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Reinvestment Risk

By: Punam Sharma

  • Reinvestment risk is one of the risk investor faces when invested in debt market.
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  • It refers to the risk that the coupon or principal amount will have to be reinvested at a lower yield rate prevailing at the time of maturity or when the coupon amount is received.
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  • Reinvestment risk is greatly influenced by market interest rate.
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  • When interest rate falls, investors face higher reinvestment risk.
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Reinvestment Risk & Interest Rate

 

  • Most of time, investors reinvest the coupon or principal amount received, which will be at the current market yields.
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  • The current market yield can be higher, lower or equal to the coupon rate at the time of investment.
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  • In case the current market yield is lower, the coupon proceeds or principal received will be reinvested at lower rate thereby reducing investor return.
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  • This risk of reinvesting at a lower rate is called reinvestment risk.
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Reinvestment Risk

     

  • One way investors can reduce reinvestment risk is by staying invested for a longer duration.
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Impact of Reinvestment Risk explained through example
 

 
Impact of Reinvestment Risk explained through example

 

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Industry Sector of GDP

By: Punam Sharma

Industry Sector of GDP

 

  • Industry sector’s share in total GDP has mostly remained stagnant between 10% and 20% since FY1951, FY2014 being 18.7%.
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  • Industry sector is broadly divided into 3 subsectors namely – Mining & Quarrying, Manufacturing and Electricity, Gas & Water Supply.
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  • Manufacturing sector since FY1951 has the largest share contribution to the industry sector. FY2014 being 14.94%.
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  • Sectors mining & quarrying, electricity, gas & water supply has minuscule share of around 2% each since FY1951.
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Industry Sector Growth
 

  • Industry sector has recorded average growth of around 5.8% (FY1952 to FY2014).
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  • FY2014, industry sector recorded a contraction at -0.15% on account of moderation in both domestic and global demand and rising input cost.
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  • Since FY1952, industry sector has only contracted 3 times – FY1980, FY1992 and FY2014.
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  • The industrial sector contraction mostly reflects manufacturing sector contraction due to its high share contribution.
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  • Mining sector consecutively since 2 years has contracted at -2.16% and -1.38% FY2013 and 2014 respectively.
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  • FY2014, manufacturing sector contracted by 0.71% reflecting poor investment demands and consumer spending weakness.
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  • Electricity sector since FY1952 has never recorded a contraction although electricity sector growth has fluctuated from 11.63% in FY1952 to 5.92% in FY2014.
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Industry and Sub Industry Sector Growth

 
Gross Capital Formation (GCF) in Industry Sector
 
Gross Capital Formation (GCF) in Industry Sector

 

  • Manufacturing sector GCF share to total GCF is the highest among all the sub sectors including from service and agriculture sector between 20% and 40%.
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  • However since 3 years, GCF in manufacturing sector has been declining from 35% in FY2011 to 24% in FY2014.
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  • Decline in GCF in manufacturing sector can be reflected in overall decline in industry sector GCF from 46% in FY2011 to 34% in FY2014.
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Initial Public Offer (IPO)

By: Punam Sharma

  • A company can raise capital either by issuing debt or equity.
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  • It can raise equity capital via public issue, rights issue, bonus issue or private placement.
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  • Public issue refers to issue of shares to new investors and can classified as initial public offer (IPO) and offer for sale (OFS)1.
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IPO snap shot
 
IPO snap shot

 

  • Chart below shows no of IPOs issued and amount raised over the years.
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No of IPO’s issued over the years

 
Amount of IPO raised over the years

 

  • From the above charts, we can observe 1996 had the maximum IPOs issued till date while 2003 was the year when least no of IPOs were issued.
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  • 2008 had the highest amount of 42,595 crore raised through IPO.
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  • In 2014, no of IPOs issued was higher at 38 compared to 33 in 2013, however amount raised through IPO was much lower at 1,236 crore as against 6,258 crore in 2013

 

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Per Capita Income

By: Punam Sharma

  • Per capita income refers to income earned per person in a country on an average basis.
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  • It is calculated by dividing country’s national income by its total population.
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  • Per capita income is used as a tool to measure a country’s standard of living. However, it represents average income per person therefore does not always give accurate representation of the country’s standard of living due to skewness of data towards a small portion of population earning higher income.
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  • Rising per capita income signals growth in the economy translating a productivity increase.
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  • Chart below shows trend in India’s per capita national income over years in actual and growth terms.
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Per Capita Income Trend

 

  • Per capita income can also be applied to a city or state as well.
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  • Indian states have significant disparities in their per capita income with Bihar having lowest per capita income of around 312 and Delhi with highest per capita income of around 2199.
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Per Capita Income Trend

 

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Moving Average

By: Punam Sharma

  • Moving average is a technical trend indicator used to gauge price direction of the stock or index.
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  • As the name implies, it averages the price of the stock or index and as the price data moves, average also moves.
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  • New daily price is included to calculate the average and old price data is removed one day at a time.
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  • Price average can be calculated over various time spans, common ones being 15,20,30,50,100,200 days.
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  • Longer the time span, less sensitive the average will be to price changes.
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How is moving average calculated?
 

  • There are 2 ways to calculate moving average-Simple Moving Average and Exponential Moving Average.
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  • However, in general while speaking of moving average, simple moving average is referred.
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  • Simple moving average is calculated by taking the average of the stock price over given period of time.
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  • For example 200 day moving average (DMA) is calculated by adding closing price of stock from last 200 days including current closing price and then dividing it by 200 (total number of time periods)
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Why moving average is used
 

  • The main purpose to use moving average is to identify the price trend of a stock or index as it helps to smoothen out the day to day price fluctuations.
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  • Generally, when the stock price is above the moving average upward trend is considered and when stock price is below the moving average the trend is considered downward.
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  • It is to be noted that moving average is a lagging indicator as it uses historical data and just shows the price trend.
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  • Other uses of moving average are it helps determine the support and resistance level of a stock price, setting stop losses.
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Crossover
 

  • Crossover is a common signal used in moving average to understand the shifts in price trends.
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  • Price crossover refers to when the stock price crosses through the moving average either above or below signaling change in trend.
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  • Charts below show nifty spot price and its 200 DMA from January 2000 to September 2014.
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Divergence from moving average
 

  • Divergence from moving average is calculated as the difference between stock prices from its moving average.
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  • Divergence signals trend reversals.
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  • When the divergence is high on either sides there is eminent trend reversal which can be observed in below chart.
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Divergence of Nifty Spot Price from 200 DMA

 

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Service Sector of GDP

By: Punam Sharma

  • Service sector is broadly divided into construction, trade, hotels, transport & communication, finance, insurance, real estate, community and social & personal services.
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Sectoral Contribution to total Service Sector

 

  • Since 1951, trade, hotel, transportation & communication sector has always had the highest share in service sector.
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  • Over the years, share of finance, insurance, real estate & business service has been increasing from 24% in FY1951 to around 31% in FY2014.
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  • However, community social & personal services share has fallen from 29% in FY1951 to 19% in FY2014 while construction share in service sector has hovered around 11% to 15%.
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  • Service sector over the years has been the major contributor to overall GDP growth surpassing agriculture share.
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  • Over the years, share of service sector to total GDP has increased sharply from 35% in FY1951 to 67% in FY2014.
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Service Sector contributation to total GDP

 

  • Service sector has always recorded positive growth. Since FY1952 till FY2014, sector average growth rate is around 6%.
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Gross Capital Formation (GCF) in Service Sector
 

  • GCF in service sector as % to total GCF over the years has always been the highest ranging from 49% to 70%.
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  • Service sector GCF share to total GCF was 58% for FY2013.
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Gross Capital Formation (GCF) in Service Sector

 
”% to total GCF

 

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Consumer Price Index (CPI)

By: Punam Sharma

  • Consumer level price changes of goods and services are measured by CPI.
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  • Earlier India did not have a single CPI but there were four CPI namely CPI-Industrial workers, CPI- Rural Labourer, CPI-Agricultural Labourer and CPI-Urban Non-Manual Employees.
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  • However CPI-Urban Non-Manual Employees has been discontinued and a new index was launched.
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  • New CPI index (base 2010) was launched in January 2011 which measures changes in prices of goods and services consumed by rural and urban population.
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  • In the new CPI, food which has been major contributor to inflation has been given higher weightage.
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  • However, the most important factor is that new CPI captures price changes in service sector (contributing 60% of GDP) which is not captured in the whole sale price index (WPI).
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  • After the Urjit Patel Committee report, RBI monitors inflation at CPI level more closely.
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  • Charts below shows broad breakup of the index and CPI-inflation trend over the years.
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Percentage of CPI

 
Inflation Trend

 

  • We can observe from the above chart that food having highest weightage of around 49% has been the major contributor for the high inflation.
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  • Food inflation has increased from around 4% in January 2012 to 9.14% in July 2014. Food inflation had gone as high as 14.45% in November 2013.
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  • Over the years, clothing, bedding and footwear inflation has decreased from around 22% in January 2012 to 8.73% in July 2014.
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  • Miscellaneous inflation which mostly includes composition of service sector has hovered around 6 to 9% over the years.
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Difference between component weightings in CPI-Rural and CPI-Urban
 
Difference between component weightings in CPI-Rural and CPI-Urban

 

  • From the above chart, we can observe that CPI-rural level has higher component weightings with food having share of around 59%.
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  • Most important difference is that housing inflation is not included in CPI-rural and only captured at CPI-urban level.
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  • Indian economy is broadly divided into 3 sectors which contribute to the gross domestic product of (GDP)1 of the country namely agriculture and allied activities, industry and services.
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  • Agriculture and allied activities include agricultural products, livestock, forestry & logging, fishery.
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  • Share of agriculture and allied activities sector to total GDP was 13.94% in FY2014.
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  • Over the years, there has been a continuous decline in the share of agriculture and allied activities sector to total GDP from around 52% in FY1951 to around 14% in FY2014.
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  • The falling share of agriculture and allied sectors in GDP can be attributed to the expected outcome of a fast growing and structurally changing economy.
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Agriculture & Allied activities Sector Contribution to total GDP

 

  • Agriculture and allied activities sector grew by 4.7% in FY2014 compared to a 1.4% growth in FY2013.
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  • Post the negative growth in FY2003, agriculture and allied activities sector has shown positive average growth of around 4.09% (FY2004 to FY2014).
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Trend of Agriculture & Allied activities-GDP & Growth

 

  • Gross capital formation (GCF) in agriculture and allied Sectors as % to GDP in this sector has been showing a steady increasing trend from 13.5% in FY2005 to 21.2% in FY2013.
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  • Agriculture and allied activities sector GCF share to total GCF was 7.7% for FY2014.
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Agritulture & Allied activities sector Gross Capital Formation

 

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Personal Income Tax

By: Punam Sharma

History of Personal Income Tax of India
 
History of Personal Income Tax of India

 

 

  • In India, personal income tax is paid on the income earned. Higher the income, higher the tax paid.
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  • Over the years, income tax slabs and rates have undergone a lot of changes.
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  • Compared to today, historically tax rates were much higher with more income tax slabs.
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  • Personal income tax over the years has been rationalized and the recommendation from Tax Reform Committee,1991, personal income tax slabs were reduced to 3 along with tax rates brought down to 20%,30% and 40%.
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  • From financial year 1997-98 tax rates have been further reduced to 10%, 20% and 30% which has remained constant till date. However income tax slab amounts have undergone changes.
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  • Chart below shows trend in personal income tax collection.
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Trend in Personal Income Tax collection

 

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Alpha

By: Punam Sharma

What is alpha?
 

  • Alpha refers to the excess return on a stock portfolio or fund over and above the benchmark1.
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Alpha = Actual Portfolio Return – Benchmark Return
 

  • Generally, one generates alpha by actively managing a stock portfolio or fund with diversification, risk management.
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  • It is one way to measure stock portfolio or fund performance as it shows how much returns is generated by actively managing the stock portfolio or fund in comparison to benchmark returns.
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  • Positive alpha means stock portfolio or fund return has outperformed the benchmark return while negative alpha means underperformance of the stock portfolio or fund management.
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  • Suppose stock portfolio or fund return is 15% p.a. and benchmark return is 10% p.a. then we can say the stock portfolio or fund has generated positive alpha of 5% p.a.
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Jensen Alpha
 

  • Jensen alpha is another way to measure alpha by adjusting for the risk (beta2) taken.
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  • Jensen alpha formula is
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a = Rp – [Rf + (Rm –Rf) * ß

 
Where
a = Alpha
Rp = Portfolio return Rf = Risk free rate
Rm = Benchmark (Market) return
ß = Portfolio beta
 

  • From the above formula, we can see that there are 3 determinants of alpha – portfolio return, benchmark return and portfolio beta.
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  • Out of the three, portfolio beta can be actively managed by constructing a low or high beta portfolio as portfolio return is outcome of active management of portfolio beta and benchmark return cannot be controlled.
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  • Positive alpha is when portfolio return outperformed the benchmark return reflecting better risk adjusted portfolio.
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  • While negative alpha is when portfolio underperforms the benchmark reflecting portfolio has earned little for the risk taken.
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Link between alpha and beta
 

  • Alpha is the excess return one earns on a stock portfolio or fund vis a vis the benchmark returns.
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  • However, one should also measure the excess return generated against the risk taken for the investment.
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  • It is not correct to say stock portfolio or fund generated positive alpha unless it is adjusted for risk taken to invest.
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  • Let’s understand the link between alpha and beta with help of an example.
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  • Let’s assume a stock portfolio has a return of 14%p.a., beta of 1.5 and benchmark return of 12%p.a.
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  • We can see that without taking risk into consideration the stock portfolio has a positive alpha of 2%p.a. (14%-12%).
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  • Is this sufficient to say it’s a good investment without adjusting for the risk taken to invest?
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  • The portfolio has got beta of 1.5 which means its 50% more volatile than the benchmark. Therefore the portfolio should have earned a return of 18% p.a. (12% * 50%).
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  • However it has generated return of 14% p.a. i.e. 4% lower than the return required to compensate for the risk taken.
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  • Therefore, technically the portfolio has generated negative alpha of 4% which shows poor management skill or not a good investment even though portfolio return was higher than the benchmark return.
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  • Generally, investors prefer investing in stock portfolio or fund which has positive high alpha and low beta.
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