Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Security Analysis – II - Question Paper

< TOP >

10. The subsequent principles are to be applied while using support and resistance lines for pattern analysis:

i. Support and resistance lines are only approximations of the levels, prices may be expected to ‘obey’. They should, therefore, be drawn using judgement, and clues from the past price behavior.

ii. Penetration of a support and resistance line, also confirmed by an underlying price pattern, is a fairly sure indication of a strong ensuing move in the identical direction. New highs are reached after a resistance line is penetrated and new low follow penetration of a support line.

iii. Prices are stated to remain in a ‘congestion zone’ as long as they fluctuate in narrow ranges within a support and resistance level. The direction of breakout from a congestion zone cannot be predicted in advance.

iv. The higher the quantity accompanying the confirmation of a support or resistance level, the more its significance.

v. The speed and extent of the previous move determines the significance of a support or resistance level. Prices penetrate support (resistance) level generally after slowing down from a previous low (high) and hovering around a level for sometime.

Support and resistance levels repeat their effectiveness time and again, even if separated by many years.

< TOP >

Caselet 3

11. The different kinds of beta values are as under:

Negative beta - A beta less than 0 - which would indicate an inverse relation to the market - is possible but highly unlikely. a few investors used to believe that gold and gold stocks should have negative betas because they tended to do better when the stock market declined, but this hasn't proved to be actual over the long term.

Beta of 0 - Basically, cash has a beta of 0. In other words, regardless of which way the market moves, the value of cash remains unchanged (given no inflation).

Beta ranging from 0 and one - Companies with volatilities lower than the market have a beta of less than one (but more than 0).

Beta of one - A beta of one represents the volatility of the provided index used to represent the overall market, against which other stocks and their betas are measured.

Beta greater than one - This denotes a volatility that is greater than the broad-based index. Technology companies on the Nifty have a beta higher than 1.

Beta greater than 100 - This is impossible as it essentially denotes a volatility that is 100 times greater than the market. If a stock had a beta of 100, it would be expected to go to 0 on any decline in the stock market. If you ever see a beta of over 100 on a research site it is usually the outcome of a statistical error, or the provided stock has experienced large swings due to low liquidity, such as an over the counter stock. For the most part, stocks of well-known companies rarely ever have a beta higher than 4.

< TOP >

12. Beta seems to be good measure for determining risk of an investment but there are a few issues with relying on beta scores alone.

· Beta looks backward and history is not always an right predictor of the future.

· Beta also doesn’t account for modifications that are in the works, such as new lines of business or industry shifts.

· The stocks, which have substantial weight in the portfolio, may outcome in a lower beta implying that the risk is very low and the other stocks may outcome in a higher beta implying that the stocks are risky. Thus the accuracy of the beta estimate is based on the right index chosen.

· Beta suggests a stock’s price volatility relative to the whole market, but that volatility can be upward as well as downward movement. In a sustained advancing market, a stock that is outperforming the whole market would have a beta greater than 1.

· Before estimating the beta 1 needs to decide the time horizon over which the regression has to be made. If only few observations are made then the estimate may not reflect the actual beta.

· Accuracy of the beta also depends on the time interval over which the returns are calculated. The interval should be chosen based on the trading cycle of the user i.e. if the trading cycle is daily it is better to have monthly returns for regression otherwise outcomes may not be actually reflecting the modifications.



< TOP >

13. If we consider the general economic cycle it will be like slowdown in the economy, a recession, revival in the economic activity followed by and economic boom and then slowdown. If we observe the economic activity during every of these phases we obtain that every 1 is a distinct phase. The characteristics of slowdown in the economy are various from that of economic recession and the characteristics of recession are various from the characteristics of the revival in the economy. That is, any parameter calculated in 1 phase may not be applicable to study the characteristics of any other phase. Similar is the issue with Beta also. A Beta calculated during periods of recession is not applicable during the periods of boom or during the periods of economic revival. It has to be adjusted properly in order to reflect he characteristics of the period under study. Therefore, beta which denotes the systematic risk or undiversified risk component calculated in a few other period fails to reflect correctly the associated risk of a stock during periods of economic slowdown and recession.

< TOP >

< TOP OF THE DOCUMENT >

Earning:   Approval pending.