SUMMER TRAINING REPORT

Conducted at
LPS Bossard, Rohtak
On
Methods of Analyzing of risk and return
with respect to low and high speculative stock

Submitted to
Institute Of Management Studies & Research, MD University
Rohtak

In partial fulfillment of the requirements

For the award of degree of Master of Business Administration
(2017-2019)

Submitted by:
Roll No-309
MBA -2.3
 DECLARATION

I Diksha , Roll No.309. , student of MBA(2year) 3rd semester; Institute of Management

Studies And Research, MDU Rohtak, hereby declare that the Summer Training Report titled
“Analysis of risk and return with respect to low and high speculative stock at LPS Bossard” is
an original piece of work done during summer training and the same has not been submitted to
any other institute for the award of any other degree. I also certify that the respective
organization is aware about the report and it has been undertaken under their sole supervision
and guidance.

Signature of the Candidate

 ACKNOWLEDGEMENT

This project has received the whole-hearted support of many individuals and I am personally
grateful to each and everyone.

I am extremely thankful to Dr.A.S BOORA , Director of IMSAR, for permitting me to do this

project and for his professional advice and experience sharing.

It’s my great pleasure to express my deep sense of gratitude to the management of LPS Bossard,
for granting me permission to undertake my project in the organization. I take this opportunity to
express my gratitude to ----(Manager Training finance), for his valuable guidance. I would also
like to thank all the employees of LPS Bossard for their help and guidance.

Diksha
 CONTENT
Particular
 COMPANY PROFILE
 RESEARCH EXTRACT
 INTRODUCTION
 RISK
 BETA
 ALPHA
 STANDARD DEVIATION
 CORRELATION
 F-TEST
 SPECULATION. LITERATURE REVIEW
 PROBLEM STATEMENT
 RESEARCH METHODOLOGY
 Company profile
COMPANY PROFILE

COMPANY AT A GLANCE
LPS BOSSARD takes this opportunity to introduce ourselves as a joint venture
between M/s Lakshmi Precision Screws Ltd., Rohtak and Bossard AG,
Switzerland. Incorporated in November 97, this joint venture has been christened
as LPS BOSSARD PVT LTD.
It became operational in 1998 with specializing in Industrial Assembly
Technology and within a short span we are now a 90-member family serving to
our customers all over India with sales over Rs. 550 million with a steady
growth.
The company have a range of more than 75,000 of fasteners in Stainless steel,
High tensile steel, MS, Brass, Copper, Aluminum, Titanium Alloy, Inconel and
Plastics. Its range includes standard items (as per DIN, ISO, JIS, NFE, and other
National & International Std.) and Multifunctional fasteners like, Self drilling
screw, Thread cutting, Thread Forming screws, EcoSyn, EcoFix and many more.
Apart from these the company also develop and supply items as per customer
specifications.
LPS have joined hands with many world repute companies like Panduit Corp.
for distribution of Cable ties and Wiring Accessories, Recoil Fasteners Australia
for Thread Damage Repair Kits, Inserts and Insertion Tools, Fairchild Fasteners
for Tension Latches, ¼ Turn Fasteners, Push Button Fasteners, to cater to the
needs of customers for C items.

COMPANY`S AIM :
The company aim at providing the latest in Fastening Technology and C parts
management to the customers in India.
In its main operational activity Fastening Technology, it is headquartered in
Rohtak, Haryana and have formed regional offices at New Delhi, Bangalore &
Pune. In an effort to be closer to the customers it also have offices in Bangalore,
Chennai, Hyderabad & Mumbai etc

PARENT COMPANIES
LPS Ltd.
Founded in March 1972, LPS is one of the leading manufacturers and suppliers
of high tensile fasteners such as Bolts, Screws, Nuts and similar parts for
Automobile and other Industrial Sectors and has acquired the state of art
technology. LPS is Accredited in Mechanical and Chemical Testing since 1995
by A2LA (American Association for Laboratory Accreditation, USA) and
NABL (National Accreditation Board for Calibration & Testing Laboratories)
and is ISO certified since 1996. LPS also got QS 9000 in March 2000.

Bossard AG
Bossard a leading logistic-oriented group for fastening technology was founded
in 1831 in Zug, Switzerland and today is managed by the seventh generation of
the Bossard Family with roughly 1600 employees. Bossard is the first company
in this sector to get an ISO 9001/9002 & 14001 certification (since 1986).
Bossard has its global presence with regional
business units in Europe, United States and Asia/Pacific and operations in over
76 countries having a turnover of over US$ 400 Million.
COMPANY’S VISION
“We want to be “the trusted expert Brand” providing assembly technology
solutions for our customers globally”

Company’s current business policy is in line with our principals based on an

overall medium-term entrepreneurial vision. The company see itself as an
international logistic-oriented group for Fastening Technology and C parts
management. LPS have access to worldwide procurement and engineering
know-how.
QUALITY POLICY

“We at LPS Bossard will provide reliable quality products economically on

time to the total customer satisfaction.”
In order to meet above policy LPS have clear objectives that “to increase
confidence of customer by providing quality products on time” and “to reduce
cost of customer product by providing technical and logistics support

GUIDING PRINCIPLES FOR THE ACTIVITIES

Customer Focus
LPS focuses on the real needs of our customers.
LPS understands their problems and can solve them. That’s why they develop
custom-tailored products and services for every customer.
Value Added
Not all products and services add value – but they all lead to costs. Key for the
customer is the perceived value. That’s why the company cannot be inexpensive
but, instead, offer the best value.
Quality
All stakeholders can rest assured that the company invariably deliver what they
promise. That’s why they can offer their customers security, convenience and
cost-effectiveness.
People
LPS rely on highly motivated employees, empower them to contribute to the
group’s success and let them participate in it. That’s why they are having teams
to coordinate the activities.

“Our employees are our greatest assets.”

Independence
LPS have always put the trust in creativity, innovation and unconventional
thinking.

CORE COMPETENCIES

Main Service
LPS is at home in the market for fastening elements worldwide and know how
and where to manufacture and develop such elements.
Engineering
LPS is familiar with customer-specific problems in fastening technology and
know how to solve them.
Logistics
The company accustomed to customer-specific supply requirements and have
the necessary systems and solutions in place.
Communication
The company aware of the availability needs of our customers and know how to
develop and support inter-company procurement systems.

PRODUCT AND SERVICE PACKAGE

Basic Product
As the company offers a variety of fasteners to the diversified needs of market.
Providing reliable quality products on time is main or basic service. Functional
products must be available in sufficient number and at an acceptable price. To
this end the company maintains a worldwide manufacturing, development and
procurement network with several linked warehouse locations.
Product support
In fastening technology, there is more to fully exploiting the rationalization
potential than global product availability. That is why company offers product
support to help our customers manufacture a better product and to lower
production costs. This engineering service can improve the product through
identifying the most suitable materials, enhancing the quality of the fastening or
providing greater protection against corrosion or loosening. Lower production
costs can be achieved by reducing the number of different parts through using
multifunctional parts and through introducing simpler assembly techniques.

Business Support
Company’s major third strength is business support. Its starting point here is the
high availability of products and the assumption that C parts accounts for 50
percent of the total procurement costs, but only for 5 percent of the value of the
products.
They have developed, and repeatedly implemented, proven logistic systems that
can reduce costs for procurement, warehousing and assembly by 30 percent or
more. Such logistic systems have considerable savings potential because only
some 15 percent of the total in-place costs are related to the actual fastening
element. Numerous companies are not yet using saving potential.
Currently LPS can offer Two-Bin, Kanban Card, Kanban Barcode, Edifact and
SmartBin systems.

C Parts management
There is a clear trend worldwide towards procuring C parts from a single source
and towards overall C part management. The single source competencies
acquired through three service levels makes the company as an experienced and
reliable supplier of comprehensive C part management.
 OUR STRENGTHS
Globally the group has a specialization in handling the needs of many
industries like:
Air Conditioner Home Appliances Aero Space
Wind Mill

Medical Equipment Instrumentation Energy Meter

Locomotive

Automobile Electrical & Electronics Hydro Power

Defense

Accredited worldwide
Within the first year of their operations they had been certified as an ISO 9002
certified by UL USA. LPS have been rated as best suppliers by many of its
customers and this is the biggest certificate they have, and will always achieve.
MAJOR CUSTOMERS
Asea Brown Boveri Bombardier All BHEL All
Bharat Electronics Ltd.

Amtrex Hitachi Enercon India Crompton

Greaves

MICO Behr India ISRO

VSSC

DRDL DLW TATA’s

Dhananjay ltd.

Tecumseh Secure MetersGE BE Wipro GE

SIEMENS Alstom JCB Vatech

Hydro

“We believe in long lasting business relationship”

PRESENCE IN INDIA
Managing Director : Mr. Rajesh Jain

General Manager : Mr. Vineet Talwar

Head Office
LPS Bossard Pvt. Ltd.
NH- 10, Delhi Rohtak Road
Kharawar By pass
Rohtak – 124 001.
Haryana. India

Phone : +91-1262-305102- 232

Fax : +91-1262-305111-113
E-mail : [email protected]
Website : www.bossard.com

CHAPTER- 2
 2.1 RESEARCH EXTRACT

EVERY investment is associated with some amount of risk. Some investment has low
risk and for the same amount of there might be a difference of risk. As a financial
manager one of the basic jobs is to get higher amount of return at lower risk.

When an investor buys stock or takes an equity position in a firm, he or she is exposed
to many risks. Some risk may affect only one or a few firms and it is this risk that we
categorize as firm-specific risk. Within this category, we would consider a wide
range of risks, starting with the risk that a firm may have misjudged the demand for a
product from its customers; we call this project risk.

As an investor, you could invest your entire portfolio in one asset. If you do so, you are
exposed to both firm-specific and market risk. If, however, you expand your portfolio
to include other assets or stocks, you are diversifying, and by doing so, you can reduce
your exposure to firm-specific risk. There are two reasons why diversification reduces
or, at the limit, eliminates firm specific risk. The first is that each investment in a
diversified portfolio is a much smaller percentage of that portfolio than would be the
case if you were not diversified.

In this project risk per unit of return is calculated to find out the best return per unit of
risk. Mean, correlation, standard deviation, beta alpha is being calculated.

F-test is done on return average and standard deviation to find out to see whether
there is variance or not.

2.2 INTRODUCTION

The basic motive for the firm’s financial management regarding any
investment is that the investment should increase the value of the
equity. So in order for a firm’s management to choose only those
investments which meet this maximization of equity value criterion,
they must choose only those investments whose present value to the
owners exceeds the cost of investment. However to determine the
capitalized value of an asset the firm’s financial management must
be able to estimate the cash flows which will accrue and be
distributed to the stockholders from the investment and the rate at
which these flows are capitalized by the market. To identify this
capitalization rate or required return on equity and its relation to
various types of investment risks is the aim of the stock with low
value high speculation.

This empirical research intends to arrive at the required rate of return

 based on the five variables which are divided into two parts; viz:

•The distribution variables: standard deviation, skewness and

covariance and;

The financial risk variables: debt-equity ratio and dividend

•
payout ratio.

2.3 RISK

Risk, for most of us, refers to the likelihood that in life’s games of chance, we will receive an outcome
that we will not like. For instance, the risk of driving a car too fast is getting a speeding ticket, or worse
still, getting into an accident. Webster’s dictionary, in fact, defines risk as “exposing to danger or
hazard”. Thus, risk is perceived almost entirely in negative terms.
In finance, our definition of risk is both different and broader. Risk, as we see it, refers to the
likelihood that we will receive a return on an investment that is different from the return we expected
to make. Thus, risk includes not only the bad outcomes, i.e., returns that are lower than expected, but
also good outcomes, i.e., returns that are higher than expected. In fact, we can refer to the former as
downside risk and the latter is upside risk; but we consider both when measuring risk.
Risk is a concept that denotes a potential negative impact to an asset or some characteristic of value
that may arise from some present process or future event. In everyday usage, risk is often used
synonymously with the probability of a known loss.

Paradoxically, a probable loss can be uncertain and relative in an individual event while having a
certainty in the aggregate of multiple events.
Qualitatively, risk is considered proportional to the expected losses which can be caused by an event
and to the probability of this event. The harsher the loss and the more likely the event, the greater
the overall risk.

CLASSIFICATION OF RISK

Risk can be classified into the following categories:

• Systematic risk
• Unsystematic risk

Systematic risk: The systematic risk affects the entire market. Also known as "undiversifiable
risk" or "market risk." Systematic risk is a risk of security that cannot be reduced through
diversification. This indicates that the entire market is moving in a particular direction either
downward or upward. The economic conditions, political situations and sociological changes affect
the security market.
Variability in a security’s total returns that is directly associated with overall movements in the
general market or economy is called systematic or market or general risk. In other words, Systematic
risk is the risk attributable to broad macro factors affecting all securities.

Virtually all securities have some systematic risk, whether bonds or stocks, because systematic
risk directly encompasses the interest rate, market risk and inflation risk. The investor cannot escape
this part of risk, because no matter how well he or she diversifies, the risk of the overall market
cannot be avoided.

The systematic risk is further sub-divided into-

• Market Risk
• Purchasing Power Risk
• Interest Rate Risk
MARKET RISK:
Jack Clark Francis has defined market risk as that portion of total variability of return caused by the
alternating forces of bull and bear markets. When the security index moves upward with frequent
irregular pauses for a significant period of time, it is known as bull market. In the bull market, the
index moves from a low level to the peak. Bear market is just a reverse to the bull market; the index
declines haltingly from the peak to a market low point called trough for a significant period of time.
During the bull and bear market more than 80 per cent of the securities’ prices rise or fall along with
the stock market indices.

The forces that affect stock market are tangible and intangible events. The tangible events are real
events such as earthquake, war, political uncertainty, an election year, illness or death of president,
and fall in the value of currency.

Intangible events are related to market psychology. The market psychology is affected by the real
events. But reactions to the tangible events become over reactions and they push the market in a
particular direction.

For example: The Bull Run in 1994 FII’s investment and liberalization policies gave buoyancy to the
market. The market psychology was positive. Small investors entered

the market and prices of stocks without adequate supportive fundamental factors soared up.

In 1996, the political turmoil and recession in the economy resulted in the fall of share prices and the
small investors lost faith in the market. There was a rush to sell the shares and the stocks that were
floated in the primary market were not received well.

The market risk in equity shares is much greater than it is in bonds. Equity shares value and
prices are related in some fashion to earnings. Current and prospective dividends, which are made
possible by earnings, theoretically, should be capitalized at a rate that will provide yields to
compensate for the basic risks.

In short, the crux of the market risk is likelihood of incurring capital losses from price changes
engendered by a speculative psychology.

PURCHASING POWER RISK:

The negative relation between equity valuations and expected inflation is found to be the result of
two effects: a rise in expected inflation coincides with both (i) lower expected real earnings growth

and (ii) higher required real returns.

A one percentage point increase in expected inflation is estimated to rise required real stock returns
about one percentage point, which on average would imply a 20 percent decline in stock prices.

But the inflation factor in expected real stock returns is also in long-term Treasury yields;

consequently, expected inflation has little effect on the long-run equity premium.

Variations in the returns are caused also by the loss of purchasing power of currency. Inflation is the
reason behind the loss of purchasing power. Purchasing power risk is the probable loss in the
purchasing power of the returns to be received. The rise in price penalizes the returns to the investor,

and every potential rise in the price is a risk to the investor.

INTEREST RATE RISK:

A major source of risk to the holders of high quality bonds is changes in interest rates, commonly
referred to an interest rate risk. These high- quality bonds are not subject to either substantial
business risk or financial risk.

If there is an increase in risk free rate of interest (i.e., MIBOR, interest rate on government bonds and
interest rate on treasury bills), then there would be definite shift in the funds from low yielding bonds
to high yielding bonds and from stocks to bonds.

Likewise, if the stock market is in a depressed condition, investors would like to shift their money to
the bond market, to have an assured rate of return.For example: The best example is that in April
1996, most of the initial public offerings of many companies remained undersubscribed but IDBI and
IFC bonds were oversubscribed. The assured rate of return attracted the investors from the stock
market to the bond market.
UNSYSTEMATIC RISK
Unsystematic risk is unique and peculiar to an industry or to a firm. Unsystematic risk stems from
managerial inefficiency, technological change in the production process, availability of raw materials,
change in the consumer preference, and lobour problems. The nature and magnitude of above factors
differ from industry to industry, and company to company.

Technological changes affect the information technology industry more than that of consumer
product industry. Thus it differs from industry to industry.

The changes in the consumer preference affect the consumer products like television sets,
washing machines, refrigerators, etc more than they affect the iron and steel industry.

Unsystematic risk can be classified into two categories namely:

• Business Risk
• Financial Risk

BUSINESS RISK
Business risk, which is sometimes called operating risk, is the risk associated with the normal day-to-
day operations of the firm. Business risk is concerned to Earnings before interest and tax. Earnings
before interest and taxes can be viewed as the operating profit of the firm; that is, the profit of the
firm before deducting financing charges and taxes. Business risk represents the chance of loss and the
variability of return created by a firm’s uses of funds. The two components of business risk signify the
chance that the firm will fail because of the inability of the assets of the firm to

generate a sufficient level of earnings before interest and the variability of such earnings.
FINANCIAL RISK:
Financial risk is created by the use of fixed cost securities (i.e., debt and preference shares). Financial
risk is the chance of loss and the variability of the owner’s return created by a firm’s sources of funds.
Financial risk is the chance of loss and the variability of the owners’ return created by a firm’s sources
of funds. The two components of financial risk reflect the chance that the firm will fail because of the
inability to meet interest and/ or principal payments on debt, and the variability of earnings available
to Equity holders caused by fixed financing changes (i.e., interest expense and preferred dividends). In

case the firm does not employ debt, there will be no financial risk.
An important aspect of financial risk is the interrelationship between financial risk and business
risk. In effect, business risk is basic to the firm, but the firm, but the firm’s risk can be affected by the
amount of debt financing used by the firm. Whatever be the amount of business risk associated with
the firm, the firm’s risk will be increased by the use of debt financing. As a result, it follows that the
amount of debt financing used by the firm should be determined largely by the amount of business
risk that the firm that the firm faces. If its business risk is low, then it can use more debt financing
without fear of default, or a marked impact on the earnings available to the equity share holders.
Conversely, if the firm faces, a lot of business risk, then the use of a lot of debt financing may
jeopardize the firm’s operations.

DIVERSIFIABLE AND NON-DIVERSIFIABLE RISK

Although there are many reasons that actual returns may differ from expected returns, we can group
the reasons into two categories: firm-specific and market-wide. The risks that arise from firm-specific
actions affect one or a few investments, while the risk arising from market-wide reasons affect many
or all investments. This distinction is critical to the way we assess risk in finance.

THE COMPONENTS OF RISK

When an investor buys stock or takes an equity position in a firm, he or she is exposed to many risks.
Some risk may affect only one or a few firms and it is this risk that we categorize as firm-specific
risk. Within this category, we would consider a wide range of risks, starting with the risk that a firm
may have misjudged the demand for a product from its customers; we call this project risk. For
instance, in the coming chapters, we will be analyzing Boeing’s investment in a Super Jumbo jet. This
investment is based on the assumption that airlines want a larger airplane and are will be willing to
pay a higher price for it. If Boeing has misjudged this demand, it will clearly have an impact on
Boeing’s earnings and value, but it should not have a significant effect on other firms in the market.
The risk could also arise from competitors proving to be stronger or weaker than anticipated; we call
this competitive risk. For instance, assume that Boeing and Airbus are competing for an order from
Quantas, the Australian airline. The possibility that Airbus may win the bid is a potential source of risk
to Boeing and perhaps a few of its suppliers. But again, only a handful of firms in the market will be
affected by it. Similarly, the Home Depot recently launched an online store to sell its home
improvement products. Whether it

succeeds or not is clearly important to the Home Depot and its competitors, but it is unlikely to have
an impact on the rest of the market. In fact, we would extend our risk measures to include risks that
may affect an entire sector but are restricted to that sector; we call this sector risk. For instance, a
cut in the defense budget in the United States will adversely affect all firms in the defense business,
including Boeing, but there should be no significant impact on other sectors, such as food and
apparel. What is common across the three risks described above project, competitive and sector risk –
is that they affect only a small sub-set of firms. There is other risk that is much more pervasive and
affects many if not all investments. For instance, when interest rates increase, all investments are
negatively affected, albeit to different degrees. Similarly, when the economy weakens, all firms feel
the effects, though cyclical firms (such as automobiles, steel and housing) may feel it more. We term
this risk market risk.
Finally, there are risks that fall in a gray area, depending upon how many assets they affect. For
instance, when the dollar strengthens against other currencies, it has a significant impact on the
earnings and values of firms with international operations. If most firms in the market have significant
international operations, it could well be categorized as market risk. If only a few do, it would be
closer to firm-specific risk.
WHY DIVERSIFICATION REDUCES OR ELIMINATES FIRM-SPECIFIC
RISK: AN INTUITIVE EXPLANATION
As an investor, you could invest your entire portfolio in one asset, say Boeing. If you do so, you are
exposed to both firm-specific and market risk. If, however, you expand your portfolio to include other
assets or stocks, you are diversifying, and by doing so, you can reduce your exposure to firm-specific
risk. There are two reasons why diversification reduces or, at the limit, eliminates firm specific risk.
The first is that each investment in a diversified portfolio is a much smaller percentage of that
portfolio than would be the case if you were not diversified. Thus, any action that increases or
decreases the value of only that investment or a small group of investments will have only a small
impact on your overall portfolio, whereas undiversified investors are much more exposed to changes
in the values of the investments in their portfolios. The second reason is that the effects of firm-
specific actions on the prices of individual assets in a portfolio can be either positive or negative for
each asset for any period. Thus, in very large portfolios, this risk will average out to zero and will not
affect the overall value of the portfolio. In contrast, the effects of market-wide movements are likely
to be in the same direction for most or all investments in a portfolio, though some assets may be
affected 12 more than others. For instance, other things being equal,
an increase in interest rates will lower the values of most assets in a portfolio. Being more diversified
does not eliminate this risk.

MODELS OF DEFAULT RISK

The risk that we have discussed relates to cash flows on investments being different from expected
cash flows. There are some investments, however, in which the cash flows are promised when the
investment is made. This is the case, for instance, when you lend to a business or buy a corporate
bond; the borrower may default on interest and principal payments on the borrowing. Generally
speaking, borrowers with higher default risk should pay higher interest rates on their borrowing than
those with lower default risk. This section examines the measurement of default risk and the
relationship of default risk to interest rates on borrowing. In contrast to the general risk and return
models for equity, which evaluate the effects of market risk on expected returns, models of default
risk measure the consequences of firm-specific default risk on promised returns. While diversification
can be used to explain why firm-specific risk will not be priced into expected returns for equities, the
same rationale cannot be applied to securities that have limited upside potential and much greater
downside potential from firm-specific events. To see what we mean by limited upside potential,
consider investing in the bond issued by a company. The coupons are fixed at the time of the issue
and these coupons represent the promised cash flow on the bond. The best case scenario for you as
an investor is that you receive the promised cash flows; you are not entitled to more than these cash
flows even if the company is wildly successful. All other scenarios contain only bad news, though in
varying degrees, with the delivered cash flows being less than the promised cash flows.
Consequently, the expected return on a corporate bond is likely to reflect the firm specific default risk
of the firm issuing the bond.

THE DETERMINANTS OF DEFAULT RISK

The default risk of a firm is a function of two variables. The first is the firm’s capacity to generate cash
flows from operations and the second is its financial obligations – including interest and principal
payments7. Firms that generate high cash flows relative to their financial obligations should have
lower default risk than firms that generate low cash flows relative to their financial obligations. Thus,
firms with significant existing investments, which generate relatively high cash flows, will have lower
default risk than firms that do not. In addition to the magnitude of a firm’s cash flows, the default risk
is also affected by the volatility in these cash flows. The more stability there is in cash flows the lower
the default risk in the firm. Firms that operate in predictable and stable businesses will have lower
default risk than will other similar firms that operate in cyclical or volatile businesses. Most models of
default risk use

financial ratios to measure the cash flow coverage (i.e., the magnitude of cash flows relative to
obligations) and control for industry effects to evaluate the variability in cash flows.
 THE RISK OF AN INDIVIDUAL ASSET

• The risk of any asset is the risk that it adds to the market portfolio.

• Statistically, this risk can be measured by how much an asset moves with the market (called
the covariance).

• Beta is a standardized measure of this covariance

• Beta is a measure of the non-diversifiable risk for any asset can be measured by the covariance
of its returns with returns on a market index, which is defined to be the asset's beta.

• The cost of equity will be the required return,

Cost of Equity = Rf + Equity Beta * (E(Rm) - Rf)

where,
Rf = Riskfree rate
E (Rm) = Expected Return on the Market Index
2.3 BETA
The Beta coefficient, in terms of finance and investing, is a measure of volatility of a stock or
portfolio in relation to the rest of the financial market.
An asset with a beta of 0 means that its price is not at all correlated with the market; that asset is
independent. A positive beta means that the asset generally follows the

market. A negative beta shows that the asset inversely follows the market; the asset generally
decreases in value if the market goes up.
The beta coefficient is a key parameter in the capital asset pricing model (CAPM). It measures the part
of the asset's statistical variance that cannot be mitigated by the diversification provided by the
portfolio of many risky assets, because it is correlated with the return of the other assets that are in
the portfolio. Beta is calculated for individual companies using regression analysis.
The formula for the Beta of an asset within a portfolio is

Where

ra measures the rate of return of the asset, rp measures the rate of return of the portfolio of which

the asset is a part and Cov(ra,rp) is the covariance between the rates of return.

In the CAPM formulation, the portfolio is the market portfolio that contains all risky assets, and so the
rp terms in the formula are replaced by rm, the rate of return of the market.

Beta is also referred to as financial elasticity or correlated relative volatility, and can be referred to
as a measure of the asset's 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.

On a portfolio level, measuring beta is thought to separate a manager's skill from his or her willingness
to take risk.
The beta movement should be distinguished from the actual returns of the stocks. For example, a sector
may be performing well and may have good prospects, but the fact that its movement does not
correlate well with the broader market index may decrease its beta. However, it should not be taken as
a reflection on the overall attractiveness or the loss of it for the sector, or stock as the case may be. Beta
is a measure of risk and not to be confused with the attractiveness of the investment.
The beta coefficient was born out of linear regression analysis. It is linked to a regression analysis of the
returns of a portfolio (such as a stock index) (x-axis) in a specific period versus the returns of an
individual asset (y-axis) in a specific year.

The regression line is then called the Security Characteristic Line (SCL).

αa is called the asset's alpha coefficient βa is

called the asset's beta coefficient.

Both coefficients have an important role in Modern portfolio theory.

For example, in a year where the broad market or benchmark index returns 25% above the risk free
rate, suppose two managers gain 50% above the risk free rate. Since this higher return is theoretically
possible merely by taking a leveraged position in the broad market to double the beta so it is exactly
2.0, we would expect a skilled portfolio manager to have built the outperforming portfolio with a beta
somewhat less than 2, such that the excess return not explained by the beta is positive. If one of the
managers' portfolios has an average beta of 3.0, and the other's has a beta of only
1.5, then the CAPM simply states that the extra return of the first manager is not sufficient to
compensate us for that manager's risk, whereas the second manager has done more than expected
given the risk. Whether investors can expect the second manager to duplicate that performance in
future periods is of course a different question.
2.4 ALPHA

Alpha is a risk-adjusted measure of the so-called "excess return" on an investment. It is a common

measure of assessing an active manager's performance as it is the return in excess of a benchmark
index.
The difference between the fair and actually expected rates of return on a stock is called the stock's
alpha.
The alpha coefficient (αi) is a parameter in the capital asset pricing model. In fact it is the intercept
of the Security Characteristic Line (SCL). One can prove that in an efficient market, the expected
value of the alpha coefficient equals the return of the risk free asset.
A share’s alpha value is a measure of its abnormal return, and represents the amount by which the
share’s returns are currently above, or below the required return, given its systematic risk.

INTERPRETATION OF ALPHA

Alpha values assume significance in the investment market. They help an investor decide
whether stocks are undervalued, overvalued or rightly valued. The following rules would help make
the choice.

Rule 1: A positive Alpha value indicates that the expected return from this stock could be higher than
the mandated by CAPM to the extent of the alpha value. Hence stocks with positive alpha should be
considered as under valued stocks. Such stocks are therefore much sought after in the market and
should be bought.

Rule2: A negative Alpha value indicates that the expected return from this stock will be less than the
mandated by CAPM to the extent of the alpha value. Hence stocks with negative alpha should be
considered as over valued stocks. Such stocks are to be sold.

2.5 STANDARD DEVIATION

In probability and statistics, the standard deviation of a probability distribution, random variable, or
population or multiset of values is a measure of the spread of its values. The standard deviation is
usually denoted with the letter σ (lower case sigma). It is defined as the square root of the variance.
To understand standard deviation, keep in mind that variance is the average of the squared
differences between data points and the mean. Variance is tabulated in units squared. Standard
deviation, being the square root of that quantity, therefore measures the spread of data about the
mean, measured in the same units as the data.
In finance, standard deviation is a representation of the risk associated with a given security (stocks,
bonds, property, etc.), or the risk of a portfolio of securities. Risk is an important factor in determining
how to efficiently manage a portfolio of investments because it determines the variation in returns on
the asset and/or portfolio and gives investors a mathematical basis for investment decisions. The
overall concept of risk is that as it increases, the expected return on the asset will increase as a result
of the risk premium earned – in other words, investors should expect a higher return on an investment
when said investment carries a higher level of risk.
For example, you have a choice between two stocks: Stock A historically returns 5% with a standard
deviation of 10%, while Stock B returns 6% and carries a standard

deviation of 20%. On the basis of risk and return, an investor may decide that Stock A is the better
choice, because Stock B's additional percentage point of return generated (an additional 20% in dollar
terms) is not worth double the degree of risk associated with Stock A. Stock B is likely to fall short of
the initial investment more often than Stock A under the same circumstances, and will return only one
percentage point more on average. In this example, Stock A has the potential to earn 10% more than
the expected return, but is equally likely to earn 10% less than the expected return.
Calculating the average return (or arithmetic mean) of a security over a given number of periods will
generate an expected return on the asset.
For each period, subtracting the expected return from the actual return results in the variance. Square
the variance in each period to find the effect of the result on the overall risk of the asset. The larger
the variance in a period, the greater risk the security carries. Taking the average of the squared
variances results in the measurement of overall units of risk associated with the asset. Finding the
square root of this variance will result in the standard deviation of the investment tool in question.
2.6 CORRELATION
In the world of finance, a statistical measure of how two securities moves in relation to each other. C
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 by an equal amount in the opposite direction.
If the correlation is 0, the movements of the securities is said to have no correlation, it is completely
random. If one security moves up or down there is as good a chance that the other will move either up
or down, the way in which they move is totally random.

In real life however you likely will not find perfectly correlated securities, rather you will find securities
with some degree of correlation. For example, the performance of two stocks within the same
industry is strongly positively correlated although it may not be exactly +1.correlations are used in
advanced portfolio management.
2.7 F-TEST

An F-test is any statistical test in which the test statistic has an F-distribution if the null hypothesis is
true. The name was coined by George W. Snedecor, in honour of Sir Ronald A. Fisher. Fisher initially
developed the statistic as the variance ratio in the 1920s. Examples include:
The hypothesis that the means of multiple normally distributed populations, all having the same
standard deviation, are equal. This is perhaps the most well-known of hypotheses tested by means of
an F-test, and the simplest problem in the analysis of variance (ANOVA).

The hypothesis that the standard deviations of two normally distributed populations are equal, and
thus those they are of comparable origin.

Note that if it is equality of variances (or standard deviations) that is being tested, the F-test is
extremely non-robust to non-normality. That is, even if the data displays only modest departures from
the normal distribution, the test is unreliable and should not be used.
The general formula for an F- test is: F = (between-group variability) / (within-group variability)
In many cases, the F-test statistic can be calculated through a straightforward process. In the case of
regression: consider two models, 1 and 2, where model 1 is nested within model 2. That is, model 1
has p1 parameters, and model 2 has p2

parameters, where p2 > p1. (Any constant parameter in the model is included when counting the
parameters.

2.8 SPECULATION
Financial speculation, involves the buying, holding, selling, and short-selling of stocks, bonds,
commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to
profit from fluctuations in its price as opposed to buying it for use or for income via methods such as
dividends or interest. Speculation or agitates represents one of four market roles in Western
financial markets, distinct from hedging, long- or short-term investing, and arbitrage. Another service
provided by speculators to a market is that by risking their own capital in the hope of profit, they add
liquidity to the market and make it easier for others to offset risk, including those who may be
classified as hedgers and arbitrageurs.

If a certain market - for example, pork bellies - had no speculators, then only producers (hog farmers)
and consumers (butchers, etc.) would participate in that market. With fewer players in the market,
there would be a larger spread between the current bid and ask price of pork bellies. Any new entrant
in the market who wants to either buy or sell pork bellies would be forced to accept an illiquid market
and market prices that have a large bid-ask spread or might even find it difficult to find a co-party to
buy or sell to. A speculator (e.g. a pork dealer) may exploit the difference in the

spread and, in competition with other speculators, reduce the spread, thus creating a more efficient
market.
Auctions are a method of squeezing out speculators from a transaction, but they may have their own
perverse effects; see winner's curse. The winner's curse is however not very significant to markets
with high liquidity for both buyers and sellers, as the auction for selling the product and the auction
for buying the product occur simultaneously, and the two prices are separated only by a relatively
small spread. This mechanism prevents the winner's curse phenomenon from causing mispricing to
any degree greater than the spread.
Speculative purchasing can also create inflationary pressure, causing particular prices to increase
above their true value (real value - adjusted for inflation) simply because the speculative purchasing
artificially increases the demand. Speculative selling can also have the opposite effect, causing prices
to artificially decrease below their true value in a similar fashion. In various situations, price rises due
to speculative purchasing cause further speculative purchasing in the hope that the price will continue
to rise. This creates a positive feedback loop in which prices rise dramatically above the underlying
value or worth of the items. This is known as an economic bubble. Such a period of increasing
speculative purchasing is typically followed by one of speculative selling in which the price falls
significantly, in extreme cases this may lead to crashes. Overall, the participation of speculators in
financial markets tends to be accompanied by significant increase in short-term market volatility. This
is not necessarily a bad thing, as heightened level of volatility implies that the market will be able to
correct perceived mispricing more rapidly and in a more drastic manner.

CHAPTER-3
 3.1 LITERATURE REVIEW

There are numerous studies done to estimate the required rate of return on the stock.
Most of the research studies are based on the theories proposed by:

• The Risk/Return Trade Off

• The Capital Asset Pricing Model
• Gordon’s Model
• Dividend Discount Model
• Sharpe’s Model

THE RISK / RETURN TRADEOFF

The risk/return tradeoff could easily be called the "ability-to-sleep at- night test." While some people
can handle the equivalent of financial skydiving without batting an eye, others are terrified to climb
the financial ladder without a secure harness. Deciding what amount of risk you can take while
remaining comfortable with your investments is very important.
In the investing world, the dictionary definition of risk is the chance that an investment's
actual return will be different than expected. Technically, this is measured in statistics by standard
deviation. Risk means you have the possibility of losing some or even all of our original investment.
 Low levels of uncertainty (low risk) are associated with low potential returns. High levels of
uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is the
balance between the desire for the lowest possible risk and the highest possible return. This is
demonstrated graphically in the chart below.

A higher standard deviation means a higher risk and higher possible return. A common misconception
is that higher risk equals greater return. The risk/return tradeoff tells us that the higher risk gives us
the possibility of higher returns. There are
no guarantees. Just as risk means higher potential returns, it also means higher potential losses.
On the lower end of the scale, the risk-free rate of return is represented by the return on Treasury
Bills rate because their chance of default is next to nothing. If the risk-free rate is currently 6%, this
means, with virtually no risk, we can earn 6% per year on our money.

THE CAPITAL ASSET PRICING MODEL [CAP-M]

The Capital Asset Pricing Model (CAPM) is an equilibrium model which describes the pricing of assets,
as well as derivatives. The model concludes that the expected return of an asset (or derivative) equals
the riskless return plus a measure of the assets nondiversable risk (beta) times the market-wide risk
premium (excess expected return of the market portfolio over the riskless return). That is:

Expected Security Return = Risk free Return + Beta X (Expected Market Risk Premium)

It concludes that only the risk which cannot be diversified away by holding a welldiversified portfolio
(e.g. the market portfolio) will affect the market price of the asset.

This risk is called systematic risk, while risk that can be diversified away is called diversifiable risk (or
nonsystematic risk).

DIVIDEND DISCOUNT MODEL

In the strictest sense, the only cash flow you receive from a firm when you buy publicly traded stock is
the dividend. The simplest model for valuing equity is the dividend discount model -- the value of a
stock is the present value of expected dividends on it. While many analysts have turned away from
the dividend discount model and viewed it as outmoded, much of the intuition that drives discounted
cash flow valuation is embedded in the model. In fact, there are specific companies where the
dividend discount model remains a useful took for estimating value.

Any stock is ultimately worth no more than what it will provide investors in current and future
dividends. Financial theory says that the value of a stock is worth all of the future cash flows expected
to be generated by the firm, discounted by an appropriate risk-adjusted rate. According to the DDM,
dividends are the cash flows that are returned to the shareholder.
To value a company using the DDM, you calculate the value of dividend payments that you think a
stock will throw-off in the years ahead. Here is what the model says:

ZERO GROWTH MODEL

P0 = Div
R

where

P = the price at time 0 r =

discount rate
Div = annual dividend

Therefore the required rate of return on Equity is:

R = Div
P

MULTI-STAGE MODELS
To get around the problem posed by un-steady dividends, multistage models take the DDM a step
closer to reality by assuming that the company will experience differing growth phases. Stock analysts
build complex forecast models with many phases of differing growth to better reflect real prospects.
For example, a multi-stage DDM may predict that a company will have a dividend that grows at 5%
for seven years, 3% for the following three years and then at 2% in perpetuity. However, such an
approach brings even more assumptions into the model although it doesn't assume that a dividend
will grow at a constant rate, it must guess when and by how much a dividend will change over time.
Another sticking point with the DDM is that no one really knows for certain the appropriate expected
rate of return to use. It’s not always wise simply to use the longterm interest rate because the
appropriateness of this can change.

GORDON’S MODEL

The Gordon’s Model works on the similar lines as that of the Dividend Discount Model. A model for
determining the intrinsic value of a stock, based on a future series of dividends that grow at a
constant rate. Given a dividend per share that is payable in one year, and the assumption that the
dividend grows at a constant rate forever (in perpetuity), the model solves for the present value of
the infinite series of future dividends.

Stock Value ( P ) = D
k-G

where:
D = Expected dividend per share one year from now k =
Required rate of return for equity investor
G = Growth rate in dividends (in perpetuity)

Therefore the expected rate of return on equity is given by:

 K=D+G
P
Because the model simplistically assumes a constant growth rate, it is generally only used for mature
companies (or broad market indices) with low to moderate growth rates.

SHARPE’S MODEL

The limitation of Markowitz Model was that it related each security to every other security in the
portfolio, demanding the sophistication and volume of work well beyond the capacity of all but a few
analysts. Consequently, its application remained severely limited until William F. Sharpe published a
model simplifying the mathematical calculations required by Markowitz Model.
Sharpe assumed that, for the sake of simplicity, the return on security could be regarded as
being linearly related to a single index. Theoretically, the market index should consist of all the
securities trading on the market. However, a popular average can be treated as a surrogate for
marker index. Acceptance of the idea of the market index, Sharpe argued, would obviate the need for
calculating thousands of covariances between securities, because any movements in securities could
be attributed to movements in single underlying factor being measured by the market index. The
simplification of Markovitz Model has come to be known as Market Model or Single-Index Model
[SIM].

3.2 PROBLEM STATEMENT:

Identification Of Required Rate Of Return And Risk Of A Particular Stock Based Upon Different Risk
Elements Prevailing In The Market And Other Economic Factors, For Equity With Low Value And High
Volatility Speculation stocks.

3.3 RESEARCH OBJECTIVE

• To Study the Risk and Return of Stock.

• To Test the Variability between Variables, Such as variance of returns covariance etc.
 CHAPTER-4
RESEARCH METHODOLOGY
4.1 TYPE OF RESEARCH

Type of research is Descriptive research, which is Quantitative in nature.

4.2 SAMPLING TECHNIQUE

Technique use for selection of samples is simple random sampling technique.

4.3 SAMPLE SIZE

IT industry is selected by simple random sampling. In that industry five stocks are selected from large
cap and five stocks are selected from lower and medium capitalization.

4.4 DATA COLLECTION

Secondary Data

Historical stock prices.

4.5 SOURCES OF DATA

The data relating to the study is taken from two databases namely prowess and capital line plus.

• Large Volumes of Data

 • Time Constrain

4.6 HYPOTHESIS

• Null Hypothesis: There is no difference in volatility with respect to low priced high
speculative share.
H0- denotes null hypothesis.
Mathematically it is represented as:

ρ= F(X1, X2, X3, X4, X5)

where
The Dependent Variable:

ρ: required rate of return

The Independent Variables:

X1: Variance
X2: Skewness
X3: Correlation coefficient
X4: Debt-equity Ratio
X5: Dividends-Earnings Ratio

• Alternative Hypothesis: There is difference in volatility with respect to low priced and high
speculative share.
Ha- denotes alternative hypothesis.
 4.7 LIMITATIONS OF THE RESEARCH

• The sample companies consisted of the stocks in the index, but since not all the information
was available it acts as constraints to the result.
• Ideally, the research should have been done throughout the cross section of the stocks in
India, but this would have been beyond my scope of study due to limited resources.
• As the sample size will be small there is a very limited chance to carry out an in-depth study.