Chapter 1 Introduction to Portfolio Theory Before we look theory of portfolio, let us first try to understand what is portfolio.

Now a day, everybody is acquiring different sets of assets such as gold, silver, building, insurance policies etc. for making a provision for future. The risk of each of such investment is to be understood before hand. Many times the investors go on acquiring assets in an ad-hoc and unplanned manner. All these leads to high risk, low return profile. All these assets constitute portfolio. And to manage once portfolio with highest return for the lowest risk is called portfolio management. Risk return analysis is essential for portfolio management. As there is a trade off between risk and return. More the return you must take more risk. There are two basic principles of finance form the basis of portfolio theory. 1) Time value of money 2) Safety of money Investment Activity is based on three components which are as below: 1) Wealth or Asset shifting of one asset to another 2) Income (y-e) gives savings 3) Borrowings of money (e-y) gives dis-savings The choice of investment is mainly depend on available alternatives, opportunity set and secondly, the preference of investors. The above three sources has their own constraints. Some of them are risk less with certainly and others are risky and uncertain. There is no rigid rule on the optimum numbers of asset in a portfolio. It is depend on the amount of fund, investors goals and their preferences and risks tolerance. The economies of management of fund reach the optimum for such number as to for individual and 100 for bigger size funds of investment of companies. The ultimate aim of portfolio is to maximise the return and minimise the risk. Risk is uncertainly and variability of the income\capital appreciation or loss of both. There are two major types of risks those are: 1) Systematic risks 2) Unsystematic risks The market problems, raw material availability, tax policy of Government are of first type of risks. Whereas mismanagement, increasing inventory, defective marketing are the examples of second type of risks. The unsystematic risk can be reduced by diversifying into few companies to various industry groups, asset groups or different types of instrument like bonds, debentures etc. The asset classes bank deposits, company deposits, gold, silver, land, real estate etc. The industry group includes tea, sugar, cement, paper, steel, electronics,

computer etc. The second category of risk can be managed by the use of Beta of different company shares. The beta is percentage change in the scrip return divided by the percentage change in market return. The Beta is readily available of well traded companies from financial Journals like Dalal Street, Capital Market. If Beta is 1, the scrip risk is the same as the market risk. If Beta is less than one then scrip risk is less than market risk. The defensive investors should invest in scrip with Beta less than 1 and vice versa. As stated earlier, risk has got direct relationship with expected return. All investments are risky. But proper management of risk with right choice of investment whose risks are compensating each other is the main task of intelligent investor. Following chart shows riskiness of different assets.

EQUITY OR VENTURE CAPITAL FUNDS

EXPECTED RETURN

EQUITY OR BLUE CHIP COMPANIES

FDs OF COMPANIES

DEBENTURE/BONDS OF COMPANIES MUTUAL FUNDS SCHEMES

P.S.U. BONDS

RISK FREE RETURN (BASED ON INFLATION RATE)

RISK ( )STANDARD DEVIATION

From above chart it is quite clear that the value of expected return is highest when risk is at highest point.

Chapter 2 Capital Market Theory As seen in earlier chapter, return is directly associated with risk. Two plus two will not make it four in the aggregation of risk. This is shown by famous author MARKOWITZ. Capital market theory deals with minimizing risk for given return. Capital market theory is extension of portfolio theory of MARKOWITZ. Capital Market Asset Pricing Model (CAPM) incorporates a relationship, explains how asset should be priced in capital market. Following are some assumptions of Capital Market Theory: 1. Investors are expected to make decisions based solely on risk return assessments. 2. The transaction of purchase and sales can be undertaken in infinitely divisible units. 3. Investors can sell short any number of shares without limit. 4. Personal income taxation is assumed to be zero. 5. Investors can borrow/lend the desired amount at risk less rates. From the above assumptions some of them are unrealistic provide a basis for an efficient frontier line common to all. If all investors hold same risky portfolio, then in equilibrium, it must be the market portfolio. In that sense RfM straight line is Capital Market Line (CML).

The equation of the capital market line connecting the riskless assets with a risky portfolio is
RM - RF M

Re = Rf +

The subscript (e) denotes the efficient portfolio.

In case of portfolios involving complete diversification, where the unsystematic risk tends to zero, there is only systematic risk which is measured by Beta (). We have seen earlier that all portfolios of investments lie along a straight line in the return to Beta space. The equation of that straight line is Security Market Line (SML). The equation for the same is as below, Ri Rf = i (RM RF)

Expected Return

Y Rm M

Rf O

DEFENSIVE SECURITIES

AGGRESSIVE SECURITIES

Beta (Systematic Risk)

1.0

The theory of Market efficiency and Random walk theory explain the price formulation through the absorption of information in a perfect manner. The market is said to be efficient, if price is determined by competitive force of supply and demand. According to CAPM there is an efficiency frontier for each investor. In the Modern portfolio theory, risk is presented by the concept of Beta in substitution of the SD of expected return in CAPM. The portfolio theory and portfolio management constitute the rational ground to base the purchase and sale of the investor. The theory in which it is assume that no one can predict the prices of shares based on the past or historical trends is called Random Walk Theory. As opposed to the above theory, the Trend Walk Theory postulates that the investor goes by the past trends and buy those which are others are buying. The present is offshoot of past and the

market absorb the information. In the contrast to Random Walk Theory, this theory is more realistic. Under Capital Asset Pricing Theory, the return on each security is related to the total risk inherent in that security. If the risk is spread over a number of securities in the market, then the company related risks are covered, reduced or eliminated. This model postulates that the company risk and the market risk are related by a variable called Beta. Symbolically it is presented as below; (Ri Rf) = Bi (RM Rf) Where, Ri = Rate of price appreciation on the scrip i Rf = Risk Free Return RM = Market Risk Bi = constant The Modern Portfolio Theory is closely related to the above theory. Under this, companies have different type of risks. These risks can not be completely eliminated in any investment. In this theory the risk is reduced or eliminated by choosing companies in the portfolio whose covariance is negative. The concept of Beta as a measure of systematic risk is useful in portfolio management. It measures the movement of scrip in relation to the market trend. Thus, Beta can be +ve or ve depending upon the movement of individual scrip. The scrip said to be aggressive when Beta is more than 1 and those are called defensive whos Beta value is less than 1. The formula for calculation of Beta is Rj = a + Bj RM + u Where, Rj = Return on Security, RM = return on market index, Bj = measure of risk, a = intercept term, u = error term introduced to estimate this regression equation. For a portfolio of securities, it is not only the expected returns and variances that matter but the covariances as between these securities. The covariance term is crucial in Modern Portfolio Theory and particularly in diversification of Markowitz type. If the covariance is zero , the weighted sum of variances is not changed. If it is more than one, and positive, risk is increased. If it is less than one or negative, risk is decreased. In the words of Markowitz , Not only does the portfolio analysis imply diversification, it implies the right kind of diversification for right reason. It is necessary to avoid investing in securities with high covariances among themselves.

Chapter 3 Risk and return in portfolio management The main objective of portfolio management is to maximise the return and minimise the risk. Risk and return thus have direct relationship. If you want more return, you have to take more or higher risk and vice-versa. The question then comes up is what is risk?. In short the risk can be defined as, uncertainly of the income\capital appreciation or loss of both. There are two types of risk, 1) Systematic risk 2) Unsystematic risk. As stated earlier the objective of portfolio is minimise risk and maximise return. The first type of risk can be minimise by diversifying funds in to different groups of industries. The second type of risk is managed by the use of Beta of different company shares. After seeing risk and type, lets now look at return. The term return can be stated as income for investment either in the form of interest, dividend or capital appreciation. Return is a key factor of both i.e. investors and the company who accepts such investment. Return motivates investors to invest more and for company who accept such investment it is a great tool to evaluate the performance of their asset. As we seen the two types of risk, the return are also two types, 1) Realised return 2) expected return. The former is actually earned income of the past and later is return expected or anticipated by the investor. The decisions of investment are made through later. Although the later is depend on former The return has got two elements, 1) Income 2) price changes. So, to calculate total return the formula is, Total return=Income + price change. The price change is the difference between the purchase price and sale price and income is actual cash inflow over the period. This formula is acceptable for the given period of time. But if we want to calculate return for more than one year the new have to calculate by average returns. These are measured by taking arithmetic average or geometric average. The formulas of both are as below, 1) Arithmetic average. x = xi n

Where X; is the return for the period i. And n is number of years

2) Geometric average: The above averages cant suitable to measure growth rate. Geometric average is more useful as a measure of compound cumulative returns over period of time. The Mathematical representation is as below: G= [(1+r1) (1+ r2)........ (1+ rn)]1/n -1 Where, G=Geometric average, r=total return, n=number of years The relation of risk and return in portfolio management can be express by following chart. y Rewards N M I R0 R1 R2 x Risk At R0 risk the reward is I, but as we goes on taking higher or more risk say R1 or R2 the reward also goes on increasing say M or N 0

Chapter 04 Capital Asset Pricing Model Summary The Capital Asset Pricing Model was developed to explain how risky securities are priced in market. This was attributed to expert like Sharpe and Linter. Theory of Markowitz is more theoretical, Capital Asset Pricing Model aims at a more practical approach to stock valuation. Capital Asset Pricing Model is based on certain assumptions. Those are : 1) Investor aims at maximizing the utility of his wealth rather than wealth or return 2) About risk and return investors have similar expectations 3) Decision of investment is made by investor on rational basis 4) There is free access to all available information at not extra cost and loss of time for investors 5) Investor should have identical time horizons The above assumptions are common to both Capital Asset Pricing Model and Modern Portfolio Theory, some in Capital Asset Pricing Model. Besides, it is also necessary to assume in Capital Asset Pricing Model that total asset quantity is fixed and all assets are divisible and marketable. Under Capital Asset Pricing Model, the equilibrium situation arises when all frictions, like taxes, transaction costs and different risks free borrowings rates are assumed away. The Capital Market Line reflects the relationship of total risk and expected return. The total risk includes both systematic and unsystematic risks. The risk free rate can be thought as the price of time and the slope of Capital Market Line as the price of risk. Unlike Capital Market Line, which considered the total risk as a measure of variability of return, SML (Security Market Line) takes into account only the systematic risk, which is not possible to reduce by diversification. Beta is used in the Security Market Line. This line depicts a linear relationship between expected return and the systematic risk. Symbolically, Security Market Line is presented as below : Ri = Rf + i (Rm Rf) Where, Ri = Return on security Rf = Risk free return Rm = Market return

i = Beta of scrip i related to market risk From the above equation, we can estimate the expected return on a security. In real world, investors get higher return for higher risk and they are more concerned with company related risk rather than market related risk. The company use Capital Asset Pricing Model to determine the cost of equity for the firm, to estimate the required return for divisions, to determine the hurdle rates for corporate investment. In case and rules to be charged to cover the costs. Thus Capital Asset Pricing Model is useful tool for investment analysis and portfolio management. The limitations of the Capital Asset Pricing Model theory are stated as below : 1) This theory is unrealistic for any average investor 2) Empirical test of the model have not proved useful 3) Data and analysis is to be based on ex post factors while anticipation of future risks and returns are ex ante and both may not be related. 4) This theory assumes that all investors are risk averse. To eliminate unsystematic risk, investors used diversification the traditional theory laid down diversification as a technique of selection of securities in portfolio. This is called Random or Simple diversification. Markowitz who is regarded as pioneer of researcher who found that random or simple diversification may results into Nave diversification, which do not lead to any reduction risk. For e.g. Cycle and tubes are related industries. One invest in those two types of industries which are highly correlated in a positive manner, the risk will be increased by diversification rather than reducing. Thus, investor who had invested in correlated industries like steel, ferrous materials, mini steel resulted into increase risk.

Chapter 5 Portfolio Analysis Analysis of Portfolio is one of the most important thing in portfolio management. As we seen that investor may goes on acquiring assets on ad-hoc basis, and normally resulted into high risk and low return. So by analyzing portfolio one can get true and correct knowledge of risk and return on portfolio. Every security in portfolio contributes returns in the proportion of its investment in security. In short, the expected return of portfolio is weighted average of the expected return of each security. Here the question may arise in the mind is, why investor has acquire so many securities in his portfolio? When some of the securities give him maximum return, the answer of this question lie in the investors perception of risk attached to investment, his objective of income, safety, appreciation, liquidity and hedge against loss of value of money. This pattern of investment is normally called diversification, which aims at the reduction or even elimination of non-systematic or company related risks and achieves the specific objectives of investors. Risk on portfolio is different from the risk on individual securities. The expected return depends on the probability of the returns and their weighted contribution to the risk of the portfolio. There are two measures of risk in this context. i] absolute deviation ii] standard deviation. The basic equation for calculating risk can be formulated as a regression equation. Thus, (y = + X + E) where, y = Return in the security in a given period. X = Market return = The intercept where the regression line crossed the y axis = The slope of the regression line E = Error term containing all residuals Y
BETA

+X+E

Stock Return

BETA

Alpha :
Market Return (or Market Index)

Alpha is the distance between the horizontal axis and the lines intersection with y axis. It measures the unsystematic risk of company. Beta describes relationship between the stocks return and the market index return.

Chapter 06 Markowitz Model Summary Risk management and their application for selecting portfolio is important task for portfolio management. Harry M. Markowitz introduces new concepts in it. This model is theoretical framework for analysis of risk and return and their inter relationship. He used statistical analysis for risk measurement and mathematic programming for selection of assets. An efficient portfolio management is expected to yield the highest return for given level of risk for given level of return. Risk and rewards are two aspects of investment considered by investors. Risk index is measured by the variances, which are in statistical terms called variance and co variance. The modern portfolio management theory can be stated as, the qualification of risk and the need for optimization of return with lowest risk. This theory emphasizes on: 1.Trade between risk and return 2.Need for maximization of these securities called diversification. The above theory is based on following assumptions: 1) Investors are rational and want to maximize their utility with given level of income or money. 2) The market is efficient and absorbs the information quickly and perfectly. 3) Investors have free access to fair and correct information on the return and risk. 4) Investors try to minimize the risk and maximize the returns. 5) Investors prefer higher return to lower return for given level of risk. Markowitz theory of diversification attaches importance of standard deviation to reduce it to zero, if possible co variance to have as much as possible negative effect among the securities within the portfolio and co efficient of correlation to have -1. For building up efficient set of portfolio management, we need to look into following important parameters: 1) Expected returns 2) Covariance of one asset return to other asset return 3) Variability of return as measured by standard deviation from mean.

In general, higher the expected returns and lower the standard deviation. In this method the risk is calculated by standard deviation of the return over the mean for numbers of observations. Whereas portfolio risk is calculated by following formula: Cov x Y = (1 N) (RX RX) (R Y R Y)

Where, RX = Return on security X, RY = Return on security Y, RX and R Y = Expected returns on them respectively. N = Number of observations. The another method to indicate the difference or similarity in the behavior of two variables.The formula is: V
X

Y = Cov XY

X Y

Where, Cov XY = Covariance between x & y X = Standard deviation of x Y = Standard deviation of y

Sharp Model In this method, optimal portfolio is set up by using the single index model. Symbolically it is represented as, Sharp Index = RJ RF BJ Where, RJ = Expected return on the stock RF = Risk free return BJ = Beta relating the J stock to the market return. The return on any stock depends on some constant () called Alpha plus coefficient () called Beta, times the value of a stock Index (I), plus random component. The sharp model equation set as below: RJ = J + JI +eJ Where, RJ = Expected return on security J J = Alpha coefficient

J = beta coefficient is the slope of straight line I = Expected returns on index of the market eJ = Error term with a mean zero and standard deviation which is constant.

The Markowitz model had serious practical limitations due to rigorous involved in compiling the expected returns standard deviation, variance and covariance of each security to every other in the portfolio. Sharp model has simplified this process by relating the return in a security to a single market index. This will theoretically reflect all well trade securities in the market. Secondly it will reduce and simplify the work involved in compiling elaborate matrices of variances as between individual securities. Arbitrage Pricing Theory Like CAPM (Capital Asset Pricing model) Arbitrage Pricing Theory is an equilibrium model of asset pricing but assumes that the return are generated by a factor model. Arbitrage Pricing Model assumptions are: 1) Investors do not look at expected returns and standard deviation. If the price of asset is different in different market, Arbitrage Pricing Model brings them to the same price. 2) Investors prefer higher wealth / return to lower wealth 3) Arbitrage Pricing Model is based on the return generated by factor model. In Arbitrage Pricing Model, there are two factor models; 1. Single Factor Model 2. Multiple Factor Model In the first model, asset price depends on single factor, say Gross National Production or Industrial production or Money supply inflation rate and so on. Whereas in multiple factor model, number of variables are taken into account for the asset price model. This theory claims that the non factor risk can be reduced to zero, it is not possible in real life. Therefore in practical investment, it is better to combine the Capital Asset Pricing model and Arbitrage Pricing Model. Most investors prefer no doubt higher level of expected return and dislike higher level of risk. The fact is trade off between them which is not considered by the Arbitrage Pricing Model. Synthesis of Capital Asset Pricing model and Arbitrage Pricing Model is therefore more realistic.

Chapter 7 Modern Portfolio Theory Modern portfolio theory assumes that investors are normally risk averse and they try to minimise risk by all possible methods. MPT depends on the concepts of diversification and the use of Beta for reducing the risk. The basis of MPT can be stated as below; 1. Diversification 2. CAP Theory and Concept of Dominance 3. Role of Beta Diversification means investment in more than one assets or industry with a view to reduce risk. This can be explained more effectively with the help of chart. While closely observing chart below we can easily conclude that if the investor prefers to be on the curved line AB than that of straight line AB he will earn more return with same amount of risk at the point P as compare to point Q.

CAP Theory and concept of dominance is another concept of MPT. As we are aware that risk and return has direct relationship. Investor or portfolio managers are entitled to make various combinations of assets in portfolio. These combinations are called opportunity set. A portfolio manager has opportunity to include risk free assets in his portfolio. Like FDs, bonds etc. if he includes such risk free assets, he lowers the risk of the total portfolio.

Systematic and unsystematic are the two types of risks in the market. Out of which the later one can be reduced by diversification but the former can be reduced or handled through Beta. Thus, Beta plays a significant role in portfolio management. In short we can say that Beta is used for managing non-diversifiable part of risk. The portfolio investment strategy includes following points; 1. Asset allocation 2. Risk Management Strategy 3. Duration 4. Beta 5. Target Return 6. Borrowing for investment Every investor wants to maximise the return, but at the same time he has to keep eye on his regular inflow and outflow of cash. He has to do proper allocation of assets he held to achieve income, growth and mixture of both. Strategy for risk management is depending on type of risk investor faced. For unsystematic risk management of duration and diversification is enough. And for systematic risk use of Beta is essential. The targeted return is another important point in investment strategy. An investor who wants only risk free return can invest in Government bonds or FDs, which will yield him only 6 10% and sometime more. But if he wants to have higher return and ready to take higher risk the risk premium is available to him. If the market return is 20% with the Beta of 1.3, he will get 26%, which is the target return.

Chapter 8 Portfolio Management: Construction, Revision and Evaluation Theory of portfolio is the basis of portfolio management. It relates to the efficient portfolio investment in financial as well as physical assets. A portfolio of an individual or corporate unit is the holdings of different securities. These holdings are the result of individual preferences and decisions of the holders. Following are some of the preferences of client or investors which must noted first before investment. 1. Income and saving decision. 2. Asset preference profile. 3. Investors objectives, financial commitments. 4. Tax brackets and his preference for planning tax liability 5. Time horizon in which investment should fructify. After seeing the preferences of investor lets look at different objectives of investors. These are to be specified in the first place. 1. Income 2. Capital appreciation 3. Future provision The investor has to set out his priorities of investment keeping the following motives in mind. 1. Capital Appreciation. 2. Income. 3. Marketability or Liquidity. 4. Safety or Security. 5. Hedge against Inflation. While looking at preferences, objectives and motives one should not forget the main point in investment, and that is Tax. Investor should look after tax provision before investing in any security. Some securities interest is fully tax exempted whereas others are taxable. Investor has to decide carefully the allocation of such securities in portfolio. The other income source from investment is capital gain. This refers to profits earned on the transfer, sale or exchange of an asset. The long term capital gains are exempted if these funds are invested in Central Government securities, UTI or CGI schemes. Allocation of available funds among different set of assets for investment is called portfolio construction. The basic objective of portfolio management is to maximise yield and minimise risk.

The other ancillary objectives are as below; 1. Regular income 2. Appreciation of capital 3. Liquidity and Marketability 4. Minimising of Tax Liability 5. Safety of Investment As we know all investments have risks, some of them are higher and some of others have lower. The relationship between risk and return is direct. There are two types of risks, i] systematic and ii] unsystematic. The former can be controlled by using of Beta values and the later can be handled by diversifying the scrips up to optimum level of about 15 shares. In the management of portfolio, the risk management is vital. Every investment strategy should have time horizon from short period of one year to a few years. Capital gains is considered long term if equity investment is for at least one year and other investments for at least three years. Portfolio management encompasses three major categories of activities. 1. Asset allocation 2. Shift between classes of assets 3. Security selection within each class. To construct efficient portfolio, we have to conceptualise various combinations of investments in the basket and designate them as portfolio 1 to n. Then the expected returns from these portfolios are to be worked out. As seen earlier the risk part is handled by diversification and taking into account the values of Beta. Since market behaviour is outside the control of investor, he can only reduce the specific component of risk by choosing the individual scrips with proper betas, to achieve the result. In the real world, there are three different levels of efficiency of the stock market. Those are, 1. Weak Form 2. Semi-Strong Form 3. Strong Form The selection of portfolio is vital in case of weak form. As in weak market condition the portfolio should give investor maximum return with that of minimum risk. Following are elements of portfolio management, 1. Identification of investors objectives, preferences etc. 2. Strategies for investment policy formulated. 3. Constant review and monitoring of performance. 4. Evaluation of portfolio for results to compare.

The investment alternatives for portfolio management are set out as below, 1. Asset Class 2. Industry Groups 3. High Income Yielding Securities 4. Companies with Export Orientation 5. Companies based on Locations 6. Types of Management, viz., Family, Professional etc. Portfolio management is based upon Security Analysis, which is an analysis of share price. This analysis is done in following way, 1. Analysis at Macro Level of Market 2. Analysis at Macro Level of Company The theories explain these analyses are i] Fundamentalist Theory ii] Chartist School iii] Random Walk School. Investment analysts and Portfolio Managers constantly monitor and evaluate the results of their performance. Any revision in portfolio is required or not is decided on this evaluation. The basic features of good portfolio managers are their ability to perceive the market trends correctly and make correct expectations and estimates regarding risk, returns, ability to make proper diversification, to reduce the company related risk and use of estimates for selection of securities to reduce the systematic risk. Following are some of the measures along with their formulas to calculate portfolio performance, which are used by portfolio managers and investors who manages their own portfolio. 1. Sharps Measure ST = (Rt Rf) t Where, ST = Sharp Index Rt = Average Return on Portfolio Rf = Risk Free Return t = Total Risk of the Portfolio 2. Treynors Measure Tn = (Rn Rf) n Where, Tn = Treynors measure of evaluation Rn = Return on Portfolio Rf = Risk Free Rate n = Beta, as Measure of systematic Risk

Chapter 9 Portfolio Management by Corporates Corporates are owned by investors, whose objective is maximization of their wealth. In India, the ownership of corporate is mainly in the hands of financial institutions and mutual funds companies. The individual share holders percentage in this is just 20% to 30%. Corporate managers secure funds from banks, financial institutions so their interest stands prominent in the minds of portfolio managers. In the case of listed corporate securities, there is no dialogue between corporate managers and investors. The exception here is daily price quotation of scrip on the exchange. The companies normally keep continuous contact with financing banker and institution. The role of individual investor can have their say only at annul general body meetings. The performance and operations of corporates are also guided by the Government and SEBI Regulations, company law and the listing agreement with stock exchange. Leaving aside the above regulations and code of conduct in respect of listed companies, the operational result and risk and return aspect shows their impact on the stock exchange. A company which is of loan and investment type will be less preferred by the investors, as compared to manufacturing companies like HLL, Reliance L & T etc. Investment by corporate business may be in physical and financial assets. If it is in financial assets the Markowitz analysis of risk return holds good. But of it is in physical assets, as a part of business, we have to take in to account the project risk, revenue sensitivity etc. Following are the different types of risks which lead to any type of business, 1. Business Risk 2. Market Risk 3. Financial Risk 4. Purchasing Power Risk 5. Interest Rate Risk All above risks can be summarized in one type i.e. market or systematic risks. These types of risks cant be reduced by diversification but can be adjusted through the use of market Beta and the company Beta. Beta provides a tool for the corporate managers to understand and the risk which they can take with the expected return of investors. The formula of Beta calculation is as below,

Jm

J m 2

Where, RJm = expected correlation between possible returns for the security and that of market portfolio. = standard deviation of security m= standard deviation of market portfolio The values of Beta are published by the Equity Research organizations, capital market, and ICF AI journal. In the corporate business what investors prefers are companys physical operations as also its financial operations should be at that level of risk relative to return. The CAPM provides an appropriate theoretical framework to the assessment of risk and return within the operating business of corporates. The investment decisions are made independent of financial decision; but a corporate manager has to correlate them at the time of taking such decisions. Project undertaken, are generally decided on the basis of business strategy. Such decisions are also based on financial returns or estimated return. These returns can estimated on the basis of expected cash flow over the period of project. The risk associated with the return can be calculated in terms of variability of return by using company Beta and project Beta to compare it with industry Beta. Company Revenue Sensitivity and Company gearing factor are also useful indicators of investor perception of the company. According to Alan Bainbridge, CAPM provides the appropriate theoretical framework to link the requirements of investors in terms of their risk return perception to that of the investment decisions of the corporate manager. Corporate management has to take the investor interest into account in making financial, dividend and investment decision. As per the Agency Theory, the Corporate Managers are a group who are agents of the owner interest. There must be reconciliation between owners interest and debtors, creditors, Government and the general public. Agency theory describe that management acts in the best interest of owners or investors and the objectives of both are the same. A corporate manager has to operate his portfolio keeping in view their contribution to the wealth of the company in which investors are interested.