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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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