Bank return), Select the input X (independent, Sensex return), \ Click OK. You will get the following results. ‘Summary output Regression Statistics astige 0.859143 R Square 0.727853 Observations 2 ~~h ? change in Sensex will cause 8 | 006 unit et FOC Bank stock Move i UnISON. An gay higher return than market return, fg aim If a boom period is anticipated, itis a py wr bis investment proposal. The indicates that 72. ‘variations in the Sensex return, Ty, ‘Mr Mohan is advised to have dg, SUMMARY has two components, systematic and untae and global financial criss - pink is measured ty the variability of rerum. Risk which are known as mat market as a whole. Tangible events such as War peychology affect the entire stock market, . si cae risk isthe variation in return caused by the changes in the markes iner= Toe . see Mf caused by inflation. Infladon reduces the real rate of return earned fs - nique to the particular industry or company. This is classified into busines = and financial risk. . Fare ks caused by the operating environment ofthe business. This may be caused by aioe tuctations i sales or personnel management or external factors like government oO rules and regulations. ‘e Prnancial rink emerges from the debt component of the capital structure Fer cusiyie f the past planning and diversification ofthe investment can moderate the efe* the various risk factors. © Statistically, the standard deviation and beta eatimation help to quantify the risk.