South Eastern University of Sri Lanka

Programme: Final Year BBA , Semester –I, 2020/2021

Course: FIM 41063 Portfolio Management

Topic: Single Index Model

Lecturer: Dr. S.Safeena M.G Hassan Ph.D (UJA), M.Sc (SJP),
BBA (Hons.) (Col) and (EUSL)
Senior Lecturer
Department of Management
Faculty of Management and Commerce
Sharpe Single Index Model

 This model was introduced by William F.

Sharpe in order to simplifying the
mathematical calculation required by the
Markowitz model.
 All stocks are affected by the movement in the
stock market
 According to the analysts view characteristics
lines shows the relationship between return on
individual securities and return on market
portfolio.
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 Alpha - α
 The value of α can be thought of as an return on the
security that goes with an return of zero on the
market portfolio.
 If security is underpriced, the value of α is positive
 If security is overpriced, the value of α is negative.
 If α is 3% would earn 3% return even when the
market returns is zero and it would earn an
additional 3% at levels of market return.
 Conversely, a security with an α = - 4.5% would lose
4.5% return when the market return is zero and
would loses 4.5% return at all levels of market
return. 3
Calculation of Return and Risk using the
Single Index Model

Expected Return
Ri = αi+ βiRm

Expected Risk
ό2i = βi2 б2m + б2ei

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Problem-01

Calculated Alpha and beta values are 6.3%,

1.41 respectively for X company, 15.1% and
1.78 for Y Company assume that the market
has an expected return of 10% with an
expected standard deviation of 08% .

 Calculate the return of each securities

 Calculate the covariance of these two securities

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 Problem-02

 It the estimated values of α, β and б2ei of a

security are 2%, 1.5 and 300 respectively. If the
market index is expected to provide a return of
20%, with variance of 120, what would be the
expected return and risk of the security?

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 Problem-03
The table below show an analyst’s estimates of the
excess returns for a security and the market
portfolio associated with each of several events, as
well as estimates of the probabilities of the events.
Calculate the βim, αi and unsystematic risk of
portfolio.
Events Probability Excess returns on Excess return on the
security i %
market portfolio
A 0.10 18.0 13.0
B 0.20 13.0 00.0
C 0.10 08.0 11.0
D 0.30 -08.0 -06.0
7
E 0.30 25.0 18.0
Calculation of Portfolio Return using
the Single Index Model

Operations Management - S.Safeena Mg Hassan 8

Risk of Portfolio

Weighted average of the variance of residual returns of individual

securities

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Problem-04
The following table shows the basic input data such as weight age, alphas,
betas and residual variances of the individual securities.
You are required to calculate Portfolio return and variance.

Security Weight age Alpha Beta Residual Variance

A 0.2 2.0 1.7 370

B 0.1 3.5 0.5 240

C 0.4 1.5 0.7 410

D 0.3 0.75 1.3 285

Assume that the projected market return is 15% and market return variance
is 320.
 Problem-05
Following information related with investment of a portfolio..

Security Name Amount Expected Beta

Invested(000) Return

A 1000 8 0.08
B 2000 12 0.95
C 3000 15 1.10
D 4000 18 1.40

1. What is the expected return on this Portfolio?

2. What is the beta of this Portfolio?
3. Does this Portfolio have more or less systematic risk than an
average asset?
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