BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, PILANI - K. K.

BIRLA GOA CAMPUS

Second Semester 2022-23, Comprehensive Examination
Course Title: Security Analysis and Portfolio Management Course No.: ECON F412, FIN F313
Examination Date: 19-05-2023 (AN) Max Marks: 80

Instructions: Use of calculators are allowed. This is an CLOSED-book examination. Please

write with a blue pen. Answers are to be presented in the required format wherever mentioned
for evaluation.

Section A: CROSSWORD(Each word carries 1mark)The max time is 30 minutes [17*1 = 17M]
Down
1. A---------------sale is a transaction in which the seller sells overpriced stock that he/she
does not own but borrows from another investor through a broker.
2. The ------------ theorem suggests that investment and financing are two different
decisions.
3. ------------is a high price range in which selling activity is sufficient to stop a price rise.
4. -----------of returns is the measure of the degree to which rates of return move together
relative to the individual mean values over time.
5. --------------risk is the risk that a bond is repaid early, and an investor has to find a new
place to invest with the risk of lower returns.
6. Property, plants and equipment are examples of -------------assets and claims on such
assets are
examples of financial assets.
7. The ---------- line is the 9-day moving average of the MACD line itself and is an
estimated valuation for the movement of the oscillator that makes bullish and bearish
MACD turns easier to see.
8. -----------measure represents the average excess return of the portfolio above that
predicted by an asset pricing model.
Across
9. --------------- risk is the risk that the market price of a bond will fall with the rise in market
interest rate.
10. A -----------form EMH is when prices reflect all historical information only.
11. --------- is a low-price range in which buying activity is sufficient to stop a decline in price.
12. The market -------------- in its' pure form means shifting funds between a market index
portfolio and safe assets such as T-bills or money market funds depending on whether the
market as a whole is expected to outperform the safe asset.
13. The ------------- is a composite measure that considers both coupon and maturity of the
bond to measure price sensitivity to interest rate changes.
14. The --------------- measure is calculated as excess returns per unit of systematic risk.
15. The APT differs from the CAPM because the APT recognizes multiple ---------risk factors.
16. Relative --------- index is a momentum oscillator indicator in technical analysis.
17. The parameter which demonstrates how the duration of a bond changes as the interest rate
changes and measures the curvature in the relationship between bond prices and bond
yields is _________

Section B:
Q 1. You are hired as a fixed-income portfolio manager. You have information about a corporate
bond issued recently in the market. This is a green bond issued to fund projects with positive
 environmentalbenefits. The bond is an AAA-rated bond. The par value of the bonds is ₹1000.
The characteristics of the bonds are provided below: -
You also have information on a Social bond. [5 marks]
Bond Time to maturity Coupon rate p.a. Payments
Social Bond (S) 6 years 6% Annual
Green bond (G) 4 years 8% Annual
The market interest rate (yield to maturity) is 8% p.a. for Green bonds and 6%p.a. for Social
bonds atthe time of issuance. State Whether True/False

1.1 The % change in price for 150 basis points increase in market interest rate usingduration and
convexity adjustment together for Green bond is between –ve 6% to –ve 3%
_________________True
1.2 The interest rate risk of Green bond is higher than Social bond____________ False
1.3 Ceteris paribus, higher the coupon rate, higher is the interest rate risk________ False
1.4 The annual convexity of Green bond is higher than Social bond ________ False
1.5 The Macaulay duration in years of Green bond is lower than Social bond ________ True

Q 2.1. Suppose there are 2 risky stocks, A and B. Stock A has an expected return of 4% and a standard
deviation of return of 5%. The corresponding statistics for Stock B are 11% and 9%, respectively. The
correlation coefficient between the returns of stocks A and B is -ve0.5. An investor wants to achieve a
standard deviation of 7% in his portfolio. What is the optimal portfolio (proportion invested in assets) for
the investor and what is the expected return of this portfolio? There are no restrictions in the market.Solve
with steps and answer in your answer sheet as the format given below. [2 marks]
WA (% upto 2 decimal) WB (% upto 2 decimal) E(Rp) (% upto 2 decimal)

Set I
A 4% 5% 17.7597% 100.000%
B 11% 9% 82.2403% 100.000%

CORREL -0.5 var-cov

0.25000% -0.22500%
Variance 0.0049 -0.22500% 0.81000%
standard deviation 0.07

sum of weights 1

1.5 MARK 1.5 MARK 1 MARK

E xpected return 9.76% Wa Wb E(RP)
17.76% 82.24% 9.76%
OR 119.32% -19.32% 2.65%
Q 2.2) Assume two stocks have the following characteristics: -
Expected Return Standard deviation
C 16% 8%
S 9% 5%
The coefficient of correlation between the returns of the two stocks is 0.
What is the % investment in the two stocks in order to have a minimum variance portfolio? Short selling
is allowed. What is the standard deviation achieved for the MVP? Solve with steps and answer in your
answer sheet as the format given below. There are no restrictions in the market. [2 marks]
WC (% upto 2 decimal) WS (% upto 2 decimal) sigma(Rp) (% upto 2 decimal)

SET I
C 16% 8% 28.1% 100%
S 9% 5% 71.9% 100%

RHO 0
0.6400% 0
W1 0.280899 0 0.2500%
W2 0.719101

VARIANCE 0.001798
STDEV 0.0424
1.5 MARK 1.5 MARK 1 MARK
SUM OF WEIGHTS 1 wc ws sigma(RP)
28.09% 71.91% 4.24%
Q 2.3) You are trying to analyse the performance of the actively managed fund. You have the following
information about the fund, market index and treasury security.
Stdev of
Returns returns beta
Fund 32.00% 16% 1.5
Market index 17.00% 14%
90-day Treasury-
bill 6.00% 0.00%

You gathered more insights into the fund and found that fund was not fully diversified. The manager
had included certain securities which they expected to be real winners, but that led to a compromise on
the diversification. Do you think their selection of winners was justified? Answer by calculating the
alpha i.e. returns over and above a required return due to a relevant measure of risk when the fund is
not fully diversified. Solve with steps and answer as the format given below, in your answer sheet.
Alpha % Justified/Not justified

[2 marks]
Stdev of
Returns beta
returns
Fund 32.00% 16% 1.5
Market index 17.00% 14%
90 day Treasury-
6.00% 0.00%
bill
 Rs 0.185714 CML
alpha now 13.43%
Justified as compensating for total risk
1 MARK 1 MARK

Justified/Not
Alpha %
justified

13.43% Justified

QUESTION – III (10 MARKS)

You are hired as a fixed income portfolio manager. You have information about corporate bonds
which are issued recently in the market. There is a green bond which is issued to fund projects with
positive environmental benefits. The bonds issued were AAA-rated bonds. The par value of the bond
is ₹1000. The characteristics of the bond are provided below: -

Bond Time to maturity Coupon rate p.a. Payments

Green bond (G) 3 years 8% Semi-Annual

The market interest rate (yield to maturity) is 9% p.a. for Green bonds at the time of issuance. You
plan to invest in the bond.
The expected inflation is expected to rise and market interest rates are expected to rise by 350 basis
points.

2 marks for graph

Bond: Green
Face value 1000

Maturity 6 semi-annual periods

Coupon 4%
ytm 4.5%
t CF PV factor PV of CF PV as % of Price t*Pv as % of price (t^2+t)*PV as a % of Price
1 40 0.956938 38.27751 0.039290797 0.039290797 0.078581593
2 40 0.91573 36.6292 0.037598848 0.075197697 0.22559309
3 40 0.876297 35.05186 0.035979759 0.107939278 0.431757111
4 40 0.838561 33.54245 0.034430392 0.137721566 0.688607832
5 40 0.802451 32.09804 0.032947743 0.164738716 0.988432294
6 1040 0.767896 798.6116 0.819752461 4.918514767 34.42960337

974.2106 5.44340282 36.84257529

duration 2.721701 5.208997914
convexity 8.434462

modified duration 2.604499 annual periods 1 MARK

convexity 8.434462 annual periods 1 MARK

% change in price for 350 basis points increase

100 basis points change

% Change in Price -9.116%

with convexity adjustment

% change in price -8.599% 2 MARKS

2.4 Duration of 3 year zero coupon bond 2 20%

Duration of perpetual bond 12.11111 0.3

Duration of Green bond 2.721701

These are Macaulay duration

Duration of liability 7 years
Matching duration
w in perpetual bond w
w in Green bond 0.8-w

w*12.11+(0.8-w)*(2.7217) + 20%*2 = 7 Matching duration of asset with that of liability (I

4.42264
0.471079961

47.11% w Perpetual bond 2 MARKS

32.89% 0.8-w Green bond 2 MARKS

20.00% given 2-year zero coupon bond

Q3.1 (2 marks) Calculate Annual Modified Duration and annual Convexity for the Green bond.

Q3.2 (2 marks) Calculate the % change in price with the adjustments of relevant measures for the
Green bond for 350 basis points increase in market interest rates.

Q3.3 (2 marks) Draw a graph showing the relationship of Bond price with Bond yield and the
relevant measures. Show the underestimation and overestimation of prices due to the slope measure
and the required adjustment needed for the same in the same graph.
Q3.4 (4 marks) An insurance company wishes to shield its overall financial obligation from exposure
to interest rate fluctuations. They wanted to fund the obligation using 2-year zero coupon bond (20%
proportion investment for immunization), perpetual bond paying annual coupons (ytm being 9% p.a.)
and the Green bond as in the Table above. The insurance company has an expected obligation of $24000
in 7 years. What should the proportion invested in Green bond and Perpetual bond be to shield their
obligation from market interest rate fluctuations? Note use annual Macaulay duration of Green bond for
calculation.

QUESTION – IV (10 MARKS)

You are trying to analyze the performance of the actively managed fund. You have the following
information about the fund. The fund comprises stocks, bonds and some cash holdings. The Tables
below provide information on the market value of these asset classes in the fund, the correlation of
returns between asset classes, and their expected returns and standard deviation of returns. All values
are annualized values. The correlation of returns of these asset classes with the market index (which is
the benchmark index) is also provided.
The expected return of the market index was 8% p.a. and the standard deviation of returns of the market
index was 24% p.a.
Invested Standard
Market deviation
value Expected of
Asset classes in (INR Return returns
Fund million) (%) (%)
Stock 1500 18% 25%
Bond 800 9% 12%
Cash 600 6% 0%

Correlation Stock Bond Cash Market

matrix
Stock 1 -ve 0.3 0 0.8
Bond -ve 0.3 1 0 0.2
Cash 0 0 1 0
Market 0.8 0.2 0 1

Q4.1 (3 marks) Calculate the expected return and standard deviation of the fund’s return.
Q4.2 (4 marks) Calculate the beta of stock, bond and cash and present it in 3x1 matrix form.
Calculate the beta of the fund.

Q4.3 (3 mark) Calculate the Jensen alpha for the fund if the relevant risk measure is
justsystematic risk (i.e. calculate returns over and above a required return due to systematic
risk).

Asset classes
Market
in Fund
value
Expected
(INR million)
Return
Standard(%)deviation of returns (%) weights
Stock 1500 18% 25% 0.517241
Bond 800 9% 12% 0.275862
Cash 600 6% 0% 0.206897
2900 3.1 Expected return of fund 13.03% 1 MARK

Correlation
Stock Bond Cash Market
matrix
Stock 1 -0.3 0 0.8
Bond -0.3 1 0 0.2
Cash 0 0 1 0
Market 0.8 0.2 0 1

Market return 8%
standard
deviation of
return 24%

Standard
deviation of
returns
variance
Stock Bond Cash
covariance matrix
Stock 6.25% -0.90% 0.00%
Bond -0.90% 1.44% 0.00%
Cash 0.00% 0.00% 0.00%

WT sigma W 0.015249
STANDARD
DEVIATION
3.1 OF FUND 12.35% 2 MARKS

3.2 BETA COVARIANCE(Ri, Rm)/(sigma of Rm)^2

Stock 0.833333 1 MARKS

Bond 0.1 1 MARKS
Cash 0 1 MARKS

beta of fund 0.458621 1 MARKS

3.3

required return 0.069172

jensen alpha 6.12% 3 MARKS

Question V (20 MARKS)

You are working as an intern at XYZ Hedge fund, and your task is to deliver a 20% return with minimum
risk. You have done some thorough research on equity-linked funds and have suggested an overall
investment plan that allocates the assets across three broad classes to achieve diversification. There is
short selling allowed in the market.
1. A Digital fund (DF)
2. A Venture advisor fund (VA)
3. A Pharma fund (PF)

You wanted to calculate the estimates of portfolio inputs to the optimization problem using a Fama-
French 3-factor model. You calculated the estimates by running a multivariate regression.

𝑅𝑖 = 𝛼𝑖 + 𝖰𝑖1 (𝑹𝒎 − 𝑹𝒇) + 𝖰𝑖2 𝑺𝑴𝑩 + 𝖰𝑖3 𝑯𝑴𝑳 + 𝑒𝑖

Where Ri returns to asset i, 𝛼𝑖 is the intercept term in the equation for asset i,

𝖰𝑖𝑧 𝑖𝑠 𝑠𝑒𝑛𝑠𝑖𝑡𝑖𝑣𝑖𝑡𝑦 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑡𝑜 𝑎𝑠𝑠𝑒𝑡 𝑖 𝑡𝑜 𝑓𝑎𝑐𝑡𝑜𝑟𝑠, 𝑒𝑖 𝑖𝑠 𝑒𝑟𝑟𝑜𝑟 𝑡𝑒𝑟𝑚

The monthly return (i.e. premiums) related to risk factors such as Market risk premium was 0.5%. The
monthly returns associated with SMB and HML were calculated from Table 5.1
Table 5.1: Returns information
Returns Value stocks Neutral stocks Growth stocks
Small size 0.8% 0.6% 0.4%
Big size 0.3% 0.5% 0.5%
The monthly standard deviation of returns for Market risk premium was 1.5%, SMB was 1.2%, and

HML was 1%. All factor returns and factor standard deviation are monthly
rates.The factor correlation coefficients are provided in Table 5.2
Correlation Market risk premium SMB HML
Market risk premium 1 -ve0.2 -ve0.5
SMB -ve0.2 1 0.6
HML -ve0.5 0.6 1
Note: -ve means negative

Following are the results of the regression performed. The monthly returns of the fund (dependent
variable; Ri) were regressed against the monthly returns of the three factors
𝑅𝑖 = 𝛼𝑖 + 𝖰𝑖1 ∗ (𝑹𝒎 − 𝑹𝒇) + 𝖰𝑖2 𝑺𝑴𝑩 + 𝖰𝑖3 𝑯𝑴𝑳 + 𝑒𝑖
The estimates of α’s, β’s and error variance for all three funds are provided in Table 5.3 from the
regression output ran with monthly returns.

Table 5.3: Regression Output (All significant)

Funds (i) αi βi1 βi2 βi3 error variancei
DF 0.2% 0.8 -ve0.5 0.2 0.1%
VA 1.8% 0.3 0.2 0.4 0.04%
PF 0.6% 0.3 0.4 0.2 0.01%

All annualized values to be calculated as APR monthly compounding

 Q5.1 (4 marks) Calculate the annualized return for all three funds and write as a 3x1 matrix. Answers
in % till 2 decimal places.

Q5.2 (4 marks) Calculate the annualized standard deviation of returns for all three funds as 3x1 matrix.
Answers in % expressed in 2 decimal places.

Q5.3 (4 marks + 3 marks + 1 marks) Calculate the annualized covariance and correlation coefficientsfor
the three funds and present it as 3x3 matrix of variance-covariance matrix and correlation matrix.
Comment on the correlation values. Covariances expressed as % with 2 decimal places, and correlation
expressed as decimals 2 digit.

Q5.4 (4 marks) How will you solve the asset allocation problem? Write your portfolio optimization
method equations (objective function) and constraints as matrix equations wherever possible.

ALPHA B MU Rm-Rf SMB HML sigh

Market risk premium
2.40% 0.8 -0.5 0.2 6.00% Rm-Rf 0.27% -0.04% -0.09% 1.20% 0.00% 0.00%
SMB 21.60% 0.3 0.2 0.4 2.00% SMB -0.04% 0.17% 0.09% 0.00% 0.48% 0.00%
HML 7.20% 0.3 0.4 0.2 1.20% HML -0.09% 0.09% 0.12% 0.00% 0.00% 0.12%

Value Neutral Growth

Returns
4 marks Annualized return VAR-COV 4 marks stocks stocks stocks
Small
0.80% 0.60% 0.40%
EXPECTED RETURN 6.44% 1.41% 0.01% 0.01% size
24.28% 0.01% 0.52% 0.04% Big size 0.30% 0.50% 0.50%
10.04% 0.01% 0.04% 0.17%
SMB 0.17%
4 marks 3 marks HML 0.10%
Annualized STANDARD DEVIATION
CORRELATION
11.87% 1.00 0.01 0.01
7.19% 0.01 1.00 0.14
4.12% 0.01 0.14 1.00

1 mark
As correlations are LOW, there can be diversification achieved.
You get marks for the comment only if you have the correlation values

4.4 4 MARKS

Min WT∑W

s.t.
WTI = 1
T
W R>=20%
1
 Data for Q6-Q7

An insurance company wishes to shield its overall financial obligation from exposure to interest rate
fluctuations. They wanted to fund the obligation using 3-year zero coupon bond and a perpetual bond paying
fixed annual coupons (ytm being 7% p.a.). The insurance company has an expected obligation of $24000 in 6
years.
Q6. What should the proportion invested in perpetual bonds be for immunization? [3 marks]
24.41%

Q7. After 1 year, the market interest rate for perpetual bond reduces by 100 basis points. What should
the proportion invested in perpetual bonds be for immunization after 1 year has passed? (Note there will
be reallocation as years remaining for expected obligation is 5 years now and time to maturity remaining
for zero coupon bond will be 2 years.) [3 marks]

19.15%
ZERO COUPON BOND 3
Perpetual bond 15.28571

w1 0.5 3 0.755899
w2 0.5 15.28571 0.244101 c

w1*3 + (1-w1)*15.28 = 6 5.998954

w1*3 -15.28*w1 +15.28 = 6

-12.29 -9.29
0.755899
8 c

ZERO COUPON BOND 2

Perpetual bond 17.66667 6.00%

w1 2 0.808551
w2 17.66667 0.191449 c

w1*2 + (1-w1)*17.67 = 4.999362

w1*2 -17.67*w1 +17.67 = 5

-15.67 -12.67
0.808551
9 b

Data for Q8 to Q10

You are trying to analyze the performance of the actively managed fund. You have the following information about
the fund. The fund comprises stocks, bonds and some cash holdings. The Tables below provide information on the
market value of these asset classes in the fund, the correlation of returns between asset classes, and their expected
returns and standard deviation of returns. All values are annualized values. The correlation of returns of these asset
classes with the market index (which isthe benchmark index) is also provided.
The expected return of the market index was 7% p.a. and the standard deviation of returns of the marketindex was 20%
p.a.

Investment
value in Standard
fund (INR Expected deviation of
Asset classes in Fund million) Return (%) returns (%)
Stock 1000 15% 25%
Bond 750 8% 12%
Cash 550 6% 0%
2
 Correlation Stock Bond Cash Market
matrix
Stock 1 -ve 0.2 0 0.7
Bond -ve 0.2 1 0 0.2
Cash 0 0 1 0
Market 0.7 0.2 0 1

1. What is the Beta of the fund? 0.4196

2. What is the fund’s Sharpe measure, and did it overperform or underperform the market?
(Remember:variance= wT∑w) 0.423057 overperformed
3. What is the fund’s Treynor measure, and did it overperform or underperform the market?
0.108808 overperformed
[3*2 = 6 marks]

BETA COVARIANCE(Ri, Rm)/(sigma of Rm)^2

Stock 0.875
Bond 0.12
Cash 0

beta of fund 0.419565

Sharpe measure 0.423057 overperformed

Fund Treynor measure 0.108808 overperformed

Sharpe measure 0.05

Market Treynor measure 0.01