International Journal of Contemporary Business Studies

International Journal of Contemporary Business StudiesVol: 3, No: 4. May, 2012 ISSN 2156-7506Available online at http://www.akpinsight.webs.comMETHODOLOGYDataThe sample used in this study consists of 36 non financial-companies, listed on Pakistan’s KSE 100indice. The companies included in this sample cover a variety of industry sectors (like cement, food, oiland gas, tobacco, electricity, textile and automobile) and are Pakistan’s leading firms. Firms belonging tofinancial sector are excluded from the sample to enhance reliability. However as we required marketportfolio returns as well in our study, therefore as proxy for market portfolio of Pakistan we used all 100companies (both from financial and non-financial sectors) listed on KSE 100 indice. The daily returns ofstocks in sample have been obtained from business recorder 1 . The study is conducted on market data ofpast 4 years. The sample period ranges from January-2007 till December-2010. We use 12 monthsTreasury bill rate of Pakistan’s t-bills as proxy for the risk-free rates obtained from Pakistan State Bankwebsite 2 . KSE-100 indice values are used for proxy of market return; that are available at official websiteof KSE 3 .Portfolio formation and formulas for measurementThe methodology of portfolio formation on basis of size (market capitalization) and value (BV/MV) issame as followed by Fama and French (1993). The 36 raw companies were sorted on the basis of Avg.yearly market capitalization initially from smallest to largest (A to Z) or such that firms sort in ascendingorder of size (small size firms on top and big size on bottom). Two portfolios with 18 companies eachwere selected from size based sorting. Then each of these 2 portfolios (containing 18 firms in each) wasfurther sorted on the basis of avg. yearly Book value-to-market value ratio from largest to smallest (Z toA). The firms sort in descending order of their BV/MV ratio (firms with high BV/MV on top and lowBV/MV on bottom). Then each 18 firm’s portfolio was further divided into 3 portfolios of 6 companieseach after sorting BV/MV basis. This resulted in total 6 portfolios of 6 companies each on BV/MV basisfor a single year. Each of these 6 portfolios was then ultimately sorted on the basis of Debt-to-equityratios of each firm from largest to smallest (Z to A). The firms sort in descending order of their D/E ratio(firms with high debt on top and low debt or equity financing on bottom). Then each of six BV/MV basedportfolio is further divided into two portfolios of 3 companies each. This resulted in 12 portfolios of 3companies each on D/E basis for a single year.BV/MV ratio is calculated by using the following formula:Book to market ratio = Book value of share/market Value of ShareD/E ratio is calculated by using the following formula:Debt to equity ratio= total long term debt/total equityFor the firms D/E ratio is given in their annual reports, we used the figures without any furthermodifications.From daily prices the daily returns are calculated by using following formula:Return of stock=Ln (P t / P t-1 )Where,Ln = Natural logP t = Closing price of share on day ‘t’P t-1 = Closing price of share on day ‘t-1’Average monthly returns of stocks are calculated by taking averages of daily returns.1 www.brecorder.com/2 www.sbp.org.pk/3 www.kse.com.pk/10Copyright © 2012. Academy of Knowledge Process