CAPITAL MARKET AND PORTFOLIO

MANAGEMENT

ANSWER 1:
INTRODUCTION:

The standard deviation of an investment portfolio is commonly referred to as the volatility of an

investment portfolio by individuals who are more technically oriented. The standard deviation,
for example, might be used to establish whether or not a threat is related with a particular
protection that bureaucracy has in its portfolio. The correlation coefficient can be used to
characterise the link between different stock returns. The price of the correlation coefficient is
found in the range of -1 to +1. If the correlation coefficient is calculated wrongly, it indicates that
the stocks have an antagonistic relationship, implying that inventory returns are unaffected by the
returns of any other stock in the portfolio. It's also worth noting that in some circumstances, the
inverse is also true. The square root of the variance in the same facts set, random variable,
statistical population, or probability distribution is equal to the variance in those facts sets and
variables. 

CONCEPT AND APPLICATION:

Examining the number of variations and their distribution among values yields the standard
deviation. The term "known deviations" refers to the dispersion of a data collection with respect
to its underlying distribution. A low standard deviation, on the other hand, indicates that the
values are close to what would be expected from the entire sample, whereas a high standard
deviation indicates that the values are broader. The lowercase Greek letter sigma for population
standard deviation or the Latin letter s for sample standard deviation is frequently abbreviated for
standard deviation and is frequently represented in mathematical texts and equations by the
lowercase Greek letter sigma for population standard deviation or the Latin letter s for sample
standard deviation.

There is no association between the shares. The symbol (+) or (-) is also important in creating the
relationship. This positive or bad mark allows us to establish whether or not the returns on these
stocks are correlated, or whether they move in the same way. The energy of a relationship is also
shown by the location of the co-efficient cost between -1 and +1.

In this case, we'll start by calculating the daily returns on equities A, B, and C.

1|Page
The daily returns can be calculated using the components under:

Daily return = Pt/Pt-1

Where, 
Pt = Price at the end of the day 
Pt-1 = Price at the end of the previous day 

Table showing the calculation of daily returns

Day Stock A Stock B Stock C

Close Daily Close Daily Close Daily return
price return price return price
1 0.4 2.2 0.6
2 1.1 175% 1.3 -41% 0.5 -17%
3 0.9 -18% 1.2 -8% 1.4 180%
4 1.7 89% 1.9 58% 1.6 14%
Total return 245.70% 9.7% 177.61%

Using the daily returns obtained previously, we will now determine the average return on each
stock, which may be used to estimate the stock's predicted return.

Expected return from stock A = 175%-18%+89%/3

= 81.90%
Expected return from stock B = -41%-8%+58%/3

= 3.24%
Expected return from stock C = -17%+180%+14%/3

= 59.21%
If all three stocks are given identical weight in the portfolio, the portfolio's projected return will
be

RP = Wa X ERa + Wb X ERb +Wc X ERc

= .33*.8190 +.33*.0324+.33*.5921

= .4763 or 47.63%

2|Page
Now we shall calculate covariance between stock A, stock B, and Stock C:

Cov(a,b,c) = (Ra1 – ERa) * (Rb1-ERb)* (Rc1-ERc) + (Ra2 – ERa) * (Rb2-ERb)* (Rc2-ERc)+

(Ra3 – ERa) * (Rb3-ERb)* (Rc3-ERc)+ (Ra4 – ERa) * (Rb4-ERb)* (Rc4-ERc) / n-1

= (.00122+.00266+.00011)/3

= .0013

To determine the volatility of the portfolio, we need to determine the standard deviation of
the portfolio. The formula of standard deviation for the given case would be:
2 2 2 2
√ ( Wa ) X ( Ra−ERa ) + ( Wg ) X ( Rg−ERg ) +Cov(a , g)
2 2 2 2 2 2
√ ( Wa ) X ( Ra−ERa ) + ( Wb ) X ( Rb−ERb ) + ( Wc ) X ( Rc−ERc ) +2∗Wa∗Wb∗Wc∗Cov (a , b , c )

Where, √ MA X (WA−RP)2 + MB X (WB−RP)2

Wa= weight of investment in Stock A

Wb = weight of investment in Stock B

Wc = weight of investment in Stock C

Ra- ERa = Standard deviation of Stock A i.e., the difference between the actual and expected
return of Stock A

Rb- Erb = Standard deviation of Stock B i.e., the difference between the actual and expected
return of Stock B

Rc- Erc = Standard deviation of Stock C i.e., the difference between the actual and expected
return of Stock C

Cov (a,b,c) = how changes in a stock’s returns are related to changes in the market’s returns

2 2 2 2 2 2
√ ( 0.33 ) X (2.4570−.8190 ) + ( 0.33 ) X ( .0973−0324 ) + ( 0.33 ) X ( 1.7761−.5921 ) +2∗.33∗.33∗.33∗.0013

= 1.22%

3|Page
Correlation is the term used to describe the relationship between outstanding stock performance.
Correlation is determined by dividing the covariance of each inventory by its standard deviation.

The standard deviation of the shares A, B, and C is calculated as the difference between the daily
and average price of the stock.

Average price of Stock A = 0.4+1.1+0.9+1.7/4

= 1.025

Average price of Stock B= 2.2+1.3+1.2+1.9/4

= 1.65
Average price of Stock C= 0.6+0.5+1.4+1.6/4

= 1.025
Based on the average prices the standard deviation of stocks is:

Stock A= 97%

Stock B= 51%

Stock C= 106%

Corr (a,b) = -0.27

Corr (b,c) = -0.04

Corr (a,c) = -0.95

CONCLUSION:
The portfolio's standard deviation with equities A, B, and C having the same weight (as stated) is
1.22 percent, according to the assumptions. Furthermore, the stock correlation is negative, which
means that the return on one inventory is unaffected by the return on another.

4|Page
ANSWER 2:
INTRODUCTION:
The term CAPM, or Capital Asset Pricing Model of Value Analysis, refers to a formulation that
explains the relationship between systematic chance and the expected return on an inventory.
The CAPM is the most popular name for this connection. CAPM is widely used in financial
control to analyse stock risks and forecast asset returns, taking into consideration both the risk
associated with these equities as well as the cost of capital. The time value of money is
represented by the risk-free rate of return in the CAPM recipe. The CAPM method's unique
components result in the investor taking on additional risk. An ability assignment's beta is a
percentage of the amount of dangers that the investment adds to a portfolio that mimics the
market. A stock's beta will be greater than one if it is riskier than the market. The algorithm
allows a stock with a beta of less than one because it lowers the portfolio's risk.

CONCEPT AND APPLICATION:

It's a technique for calculating risk that was developed as part of the CAPM strategy. Individuals
make the decision that they want their stock to return to a level that is as close to the cost of
capital as possible. When expected returns are taken into account, the CAPM formula accurately
reflects the connection between expected returns and risk. When inventory's risk and issue with
the time value of money are compared to its combined return, the capital asset pricing model's
goal is to assess if inventory is really valued.

The maximum risk that funding can bring to an open market portfolio is represented by the beta
of an asset or investment.

The market risk premium, which is the predicted return on the market over the risk-free fee
generated within the market or on price T-bills, is used to calculate the return on inventory using
the Capital asset pricing model. The threat-free rate is then applied to the goods' beta and
marketplace threat top rates. The ultimate outcome should give a financial backer a significant
return or rebate rate to use in determining the inventory's value.

The capital assets pricing version (CAPM) is computed by using the following equation:

= R - β (ERR)

R – It represents the predicted chance–the loose fee of going back.

β – It way the beta of the furnished shares.

5|Page
ER – It represents the standard charge of return of the return.

A variety of assumptions underpin the CAPM model, which may contribute to its unreliability.
Several assumptions supporting the concept have been proven untrue.

The two most important assumptions regarding this economic hypothesis are:

1. Securities markets are relatively active and effective (huge documents relating
government agencies are grabbed and assimilated quickly and frequently).
2. Those business sectors are crushed by sensible, risk-averse investors seeking money from
their speculations.

Regardless of these problems, CAPM components are widely employed since they allow for easy
comparisons of various investment options.

Taking beta into consideration admits that an inventory's price volatility can be utilised to assess
risk. Neither option is equally risky. Because inventory returns (and related hazards) are not
routinely communicated, historical data is not always reliable.

The CAPM model's other basic assumptions all revolve on the risk-free rate. It is not true in real-
time markets since the risk-free rate of the bonds might fluctuate over time.

Illustrative market portfolio used to determine Market Risk Premium. Unlike stock, it cannot be
sold or converted into an option.

In this case, we must compare the predicted return from the store to the CAPM-consistent return.

The Expected returns from the stocks as given in the question can be calculated and
depicted as below:
Particulars Tata Adani Power Ranbaxy PNB
Risk-free rate 7% 7% 7% 7%
β 1.7 1.4 1.1 1.2
Return from 18% 18% 18% 18%
market (Rm)
Expected return 21% 16% 23% 19%
from stock
CAPM 25.7% 22.40% 19.10% 20.20%

CONCLUSION:
For Tata, the stock may be regarded expensive because the projected rate of return (on the stock
Tata), i.e., 21%, no longer surpasses the return computed using CAPM. Because the predicted

6|Page
rate of return (from the stock Adani power), i.e., 16 percent, no longer surpasses the return
consistent with CAPM, it can be concluded that the stock is overpriced. Because the expected
rate of return (on the stock Ranbaxy) is better than the CAPM rate of return, it is possible to say
that the inventory is underpriced for Ranbaxy.

For PNB, the stock may be regarded overvalued because the projected rate of return (from the
stock PNB), i.e., 19 percent, no longer surpasses the return estimated using CAPM.

As a result, Tata, Adani Power, and PNB are all overvalued, whereas Ranbaxy is undervalued.

ANSWER 3A.
INTRODUCTION:
Investing has always been exciting. It allows investors to build money and broaden their
financial horizons. Investing has captivated us all from the start. What began as a simple
investment in gold, real estate, and other traditional assets has grown to include stock, debt,
commodities, and more.

Today's financial market is large and full of alternatives. There are numerous options, each with
its own set of advantages and disadvantages. But how do you go about investing? Is it all
straightforward to choose or are there elements influencing investment choices? They are.

The factors that influence our investment decisions are the same whether we are seasoned
investors or newcomers. We examine the aspects that influence our financial decisions. Follow.

CONCEPT

Major Factors that Influence our Investment Choices

 Investment Goals:  First, creating goals is always the first step. Before investing, we
must be conscious of our needs. It affects our investment goals. Whether you want to
save for retirement, buy a dream home, pay for your child's school, or just cover a
future need, you need to know your goals. It is possible to set short-term, mid-term,
and long-term goals. This manner, you may tailor your investment choices to your
objectives. We've seen folks invest based on their ambitions. For short term goals, go
for bank fixed deposits, mutual funds, etc., whereas for medium to long term goals, go
for equity investments. For example, if you wish to reach Rs 10 lacs by the age of 35,
you need spend the money carefully in relevant investment possibilities.

7|Page
 Risk Tolerance Level: Understanding your risk tolerance helps you manage the
investment's risk and discomfort. Risk perception typically influences risk tolerance.
Some people may be willing to accept a lower return if the risk is modest. Some may
try to leverage high-risk to maximise returns. Understanding your risk tolerance is
critical when making investing decisions. Those who can manage high risk can go for
volatile options like equity, while those who want low risk can go for fixed deposit,
gold, and real estate. Although historically the equity market has been a highly
lucrative platform with plenty of rewards, it is still favoured.
 Income Level:  You must invest your money in order to receive returns and pursue
increase in your wealth. The quantity of money we can invest in the market is
determined by our income levels. It may also have an effect on our level of risk
tolerance. Investors who have a large pool of income are more likely to take risks and
make substantial investments than those who have a smaller pool of income. Having a
greater income stream can definitely open doors to new investment patterns and
options.
 Taxation Liability:  Our income is frequently impacted by tax liabilities, which
affects our investable income. And, of course, with less investible income, you'll have
to accept a lower return. When it comes to influencing our investment decisions, it's a
major element. However, it is not all doom and gloom for investors, as there are a
number of investment programmes that can help decrease tax liability. Options such as
ELSS and other Sec 80CC-related investments have become popular among those
looking to invest while receiving tax benefits. These provide you with the benefit of
building your wealth while reducing your tax burden.
 Emotional Check:  Emotions play a big role in investment decisions. It's no surprise
that the market is often led by rumours rather than logic. To be fair, investing takes
emotional control and avoiding impulsive decisions. For example, the stock market
frequently shifts between bearish and bullish patterns. Most people are unsure whether
to hold or sell stocks. Choosing patience and sticking to your goals will benefit you
here. Similarly, in India, some people still invest in gold and real estate for emotional
reasons.
 Need for Liquidity:  Unpredictable events may develop when you require an
immediate financial infusion. We've all heard that we should keep an emergency fund
handy. When emergency finances aren't enough, you may have to tap into your
investment and liquidate it. Liquidity measures how easily an asset or security may be
converted into cash. The ability to dispose assets is a crucial factor in investment
decisions. People invest in high liquidity assets including stocks, fixed deposits, liquid
money, and more. The opportunity to rapidly sell them off in times of need is a
genuine deal. -breaker. 

8|Page
Other considerations besides the one stated above often guide or impact investment. Family
history, personal characteristics, financial obligations, and other factors influence investment
decisions. These characteristics do affect choices, but it is ultimately up to the individual to
design a sound investment portfolio based on their needs and profile. Create a strategy that helps
you structure and balance your portfolio while also maximising your return.

CONCLUSION:
In addition, an investor may select the investment that is best acceptable for them, based mostly
on the features listed above, and determine the amount of rent they will charge for that
investment throughout the selection and selection process.

ANSWER 3B.
INTRODUCTION:

It is a contract for a monetary asset that may be bought or sold. A financial instrument
transaction involves contractual obligations between parties. If a corporation pays cash for a
bond, another party must supply a financial instrument to complete the transaction. One
corporation must offer cash, while the other must furnish a bond.

Checks, bonds, and securities are basic financial instruments. Financial instruments are classified
as cash, derivatives, and foreign exchange.

CONCEPT AND APPLICATION:

Types of Financial Instruments

9|Page
 1. Cash Instruments: Cash instruments are financial products whose values are
immediately affected by market conditions.

There are two sorts of cash instruments:

- securities
- deposits, and loans.
 Securities: A security is a monetary-valued financial instrument traded on the stock
exchange. A security indicates ownership of a portion of a publicly traded corporation
on the stock exchange when purchased or sold.
 Deposits and Loans: Both deposits and loans are considered cash instruments
because they represent monetary assets that have some sort of contractual agreement
between parties.

2. Derivative Instruments: Derivative instruments are financial products whose values are
based on underlying assets such as commodities, currencies, bonds, stocks, and stock
indexes.

Synthetic agreements, forwards, futures, options, and swaps are the five most frequent
derivatives instruments. This is covered in greater depth further down.

 Synthetic Agreement for Foreign Exchange (SAFE): A SAFE is an agreement that

ensures a specific exchange rate for a specified length of time in the over-the-counter
(OTC) market.

10 | P a g e
  Forward: A forward is a contract between two parties that includes adjustable
derivatives and involves an exchange at a predetermined price at the end of the
contract.
 Future: A future is a derivative transaction that allows you to trade derivatives at a
predetermined exchange rate at a future date.
 Options: An option is an agreement between two parties in which the seller grants the
buyer the right to purchase or sell a certain number of derivatives at a predetermined
price for a specific period of time.
 Interest Rate Swap: An interest rate swap is a derivative agreement between two
parties that involves the swapping of interest rates where each party agrees to pay
other interest rates on their loans in different currencies.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments that are traded on a foreign exchange
market, principally currency agreements and derivatives. There are three types of currency
agreements: Spot, Outright Forwards, Currency Swap.

 Spot: A currency agreement in which the actual currency exchange occurs no later than
the second working day after the agreement's original date. The money exchange is done
"on the spot," hence the term "spot" (limited timeframe).
 Outright Forwards: A currency arrangement in which the actual exchange of money
occurs "forwardly" and before to the actual date of the agreed-upon requirement is
defined as follows: It is advantageous in situations where currency rates fluctuate and
change often.
 Currency Swap: A currency swap is the act of buying and selling currencies with
different defined value dates at the same time.

CONCLUSION:
Based on his or her investment objectives, an investor may decide to keep either an equity device
or a debt instrument in his or her portfolio at any one time. The inclusion of a mix of these
various forms of financial instruments in their investment portfolio will also help to boost the
diversity of their portfolio.

11 | P a g e