Alpha - Beta1

8/8/2019 Alpha - Beta1

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ALPHA

A measure of performance on a risk-adjustedbasis.Alpha takes the volatility (price risk) of a mutual

fund and compares its risk-adjusted performanceto a benchmark index. The excess return of thefund relative to the return of the benchmark indexis a fund's alpha.

The abnormal rate of return on a security or

portfolio in excess of what would be predicted byan equilibrium model like the capital asset pricingmodel (CAPM).


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`Alpha is one of five technical risk ratios; the others

are beta, standard deviation, R-squared, and the

Sharpe ratio. These are all statistical

measurements used in modern portfolio theory(MPT). All of these indicators are intended to help

investors determine the risk-reward profile of a

mutual fund. Simply stated, alpha is often

considered to represent the value that a portfoliomanager adds to or subtracts from a fund's return.


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` A positive alpha of 1.0 means the fund has outperformed itsbenchmark index by 1%. Correspondingly, a similarnegative alpha would indicate an underperformance of 1%.

2. If a CAPM analysis estimates that a portfolio should earn

10% based on the risk of the portfolio but the portfolioactually earns 15%, the portfolio's alpha would be 5%. This5% is the excess return over what was predicted in theCAPM model.

`


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` Beta is calculated using regression

analysis, and you can think of beta as the

tendency of a security's returns to respond

to swings in the market. A beta of 1

indicates that the security's price will move

with the market. A beta of less than 1

means that the security will be less volatilethan the market. A beta of greater than 1

indicates that the security's price will be

more volatile than the market.


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` For example, if a stock's beta is 1.2, it's

theoretically 20% more volatile than the

market.

Many utilities stocks have a beta of less

than 1. Conversely, most high-tech

Nasdaq-based stocks have a beta ofgreater than 1, offering the possibility of a

higher rate of return, but also posing more

risk.


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A standard against which the

performance of a security, mutual

fund or investment manager can bemeasured. Generally, broad market

and market-segment stock and bond

indexes are used for this purpose.


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` When evaluating the performance of any

investment, it's important to compare it against an

appropriate benchmark.

` In the financial field, there are dozens of indexesthat analysts use to gauge the performance of any

given investment including the Nifty , Sensex ,

S&P 500, the Dow Jones Industrial Average, the

Russell 2000 Index and the Lehman BrothersAggregate Bond Index.


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`SML Mean

A line that graphs the systematic,

or market risk versus return of thewhole market at a certain time

and shows all risky marketable

securities.Also refered to as the

"characteristic line".


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`The SML essentially graphs the

results from the capital asset

pricing model (CAPM) formula.The x-axis represents the risk

(beta), and the y-axis represents

the expected return. The marketrisk premium is determined

from the slope of the SML.


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` The security market line is a useful tool indetermining whether an asset being considered fora portfolio offers a reasonable expected return forrisk. Individual securities are plotted on the SMLgraph.

` If the security's risk versus expected return is plottedabove the SML, it is undervalued because theinvestor can expect a greater return for the inherentrisk. A security plotted below the SML isovervalued because the investor would beaccepting less return for the amount of riskassumed.


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A model that describes the

relationship between risk and

expected Return and that is used inthe pricing of risky securities.

The general idea behind CAPM is

that investors need to becompensated in two ways: time value

of money and risk


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` . The time value of money is represented by therisk-free (rf) rate in the formula and compensatesthe investors for placing money in any investmentover a period of time. The other half of the formula

represents risk and calculates the amount ofcompensation the investor needs for takingon additional risk. This is calculated by taking arisk measure (beta) that compares the returns of

the asset to the market over a period of time andto the market premium (Rm-rf).


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` CAPM

The CAPM says that the expected return of a

security or a portfolio equals the rate on a risk-free

security plus a risk premium. If this expectedreturn does not meet or beat the required return,

then the investment should not be undertaken.

The security market line plots the results of the

CAPM for all different risks (betas).


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` CCAPM

` What Does Consumption Capital Asset Pricing

Model - CCAPMMean?

A financial model that extends the concepts of thecapital asset pricing model (CAPM) to include

the amount that an individual or firm wishes to

consume in the future. The CCAPM uses

consumption measures, in terms of a consumptionbeta, in its calculation of a given investment's

expected return.


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` CCAPM

In its simplest form, the CCAPM differs from the

CAPM by only the beta coefficient used in the

calculation. The beta for consumption attempts tomeasure the covariance between an investor's ability

to consume goods and services from investments, and

the return from a market index.

In practice, the CCAPM is used less frequently than

the CAPM, and should probably only be used on a

theoretical basis.


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`

A line used in the capital asset pricing model to illustratethe rates of return for efficient portfolios depending on therisk-free rate of return and the level of risk(standard deviation) for a particular portfolio.

`

The CML is derived by drawing a tangent line from theintercept point on the efficient frontier to the point where theexpected return equals the risk-free rate of return.


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The CML is considered to be superior to the

efficient frontier since it takes into account the

inclusion of a risk-free asset in the portfolio. The

capital asset pricing model (CAPM) demonstratesthat the market portfolio is essentially the efficient

frontier. This is achieved visually through the

security market line (SML).


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` UNPREDICTABLE market

` No Relation Present & Future Prices of Shares .

` Successive Price Changes which are independent

of each other No Trends` No adequate explaination of Price Changes

` Price Change Permanent And Transitory

Component


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` Permanent Component true or intrinsic value-

earnings ,dividends, asset structure,mangt

efficiency, competitive positions , enviornmental

factors ,specific to co. and inductry by trend` Transitory component psychological forces,

bearish or bullish tendencies.


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` Efficiency of Markets

` Capital Markets operate to a high degree of

perfection .

` Root RandomWalk Theory .` Existence of Efficient Markets- Large No. Of

rational Investors and speculators- maximise

profits- predicting Future Earnings , dividends and

Value of Shares.


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` Information transmitted spontaneously

` Fair Price

` Efficient Market Price Adjustment competitive

Norms .` Each Price is independent of the previous day .

` Level of Efficiency Level of Information


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` Weak Form reflect past prices

` Semi Strong reflect publicly available information

along with past info. co. announcements ,

brokers reports ,industry forecast, co. results .` Strong Form Reflect all information publicly

and generally available info- insider info. take

over , collaborations etc.


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` Reflect new info quickly prevents investors to

cash in on it .

` Weak Form- unable to pick winners based on

movements of past share prices.` Semi Strong Based on Publicly available info.

Hence no consistency in Excess profit making .

High Earnings News immediately reflected in

Prices .


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` Strong Form : No Ecxess Profits All informations

are reflected in the Share Prices ,

- Whether new analysis or Insider Hot Tip .

FAIR GAME CONCEPTAbility of investors to pick winners and make excess

profits depends on the speed and efficiency of the

market at absorbing that info

Efficiency Fair game


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` Efficient market Related to a particular set of

information- investors enjoy expected rate of

return against the risk involved with no consistent

abnormal returns.` Efficient Market fair game for investors

` EMH is more comprehensive compared to RWT

as it not only refers to past share price movements

but to all market informations .


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` Informations costless to all MP

` No Transaction Costs

` All investors take similar view on implications of

market informations .` EMH & Indian Stock Market

NeitherFair nor Efficient

Information neither freely available nor

transmitted.


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` Rampant Price Rigging and Insider Trading

` Circulation of Misinformation

` Investors Information Processing Ability Limited.

` Inadequate organisation and infrastructure` Frequent Changes in Tax Laws- Effects Long Term

Investments

` Fixed interest securities Low rates Ineffective

hedge against Inflation

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Alpha - Beta1