ECON F412/FIN F313: SECURITY ANALYSIS AND

PORTFOLIO MANAGEMENT
SEM – I 2021-2022
Practice Problems Set – I
1. An investor wants to invest in a company XYZ. Based on the situation of
economy, the returns of the company in each case are given as below:

State of economy Probability of event Expected returns

Boom 0.4 12%
Normal 0.4 6%
Recession 0.2 -2%

He has decided to invest if he is likely to earn a return of 6% or more.

Would you recommend investing in company XYZ to him? Why or why
not? Also calculate the risk.

2. Given the following price information, construct a value-weighted index

for the stocks X, Y and Z. What is the major drawback of this type of
index? (Base value of index as 1000)

Stock No. of Shares Price

T T+1
X 1,00,000 80 84
Y 15,000 53 45
Z 2,000 33 20

3. Given are annual rate of returns for stocks X, Y and Z.

Year Stock A Stock B Stock C

2018 12% 15% 20%
2019 8% 10% 9%
2020 -6% 3% 5%

a. Calculate arithmetic mean rate of return (AAR) for each stock.

b. Calculate geometric mean rate of return (AHPR) for each stock.
c. Are these 2 values different? If yes, what could be the reason?
4. Suppose you are an investor and you bought 500 shares of a company
XYZ at Rs. 100 per share using your margin account given an initial
margin requirement of 50% and maintenance margin requirement is 30%.
What will be the margin call price? Also, assuming that you have
borrowed the maximum amount of money with 5% interest rate and
commission of Rs. 1000 on transactions, if the price of share increases to
Rs. 120 per share, calculate the returns.

5. Answer the following questions:

a. If the monthly returns of a stock ABC are 3%, what are its
annualized returns.
b. If the weekly returns risk of a stock XYZ are 1%, what are its
annualized risk.
c. Given a stock with expected return of 12% and standard deviation
of 15%, find the coefficient of variation.
d. What happens if the expected return of a stock is 12% and required
rate of return of the same stock is 13%.

6. Consider the closing price of a price weighted index comprising of 2

securities was 262.5 (closing price of security 1: Rs.80; closing price of
security 2:130) on Day 1. After the closing hours, the management of
company 2 opts for a 4 for 1 stock split.

a. Find the divisor for Day 1 and opening session of Day 2.

b. What happened to weight of the security 2 post stock split and
what can you infer from this?
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ECON F412/FIN F313: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
Problem Set –Portfolio Theory

1. An investor invests in a portfolio consisting of equities and T-bills. The expected

return on equity is 12%, and the risk 15%. The return on T-bills is 6%. The investor
chooses to split their investable sum in the following manner: 70% in equities and
30% in T-bills. Find the expected return and risk of the investor’s portfolio.

2. You are an investor looking to invest in a portfolio consisting of two stocks. Your
choices for the same are listed below, in ordered pairs of (expected return, risk):
Stock A: (15%, 18%)
Stock B: (10%, 16%)
Stock C: (30%, 25%)
Given that the portfolio is to be equally-weighted in both stocks, and given that the
covariances are σAB = 0.015, σBC = 0.03 and σCA = 0.021 which two stocks would you
pick to maximize the diversification benefit?

3. As an investor, you wish to invest in a portfolio consisting of debt and equity. The
expected return and risk for debt are 15% and 18%, while the expected return and risk
for equity are 25% and 35%. Find the weights of debt and equity in the minimum
variance portfolio consisting of these two assets, given that the covariance is 0.055.
Also find the expected return and risk of this minimum variance portfolio.

4. Consider a portfolio consisting of stock A and stock B, with expected returns 24%
and 16% and risks 32% and 20%, respectively. If the total expected return and risk of
the portfolio are 21% and 27% respectively, find the weights of stocks A and B in this
portfolio. Also find the correlation between the stocks, and the extent of
diversification.

5. Consider an investor wanting to invest 35% of their total investable sum in T-bills and
the remaining 65% in the portfolio of two risky assets in the previous question. Given
that the T-bill return is 8%, find:
a. The investor’s index of risk aversion
b. The investor’s expected return and risk from this investment
ECON F412/FIN F313: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
First Semester, 2021-22
Problem Set – I [Portfolio Theory]: Solutions

1. Expected return, E(r) = (0.7*0.12) + (0.3*0.06) = (0.084 + 0.018) = 0.102, i.e., 10.2%
Risk = 0.7*0.15 = 0.105, i.e., 10.5%.

2. The portfolio with the highest diversification benefit will have the lowest correlation
among its stocks. For a portfolio consisting of assets 1 and 2, portfolio correlation is
given by ρ12 = σ12/σ1σ2
ρAB = σAB/σAσB = 0.015/(0.18*0.16) = 0.52
ρBC = σBC/σBσC = 0.03/(0.16*0.25) = 0.75
ρCA = σCA/σCσA = 0.021/(0.25*0.18) = 0.47
The portfolio consisting of stocks A and C would be the best option among these for
diversification.

3. σp2 = wD2σD2 + wE2σE2 + 2wDwEσDE

In the minimum variance portfolio, we minimize σp2 subject to the constraint wD + wE
= 1, and on doing so, obtain
wD,min = (σE2 – σDE)/(σE2 + σD2 - 2σDE)
wD,min = ((0.35*0.35) – 0.055)/((0.35*0.35) + (0.18*0.18) – 2*0.055) = 0.0675/0.0449
wD,min = 1.5033 and wE,min = 1 – 1.5033 = -0.5033
Hence, investing in the minimum variance portfolio involves short-selling equity, and
increasing investment in debt.
E(r) = (1.5033*0.15) + (-0.5033*0.25) = 0.09967, i.e., 9.97%
Risk = ((1.5033*1.5033*0.18*0.18) + (-0.5033*-0.5033*0.35*0.35) + 2*1.5033*-
0.5033*0.055)1/2 = 0.021021/2 = 0.145, i.e., 14.5%.

4. E(r) = wA*0.24 + wB*0.16 = 0.21

Considering wA + wB = 1,
wA*0.24 + (1 – wA)*0.16 = 0.21
wA*0.08 + 0.16 = 0.21
wA = (0.21 – 0.16)/0.08 = 0.05/0.08 = 0.625
wB = 1 – wA = 0.375
Portfolio risk is given by σ = (wA2σA2 + wB2σB2 + 2wAwBρABσAσB)1/2
From this,
ρAB = (σ2 – wA2σA2 – wB2σB2)/(2wAwBσAσB)
= ((0.27*0.27) – (0.625*0.625*0.32*0.32) – (0.375*0.375*0.2*0.2)) /
(2*0.625*0.375*0.32*0.2)
= 0.027275/0.03
= 0.91
Since the correlation between the stocks is very high, this is not a well-diversified
portfolio to invest in.

5. a. The index of risk aversion is given by

A = (E(rp) - rf)/(y*σp2), where rp and σp refer to the return and risk of the risky
portfolio.
A = (0.21 – 0.08)/(0.65*(0.27*0.27)) = 0.13/0.047385 = 2.744

b. E(r) = (0.65*0.21) + (0.35*0.08) = 0.1365 + 0.028 = 0.1645, i.e., 16.45%

Risk = 0.65*0.27 = 0.1755, i.e., 17.55%.
 ECON F412/FIN F313: SECURITY ANALYSIS AND
PORTFOLIO MANAGEMENT
SEM – I 2021-2022
Practice Problems Set – SIM and CAPM
1. Given characteristics of securities:

Stock Alpha Beta Firm specific

risk (SD)
X 0.5% 1.5 9%
Y 1% 0.8 10%

If the market excess return is 8% and market’s standard deviation is 11%

find the risk and return of portfolio with weights 70% of stock X and 30%
of stock Y.

2. Given the beta for a particular stock is 0.9, the risk-free rate is 6.5% and
the expected market return is 12.5%, what is the expected return on the
stock?

3. What is the market risk premium given an expected return on a security

of 13.6%, a stock beta of 1.2, and a risk-free interest rate of 4.0%,
according to the CAPM model?

4. Given is the following information regarding two securities 1 and 2 that

satisfy the security market line: E(r1) = 10%; E(r2) = 12%; β1 = 1; β2 =
1.4. What can we say about the pricing of another security 3 in the market
that has an expected return of 14% with a beta of 1.2?

5. Given risk-free rate of 10% and the expected market returns of 14%.
Compute the expected return for the following stocks. Where would they
fall on an SML graph?

Stock Beta Expected

returns
A 0.85 14%
B 1.25 12%
C -0.20 11%
6. Which assumptions of CAPM model will affect its equilibrium result?
Explain.
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 Birla Institute of Technology & Science, Pilani
Hyderabad Campus

Semester-I, 2021-22
ECON F412/FIN F313: Security Analysis & Portfolio Management

Problem Set: Portfolio Performance Evaluation

1. Evaluate the relative performance of the following funds using the Sharpe ratio.
A: Risk = 30%, Return = 25%, Beta = 1.2
B: Risk = 18%, Return = 20%, Beta = 1.5
Assume the risk-free rate is 7%. Further, the market has a risk of 15% and return of 18%.

2. For the same two portfolios mentioned above, evaluate the relative performance using the
Treynor ratio. Are the results the same? Why or why not?

3. What is the Jensen’s alpha for a portfolio whose expected return is 18%, beta is 1.5, and
the expected market return is 14%? Also calculate the information ratio for this portfolio,
if the unsystematic risk is 22%. Assume that the risk-free rate is 7%.

4. Suppose you are an investor, looking to invest in one of the following portfolios.
Portfolio 1: Risk 15%, Return 12%, Beta 1.4
Portfolio 2: Risk 25%, Return 22%, Beta 1.1
Assuming that the market return is 18% and its standard deviation is 20%, which portfolio
would you choose, if your preferred performance measure is the M-squared measure? Risk-
free rate = 7%.

5. Consider the following information on investment in three different sectors A, B, and C.

Find the excess returns that can be attributed to security and sectoral allocation,
respectively.

Portfolio Benchmark Portfolio Benchmark

Weight Weight Return Return

Sector A 0.4 0.5 0.24 0.20

Sector B 0.3 0.1 0.18 0.15

Sector C 0.3 0.4 0.30 0.28