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Assignment No2

The document is a student assignment that contains answers to four questions about finance concepts. It includes: 1) Computations of beta values for top 30 companies in the Sensex index, identifying Bajaj Finance and IndusInd Bank as having the highest betas and HCL Tech and PowerGrid as the lowest. 2) Explanations of levered and unlevered beta, and formulas to calculate each. 3) Statement that the beta of debt-free companies would be their unlevered beta. 4) Definitions of systematic risk as risks that affect the entire market, and unsystematic risk as risks specific to individual securities.

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sarvesh patil
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72 views

Assignment No2

The document is a student assignment that contains answers to four questions about finance concepts. It includes: 1) Computations of beta values for top 30 companies in the Sensex index, identifying Bajaj Finance and IndusInd Bank as having the highest betas and HCL Tech and PowerGrid as the lowest. 2) Explanations of levered and unlevered beta, and formulas to calculate each. 3) Statement that the beta of debt-free companies would be their unlevered beta. 4) Definitions of systematic risk as risks that affect the entire market, and unsystematic risk as risks specific to individual securities.

Uploaded by

sarvesh patil
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Assignment No.

Name- Sarvesh Patil


Mis- 111710089
Subject- Finance for Engineers
Branch- Mechanical

Q1. Beta is considered as a tool for measuring the risk.


Sensex is an index of Top 30 companies. Showing
computation, name the two companies having highest beta
in the last week when Sensex crashed from 40k to 26k. Also
name the two companies with lowest beta. Show
computation for 10 days from 15th march onwards.
Ans.
Beta, used in capital asset pricing model (CAPM), is a
measure of the volatility, or systematic risk, of a security or
portfolio, in comparison to the market as a whole.
The beta is computed by using following formula
Beta coefficient(β)= Covariance(Re,Rm)
Variance(Rm)
where:
Re=the return on an individual stock
Rm=the return on the overall market
Covariance=how changes in a stock’s returns arerelated to changes i
n the market’s returns
Variance=how far the market’s data points spreadout from their aver
age value
The beta coefficient can be interpreted as follows:
 β =1 exactly as volatile as the market
 β >1 more volatile than the market
 β <1>0 less volatile than the market
 β =0 uncorrelated to the market
 β <0 negatively correlated to the market
By computing the beta value of the top 30 companies we got the
following results.
Companies Beta value
Asian Paints 0.954681
Axis Bank 1.674942
Bajaj Auto 0.870660
Bajaj Finance 1.830381
Bharti Airtel 0.941965
Hcl Tech 0.529735
HDFC 1.145327
HDFC Bank 1.021121
Hero Motor 0.876376
Hindustan Uniliver 0.768316
ICIC Bank 1.227555
IndusInd Bank 1.836703
Infosys 0.864754
ITC 0.656475
Kotak 1.221221
L&T 1.158473
Mahindra & Mahindra Ltd. 0.647061
Maruti 1.185666
Nestle 0.752294
NTPC 0.563293
ONGC 0.683980
PowerGrid 0.475856
Reliance 1.131950
SBIN 0.784475
SUN Pharma 0.594720
TATA Steel 0.712179
TCS 0.612328
Tech Mahindra 0.862298
TITAN 0.851167
Ultra Cemco 1.028098

From the above result it is anticipated that the beta value of


Bajaj Finance and IndusInd bank are the highest.
 The beta value of this companies are greater than 1,
which means the companies are more volatile than the
market.
 The beta value of Bajaj finance and IndusInd Bank is
1.830381 and 1.836703 which mean both the
companies had returned 183% of the market would
have returned in a given period (15 march-31 march).
Similarly, the beta value of HCL tech and PowerGrid is lowest
as compare to others.
 As the beta value of this companies are lower than 1,
hence they are less volatile than the market.
 The beta value of HCL tech and PowerGrid is 0.529735
and 0.47586 which mean both the companies had
returned 52.9% and 47.5% of the market would have
returned in a given period (15 march-31 march).

Computation of the beta values:


Step 1-Download the historical adjoint closing price of the
company and the index for the comparison benchmark
Step 2- Calculate the return value for both company and
the BSE sensex as shown below.

Step 3- Calculate the covariance of the company to the


BSE index by using =COVARIANCE.P(all the returns of the
company, all the returns of the BSE ).

Step 4- Find the Variance of the company using


=VAR.P(all the returns of the company).
Step 5-Calculate the beta value by dividing calculated
covariance by variance

Similarly, we can calculate the beta value of other


companies as shown below
IndusInd Bank

HCL Tech

PowerGrid
Q2. What is beta of a levered firm and unlevered firm?
Ans.
Levered Beta: -  Levered beta is a financial calculation
that indicates the systematic risk of a stock used in the
capital asset pricing model (CAPM).
A key determinant of beta is leverage, i.e. the level of
the firm’s debt compared to equity. The systematic risk
includes the different types of risk that may affect the
stock performance, including macroeconomic factors,
political events, etc., and it cannot be leveraged through
diversification.
Example-
A financial analyst at Goldman Sachs. One of his daily
tasks includes the calculation of a stock’s leveraged beta
to determine the effect of leverage on the stock’s risk.
Currently, he analyses a stock with a beta 1.25, and a
debt-to-equity ratio 13%. Also, the company is taxed at
35%.
Calculate the unlevered beta formula of the stock
Unlevered beta= beta / 1 + (1 – tax rate) x (debt /equity)
= 1.25 / 1 + (1 – 35%) x 13% = 1.33.

Calculate the levered beta formula of the stock


Levered beta= unlevered beta (1+ (1-tax rate)
(Debt/Equity))
= 1.33 x (1 + (1-35%) x 13% = 1.45.

Unlevered Beta: -
Beta is a measure of market risk. Unlevered beta (or
asset beta) measures the market risk of the company
without the impact of debt. Unlevering a beta removes
the financial effects of leverage thus isolating the risk
due solely to company assets. In other words, how much
did the company's equity contribute to its risk profile.
Unlevering the beta removes any beneficial or
detrimental effects gained by adding debt to the
firm's capital structure. Comparing companies'
unlevered betas gives an investor clarity on the
composition of risk being assumed when purchasing the
stock.
The formula for unlevered beta is as follow

Unlevered beta = beta / [1 + ((1 - Tax Rate) x Debt/Equity)]

Example-
Calculate the unlevered beta for Tesla, Inc. As of November
2017, its beta is 0.73, Debt per equity ratio is 2.2, and its
corporate tax rate is 35%.

Unleverd beta = 0.73 / [1 +((1 – 0.35) x 2.2)]

= 0.73 / 1 + (0.65 x 2.2)

= 0.73 / 2.43 = 0.30

Q3. Based on the answer to question 1, What will be the


beta of two companies if they are debt free?
Ans.
As we know that,
Unlevered beta= beta / 1 + (1 – tax rate) x (debt /equity)
Therefore, for debt=0
Unlevered beta = beta
Similarly,
Levered beta= unlevered beta (1+ (1-tax rate)
(Debt/Equity))
For debt=0
Levered beta= unlevered beta

Thus, from above equation we can conclude that the


levered and unlevered beta of the debt free companies
are equal

Q4. What is systematic and unsystematic risk?


Ans.

Systematic risk
This is the risk that highlights the possibility of a collapse
of the entire financial system or the stock market
causing a catastrophic impact on the entire system in
the country. It refers to the risks caused by financial
system instability, potentially catastrophic or
idiosyncratic events to the interlinkages and other
interdependencies in the overall market.
For e.g. Mr ‘A’ has made a portfolio constituting 500
shares of a Media company, 500 Corporate bonds, and
500 Government bonds. A recent interest rate cut has
been announced by the Central Bank due to which Mr
‘A’ wants to reconsider the impact on his portfolio and
how he can re-work around it. Given that the Beta of the
portfolio is 2.0, it is assumed that portfolio returns will
be fluctuating 2.0 times more than the market returns.
If the market spikes by 3%, the portfolio will
increase by 3%*2.0 = 6%. On the other hand, if the
market falls by 3%, the overall portfolio will also
decrease by 6%. Accordingly, Mr ‘A’ will have to lower
the exposure of stocks and perhaps increase exposure in
bonds as the fluctuations are not sharp in bonds
compared to stocks. The asset allocation can be
considered as 250 shares of Media firm, 500 Corporate
Bonds and 750 Municipal bonds. This may seem to be a
defensive mode but Municipal bonds are perhaps the
most secure in terms of a default offering stable returns.

The sources of systematic risks can be:


 Political instability or other Governmental decision
having widespread impact
 Economic crashes and Recession
 Changes in taxation laws
 Natural Disasters
 Foreign Investment Policies

Unsystematic risk
Also known as Diversifiable or Non-systematic risk, it is
the threat related to a specific security or a portfolio of
securities. Investors construct these diversified
portfolios for allocating risks over various classes of
assets. Let us consider an example of a clearer
understanding:
On March 1, 2016, Mr. Matthew invests $50,000 in a
diversified portfolio which invests 50% in stocks of
Automobile companies, 20% in I.T. stocks and a balance
of 30% in stocks of Airline companies. On February 28,
2017, the value of the portfolio is enhanced to $57,500
thereby bringing annual growth of 15% [$57,500 –
$50,000 *100]
One fine day, he gets to know that one of the airlines
has defaulted on employee salary payments due to
which the employees are on strike and other airlines are
expected to follow the same tactic. The investor is
worried and one option to be considered for Mr.
Matthew is to either hold on to the investment with the
expectation of the issue getting resolved or he can divert
those funds to other sectors that are experiencing
stability or maybe divert them in bond investments.

Some of the other examples of unsystematic risks are:


 Change in regulations impacting one industry
 The entry of a new competitor in the market
 A firm forced to recall one of its products (For e.g. the
Galaxy Note 7 phone recalled by Samsung due to its
battery turning flammable)
 A company exposed to have made fraudulent activities
with its financial statements (For instance Satyam
computers fudging their balance sheets)
 An employee union tactic for senior management to
meet their demands

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