INTERNATIONAL BANKING AND FINANCE ASSIGNMENT

CAPM ANALYSIS: The Case of AMBUJA CEMENTS LIMITED in Bombay Stock Exchange

BY UDATHA PRAVEEN KUMAR ROLL NO.:1103026 PGDM-BIF

CAPITAL ASSET PRICING MODEL (CAPM):

Capital Asset Pricing Model (CAPM) is the model to represent the relationship between risk and return as the value of the firm is affected by these two key factors. Risk: Risk refers to the dispersion of a probability distribution. It is of two types: Diversifiable (unsystematic) risk refers to the market risk. It is the aggregate market returns. Undiversifiable (systematic) risk refers to the industry-specific risk in the portfolio. It is associated with the company returns and is uncorrelated with aggregate market returns. Return: Return from an investment is the realizable cash flow earned by its owner during a given period of time. Beta: Beta is the measure of the extent to which return on a financial asset fluctuates with the return on the market portfolio.

About Ambuja Cements Limited:

Ambuja Cements Ltd. (ACL) is one of the leading cement manufacturing companies in India. The Company, initially called Gujarat Ambuja Cements Ltd., was founded by Narotam Sekhsaria in 1983 with a partner, Suresh Neotia. Sekhsarias business acumen and leadership skills put the company on a fast track to growth. The Company commenced cement production in 1986. The global cement major Holcim acquired management control of ACL in 2006. Holcim today holds little over 46% equity in ACL. The Company is currently known as Ambuja Cements Ltd. ACL has grown dynamically over the past decade. Its current cement capacity is about 25 million tonnes. The Company has five integrated cement manufacturing plants and eight cement grinding units across the country. ACL enjoys a reputation of being one of the most efficient cement manufacturers in the world. Its environment protection measures are on par with the finest in the country. It is one of the most profitable and innovative cement companies in India. ACL is the first Indian cement manufacturers to build a captive port with three terminals along the countrys western coastline to facilitate timely, cost effective and environmentally cleaner shipments of bulk cement to its customers. The Company has its own fleet of ships. ACL has also pioneered the development of the multiple bio-mass co-fired technology for generating greener power in its captive plants. ACL has always met tough challenges and seized the opportunities that have come its way. It has nurtured the same spirit of enterprise and search for cutting-edge technology with which it started. It thus continues to be the driving force and in many ways a benchmark for the cement industry in India.

BSE SENSEX- Index and its calculation:

The Bombay Stock Exchange (BSE) regularly reviews and modifies its composition to be sure it reflects current market conditions. The index is calculated based on a free float capitalization methoda variation of the market capitalization method. Instead of using a company's outstanding shares it uses its float, or shares that are readily available for trading.

The free-float method, therefore, does not include restricted stocks, such as those held by promoters, government and strategic investors. Initially, the index was calculated based on the full market capitalization method. However this was shifted to the free float method with effect from September 1, 2003. Globally, the free float market capitalization is regarded as the industry best-practice. As per free float capitalization methodology, the level of index at any point of time reflects the free float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is multiplied by a free float factor to determine the free float market capitalization. Free float factor is also referred as adjustment factor. Free float factor represent the percentage of shares that are readily available for trading. The calculation of SENSEX involves dividing the free float market capitalization of 30 companies in the index by a number called index divisor. The divisor is the only link to original base period value of the SENSEX. It keeps the index comparable over time and is the adjustment point for all index adjustments arising out of corporate actions, replacement of scrips, etc. Assumptions: Sample selection: ITC Ltd. is selected as the company for the calculation of the systematic risk. BSE sensex is considered as the market index to calculate the unsystematic risk. Data selection: The study covers the period from April 1, 1998 to March 31, 2011. The stock values are taken from the mentioned time period. The data has been collected from the PROWESS (CMIE) database. Returns calculated using a longer time period might result in changes of Beta over the examined period introducing biases in beta estimates. Hence, in order to obtain better estimates of the value of the beta coefficient, it includes daily stock values. The consecutive repetitive values in the sensex data has been deleted for better analysis. The Rf Value for the year 2010-2011 is assumed to be 8.5.

Methodology:
Ke = Rf (Rm -Rf ) Where, Ke is the expected return on the capital asset, Rf is the rate of return on a risk-free asset, Rm is the rate of return on the market index, is the slope i.e., the measure of unsystematic risk.

Year

199 7-88 199 8-99 199 9-00 200 0-01 200 1-02 200 2-03 200 3-04 200 4-05 200 5-06 200 6-07 200 7-08 200 8-09 200 9-10 201 0-11 201 1-12

Average Daily Return AMBUJA CEMENTS BSE 0.0039648 0.00653 82 79 0.0086280 0.00242 91 5316 0.0212119 0.01236 72 8669 0.0228838 0.01348 53 4538 0.0216933 0.00066 79 7828 0.0170263 0.00570 25 0087 0.0460570 6 0.0214449 02 0.0729627 27 0.0043432 6 0.0112876 05 0.0445165 18 0.0486615 15 0.0174783 49 0.0128296 12 0.02943 2887 0.00612 4823 0.02493 8121 0.00365 4514 0.00941 5701 0.01782 6042 0.02339 5184 0.00379 5761 0.00510 9528

Daily Risk AMBUJA CEMENTS BSE 0.4080217 0.17064 83 4119 0.5348195 61 0.8493410 38 0.6222063 28 0.4624867 35 0.2653392 7 0.4172872 53 0.3566499 51

1 0.00653 79

Holding Period Return AMBUJA CEMENTS BSE 0.0416971 0.11964 47 2926 0.0917218 0.07684 54 6911 0.3990610 0.26017 33 5402 0.3951979 23 0.3538357 55 0.2247027 42 0.4480189 64 0.2501245 02 3.0029055 69 0.0037629 35 0.1425030 98 0.6942496 49 0.4003343 08 0.1955117 31 0.1427737 23 0.36489 2797 0.01963 3669 0.09991 3658 0.45557 767 0.11604 3498 0.43716 4086 0.07471 5882 0.18816 2205 0.52988 792 0.40456 1337 0.07645 1091 0.15179 6352

Slope

CAPM

1.29852 6885 1.52747 195 0.07529 9566 0.00907 4816 0.09004 3184 0.07131 0252 0.20314 266 0.31907 3889 0.71013 8501 0.20173 7439 0.08177 6159 0.07893 1832 0.18672 3836 0.27207 9318 0.04919 4236

7.6074 69971 8.3141 64628 7.9255 45219 6.9826 21038 9.3281 91042 5.1930 70072 4.1089 41966 5.2819 96905 3.7424 73448 6.3912 68871 7.4404 70001 6.2440 83434 6.1959 78403 8.1225 72486 7.8754 79719

0 0.23638 8441 0.07017 4228 0.24909 6857 0.27475 9168 0.06898 6399 0.03062 2392 0.18859 6604 0.09477 9297 0.30964 4099 0.16753 7006 0.15136 5218

2.1417222 0.5498368 94 0.3654360 5 0.8493948 4 0.5547099 53

0.4171594 0.3888105 96

Graph 1: Risk and Return of company and the BSE sensex

12

10 R I S K A N D

CAPM daily risk of BSE

6 daily risk ambuja cement 4 average daily return of BSE

R average daily return E 2 T U R 0 N ` ` -2 ` ` YEAR ` The` values of the risk and return of the AMBUJA CEMENTS Ltd. and the BSE sensex is ` plotted on the graph by taking time period in years on x-axis and the return and risk values ` on the y-axis. ` Inference: From this graph it is understood that the BSE risk and return have been gradually ` changing from the period 1997-2012. It can be observed that the market risk is higher at some ` point of time i.e. in 1998-1999, 2005-2006, 2004-2005 and in the year 2009-2010. We also ` observe that the company risk also has been at peaks in the years 2005-06 with steep increase and `then decreased sharply. we can understand that the company return has remained almost ` unchanged from the period of 2001-2002 whereas the CAPM return has showed a range of ` variations in the value of return. The CAPM return was found to be the maximum in the year ` 2001-02, after that it has steeply decreasing till 2005-06 and then gradually rising till 200809. ` Further it decreased till 2010-11. ` ` Conclusion: The` findings are not in the support of the CAPM model, as the basic hypothesis of CAPM is that` higher level of Risk (Beta) is associated with the higher level of return. The CAPM was

not perfectly accurate; it still provides a legitimate explanation that expected return is proportional to their systematic risk and the expected excess return to the market. The inaccuracies in this and other empirical tests can be improved with better proxies for the market and the risk free rate and better econometric techniques.

1997-88 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12