Capital Market and Portfolio Management

1. From the following information, calculate the volatility of the portfolio and comment on
the relationship among the stocks return. (10 Marks)

TABLE BELOW

Day Stock A Stock B Stock C

1 0.4 2.2 0.6

2 1.1 1.3 0.5

3 0.9 1.2 1.4

4 1.7 1.9 1.6

SOLUTION:

Introduction:

On the particular side of things, the shakiness of a portfolio is by and large called the standard
deviation of the portfolio. An outline of this is the utilization of the standard deviation to check
out whether there is a risk related with unequivocal security that affiliation has in its portfolio.

Considering the affiliation, it is achievable to depict the relationship between various stock
returns. The cost of the affiliation coefficient lies in a degree between - 1 and +1. Assuming the
affiliation coefficient still uncertain, it proposes a hostile relationship among the stocks,
recommending that the advantages from stock won't be impacted by the advantages of another
stock. It ought to additionally be seen that the inverse likewise remains steady.
The normal, annihilated arrangement of genuine elements set, random variable, evident people,
or trustworthiness stream is the square base of its instability.

Thought and application:

An examination of the standard deviation can be facilitated by considering the amount of

collections there are and how they are scattered among values. Recognized deviations infer the
scattering of an edifying record basically indistinguishable from the proposing stream. It ought to
be noted, notwithstanding, that a low standard deviation typically affirms that the attributes are
near what might be generally anticipated from the model as a rule, while a specific presumption
deviation shows that the qualities are more wide. The unavoidable takeoff is reduced as SD and
is consistently tended to in numerical texts and conditions through the lowercase Greek letter
sigma σ, for everyone a la mode deviation, or the Latin letter s, for the model standard deviation.

The relationship among the offers is unitless. As another decision, the image (+) or (- ) expects a
significant part in picking the relationship. This staggering or the horrendous etching grants us to
perceive whether the advantages from these stocks are correlational, i.e., circle inside a similar
course or not. Likewise, how crazy or low the co-proficient expense is organized among - 1 to +1
portrays the energy of this relationship.

We will at first work out the reliably gets back from stock A, stock B, and stock C inside the
given case.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%

Based on daily returns as calculated above, we shall now determine the average return from each
stock which can be used as the expected return from the stock.

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%

Assuming that all the three stocks hold equal weight in the portfolio, the expected return of the
portfolio will be

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

= .33*.8190 +.33*.0324+.33*.5921
 = .4763 or 47.63%

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:

√ ( Wa ) 2 2 2 2
X ( Ra−ERa ) + ( Wg ) X ( Rg−ERg ) +Cov(a , g)

√ ( Wa ) 2 2 2 2 2 2
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

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

= 1.22%

The relation among exceptional stock returns is defined as the correlation. Correlation is decided
by using dividing the covariance via the standard deviation of each inventory.

The standard deviation of the shares A, B, C is determined as a difference between the stock's
daily rate and the average price.

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 standard deviation of the portfolio with stock A, stock B, stock C conveying a similar weight
(as expected) is 1.22%. Likewise, the connection among the offers is negative; along these lines,
the profit from one stock isn't impacted by gets back from another stock.

2. You are a financial advisor at XYZ Stock Broking firm. Calculate the return as per
CAPM for following company’s stock, identify whether the stocks are undervalued,
overvalued or correctly priced and advise accordingly. Returns of T- Bill is 7%. (10 Marks)

Stock Expected Return Beta

Tata 21% 1.7

Adani Power 16% 1.4

Ranbaxy 23% 1.1

PNB 19% 1.2

Sensex 18%

Solution:

Introduction:

CAPM, which stands for Capital Asset Pricing Model of Value Analysis, is a definition that
depicts the association between effective chance and the typical return from a stock, which is
alluded to best as the CAPM. In financial control, CAPM is chiefly used to review chances in
shares and to create expected gains from assets, considering the risk related with these stocks
notwithstanding the cost of capital. The risk free expense of return inside the CAPM equation
tends to the time worth of cash. Select pieces of the CAPM system contain the additional chance
taken by the monetary benefactor. The beta of a limit task is a part of the quantity of perils the
hypothesis will add to a portfolio that takes after the market. If a stock is more perilous than the
market, it will have a beta more basic than one. In case a stock has a beta of considerably short of
what one, the formula recognizes it'll lessen the portfolio's risk.

Thought and application:

It is a technique for finding out purposeful risk that has been made as a part of the CAPM
approach. A decision is made that people wish for their stock to get back with the point that it
will return as unclear as possible to the cost of capital. The CAPM condition expressly depicts
the association between expected returns and risk with respect to expected returns. The objective
of the Capital asset assessing variation is to evaluate whether or not stock is truly regarded when
its danger and issue of the time cost of money are veered from its joint return.

The beta of a gave securities or adventure tends to the most extreme danger that financing might
add to a given portfolio to be had inside the open market.

To pick the return from stock using the Capital assets assessing variation, a stock's beta is
improved by the market peril premium, which is the return expected from the business
community over the risk free cost winning inside the market or the worth T-bills. The peril free
rate is then added to the stock's beta and the business community risk top rate. The possible
results ought to pass on a financial ally the huge return or rebate charge they could use to track
down the worth of the stock.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.

ER – It represents the standard charge of return of the return.

The CAPM model is maintained by a couple of doubts, which may in like manner make the
methodology less strong. Two or three suspicions support this model has been shown not to stay
aware of. The two biggest essential doubts on this financial hypothesis are:

1. Securities markets are fairly strong and amazing (this is, adequate estimated records
about the workplaces is rapidly and for the most part appropriated and assimilated);

2. Those business regions are crushed by typical, risk reluctant monetary benefactors, who
avoid probability and search for cash from their theories.

Notwithstanding, paying little mind to these hardships, the CAPM parts are still commonly
utilized because it is fundamental and considers clear connections of various decisions open for
hypothesis.

Contemplating beta recognizes that a stock's worth whimsy can check risk. Notwithstanding, the
charge exercises in the two ways are not comparably hazardous. Using past or evident
information to close a stock's precariousness isn't general, as stock returns (and dangers) aren't
normally surrounded.

Every single secret doubt of the CAPM model is with respect to the peril free rate acknowledged
through the restricting time period. It doesn't stay aware of persistently and genuine business
areas in which it has been obvious that the peril disconnected speed of the bonds can contrast
throughout the staying aware of season of the bonds.
The market portfolio that is utilized to find the market peril premium is just a hypothetical worth.
It's everything except a strong asset that can be sold or set into a decision rather than the stock.

Inside the given case, to pick the valuation of stock as unsurprising with CAPM, we want to
check out the typical return from the store with the return as per CAPM

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: as the ordinary speed of return (from the stock Tata), i.e., 21%, does now don't
outperform the return as per CAPM, it might be contemplated that the stock is misrepresented.

For Adani power: because the expected speed of return (from the stock Adani power), i.e., 16%,
do now don't outperform the return as unsurprising with CAPM, it might be contemplated that
the stock is misrepresented.
For Ranbaxy: as the ordinary speed of return (from the stock Ranbaxy), i.e., 23%, is more than
the return as per CAPM, it will in general be contemplated that the stock is under-assessed.

For PNB: as the ordinary speed of return (from the stock PNB), i.e., 19%, does now don't
outperform the return as per CAPM, it may be surmised that the stock is exaggerated.

Fittingly, pretty much, Tata, Adani Power, and PNB are misrepresented even as the stock of
Ranbaxy is under assessed.

3. Sunaina has qualified her Investment Banking certification and has applied for a job
with an Investment bank. As a part of preliminary round of interview, she is supposed to
answer the following questions

a. Factors that impacts the investment decisions of a person. (5 Marks)

Solution:

Introduction:

The term 'theory' suggests the premium or returns that one expects that the financial backer ought
to get on an interest as pay through the asset being alluded to. It is an authoritative objective of
any kind of dare to restrict risk on a theory while intensifying the return at the same time. While
risk return examination is of most outrageous importance in powerful in any endeavor decision, a
collection of components may affect the assurance of the financing source.

Thought and application:

The different components impacting an endeavor choice are:

1. Return on adventure It's far the rule and a major manner of thinking of any theory. It's far
assessed in rate terms and is depicted as a rate. Specialists ought to incidentally assess the speed
of return obtained on their portfolio, and depending on the examinations, the mix of the portfolio
can be improved. It will allow the monetary benefactor to deliver better benefits from their
course of action of hypotheses.

2. Inflation-Inflation may impact the benefit from the portfolio. Therefore, a monetary
supporter necessities to pick the theory types which could beat the expanding rate, or, more then
likely the portfolio's return may come to be appalling. Properly, a useful course of action of
adventures is constantly considered to be prepared for winning extension results.

3. Tax benefits The obligation available benefits play a basic limit when making plans for
any endeavor. Costs are a rate and may tidy up or discredit the benefits on financing if not as
expected pondered. For instance, a theory elective troubled gigantically ought to be avoided or
may in like manner get a decrease tendency than the endeavor elective that permits in benefits
looking like obligation deductions on pay.

4. Frequency of return-while the speed of return plays out a good estimated limit in any
sponsoring decision, the return repeat is furthermore huge. A few dealers may also pick a month
to month return, while others may require a yearly return. If the benefits are gotten early, they
may be reinvested. Regardless, the measure of one of these benefits can be generously less.

5. Risk cutoff – Threat may be portrayed because of the shot at a setback. Chance checks
the degree of setback taking district. The genuine return from the theory can in like manner go
from the typical return. This qualification is constrained by peril appraisal. It's miles for the most
part communicated that the better the risk, the better is the honor. In this manner, a peril taking
monetary supporter may additionally pick a perilous interest completely anticipating better
yields. All the while, a peril reluctant monetary supporter hate a temperamental endeavor and
may facilitate with different, more secure decisions.

Conclusion:

A monetary benefactor may in like manner pick the endeavor which best suits them, considering
on the above factors discussed, and hence conclude the sum they will rent a theory.

b. Differentiation between the two crucial classes of money related instruments that a monetary
patron utilizes in their portfolios. (5 Marks)

Game plan:

Introduction:

Money related gadgets can be portrayed as an arrangement, clarification or report that tends to an
asset or something like that for someone else all through having real liability in regards to
someone else. You can, for instance, buy a bond, make an exchange, buy a bond, buy a
proposition, cover a trade bill, and so on.

There are various ways that monetary units can be gathered, including, yet not confined to:

1. Subordinate instruments
2. Cash instruments

3. Asset style – Asset grandness is furthermore bifurcated into Debt instrument or charge based
totally, qualities or worth fundamentally based and forex units.

Thought and application:

A money related instrument has an essential asset from which it surmises its expense. For
example, a worth instrument tends to possession in an association. The belonging is the asset. SO
is the circumstance of financing in gold, items, oil, and so onThe primary classes of financial
instruments that an investor makes use of of their portfolio are:

1. Equity-based

2. Debt-based

The significant differences between them are tabled below:

S.No. Basis Equity Debt
1. Ownership Equity represents a part of Debt does not represent
ownership in the company. It any ownership in the
lets in the proper to own a percentage capital of the
part of the proportion capital company. Neither are
utilizing the equity the holders of debt
shareholder. gadgets allocated any
stocks.
2. Cost For the company, the cost of For an investor, the cost
equity is the dividend to be of debts is the interest
 paid to the equity investors. paid periodically. An
But, the employer isn't investor is compulsorily
always sure to pay dividends. required to pay interest
on his debts.
3. Tax benefits The dividends are not tax- The interest payments
deductible and hence can also are tax-deductible and
increase the price of help in reducing the
investment. value of the investment.
4. Nature of return Return on equity gadgets is Return on debt devices
variable and irregular. The is fixed and normal. The
dividends are an interest payments are a
apportionment of profit. charge on income.
5. Types Equity instruments are Debt instruments are
investments in shares and investments in term
stocks. loans, debentures, etc.
6. Repayment The equity investors do not The debts taken are to
experience any desire rights be repaid at non-stop
inside the occasion of the intervals. In the event of
winding-up of the non-repayment or
corporation. They're paid at delayed bills, the debt
last after the agreement of holders can also lodge to
claims of debt holders and legal motion.
different creditors.
Conclusion:

An investor can hold an equity device or a debt instrument in his portfolio based on the
investment goals. They may additionally diversify their portfolio by keeping a mix of these
unique classes of financial instruments in their portfolio.