REVIEW OF LITERATURE

A study on CAPM by Valeed. A. Ansari (2000) Capital Asset Pricing Model: Should We Stop Using It reviews the content and scope of the model and examines the issues in the controversy and provides an empirical assessment of the model in India. The debate centres on whether the factors can possibly represent economically relevant aggregate risk. The study also reveals that the evidence is not sufficient to drop the use of CAPM. It also suggests the use of CAPM after understanding the limitations.

Manjunatha .T, Mallikarjunappa .T, and Mustiary Begum (2007) in their study entitled Does Capital Asset Pricing Model Hold in the Indian Market ? test the intercept and the slope for the standard form of CAPM. The study was based on the BSE sensex companies that were part of the index from the beginning 3 January, 2000 to 31 December, 2003. The results of the study indicated that the intercept was significantly different from risk free rate of returns and the slope was not equal to the difference between the market returns and risk free rate returns. Therefore, both the intercept and slope test indicated that the CAPM did not hold in the Indian context. The result also showed that there was inverse relationship between the portfolio returns and their betas. Further, low beta portfolios had yielded higher returns than the high beta portfolios. One of the reasons for this inverse relationship between returns and betas were the short period considered for the study.

Craig W. French (2003) in his article. Treynor Capital Asset Pricing Model, observes that the innovation of Treynors CAPM has not enjoyed the public support. This paper also investigated the assertion and concluded that, like so many of Fisher Blacks other beliefs, it seems to be accurate.

Manjunatha . T, Mallikarjunappa . T and Mustiary Begum. (2007) in their study Capital Asset Pricing Model: Beta and Size Tests test on intercept, beta and size coefficients for sample companies. The study was based on the BSE Sensex companies that were part of the index form the beginning upto 30th June 2005. The result of the study showed
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that the intercept was not significantly different from zero and neither beta nor size explains variation in portfolio returns. They concluded that the intercept of the CAPM was equal to the risk free rate of returns but to beta and size factors did not explain the portfolio returns in Indian Market. The exception was market value weighted portfolio returns were used. In this case beta explained the portfolio returns.

Dhankar and Kumar (2007) in their CAPM in Indian stock market considered monthly returns of composite portfolio of 100 stocks of BSE 100 for the period from June 1996 to May 2005. It involved testing of relationship between risk and return of 100 companies stocks, and a set of ten portfolios. The findings are in favour of the model and assert a positive and linear relationship between risk and returns the study also reported that as diversification was carried out, non-market risk considerably declined. These findings support the CAPM in Indian stock market in establishing trade-off between risk and returns.

Tamal Datta Chaudhuri (2008) in his paper entitled A Structural Approach to Stock Market Returns, Risk- Free Rate, and CAPM developed a structural model, which showed market returns and the risk- free rate were interdependent. It builds in macroeconomic and other structural features of an economy, which were referred to quite frequently as affecting the share price movements. This interdependence was estimated. Monthly data from March 2001 to January 2007 was taken for the analysis. The study suggested that instead of using exogenous values of stock returns and the risk free rate for deriving the desired rate of returns for individual stocks as per Capital Asset Pricing Model, one should use the estimated values of these variables from the reduced from equations derived from the model.

Manjunatha, T and Mallikarjunappa .T (2006) in their paper An Empirical Testing of Risk Factors in the Returns on Indian Capital Market test on CAPM intercept, beta and a number of risk factors. The study also tests intercept, beta, size, book to market equity ratio, earnings to price ratio and excess market returns factors for sample companies. The results of the study showed that, intercept was not significantly different from zero and neither the beta nor other risk factors explained variation in portfolio returns. They concluded that the intercept of the CAPM was equal to the risk free rate of returns.
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The above literature provided an overview of different valuation models associated with risk and returns of equity.

STATEMENT OF THE PROBLEM The CAPM helps to find out the exerted return on securities. And it also predicts the relationship between risk & returns on securities. There were a lot of studies that assessed this model and the result showed not to drop the use of CAPM. These studies are in favor of the model and assert a positive and linear relationship between risk & returns. These studies also a report that as diversification was carried out, non-market risk considerably declined. These finding supports that CAPM in Indian stock market in establishing trade-off between risk & returns. The earlier studies did not make an approach to analyze application of CAPM in sector index in the Indian capital market. An attempt has been made in this study to evaluate risk & return relationship using CAPM model. Hence this study mainly a instant covering sample stocks of NSE ( IT ) Index. NEED OF THE STUDY Over the decades, the CAPM is tested in its various forms in the world markets whether it is favorable or not favorable. In India there have been major changes in economic and financial policies. Today the different corporations are taking their financing & investment decisions in a different environment. Hence the present study makes an attempt to test the application of CAPM in IT index of NSE.

OBJECTIVES OF THE STUDY 1) To study the relationship between securities return and market returns. 2) To test the validity of the CAPM in the NSE information technology index. 3) To summarize the finding, suggestion and conclusion of the study.

HYPOTHESIS OF THE STUDY

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HO1 :- There is no relationship between the securities return & Market return. HO2:- The(intercept) Alpha in the CAPM is not equal to zero. METHODOLOGY OF THE STUDY: SAMPLE DESIGN To test the relation between risk & return in the Indian capital market, NSE IT index was taken for this study. There are 20 companies listed in NSE IT index. Before selecting the sample, the availability of daily adjusted closing share price and NSE IT index was taken into account. Only 10 companies out of 20 have fulfilled the above said criteria. The name of the sample companies are given in Table-1.1 Table-1.1 Name of the Sample Companies SI.No 1 2 3 4 5 6 7 8 9 10 Name of the Sample Companies Tata Consultancy Services Ltd. Infosys Technologies Ltd. Wipro Ltd. H C L Technologies Ltd. Oracle Financial Services Software Ltd. Mphasis Ltd. Tech Mahindra Ltd. Patni Computer Systems Ltd. Financial Technologies (India) Ltd. Educomp Solutions Ltd.

SOURCES OF DATA The daily closing share price of the sample companies and IT index were taken from PROWESS Corporate Data Base. The other relevant information for this study was obtained from various books, tools & websites.

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PERIOD OF THE STUDY For the purpose of analyzing the risk and return relationship of sample companies listed in NSE IT index, a study period covers from January 2006 to December 2010.

TOOLS USED FOR THE STUDY The CAPM consists of the time series regression for each security. The tools used for the study are as follow:

a) DAILY RETURNS The daily returns of the security are calculated as : Ri = (Pt Pt-1 ) / Pt-1 Where, Ri Pi Pt-1 = =
=

Returns on securities I Closing share price of securities I for the timet Closing share price of securities I for the timet-1

Where Rit is the returns on securities I, Pit is the closing price of securities I, for the time t and pit-1 is the closing price of securities I, for time t-1.

b) MEAN Mean is the statistical representation of the typical value of a series of numbers, computed as the sum of all the numbers in the series divided by tge count of all numbers in the series. The average daily returns are calculated using the Arithmetic mean: Mean = { Xi / N } Where,
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X=represents mean =Symbol of summation Xi=Value of the ith item X, i=1,2,3,4 n N=total number of items.

c) STANDARD DEVIATION Standard Deviation is a measure of the dispersion of a set of data from its mean. The more spread for the data, higher the deviation., Standard Deviation is a representation of the risk associated with a given security. Standard Deviation is also known as historical volatility. It is calculated by S.D = { (Xi-X)2 / N } d) VARIANCE Variance is a measure of the dispersion of a set of data points around their mean value. It measures the variability from an average. It helps to determine the risk an investor might take. Variance is the square of the Standard Deviation. Variance = { (Xi-X)2 / N-1 } e) BETA (SYSTEMATIC RISK) Beta measures the systematic rick compared to the market or benchmark index. It is the tendency of a securitys returns to respond to swings in the market. A beta of 1 indicates that the securitys price will move with the market. A beta value less than 1 means that the security will be less volatile than the market. A beta value greater than 1 indicates that the securitys price will be more volatile than the market. It is calculated as: = {nXY(X)(Y) / nX2-(X)2} Where, XY measures the product of market and stock return. X Measures the market returns and Y Measures the security returns
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n represent number of sample companies

f) ALPHA Alpha is a measure of performance on a risk adjusted basis. Alpha takes the volatility (price risk)of the security and compares its rick adjusted performance to a benchmark index. The excess returns of the security relative to the returns of the benchmark index are a securitys Alpha. A positive alpha of 1.0 mean that the security has outperformed its benchmark index by 1% . Correspondingly, a similar negative alpha would indicate an under performance, = Y X Where, X Is the markets returns and represents beta of the security. Y represents security returns.

g) CAPM (CAPITAL ASSET PRICING MODEL) CAPM has been widely accepted as the most appropriate technique of evaluating the expected return. The CAPM is an equilibrium model that explains the excess return form market return and risk free rate.

Where,

is the expected return on the capital asset is the risk-free rate of interest such as interest arising from government

bonds

(the beta) is the sensitivity of the expected excess asset returns to the

expected excess market returns, or also

,
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is the expected return of the market is sometimes known as the market premium or risk

premium (the difference between the expected market rate of return and the riskfree rate of return). h) RISK FREE RATE (RF) The 91 days t-bill rates are taken as a risk free rates, which are taken from the year 2006 to 2010 is 6.09% LIMITATIONS OF THE STUDY
1) The study is based only on secondary data. 2) The sample consists only of selected NSE IT Index. 3) The study period is restricted to 5 years.

CHAPTER SCHEME Chapter I: Chapter II: Introduction. Review Of literature, statement of the problem, need of the study,

objective of the study, Hypothesis of the study, methodology of the study, tools & limitation of the study. Chapter III: Chapter IV: Analysis of risk & return relationship of NSE IT Index companies. Finding, suggestion & conclusion.

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