Portfolio Management Section A - Practical Questions Retum and Risk of a Security Question 1 A stock costing T 120 pays no dividends. The possible prices that the stock might sell for at the end of the year with the respective probabilities are: Price Probability 15 O41 120 0.1 125 02 130 03 1B5 02 140 0.1 Required: (@ Calculate the expected return. Gi) Calculate the Standard deviation of returns, Answer (i) Here, the probable returns have to be calculated using the formula pe D#Pi-Po Po Calculation of Probable Returns Possible prices (P1) Pi -Po [(P1 - Po)/Po] x 100 z z Return (percent) 115 5 417 120 0 0.00 125 5 417 130 10 833 1235 1s 1250 140 20 1667 Calculation of Expected Returns Possible return Probability Product Xi P(X) Xix p(X) BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management 4.17 0.00 447 833 1250 16.67 oa oa 02 03 02 ot 0.417 0.000 0.834 2.499 2.500 1.667 Expected return (%)= 7.083% (ii) Calculation of Standard Deviation of Returns Probable return Deviation | Deviation squared] Product x (%i-X) (i -P (% -X¥ p(X) “ll -11253 126.63 12.66 0.00 O41 -7.083 50.17 5.017 4.17 02 -2.913 B49 1.698 8.33 03 1.247 1.56 0.467 12.50 02 5.417 29.34 5.869 16.67 O41 9.587 9191 9.191 0? = 34.902 Variance, o? = 34.902 percent Standard deviation, = 5.908 percent Question 2 Following information is available in respect of expected dividend, market price and market condition after one year. Market condition Probability Market Price (3) idend per share(3) Good 025) 115 9 Normal 050 107 5 Bad 025, 7 3 The existing market price of an equity share is £106 (EV. Z 1), which is cum 10% bonus debenture of Z 6 each, per share. M/s. X Finance Company Ltd. had offered the buy-back of debentures at face value. Find out the expected return and variability of returns of the equity shares if buyback offer is accepted by theinvestor. And also advise-Whether to accept buy back offer? Answer BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed ‘The Expected Return of the equity share may be found as follows: Market Condition | _ Probability Total Return Cost* Net Return Good 0.25 =124 = 100 =24 Normal 0.50 <112 =100 =12 Bad 0.25 = 100 = 100 0 (24%0.25) + (12x 0.50) + (0x 0.25) 2 . oT 100 Too x 100= 12% ‘The variability of return can be calculated in terms of standard deviation. Variance = 0.25 (24- 12)?+ 0:50 (12 - 12)? + 0.25 (0- 12)° 0.25 (12)? + 050 (0)? + 0.25 (-12¥ =36+0+36 =72 Expected Return = Standard Deviation Stan dard Deviation = 8.485 or say 8.49 “The present market price of the share is ¥ 106 cum bonus 10% debenture of ¥ 6 each; hence the net cost is 100. M/s X Finance company has offered the buyback of debenture at face value, There is reasonable 10% rate of interest compared to expected return 12% from the market. Considering the dividend rate and market price the creditworthiness of the company seems to be very good. The decision regarding buy- back should be taken considering the maturity period and opportunity in the market. Normally, if the maturity period islow say up to Lyear better to wait otherwise to opt buy back option. Return and Risk of Portfoli Question 3 ‘The historical rates of return of two securities over the past ten years are given. Calculate the Covariance and the Correlation coefficient of the two sean Year 1 2 3 4 5 6 7 8 9 10 ‘Security 1: 12 8 7 1 | i | i | 0 | 20 | t6 | 22 (Retun porcont) ‘Security 2: 20 | 22 | 24 | ae | as | 20 | 24 | 25 | 22 | 20 (Return percent) Answer Calculation of Covariance Deviation | Deviation Deviation | Deviation | Product of Year] Ry Hon 7 n | Produc "Laie | ei—m?] | crafted | (Ra— Re" | deviations BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management 1 12 2.8) 7.84 20 -1 1 28 2 8 -68 46.24 22 1 1 68 3 78 60.84 24 3 9 23.4 4 14 -08 0.64 18 3 9 2 5 16 12 144 15 6 36 72 6 15 02 0.04 20 -1 1 0.2 7 18 32 10.24 24 9 96 8 20 52 27.04 25 4 16 20.8 9 16 12 144 22 1 1 12 wo | 22 72 S184 20 -1 1 72 nie 143 E= 207.60 Riz ea E=84.00 TRO Covariance = L=t/B2-RalIRe“Ra}_ gy 49 N Stan dard Deviation of Security 1 i= 456 Stan dard Deviation of Security 2 Correlation Coefficient Cow: 102 aay 770.0605 Question + Mr. A is interested to invest & 1,00,000 in the securities market. He selected two securities B and D for this purpose. The riskreturn profile of these securities are as follows: Security Risk(o) Expected Return (ER) BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management eel B 10% 12% 18% 20% Co-efficient of correlation between Band Dis 0.15. You are required to calculate the portfolio return and risk of the following portfolios of B and D to be considered by Mr. A for his investment. @ 100 percent investment in B only; (i) 50 percent of the fund in Band therestS0 percentin D; (tit) 75 percent of the fund in Band therest 25 percentin D; and (iv) 100 percent investment in D only. Also indicate that which portfolio is best for him from risk as well asreturn point of view? Answer We have Ep = WiFi + Wak: + WE. and for standard deviation o% =) wiwjoy Two asset portfolio oty = whol, + wiz02) +2 wiwi01e2p12 Substituting the resp ective values we get, G) All funds invested in B Fp = 12% 6» = 10% 50% of funds in each of B& D Bp = 0.50 x 12% + 050x 20% = 16% op = (0.50)? (10%)? + (0.50)? (18%)? + 2 (0.50) (0.50) (0.15) (10%) (18%) 119.50 o'p= 25+ 81+ 13: 6 = 10.93% (iii) 75% in Band 25% in D E, = 0.75% x 12% + 0.25% x 20= 14% op = (0.75)? (10%)*+ (0.25)? (18%)? +2 (0.75) (0.25) (0.15) (10%) (18%) oy = 5625 + 2025+ 10.125 = 86.625 6 =9.31% (iv) All funds in D Ey = 20% BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management @ qi) Gv) 12 16 20 ° 10 10.93 931 18 In the terms of return, we see that portfolio (iv) is the best portfolio. In terms of risk, we see that portfolio (iii) is the best port Question 5 Consider the following information on two stocks, A and B: Year Roturn on A(%) Roturn on B(%) 2022 10 12 2023 16 18 You are required to determine: (@_Theexpected return on portfolio containing A and B in proportion of 40% and 60% respectively. Gi) The Standard Deviation of return from each of the two stocks. Gil) The covariance of returns fromthe two stocks. (iv) Correlation coefficient between the returns ofthe two stocks. (%)__ Therisk of a portfolio containing Aand B in the proportion of 40% and 60%. Answer (i) Expected return of the portfolio A and B E(A) = (10+ 16)/2= 13% E(B) = (12 + 18)/2= 15% Stock A: Vari Standard deviation Standard deviation = i Covariance of stocks A and B Covag = 0.5 (10 - 13) (12 - 15) + 0.5 (16 - 13) (18- 15)=9 (iv) Correlation of cvefficient =3% 0.6 (15) = 14.29% ince = 0.5 (10 - 13)? + 0.5 (16 - 13° =9 0.5 (12 - 15}*+0.5 (18 - 15) =9 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ©) Cov 9 Tape “757 Onn Portfolio Risk op = RGR + XBe} + 2Xa¥s(Cnoneas) =v = VISEF 3244 53: (@)? + 2(0.4)(0.0)(3)(3)) 3% Question 6 Ramesh has identified stocks of two companies A and Bhaving good investment potential: Following data is available for these stocks: Year ‘A (Market Price per Share in t) B (Market Price per Share in 2) 2017 19.60 8.70 2018 18.75 12.80 2019 33.42 16.20 2020 42.64 18.25 2021 43.25 15.60 2022 44.60 13.25 2023 3475 18.60 ‘You are required to calculate: @o @ ‘The Riskand Return by investing in Stock A and B ‘The Risk and Return by investing in a portfolio of these Stocks if he invests in Stock A and B in proportion of 6:4. Gil) The better opportunity for investment Answer A B Year | Market|Return]Return -| Squared [Market] Return |Return -| Squared | (Return - A) Price | (%) | A Price | (%) | B x Per Per (Return -B) Share Share 2017| 19.60 8.70 2018] 18.75 | -434 | -18.33 | 335.9889 | 12.80 | 47.13 | 30.94 | 957.2836] -S67.1302 2019] 33.42 | 78.24 | 6425 |4128.0625| 1620 | 26.56 | 1037 | 107.5369] 666.2725 2020] 42.64 | 27.59 | 13.60 | 1849600 | 1825 | 12.65 | -3.54 | 12.5316 | -48.1440 2021] 43.25 | 1.43 | -12.56 | 157.7536 | 1560 | -1452] -30.71 | 943.1041] 385.7176 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management 2022| 44.60 | 3.12 | -10.87 | 118.1569 | 1325 | -15.06| -31.25 | 976.5625| 339.6875 2023] 34.75 | -22.09| -36.08 |1301.7664| 1860 | 4038 | 24.19 | sa5.1561] -872.7752 83.95, 62.26.6883 97.14 ase2.1748| 96.3718 Mean(A) | 13.99 |Variance| 1037.7814| Mean | 16.19 [Variance] 597.0291 |Cov (®) ~ 16.062 (@)__ Return A= 13.99% and Risk (SD) = 2.2146% and Return B= 16.19% and Risk (SD) = /597,0291 = 24.4342% Return of Portfelio = 0.60 x 13.99% + 0.40 x 16.19% = 14.87% Risk (Standard Deviation) of Portfolio = [0602s 1037.7814 + 0.402 597.0201 + 2 x 0.60 x 0.40 x (-16.0620))# = [873.6013 + 95.8247 -7.7098)% = 1.4806% On the basis of Return ‘B’ is preferable and on the basis of Risk Portfolio Investment’ is preferable over the individual stocks. Minimum Risk Portfolio Question 7 An investor has decided to invest € 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 at follows: Probability ABC(%) XYZ (%) 0.20 12 16 0.25 14 10 0.25 7 28 0.30 28 2 You are required to @ Comment on return and risk ofinvestment in individual shares. Gi) Compare the risk and return of these two shares with a Portfolio of these shares in equal proportions. Find out the proportion of each of the above shares to formulate a minimum riskportfolio. Answer @ ABC (%) ‘XYZ (%) 1x2 (%) 1x3(%) @) @) @® e 2 16 2.40 32 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management et 025, 14 10 3.50 28 025 7 28 AIS 70 030 28 -2 8.40 06 ‘Average return 12.55) 12.4 Hence the expected return from ABC = 12.55% and XYZ is 12.1% Probability (ABC -ABC)(ABC-ABCY] 1x3 | (XYZ- XYZ) |(X¥Z - X¥7/ xo @) @) GB) Mm ©) (6) 0.20 055 0.3025 0.06 39) 15.21 3.04 0.28 1.45 2.1028 053 -24 441 1.40 0.28 -19.55 | 382.2025 | 9555 15.9 25281 63.20 0.30 1s.45 | 238.7025 | 71.61 -141 19881 59.64 167.78 126.98 oage= 167.75(%)?; 0 ABC= 12.95% ofr = 126.98(%)*; 6 XVZ= 1127% (i) orderto find risk of portfolio of two shares, the covariance between the two is necessary here. Probability (ABC - ABQ) (x¥Z-X¥7Z) 2x3 1x4 @) @) @) “ eo 0.20 -0.55 3.9 2.145, 0.429 0.25 1.45 “2.1 3.045, -0.761 0.25 19.55, 15.9 -310.845 “7771 0.30 15.45 141 -217.845 -6535 -144.25, op = (0.5 x 0.5 x 167.75) + (0.5x 0.5 x 126.98) +2 x (-14425)x 05x 0.5 o*p = 41.9375 + 31.745 - 72.125 E(R)) = (05x 12.55) + (05x 12.1) = 12.325% Hence, the return is 12.325% with the risk of 1.25% for the portfolio. Thus the portfolio results in the reduction of risk by the combination of two shares. For constructing the minimum risk portfolio the condition to be satisfied is ox ~ Tacox0x ox - Covax FORO _ gy, -_ OK COVAX_ iat OF IT KOROK Oa + OF — ZCOVaK ox = Standard Deviation of XYZ o4 = Standard Deviation of ABC tax = Coefficent of Correlation between XYZand ABC Xane= BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed Covax = Covariance between XYZ.and ABC Therefore, . 126.98 - (-14425) 271.23 ABC = eae 167 75- [ax lee25y] | 5323 740 7 46% ABC = 46%, WXVZ= 1 -0.46 = 0.54 or 54% Question 5 An investor has two portfolios known to be on minimum variance set for a population of three securities A, Band C having below mentioned weights: Wa We We Portfolio X 030) 0.40) 0.30) Portfolio Y 0.20 050 030 Itis supposed that there are no restrictions on short sales. (@ What would be the weight for each stock for a portfolio constructed by investing % 5,000 in portfolio X and 3,000 in portfolio Y? Gi) Suppose the investor invests & 4,000 out of € 8,000 in security A. Howhe will allocate the balance between security Band Cto ensure that his portfolio is on minimum variance set? Answer (i) Investment committed to each security would be: A@) ET) c@ ‘Total(%) Portfolio X 1,500 2,000 1,500 5,000 Portfolio Y 600 1,500 900 3,000 Combined Portfolio 2,100 3,500 2,400 8,000 + Stock weights 0.26 0.44 030 (ii) The equation of critical line takes the followin gform: We =a+b Wa Substituting the values of Ws & We from portfolio X and Y in above equation, we get 0.40= a+ 030b,and os a+ 0.20b 4 and thus, the Solving above equation, we obtain the slope and intercept, a = 0.70 and b= critical line is We = 0.70 - Wa half of thefunds We = 0.70 - 0.50 = 0.20 wwested in security Athen, BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed Since Ws + Wa + We We=1-0.50 -0.20= 030 Allocation of funds to security B = 0.20 x 8,000 = 1,600, and C= 0.30.x 8,000 = 2,400 Seaurit Markowitz Efficient Portfolio Question 9 Following is the data regarding six securities: A B c D Return (%) 8 8 12 4 Risk (Standard deviation) 4 5 12 4 (Assuming three will have to be selected, state which ones will be picked. Gi) Assuming perfect correlation, show whether itis preferable to invest 75% in A and 25% in Cor to invest 100% in E. Answer (@) Security A has a return of 8% for a risk of 4, whereas Band F have a higher risk for the same return, Hence, among themA dominates. For the same degree of risk 4, security D has only a return of 4%, Hence, Dis also dominated by A. Security C & E remain in reckoning as they have higher return though with higher degree of risk. Hence, the ones to be selected are 4, C& E, (ii) Theaverage values for A and C for a proportion of 3:1 will be: pis GED*CE1) _ oo + + x12: Return - S¥8*OX*2) _ oo, Therefore: TS%A 100% E 28% - Risk 6% 5% Return 9% 9% For the same 9% return the risk is lower in E. Hence, Ewill be preferable. Question 10 X Co, Ltd,, invested on 01.04.2022 in certain equity shares as below: Name of Co. No. of shares Cost(3) BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management M Ltd. NLta. 1,000 (& 100 each) 500 (10 each) 2,00,000 150,000 Ltd. respectively. On 01.04.2023, investment advisors ending 31.03.2024 are likely to be In September, 2022, 10% dividend was paid out by M Ltd. and in October, 2022, 30% dividend paid out by NLéd. On 31.3.2023 market quotations showed a value of & 220 an. 's indicate (a) that the 4% 290 per sharefor M Ltd. and N idends from MLtd. and N Ltd. for the year 20% and 35%, respectively and (b) that the probabilities of market quotations on 3 1.03.2024are as below: Probability factor Price/share of M Ltd. Price/share of N Ltd. 02 220 290 0s 250 310 03 280 330 ‘You are required to: deviation in each case. Calculate the average return from the portfolio for the year ended 31.03.2023; Calculate the expected average return from the portfolio for the year 2023-24; and Advise X Co. Ltd,, of the comparative risk in the two investments by calculating the standard (iv) Analysethe two investments from Risk-Return Trade off viewpoint for X Co, Id. Answer Workings: Particulars (Calculation in 7/share) M N Calculation of return on portfolio for 2022-23 Dividend received during the year 40 3 Capital gain/loss by 31.03.23 Market value by 31.03.23 220 290 Cost of investment 200 300 Gain floss 20 Q10 Yield 30 O7 Cost 200 300 % return 15% ©) 233% ‘Weight in the portfolio (2,00,000:1,50,000) 57 B Weighted average return 755% Calculation of estimated return for 2023-24 Expected dividend 20 35 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management et Capital gain by 31.03.24 (20x 0.2) + (250x 0.5) + (280 x 0.3) - 220 = (253 -220) 33 - (290x 0.2) + (310 0.5) + (330 x 0.3) -290= (312 -290) - 22 Yield 53 255) Market Value 01.04.23 220 290 % return 24.09% 8.79% Weight in portfolio* [(1,000 x 220):(600x 290)] 60.3 397 Weighted average (Expected) return 18.02% “The market value on 3 1.03.23 is used asthe base for calculating yield for 2023-24 (@)_ Average Return from Portfolio for the year ended 31.03.2023 is 755% (ii) Expected Average Return from portfolio for the year 2023-24 is 18.02% Gil) Calculation of Standard Deviation MLtd. Exp. Exp.| Exp. Exp. | Prob. ](1)x(2)] Dev. | Square] (2)x(3) market div. Return (9%) | Factor] \(Pu -Px)] of dev. value Q @ @) 20 | 0 | 20 | 20 9.09 02 | 182 | -1501 | 22530] 45.06 250 | 30 | 20 | 50 | 22.73 os | 1137 | -137 | 188 0.94 280 | 60 | 20 | a | 3636 | 03 | 1091 | 1226 | 15031] 45.09 24.10 e%4= 91.09 Standard Deviation (ou) =9.54% NLtd. Exp. | Exp.| Exp. Exp. | Prob. ](1)x(2)] Dev. ]Square] (2)x(3) market div. Return (9%) | Factor] (Px -Px)] of dev. value @ @ G) 290 | o | as | 38 121 o2 | o24 | -7s8 | s746 [1149 310 | 20| 35 | 235) 8.10 os | 405 | -059 | 048 0.24 330 | 40| 35] 435 | 1500 | 03 | 450 | 621 | 3856] 1157 879 on = 23.30 Standard Deviation (or) =4.83% Share of company M Ltd. is more risky as the $.D. is more than company N Ltd. (iv) To analyse the investments from risk-return trade off view point, we shall compute the Coefficient of Variation (CV) of each investment as follows: Mita, = 52x 100 - 254, 1099 = 39.59% Men 2410" BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management sD 100 = =x 100 = 54.95% 79 ‘Thus, from risk-reward trade off view point investment in M Ltd. is better. ‘Mean Capital Asset Pricing Model (CAPM). Question 11 ‘The risk premium for the market is 10%. Assuming Beta values of Security Kare 0,0.25, 0.42, 1.00 and 1.67. Compute the risk premium on Security K. Answer Market Risk Premium is 10% BValue of K Risk Premium of K 0.00) 0% 0.25) 2.50% 0.42 420% 1.00 10.00% 167 16.70% Question 12 A company’s betais 1.40. The market return is 14% and the risk free rate is 10%. (@_— Whatis the expected return ofthe company’s stockbated on CAPM. Gi) F tho risk promium on the market goes up by 2.50% points, what would be the revited expected return on this stock? Answer (i) Computation of expected return based on CAPM Ry= Ret B (Ru —R9 = 10% + 1.40 (14% - 10%) = 10% + 5.6% = 15.6% (ii) Computation of expected return if the market risk premium goes up by 2.50% points ‘Thereturn fromthe market goes up by 2.50% ie. 14% + 250% = 16.50% Expected Return based on CAPM is given by Rj= 10% + 1.40 (165% - 10%) = 10% + 1.40.x 6.5% = 10% + 9.10% = 19.10% Question 13 Pearl Itd. expects that considering the current market prices, the equity shareholders as per Moderate Approach, should get a return of at least 15.50% while the current return on the market is 12%, RBI has dosed the latest auction for ¥ 2,500 crores of 182 day bills for the lowest bid of 4.3% although BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed there were bidders at a higher rate of 4.6% also for lots of less than % 10 crores. What is Pearl Ltd’s Beta? Answer Determining Risk free rate: Two risk free rates are given. The aggressive approach would be to consider 4.6% while the conservative approach would be to take 43%, If we take the moderate value then the simple average of the two ie 4.45% would be considered Application of CAPM Ry=Ret B(Ru— RD 15.50% = 4.45% + B (12% — 445%) Question 14 Mr. Tempest has the following portfolio of four shares: Name Beta Investment tLakh (Oxy Rin Led. 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% andthe marketrate of return is 14%. Required: (@ Determine the portfolio return. (il) Calculate the portfolio Beta. Note: Round off calculations to 4 decimals. Answer First we shall compute Portfolio Beta using the weighted average method as follows: = 0.45 x 0.0884+ 0.35x 0.1657 + 1.15x 0.2486 + 185x 0.4972 .03 98 + 0.058 + 0.2859 + 0.9198 = 13035 Accordingly, G) Portfolio Retum using CAPM formula will be as follows: Rp= Re+ Betap (Ru - Re) =7% + 13035 (14%- 7%) BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed 7% + 13035 7%) =7%+9.1245% = 16.1245% Portfolio Beta As calculated above 1.3035, Question 15 Mr. FedUp wants to invest an amount of ¥ 520 lakhs and had approached his Portfolio Manager. The Portfolio Manager had advised Mr. FedUp to invest in the following mann ‘Secu Moderate | Better Good Very Good Best “Amount (in Lakhs) 60 80 100 120 160 Beta 05 1.00 0.80 1.20 150 You are required to advise Mr. FedUp in regard to the following, using Capital Asset Pricing Methodology: (@ Expected return on the portfollo, if Government Securities are at 6% and NIFTY Is yielding 10%. (i) Advisability of replacing Security “Better” with NIFTY. Note: Round off calculations to 3 decimals, Answer (i) Computation of Expected Retumn from Portfolio 60 80 100 120 160 Aver 0.50x——+ 100 0.80 x ——+ 120 x e+ 150 x meee= 1.104 werage B= 050% 5+ LOOKED + OBDK Ot OKO TLS DG Asper CAPN = 0.08 + 1.104 (0.10 - 0.08) = 0.10208 10.208% As computed above the oxpocted roturn from Bottor is 10% same as from Nifty, honce there will beno difference even ifthe replacement of security is made. The main logic behind this neutrality is that the beta of security ‘Better’ is 1 which deaily indicates that this security shall yield same return as market return, Question 16 A company has a choice of investments between several different equity ori snted mutual funds. The company has an amount of & { crore to invest. The details of the mutual funds are as follows: Mutual Fund Bota a 16 B 1.0 c 09 D 20 E 06 Required: BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed (i) __‘F the company invests 20% ofits investment in each of the first two mutual funds and an equal amount in the mutual funds C, D and E, what is the beta of the portfolio? F 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? F 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? Answer (With 20% investment in each MF Portfolio Beta is the weighted average of the Betas of various securities calculated as below: Investment Beta (B) Investment ({Lacs) | Weighted Investment A 16 20 32 B 10 20 20 c 09 20 18 D 20 20 40 E 06 20 2 100 122 Weighted Beta (B) = 122/100 = 1.22 With varied percentages of investments portfolio beta is calculated as follows: Investment Beta (B) Investment (Lacs) | Weighted Investment A 16 15 24 B 10 30 30 c 09 15 135 D 20 30 60 E 06 10 6 100 133.5 Weighted Beta (B) = 133.5/100= 1335 (iii) Expected return of the portfolio with pattern of investment as in case (I) = 12% x 1.22 i.e. 14.64% Expected Return with pattern of investment as in case (li) = 12% x 1.335 ie,, 16.02% Question 17 Treasury Bills give a return of 5%, Market Return is 13%. @ — Whatisihe marketrisk premium (Gi) Compute the B Value and required returns for the following combination of investments. Treasury Bill 100 70 30 0 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management Market 0 30 70 100 Answer Market Risk Premium = Ru ~ Re= 13% - 5% = 8% Bis the weighted average investing in portfolio consisting of market (B = 1) and treasury bills (B = 0) Portfolio | Treasury Bills:Market 8 R= Rr+ Bx (Ra Rp 1 100:0 0 5% +0 (13% - 5%) = 5% 2 70:30 0.7 (0) +03 (1)=03 | 5%+0.3 (13% -5%)=7.40% 3 30:70 0.3(0)+0.7 (1)=07 | 5%+0.7 (13% - 5%) = 10.60% 4 0:100 1 5% + 1.0 (13% - 5%) = 13% Question 18 Mr. A is having 1 lakh shares of K Ltd. The beta of the company is 1.40. Mr. B a financial advisor has suggested having the following portfolio: Security Beta %hol L 1.20 10 M 0.75, 10 N 0.40 30 ° 1.40 50 100 Market Return is 12%, Risk free rate is 8%. You are required to calaulate the following for the present investment and suggested portfolio: (@_— Whatis the expected return based on CAPM and also (2) Ifthe market goes up by 2.5%. Q) Ifthe market goes down by 25%. G) _ Ifthe market is giving a negative return of 2.5%. Gi) F probability of market giving negative return is more, please advise Mr. A whether to continue the holdings of M/s. K Ltd. or to buy the portfolio as per the suggestion of Mr. B. Ifso, why? Answer Working Notes Calculation of Portfolio Beta suggested by Mr. B Security Beta ‘Wt of Holding Beta x Wt. of Holding L 1.20 On 0.120 M 07S on 0.075 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management et N 0.40 03 0.120 ° 1.40 os. 0.700 Total 1.0 1.015 Portfolio Betais 1.015 Calculation of Expected Return based on CAPM at present situation - Particulars | Risk Free Beta Market Risk | BetaxRisk | Expected Rate (Ri) Return | Premium | Premium | Return =Rn- Rr a € a e=d-b f=cexe | g=b+f KLtd. 1.400 12 4 5.600 13.60 Portfolio 1.015 2 4 4.060 12.06 G4) _ Calculation of Expected Return based on CAPM if market goes up by 2.5% Particulars] RiskFree | Beta | Market | Risk | Betax Risk] Expected Rate (Ri) Retum | Premium | Premium | Retum =Ru-Re a b c a e=d-b Kita 8 1.400 145 6S 9.100 17.10 Portfolio 8 1015 145 6s 6.598 1460 (2) Calailation of Expected Return based on CAPM if market goes down by 2.5%: Particulars | RiskFree | Beta | Market | Risk | Beta Risk] Expected Rate(Ri) Retum | Premium | Premium | Return =Ru-Re a b c a e=d-b g=b+f KItd 8 1.400 95 15 10.10 Portfolio 8 1915 95 15 952 (3) Calaulation of Expected Return based on CAPM if market gives negativereturns of 2.5%: Particulars] RiskFree | Beta | Market | Risk | Betax Risk] Expected Rate(Ri) Retum | Premium | Premium | Return =Ru-Re a b c a e=d-b | f=cxe | g=b+f KLtd 8 1.400 -25 -105 | -14700 | -6.70 Portfolio 8 1015 -25 -105 | -106s8 | -2.66 Gi F the probability of market giving negative return is more, it is advisable to Mr. A to buy the portfolio suggested by Mr. B because Beta of the portfolio is less than of KLtd. BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed Question 19 Aholds the following p ortfoli Share/Bond Beta 1 Price (3) Epsilon Lid. 08 8 Sigma Ltd. 07 35 Omega Ltd. os 45 2 135 GOI Bonds 0.01 1,000 140 1,005 Calculate: (@__Theexpected rate of return of each security using Capital Asset Pricing Method (CAPM) Gi) The Simple average return of Risk-free return is 14%, portfolio. Answer Gi) Expected rate of retum, Total Investments Dividends Capital G: Epsilon Ltd. 25 2 25 Sigma Ltd. 35 2 25 Omega Ltd 45 2 90 GOI Bonds 1,000 140 5 1,105 146 145 Expected Return on market portfoli: wes 26.33% CAPM: E(Rs) = Rr+ B [E(Rx) ~Re] Epsilon td —~—~sdavO8RO33-1= 14986 3.86% Sigma ltd. «1440.7 2633-14= 144863 2.63% Omegalid, 140.5 [2633-14]= 1446.17 0.17% GolBonds 14+ 0.01[26.33-14]= 1440.12 4.12% (ii) Average Return of Portfolio. _ 23.864 22.634 20.17 + 14.12 . 4 Alternatively, Portfolio Beta = = 14405025 (26.33 - 14) = 144 6.20 = 20.20% BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management Question 20 ‘Your dient is holding the following securities: Particulars of Securities | __ Cost (%) Market Price (¥) Beta Equity Shares: co. 8,000 800 8,200 08 Co. 10,000 800 10,500 or Co.Z. 16,000 800 22,000 os PSU Bonds 34,000 3,400 32,300 02 Assuming a Risk-free rate of 15%, calculate: - Expected rate of return in each, using the Capital Asset Pricing Model (CAPM). - Simple Averagereturn of the portfolio. Answer Calculation of expected return on market portfolio (Rn) Investment Cost (2) Capital Gains (3) Shares X 8,000 200 Shares Y 10,000 500 Shares Z 16,000 6,000 PSU Bonds 34,000 3,400 -1,700 68,000 5,800 5,000 b= Se 100 = 15.88% Calculation of expected rate of return on individual security: SharesX = 15 + 0.8 (15.88 - 15) = 15.70% Shares Y = 15 + 0.7 (15.88 - 15)= 15.62% Shares Z= 15+ 0.5 (15.68 - 15) = 15.44% PSU Bonds = 15 + 0.2 (15.88 - 15) = 15.18% Calculation of the Average Return of the Portfolio: 15,70 + 15.62 * 1544+ 1518 J soy Question 21 Your dient is holding the following securities: Particulars of Securities | _ Cost (%) jends/Interest (%)| Market price (%) Beta Equity Shares: BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management et Gold Ltd. 10,000 1725 9,800 0.6 er Ltd, 15,000 1,000 16,200 08 Bronze Ltd. 14,000 700 20,000 06 GOI Bonds 36,000 3,600 34,500 0.01 Simple average return of the portfolio is 15.7%, calculate: (Expected rate of return in each, using the Capital Asset Pricing Model (CAPM). (ii) Riskfree rate ofretarn, Answer Particulars of Securities Cost (%) Dividend (2) Capital gain (%) Gold Ltd. 10,000 175 =200 Silver Ltd. 15,000 1,000 1,200 Bronze Ltd. 14,000 700 6,000 GOI Bonds 36,000 3,600 1500 Total 75,000 7,025 5,500 Expected rate of return on market portfolio ' + ‘ati _ Dividend Earned + Capital appreciation | | 4g Initial investment _ 1128+ 75500 99 16.796 “75,000 “0 1°" Risk free return Simple average of Betas* = (0.6 + 0.8+ 0.6+ 0.01)/4= 0.50 “Since Simple average return of the portfolio is given in question. Average return = Risk free return + Average Betas (Exp ected return - Risk free return) 157 = Riskfree return + 0.50(167 -Riskfree return) Risk free return = 14.7% Expected Rate of Return for each security is Rate of Return = Re+ B(Ra-R) Gold Ltd. = 147 + 0.6 (16.7 - 14.7) = 15.90% Silver Ltd.= 147 + 0.8 (16.7 - 14.7) = 16.30% Bronze Ltd. = 14.7 + 0.6 (16.7 - 14.7) = 15.90% GOI Bonds = 14.7 + 0.01 (16.7 - 14.7) = 14.72% Question 22 Suppose one of your HNI clients ish olding the following portfolio as perhis risk appetite: BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management eel Particulars No. of Securities Equity Shares: GLa. 1,000 Std. 1,000 BLed. 500 PSU Bonds 20,000 The other data related to each of these securities (per share/bond) is as follows: Cost lends/Interest Market price Beta z z z 10,000 4725 9,800 06 15,000 1,000 16,200 08 28,000 1,400 28,300 06 1.800 180 1725 0.10 ‘Your dient is interested in investing some more funds in Bonds issued by GOL. (2) Estimate the minimum rate of return that your dient would expect from these Bonds keeping in viow his risk app otite and assuming Market Return as 12.70%. (2) Analyze whether this portfolio has out-performed the market or not assuming Risk Free Rate of Return as 7%. Answer (1) Working Notes: Calculation of Return on each single security Cost t | No.of | Total Cost ay | Secu) (3) =(1)x ties @) @) G Ltd. | 10,000} 1,000 | 1,00,00,000 | 1,725 | -200 | 1,525 60,00,000 SLtd. | 15,000 1,000 | 1,50,00,000 | 1,000 | 1,200 | 2,200 | 22,00,000 | 0.8 | 1,20,00,000 BLtd. | 28,000] 500 | 1,40,00,000 | 1,400 | 300 | 1,700] 8,50,000 | 0.6 | 84,00,000 PSU | 1,800 | 20,000 | 3,60,00,000 | 180 | -75 | 105 |21,00,000 | 0.10 | 36,00,000 Bonds Total 7,50,00,000 [66,75,000 3,00,00,000| Total] Total |Beta] (6)x(3) (4) | Income | (6) Rate of Return earned on the Portfolio _ Dividend Earned+ Capital appreciation . Initial investment 266,75,000 x 100= 8.90% 100 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed 27,50,00,000 Weighted Average Beta of the Portfolio = 3:00,00,000 7,50,00,000 Expected Risk Free Rate of Return using CAPM 8.90% = Re+ 0.40 [12.70% -Ra 8.90% = Re+ 5.08 - 0.40 Ry 3.82% = 0.60 Rr Re= 6.37% ‘Thus keeping in view the present risk appetite, the client would expect at least areturn of 637% on Bonds. (2) Theexpected return on the Portfolio using CAPM: = 7% + 0.40 [12.70% - 7%] = 9.28% Since the actual return is 8.90% which is quite lower than expected return considering the systematic risk bone by the investor and hence portfolio has not outperformed the market rather has underperformed. Question 23 XYZ Led. has cubstantial cash flow 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.ofshares | Beta _| Market price per share (%) | Expected dividend yield I 60,000 116 4.29) 19.50% 0 80,000 228 2.92 24.00% m1 1,00,000 0.90 2.47 17.50% Vv 125,000 150 3.4 26.00% The current market return is 19% and the risk free rate is 11%. Required to: (Calculate the risk of XYZ's short-term investment portfolio relative to that of the market; (ii) Whether XYZ should change the composition of its portfolio. Answer (i) Computation of Beta of Portfolio Investment] No-of [Market] Market [Dividend]. ,.,.4]Compo[ , [Weighted investment) shares | Price | value | Yield | Y“°"*) ction B 1 60,000] 429 [257,400 | 19.50% | 50,193 [02339] 116 | 0.27 u 80,000 | 2.92 | 2,33,600 | 24.00% | 56,064 | 02123 0.48, BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed m1 1,00,000| 2.17 | 2,17,000 | 17.50% | 37,975 | 0.1972| 0.90 | 0.18 wv 125,000] 3.14 | 3,92,500 | 26.00% | 1,02,050| 03566] 150 | 053 11,00,500 2,46,282 | 1.0000 1.46 3 2,46,282 =11,00,500 0.2238 Market Risk implicit 0.2238 = 0.11 +B (0.19 -0.11) 0.088 +0.11 = 0.2238 Market 6 implicit is 1.42 while the portfolio B is 1.46. Thus the portfolio is marginally risky compared to the market. ‘The decision regarding change of composition may be taken by comparing the dividend yield Given) and the expected return as per CAPM a: follows: Expected return Re as per CAPM is: R= Rr+ (Ru Rr) 8 For investment I Rs = 0.114 (0.19 -0.11) 116 = 20.28% For investment II R= 0.11-+ (0.19 -0.11)2.28 = 29.24% For investment IT Rs = 0.11 + (0.19 -0.11) 0.90 = 1820% 11+ (0.19 -0.11) 150 =23% For investment IV Rs Comparison of dividend yield with the expected return Rs shows that the dividend yields of investment |, Il and III are less than the corresponding Rs So, these investments are over-priced and should be sold by the investor. However, in case of investment IV, the dividend yield is more than the corresponding Rs, so, XYZLtd. should increase its proportion. Question 24 A Ltd. has an expected return of 22% and Standard deviation of 40%. B Ltd. has an expected return of 24% and Standard doviation of 38%. A Ltd. has a beta of 0.86 and B Ltd. has a beta of 1.24. Tho correlation coeffident between the return of A Ltd. and B Ltd. is 0.72. The Standard deviation of the market return is 20%. Suggest: (@__Isinvesting in B Ltd. better than investing in A Ltd? Gi) Fyou invest 30% in B Ltd. and 70% in A Led., what is your expected rate of return and portfolio Standard deviation? BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed Gif) Whatis the market portfolios expected rate of return and howmuch is the risk-free rate? Gv) Whatis the beta of Portfolio if A Ltd’s weight is 70% and B Ltd’s weight is 30%? Answer (i) A Ltd. has lower return and higher risk than B Led. investing in B Ltd. is better than in A Ltd. because the returns are higher and the risk, lower. However, investing in both will yield diversification advantage. Rap= 0.22X0.7 + 0.24X0.3 = 22.6% ofp = 0.402 0.)2 + 0,38?x 0.3?+ 2x 07 x 0.3 x 0.72 x 0.40x 038 = 0.1374 oxs = [45 = 0.1374 = 0.3707 = 37.07% ‘Thisrisk-free rate will be the same for A and B Ltd. Their rates of return are given as follows: Ry=22 = Ret (Rn RQ 0.86 Rg =24= Ret (Ry RA 1.24 Ry -Ra= -2= (Bu -R9 (-0.38) 0.38 = 5.26% Ra=22 = Ret (5.26) 0.86 Re= 17.48% Rp = 24= Ret (5.26) 1.24 Re= 17.48% Ru 17.48 = 5.26 Ry = 22.74% (iv) Baz = Bax Wa+ Bax We £0.86 x 0.7 +1.24x0.3 = 0.974 Question 25 ‘The expected returns and Beta ofthree stocks are given below Stock A B ¢ Expected Return (%) 18 i 15 Beta Factor 17 06 12 If the risk free rate is 9% and the expected rate of return on the market portfolio is 14% which of the above stocks are over, under or correctly valued in the market? What shall be the strategy? Answer Required Rate of Return is given by Rj= Ret B (Rn - RQ ForStockA, Rj=9+ 1.7 (14-9) = 17.50% BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed StockB, Ri=9+0.6(14- 9) = 12.00% StockC, Rj=9+1.2(14-9= 15.00% Required Return % | Expected Retum % Valuation Decision 17.50% 16.00% Under Valued Buy 12.00% 11.00% Over Valued sal 15.00% 15.00% Correctly Valued Hold Question 26 Information related to an investments as follows: Risk free rate 10% Market Return 18% Beta 12 (@ What wouldbe the return from this investment? Gi) Fthe projected return is 18%, is the investment rightly valued? (iil) Whatis your strategy? Answer Required rate of Return as per CAPM is given by R)= RetB Ru - RQ = 10+ 12 (15 -10)= 16% Gi) Since projected return is 18%, the stock is not rightly valued rather undervalued as return as per CAPM less than Projected Return. (iil) Had this Project Return Is considered as expected return, the decision should be to BUY the share, Question 27 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: | Conditional Returns % Economic scenari a 3 wadket Growth 0.40 25 20 18 Stagnation 0.30 10 15 B Recession 0.30 5 8 3 Tho 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. Answer BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management S Expected Return on stockA=E(4)= 2, 4 (GS & R denotes Growth, Stagnation and Recession) Expected Return on ‘A’ = 0.40x 25 + 0.30x 10+ 0.30x(-5) = 115% Expected Return on ‘E’= 0.40% 20+ 0.30x 15+0.30x(-8) = 10.1% Expected Return on Market index = 0.40x 18 + 030x 13+ 030x (-3) = 10.2% Variance of Market index = (18 - 10.2)? (0.40) + (13 - 10.2)? (0.30) + (-3 - 10.2¥ (0.30) = 2434+ 235 +5227 = 7896 (%}! Covariance of stock A and Market Index M y M,— EOD] = (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 = 10620 Covariance of stock Band Market index M (20 - 10.1) (18 - 102) (0.40) + (15 - 10.1) (13 - 10.2) (0.30) +(-8 - 10.1)(-3 - 10.2)(0.30) = 30.89+ £12+71.67 = 106.68 Cov (AM) _ 106.20 Var 78.96 Beta for stock A = Cov (BM) _ 106. Beta for stock B = = Var 78.96 351, Required Return for A R (A) = Ret B(Rm- RD. 11% + 1.345 (102 - 11)% = 9.924% Required Return for B 11% + 1.351 (102 - 11)% = 9.92% Jensen’s Alpha for Stock A EA) -R(A)iz. 11.5 % - 9.924% = 1576% Jensen's Alpha for Stock B E(B) -RG)ie. 10.1% - 9.92% = 0.18% Since stock A and B both have positive Alpha, therefore, they are UNDERPRICED. The investor should make fresh investment in them, Beta Question 28 The distribution of return of security F and the market portfolio ‘P’is given below: Probability Return % BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management eee F P 0.30 30 ~10 0.40 20 20 0.30 ° 30 You are required to calailate the expected return of security ‘F and the market portfolio ‘P, the covariance between the market portfolio and security and beta for the security. Answer Security F Deviations of F| (Deviation)” Pro (P) ad Pa (Rr-ER) ofF ns 03 30 B 169 507 04 20 3 9 36 03 ° 7 289 867 ER; = 17 Varr= 141 Stan dard Deviation of = 141 = 11.87 Market Portfolio, P [Exp.Return] Dev.of P | (Dev. of (Deviation of F) x] (Dev. of Fx Dev, RM) Pt | RexPn [(Ru-ERY| PP | VP"? | (Deviation of P) | Dev. of P) xP -10 | 03 3 -24 | 576 1728 -312 -93.6 20 | 04 6 36 144 18 12 30 | 03 16 256 168 -272 -81.6 Varn = 264 Co Var Pa = Ey 14 rar 0 Var Pr on = 1625 -168 Beta = CoVar Pu -168 on 26h Question 29 Given below is information of market rates of Returns and Data from two Companies A and B: Year 1 Year 2 Year 3 Market (%) 12.0 110 90 Company A (%) 13.0 15 98 Company B (%) 110 10.5 958 ‘You are required to determine the beta coefficients ofthe Shares of Company A and Company B. BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management Answer Company A: Year Rem % Market soko % Deviation Deviation DRixD Ru Rie 1 13.0 12.0 157 1.33 2.09) L177 2 us 11.0 0.07 0.33 0.02 O41 3 98 9.0 1.63 1.67 2.72 2.79 343 32.0) 4.83 467 Average Ri = 11.43, Average Ru= 10.67 [2@e Ra@s — Ra) Covariance Covariance = “23 161 Rm —R, Variance (on?) = [2m Ra)” {ow = 482.1587 3 aot. 103 Company B: Market return % year | Retun% ] Marketretum % | Deviation | Deviation | J ecpry | ret (8) (Ry) Re Ry 1 110) 120 067 133 0.89 177 2 105 110 oa7 033 0.06 0.11 3 95 9.0 -0.83 -1.67 139 2.79 310 320 234 467 Average Re= 10.33, Average Ru= 10.67 Covariance = [2m mR ~ Ry) 1 Vartanin fmt = 2m ~ Kn) TY BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management Question 30 ‘The following information is available in respect of Security X Equilibrium Return 15% Market Return 18% 7% Treasury Bond Trading at $140 Covariance of Market Return and Security Return 225%} Coefficient of Correlation 075 ‘You are required to determine the Standard Deviation of Market Return and Security Return. Answer First we shall compute the B of Security X Coupon Payment ___7 Risk Pree Rate = — rent Market Price 140 = 5% Assuming equilibrium return to be equal to CAPM return then: 15% = Rr+ (Ru - RQ 15% = 5%+ B,(15% - 5%) Bel (@ Standard Deviation of Market Return a= Sov. 225 _ on of = 225 om = 225 = 15% (ii) Standard Deviation of Security Return & oo o78= Br = Tak Pea Tg OTS = 1 a. 20% 075 Question 31 ‘The following information are available with respect of Krishna Ltd. BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management eel Krishna Ltd Market y — Return on ear [Average share] Dividend per | _ Average Dividend | Govt. Bonds price() | _ Share() Index Yield 2020 245 20 2013 % ™% 2021 253 22 2130 5% 6% 2022 310 25 2350 6% 6% 2023 330 30 2580 7% 6% Compute Beta Value ofthe Krishna Ltd. at the end of 2023 and state your observation. Answer (@)_ Computation of Beta Value Calculation of Returns Returns = PEt Pi“ PI. 199 Po Year Returns 2020-24 [22+ (253 -2.45)}/245] x 100 = 122.4% 2021-22 [25+ (510 -253)}/253] x 100 = 32.41% 2022-23 [30 + (330 - 310}/310}x 100 = 16.13% Calculation of Returns from market Index Year % of Index Appreciation Dividend Yield % | Total Return % 2020-21 | [(@130- 2013)/2013]x 100 = 5.81% 5% 10.81% 2021-22 | [@350— 2130)/2130] x 100 = 1033% 6% 16.33% 2022-23 | [@S80-2350)/2350] x 100 - 9.79% 7% 16.79% Computation of Beta Year Krishna Ltd.(X) | Market Index(¥) xY ¥ 2020-21 12.24% 10.81% 13231 11686 2021-22 32.41% 16:33% 529.25 26667 2022-23, 16.13% 16.79% 270.82 281.90 Total 60.78% 93% 932.38 665.43 Average Return of Krishna Ltd. = a = 20.26% DxY Dy? - ny Beta (8) = BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed = eae inter 2018-19 6% + 1.897 (10.81% - 6%) = 15.12% 12.24% Sell 2019-20 6% + 1.897 (16.33% - 6%) = 25.60% 32.41% Buy 2020-21 6% + 1.897 (16.79% - 6%) = 26.47% 16.13% Sell Question 32 ‘Tho following information is available with resp ect of Jaykay Ltd. Jay Kay Limited Market — Return on Year [Averageshare] pos gy ‘Average | Dividend | Govt ponds Price (3) Index Yield (%6) 7020 2a 20 182 a 6 2021 219 25 1980 5 5 2022 305 30 2258 6 4 2023 322 35 2220 7 5 Compute Beta Value of the company 2s atthe end of 2023. Whatiis your observation? Answer (Computation of Beta Value Calculation of Retums Returns = D+ (P1= PO). 199 Po Year Returns 2020-21 [25+ (279 -240)}/242] x 100 = 25.62% 2021-22 [60+ (305 -275)}/279] x 100 = 2007% 2022-23 [35 + (822 - 305}/305] x 100 = 17.05% Calculation of Retums from market Index Year of Index Appreciation Total Return % 2020-21 | (1950 - 1012/1812] x 100= 7.62% 5% 12.62% 2021-22 | [(2258 - 1950)/1950]x 100 = 1579% 6% 21.79% 2022-23 | |(2220- 2288)/2258]x 100 =(-)1.68% ™% 5.32% Computation of Beta BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management eee Ll Year x ¥ XY, Ye 2020-21 25.62 12.62 323.32 159.26 2021-22 20.07 21.79 43733 47480 2022-23 17.08 5.32 90.71 28.30 62.74 39.73 051.36 66236 62.74 Average Return of Jay Kay Ltd. = ——= 20.91% Average Market Return = ——= 13.24% xy Beta (®)= ae 85136 -3x 2091x1324 4 1g 662.36 -3 (S25 (ii) Observation Expected Return(%) Actual Return (%) Action 2020-21 | 5% +0.15 (12.62% - 5%) = 6.143% 25.62% Buy 2021-22 | 4% +0.15 (21.79% - 4%) = 6.669% 20.07% Buy 2022-23 | 5%+0.15 6.32% -5%) = 5.048% 17.05% Buy Question 33 The total market value of the equity share of O.R.E. Company is 60,00,000 and the total value of the debt is ¥ 40,00,000. The treasurer estimate that the beta of the stock Is currently 1.5 and that the expected risk premium on the market is 10 percent. The treasury bill rate is 8 percent. Required: (1) Whatis the beta of the Company's existing portfolio of assets? (2) Estimate the Company’s Cost of capital and the discount rate for an expansion of the company’s present business. Answer 5 Here Beniny As Baste = 0 Ve=%60lakhs BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management ed Vp = 40 lakhs Vo=% 100 lakhs 60 lakhs Basar 15% 700 Takhs 09 (2) Cost of Capital for discounting company’s expansion of existing business shall be computed as. follows: Company's cost of capital = Rr+ Bax Market Risk premium Where, Re= Risk free rate of return Bs = Beta of company assets Therefore, company’s cost of capital (WACC) = 8%+ 0.9x 10= 17% Question 34 Equity of KGF Ltd. (KGFL) is % 410 Crores, its debt, is worth % 170 Crores. Printer Division segments value is attributable to 74%, which has an Asset Beta (Br) of 1.45, balance value is applied on Spares and Consumables Division, which hasan Asset Beta (Bs«) of 1.20. KGFL Debt beta (Bx) is 0.24 You are required to calculate: @ Equity Beta (B:} Gi) Ascertain Equity Beta (Bs), if KGF Ltd. decides to change its Debt Equity position by raising further debt and buying back of equity to have its Debt Equity Ratio at 1.90. Assume that the present Debt Beta (Boi) is 0.35 and any further funds raised by way of Debt will have a Beta (Bor) of 0.40. Gil) Whether the new Equity Beta (B:) justifies increase in the value of equity on account of leverage? Note: Present all calculations in % Crore Answer (Equity Beta To calculate Equity Beta first we shall calculate Weighted Average of Asset Beta as follows: = 145 0.744 1.20% 0.26 = 1073 +0312= 1385 Nowweshall compute Equity Beta using the following formula: Da-t) Pou FDC) E Bren = Bows St Accordingly, 410 170 £385 = Bown 3704 170 *P™* 410+ 170 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management 1.385 = Boy x Ge+ 0.24 SO Bomsy = 1.86 (ii) Equity Bota on change in Capital Structure Amount of Debt to be raised: Particulars Value Total Value of Firm (Equity € 410 cr + Debt 170 a) 7560 Gr Desired Debt Equity Ratio Desired Debt Level = (Total Value x Debt Ratic)/(Debt Ratio + Equity Ratio) 7360 Gr Less: Value of Existing Debt 17001) Value of Debt to be Raised 2210 Equity after Repurchase = Total value of Firm - Desired Debt Value = 580 Cr -% 380 Cr = 200 > Weighted Average Beta of KGFL: source of Go Weight nee Weighted Beta Equity 200 0345 Be 0345 Debt 4 170 0.293 035 0.103 Debt -2 210 0.362 040 0.45 360 Weighted Average Beta 0.248 +(0345x) Buse = 0.248 + 0.345x 1385 = 0.248 + 0.345x 0.345x = 1.385 -0.248, 0.345x = 1.137 x= 1137/0345 = 3.296 Boguiy = 3.296 Portfolio Beta Management i) Yes, it justifies the increase as it leads to increase in the Value of Equity due to increase in Beta. Question 35 A Portfolio Manager (PM) has the following four stocks in his portfolio: ‘Security No. of Shares Market Price per share (2) 6 VSL 10,000 50 09 csL 5,000 20 10 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management nn SML 8,000 28 15 APL. 2,000 200 12 Compute the following: (@) Portfolio beta. (0) _ Fthe PM seeks to reduce the beta to 0.8, how much risk free investment should he bring in? (Q__ Fthe PM seeks to increase the beta to 1.2, howmuch risk free investment should he bring in? Also showthe revised portfolio and verify the Portfolio Beta in (b) and (c) above. Answer @ Security | No.of | Market Price] (1)x(2) | Ytototal] & wx shares | PerShare () @ Q) @ VSL 10,000 50 3,00,000 | 0.4167 08 0375 csL 5,000 20 1,00,000 | 0.0833 1 0.083 SML 8,000 28 200,000 | 0.1667 4s 0.280 APL 2,000 200 400,000 | 03333 42 0.400 12,00,000 1 1.108 Portfolio beta = 1.108 (i) Required Beta 08 should become (0.8/ 1.108) 72.2 % of present portfolio FZ 12,00,000 is 72.20%, total portfolio should be & 12,00,000x 100/72.20) = % 16,62,050 Additional investment in zero risk should be (% 16,62,050 -% 12,00,000) = % 462,050 Revised Portfolio will be Security] No.of | Market Price | (1)x(2) | %tototd | & wx shares | Por Share @) © @ @) VSL 10,000, 50 5,00,000 0.3008 09 0.271 csL 5,000 20 1,00,000 0.0602, 1 0.060, SML 8,000 25 2,00,000 0.1203, LS 0.180, APL 2,000 200 4,00,000 0.2407 12 0.289, Risk free asset} 46,205 10 4,62,050 0.2780, o o 16,62,050 1 0.800, To increase Beta to 1.2 Required beta 12 BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)Portfolio Management should become (1.2/1.108) 18.30% of present beta IF 2,00,000 is 108.30%, the total portfolio should be & 12,00,000x 100/108.30) = 3 11,08,033 say € 11,08,030 Additional investment should be (~) 91,967 i.e. Divest € 91.970 of Risk Free Asset Revised Portfolio will be ‘Security No.of ] Market Price | (1)x(2) | %tototal Bg wx shares | Per Share Ww) 6 @ @) VsL 10,000 50, 5,00,000 | 0.4513 0.9 0.406 cL. 5,000 20 1,00,000 | 0.0903 1 0.090 SML 8,000 28 2,00,000 | 0.1805 LS 0271 APL 2,000 200 4,00,000 | 0.3610 12 0.433 Risk free asset] -9,197 10 -91,970 | -0.0830 o 0 11,08,030 1 1.20 Portfolio beta = 1.20 Sharpe Index Model (Systematic & Unsystematic Risk) Question 36 Following are risk and return estimates for two stocks Stock Expected returns (4%) Beta Specific SD of expected return (%) A 14 0.8 35 B 18 12 5 ‘The market index hasa Standard Deviation (8D) of 25% and risk free rate on Treasury Bills is 6%. You are required to calculate: 0 Gi ‘The standard deviation of expected returns on A and B. Supp osea portfolio is to be constructed with the proportions of 25%, 40% and 35% in stock A, B and Treasury Bills respectively, what would be the expected return, standard deviation of expected return of the portfolio? Answer @ Total Risk = Systematic Risk + Unsystematic Risk Stock A Systematic Risk = Bo’ = (0.8) x (25)?= 400 Unsystematic Risk = (35)? 400 + @5)*= v7 Total Risk = 40.31% BY CA AJAY AGARWAL (AIR-1) AIRICA Career Institute (ACI)