CIIAPTER I

INTRODUCTION AND METIIODOLOGY

An investment IS a con i~n~ t~nen t of funds ~nade 111 expectation of soliie

positive rate of return ' Investors sacrifice current consu~nptio~i in the Iiopt.

of attaining increased future consumption They invest their savings in one

form or other to get h~gher return in future

The rate of return varies fro111 one for111 of Ilirestlnerlt to tlie ot11i.r

depend~ng 011 tlie degree of r ~ s k ~nvolved In ~t That is, w ~ t h liigli rleprce 111

risk the ~nvestor's expected return is more and vlce versa However tlic

choice of investment depends on the investors' risk preference Tlie

~n\,est~nent objective is to select assets which have the maximum expected

return In t he~ r r ~ s k class, otherwise stated, the object~ve is to nlaxuillst. tlie

~nvestor's cxpecled wealtli at some preferred l e ~ s l of risk "very invest~nrnt

~ n e d ~ u m 1s subject to varled magn~tude of risk and ~ t s return expectat~o~i are

contingent to the r ~ s k perceptton of the investors Thus the rtsk and return are

so Inextricably ~nterwined that they can be regarded as two s ~ d e s of [lie s:liile

COlll.

'Frsl~er E Doriald and Jordan J Ronald. Secur.rf\' A~rtrlj.\~.\ rrtrd Pvrrfolro A.la~~nget~re~lr, Prent~ce Hall INC , New Jersey, 1987 1, 2

'Francis J Clarke. Itivesfniet~r Annijsls o ~ r d Motrt~ge~iletrr. McCraw Hill Int Ed~tion New York 1986 p 5

L

The baslc postulate underlying modern finance theory 1s tl~at assets

with same rlsk should have same expected return Therefore I I I C prlces o f

assets In tlle capital market should adjust until equ~valent rlsk assets havr

ident~cal expected return. Investor's perception of riskiness of an invest~l~e~rt

and the returns that are l~kely to be generated from such investlnents, the

certain~ty or otherwise of the return are the important factors that go into the

valuation of an investlnent A~nong the various Investlnents, Investlnent 111

equlty shares occupies an unlque place as ~t 1s expected to y~eld higher tl1;111

otlier Investments

The security ~narket, provid~ng f a ~ r prlces and free and actlvr ~ l ~ i ~ r k c t

10 d~verse s ecu r~ t~es to s u ~ t the varylng nutlon and wl11111s or a \'as1 III;IS\ of

savers about l i qu~d~ ty protitabiliry and r ~ s k elelllent I I I tlie~r I I I V C S ~ I ~ ~ C I I I . pl.~y

a v~ta l role In channel~sing savlrigs Into 111os1 pruducl~ve clla~l~lel ol

~nvest~nent. ' ESlicient security pr~cing therefore, l a ~ ~ t a i n o u ~ ~ t s to eflic~etlt

allocat~on of economlc resources which 1s good f'ur orderly econwnlc

developli~ent and for every body for that niatter If tllr securities ; I IC

efficiently priced Investors would obtain just return on tlleir irivest~nerits. cost

of funds would be just and no one make abnornial prolit '

'Srlvastava R M , Esser~r~alsoJBus~ness Finance, Himalaya P u b l ~ s l ~ i ~ ~ p House, Bombay 1985, p 332.

'Yalaguresh B Yalawar "Rate of Return and E f f i c ~ e ~ ~ c y of bollihey Stock Excllange" In Stock Market Eflciency and Price Beltavruirr~ Tltp 11rdi011 Experience Ed. by 0 P Gupta Anlnol Publ~cation 1989 p 192

3

The vital funct~on o f capital market III Ilia nod ern econonly

underscores the rlnportance o f flow o f fund I n w h ~ c l ~ the deliland for citp~tal

funds, developed by business enterprises would be lnet by supply o f f ~ ~ n d s

~ n o b ~ l ~ s e d through savings However the security ~narket can perforni its

funct~on only i f i t is able to build-up the ~nvestor's confidence by ensuring

that return from an Investment opportunrty coniniensurate to r ~ s k assoc~atctl

w ~ t h ~t The securlty is sad to be falrly p r~ced ~f an Illvestor can expect

appropriate return for assum~ng r ~ s k

In llirs per~od o f econolnlc l~beral isat~on i t lias beconie all-llir-1110re

relevant to study security prlclng In accordance to their ~nllerent r ~ s k and the

cf f ic~ency w ~ t h wh~ch securlty market perforni 1111s funct~on

O r ~ e o f the central Issue In tlie theory of firlarice 1s the r e l ; ~ t ~ n r ~ s l ~ ~ p

between expected rlsk and return conjunction encompasses sclent~fic anatonly

o f belleves that hlstory o f share prlces contalri i n Itsel securlty prlce be l i av l o l~~

Technical analys~s strongly patterns arid glve the clue to the iuture. i e tlie

study o f past returns can help investors to assess future return Ef f i c~e l i t

Market Hqpotlies~s r~npllaslses on requ~red by rnd~v~duals Inveshng 111 assets "

The core o f the rlsk retilrli unpred~ctab~l~ty o f securlty returns W l l z r r ; ~ ~

'Paul M Van Arsdell, Corporatrotl Fulatlce, The Ronald Press Co Ltd.. New York 1986 p 887

'Turnball Stuart. "Market Value and Systeniat~c R ~ s k " . J v r r ~ ~ r n l r)/ Flr~ance, September 1977 p 1125.

4

fundacnental analysls asserts that the share prlce 1s an oif-stloot of the

lnteractlon of fundamental factors that influence the ~nvestor's r ~ s k perceptloll

Whatever may be the type of analysis,the bas~c quest~ons arise before

lnahng Investlilent In security are.-

- How IS tlie prlce of the securlty fixed In the ~narkct?

- Why there is w ~ d e varlatlon in the prices of securltles of different l i r~~ i s "

- Does past prlceireturn ~nfluence the presentiluture prlceireturn"

- Whether the Intrinsic value of the firm Influence the share price"

In the attempt to answer tliese questions d~ffererrt tlieorles have c(1111e

out with d~fferent postulates about the bellavrour of share prlces

Statenlent of the Probleni

It 1s a well documented ('act that investment In equ~ty sllilrcs ( I C L L I I I I C S

all Important place In the cap~tal market as 11 IS expected to y~cld li~glrer rate

of return when compared to other for111 of Invesllnents However the nlarket

prlce of thc securlty 1s subject to Iilgli degree of fluctuat~ons The predlcuoll

ul' llic future prlces of shares is itnporlant for investors to reap Inore l~e~ie l i l \

from tl ie~r investnients The Guvernnient a l~d the soclety also evlnce kcrri

interest 111 the behav~our of share pr~ces and function~ng of cap~tal finarkel :IS

it acts as the lndlcator of econolnlc growth and developnient As a11

econo~nic paralneter, its active role has become irnperat~ve to the ador)t1(111 01

pollc~es tuned towards the efficient function~ng of market ecollomy Tlie

coniplex~ties assoc~ated w ~ t h the prlclng of shares and effic~erit I U I I ~ I I ~ I I I I I ~ (11

cap~tal lriarket opens up the l l~quis l t lo~~ to make enquiry Into 11s be l~av~our .

which 1s of great Importance to polley makers. acade~lllc~ans, players $11

t inanc~ng ~nter~ned~at ion and the investing publlc.

Hence the present study makes an attelrlpt 111 the s;t~d d11cct1011 10

study the ratlor~ale assoelated w ~ t h security prlclng, the beliavlot~r of recur^^,

the extent lo w h ~ c l ~ tlie return cotnmensurate rlsk as well as the factors tI121t

affect r ~ s k An attelnpt also has been made to study the Investors perceptlol1

of r ~ s k .

Need for the Study

From tlie revlew of existrng stud~es'dearth of works 111 l~itilali context

to test the effic~ency of cap~tal market 1s qulte expl~c~c. Besides. the

Ilnportant areas where lnd~an researchers have not co~lcrlltrated lnuch are tllr

relat~onshlp of rlsk and return and the factors af'fect~np r ~ s k of a firm Thc

present study focusses on the behaviour of returns. ~ t s relatlo~ish~p w1t11 rlsk

which ~nc~dentally throws l~ght on the efficiency and behavloi~r of equ~ty

rnarket In respect of prlclng ~nechanlsm. In a d d ~ t ~ o n the present study I I ~ I : ,

atte~npted to make a primary ~nvest~gation lnto the investors perception of r ~ s k

wh~ch no study has probed as far as the researchers knowledge goes

7Baru;r Samir K, Raghunathan V. Verlna J K, "Research 111 C;ip~t:~l Market - A rev~ew", V~kolpa. Vo1.91 No. 1 J~II-Marcli 1994 pj) 15-20

(3

Objective of the Study

The focus of the present them is to examine the behavlour of returns

on equlty shares and the r ~ s k associated with the returns. Inc~de~~tally 11 alllls

at evaluating the parlty between risk and return in determining the equil~br~ulli

level in the prlces In lnd~an cap~tal market The study also trlzd lo zxplol-r

the factors affectrr~g r ~ s k The man emphasis is on exploring dltlerent r~sk

variables and observing thelr tie-up w~th requlred rate of return on eqully

shares in India, assulnlng the ex-post return ~nforrnat~un works as surc~galate

for ex-ante prediction of securlty return More spec~fically ~t IS co~ l i l~~~ l t ed

to lnvestlgate the assoc~ation between equlty returns and varlous rlsk ~r~casurc\

l ~ k e distributional var~ables, market factor and corporate funtla~~~entals

Incidentally the study also aims to make observation wltl~ regard to return

regillar~ty associated w~th equity shares where the r a t ~ d o ~ ~ ~ ~ l e s s or <1111erw1sc

of securlty return IS studled

The study also has trled to make a prel~ln~~lary etlqu~ry on the

perception of risk of different tylxs of Investors

Research Questiolis

In order to fulfil the aforesaid objectives the study has attempted tu

provlde answers to the following questions by making use of Indian share

price data.

I Do periodic returns on equ~ty shares are Independent of each otlier or

random In nature?

7

2 Does d~vers~f icat ion reduce the r~sk'?

3 . If d~vers~ l ica t~on reduce the risk, to what extent tile portto110 can be

diversified'?

4. D o market risk (established by CAPM) explalns the relat~ve difference 111

the share prlces In I n d ~ a and ~f yes how far'!

5 . D o distr~but~orial varrables viz standard deviat~on o f returns. tluril an11

fourth rnoment and market covariance have any relat~onship w ~ t h rate ot

return on equlty shares?

6 D o financial variables i e corporate funda~rientals are d~scounted In tile

securlty n~arket to enable the share returns to represent in t r~nb~c valuc"

7. What are the s~gnificant factors that deterln~ne the r ~ s k o f a ~ol l lpany' \

security? .

8. How do different inivestors percelve risk?

9. How far risk perception d~ f fe r between ind~vrdual and ~ n s t ~ t i ~ t ~ o n a l

~nvestors"

H y p o t l ~ r *

Based on the above sa~d objectrves the fol low~ng hypotheses have

been tested.

H , - The returns on equity shares are independent o f each other

H, - Risk reduces by d~versificatron and return is Ilnearly related to r ~ s k

H, - Distribut~onal,tnarket and financral var~ables are relevant to tlic

determinat~on o f rate o f re turn on equltles.

H, - Select financial var~ables perceived by the researcher deterii l~~ie risk

of an equlty share to a major extent

H, - The risk perception of ind~vidual equlty sliare holders differs fruni

that of irist~tut~onal sliare holders

Methodology

The sample drawn for the present study were rroni act~vely traded

shares only, as for cross sectional regression availab~lity of regular and

continuous data is a must The most restrlctlve factor in determining tlie s ~ z e

and composit~on of the sample was avallab~l~ty of regular prlce quotalloils

Considering the avallab~lity of continuous and coinplete data 71 act~vely

traded stocks belonging to different industry class~tications from Bonibay

Stock Exchange Official Directory were cons~dered durlrig tlie per~od I975

to 1992. Mo~itlietid prices were put to use for tli~s work To asless tlic

explanatory power of corporate fundamentals 18 years li~iaiicial stateliierits

were c~l lec ted In all 9 finaiic~al ratios from 23 were cons~dered as

explanatory variables The selection of 9 represeritative var~ables were hiised

on p r~nc~pa l component analys~s The ratlo having the hrghest corrcl;it1<111

with the principal component was considered tlie best rcpresentatlve of group

of similar ratios A sample of 100 investors was contacted icdopt~ng

convenient sa~rlpllng method to elicit information pertalnliig to tI1c11

perception of risk

9

Source of Data

The present study IS a blend of prlmary and secondary data Data

relatlng to company fundamentals, their monthend prices, dlvldend, bonus

share infor~nat~ons etc were collected from Bombay Stock Exchange

Directory Bombay sensitive Index ~nfor~nation were collected fro111 data

publ:shed by Bombay Stock Exchange foundation. To u~ldzrlta~ld ~n~ t . s to r ' \

perceptton, a deta~led quest~onnaire was adln~rl~stered on a cross sectlotl of

Investors both lnd~vidual and ~nst~tut~onal. Besides, fund managers. t~ank

offic~als, stock brokers, and officials of Madras and Dclh~ stock exclla~~ge

were contacted personally to have first hand ~niormatlon about the tllattcr

under study.

Period of Study

The entlre analys~s was carr~ed out for a period of 10 years I t. 1ro111

1981 to 1990. Thouglr the data were collected from 1975 to 1992 the actuill

observat~o~: was confined to 10 years only Data relating to tllr lirst S I X

years were used to construct d~tierent f i~~anc~a l growl11 rates such 21s growtl~

III sales. growth ~n assets. earnings, d~v~dends etc However the <IIII;I

pertaining to 1991 and 1992 could not be used as the result were gettltlg

distorted In the tllne serles analys~s because of the erratlc share prlce

behaviour caused due to a series of inc~dents like securlty scam. Bo~llhay

bomb blast, earth quakes, Ayodhya issue etc. It is however assumed that for

a behavioural study l ~ k e thls 10 years per~od IS suffic~ent The per~od was

also cons~dered adequate to identlfy those consistent r~sk factors whrch

interact with securlty returns.

Statistical Tech~l iques Used

Several pardlnetrlc iuld n o ~ ~ - p a r a ~ ~ ~ e l r ~ c s l ~ ~ l ~ r t ~ c a l tools were used lor

the analysls of the study. They are s~mple regresslon ~ n u l t ~ p l e regressxon.

pr~nctpal component analys~s, chi-square test, run test and ser~al c o r r e l a t ~ o ~ ~

or auto correlat~on and such alike.

Sinlple Regression

Simple regresslon glves the Ilnear relat~onshlp between e x p l a ~ ~ ~ e d and

explanatory var~able. The vlrtue of h e a r relat~onsh~p 1s s ~ n ~ p l e \)ut qulte

robust. I n this study for extracting the relative ~nfluenct. or 111arkct 1-t~ctor ~ I I

secur~ty return tlus tool Ilas been used. The regress~o~~ Illterccpt (X) 15

supposed not to be s~gn~f icant ly dlfrerent from zero and the slope c o c l l i c ~ s ~ ~ t

(0) ~ n ~ p l y i n g the degree of assoclatloll between varlables Tllc SI~IIII~L~IIILC

of coeffic~ents were tested by 't ' ratlo and overall explanatory power was

measured through R2 value

Mu l t i p l e Regression

I t 1s a regress~onal analysls cond~t~onal upon lixed values ol the

explanatory variables and what IS oblalned 1s the average or Illenn value o f Y ,

a mean response o f Y for fixed value o f X variables. The rnult~ple r eg ress~o~~

analysis was used for estimat~ng the relat~onsh~p between the share returus

and d~fferent d~str~but lonal market and financial varlables as well as to

deter~n~ne the explanatory power o f seven financial variables o n systelnatlc

rlsk (Beta). The data was nia~nly analysed on the basls o f coef l i i~cnt ot

~nult lp le deter~n~nat~on (R2) wl i~ch was found I n every regresslon c q t ~ a t ~ o ~ ~

Principal Component Analysis

It IS generally performed to simplify the description of a set of

interrelated var~ables It can be surnmar~sed as a method of transfor~~ilnp the

original variables into new uncorrelated var~ables The new var~ables are

called principal components. The company funda~nentals considered were 23

in number. Which were segregated into 9 categories based on t l ~ e i ~

theoretical s ~ ~ n i l a r ~ t y . The representative of a particular category was choseti

on the basls of the h~ghest correlation w1t11 the pr~ncipal colnponent fro111 eil~ll

group of ratlos which were later considered as ~ndependent varlahles I I I the

multrple regressions

Subset Regression

T h ~ s techn~que enables d detalled exalnlnatlon of regressiun ~nodels

It prov~des all posslble subset variables where from the regresslor) equations

that can show i~nprove~nent In the explanatory power can be considerrd

Different subset regression equations were selected by using the rule of tl1u1111)

applicable to subset regressions.

Chi-Square Analysis

T h ~ s technique enables to test the d~fference between expected arid

observed frequencies. Tlils techn~que has been used for the a~la lys~s to

exalnlne whether there exlst any s~gnlficant d ~ f f e r e n ~ e In the perceptlolls ~ 1 1

inst~tut~onal and indlvrdual Investors

12

R u n Test

T o test randomness In a serles o f numbers run lest IS used. I t IS a

non-parametric test. T h ~ s e x h ~ b ~ t whether the relationsh~p betweell successive

numbers 1s random or not T o test the randomness In the share returns run

test had been appl~ed. T o test the ~ndepender~ce o f returns i n the serles ut

returns the number o f runs were calci~lated In the serles and tested whether

they were s~gn~ficantly d~fferent from the number of runs i n a purely rando111

serles o f same slze.

Auto Correlation

Auto correlal~un otherw~se called ser~al correlat~ur~ relcr l o 1I1e

correlat~on cwf f ic~ent between a serles o f number w ~ t h lagg~ng nu~nbrrs o11

the same tlnie serles. The ser.al correlat~on analysis had to be carr~ed out

to detect the trend i n security returns The ser~al correlation were calcula~e~l

w ~ t h 24 lags to detect the relat~onship o f return with successive returns up 111

24 lags there by ~nd icat~ng dependence or independence

Data Analysis

The analysls In undertaken In four phases I n the lirst phase the

behav~our o f return as well as risk 1s studled. For the purpose o f study~ng

return and testlng the random walk behaviour or otherw~se the ser~al

correlat~on analys~s and n ln test were adopted. Ser~al correlat~on analys~s

assumes the existence o f a statistical distribut~on where in the lags had bee11

13

carried out up to 24 in serlal order. The auto correlat~on coeffic~ent Ineasurr:

the degree and dlrectlon of relatlonsh~p of two returns I r l the series of

returns. The coefficient l ~ e s between + 1 to -1 ind~cat~ng posltivr nrgatlve

or zero correlation A zero correlation indicates absence of any pattern The

auto correlation coefficient of the data are said to be significant wlie~i they

are more than 2 standard error at 5% level of significance and 3 starldt~rd

error at I % level of slgn~ficance. When auto correlauon coeflic~ents iirr

significant ~t lnd~cates returns depend on 11s preceding return Tllus future

return can be easlly predicted. In the light of ~t the data of returns had heen

analysed for thew dependence or otherw~se by 24 lags

The auto correlatlon coeffic~ent can be calculatrd lor t i 1 1 1 ~ lag K IS

Where r, = auto correlation corftic~ent

k = the length of time lag.

n = number of observation.

X, = value of the var~able at tltne t

14

To substantiate the results of auto correlat~on and to es tabl~s l~ tile

behav~our of returns a non-parametric test also was ad~i i~n~stered by the hell)

of run test. Run test is simply a sequence of ident~cal observat~ons Hav~ng

observed a sequence of observat~on of which n, are one kind and 11, are ol the

other I n d , the randomness can be tested by countlng the nu~nher of runs

The test is performed by comparing the actual number of runs (R) w ~ t l ~ l l l i ~ t

of expected nu~liber of runs (M) on tlie assull1ptloli that successive retulns

are ~ndependent of each other If the observed runs are not s ~ g ~ ~ ~ l i c a ~ ~ t l q

d~fferent than that of expected runs (M) than 11 IS ~nlkrred. tile successive

returns are independent. The degree of randomness present In the data IS

studied with the help of K value K value is notli~ng but tile d ~ l f e r e n ~ e

between observed and expected rums In terllls of expected runs

The formula used to find K value 1s

R - M K =

M

Where R = Observed nurnber of runs

M = expected number of runs.

The expected number of runs are calculated by the forniula

15

and, Standard dev~at~on o f the sampllng d~stnbution o f expected nuluber o l

runs 1s

Where

M R = Mean o f sampl~ng d~str~but lon o f nuliiber o f runs

OR = Standard error o f sampling d~s t r~bu t~on

n, = riu~nber o f observat~ons o f one klrid

n2 = number o f observat~on o f other klnd

The standard nor~nal varlate can be calculated w ~ t h the lor11iul:i

R - MR Standard Normal Varlate Z = ---------

OR

Observed number o f ruris - Expected nu~iiber ol rurir I.e., Z =

Standard Deviat~on o f Su~n

'The co~nputed value o f Z can be co~i~pared w ~ t h tlie standard or

c r ~ t ~ c a l value o f Z obtalned from the table o f standard nornial d ~ s t r ~ b u t l o ~ i for

the level o f s~gn~ficance The sequence IS sad to be r a ~ i d o ~ n IT the Z value

1s less than the table value at a particular level o f sigri~lica~ice

Tlus test is e~nployed not only for testing wl~cther tliz results

corroborate with that o f serial correlation result but also to dlscovzr t l ~c

presence o f occas~onal non-random changes In returns.

Behav~our of r~ sk IS studled by observ~ng the changes 111 r ~ s k :IS

measured by standard dev~atron by ~nalung add~ttons to tile portfolrr~. selcct~ng

scrlps at rand0111 However to exarntne the relat~onsh~p that portfol~o stal~d;ird

d e v ~ a t ~ o n decreases to an asymptote as dlvers~ficat~on increases a Illtear

regresslon analys~s was performed by fitt~ng a least square regressloll

function. Y = p ( l / X ) + A

Where.

Y = Computed mean portfol~o standard d e v ~ a t ~ o ~ l at eac l~ level ot X

X = Porlfol~o size

Furtller to determ~ne the ~narket rlsk (beta) of each ~ r ~ d ~ v ~ d u i ~ l sccurlly

t ~ t ~ ~ e s e r~es regresslon analys~s was adopted. Towards Ihts e~ldeavour the

return relattng to all selected scrlps were regressed ~ndrpcndc~ttly w1l11 ~nitrkct

Index to ascertain co~npanyw~se beta and 11s explanatory power on security

return.

The est~mated character~st~c lines

Rl = a + OR,,,, + e,

Where.

R, = Return on ind~vidual scrlp calculated

reno nor L. Jack, "How to Rate Managelllent of I nves t~~~en l Funds". Harvard Business Review, Jan-Feb 1965, pp 63-75

17

R, = Return on market Index calculated s~rnilar to return as above

a = Regress~on Intercept

0 = Slope cwf f ic~ent lnd~cat~ng market or systematic r ~ s k

e, = Error term.

T o evaluate whether the relat~onship between return and 111arket r ~ s k

IS lrnear or otherw~se linear second and th~ rd order cross sect~o~lal regresslolls

were run

The l~near regresslon form and second and th~ rd ordcr ~~OI~I~<)IIII~II fils

used In t h ~ s phase o f the study were

Y = Bo + B , X + e,

Y = B, + B , X + B2x2 + e,

Y = Bo + B , X + B 2 x 2 + B 3 x 3 + e,

I n the second phase ~~ iu l t rp le cross sect~onal regression ~~~I; I~I~II I wcre

est~mated to determ~ne the relat~onsh~p between d e p e ~ ~ d c ~ ~ t and ~ndepc~ide~l t

varrablcs Stepwrse neth hod o f regresslrlg thc depelidelit and ~ ~ i d e l > r ~ ~ r l c ~ ~ l

var~ables was also used so as to find out how Independent var~ahles

collect~vely and ~ n d ~ v ~ d u a l l y affect the dependent var~ahles

I n the thlrd phase o f analysis the study e~nployed multiple regressloll

to esti~nale determinants o f r ~ s k

The ~nult ip le regresslon equation. o f general from adopted in tllcsr

two phases (3rd and 4Ih) IS glven as

The data was ~ n a ~ n l y analysed on b a s ~ s of coeffic~ent of ~nul t~pl t .

deterlnlnat~on (R') w h ~ c h was found for every regresslor) the for111 ol

regresslon equatlon In 3rd phase w ~ t h all dependent var~ables was as tollowr

R2t-1 = X + BISDit + B2SK,t + B3KUR,t + B4h4B,t + BsdP,I + B,LOG S,t + B, LEV,[ + B8P,t + B,EV,I + B,,,AB,t +

BIIPE, t + BIZEGlt + BI3LIQ,t + e,

Where,

SDit = Standard dev~atlon of tth firm's return for tth per~orl n~easured its

Sk,t = Skewness of the return for the lth firm for tth pzr~otl calculated as

Kur,t = Kurtos~s of returns of the I'h fir111 for tth period calculated as

Mb,t = Market covarlanct: of return calculated as

R, R m as COV ------

6m2

Dp,t = D~v~dend payment of the firm ' I 'for 't'tll per~od as i~leasured by

( I ) DPS i EPS (2) DPS 1 100 (3) Changes o f D~vade~~clld pcr

share

LogS,t = Size of ith firm for th per~od measured as ( I ) Log of total anets

(2) log of total sales (3) log of net worth

LEV,[ = Leverage of I ' ~ firm dur~ng tIh per~od ~ncasurcd as ( I ) ( L o ~ l g - t c r ~ ~ ~

debt+ Debenture + Short-term Debt) I Total Asselr ('2)

(Long-term Debt + Short-terin Debt + Debenture)/ Net Wort11

(3) (Long-term Debt + Debenture) i Total Assets (4) (Long-ter111

Debt + Debentureli Net Worth

P,t = Profitab~l~ty of I ' ~ firm for tlh period measured as

(Operat~ng Profit + Non-operating Profit) (1)

Net Worth

Operating profit + non Operat~ng Profit + Interest ( 2 )

Net worth + Debenture + long-term debt

Operating profit + non operatang profit (3 )

Total Assets

Operating profit + Non Operating Profit + Interest (4)

Net Worth

Operat~ng Profit + Non Operat~ng Profit ( 5 )

F~xed Assets

EV,t = Earnlng v a r ~ a b ~ l ~ t y o f lth firm for tih per~od co~~rputcd 21s the

standard deviat~on of firms EPS for the lllost recent five years

Ab't = Accountrr~g beta o f r th f i rm form tth per~od IS measured ac the

regresslon coeffic~ent o f EPS of lib f i rm In relat~on to average

EPS of all firms put together by for~nula

EPS,, + EPS,,

82EPS , 8'EPSm, I PE,t = Prrce earning ratio for lth stock for tih period i n the price o f one

share d~vrded by EPS for last year

G,t = Growth o f lth firm for Ch perlod computed as ( I ) growth o f illlets

(2) growth o f sales dur~ng five ~~nlnediate preceed~ng years

Liq,t = l ~ q u i d ~ t y o f ith firm during t'h per~od measured as ( I ) Current

Assets 1 Current Liab~lit ies. (2) Current Assets 1 Total Assets.

The representatlve of each group of financlal ratios was selected wlth

the help of the ratlo hav~ng tugliest correlation with pr~ncipal colnpollerit ol

the group of ratlos. Thus out of 23 financlal var~ables 9 financ~al var~;ihle

were selected

In the tli~rd phase of the analysls market rlsk was regressed agalllst

seven Independent financ~al varlables They were slze, leverage. return t111

Investlnent, dlv~dend payout, accounting beta, growth s ~ d I lqu~d~ly

The fourth and last phase of tlic analysls was conducted by the help

of prlmary data collected from a cross sectlon of Investors ~ncludi~ig

lndlvldual and insutut~onal Investors The data collected was analysed wlt!~

the help of chi-square test to draw inference about the rlsk 1,erccptloli of

~lldlvidual and ~ns t~tu t~onal Investors

The test statlstlc was

(0 - E ) ~ x2 = .-......

E Where,

x2 = Chi-square value

0 = Observed frequency

E = expected frequency

In order to test the relationship between risk varlables and rate of

return on equities the rate of return on equity shares was calculated as tilt

22

geometnc mean of the expost monthly returns. The geometric ineali rate 1s

the same as the compounded rate of return ~ e r l o v e ~ and ~ r d i t t ~ ' ~ have

einplr~cally found out that geoinetric mean rate of return is almost same as

internal rate of return. Guptall used internal rate of return In 111s study

The rate of return for single tlme penod is calculated as

Where.

St + I = terminal prlce

St = In~tlal prlce

dl = dlvidend of tlme period 't' p a~d dur~rig the time perrod t + I

In thrs study the ad ju s t~ne~~ t for bonus shares 1s done by 111~1t1plyt11g

the post bonus Issue average prices and dividends by a bonus i ldjt~st~ne~ll

factorL2 (I + r) where r is the ratio of bonus Issue For example 11 a bollus

' ~e r l ove , M . , "Factors Affectrng D~fferences A~nong RaLe of Retur~ls on Investment on Individual Com~non Stock", Revrew of Econonircs ntid Stanstrcs, Vol 3 , Aug 1968, p.252.

IO~rd~ t t i . F .D , "Risk and Required Rate of Return on E q u ~ t ~ e s " , Journal of F~natlce, Vol 22, March 1967, p 23.

"Gupta, L.C , Rate of Rerun1 on Equrties rlze I t~d~nr l Expr,?entr. Oxford University Publicat~on 1981 Delhi p. 12

23

Issue IS made at one share for every 4 shares held then r will be 114 and

bonus adjustment will be I + 114 ie 514. In order to adjust right Issue

~nformation regarding value at which rights were traded In stock ~narket 111

this study no adjustment was made In the sliare prlces for right Issue because

for many firms the value of rights issue were not available In tlie stock

market quotation

L i ~ n i t a t i o ~ ~ s of the Study

I . Data collected frorii Bombay Stock Exchange Directory are subject to the

defic~ency of secondary dala

2. The colnputatlon of Independent var~ables are based on past accounttllg

data for whlch the accounting procedure (nay d~ffer among tlie sa1~1l)lt:

UllltS.

3 Expost ~nforlnat~on 1s used to f r a ~ i ~ e an oplnlori about the future beliavlour

of share prlce

~e l e r ; n r e of the Study

The study has important ~rnpl~cat~ons pertalnllig to the eificlel~cy ol

l nd~an Capital Market. Test~ng of independence or interdependence of the

p e r ~ o d ~ c stock return and spec~fic enquiry on r ~ s k return relatlonsh~p

conducted (nay be of greater s~gnificance to the players in the Indian Cap~tal

Market The analys~s draws Inferences on the efficiency of lndlan Cap~tal

Market to accurately discount various nsk factors. The Inaln justificatlol~ oi

24

the study is that lnost o f the work down i n I nd~a have concentrated 011

studylr~g the share prlces behav~our by lestlng only rando~nness than s l u d y ~ ~ ~ g

the behaviour exhaustively. Where i n the present study the beliav~our o f

return IS studied i n relation to risk also. From an examinat~on o f e~llplrlcal

ev~dences ava~lable I n lnd~an context 11 is found that very few have exa~iilned

the relationsh~p o f risk and return l 3 The present study has attenlpted to

analyse the behaviour of return In isolat~on as well as I n relat~on to r ~ s k

~nvestor's percept~on towards r ~ s k f i l l the gap 111 empirical analysls o f

behav~our of return and r ~ s k as far as equlty share prlces are concer~led

Orgallisation of Chapters

The thes~s contains nlne chapters

The first chapter belng an introductory one narrates the: rl;llure ( ~ f (111:

probleu~, slgnlficance,object~ve hypothes~s l~rn~tations elc o f the s t ~ ~ d y

The second chapter contans the scenarlo o f Ind~an Cap~tal Market

along w ~ t h the rccent developments and prohle~ns

The thlrd chapter glves a tlieorel~cal frame work o f varlous sources

of rlsk and thelr relat~onsh~p wlth returns

The fourth chapter reviews exlstlng l~terature The fifth chapter I!.

divided into two parts The first part deals with behaviour o f returns and tlie

I 3~a rua . Raghunathan, Verma, op. a t . , pp 15-20

25

second deals wlth b e h a v ~ o u r of risk, effects o f d ive r s~f i ca t~o t i 011 risk and r tsh

return relationship as postulated by CAPM.

E m p ~ r l c a l e v ~ d e n c e s o n Impact of several d ~ s t r t b u t ~ o n a l nrarket and

financtal r ~ s k variables on the rate of return IS presented 111 the s ~ x t l i cliapler

An enquiry of the fundamental factors affecting risk of a cutnpeny

IS attempted in the seventh chapter

T h e e ~ g h t h chapter presents an analysis o n tlir r ~ s k perceptluri ol Investors

Chapter nlne summartses tile study l e a d ~ n g I C I a fkw suggt-stlr,ll\