ABSTRACT

Indian securities market is a highly volatile and sensitive market where portfolio construction
is highly important to get good returns. Thus the main focus of this research is to construct an
optimal equity portfolio with the help of Sharpe index model. Fifteen companies have been
selected and excess to beta ratio has been calculated and ranked the companies based on that
ratio. The cut-off point was calculated based on the highest value and cut-off point should be
used to calculate the proportion of money to be invested in each stocks.

INTRODUCTION
Indian securities market came into existence as a most predominant market due to the
globalisation and liberalisation which happened in the year of 1990s. Though it happened to
be a predominant market, only less than 2% of total population invests in stocks. Primarily it
has been divided into two parts, Primary market and secondary market. IPO happens in
primary market and trading of issued shares will happen in secondary market. Security
analysis and portfolio management will help to construct the optimum portfolio for the
equities market and helps to make the right decision for investment.
Generally, Security Analysis is broadly classified into three categories:
Fundamental Analysis
Fundamental Analysis refers to the evaluation of securities with the help of certain
fundamental business factors such as financial statements, current interest rates as well as
competitors products and financial market. Financial statements are nothing but proofs or
written records of various financial transactions of an investor or company. Financial
statements are used by financial experts to study and analyze the profits, liabilities, assets of
an organization or an individual.
Technical Analysis
Technical analysis refers to the analysis of securities and helps the finance professionals to
forecast the price trends through past price trends and market data.
Quantitative Analysis
Quantitative analysis refers to the analysis of securities using quantitative data. There are
many theories present in Security Analysis and Portfolio Management. Harry Markowitz was
the first who had given Modern portfolio theory and he is called as Father of Modern
Portfolio Theory. He provided analytical tools for analysis and selection of optimal portfolio.
This portfolio approach won him Nobel Prize in 1990. There was numerous complex
calculation should be done for the construction of portfolio in Markowitz model. So,
Markowitz work was extended by William Sharpe Model to reduce the complexity.
William Sharpe model will be the best model for Long-term investment and it has been
given as single index model because Individual market return in relation with the market
return is taken into consideration for the construction of optimum portfolio.

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STATEMENT OF PROBLEM
The portfolio should not be constructed based on the brand identity, current performance etc
because that would not help investors in achieving the anticipated return. The main aim of
portfolio construction is diversification and to maintain perfect negative correlation between
the securities. The optimum portfolio gives the investors a better clarity to invest the right
proportion of money in the right stock and it helps the investors to get maximum returns with
minimal risk.

OBJECTIVE OF THE STUDY

To study the relative market performance of 15 companies listed in National Stock
Exchange, India.
To construct an optimal portfolio and analyze its risk and return, for the investments
made by investors.
To calculate the proportion of money to be invested by investors out of their
investment.

SCOPE OF THE STUDY

Scope of the study is to construct the optimum portfolio to reduce its risk and maximise the
profits. Based on the historical performance, risk and return of those companies should be
analysed and top companies should be selected for construction of portfolio.

LIMITATIONS
Portfolio is constructed based only on risk and return.
Stock prices considered only for 5 years so that the real impact cannot be found.
This research is not be suitable for short-term investment.

REVIEW OF LITERATURE
Kwok Wai Yu, Xiao Qi Yang, Heung Wong (2007), explained the applications of the Sharpe
rule in portfolio measurement and management. It proposes that a portion of the portfolio
value should be invested in some other assets for portfolio improvement. With the help of
Sharpe rule they determined that the new stocks are worthy of adding to the old portfolio if
they satisfy a condition, in which the average return rate of these stocks is greater than the
return rate of the old portfolio.

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METHODOLOGY
Descriptive study has been done for the construction of portfolio of stocks where results
obtained on the selected companies. Secondary data is taken for the study and data has been
collected from various sources like National stock exchange website, Reserve Bank of India
website and other databases.
Sample Size: 15
The steps in constructing the portfolio using the Sharpe Method are as follows.
Find the excess return to ratio
Arrange the calculated excess return to ration in the descending order.
Find the cut-off points

TOOLS USED
Beta Coefficient
Beta coefficient is the relative measure of non-diversifiable risk. It is an index of the degree
of movement of an assets return in response to a change in the markets return.
=Correlation*(Y)/(X)
Where, (Y) = Standard Deviation of Individual Stock,
(X) = Standard Deviation of Market

Return
The total gain or loss experienced on an investment over a given period of time, calculated by
dividing the assets cash distributions during the period, plus change in value, by its
beginning-of-period investment value is termed as return.
Return = ((Todays market price Yesterdays market price)/Yesterdays market price)*100

Efficient Portfolio
A portfolio that maximizes return for a given level of risk or minimizes risk for a given level
of return is termed as an efficient portfolio.

Risk-Free Rate of Return (Rf)

Risk-free rate of return is the required return on a risk free asset, typically a three month
treasury bill.

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Excess Return to Beta Ratio

Excess Return to Beta Ratio = Ri-Rf/i
Where, Ri= the expected return on stock,
Rf = the return on a riskless asset,
i= the expected change in the rate of return on stock associated with one unit change
in the market return.

Cut-off Point
Ci = (

(Ri-Rf) /ei)/ (1+

Investment to be made in each Security

Xi=Zi/
Where, Xi= the proportion of investment of each stock.
And
Zi=i/ei (Ri-Rf/i-Ci)
Where, Ci = the cut-off point.

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ANALYSIS AND DISCUSSIONS

Table 1: Return, Standard Deviation, Beta and Residual Variance of Individual Stock
Portfolio Scrips

Individual
Return

Unsystematic Risk

ITC

45.15630781

2.48941059

0.561263549

6.197165084

HDFC
INFOSYS
ICICI
ONGC
SBI
TATA MOTORS
M&M
NTPC
BHEL
CIPLA
WIPRO
DLF
RANBAXY
SAIL

-8.034497417
2.956756271
72.82353214
-39.13308354
62.29244616
60.63047122
69.60074429
0.866573602
-85.35497731
51.13273521
49.03034737
-36.97339488
49.53198033
-10.1237203

3.792903111
1.923710021
3.39112593
3.322595538
2.734717596
4.300381038
3.386513204
1.964663737
3.593234935
1.938771035
2.803540103
3.937281052
2.989680009
3.231801617

1.148901333
0.692962931
1.549568331
0.825152399
1.143667091
1.30728804
1.074686915
0.722779541
1.032742164
0.498426256
0.886436543
1.572556532
0.745920128
1.296612145

14.38611401
3.700660244
11.49973507
11.03964111
7.478680331
18.49327707
11.46847168
3.859903601
12.9113373
3.758833127
7.85983711
15.50218208
8.938186558
10.44454169

Table 2: Excess return to beta ratio

Portfolio Scrips

(Ri-Rf)/

Rank

ITC
HDFC
INFOSYS
ICICI
ONGC
SBI
TATA MOTORS
M&M
NTPC
BHEL
CIPLA
WIPRO
DLF
RANBAXY
SAIL

65.77357
-14.1653
-7.62414
41.6784
-57.4113
47.2624
40.07569
57.09639
-10.2015
-90.6276
86.05633
46.01609
-28.7515
55.35711
-14.1628

2
12
9
7
14
5
8
3
10
15
1
6
13
4
11

New Ranking
CIPLA
ITC
M&M
RANBAXY
SBI
WIPRO
ICICI
TATA MOTORS
INFOSYS
NTPC
SAIL
HDFC
DLF
ONGC
BHEL

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CIPLA yielded the maximum return among the companies selected and Bharat Heavy
Electricals Limited yielded lower return following that ONGC and DLF yielded lower return.
Pharma and FMCG have shown a higher return in all the companies chosen for the analysis.
It shows that Pharma is the growing sector and it is most preferred investable securities in
India. Beta is greater than 1 in Mahindra and Mahindra, State Bank of India, ICICI, Tata
Motors, SAIL, HDFC, DLF and BHEL, which shows that these securities have more risk and
at the same time the reward per unit of risks is also more.
Sharpe has provided a model for the selection of appropriate securities in a portfolio.
The excess return of any stock is directly related to its excess return to beta ratio.
The ratio provides a relationship between potential risk and reward. Ranking of the stocks are
done on the basis of their excess return to beta. Based on the excess return to beta ratio the
scrips are ranked from 1 to 15, with Cipla being in the first rank and BHEL being in the last.
The excess return to beta ratio was calculated using 8.24% as risk free rate of return.

Table 3: Cut-off point calculation for 15 companies

Scrip's

(Ri-Rf)/

(Ri-Rf)/

Cumulative
(Ri-Rf)/

(RiRf)/New USR

CIPLA
ITC
M&M
RANBAXY
SBI
WIPRO
ICICI
TATA MOTORS
INFOSYS
NTPC
SAIL
HDFC
DLF
ONGC
BHEL

86.0533
65.7735
57.096
55.357
47.262
46.016
41.678
40.075
-7.624
-10.201
-14.162
-14.165
-28.7515
-57.411
-90.627

5.687379398
3.341892869
5.749556017
3.445805809
8.265778228
4.600165897
8.699877204
3.703284478
-0.989405019
-1.380681883
-2.279726714
-1.318923544
-4.586181493
-3.541066306
-7.48621515

5.687379398
9.029272267
14.77882828
18.22463409
26.49041232
31.09057822
39.79045542
43.4937399
42.50433488
41.123653
38.84392628
37.52500274
32.93882125
29.39775494
21.91153979

19.32693481
30.68340342
50.22162771
61.93121477
90.02010172
105.6524519
135.2165003
147.8010551
144.4388446
139.7469915
131.9999913
127.5180062
111.9331781
99.8998754
74.46011096

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Scrip's

CIPLA
ITC
M&M
RANBAXY
SBI
WIPRO
ICICI
TATA MOTORS
INFOSYS
NTPC
SAIL
HDFC
DLF
ONGC
BHEL

0.066085602
0.050785206
0.100691043
0.062246653
0.174891585
0.099964625
0.20866171
0.092387723
0.12975957
0.13533938
0.160970084
0.093039463
0.159522223
0.061678823
0.082601603

Cumulative
/

1+

0.066085602
0.116870808
0.217561851
0.279808504
0.454700089
0.554664714
0.763326424
0.855714147
0.985473717
1.120813097
1.281783181
1.374822645
1.534344868
1.59602369
1.678625293

1.224573046
1.397152067
1.739321824
1.9508493
2.545168408
2.884869641
3.593946876
3.907900171
4.348851017
4.808763253
5.355774118
5.671942166
6.214032888
6.423630754
6.704328713

Cut Off Point

(Ci)
15.7825904
21.96139142
28.87425835
31.74577082
35.36901583
36.6229553
37.62339982
37.82109281
33.21310481
29.06090073
24.64629545
22.48224726
18.0129684
15.55193305
11.10627389

Table 4: Selection of stocks among 15 companies

Scrips

Cut Off

CIPLA
ITC
M&M
RANBAXY
SBI
WIPRO
ICICI
TATA MOTORS

15.78259
21.96139
28.87426
31.74577
35.36902
36.62296
37.6234
37.82109

Table 5: Proportion of funds invested

Scrips

CIPLA

6.395374073

41.96%

ITC
M&M
RANBAXY
SBI
WIPRO
ICICI
TATA MOTORS

2.530425592
1.806077157
1.463401973
1.443729097
0.924188657
0.519553808
0.159321617

16.60%
11.85%
9.60%
9.47%
6.06%
3.41%
1.05%
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Cutoff Point
The selection of the stocks depends on a unique cut-off rate such that all stocks with higher
ratios of excess return to beta are included and stocks with lower ratios are left out. The
cumulated values of Ci start declining after a particular Ci and that point is taken as the cutoff point and that stock ratio is the cut-off ratio C. In Table 3 the highest value of Ci is taken
as the cut-off point that is C*

Construction of optimum portfolio

After determining the securities to be selected, one should find out how much should be
invested in each security. The percentage of funds to be invested in each security can be
estimated. As already mentioned all the stock with Ci greater than cut off point can be
included in the portfolio.
By using Sharpe index model thus we are able to find out the proportion of investments to be
made for an optimal portfolio. The maximum investment should be made in CIPLA with a
proportion of 42%. Following that ITC, Mahindra and Mahindra and RANBAXY are the
next three companies where major percentage of investment can be made.

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FINDINGS & RECOMMENDATIONS

The Pharma and FMCG sectors are the major contributors for the portfolio. Among
the selected 15 stocks, pharmaceutical sector is performing well. The beta values for
those stocks are lesser than 1 which indicates, minimal risk is involved in those
stocks.
The CIPLA forms the major contribution with 42% followed by ITC with 17%.
The recommended proportion investments to the companies according to constructed
portfolio are Cipla 42%, ITC 17%, M&M 12%, Ranbaxy 10%, SBI 9%, Wipro 6%,
ICICI 3%, and Tata Motors 1%.
Investors expecting high return for the minimal risk can go for Cipla (<1).
To investors who are risk lovers can go for M&M.

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CONCLUSION
Though there are 15 stocks that meet the criteria for being included in the Portfolio, the
portfolio is constructed with the top 8 stocks that meet the criteria to be included in the
portfolio according to the Sharpe Index Model. Those stocks are: CIPLA, ITC, Mahindra &
Mahindra, Ranbaxy, State Bank of India, Wipro, ICICI and Tata Motors. The portfolio
predominantly consists of stocks from the pharmaceutical sector.
Thus the portfolio construction table would help an investor in investment decisions. And the
investor would select any company among the fifteen companies from the above portfolio
table.

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