410 SFM - COMPILER

Risk, Return and

Portfolio
Years May Nov
RTP Paper RTP Paper
2008 NA NA No Yes
2009 Yes Yes Yes Yes
2010 Yes Yes Yes Yes
2011 Yes Yes Yes Yes
2012 Yes Yes Yes Yes
2013 Yes Yes Yes Yes
2014 Yes No Yes Yes
2015 Yes Yes Yes No
2016 Yes Yes Yes Yes
2017 Yes Yes Yes Yes
2018 (Old) Yes Yes Yes Yes
2018 (New) Yes Yes Yes Yes
2008
Question 1 - Nov Paper 5 Marks
Consider the following information on two stocks, A and B:
Year Return on A (%) Return on B (%)
2006 10 12
2007 16 18
You are required to determine:
The expected return on a portfolio containing A and B in the proportion of
40% and 60% respectively.
The Standard Deviation of return from each of the two stocks.
The covariance of returns from the two stocks.
Correlation coefficient between the returns of the two stocks.
The risk of a portfolio containing A and B in the proportion of 40% and 60%.
Solution
(i) Expected return of the portfolio A and B
E (A) = (10 + 16) / 2 = 13%
E (B) = (12 + 18) / 2 = 15%
Rp = 0.4 (13) + 0.6 (15) = 14.2%
(ii) Stock A:
Variance = 0.5 (10 – 13)² + 0.5 (16– 13) ² = 9
Standard deviation = 9 = 3%
Stock B:
 SFM - COMPILER 411

Variance = 0.5 (12 – 15) ² + 0.5 (18– 15) ² = 9

Standard deviation = 3%
(iii) Covariance of stocks A and B
COVAB = 0.5 (10– 13) (12– 15) + 0.5 (16– 13) (18– 15) = 9
(iv) Correlation of coefficient
COVAB 9
CORAB = σAσB = 3 x 3 = 1

(v) Portfolio Risk

Since, CORAB = 1SD of the portfolio can be calculated as weighted average
of SD of individual securities
σp = 0.4 (3) + 0.6 (3) = 3%

Question 2 : Nov 2008 Paper – 8 Marks

The closing value of Sensex for the month of October, 2007 is given
below:
Date Closing Sensex Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260
You are required to test the week form of efficient market hypothesis by
applying the run test at 5% and 10% level of significance.
Following value can be used :
Value of t at 5% is 2.101 at 18 degrees of freedom
Value of t at 10% is 1.734 at 18 degrees of freedom
Value of t at 5% is 2.086 at 20 degrees of freedom.
412 SFM - COMPILER

Value of t at 10% is 1.725 at 20 degrees of freedom.

Solution
Date Closing Sensex Sign ofPrice Charge
1.10.07 2800
3.10.07 2780 –
4.10.07 2795 +
5.10.07 2830 +
8.10.07 2760 –
9.10.07 2790 +
10.10.07 2880 +
11.10.07 2960 +
12.10.07 2990 +
15.10.07 3200 +
16.10.07 3300 +
17.10.07 3450 +
19.10.07 3360 –
22.10.07 3290 –
23.10.07 3360 +
24.10.07 3340 –
25.10.07 3290 –
29.10.07 3240 –
30.10.07 3140 –
31.10.07 3260 +
Total of sign of price changes (r) = 08
No of Positive changes = n1 = 11
No. of Negative changes = n2 = 08
2 x 11 x 8
µr= 11 +8 + 1 = 10.26
(2 x 11 x 8)( 2 x 11 x 8 - 11 - 8)
σr= (11 + 8)2 (11 + 8 - 1) = 2.06

Since too few runs in the case would indicate that the movement of
prices is not random. We employ a two- tailed test the randomness of prices.
Test at 5% level of significance att.05 using t- table at 18 degrees of freedom
The lower limit = 10.26– 2.101 × 2.06 = 5.932
Upper limit = 10.26 + 2.101 × 2.06 = 14.588
At 10% level of significance at 18 degrees of freedom
lower limit =10.26 – 1.734 × 2.06 = 6.688
Upper limit =10.26 + 1.734 × 2.06 = 13.832
 SFM - COMPILER 413

As seen r lies between these limits. Hence, the market exhibits weak
form of efficiency

2009
Question 3 : May 2009 RTP
Following information is available on Return (%) of shares of two
companies A andB :
Probabilities Return of A Return of B
0.05 6 8
0.20 12 18
0.50 20 28
0.20 24 34
0.05 30 44
(i) Compute expected return from the portfolio
(ii) If the investment in A and B is in the ratio of 70:30 what is the risk of the
portfolio ?

Solution
(i) Expected Return and SD for Stock A and Stock B
Stock A
Return Probability X.P ̅)
d (X – 𝑿 d2 = (x – 𝒙
̅)2 d2 . p
6 0.05 0.3 -13 169 8.45
12 0.20 2.4 -7 49 9.80
20 0.50 10.0 1 1 0.50
24 0.20 4.8 5 25 5.00
30 0.05 1.5 11 121 6.05
19 29.80
Mean = 19
SD = 29.80 = 5.46%
Stock A
Return Probability X.P ̅)
d (X – 𝑿 d2 = (x – 𝒙
̅)2 d2 . p
8 0.05 0.4 -19 361 18.05
18 0.20 3.6 -9 81 16.20
28 0.50 14.0 1 1 0.50
34 0.20 6.8 7 49 9.80
44 0.05 2.2 17 289 14.45
27 59
Mean = 27
SD = 59 = 7.68%
(ii) Risk of the portfolio at 70:30 ratio =
414 SFM - COMPILER

To Calculate Risk of the portfolio we have to calculate COR

Probability DA DB 𝑫𝑨 𝒙 𝑫𝑩 𝑫𝑨𝑫𝑩. 𝑷
0.05 -13 -19 247 12.35
0.20 -7 -9 63 12.60
0.50 1 1 1 0.50
0.20 5 7 35 7.00
0.05 11 17 187 9.35
41.80
COVAB
CORAB = σAσB = 41.80 / (5.46 x 7.68) = 41.80 /41.9328 = 0.9968

σp = wt2 A σ2 + wt2 Bσ2 B + 2 wtA wtB σAσB x CORab

= 6.12

Question 4 : May 2009 RTP

You have the following five stocks in your portfolio :
Security No of Price / Share Beta
Shares
A 10000 50 1.2
B 5000 20 2.0
C 8000 25 0.7
D 10000 100 1.0
E 500 200 1.3
(i) Compute portfolio beta
(ii) How much additional investment is required in Risk free investment to
have beta to 0.8 ?
(iii) How much additional investment is required in Security B to increase
beta to 1.4 ?
(iv) If the Nifty future is 2700 points and future have a contract multiplier of
50, how many future contracts to be hedged to obtain the position as in
(iii) above ?
Solution
(i) Portfolio Beta
Security No of Price Beta Market Weight WxB
Shares /Share (B) Value (W)
(Rs.’000)
A 10000 50 1.2 500 0.5 0.60
B 5000 20 2.0 100 0.1 0.20
C 8000 25 0.7 200 0.2 0.14
D 10000 100 1.0 100 0.1 0.10
E 500 200 1.3 100 0.1 0.13
Total 1000 1.0 1.17
 SFM - COMPILER 415

(ii) To bring portfolio beta = 0.8

Let the additional investment in risk-free securities with weight Wr i.e
Total weight =(1 +Wr)
Then we have, [WA x 1.2 + WB x 2.0 + WC x 0.7 +WD X 1.0 +WE x 1.3
)]/(1+Wr) + Wr x 0 /(1+Wr) = 0.8
Or 1.17 / ( 1+Wr) = 0.8
Or 1.17 = 0.8 ( 1+Wr)
Or 0.8 Wr = 0.37
Or Wr = 0.4625
Thus additional investment required in Risk free security is Rs. 462,500

(iii) To bring portfolio beta = 1.4

Let the additional investment in security B with weight Wb i.e total
weight = (1 +Wb)
Then we have,
[WA x 1.2 + (WB + Wb)x 2.0 + WC x 0.7 +WD X 1.0
+WE x 1.3)]/(1+Wb) = 1.4
Or {(WAx 1.2 + WB x 2.0 + WC x 0.7 +WD X 1.0 +WE x 1.3)}/(1+Wb)
+ ( Wb x 2.0) / (1 + Wb) = 1.4
Or 01.17 + Wb X 2.0 = 1.4 ( 1 + Wb)
Or 0.6 Wb = 0.23
Or Wb = 0.383334

Additional investment required in Security B = Rs. 383, 334

(iv) This Rupee value is to be hedged.

Rupee Value of one Future contract = Index Value x multiplier
= 2700 x 50 = 135000
No of Future Contracts
=(Beta of portfolio x additional investment )/Rupee Value of Future
contract
=1.17 x 383,334/ 135000
=3 (rounded)

Question 5 : May 2009 RTP

Details of portfolio held by your client which yields average return of
14% are given below
Shares Cost Dividend/Interest Market Price Beta
(Rs.)
416 SFM - COMPILER

A 30,000 5000 33000 0.7

B 40,000 4000 42000 0.9
C 20,000 2000 23000 0.8
D 15,000 2250 14000 1.1
Govt. Bond 50,000 5000 52000 1
Find out expected return of each investment using CAPM and average
return of the portfolio.
Solution
Shares Cost (Rs.) Dividend Market Capital
Bet
(Rs.) Value (Rs.) Gain (Rs.) a

A 30,000 5000 33,000 3,000 0.7

B 40,000 4000 42,000 2,000 0.8
C 20,000 2000 23,000 3,000 0.9
D 15,000 2250 14,000 -1,000 1.1
Govt. bond 50,000 5000 52,000 2,000 1.0
Total 165,000 18250 1,74,000 9,000 4.5
Dividend + Capital Appreciation (18250+ 9,000)
Expected Return = Investment = 165000 =
16.52 %
Average beta = 0.90
Avg. Return = Risk free return + Avg. Beta (Expected Return – Risk free Return)
Or 0.14 = Rf + 0.90 (0.1652- Rf)
Or 0.10 Rf = 0.1486-0.14
Or Rf = 8.6 %
Expected Rate of Return of Individual security
= Ke = Rf + ß (Km – Rf)
A 8.6 + 0.7 ( 16.52- 8.6) = 14.45
B 8.6 + 0.8 (16.52- 8.6) = 14.94
C 8.6 + 0.9 (16.52– 8.6) = 15.73
D 8.6 + 1.1 (16.52– 8.6) = 17.71
Govt. bond 8.6 + 1.0 (16.52– 8.6) = 16.52
Expected return of the Portfolio = 15.81 %

Question 6 : May 2009 Paper – 8 Marks

Mr. X owns a portfolio with the following characteristics:
Security Security Risk Free
A B security
Factor 1 sensitivity 0.80 1.50 0
 SFM - COMPILER 417

Factor 2 sensitivity 0.60 1.20 0

Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.
1. If Mr. X has f 1,00,000 to invest and sells short Rs.50,000 of security B
and purchases Rs.1,50,000 of security A what is the sensitivity of Mr. X's
portfolio to the two factors?
2. If Mr. X borrows Rs.1,00,000 at the risk free rate and invests the amount
he borrows along with the original amount of Rs.1,00,000 in security A
and B in the same proportion as described in part (i), what is the
sensitivity of the portfolio to the two factors?
3. What is the expected return premium of factor 2?
Solution
(i) Mr. X’s position in the two securities are +1.50 in security A and -0.5 in
security B. Hence the portfolio sensitivities to the two factors:-
b prop. 1 =1.50 x 0.80 + (-0.50 x 1.50)= 0.45
b prop. 2 = 1.50 x 0.60 + (-0.50 x 1.20) = 0.30
(ii) Mr. X’s current position:-

Security A Rs. 300000 / Rs. 100000 = 3

Security B -Rs. 100000 / Rs. 100000 =-1

Risk free asset-Rs. 100000 / Rs. 100000 =-1

b prop. 1 = 3.0 x 0.80 +(-1 x 1.50) +(- 1 x 0) = 0.90

b prop. 2 = 3.0 x 0.60 +(-1 x 1.20) +(-1 x 0) = 0.60
(iii) The portfolio created in part (ii) is a pure factor 2 portfolio.
Expected return on the portfolio in part (b) is:
Rp = 3 x 0.15 + (-1) x 0.20 + (-1) x 0.10 = 0.15 i.e. 15%
Therefore Expected return premium = 15% - 10% = 5%

Question 7 : May 2009 - Paper – 6 Marks

An investor has two portfolios known to be on minimum variance set for
a population of three securities A, B and C having below mentioned weights:.
WA WB WC
Portfolio X 0.30 0.40 0.30
Portfolio Y 0.20 0.50 0.30
It is supposed that there are no restrictions on short sales.
(i) What would be the weight for each stock for a portfolio constructed by
investing Rs.5,000 in portfolio X and Rs.3,000 in portfolio Y?.
418 SFM - COMPILER

(ii) Suppose the investor invests Gain Rs.4,000 out of Rs.8,000 in security A.
How he will allocate the balance between security B and C to ensure that
his portfolio is on minimum variance set?
Solution
(i) Investment committed to each security would be:-
A B C Total
Portfolio X Rs.1,500 Rs.2,000 Rs.1,500 Rs.5,000
Portfolio Y Rs.600 Rs.1,500 Rs.900 Rs.3,000
CombinedPortfolio Rs.2,100 Rs.3,500 Rs.2,400 Rs.8,000
Therefore, Stock weights 0.26 0.44 0.30 1
(ii) The equation of critical line takes the following form:-
WB = a + bWA
Substituting the values of WA & WB from portfolio X and Y in above
equation, we get
0.40 = a + 0.30b, and
0.50 = a + 0.20b
Solving above equation we obtain the slope and intercept, a = 0.70 and b= -1
and thus, the critical line is
WB = 0.70– WA
If half of the funds is invested in security A then,
WB = 0.70–0.50 = 0.20
Since WA + WB + WC =1
WC = 1- 0.50– 0.20 = 0.30
Therefore Allocation of funds to security B = 0.20 x 8,000 = Rs.1,600,
= 0.30 x8,000
Security C = Rs.2,400

Question 8 : May 2009 Paper – 8 Marks

The rates of return on the security of Company X and market portfolio
for 10 periods are given below:
Period Return of Security Return on Market
X (%) Portfolio (%)
1 12 8
2 15 12
3 11 11
4 2 -4
5 10 9.5
6 –12 -2
1. What is the beta of Security X?
 SFM - COMPILER 419

2. What is the characteristic line for security X?

Solution
Characteristic line is given by
αi +βi Rm
Return d (X – d2 = (x – Return d (Market) 𝒅𝟐 Dxdm
X ̅)
𝑿 ̅)2
𝒙 M (Market
)
12 5.67 32.15 8 2.25 5.06 12.7575
15 8.67 75.17 12 6.25 39.06 54.1875
11 4.67 21.81 11 5.25 27.56 24.5175
2 -4.33 18.75 -4 -9.75 95.06 42.2175
10 3.67 13.47 9.5 3.75 14.06 13.7625
-12 -18.33 335.99 -2 -7.75 60.06 142.0575
38 Variance 35.5 Variance COVxm =
𝒅𝟐 𝟒𝟗𝟕.𝟑𝟒 𝒅𝟐 𝒅𝒙𝒅𝒎
= = = =
𝒏 𝒏 𝒏
𝟐𝟒𝟎.𝟖𝟔
𝒏
𝒏
Mean = = 82.89 Mean = 40.14 =
𝟐𝟖𝟗.𝟓
𝟔
∑ 𝒙/n ∑ 𝒙/n
38 / 6 = 34.5 / 6 = = 48.25
6.33 5.75
CovXM 48.25
x = σ2 M = 40.14 = 1.202

Hence the characteristic line is -0.58 + 1.202 (Rm)

Question 9 :Nov 2009 - RTP – Similar to - Question 1 - Nov Paper –

5 Marks

Question 10 : Nov 2009 – RTP

The following data are available to you as a portfolio manager.
Security Expected Beta Standard
Return Deviation
O 0.32 1.70 0.50
P 0.30 1.40 0.35
Q 0.25 1.10 0.40
R 0.22 0.95 0.24
S 0.20 1.05 0.28
T 0.14 0.70 0.18
Composite 0.12 1.000 0.20
Index
T-bills 0.08 0.00 0.00
(i) In terms of a security market line (SML) , which of the securities listed
above are undervalued? Why?
420 SFM - COMPILER

(ii) Assume that a portfolio is constructed using equal portions of the six
stocks listed above.
(a) Why is the expected return of such a portfolio?
(b) What would the expected return if this portfolio was increased by 40%
through borrowed funds with the cost of borrowing at 12%?
Solution
(i)
Security Expected Beta Required Return Valuation
Return (β) =0.08 + 0.04β
O 0.32 1.70 0.148 Under Valued
P 0.30 1.40 0.136 Under Valued
Q 0.25 1.10 0.124 Under Valued
R 0.22 0.95 0.118 Under Valued
S 0.20 1.05 0.122 Under Valued
T 0.14 0.70 0.108 Under Valued
All the securities listed above are undervalued because their expected returns
plot above the SML.
(ii)
(a) Expected return on the portfolio
0.32+0.30+0.25+0.22+0.20+0.14
= 6 = 0.2383

(b) Expected return on the portfolio

RP = XRM – (X– 1) RP = (1.4) (0.2383)– (0.4) (0.12)
= 0.33362– 0.048 = 0.28562

Question 11 : Nov 2009 – RTP

Mr. Nirmal Kumar has categorized all the available stock in the market
into the following types:
(i) Small cap growth stocks
(ii) Small cap value stocks
(iii) Large cap growth stocks
(iv) Large cap value stocks
Mr. Nirmal Kumar also estimated the weights of the above categories of
stocks in the market index. Further more, the sensitivity of returns on these
categories of stocks to the three important factor are estimated to be:

Category of Weight in Factor I Factor II Factor III

Stocks the Market (Beta) (Price Book) (Inflation)
Index
 SFM - COMPILER 421

Small cap growth 25% 0.80 1.39 1.35

Small cap value 10% 0.90 0.75 1.25
Large cap growth 50% 1.165 2.75 8.65
Large cap value 15% 0.85 2.05 6.75
Risk Premium 6.85% -3.5% 0.65%
The rate of return on treasury bonds is 4.5%
Required:
(a) Using Arbitrage Pricing Theory, determine the expected return on the
market index.
(b) Using Capital Asset Pricing Model (CAPM), determine the expected
return on the market index.
(c) Mr. Nirmal Kumar wants to construct a portfolio constituting only the
‘small cap value’ and ‘large cap growth’ stocks. If the target beta for the
desired portfolio is 1, determine the composition of his portfolio.
Solution
(i) Portfolio’s return
Small cap growth = 4.5 + 0.80 x 6.85 + 1.39 x (-3.5) + 1.35 x 0.65 = 5.9925%
Small cap value = 4.5 + 0.90 x 6.85 + 0.75 x (-3.5) + 1.25 x 0.65 = 8.8525%
Large cap growth = 4.5 + 1.165 x 6.85 + 2.75 x (-3.5) + 8.65 x 0.65 = 8.478%
Large cap value = 4.5 + 0.85 x 6.85 + 2.05 x (-3.5) + 6.75 x 0.65 = 7.535%
Expected return on market index
0.10 x 8.8525 + 0.25 x 5.9925 + 0.15 x 7.535 + 0.50 x 8.478 = 7.7526%
(ii) Using CAPM,
Small cap growth = 4.5 + 6.85 x 0.80 = 9.98%
Small cap value = 4.5 + 6.85 x 0.90 = 10.665%
Large cap growth = 4.5 + 6.85 x 1.165 = 12.48%
Large cap value = 4.5 + 6.85 x 0.85 = 10.3225%
Expected return on market index
= 0.10 x 10.665 + 0.25 x 9.98 + 0.15 x 10.3225 + 0.50 x 12.45 = 11.33%
(iii) Let us assume that Mr. Nirmal will invest X1% in small cap value stock
and X2% in large cap growth stock
X1 + X2 = 1
0.90 X1 + 1.165 X2 = 1
0.90 X1 + 1.165(1– X1) = 1
0.90 X1+ 1.165– 1.165 X1 = 1
0.165 = 0.265 X1
422 SFM - COMPILER

0.165
0.265 = X1
0.623 = X1
X2 = 0.377
62.3% in small cap value
37.7% in large cap growth.

Question 12 : Nov 2009 - Paper – 10 Marks

An investor holds two stocks A and B. An analyst prepared ex-ante
probability distribution for the possible economic scenarios and the
conditional returns for two stocks and the market index as shown below:
Economic scenario Probability Conditional Returns %
A B Market
Growth 0.40 25 20 18
Stagnation 0.30 10 15 13
Recession 0.30 -5 -8 -3
The risk free rate during the next year is expected to be around 11%.
Determine whether the investor should liquidate his holdings in stocks A and
B or on the contrary make fresh investments in them. CAPM assumptions are
holding true.
Solution
(i) Expected Return
Stock A = (0.40)(25)+ 0.30(10)+ 0.30(-5)=11.5%
Stock B = (0.40×20)+(0.30×15)+0.30×(-8)=10.1%
Market = (0.40× 18) + (0.30×13) + 0.30 × (-3) =10.2%
(ii) Variance of Market index
(18-10.2)2 (0.40) + (13-10.2) 2 (0.30)+(-3-10.2 )2 (0.30)
= 24.34 + 2.35 + 52.27 = 78.96%
(iii) Covariance
Stock A and Market Index M
(25-11.5) (18-10.2)(0.40) + (10-11.5) (13-10.2) (0.30) + (-5-11.5) (-3-10.2) (0.30)
=42.12+(-1.26)+65.34=106.2
Stock B and Market index M
(20-10.1) (18-10.2) (0.40)+(15-10.1) (13-10.2) (0.30) + (-8-10.1) (-3-10.2) (0.30)
= 30.89 + 4.12+ 71.67=106.68
(Iv) Beta
COVAM 106.20
βA = σ2m = 78.96 = 1.345

COVBM 106.68
βσ = σ2m = 78.96 = 1.351

(v) Return as per CAPM = Rf + β (RM – Rf)

 SFM - COMPILER 423

Required Return for A = 11% + 1.345(10.2-11) % = 9.924%

Required Return for B = 11% + 1.351 (10.2– 11) % = 9.92%
(vi) Alpha = Actual Return – Expected Return
Alpha for Stock A = 11.5%–9.924% = 1.576%
Alpha for Stock B = 10.1%-9.92% =0.18%
Since stock A and B both have positive Alpha, therefore, the investor
should make fresh investment in them.

Question 13 : Nov 2009 - Paper – 8 Marks

A study by a Mutual fund has revealed the following data in respect of
three securities:
Security σ (%) Correlation with Index, Pm
A 20 0.60
B 18 0.95
C 12 0.75
The standard deviation of market portfolio (BSE Sensex) is observed to be
15%.
(i) What is the sensitivity of returns of each stock with respect to the
market?
(ii) What are the covariances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks
equally?
(iv) What is the beta of the portfolio consisting of equal investment in each
stock?
(v) What is the total, systematic and unsystematic risk of the portfolio in (iv)
Solution
(i) Sensitivity of each stock with market is given by its beta.
Standard deviation of Index = 15%
Variance of market Index = 0.0225
Beta of stocks =σi r/σm
A = 20 × 0.60/15 = 0.80
B = 18× 0.95/15=1.14
C= 12× 0.75/15=0.60
(ii) Covariance between any 2 stocks = β β1 2σ2m
Covariance matrix
Stock/Beta 0.80 1.14 0.60
A 400.000 205.200 108.000
B 205.200 324.000 153.900
424 SFM - COMPILER

C 108.000 153.900 144.000

(iii) Total risk of the equally weighted portfolio = Variance=200.244
0.80+1.14+0.60
(iv) β of equally weighted portfolio = 3
= 0.8467
(v) Systematic Risk β P2σm2 = 161.290
Unsystematic Risk = Total Risk– Systematic Risk
= 200.244– 161.290
= 38.954

2010
Question 14 : May 2010 - RTP
Mr. Sunil Mukharjee has estimated probable under different
macroeconomic conditions for the following three stocks:
Stock Current Rates of return (%) during different
Price macroeconomics scenarios
(Rs.) Recession Moderate Boom
Him Ice Ltd 12 -12 15 35
Kalahari Biotech 18 20 12 -5
Puma Softech 60 18 20 15
Mr. Sunil Mukharjee is exploring if it is possible to make any arbitrage profits
from the above information.
Required
Using the above information construct an arbitrage portfolio and show
the payoffs under different economic scenarios.
Solution
The rates of return in different scenarios should be changed in to rupee
pay – off per share as indicated below:
Stock Price Price under various Macroeconomic Scenarios
Rs. Recession Moderate Boom
Him Ice Ltd 12 12 – 12% = 10.56 12 + 15% = 13.8 12 + 35% = 16.20
Kalahari Biotech 18 18 + 20% = 21.60 18 + 12% = 20.16 18 – 5% = 17.10
Puma Softech 60 60 + 18% = 70.80 60 + 20% = 72.00 60 + 15% = 69.00

Construction of an arbitrage portfolio requires formation of a zero

investment portfolio. The essential condition is that portfolio must not give a
negative return.
If we short sell two stocks each of the Him Ice Ltd and Kalahari Biotech
one stock of Puma Softech can be purchased and this portfolio will qualify as
zero investment portfolio.
(-2) x Rs.12 + (-2) x Rs.18 + Rs.60 = 0
The payoff from this arbitrage portfolio under different market conditions:
Price No of Investment Scenarios
Rs. Shares Rs. Recession Moderate Boom
 SFM - COMPILER 425

Him Ice 12 -2 - 24 - 21.12 - 27.60 - 32.40

Ltd 18 -2 - 36 - 43.20 - 40.32 - 32.40
Kalahari 60 +1 60 + 70.80 + 72.00 + 69.00
Biotech
Puma
Softech
Net Pay off 0 + 6.48 + 4.08 + 2.40
Net payoff from the portfolio clearly shows that this is an arbitrage
portfolio as it has produced positive return in all the market scenarios.

Question 15 : May 2010 - RTP

Assume that you have half your money invested in T, the media
company, and the other half invested in U, the consumer product giant. The
expected returns and standard deviations on the two investments are
summarized below:
T U
Expected Return 14% 18%
Standard Deviation 25% 40%
Estimate the variance of the portfolio as a function of the correlation
coefficient (Start with –1 and increase the correlation to +1 in 0.2
increments).
Solution
Tσ 25%
Uσ 40%
Correlation Portfolio Variance S.D.
-1 56.25 7.50%
- 0.8 156.25 12.50%
- 0.6 256.25 16.01%
- 0.4 356.25 18.87%
- 0.2 456.25 21.36%
0 556.25 23.58%
0.2 656.25 25.62%
0.4 756.25 27.50%
0.6 856.25 29.26%
0.8 956.25 30.92%
1 1056.25 32.50%
The variance of the portfolio shall be computed by using the following
formula.
426 SFM - COMPILER

σ2portfolio= wA2 σ2A + (1- wA)2 σ2B + 2 wA wB ρΑΒ σA σB

For Correlation of-0.8 the variance will be as follows:
= (0.50) 2(25) 2+ (0.50) 2(40) 2+ 2 (0.50) (0.50) (25) (40) (-0.8) = 156.25
Other variances have been computed accordingly.

Question 16 : May 2010 - RTP

Suppose Mr. X in a world where there are only two assets, gold and
stocks. He is interested in investing his money in one, the other or both
assets. Consequently he collects the following data on the returns on the two
assets over the last six years.
Gold Stock Market
Average return 8% 20%
Standard deviation 25% 22%
Correlation - 0.4
a. Mr. X is constrained to pick just one, which one he would choose?
b. Mr. Y, a friend of Mr. X argues that this is wrong. He says that Mr. X is
ignoring the big payoffs that he can get on gold. How would Mr. X go
about alleviating his concern?
c. How would a portfolio composed of equal proportions in gold and stocks
do in terms of mean and variance?
d. Mr. X came to know that GPEC (a cartel of gold-producing countries) is
going to vary the amount of gold it produces with stock prices in the
country. (GPEC will produce less gold when stock markets are up and
more when it is down.) What effect will this have on his portfolios?
Explain.
Solution
(i) Mr. X would pick the stock market portfolio, since it dominates gold on
both average return and standard deviation.
(ii) The higher possible returns on gold are balanced by the lower possible
returns at other times. Note that the average return on gold is much less
than that on the stock market.
(III) The expected return on this portfolio would be (8+20)/2 = 14%. The
variance would equal (0.5)2(25)2 + (0.5)2(22)2 -
2(0.5)(0.5)(25)(22)(0.4) = 167.25; the standard deviation equals 12.93%
(Iv) If the supply of gold is negatively correlated with the level of the market,
and the price of gold is inversely related to the supply of gold, there is a
positive correlation between the return on the market and the return on
gold. This would make gold less desirable, since it does not help as much
in reducing portfolio variance. The optimal amount to invest in gold
would drop.
 SFM - COMPILER 427

Question 17 : Nov 2010 - RTP

Suppose that in the universe of available risky securities contains a large
number of shares two stocks, identically distributed with E(r) = 15%, or σ =
60%, and with a common correlation coefficient of ρ= 0.5.
(a) What is the expected return and standard deviation of an equally
weighted risky portfolio of 25 stocks?
(b) What is the smallest number of stocks necessary to generate an efficient
portfolio with a standard deviation equal to or smaller than 43%?
(c) What is the systematic risk in this security universe?
(d) If T-bills are available and yield 10%, what is the slope of the CAL?
Solution
The parameters are E(R) = 15, σ = 60, and the correlation between any pair of
stocks is ρ = 0.5.
a. The portfolio expected return is invariant to the size of the portfolio
because all stocks have identical expected returns. The standard
deviation of a portfolio with n = 25 stock is
σ2 σ2(n - 1) ½
σp = [n + p x n ]
602 602 x 25
= [ 25 + 0.5 x 25 ] ½ = 43.27

b. Because the stocks are identical, efficient portfolios are equally weighted.
To obtain a standard deviation of 43%, we need to solve for n:
602 602(n - 1)
4.32 = n - 0.5 x n
n = 36.73 - Thus we need 37 stock and will come in with volatility slightly
under the target.
c. As n gets very large, the variance of an efficient (equally weighted)
portfolio diminishes, leaving only the variance that comes from the
covariances among stocks, that is
σρ = p x σ2 = 0.5 x 602 = 42.43
D. If the risk-free is 10%, then the risk premium on any size portfolio is 15%
- 10% = 5%. The standard deviation of a well-diversified portfolio is
(practically) 42.43%; hence the slope of the Capital Allocation Line (CAL)
is S = 5/42.43 = 0.1178

Question 18 :Nov 2010 - Paper – 8 Marks – Similar to - Question 1 -

Nov Paper – 5 Marks
428 SFM - COMPILER

2011
Question 19 : May 2011 - RTP
As on 1.4.10 ABC Ltd. is expecting net income and capital expenditure
over the next five years (2010-11 to 2014-15) as follows:
Year 2010-11 2011-12 2012-13 2013-14 2014-15
Net 27,00,000 32,00,000 28,00,000 30,000,000 38,00,000
Income
Capital 24,00,000 28,00,000 22,00,000 26,00,000 32,00,000
CEO of the company is planning to finance their capital outlay with debt and
equity in the ratio of 1:1 Suppose you as a CFO advises for residual dividend
policy then what will be the expected stream under the following approaches:
(i) Pure Residual Dividend Policy
(ii) Fixed Dividend Payout Ratio
Solution
As per planed financing of capital expenditures in equal proportions by debt
and equity , the retained earning to support capital expenditure over the
period of 2010-11 to 2014-15 will be as follows:
24,00,000+28,00,000+22,00,000+26,00,000+32,00,000
= 2 = Rs.

66,00,000
The expected stream of net income over the period will be
27,00,000+32,00,000+28,00,000+30,00,000+38,00,000 = 1,55,00,000
Thus, the total amount of dividend expected to paid over the period
forthcoming is expected to be
Rs. 1,55,00,00 – Rs. 66,00,000= Rs. 89,00,000
89,00,000
And expected average dividend payout will be: 1,55,00,000 x 100 = 100 = 57.42%

Accordingly expected dividend stream under the two approaches will be as

follows:
2010-11 2011-12 2012-13 2013-14 2014-15 Total
A. Net Income 27,00,000 32,00,000 28,00,000 30,00,000 38,00,000 1,55,00,00
B. Capital Outlay 24,00,000 28,00,000 22,00,000 26,00,000 32,00,000 0
C. Equity 1,32,00,00
Financing 12,00,000 14,00,000 11,00,000 13,00,000 16,00,000 0

66,00,000
Pure Residual 15,00,000 18,00,000 17,00,000 17,00,000 22,00,000 89,00,000
Dividend (A – C)
Fixed Dividend 15,50,340 18,37,440 16,07,760 17,22,600 21,81,960 89,00,100
Payout (57.42%)
 SFM - COMPILER 429

Question 20 : May 2011 RTP

Following information is available regarding expected return; standard
deviation and beta of 6 share are available in the stock market.
Security Expected Return Beta S.D(%)
1 5 0.70 9
2 10 1.05 14
3 11 0.95 12
4 12.5 1.10 20
5 15 1.40 17.5
6 16 1.70 25
Suppose risk free rate of return is 4% and Market return is 6% and standard
deviation is 10%. You are required to compute.
(i) Which security is undervalued and which is over valued.
(ii) Assuming that funds are equally invested these six stocks, then compute.
(a) Return of portfolio (b) Risk of Portfolio
(iii) Suppose if above portfolio is invested in with margin of 40% and cost of
borrowing is 4% then what will be the position.
Solution
(i) Using capital Assets Pricing Model (CAPM) we shall find out which
security is under- valued and which security is over -valued.
Required Rate of Return = Rf + β (Rm - Rf)
R f = Risk Free Rate
β = Beta of Security
R m = Market Return
Security Required Rate of Expected Overvalued /
Return Return (%) Undervalued
1 4 + 0.70(6 – 4) = 5.4 5 Over Valued
2 4+1.05(6 – 4) = 6.10 10 Under Valued
3 4+0.95(6 – 4)=5.90 11 Under Valued
4 4+1.10(6 – 4)=6.20 12.5 Under Valued
5 4+1.40(6 – 4)=6.80 15 Under Valued
6 4+1.70(6 – 4)=7.40 16 Under Valued
Securities 2 to 6 are under- valued because their required rate of return
is less than the expected rate of return. Security 1 is over-valued as its
expected return is less than required rate of return
(ii) Return in the Portfolio = Average return of all securities
5+10+11+12.5+15+16
= 6 = 11.58%

0.7+1.05+0.95+1.10+1.4+1.7
Portfolio Beta = 6 = 1.15
430 SFM - COMPILER

(iii) Where portfolio was margined out 40% with cost of borrowings at 4% the
position expected return and risk will be as follow:
R P = 1.40(0.1158) + (-0.4)(0.04) = 0.14612
Risk = σP = 1.4σm = 1.4 x 0.1183 = 0.16562 = 16.56%

Question 21 : May 2011 - Paper – 5 Marks

Mr. Tamarind intends to invest in equity shares of a company the value
of which depends upon various parameters as mentioned below:
Factor Beta Expected in % Actual value
Value in %
GNP 1.2 7.70 7.70
Inflation 1.75 5.50 7.00
Interest rate 1.3 7.75 9.00
Stock market index 1.7 10.0 12.0
Industrial 1.00 7.50
production 7.0
If the risk free rate of interest be 9.25%, how much is the return of the
share under Arbitrage
Pricing Theory?
Solution
Factor Expected in Actual Difference Beta Diff x
% Value value in % β
GNP 7.70 7.70 0.00 1.2 0.00
Inflation 5.50 7.00 1.50 1.75 2.63
Interest rate 7.75 9.00 1.25 1.3 1.63
Stock market index 10.0 12.0 2.00 1.7 3.40
Industrial 7.50 0.50 1.00 0.50
production 7.00
Total 8.16
Rf 9.25
Return under APT 17.41

Question 22 : May 2011 - Paper – 5 Marks

Mr. Tempest has the following portfolio of four shares:
Name Beta Investment? Lakh
Oxy Rin Ltd. 0.45 0.80
Boxed Ltd. 0.35 1.50
Square Ltd. 1.15 2.25
Ellipse Ltd. 1.85 4.50
The risk free rate of return is 7% and the market rate of return is 14%.
Required:
 SFM - COMPILER 431

1. Determine the portfolio return 2. Calculate the portfolio beta

Solution
(i) Portfolio Beta = Wt Average Beta of Individual Securities
0.80 1.5 2.25 4.5
=0.45 x 9.05 + 0.35 x 9.05 + 1.15 x 9.05 + 1.85 x 9.05 = 1.3035
(ii) Portfolio Return = Rf + β (RM – Rf)
= 7 + 1.3035 (14 – 7) = 16.1245%
Question 23 : Nov 2011 - RTP
Assuming that shares of ABC Ltd. and XYZ Ltd. are correctly priced
according to Capital Asset Pricing Model. The expected return from and Beta
of these shares are as follows:
Share Beta Expected return
ABC 1.2 19.8%
XYZ 0.9 17.1%
You are required to derive Security Market Line

Solution
Expected Return as per CAPM
Re = Rf + β (RM – Rf)
Accordingly,
ReABC = Rf + 1.2 (Rm – Rf) = 19.8
ReXYZ = Rf + 0.9 (Rm – Rf) = 17.1
19.8 = Rf + 1.2 (Rm – Rf) Equation 1
17.1 = Rf + 0.9 (Rm – Rf) Equation 2
By deducting (2) from (1)
2.7 = 0.3 (Rm – R f)
Rm – Rf = 9
Rf = Rm – 9
Substituting Rf = Rm – 9 in Equation 1
19.8 = (Rm – 9) + 1.2 (Rm – Rm + 9)
19.8 = Rm – 9 + 10.8
Rm = 18%
Rf = Rm – 9 = 18 – 9 = 9%
Security Line Market = = Rf + β (Market Risk Premium) = 9% + β x 9%
432 SFM - COMPILER

Question 24 : Nov 2011 – RTP

The following information is available for the share of X Ltd. and stock
exchange for the last 4 years.
X Ltd. Index of Return Return
Share Divided Stock from from Govt.
Price Yield Exchange Market Securities
funds
Present Year 197.00 10% 2182 16% 15%
1 year ago 164.20 12% 1983 15% 15%
2 year ago 155.00 8% 1665 16% 16%
3 year ago 121.00 10% 1789 10% 14%
4 year ago 95.00 10% 1490 18% 15%
With above information available please calculate:
(i) Expected Return on X Ltd.’s share.
(ii) Expected Return on Market Index.
(iii) Risk Free Rate of Return
(iv) Beta of X Ltd
Solution
(i) Expected Return on X’s Ltd Share
Capital Gain (%)
197 = 95 (1 + r)4
197
Therefore r =  95 ¼ - 1 = 20%
 
10+12+8+10+10
Average Dividend Yield = 5 = 10%
Therefore, expected return on share of X Ltd. = 20% + 10% = 30%
(ii) Expected Return on Market Index
Capital Gain (%)
2182 = 1490 (1 + r)4
2182
Therefore r = 1490 ¼- 1 = 10%
 
16+15+16+10+18
Average Dividend Yield = 5 = 15%
Therefore, expected return on share of X Ltd. = 20% + 10% = 30%
(iii) Return from Central Govt Securities = Rf = as it is return from Govt
Securities
15+15+16+14+15
Average Dividend Yield = 5 = 15%
Thus, Risk Free Rate of Return = Rf = 15%
(iv) Beta Value of X Ltd.
30-15
𝛽𝑥 = 25-15 = 1.5
 SFM - COMPILER 433

Question 25 : Nov 2011 – Paper

A Portfolio Manager (PM) has the following four stocks in his portfolio:
Security No. of Shares Market Price per share (Rs.) b
VSL 10,000 50 0.9
CSL 5,000 20 1.0
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:
(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment
should he bring in?
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment
should he bring in?
Solution
(1) Portfolio Beta
Security No of Market Total
shares Price/share Value
VSL 10,000 50 5,00,000
CSL 5,000 20 1,00,000
SML 8,000 25 2,00,000
APL 2,000 200 4,00,000
Total 12,00,000
𝟓 𝟏 𝟐 𝟒
Portfolio Beta = 0.9 x 𝟏𝟐 + 1 x 𝟏𝟐 + 1.5 x 𝟏𝟐 + 1.2 x 𝟏𝟐 = 1.108

(2) Target Beta 0.8

It should become (0.8 / 1.108) 72.2 % of present portfolio
If Rs.12,00,000 is 72.20%,
The total portfolio should be Rs.12,00,000 × 100/72.20 = Rs.16,62,050
Additional investment in zero risk should be (Rs.16,62,050 –
Rs.12,00,000) = Rs.4,62,050
(3) To increase Beta to 1.2
Required beta 1.2
It should become 1.2 / 1.108 108.30% of present beta
If 1200000 is 108.30%,
The total portfolio should b 1200000 × 100/108.30 = 1108033
Additional investment should be (-) 91967
434 SFM - COMPILER

2012
Question 26 : May 2012 - RTP
Assuming that two securities X and Y are correctly priced on SML and
expected return from these securities are 9.40% (Rx) and 13.40% (Ry)
respectively. The Beta of these securities are 0.80 and 1.30 respectively.
Mr. A, an investment manager states that the return on market index is
9%.
You are required to determine,
(a) Whether the claim of Mr. A is right. If not then what is correct return on
market index.
(b) Risk Free Rate of Return
Solution
A Security market line exhibits relationship between expected returns
(Calculated on the basis of CAPM) of investments and their Betas. (By
expected return we mean, the total return an investor should get considering
the risk he has undertaken)
To Draw the line, Betas are taken on X-axis and the expected returns on Y -
axis
Accordingly, lets calculate Expected Returns as per CAPM
Expected Return = Rf + β (RM – Rf)
Rf = Risk Free Rate
β = Beta
Rm = Market Return
Thus,
Expected Return for x = 9.40 = Rf + 0.80 (Rm – Rf) Equation 1
Expected Return for y = 13.40 = Rf + 1.30 (Rm – Rf) Equation 2
Solving Equation 1 from Equation 2, we get Rf = 3% and Rm = 11%
(i) Thus, claim of Mr. A is not correct. The correct rate is 11%.
(ii) Risk Free Rate of Return is 3%.

Question 27 : May 2012 - Paper – 8 Marks

Indira has a fund of Rs.3 lacs which she wants to invest in share market
with rebalancing target after every 10 days to start with for a period of one
month from now. The present NIFTY is 5326. The minimum NIFTY within a
month can at most be 4793.4. She wants to know as to how she should
rebalance her portfolio under the following situations, according to the
theory of Constant Proportion Portfolio Insurance Policy, using "2" as the
multiplier:
(1) Immediately to start with.
 SFM - COMPILER 435

(2) 10 days later-being the 1st day of rebalancing if NIFTY falls to 5122.96.
(3) 10 days further from the above date if the NIFTY touches 5539.04.
For the sake of simplicity, assume that the value of her equity
component will change in tandem with that of the NIFTY and the risk free
securities in which she is going to invest will have no Beta.
Solution
5326 - 4793.40
Maximum decline in one month = 5326 x 100 = 10%
(1) Immediately to start with
Investment in equity = Multiplier x (Portfolio value – Floor value)
= 2 (3,00,000 – 2,70,000) = Rs.60,000
Indira may invest Rs.60,000 in equity and balance in risk free securities.
(2) After 10 days
Value of equity = 60,000 x 5122.96/5326 = Rs.57,713
Value of risk free investment = Rs.2,40,000
Total value of portfolio = Rs.2,97,713
Investment in equity = Multiplier x (Portfolio value – Floor value)
= 2 (2,97,713 – 2,70,000) = Rs.55,426
Revised Portfolio:
Equity = Rs.55,426
Risk free Securities = Rs.2,97,713 – Rs.55,426 = Rs.2,42,287
(3) After another 10 days
Value of equity = 55,426 x 5539.04/5122.96 = Rs.59,928
Value of risk free investment = Rs.2,42,287
Total value of portfolio = Rs.3,02,215
Investment in equity = Multiplier x (Portfolio value – Floor value)
= 2 (3,02,215 – 2,70,000) = Rs.64,430
Revised Portfolio:
Equity = Rs.64,430
Risk Free Securities = Rs.3,02,215 – Rs.64,430 = Rs.2,37,785
The investor should off-load Rs.4502 of risk free securities and divert to
Equity.

Question 28 : May 2012 - Paper – 8 Marks

A has portfolio having following features

Security B Random Error Weight

L 1.60 7 0.25
436 SFM - COMPILER

M 1.15 0.11 0.30

N 1.40 3 0.25
K 1.00 9 0.20
You are required to find out the risk of the portfolio if the standard
deviation of the market index is 18%
Solution
(i) β = 1.6 x 0.25 + 1.15 x 0.30 + 1.4 x 0.25 + 1 x 0.2 = 1.295
(ii) The Standard Deviation (Risk) of the portfolio is
= [(1.295)2(18)2+(0.25)2(7)2+(0.30)2(11)2+(0.25)2(3)2+(0.20)2(9)2)]
= [543.36 + 3.0625 + 10.89 + 0.5625 + 3.24]
= [561.115]½
= 23.69%

Question 29 : Nov 2012 - RTP

Suppose that economy A is growing rapidly and you are managing a
global equity fund that has so far invested only in developed-country stocks.
Now you have decided to add stocks of economy A to your portfolio. The table
below shows the expected rates of return, standard deviations, and
correlation coefficients (all estimated for the aggregate stock market of
developed countries and stock market of Economy A).
Developed Stocks of
Country Stock Economy A
Expected rate of return 10 15
(annualized percent)
Risk [Annualized Standard 16 30
Deviation (%)]
Correlation Coefficient (r) 0.30
Assuming the risk-free interest rate to be 3%, you are required to determine:
(a) What percentage of your portfolio should you allocate to stocks of
Economy A if you want to increase the expected rate of return on your
portfolio by 0.5%?
(b) What will be the standard deviation of your portfolio assuming that
stocks of Economy A are included in the portfolio as calculated above?
(c) Also show how well the Fund will be compensated for the risk
undertaken due to inclusion of stocks of Economy A in the portfolio?
Solution
(a) Let the weight of stocks of Economy A is expressed as w, then
(1- w) × 10.0 + w × 15.0 = 10.5
i.e. w = 0.1 or 10%.
(b) Variance of portfolio shall be:
(0.9)2 (0.16) 2 + (0.1) 2 (0.30) 2 + 2(0.9) (0.1) (0.16) (0.30) (0.30) = 0.02423
 SFM - COMPILER 437

Standard deviation is (0.02423)½

= 0.15565 or 15.6%.
(c) The Sharpe ratio will improve by approximately 0.04, as shown below:
Expected Return - Risk Free Rate of Return
Sharpe Ratio = Standard Deviation
10 - 3
Investment only in developed countries : 16 = 0.437

10.5 - 3
With inclusion of stocks of Economy A: 15.6 = 0.481

Question 30 : Nov 2012 – RTP

An investor has decided to invest to invest Rs. 1,00,000 in the shares of

two companies, namely, ABC and XYZ the projections of returns from the
shares of the two companies along with their probabilities are as follows:
Probability ABC(%) XYZ(%)
0.20 12 16
0.25 14 10
0.25 -7 28
0.30 28 -2
You are required to
(i) Comment on return and risk of investment in individual shares.
(ii) Compare the risk and return of these two shares with a Portfolio of these
shares in equal proportions.
(iii) Find out the proportion of each of the above shares to formulate a
minimum risk portfolio.
Solution
Prob. ABC XY A x P. X x P. d (A) 𝒅𝟐 d (X) 𝒅𝟐 (X).p D(A) x d(X) Dadx.p
(%) Z (A).p
(%)
0.20 12 16 2.4 3.2 -0.55 0.06 3.9 3.04 -2.145 -0.429
0.25 14 10 3.5 2.5 1.45 0.53 -2.1 1.10 -3.045 -0.761
0.25 -7 28 -1.75 7.0 -19.55 95.55 15.9 63.20 -310.845 -77.71
0.30 28 -2 8.40 -0.6 15.45 71.61 -14.1 59.64 -217.845 -65.35
Total (Average 12.55 12.1 Varianc Variance -144.25
Return) e 126.98
167.75

Hence the expected return from ABC = 12.55% and XYZ is 12.1%
Variance for ABC = 167.75 and XYZ = 126.98
SD = Variance
SD ABC = 12.95%
438 SFM - COMPILER

SD XYZ = 11.27%
Covariance = -77.71

Question 31 : Nov 2012 - Paper – 8 Marks

Mr. FedUp wants to invest an amount of Rs. 520 lakhs and had
approached his Portfolio Manager. The Portfolio Manager had advised Mr.
FedUp to invest in the following manner:
Security Moderate Better Good Very Good Best
Amount in Lakhs 60 80 100 120 160
Beta 0.5 1.00 0.80 1.20 1.50
You are required to advise Mr. FedUp in regard to the following, using
Capital Asset Pricing Methodology:
(i) Expected return on the portfolio, if the Government Securities are at 8%
and the NIFTY is yielding 10%.
(ii) Advisability of replacing Security 'Better' with NIFTY.
Solution
(i) Calculation of Expected Return on each Stock by CAPM Model
According to CAPM, Expected Return = RF + β (RM – Rf)
Moderate = 8 + 0.5 (10 – 8) = 9%
Better = 8 + 1 (10 – 8) = 10%
Good = 8 + 0.8 (10 – 8) = 9.60%
Very Good = 8 + 1.2 (10 – 8) = 10.40%
Best = 8 + 1.5 (10 – 8) = 11%

(ii) Expected Return on the Portfolio = Wt Average Return on individual

Stocks
Total Investments = 60 + 80 + 100 + 120 + 160 = 520
60 80 100
Expected Return on the portfolio = 9 x 520 + 10 x 520 + 9.60 x 520 +
120 160
10.4 x 520 + 11 x 520 = 10.208%

2013
Question 32 : May 2013 - RTP
The following information is available in respect of Security X
Equilibrium Return 15%
Market Return 15%
7% Treasury Bond Trading at $140
 SFM - COMPILER 439

Covariance of Market Return and Security Return 225%

Coefficient of Correlation 0.75
You are required to determine the Standard Deviation of Market Return and
Security Return.
Solution
𝟕
(i) 𝐑𝐟 = x 100 = 5%
𝟏𝟒𝟎
Applying CAPM

15% = 5% + β(15% - 5%)

10% = β(10%)
β =1

Cov (r,m)
β =
σ2m

225
1 =
σ2m

σ2m = 225

σm = √225
= 15

Standard Deviation of Market Return = 15

Cov (r,m)
(ii) Cor. =
σm σr

225
0.75 =
15σr

σr = 20%
Standard Deviation of Security Return = 20%

Question 33 :May 2013 – RTP – Similar to - Question 21 - May 2011

- Paper – 5 Marks

Question 34 : May 2013 - Paper – 8 Marks

On Jan 1, 2013 an investor has a portfolio of 5 shares as given below.
Security Price No of Shares Beta
A 349.60 5,000 1.15
B 480.50 7,000 0.40
C 593.52 8,000 0.90
D 734.70 10,000 0.95
E 824.85 2,000 0.85
440 SFM - COMPILER

The cost of capital to the investor is 10.5%per annum.

You are required to calculate:
(i) The beta of his portfolio.
(ii) The theoretical value of the NIFTY futures for February 2013.
(iii) The number of contracts of NIFTY the investor needs to sell to get a full
hedge until February for his portfolio if the current value of NIFTY is
5900 and NIFTY futures have a minimum trade lot requirement of 200
units. Assume that the futures are trading at their fair value.
(iv) The number of future contracts the investor should trade if he desires to
reduce the beta of his portfolios to 0.6.
No. of days in a year be treated as 365.
Given: In (1.105) = 0.0998
e(0.015858) = 1.01598
Solution
(i) Calculation of Total Portfolio
Security Price No of Shares Total
A 349.60 5,000 17,46,500
B 480.50 7,000 33,63,500
C 593.52 8,000 47,48,160
D 734.70 10,000 73,47,000
E 824.85 2,000 16,49,700
Total 1,88,54,860
(ii) Calculation of Portfolio Beta = Wt Average Beta of Individual Stocks
17,46,500 33,63,500
Portfolio Beta = 1.15 x 1,88,54,860 + 0.40 x 1,88,54,860

47,48,160 73,47,000 16,49,700

+ 0.90 x 1,88,54,860 + 0.95 x 1,88,54,860 + 0.85 x 1,88,54,860 = 0.849

(iii) Calculation of Theoretical Value of Future Contract

Cost of Capital = 10.5% p.a. Accordingly, the Continuously Compounded
Rate of Interest ln(1.105) = 0.0998
For February 2013 contract, t= 58/365= 0.1589
Further F= Sert F= 5,900e(0.0998)(0.1589)
F= Rs. 5,900e0.015858

F= Rs. 5,900X1.01598

= Rs. 5,994.28
(iv) When total portfolio is to be hedged:
Value of Stop position Requiring Hedging
= Value of Future Contract x Portfolio Beta
 SFM - COMPILER 441

1,88,54,860
= 5,994 x 200 x 0.849 = 13.35 contracts

(v) When total portfolio beta is to be reduced to 0.6:

= Number of Contracts to be sold
Value of Portfolio (βt - βt)
= F x M x βf
1,88,54,860(0.849 - 0.600)
= 5,994.28 x 200 = 3.92 contracts i.e 4 contracts

Question 35 : Nov 2013 - RTP

Following data is related to Company X, Market Index and Treasury
Bonds for the current year and last 4 years:
Year Company X Market Index Return
Average Dividend Average Market on
Share Per Market Dividend Treasury
Price share Index Yield Bonds
2009 Rs.139 Rs.7.00 1300 3% 7%
2010 Rs.147 Rs.8.50 1495 5% 9%
2011 Rs.163 Rs.9.00 1520 5.5% 8%
2012 Rs.179 Rs.9.50 1640 4.75% 8%
2013 (Current Rs.203.51 Rs.10.00 1768 5.5% 8%
Year)
With the above data estimate the beta of Company X’s share.
Solution
(i) Calculation of Capital Gain for share X
Share price has increased from 139 at the end of year 2009 to Rs. 203.51
at the end of year 2013
So the appreciation is in 4 periods (From end of 2009 to end of 2013)
139 (1 + r)4 = 203.51
203.51
Therefore r = 139 - 1 = 10%

(ii) Average annual dividend yield (%)

Year Dividend / Share Price Dividend
Yield
2009 7 / 139 x 100 5%
2010 8.5 / 147 x 100 5.8%
2011 9 / 163 x 100 5.5%
2012 9.5 / 179 x 100 5.3%
2013 10 / 203.51 x 100 4.9%
5+5.8%+5.5%+5.3%+4.9%
Average = 5 = 5.35

Therefore Expected Return on the company’s stock

442 SFM - COMPILER

= Capital Appreciation + Annual Dividend Yield

= = 10% + 5.3% = 15.3%
(iii) Calculation of Capital Gain for Market Index
Market Index has increased from 1300 at the end of year 2009 to Rs.
1768 at the end of year 2013
So the appreciation is in 4 periods (From end of 2009 to end of 2013)
1300 (1 + r)4 = 1768
1768
Therefore r =1300 1/4- 1 = 8%
 
(iv) Average Annual Dividend Yield (%)
3%+5%+5.5%+4.75%+5.5%
= 5 = 4.75%

Therefore Expected Return on the market Index

= Capital Appreciation + Annual Dividend Yield
= = 8% + 4.75% = 12.75%
(v) Average Annual Risk Free Rate
7%+9%+8%+8%+8%
= 5 = 8%

(vi) With the help of above information and using CAPM, we can calculate β
Expected Return on Stock = Rf + β (RM – Rf
15.3% = 8% + β[12.75% - 8%]
β = 1.54

Question 36 : Nov 2013 – RTP

The rates of return on the security of Company X and market portfolio
for 10 periods are given below:
Period Return of Security Return on Market
X (%) Portfolio (%)
1 20 22
2 22 20
3 25 18
4 21 16
5 18 20
6 –5 8
7 17 –6
8 19 5
9 –7 6
10 20 11
1. What is the beta of Security X?
 SFM - COMPILER 443

2. What is the characteristic line for security X?

Solution
Period 𝑹𝒙 𝑹𝒎 𝒅𝒙 𝒅𝒙 𝟐 𝒅𝒎 𝒅𝒎 𝟐 𝒅𝒙 𝒅𝒎
1 20 22 5 25 10 100 50
2 22 20 7 49 8 64 56
3 25 18 10 100 6 36 60
4 21 16 6 36 4 16 24
5 18 20 3 9 8 64 24
6 –5 8 -20 400 -4 16 80
7 17 –6 2 4 -18 324 -36
8 19 5 4 16 -7 49 -28
9 –7 6 -22 484 -6 36 132
10 20 11 5 25 -1 1 -5
Total 150 120 1148 706 357
Return 15 12 Variance Variance COVxm
= Σd2 Σd2 dxdm
= n = n = n
ΣRx
n = 114.8 = 70.6 = 35.7
SD = SD = COVxm
Βx = σ2m
Variance Variance
= 10.71 = 8.40 = 0.505
(ii) Characteristic line for security X = α + β × RM
Alpha (α) = 15 – (0.505 × 12) = 8.94%
∴Characteristic line for security X = 8.94 + 0.505 RM

Question 37 : Nov 2013 - Paper – 5 Marks

A trader is having in its portfolio shares worth Rs.85 lakhs at current
price and cash Rs.15 lakhs. The beta of share portfolio is 1.6. After 3 months
the price of shares dropped by 3.2%.
Determine:
(i) Current portfolio beta
(ii) Portfolio beta after 3 months if the trader on current date goes for long
position on Rs.100 lakhs Nifty futures.
Solution
Current portfolio
Current Beta for share = 1.6
Beta for cash = 0
Current portfolio beta = 0.85 x 1.6 + 0 x 0.15 = 1.36
Portfolio beta after 3 months:
444 SFM - COMPILER

Change in the value of portfoli of shares

Beta for portfolio of shares = change in value of market index
0.032
1.6 = change in value of market index

Change in value of market portfolio (Index) = (0.032 / 1.6) x 100 = 2%

Position taken on 100 lakh Nifty futures Long
Value of index after 3 months = Rs.100 lakh x (100 - 0.02)
= Rs.98 lakh
Mark-to-market paid = Rs.2 lakh
Cash balance after payment of mark-to-market = Rs.13 lakh
Value of portfolio after 3 months = 85 lakh x (1-0.032) + Rs.13 lakh
= Rs.95.28 lakh
100 - 95.28
Change in value of portfolio = 100 = 4.72%

Portfolio beta = 0.0472/0.02 = 2.36

Question 38 : Nov 2013 - Paper – 8 Marks

Mr Ram is holding the following securities:
Particulars Cost Dividends/Interest Market Beta
of Securities (Rs.) price (Rs.) (Rs.)
Equity Shares:
Gold Ltd. 11,000 1,800 12,000 0.6
Silver Ltd. 16,000 1,000 17,200 0.8
Bronze Ltd. 12,000 800 18,000 0.6
GOI Bonds 40,000 4,000 37,500 1.0
Average return of the portfolio is 14%, calculate:
1. Expected rate of return in each, using the Capital Asset Pricing Model
(CAPM).
2. Risk free rate of return.
Solution
(i) Expected Rate of Return on market portfolio
Securities Cost Dividends/Inte Market price Capital
rest Rs. Gains
Rs. Rs.
Equity
Shares: 11,000 1,800 12,000 1,000
Gold Ltd. 16,000 1,000 17,200 1,200
Silver Ltd. 12,000 800 18,000 6,000
Bronze Ltd. 40,000 4,000 37,500 -2,500
GOI Bonds
Total 79,000 7,600 5,700
 SFM - COMPILER 445

Dividend + Capital Gains

Return = Total Investment x 100 = 16.84%

0.6+0.8 + 0.6 + 1
(ii) Average β = 4 = 0.50(Alternatively we can also calculate
wt average beta also)
(ii) Calculation of Rf
Average Return = Rf + β (RM – Rf)
14% = Rf + 0.5(16.84 – Rf)
14 = Rf + 8.42 – 0.5Rf
Therefore Rf = 11.16%
(iv) Calculation of Expected return of each security by CAPM
Gold = 11.16 + 0.6 (16.84 – 11.16) = 14.568
Silver = 11.16 + 0.8 (16.84 – 11.16) = 15.704
Bronze = 11.16 + 0.6 (16.84 – 11.16) = 14.568
GOI = 11.16 + 1 (16.84 – 11.16) = 16.84

Question 39 : Nov 2013 - Paper – 6 Marks

Ram buys 10,000 shares of X Ltd. at a price of Rs.22 per share whose
beta value is 1.5 and sells 5,000 shares of A Ltd. at a price of Rs.40 per share
having a beta value of 2. He obtains a complete hedge by Nifty futures at
Rs.1,000 each. He closes out his position at the closing price of the next day
when the share of X Ltd. dropped by 2%, share of A Ltd, appreciated by 3%
and Nifty futures dropped by 1.5%.
What is the overall profit/loss to Ram?
Solution
No. of the Future Contract to be obtained to get a complete hedge
10,000 x 22.15 x 1.5 - 5,000 x 40 x 2
= 1,000 = 70 contracts

Thus, by purchasing 70 Nifty future contracts to be long to obtain a

complete hedge.
Cash Outlay
= 10000 x Rs.22 – 5000 x Rs.40 + 70 x Rs.1,000
= Rs.2,20,000 – Rs.2,00,000 + Rs.70,000
= Rs.90,000
Cash Inflow at Close Out
= 10000 x Rs.22 x 0.98 – 5000 x Rs.40 x 1.03 + 70 x Rs.1,000 x 0.985
= Rs.2,15,600 – Rs.2,06,000 + Rs.68,950
= Rs.78,550
Gain/ Loss
= Rs.78,550 – Rs.90,000
= - Rs.11,450 (Loss)
446 SFM - COMPILER

2014
Question 40 : May 2014 – RTP
XYZ Ltd. has substantial cash flow and until the surplus funds are
utilized to meet the future capital expenditure, likely to happen after several
months, are invested in a portfolio of short-term equity investments, details
for which are given below:
Investme No. of shares Beta Market price Expected
nt per share (Rs.) dividend Yield
I 60,000 1.16 4.29 19.50%
II 80,000 2.28 2.92 24.00%
III 1,00,000 0.90 2.17 17.50%
IV 1,25,000 1.50 3.14 26.00%
The current market return is 19% and the risk free rate is 11%. Required to:
a. Calculate the risk of XYZ’s short-term investment portfolio relative to
that of the market;
b. Whether XYZ should change the composition of its portfolio.
Solution
Investmen No of Marke Market Weigh Dividen Dividen Β Weighte
t shares t Price Value t d Yield d d
Β
I 60,000 4.29 2,57,400 23.39% 19.50% 50,193 1.16 0.27
II 80,000 2.92 2,33,600 21.23% 24.00% 56,064 2.2 0.48
III 1,00,00 2.17 2,17,000 19.72% 17.50% 37,975 8 0.18
IV 0 3.14 3,92,500 35.66% 26.00% 1,02,050 0.9 0.53
1,25,00 1.5
0
11,00,50 100 2,46,282 1.46
0
2,46,282
Return on the Portfolio = 11,00,500 x 100 = 22.38%

Market Risk implicit

2238 = 11 + β× (19 – 11)
β = 1.42
Market β implicit is 1.42 while the port folio β is 1.46. Thus the portfolio
is marginally risky compared to the market.

Question 41 : May 2014 – RTP

Expected return on two stocks for particular market returns are given in
the following table:
Market Return Aggressive Defensive
7% 4% 9%
25% 40% 18%
You are required to calculate:
 SFM - COMPILER 447

1. The Betas of the two stocks.

2. Expected return of each stock, if the market return is equally likely to be
7% to 25%.
3. The security Market Line (SML), if the risk free rate is 7.5% and market
return is equally likely to be 7% or 25%.
4. The Alphas of the two stocks.
Solution
(a) The Betas of two stocks:
Aggressive stock - 40% - 4%/25% - 7% = 2
Defensive stock - 18% - 9%/25% - 7% = 0.50
(b) Expected returns of the two stocks:-
Aggressive stock - 0.5 x 4% + 0.5 x 40% = 22%
Defensive stock - 0.5 x 9% + 0.5 x 18% = 13.5%
(c) Expected return of market portfolio = 0.5 x 7% + 0.5% x 25% = 16%
∴ Market risk prem. = 16% - 7.5% = 8.5%
∴ SML is, required return = 7.5% + βi 8.5%
(d) R s = α + βRm
Where α = Alpha
β = Beta
R m= Market Return
For Aggressive Stock 22% = αA + 2(16%) αA = -10%
For Defensive Stock 13.5% = αD + 0.50(16%) αD = 5.5%

Question 42 : Nov 2014 - RTP

Mr. A has a portfolio of Rs.5 crore consisting of equity shares of X Ltd.
and Y Ltd. with beta of 1.15. Other information is as follows:
Spot Value of Index Future = 21000
Multiplier = 150
You are requested to reduce beta of portfolio to 0.85 and increase beta to 1.45
by using:
(a) Change in composition through Risk Free securities
(b) Index futures
Solution
(i) Reduction of beta to 0.85
(a) Reduction in beta through change in composition of securities
whose beta is zero (β0)
448 SFM - COMPILER

βd = W1 x βe + W2 x β0
0.85 = W1 x 1.15 + (1 - W1) x 0
W1 = 0.85/1.15 = 0.739
So, W2 = 1 – 0.739 = 0.261
Thus, Rs.3.695 crores (Rs.5 crores x 0.739) shall remain invested in portfolio
and remaining Rs.1.305 crores shall be invested in risk free securities (say
Treasury bills)
(b) By using Index Futures
No. of Stock Index Futures to be short
Value of Spot Position to be hedged
= Existing Beta x Value of one Future Contract
1.305
= 1.15 x 21000 x 150
= 1.15 x 4.14
= 4.76 or say 5 contracts
Thus, instead of swapping Rs.1.305 crore to risk free securities, the
portfolio manager Mr. A can also reduce beta to 0.85 by selling 4.76 or 5
stock index futures.
(ii) Increasing beta to 1.45
(a) β shall be increased by investing additional amount in equity shares.
βd = W1 x βe + W2 x β2
1.45 = W1 x β1 + W2 x β2
1.45 = W1 x 1.15 + (1 - W1) x 0
W1 = 1.45/1.15 = 1.26
This can be achieved by:
(i) Holding on Rs.5 crore worth of shares
(ii) Selling short Risk Free Securities of Rs.1.30 crores (0.26 X Rs.5
crores) i.e. borrowing Rs.1.30 crores and using proceeds to buy Rs.
1.30 crores of additional shares.
(b) Increasing beta by using Index Futures i.e. buying Index futures of
Rs.1.495 crores (1.15 x Rs.1.30 crores).

The number of contracts to be boughtRs.

1.495
= 21000 x 150 = 4.746 or say 5 contracts

Question 43 : Nov 2014 - Paper – 8 Marks

The risk free rate of return Rf is 9 percent. The expected rate of return
on the market portfolio Rm is 13 percent. The expected rate of growth for the
dividend of Platinum Ltd. is 7 percent. The last dividend paid on the equity
stock of firm A was Rs.2.00. The beta of Platinum Ltd. equity stock is 1.2.
(i) What is the equilibrium price of the equity stock of Platinum Ltd.?
 SFM - COMPILER 449

(ii) How would the equilibrium price change when

• The inflation premium increases by 2 percent?
• The expected growth rate increases by 3 percent?
• The beta of Platinum Ltd. equity rises to 1.3?
Solution
(i) Expected Rate of Return as per using CAPM
= 9% + 1.2(13% - 9%)
= 9% + 4.8%= 13.8%
(ii) Equilibrium Price per share
𝐃𝟏 𝟐+𝟕% 𝟐.𝟏𝟒
IV = 𝐑𝐞−𝐠 = 𝟎.𝟏𝟑𝟖−𝟎.𝟎𝟕 = 𝟎.𝟎𝟔𝟖 = Rs.31.47

(iii) New Expected Rate of Return as per CAPM

= 9.18% + 1.3(13% - 9.18%)
= 9.18% + 4.966%= 14.146%
(iv) Equilibrium Price per share
𝐃𝟏 𝟐+𝟏𝟎% 𝟐.𝟐
IV = 𝐑𝐞−𝐠 = 𝟎.𝟏𝟒𝟏𝟒𝟔−𝟎.𝟏𝟎 = 𝟎.𝟎𝟒𝟏𝟒𝟔 = Rs.53.06

2015
Question 44 :May 2015 - RTP – Similar to - Question 35 - Nov 2013
- RTP
Question 45 :May 2015 – RTP – Similar to – Question 36 – Nov
2013 – RTP
Question 46 : May 2015 - Paper – 8 Marks
Mr Sharma is holding the following securities:
Particulars of Cost Dividends Market Price BETA
securities Rs. Rs. Rs.
Equity Shares:
Gold Ltd 10,000 1725 9,800 0.6
Silver Ltd 15,000 1000 16,200 0.8
Bronze Ltd 14,000 700 20,000 0.6
GOI Bonds 36,000 3,600 34,500 1.0
Average Rate of Return is 15.7%, calculate:
1. Expected rate of return in each, using the Capital Asset Pricing Model
(CAPM)
2. Risk free rate of return.
Solution
(i) Expected Rate of Return on market portfolio
Securities Cost Dividends Market price Capital
/Interest Rs. Gains
Rs. Rs.
450 SFM - COMPILER

Equity Shares:
Gold Ltd. 10,000 1,725 9,800 (200)
Silver Ltd. 15,000 1,000 16,200 1,200
Bronze Ltd. 14,000 700 20,000 6,000
GOI Bonds 36,000 3,600 34,500 (1,500)
Total 75,000 7,025 5,500
Dividend + Capital Gains 7,025 + 5,500
Return = Total Investment x 100 = 75,500 x 100 = 16.7%
0.6+0.8+0.6+1
(ii) Average β = 4 = 0.50(Alternatively we can also calculate wt
average beta also)
(ii) Calculation of Rf
Average Return = Rf + β (RM – Rf)
15.7% = Rf + 0.5(16.7 – Rf)
15.7 = Rf + 8.35 – 0.5Rf
Therefore Rf = 14.7%
(iv) Calculation of Expected return of each security by CAPM
Gold = 14.7 + 0.6 (16.7 – 14.7) = 15.9 %
Silver = 14.7 + 0.8 (16.7 – 14.7) = 16.3 %
Bronze = 14.7 + 0.6 (16.7 – 14.7) = 15.9 %
GOI = 14.7 + 1 (16.7 – 14.7) = 16.7 %
Question 47 : May 2015 - Paper – 8 Marks
Following are the details of a portfolio consisting of three shares
Share Portfolio Beta Expected return Total
Weight in % Variance
A 0.20 0.40 14 0.015
B 0.50 0.50 15 0.025
C 0.30 1.10 21 0.100
Standard Deviation of Market Portfolio Returns = 10%
You are given the following additional data :
Covariance (A,B) = 0.030
Covariance (A,C) = 0.020
Covariance (B,C) = 0.040
Calculate the following
i) The portfolio Beta
ii) Residual variance of each of the three shares
iii) Portfolio variance using sharpe index Model
Portfolio variance (on the basis of Modern portfolio theory given by
Markowitz)
Solution
(i) Portfolio Beta = 0.2 x 0.4 + 0.5 x 0.5 + 0.3 x 0.1 = 0.66
(ii) Residual Variance of each of the three shares
 SFM - COMPILER 451

To calculate residual variance we first have to calculate systematic risk

β2axσ2m = (0.4)2(0.01) = 0.0016
β2bxσ2m = (0.4)2(0.01) = 0.0025
β2cxσ2m = (0.4)2(0.01) = 0.00121
Residual Variance (Unsystematic Risk)
A = 0.015 – 0.0016 = 0.0134
B = 0.025 – 0.0025 = 0.0225
C = 0.100 – 0.0121 = 0.0879
(iii) Portfolio Variance using Sharper index Model
Systematic Variance of the portfolio = (0.10)2 x (0.66)2 = 0.004356
Unsystematic Variance of the portfolio = 0.0134 x (0.20)2 + 0.0225 x
(0.50)2 + 0.0879 x (0.30)2 = 0.14072
Total Variance = 0.004356 + 0.014072 = 0.018428
(iv) Portfolio Variance as per the theory given by Markowitz
= (𝑊𝐴 x 𝑊𝐴 x 𝜎 2 𝐴) + (𝑊𝐴 x 𝑊𝐵 x 𝐶𝑂𝑉𝐴𝐵 ) + (𝑊𝐴 x 𝑊𝑐 x 𝐶𝑂𝑉𝐴𝑐 )
+ (𝑊𝐵 x 𝑊𝐵 x 𝐶𝑂𝑉𝐴𝐵 ) + (𝑊𝑏 x 𝑊𝐵 x 𝜎 2 𝐵)+ (𝑊𝐵 x 𝑊𝑐 x 𝐶𝑂𝑉𝐴𝐶 )
+ (𝑊𝑐 x 𝑊𝐴 x 𝐶𝑂𝑉𝐶𝐴 ) + (𝑊𝐶 x 𝑊𝐵 x 𝐶𝑂𝑉𝑐𝐵 ) + (𝑊𝑐 x 𝑊𝑐 x 𝜎 2 𝐶)
= (0.2 x 0.2 x 0.015) + (0.2 x 0.5 x 0.030)+ (0.2 x 0.3 x 0.020)
+ (0.2 x 0.5 x 0.030) + (0.5 x 0.5 x 0.025) + (0.5 x 0.3 x 0.040)
+ (0.3 x 0.2 x 0.020) + (0.3 x 0.5 x 0.040) + (0.3 x 0.3 x 0.10)
= 0.0363
Question 48 : Nov 2015 – RTP
A study by a Mutual fund has revealed the following data in respect of
three securities:
Security σ (%) Correlation with Index, Pm
A 20 0.60
B 18 0.95
C 12 0.75
The standard deviation of market portfolio (BSE Sensex) is observed to be
15%.
(i) What is the sensitivity of returns of each stock with respect to the
market?
(ii) What are the covariances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks
equally?
(iv) What is the beta of the portfolio consisting of equal investment in each
stock?
(v) What is the total, systematic and unsystematic risk of the portfolio in
(iv)?
452 SFM - COMPILER

Solution
(i) Sensitivity of each stock with market is given by its beta.
Standard deviation of market Index = 15%
Variance of market Index = 0.0225
Beta of stocks = σi r/σm
A = 20 × 0.60/15 = 0.80
B = 18 × 0.95/15 = 1.14
C = 12 × 0.75/15 = 0.60
(ii) Covariance between any 2 stocks = β β 1 2σ2m
Covariance matrix
Stock/Beta 0.80 1.14 0.60
A 400.000 205.200 108.000
B 205.200 324.000 153.900
C 108.000 153.900 144.000

(iii) Total risk of the equally weighted portfolio (Variance)

= 400(1/3)2 + 324(1/3)2 + 144(1/3)2 + 2(205.20)(1/3)2 +
2(108.0)(1/3)2 + 2(153.900) (1/3)2 = 200.244
𝟎.𝟖𝟎+𝟏.𝟏𝟒+𝟎.𝟔𝟎
(iv) βof equally weighted portfolio = 𝟑
= 0.8467
(v) Systematic Risk β P2σm2 = (0.8467)2 (15)2 =161.302
Unsystematic Risk
= Total Risk – Systematic Risk
= 200.244 – 161.302= 38.942
Question 49 :Nov 2015 – RTP – Similar to - Question 12 - Nov 2009
- Paper – 10 Marks
Question 50 May 2016 – RTP
Suppose if Treasury Bills give a return of 5% and Market Return is 13%, then
determine
(i) The market risk premium
(ii) β Values and required returns for the following combination of
investments.
Treasury Bill 100 70 30 0
Market 0 30 70 100
Solution
(i) Market Risk Premium Rm – Rf = 13% - 5% = 8%
(ii) β is the weighted average of investing in portfolios consisting of
market (β = 1) and beta of treasury bills (β = 0)
Portfolio Treasury Bills: β R j = R f + β × (R 𝑚 − R f )
Market Portfolio
1 100:0 0 5%+0(13-5) = 5%
2 70:30 0.7(0)+0.3(1)=0.3 5%+0.3(13-5) = 7.40%
3 30:70 0.3(0)+0.7(1)=0.7 5%+0.7(13-5) = 10.60%
4 1:100 1 5%+1.0(13-5) = 13%
 SFM - COMPILER 453

Question 51 May 2016 – RTP

The following information is available for the share of X Ltd. and stock
exchange for the last 4 years.
Jay Kay Ltd. Market
Return on
Year Avg Share Average Dividend
DPS Govt. Bonds
Price Index Yield (%)
2002 242 20 1812 4 6
2003 279 25 1950 5 5
2004 305 30 2258 6 4
2005 322 35 2220 7 5
Compute Beta Value of the company at the end of the year 2005.
Solution
Computation of Beta Value
Calculation of Returns
𝐃𝟏 +(𝐏𝟏 − 𝐏𝟎 )
Return = 𝐏𝟎
x 100
Year Returns
2002-2003 25+(279− 𝟐𝟒𝟐)
x 100 = 25.62%
242
2003-2004 25+(279− 𝟐𝟒𝟐)
x 100 = 20.07%
242
2004-2005 25+(279− 𝟐𝟒𝟐)
x 100 = 17.05%
242

Computation of Returns from Market Index

Year % of Index Appreciation Dividend Total
Yield % Return %
2002-2003 1950−1812
x 100 = 7.62% 5% 12.62%
1812
2003-2004 2258−1950
x 100 = 15.79% 6% 21.79%
1950
2004-2005 2220−2258
x 100 = (-)1.68% 7% 5.32%
2258

Computation of Beta
Year X Y XY 𝐘𝟐
2002-2003 25.62 12.62 323.32 159.26
2003-2004 20.07 21.79 437.33 474.80
2004-2005 17.05 5.32 90.71 28.30
62.74 39.73 854.36 662.36
62.74 39.73
̅
X= = 20.91, ̅
Y= = 13.24,
3 3

ƩXY−n̅̅̅̅
XY ̅
Β =
ƩY2 −nƩY2
454 SFM - COMPILER

851.36−3(20.91)(13.24)
=
662.36−3(13.24)2
851.36−830.55 20.81
= = = 0.15
662.36−525.89 136.47

Question 52 May 2016 – RTP

The following details are given for X and Y companies’ stocks and the Bombay
Sensex for a period of one year. Calculate the systematic and unsystematic
risk for the companies’ stocks. What would be the portfolio risk if equal
amount of money is allocated among these stocks?
X Stock Y Stock Sensex
Average return 0.15 0.25 0.06
Variance of return 6.30 5.86 2.25
Β 0.71 0.685
Correlation Co-efficient 0.424
2
Co-efficient of determination (r ) 0.18

Solution
The co-efficient of determination (r2) gives the percentage of the variation in
the security’s return that is explained by the variation of the market index
return. In the X company stock return, 18 per cent of variation is explained by
the variation of the index and 82 per cent is not explained by the index.
According to Sharpe, the variance explained by the index is the systematic
risk. The unexplained variance or the residual variance is the unsystematic
risk.
Company X:
Systematic risk = β2i × Variance of market index
= (0.71)2 × 2.25 = 1.134

Unsystematic risk(∈2i )= Total variance of security return - Systematic risk

= 6.3 – 1.134
= 5.166
or
= Variance of Security Return (1 - r 2 )
= 6.3 X (1 - 0.18) = 6.3 X 0.82 = 5.166
Total risk = β2i x σ2m + ∈2i
= 1.134 + 5.166 = 6.3
Company Y:
Systematic risk = β2i x σ2m
= (0.685)2 x 2.25 = 1.056

Unsystematic risk = Total variance of the security return - systematic risk.

= 5.86 - 1.056 = 4.804
𝛔𝟐𝒑 = [(∑𝑵 𝟐 𝟐 𝑵 𝟐 𝟐
𝒊=𝟏 𝑿𝒊 𝜷𝒊 ) 𝛔𝐦 ] + [(∑𝒊=𝟏 𝑿𝒊 ∈𝐢 )]

= [(0.5 x 0.71 + 0.5 x 0.685)2 2.25] + [(0.5)2 (5.166)+(0.5)2 (4.804)]

= [(0.355 + 0.3425)𝟐 2.25] + [(1.292 + 1.201)] = 1.0946 + 2.493
= 3.5876
 SFM - COMPILER 455

Question 53 May 2016 – Paper – 5 Marks

The following are the data on five mutual funds:
Fund Return Standard Deviation Beta
A 15 7 1.25
B 18 10 0.75
C 14 5 1.40
D 12 6 0.98
E 16 9 1.50
You are required to compute Reward to Volatility Ratio and rank these
portfolio using:
 Sharpe method and
 Treynor's method
Assuming the risk free rate is 6%.

Solution
Sharpe Ratio S = (R p – R f )/ σp
Treynor Ratio T = (R p – R f )/ βp
Where,
R p = Return on Fund
R f = Risk-free rate
σp = Standard deviation of Fund
βp = Beta of Fund

Reward to Variability (Sharpe Ratio)

Mutual Rp Rf Rp - RF σp Reward to Ranking
Fund Variability
A 15 6 9 7 1.285 2
B 18 6 12 10 1.20 3
C 14 6 8 5 1.60 1
D 12 6 6 6 1.00 5
E 16 6 10 9 1.11 4

Reward to Variability (Treynor Ratio)

Mutual Rp Rf Rp - RF σp Reward to Ranking
Fund Variability
A 15 6 9 1.25 7.2 2
B 18 6 12 0.75 16 1
C 14 6 8 1.40 5.71 5
D 12 6 6 0.98 6.12 4
E 16 6 10 1.50 6.67 3

Question 54 Nov 2016 – RTP

A company has a choice of investments between several different equity
oriented mutual funds. The company has an amount of `1 crore to invest. The
details of the mutual funds are as follows:
Mutual Fund Beta
456 SFM - COMPILER

A 1.6
B 1.0
C 0.9
D 2.0
E 0.6
Required:
(i) If the company invests 20% of its investment in the first two mutual
funds and an equal amount in the mutual funds C, D and E, what is
the beta of the portfolio?
(ii) If the company invests 15% of its investment in C, 15% in A, 10% in E
and the balance in equal amount in the other two mutual funds, what
is the beta of the portfolio?
(iii) If the expected return of market portfolio is 12% at a beta factor of 1.0,
what will be the portfolios expected return in both the situations given
above?

Solution
With 20% investment in each MF Portfolio Beta is the weighted average of the
Betas of various securities calculated as below:
(i)
Investment Beta (β) Investment (Rs.Lacs) Weighted Investment
A 1.6 20 32
B 1.0 20 20
C 0.9 20 18
D 2.0 20 40
E 0.6 20 12
100 122

(ii) With varied percentages of investments portfolio beta is calculated as

follows:
Investment Beta (β) Investment (Rs.Lacs) Weighted Investment
A 1.6 15 24
B 1.0 30 30
C 0.9 15 13.5
D 2.0 30 60
E 0.6 10 6
100 133.5
Weighted Beta (β) = 1.335

(iii) Expected return of the portfolio with pattern of investment as in case i

= 12% × 1.22 i.e. 14.64%
Expected Return with pattern of investment as in case ii
= 12% × 1.335 i.e., 16.02%.

Question 55 - Nov 2016 – RTP – Similar to - Question 25 - Nov 2011

– Paper

Question 56 - Nov 2016 – RTP – Similar to - Question 28 - May

2012 - Paper – 8 Marks

Question 57 Nov 2016 – Paper – 5 Marks

The following information is available in respect of Security A:
 SFM - COMPILER 457

Equilibrium Return 12%

Market Return 12%
6% Treasury Bond trading at Rs.120
Co-variance of Market Return and Security Return 196%
Coefficient of Correlation 0.80
You are required to determine the Standard Deviation of:
(i) Market Return and
(ii) Security Return
Solution
𝟔
(iii) 𝐑𝐟 = x 100 = 5%
𝟏𝟐𝟎
Applying CAPM

12% = 5% + β(12% - 5%)

7% = β(7%)
β =1
Cov (r,m)
β =
σ2m
196
1 =
σ2m

σ2m = 196

σm = √196
= 14

Standard Deviation of Market Return = 14

Cov (r,m)
(iv) Cor. =
σm σr
196
0.80 = Cor. =
14σr
σr = 17.50%
Standard Deviation of Security Return = 17.50%
Question 58 Nov 2016 – Paper – 5 Marks
Mr. A has invested in three Mutual Fund (MF) schemes as per the details
given below:
Particulars MF ‘A’ MF ‘B’ MF ‘C’
Date of Investment 01-11-2015 01-02-2016 01-03-2016
Amount of Investment 1,00,000 2,00,000 2,00,000
Net Asset Value at entry date 10.30 10.00 10.10
Dividend Received upto 31-3-2016 2,850 4,500 NIL
NAD as on 31-3-2016 10.25 10.15 10.00
Assume 1 year = 365 days.
Show the amount of rupees upto two decimal points.
You are required to find out the effective yield (upto three decimal points) on
per annum basis in respect of each of the above three Mutual Fund (MF)
schemes upto 31-3-2016.
458 SFM - COMPILER

Solution
Particulars MF ‘A’ MF ‘B’ MF ‘C’
a) Investments 1,00,000 2,00,000 2,00,000
b) Opening NAV 10.30 10.00 10.10
c) No. of Units (a/b) 9,708.74 20,000 19,801.98
d) Unit NAV on 31-3-2016 10.25 10.15 10.00
e) Total NAV on 31-3-2016 (c/d) 99,514.59 2,03,000 1,98,019.86
f) Increase/Decrease of NAV(a-d) (485.41) 3,000 (1980.14)
g) Dividend Received 2,850 4,500 NIL
h) Total Yield (f+g) 2,364.59 7,500 1,980.20
i) Number of Days 152 60 31
j) Effective yield p.a. (h/a×365/i×100) 5,678% 22.813% (-)11.657%

Question 59 Nov 2016 – Paper – 8 Marks

The returns and market portfolio for a period of four years are as under:
Year % Return of Stock B % Return on Market Portfolio
1 10 8
2 12 10
3 9 9
4 3 -1
For stock B, you are required to determine:
(i) characteristic line; and
(ii) the Systematic and Unsystematic risk.
Solution
Characteristic line is given by
αi +βi Rm
Ʃxy−nx̅̅
y
βi =
Ʃx2 −n(x̅)2

αi =y
̅ − βx̅
Return on B (Y) Return on B (X) XY 𝐗𝟐 ̅)
(X – 𝑿 ̅)𝟐
(X – 𝐗 ̅)
(Y – 𝐘 ̅)𝟐
(X – 𝐘
10 8 80 64 1.50 2.25 1.50 2.25
12 10 120 100 3.50 12.25 3.50 12.25
9 9 81 81 2.50 6.25 0.50 0.25
3 -1 -3 1 1 56.25 -5.50 30.25
34 26 278 246 77.00 45.00
̅
Y = 34/4 = 8.50
̅ = 26/4 = 6.50
X
Ʃxy−nx̅̅
y 278−4(6.50)(8.50) 278−221 57
β = = = = = 0.74
Ʃx2 −n(x̅)2 246−4(6.50)2 246−169 77

α = ̅
Y - βx
̅
= 8.50 – 0.74(6.50)
 SFM - COMPILER 459

= 3.69
Hence the characteristic line is -3.69 + 0.74 (Rm)
Ʃ(x−x̅)2 77
Total Risk of Market = σm2 = = = 19.25%
n 4
45
Total Risk of Stock = = 11.25(%)
4
2
Systematic Risk = β𝑖 σ2m = (0.74)2 × 19.25 = 10.54(%)
Unsystematic Risk is = Total Risk – Systematic Risk
= 11.25 – 10.54
= 0.71(%)

Question 60 - May 2017 – RTP – Similar to - Question 54 - Nov

2016 – RTP

Question 61 May 2017 – Paper –5 Marks

A is an investor and having in its portfolio shares worth Rs.1,20,00,000 at
current price and cash Rs.10,00,000. The beta (β) of share portfolio is 1.4.
After 4 months the price of shares dropped by 1.8%.
Determine:
(i) Current portfolio beta
(ii) Portfolio beta after 4 months if A on current date goes for long position
on Rs.1,30,00,000 Nifty futures.
Show Calculations in Rs.Lakhs with four decimal points.
Solution
(i) Current portfolio
Current Beta for share = 1.4
Beta for cash =0
120 10
Current portfolio beta = x 1.4 + 0 x = 1.2923
130 130

(ii) Portfolio beta after 4 months:

Change in value of portfolio of share
Beta for portfolio of shares =
Change in value of market portfolio (Index)
0.018
1.4 =
Change in value of market portfolio (Index)
Change in value of market portfolio (Index) = (0.018 / 1.4) x 100 = 1.2857
Position taken on 100 lakh Nifty futures : Long
Value of index after 4 months = Rs.130 lakh x (1.00-0.012857)
= Rs.128.3286 lakh
Mark-to-market paid = Rs.1.6714 lakh
460 SFM - COMPILER

Cash balance after payment of mark-to-market = Rs.8.3286 lakh

Value of portfolio after 4 months =120 lakh×(1-0.018) +8.3286lakh
= Rs.126.1686 lakh
130 lakh−126.1686 lakh
Change in value of portfolio = = 2.9472%
130 lakh
Portfolio beta = 0.029472/0.012857 = 2.2923

Question 62 May 2017 – Paper –8 Marks

A Stock costing Rs.150 pays no dividends. The possible prices at which the
stock may be sold for at the end of the year with the respective probabilities
are:
Price (in Rs.) Probability
130 0.2
150 0.1
160 0.1
165 0.3
175 0.1
180 0.2
Total 1.0
You are required to:
(i) calculate the Expected Return,
(ii) calculate the Standard Deviation ( ) of Returns.
Show calculations upto three decimal points.
Solution
Here, the probable returns have to be calculated using the formula
𝐃 𝐏𝟏 − 𝐏𝟎
R= +
𝐏𝟎 𝐏𝟎

Calculations of Probable Returns

Possible Prices (𝐏𝟏 ) (Rs) 𝐏𝟏 - 𝐏𝟎 [(𝐏𝟏 - 𝐏𝟎 )] x 100 Return (per cent)
130 -20 -13.33
150 0 0.00
160 10 6.67
165 15 10.00
175 25 16.667
180 30 20.00
Calculations of Probable Returns
Possible Prices Probablility Product
𝐗𝐢 p(𝐗𝐢 ) 𝐗 𝟏 - p(𝐗 𝐢 )
-13.33 0.2 -2.667
0.00 0.1 0.000
6.667 0.1 0.667
10.00 0.3 3.000
16.667 0.1 1.667
 SFM - COMPILER 461

20.00 0.2 4.000

X = 6.667
Expected return X = 6.667 per cent
Alternatively, it can also be calculated as follows:
Expected Price = 130 x 0.2 + 150 x 0.1 + 160 x 0.1 + 165 x 0.3 + 175 x 0.1 + 180
x 0.2 = 160
160−150
Return = ×100 = 6.667%
150
Calculations of Standard Deviation of Returns
Probable return Probablility Deviation Deviation Squared Product
𝐗𝐢 p(𝐗𝐢 ) ̅)
(𝐗 𝐢 -𝐗 ̅)𝟐
(𝐗 𝐢 -𝐗 ̅)𝟐
(𝐗 𝐢 -𝐗
-13.33 0.2 -20.00 400.00 80.00
0.00 0.1 -6.667 44.449 4.445
6.667 0.1 0 0 0
10.00 0.3 3.333 11.109 3.333
16.667 0.1 10.00 100.00 10.00
20.00 0.2 13.333 177.769 35.554
σ2 = 133.332
Variance, σ2 = - 133.332 per cent
Standard deviation, σ = √133.332 = 11.547 per cent

Question 63 May 2017 – Paper –8 Marks

The five portfolios of a mutual fund experienced following result during last
10 years periods :
Portfolio Average annual Standard Correlation with
return % Deviation the market return
A 20.0 2.3 0.8869
B 17.0 1.8 0.6667
C 18.0 1.6 0.600
D 16.0 1.8 0.867
E 13.5 1.9 0.5437
Market risk : 1.2
Market rate of return : 14.3%
Risk free rate : 10.1%
Beta may be calculated only upto two decimal. Rank the portfolio using
JENSEN's ALPHA method.

Solution
Let portfolio standard deviation be σp
Market Standard Deviation = σm
Coefficient of correlation = r
σp 𝑟
Portfolio beta (βp ) = σ , ( Beta for A = 2.30 x 0.8869/1.2 = 1.7, etc)
m

Required portfolio return (R p ) = R f + βp (R m – R f ),

[R p for A = 10.1 +1.70x(14.3-10.1) = 17.24, etc.]

Portfolio Beta Return from the portfolio (R p ) (%)
462 SFM - COMPILER

A 1.70 17.24
B 1.00 14.30
C 0.80 13.46
D 1.30 15.56
E 0.86 13.71

Portfolio Average Expected Jensen’s Alpha

Return Return
% % AR – ER Rank
A 20 17.24 2.76 II
B 17 14.30 2.70 III
C 18 13.46 4.54 I
D 16 15.56 0.44 IV
E 13.5 13.71 -0.20 V

Question 64 Nov 2017 – RTP

ABC Ltd. manufactures Car Air Conditioners (ACs), Window ACs and Split
ACs constituting 60%, 25% and 15% of total market value. The stand-alone
Standard Deviation and Coefficient of Correlation with market return of Car
AC and Window AC is as follows:
S.D. Coefficient of Correlation
Car AC 0.30 0.6
Window AC 0.35 0.7
No data for stand-alone SD and Coefficient of Correlation of Split AC is not
available. However, a company who derives its half value from Split AC and
half from Window AC has a SD of 0.50 and Coefficient of correlation with
market return is 0.85. Index has a return of 10% and has SD of 0.20. Further,
the risk-free rate of return is 4%.
You are required to determine:
(i) Beta of ABC Ltd.
(ii) Cost of Equity of ABC Ltd.
Assuming that ABC Ltd. wants to raise debt of an amount equal to half of its
Market Value then determine equity beta, if yield of debt is 5%.
Solution
(i) Determination of Beta of Car AC and Window AC
σsm σs
σm

Car AC
0.6 x 0.3
= 0.90
0.2
Window AC
0.7 x 0.35
= 1.225
0.2
Beta of Split AC/ Window AC is
0.85 x 0.50
= 2.125
0.2
 SFM - COMPILER 463

The Beta of Split AC alone is

2.125 = 0.50βs + 0.50βc
= 0.50βs + 0.50 x 1.225
βs = 3.025
ABC Ltd.’s Beta shall be:
0.6 x 0.9 + 0.25 x 1.225 + 0.15 x 3.025
= 1.30

(ii) Cost of Equity of ABC Ltd.

Ke = 4% + 1.30(10% - 4%) = 11.80%

(iii) Calculation of Debt Beta

5%−4%
= 0.167
10%−4%

Accordingly, Beta of Equity shall be

1.30 = 0.50 x 0.167 + 0.50 x βe = 2.433
Question 65 Nov 2017 – RTP
Following is the data regarding six securities:
A B C D E F
Return (%) 8 8 12 4 9 8
Risk (Standard Deviation) 4 5 12 4 5 6
(i) Assuming three will have to be selected, state which ones will be
picked.
(ii) Assuming perfect correlation, show whether it is preferable to invest
75% in A and 25% in C or to invest 100% in E
Solution
(i) Security A has a return of 8% for a risk of 4, whereas B and F have a
higher risk for the same return. Hence, among them A dominates.
For the same degree of risk 4, security D has only a return of 4%.
Hence, D is also dominated by A.
Securities C and E remain in reckoning as they have a higher return
though with higher degree of risk.
Hence, the ones to be selected are A, C & E.

(ii) The average values for A and C for a proportion of 3 : 1 will be :

(3×4)+(1×2)
Risk = = 6%
4

(3×8)+(1×12)
Return = = 9%
4

Therefore: 75% A E
25% C _
Risk 6 5
Return 9% 9%
For the same 9% return the risk is lower in E. Hence, E will be
preferable.
464 SFM - COMPILER

Question 66 - Nov 2017 – RTP – Similar to - Question 21 - May 2011

- Paper – 5 Marks
Question 67 - Nov 2017 – RTP – Similar to –Question 53 - May
2016 – Paper – 5 Marks

Question 68 Nov 2017 – Paper – 10 Marks

The return of security ‘L’ and security ‘K’ for the past five years are given
below:
Year Security – L Security – K
Return % Return %
2012 10 11
2013 04 -06
2014 05 13
2015 11 08
2016 15 14
Calculate the risk and return of portfolio consisting above information.

Solution
If it is assumed 50% investment in each of the two securities then Return and
Risk of Portfolio shall be computed as follows:
Year Return Deviation Deviation Return Deviation Deviation Product of
of L (𝐑 𝐋 -̅̅̅̅
𝐑 𝐋 ) (𝐑 𝐋 -̅̅̅̅
𝐑 𝐋 )𝟐 of K ̅̅̅̅
(𝐑 𝐊 -𝐑 ̅̅̅̅ 𝟐 deviations
𝐊 ) (𝐑 𝐊 -𝐑 𝐊 )
2012 10 1 1 11 3 9 3
2013 04 -5 25 -6 -14 196 70
2014 05 -4 16 13 5 25 -20
2015 11 2 4 8 0 0 0
2016 15 6 36 14 6 36 36
Ʃ = 45 Ʃ = 82 Ʃ = 40 Ʃ = 266 89
45 40
̅̅
R̅̅L = 5 = 9 ̅̅̅̅
RK = 5 = 8

∑N ̅̅̅ ̅̅̅
i=1[R1 −R1 ][R2 −R2 ] 89
Covariance = = = 17.8
N 5

Return and Standard Deviation of Security L

45
RL = =9
5

2
(RL −̅̅̅̅
RL )
σL =√
N

82
σL =√ = 4.05
5

Standard Deviation of Security K

2
(RK −̅̅̅̅
RK )
σK =√
N
 SFM - COMPILER 465

266
σ𝐾 =√ = 7.26
5

Portfolio Return
Rp = 0.50 x 9 +0.50 x 8
= 8.50%

Portfolio Standard Deviation

σLK = (0.502 X 4.052 + 0.502 X 7.292 + 2X 0.5 X 0.5 X 17.8)½
= 5.12
Question 69 - May 2018 – RTP – Similar to - Question 32 - May
2013 – RTP

Question 70 - May 2018 – RTP – Similar to - Question 12 - Nov

2009 - Paper – 10 Marks

Question 71 May 2018 – Paper – 8 Marks

As an investment manager, you are given the following information:
Particulars Initial Dividen Market price of the Beta (Risk
Price (Rs.) d (Rs.) dividends (Rs.) Factor)
A. Equity Shares:
Manufacturing Ltd. 30 2 55 0.8
Pharma Ltd. 40 2 65 0.7
Auto Ltd. 50 2 140 0.5
B. Government of 1005 140 1010 0.99
India Bonds
By assuming risk free return as 16%, Calculate:
(i) Expected rate of return on the portfolio (aggregate) of investor;
(ii) Expected rate of return of portfolio in each above stated share/ bond
using Capital Asset Pricing Model (CAPM); and
(iii) Average Rate of Return.

Solution
D −P
a) Return on market portfolio = ( 1P 1 ) – 1
0

Total dividend = 2+2+2+140

= 146
P0 = 30+40+50+1005
= 1125
P1 = 55+65+140+1010
= 1270

146+1270
Rm = ( 1125
)–1 = 25.87%

0.8+0.7+0.5+0.994
b) Average β = = 0.7475
4

i. Expected return on portfolio

466 SFM - COMPILER

= Rf + β (Rm-Rf)
= 16+0.7475(25.87-16)
= 23.38%

ii. Re for each stock

Manufacturing = 16+0.8(25.87-16) = 23.896
Pharma = 16+0.7(25.87-16) = 22.909
Auto = 16+0.5(25.87-16) = 20.935
GOI = 16+0.99(25.87-16) = 25.771

23.896+22.909+20.935+25.7714
iii. Average Return = = 23.378%
4

Question 72 - May 2018 (New) – RTP – Similar to - Question 41 -

May 2014 – RTP

Question 73 - May 2018 (New) – RTP – Similar to - Question 47 -

May 2015 - Paper – 8 Marks

Question 74 May 2018 (New) – Paper – 10 Marks

Consider the following information on two stocks, X and Y:
Year 2016 2017
Return on X (%) 10 16
Return on Y (%) 12 18
You are required to determine:
(i) The expected return on a portfolio containing X and Y in the proportion
of 40% and 60% respectively.
(ii) The Standard Deviation of return from each of the two stocks.
(iii)The covariance of returns from the two stocks.
(iv) Correlation coefficient between the returns of the two stocks.
(v) The risk of a portfolio containing X and Y in the proportion of 40% and
60%.
Solution
(i) Expected return of the portfolio X and Y
E (X) = (10 + 16) / 2 = 13%
E (Y) = (12 + 18) / 2 = 15%
Rp = 0.4 (13) + 0.6 (15) = 14.2%

(ii) Standard Deviation of X and Y

Stock X
Variance = 0.5 (10 – 13)² + 0.5 (16– 13) ² = 9
Standard deviation = 9 = 3%
Stock Y
 SFM - COMPILER 467

Variance = 0.5 (12 – 15) ² + 0.5 (18– 15) ² = 9

Standard deviation = 3%

(iii) Covariance of stocks X and Y

COVXY = 0.5 (10– 13) (12– 15) + 0.5 (16– 13) (18– 15) = 9

(iv) Correlation of coefficient

Cov (X,Y) 9
p= =3x3=1
σx σy

(v) Portfolio Risk

σp= 0.4 (3) + 0.6 (3) = 3%

Question 75 - Nov 2018 – RTP – Similar to - Question 22 - May 2011

- Paper - 5 Marks

Question 76 - Nov 2018 – RTP – Similar to - Question 54 - Nov 2016

– RTP

Question 77 Nov 2018 – RTP

X Co., Ltd., invested on 1.4.2009 in certain equity shares as below:
Name of Co. No. of shares Cost (Rs.)
M Ltd. 1,000 (Rs.100 each) 2,00,000
N Ltd. 500 (Rs.10 each) 1,50,000
In September, 2009, 10% dividend was paid out by M Ltd. and in October,
2009, 30% dividend paid out by N Ltd. On 31.3.2010 market quotations
showed a value of Rs.220 and Rs.290 per share for M Ltd. and N Ltd.
respectively.
On 1.4.2010, investment advisors indicate (a) that the dividends from M Ltd.
and N Ltd. for the year ending 31.3.2011 are likely to be 20% and 35%,
respectively and (b) that the probabilities of market quotations on 31.3.2011
are as below:
Probability Factor Price/share of M Ltd. Price/share of N Ltd.
0.2 220 290
0.5 250 310
0.3 280 330

You are required to:

(i) Calculate the average return from the portfolio for the year ended
31.3.2010;
(ii) Calculate the expected average return from the portfolio for the year
2010-11; and
(iii) Advise X Co. Ltd., of the comparative risk in the two investments by
calculating the standard deviation in each case.
Solution
 468 SFM - COMPILER

Calculation of return on portfolio for 2009-10 (Calculation in

Rs./share)
M N
Dividend received during the year 10 3
Capital gain/loss by 31.03.10
Market value by 31.03.10 220 290
Cost of investment 200 300
Gain/loss 20 (-)10
Yield 30 (-)7
Cost 200 300
% return 15% (-)2.33%
Weight in the portfolio 57 43
Weighted average return 7.55%

Calculation of estimated return for 2010-11

Expected dividend 20 3.5
Capital gain by 31.03.11
(220x0.2) + (250x0.5) + (280x0.3) – 220 = (253-220) 33 -
(290x0.2) + (310x0.5) + (330x0.3) – 290 = (312 – 290) - 22

Yield 53 25.5
*Market Value 01.04.10 220 290
% return 24.09% 8.79%
*Weight in portfolio (1,000x220): (500x290) 60.3 39.7
Weighted average (Expected) return 18.02%
(*The market value on 31.03.10 is used as the base for
calculating yield for 10-11)

Calculation of Standard Deviation

M Ltd.
Exp. Exp. Exp. Exp. Prob. (1) x (2) Dev. Square (2) x (3)
Market Gain div. Yield (1) Factor (2) 𝑃𝑚 of Dev.
( )
value PM (3)
220 0 20 20 0.2 4 -33 1089 217.80
250 30 20 50 0.5 25 -3 9 4.5
280 60 20 80 0.3 24 27 729 218.70
53 σ2M = 441
Standard Deviation (𝛔𝐌 ) 21
 SFM - COMPILER 469

N Ltd.
Exp. Exp. Exp. Exp. Prob. (1) x (2) Dev. Square (2) x (3)
Market Gain div. Yield (1) Factor (2) 𝑃𝑛 of Dev.
( )
value PN (3)
290 0 3.5 3.5 0.2 0.8 -22 484 96.80
310 20 3.5 23.5 0.5 11.75 -2 4 2.00
330 40 3.5 43.5 0.3 13.05 18 324 97.20
25.5 σ2N = 196
Standard Deviation (𝛔𝐍 ) 14
Share of company M Ltd. is more risky as the S.D. is more than company N
Ltd.

Question 78 Nov 2018 – Paper – 8 Marks

Mr. Gupta is considering investment in the share of R. Ltd. He has the
following expectations of return on the stock and the market:
Probability Return (%)
R Ltd. Market
0.35 30 25
0.30 25 20
0.15 40 30
0.20 20 10
You are required to:
a. Calculate the expected return, variance and standard deviation for R Ltd.
b. Calculate the expected return variance and standard deviation for the
market.
c. Find out the beta co-efficient for R Ltd. shares.
Solution
P R R.P. d.R. 𝐝𝟐 𝐑. 𝐏. M M.P. dm 𝐝𝟐 𝐌. 𝐏. dRdM.P

0.35 30 10.5 2 1.4 25 8.75 3.75 4.92 +2.625

0.30 25 7.5 -3 2.7 20 6 -1.25 0.47 +1.125
0.15 40 6 12 21.6 30 4.5 8.75 11.48 15.75
0.20 20 4 -8 12.8 10 2 -11.25 25.31 18

̅
𝐗 28 𝝈𝟐 = 38.5 ̅
𝐗 21.25 𝝈𝟐 = 42.18 37.5
σ = 6.20 σ = 6.49

𝐂𝐎𝐕𝐑𝐌 = 37.5
𝐂𝐎𝐕𝐑𝐌 𝟑𝟕.𝟓
𝛃𝐑 = 𝛔𝟐 𝐌
= 𝟒𝟐.𝟏𝟖 = 0.889
470 SFM - COMPILER

Question 79 - Nov 2018 (New) – RTP – Similar to - Question 31 -

Nov 2012 - Paper – 8 Marks

Question 80 - Nov 2018 (New) – RTP – Similar to - Question 53 -

May 2016 – Paper – 5 Marks

Question 81 Nov 2018 (New) – Paper – 8 Marks

Mr. Kapoor owns a portfolio with the following characteristics:
Security X Security Y Risk Free Security
Factor 1 Sensitivity 0.75 1.50 0
Factor 2 Sensitivity 0.60 1.10 0
Expected Return 15% 20% 10%

It is assumed that security returns are generated by a two factor model.

a. If Mr. Kapoor has Rs.1,00,000 to invest and sells short Rs.50,000 of
security Y and purchases Rs.1,50,000 of security X, what is the sensitivity
of Mr. Kapoor's portfolio to the two factors ?
b. If Mr. Kapoor borrows Rs.1,00,000 at the risk free rate and invests the
amount he borrows along with the original amount of Rs.1,00,000 in
security X and Y in the same proportion as described in part (i), what is
the sensitivity of the portfolio to the two factors ?
c. What is the expected return premium of factor 2?
Solution
i. Mr. X’s position in the two securities are +1.50 in security A and - 0.5
in security B.
Hence the portfolio sensitivities to the two factors:-
b prop. 1 =1.50 x 0.75 + (-0.50 x 1.50) = 0.375
b prop. 2 = 1.50 x 0.60 + (-0.50 x 1.10) = 0.35

ii. Mr. X’s current position:-

Security A Rs.3,00,000 /Rs.1,00,000 =3
Security B –Rs.1,00,000 /Rs.1,00,000 = -1
Risk free asset –Rs.100000 /Rs.100000 = -1
b prop. 1 = 3.0 x 0.75 + (-1 x 1.50) + (- 1 x 0) = 0.75
b prop. 2 = 3.0 x 0.60 + (-1 x 1.10) + (-1 x 0) = 0.70

iii. Expected Return = Risk Free Rate of Return + Risk Premium

Let λ1 and λ2 are the Value Factor 1 and Factor 2 respectively.
Accordingly
15 = 10 + 0.75 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.10 λ2
On solving equation, the value of λ2 = 0, the expected return premium
of factor 2 = 0.