Constructing an optimum portfolio using sharpe single index model

EXECUTIVE SUMMARY

The topic of dissertation is Study on constructing an Optimum Portfolio

using Sharp Single index Model. The investors who invest in equities have one
important objective that is maximizing return and minimizing the risk. The
most effective tool to minimize risk is to invest in portfolio.
Portfolio
management in common parlance refers to the selection of securities and their
continuous shifting in the portfolio to optimize returns and minimize the risks.
To determine an optimum portfolio which will lead to superior wealth creation
by way of long term compounding effect and capital appreciation and select the
appropriate securities with better returns for making investment, determine
the proportionate of investment to be made in each individual companys
stocks. Study carried on by taking SENSEX as market index and consist
jeering daily indices for the April1, 2012 March 30 2013 period, the proposed
method formulates a unique cut off point (Cut off rate of return) and selects
stocks having excess of their expected return over risk-free rate of return
surpassing this cut-off point using the Sharpe Single index model to construct
the optimum portfolio. From the study it has been found that all the selected
companies selected move with the market index. Beta of companies like Maruti
Suzuki, Mahindra and Mahindra, Bharat Petroleum, Hindustan Petroleum,
Indian Oil Corporation, Mahindra Ugine, Airtel and idea is below 1; hence
investment in these companies is less risky. Out of the 15 selected companies
Indian Oil Corporation, Vijaya Bank, Reliance, Tata Steel and SBI are the top 5
companies having more excess return over beta. After analysis investor are
suggested that know the fundamentals of company before investing in it. Dont
stick to one company or stock; remember we have thousands of companies to
invest in. Always have a to portfolio which will not only promise higher returns
but will also diversify the risk. Dont be afraid to invest in unpopular
companies. Invest only after exhaustive research into companies. Hence this
project will help the investors to invest in the portfolio of companies which are
fundamentally very strong and have good record.

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

TABLE OF CONTENTS
CHAPTER PARTICULARS
List of Tables
List of Charts
List of Abbreviations
1

Introduction
Review of Literature & Design of Study
2.1 Introduction
2.2 Review of Literature

2
2.3 Statement of the Problem
2.4 Scope of the Study
2.5 Objectives of the Problem
2.6 Operational Definitions of Concept
2.7 Methodology
2.8 Limitations of the Study
2.9 Chapter scheme
3

Profile of the organization

Results, Analysis & Discussion

Summary of Findings, Conclusion &

Suggestions
References

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Constructing an optimum portfolio using sharpe single index model

LIST OF TABLES
SL
NO.
4.1
4.1.1
4.1.2
4.1.3
4.1.4
4.2
4.2.1
4.2.2
4.2.3
4.2.4
4.3
4.3.1
4.3.2
4.3.3
4.3.4
4.4
4.4.1
4.4.2
4.4.3
4.4.4
4.5
4.5.1
4.5.2
4.5.3
4.5.4
4.6
4.7
4.8

DESCRIPTION
Calculation for Banking Industry
Mean Return for Banking Companies
Variance for Banking Companies
Covariance for Banking Companies
Beta for Banking Companies
Calculation for Automobile Industry
Mean Return for Automobile Companies
Variance for Automobile Companies
Covariance for Automobile Companies
Beta for Automobile Companies
Calculation for Telecommunication Industry
Mean Return for Telecommunication Companies
Variance for Telecommunication Companies
Covariance for Telecommunication Companies
Beta for Telecommunication Companies
Calculation for Steel Industry
Mean Return for steel Companies
Variance for steel Companies
Covariance for steel Companies
Beta for steel Companies
Calculation for Petroleum Companies
Mean Return for Petroleum Companies
Variance for Petroleum Companies
Covariance for Petroleum Companies
Beta for Petroleum Companies
Calculation of Systematic and Unsystematic Risk
Calculation of Ranks
Calculation of Cut-Off Rate

City college, Bangalore.

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Constructing an optimum portfolio using sharpe single index model

LIST OF CHARTS
SL
NO.
4.1.1
4.1.2
4.1.3
4.1.4
4.2.1
4.2.2
4.2.3
4.2.4
4.3.1
4.3.2
4.3.3
4.3.4
4.4.1
4.4.2
4.4.3
4.4.4
4.5.1
4.5.2
4.5.3
4.5.4
4.6
4.7
4.8

DESCRIPTION
Mean Return for Banking Companies
Variance for Banking Companies
Covariance for Banking Companies
Beta for Banking Companies
Mean Return for Automobile Companies
Variance for Automobile Companies
Covariance for Automobile Companies
Beta for Automobile Companies
Mean Return for Telecommunication Companies
Variance for Telecommunication Companies
Covariance for Telecommunication Companies
Beta for Telecommunication Companies
Mean Return for steel Companies
Variance for steel Companies
Covariance for steel Companies
Beta for steel Companies
Mean Return for Petroleum Companies
Variance for Petroleum Companies
Covariance for Petroleum Companies
Beta for Petroleum Companies
Systematic and Unsystematic Risk
Ranking
Showing Cut-Off Rate

City college, Bangalore.

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Constructing an optimum portfolio using sharpe single index model

LIST OF ABBREVIATIONS

CAPM: Capital Asset Pricing Model

ROR: Rate of Return

ROI: Rate of Investment

SCL: Security Characteristic Line

SENSEX: Sensitivity Index

NSE: National Stock Exchange

BSE: Bangalore Stock Exchange

IPO: Initial Public Offering

GDP: Gross Domestic Product

LCV: Light Commercial Vehicle

GSM: Global Satellite Mobile Communication

CDMA: Code Division Multiple Access

ONGC: Oil and Natural Gas Corporation

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

CHAPTER V

SUMMARY OF FINDINGS, CONCLUSIONS &

SUGGESTIONS

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

5.1: Summary of Findings:

During the year 1st April 2012 to 31 March 2013 the market return is
0.053 and the market variance is found to be 1.654.

During the year the risk free rate of return is 7%

From the analysis it is found that all the 15 companies selected move
with the market index.

Beta of companies like Maruti Suzuki, Mahindra and Mahindra, Bharat

Petroleum, Hindustan Petroleum, Indian Oil Corp., Mahindra Ugine,
Airtel and Idea is below 1; hence investment in these companies less
risky.

Systematic risk is highest in case Reliance Communication whereas

Indian Oil Corp., has the least exposure to the systematic risk.

Similarly unsystematic risk involve in Mahindra Ugine Steel is higher

than all the other selected companies and ICICI has lesser unsystematic
risk compared to others.

Out of the 15 selected companies having more excess return over beta.

Cut-off rate is found to be at 0.047 based on which the portfolio will be

constructed.

The companies which are selected for constructing the portfolio are
Indian Oil Corp., Vijaya Bank, Reliance, Tata Steel, SBI and Jindal steel.

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

5.2 Conclusion:
Saving money is not enough. Each of us also needs to invest ones
savings intelligently in order to have enough money available for funding future
needs. Investment as we all know is a sacrifice of current money or any other
resources for the future benefits. But future is uncertain and risk is always
associated with the returns. In the market there are several investment
opportunity offering different benefits which make the investment a complex
activity. The investor who opts to invest in equity should have a portfolio.
Portfolio helps the investors to not only give higher returns but will also
diversity risk.
Sharpes Single Index Model is one of the most commonly used tools for
construction of portfolio. Hence here an attempt is made to construct an
optimal portfolio using Sharpes Single Index Model. Shapes Single Index
Model helps to formulate a well-diversified return and provide a portfolio with
most optimum return with minimum risk.
Hence this project will help the investors to invest in the portfolio of
companies which are fundamentally very strong and have good record.

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

5.3 Suggestions:
In the stock market it is very difficult to predict the share price. The rise
and fall of the share price depend upon the market condition, economy of the
country and the company status. So the investor should study the market
condition and the fundamental thoroughly before investing. The investors to
have maximum return should have a portfolio and should follow the scientific
approach like Sharpes Single Index Model for selecting an optimal portfolio.
Following are the few points that the investors should always follow.

Know what others dont know and other investors missed.

Know the fundamental s of company before investing in it.

Dont stick to one company or stock; remember we have thousands of

companies to invest in.

Always have a portfolio which will not only promise higher returns but
will also diversify the risk.

Dont be afraid to invest in unpopular companies.

Invest only after exhaustive research into companies.

Dont just worry about the returns but look the company itself and the
business it is in.

Do not panic if stocks goes down it is only a matter of time before the
companys stock would rise and if it doesnt happen right away, it
would happen in the near future.

Follow the systematic investment plan and do not invest in stocks

randomly.

Have thorough information about the movement of the stock prices.

Measure the performance of portfolio.

Review your portfolio periodically.

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

5.4 Policy Implication and Scope for Further Study:

Since the Sharpe ratio is used to characterize how well the return of an asset
compensates the investor for the risk taken, the higher the Sharpe ratio better
is the performance. Sharpe ratio is now used in many different contexts, from
performance attribution to tests of market efficiency to manage risk. The ratio
can be used to know how much additional return the investor receives for the
additional volatility of holding the risky asset over a risk-free Asset. Future
study can be done using different model like Treynor index model, Jenson
Index Model.
The portfolio can also be constructed using Technical analysis tool such as
knowing the indicators like ROC and RSI. The investors can also create
portfolio by understanding the charts and diagrams like Candle stick
approach, Bollinger charts etc. The investor can also perform trend analysis in
detail to know the stock price movements in future. Thus there are varies ways
to create portfolio which the investors can innovate and perform extensive
research over it.

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

REFERENCES

City college, Bangalore.

Constructing an optimum portfolio using sharpe single index model

System of Referencing:
Books:
Prasanna Chandra (2008) Financial Management theory and
Practices for edition, Tata McGraw Hill Companies.
Roger F Murray and Frank E. Block (2002) Security Analysis fifth
edition, Tata McGraw-Hill Companies.
Frank K. Reilly and Keith C. Brown (2003) Investment Analysis and
Portfolio Management seventh edition, Thomson South-Western Press.
Journals:
International Journal of Advancements in Computing Technology (2011),
Optimizing Portfolio Construction using Artificial Intelligence.
International Research Journal of Finance and Economics (2009), The
Process of stock Portfolio Construction with Respect to the Relationship
between Index, Return and Risk.
News Papers & Magazine:
Investment and Pension Europe Magazine (2010): Portfolio Construction:
Broaden your horizons.
Websites:
Money control, stock prices viewed on 5/2/2013, in the money control
website, http://www.moneycontrol.com/india/stockpricequote
Bombay stock exchange, about Sensex, viewed on 6/2/2013, in BSE
website
http://www.bseindia.com/about/abindices
Economy watch, Banking Industry, viewed on 6/2/2013, in Economics
watch website http://www.economywatch.com/banking
Indian Steel, steel industry of India, viewed on 7/2/2013, website,
http://www.indiastelexpo.in/IndustryOverview.php
Automobile Industry, Automobile Industry of India, viewed on
7/2/2013, website, http://www.automobileindustryindia.com

City college, Bangalore.