KHETAN EDUCATION
8. PORTFOLIO MANAGEMENT
1. Consider the following portfolios -
Portfolio A B C D E F
(ܘ܀%) 10 12 15 15 18 19
ો( ܘ%) 4 4 6 5 8 7
a. Define and specify the efficient portfolios.
b. Find out the optimum portfolio for the following investors-
(i) X is highly risk averse.
(ii) Y is risk aggressive.
(iii) Z has medium risk tolerance level.
c. What would be the optimum portfolio for an investor whose risk attitude
has not been stated?
d. Find out the optimum portfolio for an investor whose utility function is
given by, U = Rp – 0.2σଶ p
2. A conservative investor is analysing the shares of Dr. Reddy’s Laboratory,
which is currently trading at ` 1180. For the year 1999-2000, the earning
per share (EPS) was ` 40. The investor has gathered the following
scenarios for the next year with the corresponding probabilities:
EPS/ PE Ratio 20 30
50 0.20 0.35
60 0.30 0.15
You are required to calculate the expected risk and return for the share of
Dr. Reddy’s Lab.
3. The historical data of return of two securities over the past ten years are
given. Calculate the covariance and the correlation coefficient of the two
securities:
Years 1 2 3 4 5 6 7 8 9 10
Security 1 (%) 12 8 7 14 16 15 18 20 16 22
Security 2 (%) 20 22 24 18 15 20 24 25 22 20
4. The following table shows information regarding the stock of Hindalco –
Year Stock price at the end of the year Dividend of the
year
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2000 110 5
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Prof. Archana Khetan
KHETAN EDUCATION
2001 115 5
2002 123 6
2003 117 7
2004 129 7
2005 134 8
2006 150 8
Find out the expected return and risk of the share.
5. Consider two stocks i.e. x and Y:
Stocks Expected return Variance & Co- variance (%) 2
X Y
X 12% 100 -60
Y 16% -60 196
a. Construct the minimum risk portfolio.
b. Find out the benefit of diversification of the minimum risk portfolio.
c. Find out the co- efficient of variation of the minimum risk portfolio.
6. Mr. Shyam Bachhan has constructed two portfolios, the details of which are
given below:
Portfolio – 1
Securities Weights Return S.D. Correlation Matrix
ICICI Infosys
ICICI 0.3 18% 10% 1.00 0.75
Infosys 0.7 23% 0.75 0.75 1.00
Portfolio -2
Securities Weights Return S.D Correlation Matrix
ICICI Infosys HLL
ICICI 0.3 18% 10% 1.0 0.75 0.86
Infosys 0.4 23% 16% 0.75 1.00 0.68
HLL 0.3 16% 12% 0.86 0.68 1.00
You are required to:
a. Calculate the risk and return on portfolio 1 & 2.
b. Construct a portfolio out of the portfolios 1 & 2 in order to generate a return of
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20.50%. Find out the SD of such a portfolio.
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Prof. Archana Khetan
KHETAN EDUCATION
7. Consider two stocks A & B and the following portfolios P1, P2, P3, P4
comprising of the stocks A and B-
P1 P2 P3 P4
Wa 50% 100% 25% 0%
Wb 50% 0% 75% 100%
Rp 16% 14% ? 18%
σp 5% 6% ? 8%
Find out the missing figures?
8. Martha Ltd invested on 1.04.2008 in equity shares as below:
Company Number of shares Cost
(`
`)
M Ltd 1000 (` 100 each) 200000
N Ltd 500 (` 10 each) 150000
In September, 2010, M Ltd paid 10% dividend and in October, 2010, N Ltd
paid 30% dividend. On 31.03.2009, market price of shares of M Ltd and N
Ltd were ` 220 and ` 290 respectively.
P Ltd has been informed by their investment advisers that:
a. Dividends from M Ltd. and N Ltd for the year ending 31.03.2010 are likely
to be 20% and 35% respectively.
b. Probabilities of market quotations on 31.03.2010 are:
Probability Factor Price of share of M Ltd Price of share of N Ltd
0.2 220 290
0.5 250 310
0.3 280 330
You are required to:
a. Calculate the average return from the portfolio for year ended 31.03.2009.
b. Calculate the expected average return from the portfolio for the year 2008-
2010.
c. Advice P Ltd of the comparative risk of two investments by calculating
standard deviation in each case.
9. The following table provides a probability distribution on the returns of 2
stocks X and Y.
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Prof. Archana Khetan
KHETAN EDUCATION
Probability Return from X Return from Y
0.4 40 16
0.3 25 20
0.3 10 28
a. Find out the expected return, risk and coefficient of variation for each
stock.
b. Find out the covariance and correlation coefficient between the two stocks.
10. Correlation coefficient for the stock A, B, C, D and E are given below:
Stock A B C D E
A - 0.85 0.60 0.45 0.30
B 0.85 - 0.25 0.10 -0.16
C 0.60 -0.25 - 0.78 0.37
D 0.45 0.10 0.78 - 0.86
E 0.30 -0.16 0.37 0.86 -
Each stock has an expected return of 10% and a SD of 15%. If your entire
portfolio is composed of only stock A and you can add more stock to your
portfolio, which is the stock that you should select?
11. Consider the following information:
Stock Return Variance Weight in the portfolio
Stock 1 16% 484 (%)2 0.50
Stock 2 13% 256 (%)2 0.50
If the variance of the portfolio is 132 (%)2, what is the coefficient of
correlation between the stocks?
12. The following table provides the historical returns on the Sensex and the
stock of Infosys for the last 5 years –
Period Return on Sensex Return on Infosys
1 12% 16%
2 8% 6%
3 15% 20%
4 25% 35%
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5 30% 50%
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Find out the characteristic line for the stock and interpret its coefficient.
Prof. Archana Khetan
KHETAN EDUCATION
13. Turbulent Company’s stock and the market had the following returns
during the last three years and the same trend is expected to continue in
the future:
Year 1 2 3
Market (%) 1 8 0
Turbulent stock (%) 13 9 4
The gilt edged securities are trading at 6%. If equilibrium exists and the
expected return on the market is 12%. What is the expected return on
Turbulent stock?
14. Mr. India has the following scrips in his portfolio-
Particulars Beta Proportion of investment (%)
Ballarpur Industries 0.95 15
GE Shipping 1.1 20
SBI 1.25 30
Ahmadabad Electric Co. 0.8 5
BSES 1.05 20
Bombay Dyeing 0.70 10
Calculate the expected return on his portfolio if the risk free return is 4%
and return on market is 14%?
15. The following table provides the information regarding two stocks-
Stocks Beta Returns
A 0.8 7%
B 1.9 12%
Find out the expected return from the stock C, which has a beta of 2.5?
16. Given the risk free rate is 10% and the expected return on the market
portfolio is 15%. The following are the expected returns for five stocks with
their betas:
Stock Expected return (%) Expected beta
A 19 1.5
15 0.9
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B
C 17 1.25
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Prof. Archana Khetan
KHETAN EDUCATION
D 24.5 0.75
E 25 1.40
Based on this expectation, find out the stocks that are overvalued and
undervalued?
17. Suppose the assumptions of CAPM are valid and unlimited borrowing and
lending at risk less rate of interest is possible. Compute the blanks in the
following table:
Stock Expected Standard Beta Unsystematic
return Deviation risk (%)
A 14 - 1.75 12
B - 6 0.82 5
C 10 - 0.60 18
18. A mutual fund holds the following portfolio:
Stock A B C
Investment (` Crore) 200 200 100
Beta 0.5 2 4
The required rate of return on the market is 14% and that of the above
portfolio according to CAPM is 20.40%. The fund manager has proposed to
sell C for ` 100 crore and use the proceeds to purchase stock ‘D’ which has
a beta of 3. The required rate of return of the portfolio according to CAPM
is?
19. Gita has a portfolio of 8 securities, each with a market value of ` 5000. The
beta of the portfolio is 1.28 and the beta of the riskiest security is 1.75. Gita
wishes to reduce her portfolio beta to 1.15 by selling the riskiest security
and replacing it with a lower beta. What must be the beta of the
replacement security?
20. Consider the following information relating to two stocks:
Stock Expected return Standard Deviation of return
(%) (%)
P 15 30
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Q 10 20
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Prof. Archana Khetan
KHETAN EDUCATION
The returns of the two stocks exhibit perfect correlation. You are required to
determine the return and risk of the following combinations of the two
stocks:
a. 70% of P and 30% of Q
b. 50% of P and 50% of Q
c. 30% of P and 70% of Q
d. 10% of P and 90% of Q
21. The risk preference of Mr. Kumar can be represented by the following
utility function:
U=E(r) – 0.5 σ2, where symbols are in standard use.
Three portfolios for which data are provided below are available for
investment by Mr. Kumar.
Portfolio 1: An investment in an equally weighted portfolio with four
securities all of which are perfectly positively correlated with each other.
The expected return and standard deviation for the securities are as
follows:
Security Expected Return (%) Standard Deviation (%)
A 4 5
B 16 30
C 13 25
D 21 35
Portfolio 2: The minimum variance portfolio comprising an investment in
a security E and security F which have the risk return characteristics as
follows:
Security Expected Return (%) Standard Deviation (%)
E 19 33
F 14 28
The correlation coefficient between securities E and F is 0.5.
Portfolio 3: A portfolio with an expected return of 16%, a beta of 1.3 and
unsystematic risk of 12%. The volatility of market returns is 21%.
You are required to-
a. Compute the expected return and risk for each portfolio.
b. Determine which portfolio Mr. Gupta is likely to select?
You are required to determine whether investing in a combination of all the
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three stocks in equal proportions is better than investing in any one stock?
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Prof. Archana Khetan
KHETAN EDUCATION
22. The following information is available in respect of security X and security
Y:
Security Β Expected rate of return
X 1.8 22.00%
Y 1.6 20.4%
Rate of return of market portfolio is 15.3%. If risk free rate of return is 7%,
are these securities correctly priced? What would be the risk free rate of
return, if they are correctly priced?
23. A portfolio manager has the following four stocks in his portfolio:
Security No. Of shares Mkt price per share β
Varun Shipping Ltd (VSL) 10000 50 0.9
Chowgle steamship Ltd. 5000 20 1.0
(CSL)
Mercatorlines Ltd (ML) 8000 25 1.5
Aurbindo pharma Ltd 2000 200 1.2
Compute the following:
a. Portfolio beta
b. If the portfolio manager seeks to reduce the beta to 0.8, how much risk free
investment should he bring in?
c. If the portfolio manager seeks to increase the beta to 1.2, how much risk
free investment should he bring in.
24. A market analyst has estimated probable returns under different
macroeconomic conditions of the following three stocks:
Stocks Current Price Rate of return (%)
Recession Moderate growth Boom
Polar Informatics 18 -15 10
25
Season Biotech 20 15 8
-4
Good Value Ltd 76 17 20
12
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He is exploring if it is possible to make any arbitrage profits from the above
information.
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Prof. Archana Khetan
KHETAN EDUCATION
25. Consider a 3 factor APT model-
Stocks F1 (mkt) F2 (P/B) F3 (mkt cap) Return
A 0.9 0.75 1.25 8.85
B 0.8 1.39 1.35 5.99
C 0.85 2.05 6.75 ?
D 1.165 2.75 8.65 ?
RF = 4.5%; RP1 = 6.85%
Find RP2 and RP3.
Also compute the expected return from C and D.
26. The expected return on equity shares in an economy is affected by four
factors i.e. change in GDP growth, change in oil prices, change in monsoon
and change in Book value. Assume the Rf to be 10%. The values of these
factors are as follows:
Macro factors: Value of Macro factor
Change in GDP 6%
Change in Oil Prices -2%
Change in Monsoon 3%
Change in Book Value 10%
Given the following factor sensitivities of the equity shares of four
companies, find the expected return on equity shares of each company.
Factor Sensitivity
Factor Madhav Keshav Krishna Damodar
Ltd. Ltd. Ltd. Ltd
Change in GDP
1.50 2.00 0.50 0.20
Change in Oil prices
-1.00 -0.05 -0.10 -0.90
Change in Monsoon
0.20 0.50 2.00 1.50
Change in Book Value 0.50 0.65 0.55
0.25
Murari had ` 1,00,000 to invest. He borrowed 100 shares of Damodar Ltd,
and sold these at the rate of ` 500. He invested ` 150000 in the equity
shares of other three companies. Find the expected return of the portfolio.
27. Mr. X owns a portfolio with the following characteristics :
Security A Security B Risk free security
Factor 1 sensitivity 0.80 1.50 0
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Factor 1 sensitivity 0.60 1.20 0
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Expected return 15% 20% 10%
Prof. Archana Khetan
KHETAN EDUCATION
It is assumed that a two-factor model generates security returns.
(i) If Mr. X has ` 1,00,000 to invest and sells short ` 50,000 of security B and
purchases ` 1,50,000 of security A what is the sensitivity of Mr. X's
portfolio to the two factors ?
(ii) If Mr. X borrows ` 1,00,000 at the risk free rate and invests the amount
he borrows along with the original amount of ` 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?
What is the expected return premium of factor 2?
28. A foreign institutional investor proposes to invest $10 million in an Indian
security with a beta of 1.10 and standard deviation of returns of 7%. The
holding period of investment will be one year. The current rupee- dollar
exchange rate is ` 45.45/ $. The expected depreciation of rupee against
dollar over a period is 2% with a standard deviation of 10%. The expected
return from the market portfolio in India is 12% and the correlation
between the return on security and the exchange rate is 0.50. The risk free
rate of return in India is 5%.
You are required to calculate the expected return and risk to the FII.
29. An investor holds the following stocks in his portfolio. All these stocks were
purchased on March 1, 2002 at the following prices:
Name of the company No. of shares Price per share
A 1000 ` 28.00
B 4000 ` 7.00
C 2000 ` 14
D 500 ` 56.00
The correlation coefficients of these stocks return with the market and
their standards deviation of returns were as follows:
Name of the Standard Deviation Correlation Coefficient
company with the market index
A 20% 0.95
B 18% 0.85
C 14% 0.72
D 11% 0.45
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In February 28, 2003, the market prices and standard deviation of the
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returns of these four stocks are as follows:
Prof. Archana Khetan
KHETAN EDUCATION
Name of the Prices per share Standard deviation
company (%)
A ` 34.00 22.00%
B ` 5.50 17%
C ` 10.00 15.50%
D ` 70.00 12.50%
If the standard deviations of the market return is constant at 15% and
assuming that correlation coefficients of stock’s returns with the market
index remains unchanged during last year. Estimate the changes in the
proportions of systematic and unsystematic risk of the portfolio.
30. An investor has ` 1,00,000 to invest. He wants to obtain a return of 20% on
this amount. State the course of his action if return on the market portfolio
is 18% and risk free rate of return is 13%. If the SD of the market portfolio
is 5, what is the standard deviation of his action?
31. XYZ Ltd. has substantial cash fiow and until the surplus funds are utilised 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 :
Investment No. of Beta Market price per Expected
shares share ` rate
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
32. 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
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price Yield exchange market Govt.
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funds Securities
Prof. Archana Khetan
KHETAN EDUCATION
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.
Efficient Market Hypothesis
33. Mr A Shyam is testing the weak form efficient market hypothesis on the
Indian stock market. For this he has collected the data on a leading market
index for the last 15 trading days. This is given below:
Trading day Market Index
1 4500
2 4550
3 4400
4 4350
5 4300
6 4330
7 4400
8 4445
9 4440
10 4370
11 4380
12 4365
13 4500
14 4560
15 4600
Using runs test, verify the validity of the weak form of market efficiency in
the Indian stock market at the significance level of 5% and 10%.
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34. Indira has a fund of ` 3 lacs which she wants target to invest in share
market with rebalancing target after every 10 days to start with for a
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Prof. Archana Khetan
KHETAN EDUCATION
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 she should
rebalance the portfolio under the following situations according to the
theory of Constant Proportion Portfolio Insurance policy using 2 as
multiplier.
• Immediately to start with.
• 10 days later being the first day of rebalancing if Nifty falls to 5122.96
• 10 days further from the above date if the Nifty touches to 5539.04.
For the sake of simplicity, assume that the value of her equity component
will change in tandem with that of nifty and the risk free securities in which
she is going to invest will have no beta
35. An investor has ` 15 lakhs to invest. He wants to use constant dollar value
plan for managing his investments. He wants to invest his money equally in
stocks and bonds. He identified a stock for investing which is currently
trading at ` 250. He wants to revise his portfolio whenever there is 10%
change in the value of the portfolio. If the price of the share declines to `
200, then increases to ` 290 and then fall back to ` 250, show the action
taken by the investor. Also, calculate the number of shares held by him and
his gain at the end. Compare the gains from the constant dollar value plan
with those from a passive buy and hold strategy.
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