BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K K BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS

SECOND SEMESTER 2016-17

TEST 1

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412)

Instructions- Answer all questions with diagrams and examples wherever possible. Marks would be
deducted for illegible handwriting. Mere ‘yes’ or ‘no’ would fetch no marks. Justify your answers.

Q1- Risk premium is related to nominal risk free rate in investment modeling. How do you think it
explains required rate of returns for investment commitments and also the discount rates in valuation
exercises, if at all? (6M)

Q2- If market cap of three stocks with 100 , 200, 300 shares each is given at 10,000, 20,000 and 30,000
rupees based on certain beginning prices, can you find HPR and HPYs if ending prices are 200, 250 and
400? (6M)

Q3a- Diagrammatically arrange the following financial instruments in SML. Show how is it different from

CML? [Data given - CD, CP, Fixed Deposits, gold, real estate.] (5M)

Q3b. Do you think movements on the line, change of slope or parallel shifts of SML can take place?(3M)

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K K BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS; SECOND SEMESTER 2016-17; TEST -1

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412)

MODEL ANSWERS

Instructions- Answer all questions with diagrams and examples wherever possible. Marks would be
deducted for illegible handwriting. Mere ‘yes’ or ‘no’ would fetch no marks. Justify your answers.

Q1- Risk premium is related to nominal risk free rate in investment modeling. How do you think it
explains required rate of returns for investment commitments and also the discount rates in valuation
exercises, if at all? (6M)

Most investors require higher rates of return in I if they perceive uncertainty about expected returns.
This increase in ROR over NRFR =RP. However to understand RROR,one needs to understand RRFR, NRFR
also. Explain these. Then show relation n RRFR and NRFR i.e. NRFR= 1+NRFR)/ 1+ rate of inflation)
substract 1.

Then DR=RRR as cost of equity; 2- CF=OFCF use WACC. In FCF to equity use cost of equity.

Q2- If market cap of three stocks with 100 , 200, 300 shares each is given at 10,000, 20,000 and 30,000
rupees based on certain beginning prices, can you find HPR and HPYs if ending prices are 200, 250 and
400? (6M)

A market wt is 1/6; B it is 1/3; in C it is ½. Hpr=3.166, hpy= 2.166.

HPR in : a=2; b it is 2.5; and C it is 4.

Q3a- Diagrammatically arrange the following financial instruments in SML. Show how is it different from

CML? [Data given - CD, CP, Fixed Deposits, gold, real estate.] (5M)

FD, gold , CD, CP companies, commercial real estate. Use SML as in last para of ch 1 (R&B book, any
edition)with proper name s in X axis and Y axis.

Q3b. Do you think movements on the line, change of slope or parallel shifts of SML can take place?(3M)

SML on the line show change in risk characteristics of specific investments showing change in BR, FR, B

Slope change due to attitudes and yield showing return desire per same risk.

Shift in SML reflect change in real growth, market conditions easiness of money, etc. And draw those
SML lines

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K K BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS

SECOND SEMESTER 2016-17

TEST 1 MAKE UP

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412)

Instructions- Answer all questions with diagrams and examples wherever possible. Marks would be
deducted for illegible handwriting. Mere ‘yes’ or ‘no’ would fetch no marks. Justify your answers.

Q1a- What is the significance of a relative measures of Risk? Given E(R)=0.1 and 0.2 and SD as 0.001 and
0.002 for two respective stocks, which would you choose? (3M)

Q1b-If an investor believed that an investment could provide several different rates of return how

would you justify it? Hypothetically, if they are case1- prob 0.2 and ROR=0.5; Case 2- prob 0.3 and

ROR = - 0.4; Case 3-prob 0.5 and ROR=0.8, can you find a realistic expected return for this single

stock? (3M)

Q2- Cite objective and subjective forces behind a time value of money, if possible. How would you

differentiate between business risk and financial risk? (7M)

Q3a- Can asset allocation across countries factor in cultural differences? (3M)

Q3b- What common mistakes are committed by investors while formulating their policy

Statements? (4M)

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K. K. BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS

SECOND SEMESTER 2016-17

TEST 2

DEPARTMENT OF ECONOMICS

Date: 29March2017 Time: 2PM-3PM

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412/FIN F313)

Instructions- Answer all questions with diagrams and examples wherever possible. Marks would be
deducted for illegible handwriting. Mere ‘yes’ or ‘no’ would fetch no marks. Justify your answers.

Q1a- Outline the objectives and constraints of Mutual Funds (MF) and Pension Funds (PF) as institutional

investors in their ‘asset allocation/management of funds’ roles. (5M)

b- The lower correlations among investment grade bonds (IGB)) and high- yield bonds (HYB) on the

one hand and low & diverse relation in US grade bonds(USGB) and world government bonds(WGB)

support global diversifications. What could be the reasons? (3M)

Q2a- How different is an un-weighted index from a Style Index? (3M)

b- Given in 2014 for Stock A, share price is 10 and for Stock B is 20, but in 2015 it increased to 25 and

30respectively. If it is from an un-weighted index, what characteristic would be manifested? (2M)

(Hint: any component of answers in (a) and (b) in Q2, if repeated, would not fetch marks)

Q3a- Should number of transactions in NYSE can increase and average trade size decrease due to

decimalization process in stock pricing quotations? Illustratively explain why. (3M)

b- Giving a numerical example of a zero uptick, can short selling be justified? (2M)

c- Can a specialist behave like a dealer and would that make it a case of semi strong EMH? (2M)

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K. K. BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS

SECOND SEMESTER 2016-17

TEST 2

DEPARTMENT OF ECONOMICS

Date: 29March2017 Time: 2PM-3PM

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412/FIN F313)

MODEL ANSWERS

Instructions- Answer all questions with diagrams and examples wherever possible. Marks would be
deducted for illegible handwriting. Mere ‘yes’ or ‘no’ would fetch no marks. Justify your answers.

Q1a- Outline the objectives and constraints of Mutual Funds (MF) and Pension Funds (PF) as institutional

investors in their ‘asset allocation/management of funds’ roles. (5M)

A. MF pools money from investors to invest in financial assets with the objectives of capital
appreciation, high current income and money market income. Constraints in this case are those
created by law to protect MF investors and also choices made by MF managers.
PF’s objective and constraints depend upon whether the plan is defined benefit plan or defined
contribution plan. In first case, return objective is to meet plan’s actuarial rate of return (set by
actuaries to estimate future pension obligations based on assumptions of salaries, retirement
pattern life expectations, benefit formula) and so to provide retirees with income stream after
retirement. Its liquidity constraint is a function of average age of employees(older mean more
liquidity to pay current pension obligations with may be 5-10 year horizons. Tax not a
constraint).Major legal constraint is that the plan be run in accordance with Employee
Retirement and Income security act-ERISA and investment satisfy prudent expert standard
(Evaluated in context of overall pension plan portfolio).
For defined contribution case, individual worker decides how its contributions could be invested.
Constraint is worker carries risk of inadequate retirement funding and so conservatively inclined.
[not so in case of wealthy people since assets be owned by heirs] Liquidity and time horizon
constraints differ depending on average age of employees and degree of employee turnover
within firm. Also, governed by ERISA legal constraint but tax exempt.

b- The lower correlations among investment grade bonds (IGB)) and high- yield bonds (HYB) on the

one hand and low & diverse relation in US grade bonds(USGB) and world government bonds(WGB)

support global diversifications. What could be the reasons? (3M)

A- Equity characteristics of HYB in first case. Different interest rate movements and exchange rate
effects. Differential risk characteristics help in hedging. The above are the types of risks hedged
against in each case.

Q2a- How different is an un-weighted index from a Style Index? (3M)

Un-weighted case: all stocks carry equal weight regardless of price or market value. It is used by
individuals who randomly select stocks for their portfolio. Actual movements in the index is to assume
that equal dollar amounts based on AM of %changes in price or value for stocks in index where each
%change has equal weight.

Style index firms respond fast to changes in investment practices. Popularity of small cap stocks is
another as in 1980s over LT, it outperformed large cap stocks in risk adjusted basis. This led to size
indices to evaluate performance of MM. Then growth stocks and value stocks ruled. SRI tract ethical
funds

b- Given in 2014 for Stock A, share price is 10 and for Stock B is 20, but in 2015 it increased to 25 and

30respectively. If it is from an un-weighted index, what characteristic would be manifested? (2M)

(Hint: any component of answers in (a) and (b) in Q2, if repeated, would not fetch marks)

HPRs=25/10=2.5. and 30/20=1.66 ; AM =(1.5+0.66)/2=2.91/2= 1.45; AM=∑ HPY/n

Pi= 2.5 X 1.66=4.15. So square root of 4.15=2.03. So GM= 2.03-1=1.03

So GM shows downward bias.

Q3a- Should number of transactions in NYSE can increase and average trade size decrease due to

decimalization process in stock pricing quotations? Illustratively explain why. (3M)

Before 1997, quoted in 1/8 so each eight equal to 0.125 usd. In 1997, fraction of most stocks went to
1/16 and so each stock equal 0.0625 usd. Now priced in decimals cents and so spread in cent usd 30.10
-30.12. This saves money for investors since it reduces size of bid ask spread from 6.25cents to 1 cent. So
it had effect of reducing spread size and decline in transaction costs and this increased number of
transaction. Ex nyse, average daily increased to 3702000 in 2004 in 4 years from 8.77lakhs. but average
trade size decreased from 1187 shares in 2000 to 393 shares in 2004.

b- Giving a numerical example of a zero uptick, can short selling be justified? (2M)

A In set of transaction prices 42, 42.25.42.25 you can sell short at 42.25 even though it is no change from
previous trade at 42.25 because previous trade was on uptick trade.

Short selling is justified if you believe that stock is overpriced and want to take advantage of an expected
decline in the price. Short sale is made only on an uptick trade meaning price of the short sale must be
higher than last trade price. Why? Because exchanges do not want traders to force a profit on short sale
by pushing the price down through continually selling short.

c- Can a specialist behave like a dealer and would that make it a case of semi strong EMH? (2M)

In an actively traded stock such as IBM or GE, a specialist has little need to act as a dealer because
substantial public interest in stock creates a tight market that is a narrow bid ask spread, So in such a
case, main source of income would come from maintaining the limit orders for the stock. Broker income
derived from a high volume stock is substantial and without risk.

But a stock with low trading volume and high price volatility would probably have a fairly high bid ask
spread and specialist would have to be an active dealer. The specialist income from such a stock would
depend on his ability to trade it profitably. They have a major advantage when trading because of their
limit order books. Officially they are to see the limit order book. So they have monopoly on important
information regarding current supply and demand for a stock. But they share this book with other
brokers so it is not competitive advantage. So whatever advantage is derived, it is from privacy and
monopoly of information he has/had.

No. They do not support strong EMH [as they have access to unfilled limit order books and even if they
share it] and certainly it is not a case of semi strong EMH as they are privy to limit order (unfilled) books
and even if they share and make it public. They are able to derive above average returns as per studies.
First they make money as they sell shares at higher prices than their purchased price. Also they make
money when they buy and sell after unexpected announcements and when they trade in large blocks of
stock. Ib 2001 contended that specialists are doing more trading as dealers and return on their capital in
2000 was 26%.

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K K BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS

SECOND SEMESTER 2016-17

COMPREHENSIVE EXAMINATION

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412/FIN F313)

Date: May16, 2017 Time: 9AM-12Noon

Max Marks: 40

Instructions- Answer all questions. Marks would be deducted for illegible handwriting. Mere ‘yes’ or ‘no’
would fetch no marks. Justify your answers. Answers to each question be mutually exclusive. No marks
would be awarded for ‘repetitive’ answers.

Q1a- One of the first studies to test semi-strong EMH was by FFJR. What did they analyze and why was

this study important? (4M)

1b-Algebraically and graphically explain FFJR method(s) citing cases where information was

Anticipated/ not anticipated, in possible cases. (6M)

1c- Were any cases of market inefficiency found when further tests were performed?

Explain two such cases. (4M)

Q2a-Risk return measures on portfolio are main determinants of investor attitudes. Graphically use

IC maps to show risk loving and risk fearing investors. (2M)

2b- Does different utility accrue to given increments of return? Graphically explain three different

cases. (4M)

2c- In Simple Markowitz Risk Adjusted Return investor’s risk tolerance is 60 and portfolio’s

Expected return is 15%. What would be the utility percentage that the investor would prefer given

variance of return is 225%? (3M)

2d-In a Markowitz Mean-Variance approach, Given data are as follows:

Company A’s SD of returns is 1.7 and Company B’s SD is 3.5 but Mean returns are 0.6 and 1.1

respectively. Covariance (A, A)=0.029 and Cov (B,B) is 0.13 but Cov (A,B)=0.002 and Cov (B, A)=
 0.002. Find: 1- Weights of each stock in portfolio and SD for E(R) of 0.75? 2- Calculate the weights

of each stock in the portfolio if expected risk of 0.0686 is to be tolerated. 3- Can Markowitz

efficient frontier be drawn to identify roughly the above points on the frontier? (7M)

Q3-In Technical analysis, use diagrams: One mark each for a, b, c, d respectively. (4M)

3a-Which technique can be used to show duration and exact magnitude of price move?

3b- Show a rally that fails to show a new high.

3c- Show a previous low that can become a support or a good point to expect support.

3d- On a trend slope, when should you refrain from holding a long position?

Q4a- Taking long position at 9560, show payoff diagram, profit/loss, if at expiry, Nifty is at 9000

(Hint: For a future, market lot =75) (3M)

b- The Sharpe ratio of a stock is 1.5 and risk free rate is 8%, market’s expected rate of return is 16%

with SD of 4% ;and Beta of the stock= 0.5. Determine the stock’s expected return and unsystematic

risk. (3M)

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE PILANI, K K BIRLA GOA CAMPUS

DEPARTMENT OF ECONOMICS

SECOND SEMESTER 2016-17

COMPREHENSIVE EXAMINATION

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT (ECON F412/FIN F313)

MODEL ANSWERS

Date: May16, 2017 Time: 9AM-12Noon

Max Marks: 40

Instructions- Answer all questions. Marks would be deducted for illegible handwriting. Mere ‘yes’ or ‘no’
would fetch no marks. Justify your answers.

Q1a- One of the first studies to test semi-strong EMH was by Fama Fisher Jensen Roll. What did they

analyze and why was this study important? (4M)

They analyzed the effect of stock splits on share prices. 1- It provided evidence of relative efficiency of
securities markets. 2- explored whether stock splits increase shareholder wealth.3-developed a research
methodology to test market efficiency.

1b-Algebraically and graphically explain FFJR method(s) citing cases where information was

Anticipated/ not anticipated, in possible cases. (6M)

Computed abnormal returns based on market model. To estimate returns, security returns were
regressed against the returns for an index (stocks listed in NYSE).

R(it)=ai+b(ir)m(t)+e(it).

Avg or normal returns (after risk adjustment)= ai+Bi rmt

ARit=eit= rit- (ai+Bi r mt)

2nd innovation: Measure cumulative average abnormal returns CAAR by adding avg abnormal returns
AARt over time. With time periods centered around date of event or announcement date.

AARt=1/n ∑ ARit

CAAR=∑AARt

CAAR is computed by adding AARt for each time period with time periods beginning several months
before the event and ending several months after the event. So CAAR provides a picture of average price
behavior of securities over time.

If markets are efficient, CAAR is close to zero.

Anticipated

Unanticipated

Unanticipated and inefficient market

 1c- Were any cases of market inefficiency found when further tests were performed?

Explain two such case studies. (4M)

Case 1-Quarterly earning cases: JLM examined prices and quarterly earnings over the period 1963-68.
Earnings were compared with earnings for same quarter in previous year. If current quarter earnings
were 40% or more above earnings for same quarter in previous year, earnings were better than
expected. Abnormal returns calculated from 13 weeks before announcement of earnings to 26 weeks
after announcement. CAAR occurred before release and so investors correctly anticipating. But after
announcement of earnings stocks that generated above those of previous yr continued to make positive
abnormal returns. This is evidence against semi-strong EMH. Those earning below previous yr earnings,
CAAR stable after announcement. Even 1971-80 results similar results. But generally above JLM strategy
may not work in sense of replicating their experiments with modern computer and data bases.

Case 2-[Ball reviewed 20 papers that showed abnormal returns but conjectured that these could be due
to misspecification of model generating market returns. Since each showed security returns as function
of single variable , the market index]. Small firm effect- Banz found size of affirm has been highly
correlated with stock returns. Larger the market value of firm’s common stock, lower is rate of return
generated by the stock [1931-1975 nyse monthly returns common stocks]. To determine how much
difference size effect makes, Banz formed portfolios consisting of 10 smallest firms and 10 largest firms
n=10, computed average returns for these portfolios and then substracted large firm portfolio return
from small firm portfolio return. Procedure repeated for 20 smallest firms and 20 largest n=20 and for
50 smallest and 50 largest firms n=50. For overall period, difference in return between small firm rs
portfolios and large firm rl n=10 1.525 monthly difference and if annualized, small firm portfolio will
have outperformed large firm portfolio by 20% So since Banz constructed portfolios so that they had
same beta these results suggested that CAPM and single factor model are mis-specified. Since return
differential is so great between small firm and large firm and so long it persisted, it is unlikely that
investors would not begin to identify mispriced securities and compete away these abnormal profits. Roll
also said that results in Beta of small firms being systematically underestimated results in risk adjusted
returns being overstated. Also Roll-Blume-Stambaugh showed that method of forming portfolios
resulted in returns from small firms being overstated. Correctly measuring risk and return of small firm
portfolios seems to eliminate at least 50% of small firm effect.

Kiem showed 50% of small firm effect occurs in january and that too in its first five days of trading.
Stoll-Whaley said that most of these small firm effect is due to high transaction cost like bid ask spread
and commission costs. Arbel and Strabel argue that small firm effect is neglected stock effect and effect
disappears if neglected stock effect is controlled. Firm size of variable highly correlated with size is an
omitted variable in model for abnormal returns.

Weekend effect-Mis specified model does not account for weekend effect. French examined returns
generated by S&P500 index for each day of week over 1953-77. Ignoring holidays, returns for Monday is
three calendar day investment from close of trading Friday to close of trading Monday. Returns for other
days are 1 day period of investment. If expected return is linear function of period of investment, mean
return on Monday should be three times man returns mean returns for other days of week. But if the
process generating returns operating in terms of trading days, return for all five days of week will be
same. But Monday returns have been found to be negative.

Q2a-Risk return measures on portfolio are main determinants of investor attitudes. Graphically use

IC maps to show risk loving and risk fearing investors. (2M)

2b- Does different utility accrue to given increments of return? Graphically explain three different

cases. (4M)

2c- In Simple Markowitz Risk Adjusted Return investor’s risk tolerance is 60 and portfolio’s

Expected return is 15%. What would be the utility percentage that the investor would prefer, given
variance of returns at 225%? (3M)

Utility is expected return of portfolio – risk penalty

Risk penalty= risk squared/ risk tolerance=225%/60=3.75%

Risk squared is variance of returns of portfolio

So utility=15-3.75=11.25%

2d-In a Markowitz Mean-Variance approach, Given data are as follows:

Company A’s SD of returns is 1.7 and Company B’s SD is 3.5 but Mean returns are 0.6 and 1.1

respectively. Covariance (A, A)=0.029 and Cov (B,B) is 0.13 but Cov (A,B)=0.002 and Cov (B, A)=

0.002. Find: 1- Weights of each stock in portfolio and SD for E(R) of 0.75? 2- Calculate the weights

of each stock in the portfolio if expected risk of 0.0686 is to be tolerated. 3- Can Markowitz

efficient frontier be drawn to identify roughly the above points on the frontier? (7M)

For 2nd part, expected risk is given at 0.0686. so weights calculated are: w1= 0.6 and w2=0.4

Q3-In Technical analysis, use diagrams: One mark each for a, b, c, d respectively. (4M)
 3a-Which technique can be used to show duration and exact magnitude of price move?

No known tech exist

3b- Show a rally that fails to show a new high.

3c- Show a previous low that can become a support or a good point to expect support.

3d- On a trend slope, when should you refrain from holding a long position?

Q4a-In a Nifty (market lot=75) long future contracted at 9560, use payoff line to show profit/loss if price

Decreases to 9000? (3M)

Loss is560 x 75= 42000.

b- The Sharpe ratio of a stock is 1.5 and risk free rate is 8%, market’s expected rate of return is 16%

with SD of 4% and Beta of the stock= 0.5. Determine the stock’s expected return and unsystematic

risk. (3M)

Sharpe ratio= (Ra-Rf)/σ = 1.5

Ra=Rf+b (Rm-Rf)= 8%+0.5 (16%-8%)=8%+ ½ of 8%=12%. This is the stock’s expected return.

Total risk= σ = (Ra-Rf)/sharpe ratio=0.026

Unsystematic risk= σ2 –b2 σm2 = (0.026)2 – (0.5)2 x (0.04)2= 0.0007 - .25 x.0016= -3%
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