CAPM AND ITS TESTING IN INDIAN MARKET: A REVIEW

So far, the thrust area of research in investment management was actually regarding how investment can be made positive? What are the factors to be considered? Which are the beneficial assets for the investment? How maximum profits can be earned? Etc… were the questions. No one clearly ever discuss about the real risk involved in the asset investment market. The investor should firstly know or critically analyze how risk is related to the assets and how this risk deeply influence the assets , what are the risks should bear by the investor during  the time of investment  and so on .Now in order to satisfy these requirements a new area of research in the field of investment risk is being emerged .The area of research like CAPM is the best example which shows the relationship between risk and return involved in the capital asset investment. CAPM can be defined as “a model that provides a frame work to determine the required rate of return on an asset and indicates the relationship between return and risk of the assets.”

In order to have a thorough idea of CAPM we should study of its assumptions also, why because every concept or theory should be approved if it has very precise and clear cut assumptions. The assumptions of CAPM includes:-

Ø Market efficiency: The capital market efficiency implies that share prices reflect all available information. Also, individual investors are not able to affect the price of securities. This means that there are large numbers of investors holding small amount of wealth

Ø Risk aversion and mean-variance optimization: Investors are risk –averse. They evaluate a security’s return and risk in terms of the expected return and variance or standard variance respectively. They prefer the highest expected returns for a given level of risk. This implies that investors are mean variance optimizers and they form efficient portfolios.

Ø Homogeneous expectations: All investors have the same expectations about the expected returns and risks of securities.

Ø Single time period: All investor’s decisions are based on a single time period.

Ø Risk – free rate: All investors can lend and borrow at a risk free rate of interest. They form portfolios from publicly traded securities like shares and bonds. 

Testing of CAPM

According to the assumptions of CAPM the practicability will be in hinge, why because assumptions never constitute a theory’s practicability. The practicability should be clearly tested with the data availability in the market and the result should lead to the correctness of the theorem. Under CAPM ‘Beta is taken as the risk factor in the investments and how this beta is related to expected return’, we have to prove this hypothesis. There has being using a lot of methods to test the hypothesis such as empirical testing, scientific testing etc…According to the different studies the result is different. As per some studies it is considered as there is no relationship between beta and expected return, where as some other tests say that there should have a very good and strong relationship among these factors. But according to CAPM there exist a relationship between beta and rate of return but not in a very strong way .   

TESTING OF CAPM OF “BAJAJ HOLDINGS & INVESTMENT COMPANY”  

In order to get the better understanding I select the “Bajaj holdings and Investment Company” for a case study regarding CAPM. For doing the CAPM test I collect three months data i.e. from 1/April/2010 to the date of 31/June/2010. Collect closing prices of this company and whole market, treasury bill market etc... For doing the test. Now there is a prescribed formula for calculating CAPM of any company. That is :-

RI = RF + (Rm - RF) B

Where RI = return of one company

              RF = free risk security

              Rm = market return     

              B = beta value

1) If Nifty unit moves forward Re.1 , then the Bajaj holdings and investment company’s share moves 0.3932054 unit 2) This indicates that the unit value of Bajaj is much lesser than the market value 3) If we compare the RI and CAPM columns in the first table it shows that real value of shares is less than the market value 4) For shareholders this is the best time to sell out their shares in Bajaj holdings company 5) The CAPM calculation is very much effective to take the above said decisions. 6) Testing of CAPM clearly shows the relation ship between how much return receiving that much risk is also their with the investment 7) Treasury bills are best examples for risk free investment.

FINANCIAL GIMMICKS

APPLICATION OF FINANCIAL STATEMENT GIMMICKS WITH A SPECIAL REFERENCE TO CIPLA LTD

INTRODUCTION

Forensic accounting as its name implies really doing the job of “Sherlock Holmes” in the business field. A forensic accountant is an upcoming post in every corporate with the aim of protecting the interest of investors as well as the whole society. As in real fact the ‘Companies Act 1956’ is the longest and powerful act in India and in case of world overlook most of the countries who are given importance for corporate sector having the same good quality stuff in there on countries. Not only the act but various organizations like SEBI India, SEC in USA are also being established in various forms and full fledged with 1000’s of rules and regulations also nevertheless still almost all the corporate are doing so many fraud practices  as and when they wants it.

The position of an auditor may be questioned to find out these kinds of fraud activities whereas it is essential to understand the real objectives of any auditor. The problems faced by any such corporate in forms of frauds are usually called as ‘Shenanigans’ and it is full and full duty of a forensic accountant to detect such shenanigans manipulated by the various designated persons in the corporate from the top executives to the lower employees. Now here through this assignment I am very much happy to perform as forensic accountant in order to detect the financial shenanigans of “CIPLA LTD “ which is one of the number one pharmaceutical company listed and having its operations in both BSE and NSE. This is a big company having the market cap of 27263.19   and a good market value of around 325-350.

FINANCIAL SHENANIGANS AND ITS INFLUENCE IN CIPLA LTD

Financial shenanigans are simply the fraudulent practices happened in a company. The financial shenanigans are happening through various ways such as boosting of income, revenue recorded too soon, shifting of expenses to a later period and so on. A company who is doing such things have the benefits of increasing there profits in an alarming way and through this can have the exchange market benefits also. According to most of the studies the shenanigans are doing by the top executives rather than low level employees. Here through this assignment let us check some doubtful areas of operations in “CIPLA LTD” and detect if there is any financial shenanigans.

COMPANY DETAILS

The basic details of the company is given below :-

Registered office of the company : Mumbai Central , Mumbai 400008

Founder of the company                : Dr. K.A Hamied

Chairman & MD                                : Dr.Y.K Hamied

Share capital                                      : 160.58 crore       

Market cap

Market price (as on 31/7/2012)     : Rs. 340   

Dividend payout ratio                       : 100%    

P/E ratio                                               : 24.25

EPS                                                        : 14

CHECKING FINANCIAL SHENANIGANS

The process of checking financial shenanigans will take step by step process, they are listed below in each case:-

(1)  Board of directors

The board of directors of CIPLA ltd includes the following persons:-

Chairman  & MD: Dr. Y.K Hamied

Joint MD      : Mr.M.K. Hamied

Whole – time Director   : Mr.s.Radhakrishnan

Non – executive Directors: Mr.V.C.Kotwal

                                                Dr.H.R.Manchanda

                                                Mr.M.R. Raghavan

                                               Mr.Ramesh Shroff

                                               Mr.Pankaj Patel

The chances or points which are leading to shenanigans:

·       The founder and the chairman and the joint MD are from the same family. Even though they are qualified in terms of education there is a high chance for autocracy administration which is one of the shenanigan

·       The salary of Y.K Hamied increased from Rs.50000/- to the pay scale of Rs.200000/- to Rs.800000/- scale with simple resolution in 2011. This resolution was not supported by the other executives, here also it can detect autocracy  (ref: annual report 2011)

(2) Explanatory notes annexed to the annual report

The explanatory notes in the annual report say the various extra ordinary activities carried out by the company for the last financial year. The chance of shenanigans of this area is given below:-

·       As per annual report it is stated that most of the plants are installed latest water equipments with crores of rupees, here the problem is that there is no basis for this explanatory notes anywhere in annual report and it is noted that replacing this much rupee equipments in all most all the factories is because of water leakage. How everywhere in single time happened like this a questionable explanation

·       In the annual report of 2011 there is not even a single explanation note relating to any of the future activities of the company or any carry forward information’s. lack of such information in the annual report also pointed the finger towards shenanigans

(3) Area of profit 

One of the most important area of doing financial shenanigan is profit of the company. If the company profit if growing without relating to the growth of sales then it is to be noted carefully.

FIVE YEARS PROFIT ANALYSIS
YEAR	SALES	PROFITS	EXPENSES
2007	6319.35	960.39	5163.77
2008	5605.69	1081.49	4408.85
2009	5234.29	776.81	4103
2010	4203.29	701.43	3392.49
2011	3561.99	668.03	2709.43

Here as per the table and the graph there is no chance of financial shenanigans in an apparent look. The proportion of moving profits are perfectly with the moving of sales and the expenses are also moving accordingly

(4) Extra ordinary item

Extra ordinary items are usually beyond the ordinary course of business of a company, but it is very essential to explain those things in the annual report in order to get better idea for the analyzers and investors. With this context while checking the annual reports and financial statements of CIPLA ltd following items are shown suspiciously:-

·       An amount of Rs.11.9 crores have been written in the financial statements without any explanatory notes or any further details.

(5) Stock adjustments

The item stock adjustment in the profit and loss account of the CIPLA ltd shows something notable fluctuations which can be treated as a warning

STOCK ADJUSTMENTS
YEAR	ADJUSTMENT AMOUNT
2007	-30.73
2008	41.37
2009	113.55
2010	184.09
2011	125.89

Here from the above table and chart showing the fluctuations of stock adjustments for the last 5 years. While thoroughly go through the chart it is clear that there is sudden jump from -30 crore to +41.37 crore and then growing in an alarming way that is from 41.37 to 113.55 and so on which should be treated as a shenanigan

(6) Area provisions

The area of provisions is one of the most easy area to the persons who are doing financial shenanigans, usually provisions are coming under non- cash item. The details of provisions are given below:-

PROVISIONS
YEAR	PROVISIONS
2007	410.13
2008	416.81
2009	391.71
2010	1347.66
2011	1508.87

Here from the chart and table it is under stand that something very great trouble happened during 2010, because here the provisions increased from 391.71 crore to 1347.66 crore which means a high jump of Rs. 955.95 crore. While checking the balance sheet there is no such necessity to create this much 955.95 crore provisions in a single year.

(7) Tax payment and profit

Usually tax is being paying in accordance with the profits of the company. An inappropriate tax payment suspects the financial shenanigan.

TAX PAYMENT
YEAR	TAX	PROFITS
2007	139.95	807.98
2008	136.93	838.36
2009	124.5	901.31
2010	243.5	1324.99
2011	191	1151.39

Here according to the above given data it is clearly understand that the amount paid as tax and the PBT is not at all in proportion. During 2007 profit was 807.98 crore and paid tax as 139.95 crore where as in 2008 profit increased to 838.36 crore but tax payment reduced to 136.93 crore. Likely from 2009 to 2010 the profit increased at an increased rate but tax rate increased in double of the previous, so while taking into consideration this there is a chance for over taxation amount by the company peoples.

(8) Interest payment and total debt

This is one of the most suspicious areas for financial shenanigan why because the changing of total debt of the company is in unbelievable fluctuation and the interest charged thereon is also not proportionate to the total debt of the company. There is high volatility in the total debt of the company (total debt includes) which is shown below:-

INTEREST PAYMENT
YEAR	INTEREST	TOTAL DEBT
2007	11.16	123.56
2008	18.05	580.53
2009	52.23	940.24
2010	28.3	5.07
2011	10.87	441.39

Here the company takes debt of 123.56 crore and the payment of interest is justifiable as 11.16 crore but in 2008 the debt suddenly go to 580.53 in an un believable way and the rate of interest is not at all justifiable which means it so much lesser than market rates. In 2010 there in very minor debt from the highest debt in the previous which is unimaginable, here in case of debt and interest company is definitely going through a great financial shenanigan.

CONCLUSION

The financial shenanigans are really a parasite to each and every corporate in anywhere in the world. However the rules are abiding the corporate or however the organizations are try to protect the corporate from the fraud is not a matter, there are fraudulent practices in almost every corporate. In order to avoid at least to a great extent now the new post called forensic accountants are being coming in every sector. It is compulsory to have a situation to reduce the financial shenanigans in every sector corporate in order to protect the interest of general investors as well as the morale of the general public.

CIPLA ltd cannot be categorized as a fully shenanigan cached company but even though there are certain such malpractices are happening in that company also. The basic problems noted are in the areas of interest payments, debt, and board of directors and in case of certain unexplained items.