1. Return and risk of portfolio with probability Shijin T P (12351047) Suchil V (12351035) Sankalp Sam Mathews (12351005)

2. contents INTRODUCTION THEORETICAL BACKGROUND ANALYSIS FINDINGS CONCLUSION 3. RESEARCH PROBLEM Always getting the probability estimated within theQuestion?? But how to arrive at the probability? 4. OBJECTIVE OF STUDY To understand the prediction of future security return To analyse the risk and return of individual securities To analyse the risk and return of portfolio 5. STUDY TOOLS Regression Ex ante return Standard deviation Unsystematic risk Systematic risk (beta)Portfolio return Covariance Portfolio risk 6. STUDY VARIABLES Closing price of various stocks from NSE Yahoo finance Closing value of Nifty 7. RESEARCH METHODOLOGY Secondary data :- stock prices from Yahoo finance andNSE India. Predicting the future return and risk of share using regression and fundamental analysis. Portfolio construction by considering the estimated return and risk of securities. 8. The securities chosen IndustryCompanyCementACC Ltd UltratechTextileRaymond GrasimPharmaceuticalRanbaxy Dr. Reddys laboratoriesBankingAxis Bank ICICI BankFMCGColgate Palmolive Procter & Gamble 9. Limitations of the study Study based on past four years data The period was just after the financial crisis. So effectsof it was felt during this period. So data is slightly biased negatively. Study based on 10 securities The 10 securities were taken randomly Probability assumption is subjective 10. Investment is a sacrifice of current money or other resources forfuture benefits. It is a planned decision to put money in financial assets with a riskreturn trade off. Numerous avenues of investment are available today. Bank account Long term government bond Equity shares Provident fund Real estate Other form Key aspects are time and risk 11. Why invest? Income Capital appreciation Tax advantages Hedge against inflation Preparation towards personal pension plan 12. InvestmentReturnRisk 13. Return Return is the primary motivating force that drivesinvestment. It represents the reward for undertaking investment. Portfolio return is the expected return of the security contained in the portfolio. It is determined on the basis of proportion of the securities in portfolio. 14. Types of return Ex Post Returns Return calculations done after-the-fact, in order to analyze what rate of return was earned.Ex Ante Returns Return calculations may be done before-the-fact, in which case, assumptions must be made about the future 15. Estimating Expected Returns nExpectedReturn(ER)( ri i 1Where: ER = the expected return on an investment Ri = the estimated return in scenario i Probi = the probability of state i occurringProb i ) 16. Portfolio return The Expected Return on a Portfolio is simply theweighted average of the returns of the individual assets that make up the portfolio.nER( wip i1ERi) 17. Risk Risk refers to the possibility that the actual outcome ofan investment will differ from its expected outcome Risk is defined as measurable possibility of loss on an investment. 18. Types of riskSystematic riskInterest rate riskAbsolute riskUnsystematic riskPurchasing power riskBusiness riskFinancial riskOperational risk 19. Measuring Risk Ex ante Standard Deviation nEx ante(Probi)( riER i )2i 1Where: ER = the expected return on an investment Ri = the estimated return in state i Probi = the probability of state i occurring 20. Portfolio Risk 2 p= (wA)22 A+ (wB)22 B+ 2wAwBWhere, wA =Weight of security A wB = Weight of security B 2 =Variance of security A A 2 = Variance of security B B A,B =Covariance between A and BA,B 21. How to manage risk in investment?? 22. Risk and Return Risk and return are the two most important attributes of an investment. Research has shown that the two are linked in the capital markets and that generally, higher returns can only be achieved by taking on greater risk. Risk isnt just the potential loss of return, it is the potential loss of the entire investment itself (loss of both principal and interest).Retur n%Risk PremiumR FReal Return Expected Inflation RateConsequently, taking on additional risk in search of higher returns is a decision that should not be taking lightly.Ris k 23. Probability Probability is a measure or estimation of likelihood ofoccurrence of an event. Probabilities are given a value between 0 and 1. The higher the degree of probability, the more likely the event is to happen, or, in a longer series of samples, the greater the number of times such event is expected to happen. Investment decisions are based on future events . Future is uncertain . To deal with uncertainty probability is used . 24. Contents Predicting various possible states of economy mostlikely to occur and their probability of it occurring. Estimating return and risk of individual securities Construction of portfolio using Sharpes model Estimating return and risk of portfolios 25. Positives for the economy Negatives for the economy 26. Positive signs from the Indian Economy Good monsoon so good agricultural output likely High investment in infrastructure likely. Effects of recession slowly receding. Exports rising. 27. Negative signs from the Indian economy GDP growth down from 8.3% in 2008-09 to 3.99% in2012-13 Current Account Deficit gone up from $8bn in 2007 to $ 90 bn But foreign exchange reserves comes down from $300 bn to $275 bn. It can cover now only 3 times the CAD against the 37.5 times in 2007. Inflation at alarming rates. 28. Negative signs(contd) Rupee depreciation and volatility Fast reemerging US economy. Interest rates going upand so attracts investors to US. DOUBLE BLOW TO INDIAN RUPEE. $170 billion in short term debt to pay. Political confusion 29. What rating agencies says? S&P: BBB- negative outlook Moodys: stable.Above 6% growth predicted next year. Fitch: stable. 5% growth predicted next year. 30. Growth predictions IMF:3.8% in this year. 5.1% in 2014. World Bank expects India to grow by 4.7% this fiscal. Moodys: Above 6% in 2014 Fitch: 5% in next fiscal. 31. Various states of economy StateDefinitionProbability1Effects of recession continues35%2Economy limping to normalcy35%3Economy getting worse20%4High growth5%5Economy getting into recession5% 32. Prediction of future price We use regression of past 4 years to predict the futureprice of 1 year. The predicted values using regression are:CompanyReturnACC32.34%Ultratech23.06%Raymond55.53%Grasim17.69%Axis Bank12.98%ICICI13.61%P&G11.73%Colgate Palmolive28.88%Dr. Reddy's lab-1.37%Ranbaxy14.54% 33. Prediction of future price(contd) Based upon the regression derived value, we derive oneyear return. Based upon the regression derived return (arrived above), we make changes based on the industry analysis as shown in following slides. 34. Cement Industry India to invest heavily in infrastructure. Good news for cement industry. 5% Upward estimate 35. Textile Industry Indian Textile Ministry estimates the size of textileoutput in the country to expand. CAB forecasts record output of cotton despite area under cultivation coming down. Positive output. 5% upward estimate. 36. FMCG Industry Good and even monsoon. Good agricultural output means more money withrural folk. Positive impact 7% Upward estimate 37. Banking Industry 12 new foreign banks to enter India. RBI to come out with measures to encourage foreignbanks to convert into wholly owned subsidiaries (WOS) that provides near national treatment. It intends to provide level playing field with domestic banks. A blow to domestic banks. Negative outlook to them. Downward estimate by 10%. 38. Pharmaceutical companies Dr. Reddys Laboratories Sales in India, Russia and CIS nations increased by42%. Revenues rose up by 16.5%. An upward estimate of 5%. 39. Pharmaceutical companies(contd) Ranbaxy: In May 2013 the US fined the company US$500 millionafter it was found guilty of misrepresenting clinical generic drug data and selling adulterated drugs to the United States. Sep 2013: Human hair and unhygienic preparations. Banned from using Mohali facility. Poor oversight and inadequate testing and maintenance of drugs manufactured at its facilities in Paonta Sahib and Dewas, India. Compensation paid is $350million. Downward estimate of 10%. 40. The new returns are:-(note that this is also the return for the 1st state of economy i.e., if effects of recession continues(but after considering industrial analysis) CompanyRevised ReturnACC33.96%Ultratech24.21%Raymond58.30%Grasim18.57%Axis Bank11.68%ICICI12.25%P&G12.55%Colgate Palmolive30.90%Dr. Reddy's lab-1.30%Ranbaxy13.09% 41. For other states of economy, returns near to it (either decrease or increase based on the state of economy is given). An example for ACC is given here. ACC StateProbability32.34%135%33.96%235%35.65%320%25.47%45%42.45%55%22.07% 42. nExpecte d Return (ER)( riProb i )i 1Where: ER = the expected return on an investment Ri = the estimated return in scenario i Probi = the probability of state i occurring calculation 43. Expected risk nEx ante(Probi)( riER i )i 1Where: ER = the expected return on an investment Ri = the estimated return in state i Probi = the probability of state i occurring2 44. The calculation for ACC is given here.. ACC ProbabilitystateExpected Return ReturnExpected ReturnRi-E( R )Standard DeviationVariance10.3533.96%11.88%1.27%0.000056820.3535.65%12.48%2.97%0.000309030.225.47%5.09%-7.22%0.001041440.0542.45%2.12%9.76%0.000476550.0522.07%1.10%-10.61%0.000563032.68%0.00244664.95% 45. Sharpe model Step1 :calculate excess return to beta ratio of each security. Step 2:Review and rank the excess return to beta ratio in theorder from higher to lowest. Step 3:Rearrange the data with securities in order to rank determine in step 2 Step 4:determine the cut off point by applying the following formula for each security. 46. Step 5 :select the securities to be included in theportfolio by comparing excess return to beta ratio and determine cut off point for each security If excess return to beta ratio is greater than cut-off rate calculated all such securities should be included Step 6:Determine over all cut-off rate (c*)by selecting the cut-off point of last securities among them securities which are included in the portfolio 47. Step 7:Determine the weight or proportion of fundsto be invested in each selected securities of the optimum portfolio by applying the following formulaWhere,calculation 48. The weights calculated are:CompanyWeightRaymond37.66%Axis Bank62.34% 49. Expected return of portfolio nER p( wi i 1Portfolio returnER i ) 50. Expected risk of portfolio 2 p= (wA)2A,B=2 A+ (wB)22 B+ 2wAwBA,Bpi(RAi - E[RA])(RBi - E[RB]) 51. Findings Raymond Axis Bank ACC ICICI Colgate Palmolive Grasim Ultratech P&G Dr. Reddy's lab RanbaxyRisk Expected Return 56.12% 11.25% 32.68% 11.79% 29.74% 17.88% 23.30% 12.08% -1.35% 12.60%8.49% 1.70% 4.95% 1.78% 4.50% 2.71% 3.53% 1.83% 0.19% 1.91% 52. Findings(continued) SecuritiesRaymond Axis BankWeight37.66% 62.34% 53. Findings(continued) Portfolio Return Portfolio Risk28.14% 4.26% 54. Conclusion Past data as well as fundamental analysis helps us inpredicting the future value of a security, thus enabling us to predict the return available with the security. It also helps us in constructing a portfolio wherein our predicted values may be used to calculate the portfolio risk and return.