Page 285 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes R = 15, R = 12
x m
(R R m ) 2 706
2 = m = = 78.44
m
n 1 9
(R x x R ) (R m R m ) 357
Cov = = = 39.67
n 1 9
Cov 39.67
= xm = = 0.506
2 78.44
m
2. Y = 15 x = 12

Y = + x
15 = + (0.506 × 12)

= 15 – (0.506 × 12) = 8.928%
Characteristic Line for Security X = + ( × R )
m
Where R = Expected return on market index
m
Characteristic Line for Security X = 8.928 + 0.506 R
m
Alpha Coefficient

The alpha coefficient ( ) gives the vertical intercept point of the regression line. In a perfect
world, the alpha for an individual stock should be zero and the regression line should go
through the graph’s origin where the horizontal and vertical axis crosses.

If the alpha was positive, the opposite equilibrium process would occur; investors would rush to
buy the security which causes the price of the security to rise and the expected rate on it to fall.

Beta Coefficient

The risk of an individual security can be estimated under CAPM model. The market related risk,
which is also called ‘systematic risk,’ is unavoidable even by diversification of the portfolio. The
systematic risk of an individual security is measured in terms of its sensitivity to market
movements which is referred to as security’s beta. Investors can avoid or eliminate the
unsystematic risk by investing funds in wide range of securities and by having well diversified
portfolio. Beta coefficient is a measure of the volatility of stock price in relation to movement in
stock index of the market; therefore, beta is the index of systematic risk.
Cov Cor Cor
= im = i m im = i m im
I 2
Var
m m m
Where,
= Beta of individual security
I
Cov = Covariance of returns of individual security with market
im
portfolio
Var = Variance of returns of market portfolio ( 3 )
m m
Cov = Correlation coefficient between the returns of individual
im
security and the market portfolio

280 LOVELY PROFESSIONAL UNIVERSITY