Comparative Study of Risk and Returns of Bse-200 Stocks

Topics: Weighted average cost of capital, Stock, Stock market Pages: 7 (2285 words) Published: February 20, 2011
Comparative study of risk and returns of BSE-200 stocks

Kapil Malhotra

Objective of the Analysis:
The objective of my study is to understand the need to analyse the movement of the market and fulfilling them so as to achieve my goal of becoming better investor/ trader. Profit and loss are the two inseparable features of the stock market. But losses can be minimized and profits can be increased with the help of Technicals. I have done the analysis on the basis of the daily closing prices of the 50 Stocks of BSE-200 as a reference. For the purpose of analysis, I have used various parameters such as mean of the stocks, Standard Deviation, Beta and Cost of Equity.

Here, the daily trend is judged from the closing index of the day. Here we don't have to see the intraday trend or the weekly trend. Whenever the trend changes, take the Index future (or short as the case may be) and take at least 7 trades of it continuously. Index mentioned here refers to the BSE-200 index.  The Trend refers to the daily trend of the stock and not intraday but one may trade intraday based on it. There are two ways of using the information attached. If you are a slightly longer term investor, you may go on holding the stock in long if trend is up or you may go on holding the stock in short position if trend is down. If you are a short term trader you may use the information and play for small moves.

1. Computed the daily market return (BSE 200) from August 11, 2010 to October 20, 20101 taking preceding daily return as the base. 2. Calculated the average market return during the period and the standard deviation for the same. 3. Calculated the covariance between the market and respective companies return and the Beta values for the respective companies using: Betaj=cov(rj,,rm )/Var(rm )

rj measures the rate of return of the company ‘j’,
rm measures the rate of return of the market (BSE200),
and cov(rj,rm) is the covariance between the rates of return, Var(rm) is the variance of the market return.
Beta value of a company’s share gives the idea about variation of a company’s return with respect to market return. A value greater than 1 shows a higher return than market and vice-versa. A higher beta value reflects higher risk and higher expected value of return. This value is also calculated using the regression technique, the value obtained is nearly close to the calculated value. 4. Calculating Cost of Capital of the companies using CAPM Ke = Rf + β(Rm-Rf)

taking risk free return=8.13% and market return=48.41 %( i.e., the last quarter return of the market). Cost of debt : The interest rate a company is paying on all of its debt, such as loans and bonds. A company will use various bonds, loans and other forms of debt, so this measure is useful for giving an idea as to the overall rate being paid by the company to use debt financing. The measure can also give investors an idea as to the riskiness of the company compared to others, because riskier companies generally have a higher cost of debt.

Cost of Debt = (I + (M-NP)/n) / (M + NP) / 2

I = Dollar Return 
M = Maturity Value
NP = Net Proceeds of issue
n = years
5. Weighted average cost of capital :

A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.

The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing: 

Re = cost of equity 
Rd = cost of debt 
E = market value of the firm's equity 
D = market value of the firm's debt 
V = E + D 
E/V = percentage of financing that is equity ...
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