RISK COEFFICIENTS

ALPHA –

A measure of performance on a risk-adjusted

basis.
Alpha takes the volatility (price risk) of a mutual
fund and compares its risk-adjusted
performance to a benchmark index. The excess
return of the fund relative to the return of the
benchmark index is a fund's alpha.

The abnormal rate of return on a security or

portfolio in excess of what would be predicted by
an equilibrium model like the capital asset
pricing model (CAPM).
 ALPHA ………..

 Alpha is one of five technical risk ratios; the

others are beta, standard deviation, R-
squared, and the Sharpe ratio. These are
all statistical measurements used in modern
portfolio theory (MPT). All of these indicators
are intended to help investors determine the
risk-reward profile of a mutual fund. Simply
stated, alpha is often considered to represent
the value that a portfolio manager adds to or
subtracts from a fund's return.
ALPHA ……..

Apositive alpha of 1.0 means the fund

has outperformed its benchmark index by 1%.
Correspondingly, a similar negative alpha would
indicate an underperformance of 1%.

2. If a CAPM analysis estimates that a portfolio

should earn 10% based on the risk of the
portfolio but the portfolio actually earns 15%, the
portfolio's alpha would be 5%. This 5% is the excess
return over what was predicted in the CAPM model.
BETA…………..

 Betais calculated using regression

analysis, and you can think of beta as
the tendency of a security's returns to
respond to swings in the market. A
beta of 1 indicates that the security's
price will move with the market. A
beta of less than 1 means that the
security will be less volatile than the
market. A beta of greater than 1
indicates that the security's price will
be more volatile than the market.
BETA ………..

 For example, if a stock's beta is 1.2,

it's theoretically 20% more volatile
than the market.

Many utilities stocks have a beta of

less than 1. Conversely, most high-
tech Nasdaq-based stocks have a beta
of greater than 1, offering the
possibility of a higher rate of return,
but also posing more risk.
BENCH MARK
A standard against which the
performance of a security, mutual
fund or investment manager can
be measured. Generally, broad
market and market-segment
stock and bond indexes are used
for this purpose.
BENCH MARK
When evaluating the performance of any
investment, it's important to compare it
against an appropriate benchmark.
 In the financial field, there are dozens of

indexes that analysts use to gauge the

performance of any given investment
including the Nifty , Sensex , S&P 500, the
Dow Jones Industrial Average, the Russell
2000 Index and the Lehman Brothers
Aggregate Bond Index.  
SECURITIES MARKET LINE
 SML Mean
A line that graphs the
systematic, or market risk
versus return of the whole
market at a certain time and
shows all risky marketable
securities.
Also refered to as the
SECURITIES MARKET LINE
 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
SECURITIES MARKET LINE
 The security market line is a useful tool in
determining whether 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 risk versus expected return is

plotted above the SML, it is undervalued because

the investor can expect a greater return for the
inherent risk. A security plotted below the SML is
overvalued because the investor would be accepting
less return for the amount of risk assumed.
Capital Asset Pricing Model - CAPM
A model that describes the
relationship between risk and
expected Return and that is used
in the pricing of risky securities.
The general idea behind CAPM is
that investors need to be
compensated in two ways: time
value of money and risk
Capital Asset Pricing Model
 . The time value of money is represented by
the risk-free (rf) rate in the formula and
compensates the investors for placing money
in any investment over a period of time. The
other half of the formula represents risk and
calculates the amount of compensation the
investor needs for taking on additional risk.
This is calculated by taking a risk measure
(beta) that compares the returns of the asset
to the market over a period of time and to the
market premium (Rm-rf).
Capital Asset Pricing Model
 CAPM
The CAPM says that the expected return of a
security or a portfolio equals the rate on a
risk-free security plus a risk premium. If this
expected return does not meet or beat the
required return, then the investment should
not be undertaken. The security market line
plots the results of the CAPM for all different
risks (betas).
FORMULA
Consumption Capital Asset Pricing
Model
 CCAPM
 What Does Consumption Capital Asset Pricing

Model - CCAPM Mean?

A financial model that extends the concepts
of the capital asset pricing model (CAPM) to
include the amount that an individual or firm
wishes to consume in the future. The CCAPM
uses consumption measures, in terms of a
consumption beta, in its calculation of a
given investment's expected return.  
Consumption Capital Asset Pricing
 CCAPM
In its simplest form, the CCAPM differs from the
CAPM by only the beta coefficient used in the
calculation. The beta for consumption attempts to
measure the covariance between an investor's
ability to consume goods and services from
investments, and the return from a market index.

In practice, the CCAPM is used less frequently

than the CAPM, and should probably only be used
on a theoretical basis.
FORMULA
Capital Market Line


A line used in the capital asset pricing model to

illustrate the rates of return for efficient portfolios
depending on the risk-free rate of return and the
level of risk (standard deviation) for a particular
portfolio.


The CML is derived by drawing a tangent line from

the intercept point on the efficient frontier to the
point where the expected return equals the risk-free
rate of return.
Capital Market Line
The CML is considered to be superior to the
efficient frontier since it takes into account
the inclusion of a risk-free asset in the
portfolio. The capital asset pricing model
(CAPM) demonstrates that the market
portfolio is essentially the efficient frontier.
This is achieved visually through the security
market line (SML).
 
RANDOM WALK HYPOTHESIS
 UNPREDICTABLE market
 No Relation – Present & Future Prices of

Shares .
 Successive Price Changes which are

independent of each other – No Trends

 No adequate explaination of Price Changes
 Price Change – Permanent And Transitory

Component
RANDOM WALK HYPOTHESIS
 Permanent Component – true or intrinsic
value- earnings ,dividends, asset
structure,mangt efficiency, competitive
positions , enviornmental factors ,specific to
co. and inductry – by trend
 Transitory component – psychological forces,

bearish or bullish tendencies.

EFFICIENT MARKET HYPOTHESIS
 Efficiency of Markets
 Capital Markets operate to a high degree of

perfection .
 Root – Random Walk Theory .
 Existence of Efficient Markets- Large No. Of

rational Investors and speculators- maximise

profits- predicting Future Earnings ,
dividends and Value of Shares.
EFFICIENT MARKET HYPOTHESIS
 Information transmitted spontaneously
 Fair Price
 Efficient Market – Price Adjustment –

competitive Norms .
 Each Price is independent of the previous

day .
 Level of Efficiency – Level of Information
FORMS OF EFFICIENCY
 Weak Form – reflect past prices
 Semi Strong – reflect publicly available

information along with past info. – co.

announcements , brokers reports ,industry
forecast, co. results .
 Strong Form – Reflect all information –

publicly and generally available info- insider

info. – take over , collaborations etc.
EMH & INDIVIDUAL RETURNS
 Reflect new info quickly – prevents investors
to cash in on it .
 Weak Form- unable to pick winners based on

movements of past share prices.

 Semi Strong – Based on Publicly available info.

Hence no consistency in Excess profit making

. – High Earnings News – immediately
reflected in Prices .
EMH & INDIVIDUAL RETURNS
 Strong Form : No Ecxess Profits – All
informations are reflected in the Share
Prices ,
- Whether new analysis or Insider Hot Tip .
FAIR GAME CONCEPT
Ability of investors to pick winners and make
excess profits depends on the speed and
efficiency of the market at absorbing that info
Efficiency – Fair game
EMH & INDIVIDUAL RETURNS
 Efficient market – Related to a particular set
of information- investors enjoy expected rate
of return against the risk involved –with no
consistent abnormal returns.
 Efficient Market – fair game for investors
 EMH is more comprehensive compared to

RWT as it not only refers to past share price

movements but to all market informations .
EMH – Assumptions
 Informations costless to all MP
 No Transaction Costs
 All investors take similar view on implications

of market informations .
 EMH & Indian Stock Market

Neither Fair nor Efficient

Information neither freely available nor
transmitted.
EMH & Indian Stock Market

 Rampant Price Rigging and Insider Trading

 Circulation of Misinformation
 Investors Information Processing Ability

Limited.
 Inadequate organisation and infrastructure
 Frequent Changes in Tax Laws- Effects Long

Term Investments
 Fixed interest securities – Low rates –

Ineffective hedge against Inflation