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    18 views58 pages

    Strategic Financial Management Notes

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    CJ dangi
    Notes of strategic financial management

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    of 58
    vi Volume-1_ j ; PY EN) ao oe it: 1 vee 4 CA FINAL P| smn an SARC TEN ©|9893040600 Cee y TC Portfolio Management Hy INVESTMENT? F THERETO INVEST? F WHAT ARE THE INVESTMENT OBJECTIVES? W TO ACHIEVE SE OBJECTIVES? Portfolio Management PART 1: PORTFOLIO THEORIES Why should I save and invest my money? Why shouldn't I enjoy my entire income immediately? In our life ear ming cycle is shorter than spending cycle. Earning cycle is usually from the age to 25 years to 60 years while spending cycle is from birth till death. Also there are some lump sum spending but earnings are not usually lump sum to match those spending. Therefore one has to save and invest money to even out this mismatch. Now you cannot keep your savings ideal, you need to keep it working to fight at least against inflation, There are number of investment opportunities like Bullion, Real estate, Art work & Securities. In this chapter we will focus on securities Securities include Shares, Debentures, Bonds ete Three primary investment objectives are as under: 1) Return: Investor would like to earn higher returns. This is normally ‘most important objective of most of the investors. Philosophy is that first you work for money then your money should work for you. 2) Risk: Investor will try to reduce the risk of his investment and the best way is to reduce it by diversification. Means making investment in more than one security. This bunch of investments is called Portfolio. 3) Liguidity: Means nearness to cash. Investor would like to have appropriate liquidity. Means whenever he needs his money he can easily sell the investment. Ifyou want to make investment of your savings your can makeit in one of, the following two methods: 1) Direct Investment 2) Investment through Mutual funds. Direct Investment: For the purpose of direct investment though there are various assets classes but here we will focus on investment in securities only. Securities may be classified into following two parts 1) Equity Shares 2) Debt securities Complied by : Tarun Mahajan, CFA, CA | 61 1) 2) Equity Shares: Following are various methods for direct investment in equity shares: Debentures: (Part VI) Portfolio Revision ions keep on changing therefore Once a portfolio is made, it is not forever. Econo} ditions keep one need to revise his portfolio from time to time. covered in (Part VIN). Investment through mutual fund; This is the past 62 Regular Investment, 1 a. Harry Markowitz Model (Part Il) b. Sharpe portfolio optimization Model (Part III) Opportunity based investment Capital Asset Pricing Model & Market Model (Part IV) b. Factor Valuation Model (Part V) mie con ‘This iscalled portfolio churning and will ye method of investment in any class et. Itwill be covered in (Part VI) pee oie ey ae EEE [ ctu | | iia LO ates = ae a S| Lee | Equity Debt (6) | sieein Mutual Funds (8) Opportunity Based Regular CAPM & Market ‘Model(4) Harry Markowitz 2) Sharpe Portfolio Optimization (3), li Complied by : Tarun Mahajan, CFA, CA nn aaa ee Cu 63 PORTFOLIO THEORIE! There are various portfolio theories given by various experts to achieve one or more investment objectives. A portfolio theory guides investors about the method of selecting securities that will provide the highest expected rate of return for any given degree of risk or that will expose the investor to a degree of risk for a given expected rate of return Portfolio theory can be discussed under two heads 1. Traditional Approach : 2, Modern Approach i) DowJones theory ii) Random Walk theory iii) Formula plan iv) Capital Asset Pricing Model Traditional approach: Following are the various aspects covered in this approach 1, Investor's study includes an insight into his - (a) age, health, responsibilities, other ts, portfolio needs; (b) need for income, capital maintenance, liquidity; (c) attitude towards risk; and (4) Taxation status; Portfolio objectives are defined with reference to maximizing the investors’ wealth. which is subject to risk. The higher the level of risk borne, the more the expected return: Investment strategy covers examining a number of a Balancing fixed interest securities against equities; (b) Balancing high dividend payout companies against high earning growth companies as required by investor; (©) Finding the income or the growth portfolio; (@) Balancing income tax payable against capital gains tax; (©) Balancing transaction cost against capital gains from rapid switching; and (® Retaining some liquidity to seize upon bargains, Diversification reduces volatility of returns and risks and thus adequate equity diversification is sought. Balancing of equities against fixed interest bearing securities is also sought. In India, most of the share and stock brokers follow the above traditional approach for selecting a portfolio for their clients. MODERN APPROACHES Dow Jones Theory: The Dow Jones Theory is probably the most popular theory the behavior of stock market prices. The theory derives its name from Charles H. Dow, Although Dow never gave a proper shape to the theory, ideas have been expanded and articulated by many of his successors. ss rding Jassifies the movements of the prices on the share my; sory classifies the ‘The Dow Jones theory, major categories: 1. Primary Movements. Secondary Movements 3. Daily Muctua HArket into yp, ions. sy reflect the trend of the stock market. ‘They last fo brapar era ae and bear phases De eater ar Wa inet They its Crate nS and alter eae rise, Hee falls ateera Tower ind gitbacd than earlier! “Aaa result) prisioce eee hase in bound to start, i.e., price fang. Prices do uot fal conalcaliy and, after ench fall, there is core iin anette arrears higher than the previous peak The theory argues that primary movements indicate basic trends in thy market. It states that ifeyelical swings of stock market price indices are succes higher, the market trend is up and there is a bull market. On the contrary, if suecessiy, highs and lows are successively lower, the market is on a downward trend and we ares bear market. This theory thus relies upon the behavior of the indices of share marke prices in perceiving the trend in the market. ° NOt ris, + they fai ach highs, Will stan econdary movements: When the primary trend is upward, there are also downward movements of prices. Similarly, even Where the pi \e primary trend is d ard, there are upward movements of prices also. These a ese_movements are known as secondary Tavemente: Thane shatter in duration and are opposite in direction to the primas movements. These movements ni ormally last from three weeks to three months ani retrace 1/3 to 2/3 of the previous advance in a bull market or previous fall in the bear a Daily Movements: There are irregular fluctuations which occur every day in the market. These fluctuations are wi ‘Thus if the daily share market price index for a few months is plotted on the graph it will show both upward and downward fluctuations. These fluctuations are the result of speculative factors. Ai Aaattment manager really is not interested i since heis not a speculator. It ma run fluctuations in the stock Speculation isbeyond the scope Timing of investment decision the investment manager There pasts of Dow would like to purchase s| lowest trough and sell them at a time wh ae Practice, pens. Even the market, can make money only by sheer chance ofthe job of an investmer nt manager. Jones Theory: Ideally speakint a time when they have reached th en they reach the highest peak. However, ? most astute investment manager can never kno wee Pe eae cae 65 when the highest peak or the lowest through have b time his decision in such a manner that he buys the shares when they are on the rise and sells them when they are on the fall, Tt me e sans that he should be able to identify exact! when the falling or therising trend hashegun. hein Be ol a RANDOM WALK THEORY In discussing the Dow Jones theory, we have seen that the theory is based on th: assumption that the behavior of stock market itself contains trends which give clues t the future behavior of stock market prices. Thus supporters of the theory argue that market prices can be predicted if their patterns can be properly understood. Such analysis of stock market patterns is called technical analysis. Apart from this theors there are many approaches to technical analysis, Most of them, however, involve a g00 deal of subjective judgment, reached. Therefore, he has te Many investment managers and stock market analysts believe that stock market prices can never be predicted because they are not a result of any underlying factors but arc mere stastical ups and downs. This hypothesis is known as Random Walk hypothesis which states that the behavior of stock market pricesis unpredictable and that there relationship between the present prices of the shares and their future prices. Proponen' of this hypothesis argue that stock market prices are independent. In the layman's language it may be said that prices on the stock exchange behave exactly the way a drunk would behave while walking in a blind lane, i.e.. up and down, with an unsteady way going in any direction he likes, bending on the side once and on the other side the second time. FORMULA PLAN We have seen that the basic objective in timing the investment decisions is to buy low and sell high, However, this process is full of pitfalls and errors in judgment. Formula plans have, therefore, been devised to force the investment manager to follow a path that would enable him to buy securities when they are cheap and sell them when the prices are high. These plans follow an automatic procedure and are suitable for small investors as well as for investment managers of large funds. They provide an automatic timing device for ling the buy and sell transaetion. Under the formula plans, the total investible funds are divided into two major categorie 1. A specified percentages, say 50%, is to be invested in fixed income securiti includes bank deposits, debentures and Government securities. ete. 2. The second part is invested in securities yielding variable dividends like ordinary shares. In our example, since 50% of the monies are invested in fixed income securities, the balance 50% would be invested in variable securities. ‘The main advantage of the formula plan is that buying and selling is done automatically and the investment manager is not swayed by general sentiment in the market, ‘There is noeffort tochart and find out the market trend, This Capital Asset Pricing Model (CAPM): Refer Part IV ® | 9893040600 4@ ~=REGULAR INVESTMENT- “ae _ MARKOWITZ MODEL vestor should be able to calculate return & risk ¢ & risk of the portfolio(s). In this ¢ Ty make a proper portfolio in in the portfolio as well as the retu of Vario hapter,, Apter ye will learn tocalculate return & risk, SINGLE SECURITY (1) Return for a single period: Here; Return fora single period farket Price at time 0 Market Price at time 1 D, = Dividend for period 1 The share of Baker Ltd. were purchased for $50 on January 1. The stock paig | dividends totaling $2 during ensuing year. At the end, the stock was sold for $4; What was the holding period return on Baker stock for the year? (Ans: -6%) (a) Suppose a u.s. Treasury bill, maturing in 1 year, can be purchased today for Y $92,500, Assuming that the security is held until maturity, the investor will receive $ 100,000 (face amount). Determine the rate of return on this investmen: (b) Suppose a National telephone and telegraph (NTT) Company's bond, maturing in year, can be purchased today fore $975. Assuming that the bond is held until maturit the investor will receives $1000 (principal) plus 7 percent interest (that is, 0.07 * $1000=$70). Determine the rate of return on this investment. (©) Determine the implied risk premium on NTT bonds. (Hint: c=b—a) (Ans.: (a) 8.11% (b)9.74% (c) 1.64%) the year a sum of @ 4 was distributed as income (dividend) besides pital gains distribution. At the end of the year NAV was 55, calculate total return for the year. the end of the year N (Ans.:24%) @ A mutual fund had a net asset value (NAL) of €50 at the beginning of the year. During distribution and no capital gains distribution and NAV at the end of second year * p ‘Suppose the aforesaid Mutual Fund in the next year gives a dividend of 5 as income 250. Whatis the return for the second year. (Ans.: 0%) 221. A dividend of ® 4 has just been paid and Ex- dividend price now is € 23. Whst return has been earned over the past year. In case of an open ended Mutual Fund scheme the market price (Ex-dividend) w= r (Ans.: 28.57%) Complied by : Tarun Mahajan, CFA, CA | 66 = OO >—EE Pe ua or (2) Average Return Return for average Historical data: It will form an Individual series, Hence the formula for calculation of gadtg 2A Forecasted data: it will form a discrete series, Hence the formula is as follow: In portfolio management problems frequency is given in the form of probability and total of probabilities Hence the formula may be rewritten as follows Tor or 8= Te, (3) Risk Risk means uncertainty of return. Uncertainty may also be termed as fluctuation dispersion. In statistics there are various measures of dispersion but the most reliable 1s Standard deviation. torical data: It will form an Individual series. Hence the formula for calculation of standard deviatj opis as folawss Forecasted data: it will form a discreet series. Hence the formula is as follows: ’, = rt In portfolio management problems frequency is given in the form of probability and total of probabilitiesis one. Hence the formula may be rewritten as follows: oe \Set-x) o= VE er -(Ee) TE Mr. Ashok Jain a share Broker, seeks your advise on the risk and return on the Bajaj Auto Ltd. and TISCO. From the web site of Economic tin sl following information about the returns of the (wo compa Year 2002 2001 2000 1999 Return (%) Bajaj Auto 25 5 10 15 TIScO 4 85 55 7 Advise which share should be purchased (Ans.: Bajaj Auto 11.25, 10.83 TISCO 11.25, 4.51) Fund Manager of HDFC mutual fund is thinking to purchase 0} aban CIPLA. From the following data calculate the risk and return: , |Return(%) | 22 1-10 14 |B [Probability [0.3 0.2 [0.1 0.15 | 0.26 (Ans.: Return 9.45% Risk 12.10%) You have estimated the following probability distributions of expected future returns for stock X and Y: > [Stock x | Stock Y i Probability Returns | Probability | Returns | O12 -10% {0.2 2% fo2 10% joa Tm | 04 15% 0. 12% | 0.2 20% |o.2 15% | (a) Whatis the expected return for stock X? stock Y? (b) Whatis the standard de xpected returns for stock X? For stock Y? (©) Which stock would you prefer? Why? (Ans.: X:15,11.62,.77Y: 10,4,94,.49) Complied by : Tarun Mahajan, CFA, CA OA ue tus Port oe A stock costing $100 pays no dividends, The possible prices that the stock might sell for year-end and the probability of each are: YearendPrice(s) 90 [95 [100 [110 115 Probability o1 |o2 jos jaz jot (a) Whatis the expected return on the stock? (b) Whatis the standard deviation of the exp (Ans.: ) ted return? Stock Q and R do not pay dividends. Stock Q currently sells for $50 and R for $100. At m the end of the year ahead there is a fifty-fifty chance that Q will sell for either $61 or |} $57 and R for either $117 or $113, Which stock Q or R would you prefer to purchase now? Why? (Ans.:Q:18,4 R:15,2) PL td. invested on 1.4.2006 in Equity sharesas below: Company |NumberofShares Cost Rs.) | Mid. |1,000(Rs.100each) | 2,00,000, NLtd. _ |500(Rs.10¢ach) —__1,50,000 P ° 09 In September, 2006, ald 10% dividend and in Octsher, 2006, N Ltd. paid 30% dividend. On 31,3,20Q7, market price of shares of M Ltd. and N Ltd. were RS-22Vand Rs, respective PLCPEE boon informedby theirinvestmentadvisersthat: “Fpao> 142 (D Dividends from M Ltd. and N Ltd. for the year ending 31.3.2008 are likely to be 20% and 35% respectively. (i Probabilities of market quotations on 31.3.2008 are: Probability Factor |PriceofshareofMLtd. Price ofshareof N Ltd. bi Tao fig los | 280 330 You are required to: @ Calculate the average return from the portfolio for the year ended 31.3.2007. Gi) Calculate the expected average return from the portfolio for the year 200708, Gii) Advise P Ltd. of the comparative risk of two investments by calculating the Standard deviation of price as on 31” March, 2008in each case, (Ans: 7.57%, 18.01%, ¢21 & 14) ® | 9893040600 F r fective rate of interest p.a. as wo calculate th a From the following particulars, ca - total cost of funds to Bhaskar Ltd., which is planning a CP issi a Vi 1 Price of CP Rs, 97,550 Face Value - Rs. 1,00,000 Maturity 3Months Issue Expenses (Calculated on face value): Brokerage + 0.15% for Months Rating Charges 0.50 Stamp Duty + 0.175% for'3 months (Ans: 10.05%, 11.95%) Dunaway Ine. stock had the following rate of return for 1991-94; 0.2, 0.13, -0.09, 0.05. What is the arithmetic average rate of return on Dunaway's stock over this period? / What is the geometric av ‘age? Why are these returns different?(Ans: 7.25,6.69) | Types of Viel for short Term Instruments A T-bill having face value of Rs.1 matures after 91 da 000 is issued at Rs.980, It does not pay any annual yield, Bank discount lculate holder period return, Money market Yield and Bond equivalent yield. coupon and yield, Effective Holder Period Vield (HPR) Hpr=D+P_,_0+1000 R 980 /, Money Market Yield (MMY) _, Anos ud MMY = HPY x3® _ goo 7 Effective Annual Vield (EAY) FAY = (1+ HPRY® ~ 44% Bank Discount Vield (BDV) apy = Discount FaceValue™n “1000 Complied by : Tarun Mahajan, Diets cae Deca cued Bond Equivalent Vield (BEV) Dis BDY = — scount WS 20 465 FaceValue= Discoum * n ~ 999” gy = 819% BEY is same as MMY except that MMY uses 360 days in a year (1) From the following data caleulate and Effective Annual yield Market price on 1" April is Rs,2500 Market price on 1" June is Rs.2600 Dividend during April-May Rs.30 (2) Calculate Bank discount yield and Bond equivalent yield from the following data 180 days treasury bill issued at Rs.960 and redeemable at Rs.1000. (Answer (1) HPY = 5.2%, MMY=; Holding period return, Money market yield 10.69%, EAY= 35 43%, (2) BDY = 8%, BEY = 8.45%) (4) How to select a single security? 1) Ifexpected return for two securitiesis same then security having low risk will be selected 2) Ifvisk for two securities is same then security with high expected return will be selected 3) If risk and returns for two securities are different then coefficient of variation will be calculated. CV indicated risk per unit of return hence the security having low coefficient of variation will be selected Standard deviations __ Risk ‘Mean Return Coefficient of variation (5) Using Z values for selection of a security If we assume that return of a security is normally distributed. Then with the help of its means return and standard deviation of returns we can find out Z.and probability of getting areturn less than or more than a particular rate. Now on the basis of this probability we can arrive at a decision. For example we can make a criterion that we will make investment in a security if the probability of getting a return less than risk free rate of return (say 8%) is less than 20%. Or wecan simply take. decision on the basis of Zonly. these roturnsis 11 percent. If returns from the project are normally distributed, what is the chance that the it will result in a rate of return above 33 percent? What is the probability that it will result in loses (negative rates of return)? (Here Z 1=0.3413,2Z2=0.4772) (Answer 0.1587 ,0.0228) TE ® ‘The return expected from security No.642 is 224}pteent. The standard dexiation of Frbytm con n calculate bability of getting a return 1 From the data given below caleulate the probability of gettin jst 8% and decide which security is to be selected o 4 Security [A B ey AH Return | 16% | 20% Sp [Risk [5% [10% What ifyou want to take a decision on the basis of probability of getting a return more th, 259%? (Answer: 11.51%,30,859 TWO SECURITIES PORTFOLIO () Return A Portfolio is a bunch of individual securities, ‘Therefore return of a portfolio is equal ty weighted average of returns of individual securities: A, = Rw, + Rw, Here w,+w, = (2) Risk Risk of a portfolio is not simply the weighted average of Risk (Standard Deviations) of individual securities. ‘The Portfolio risk is also affected by the associ {Cormovements) of returns of two securities, Risk of a two security port following formula jation of movements tfolio is given by the o, = (om + (e,w, J +20,0,w,wsh, Here +, =1 ® Consider two securities with the following characteristics, | Security M-2 | Security Kg Expected return 24% Standard Deviation 8% I 10% Coefficient correlation | For M-2/K-3=0.36 iene Compute the expected value ofthe return and standard deviatio, ifitis to comprise M2/K3 in () 30/70 ratio, and (i) 60/40. on ofthe portfolio (Answers) 12.8% 8.18% (il) 17.6%,1. 27%) J x @ You are considering investing in two securities, X and Y. the f . securities, the follow re Ly available for the two security. Tne dts. are _ [Security [Security ] [Besta on unis evinine cas Jos Inne Sc fae alia Complied by : Tarun Mahajan, CFA, CA Peay , a l urity X and 60 percent in security Y and if and Y is +0.5, compute the following portfolio 2. The standard deviation of returns from the port (o) What happens to the expected returns and en © sre Opens pn of your funds are invested in security y? nvested in security X and 30 p (c) What happens to the expected ret inpart a) ifthe following conditions; {a) Ifyou invest 40 percent of your funds in sec the correlation of returns between X 1, Theexpected return from the nand standard deviation of returns of the portfolio exist? 1, Thecorrelation of returns between securities X and Y is +1.0. 2. Thecorrelation of returns between securities X and ¥ is + 0, 3. The correlation of return between securities X and Y is-0. ecorrelati securities X and Y is-0.7. (Ans.: (a) 8.2% 4.87% (b) 9.1% 6.29% (c) 5.6%, 4%, 2.29%) Following are the returns over a period of six years for Infosys Ltd. and ACC Ltd. Year 1_|z |a [4 Ts fe Infosys¢ [8 4 15 12 10/6 ACC(%) —|10 12-8 15-2 20 Calculate the risk and return of the two securities individually. Also calculate the risk a return of a portfolio consisting: 1. 100% infosys and 0% ACC 2. 70%infosys and 30% ACC 3. 50% Infosys and 50% ACC 4, 30% Infosys and 70% ACC 5. 0% Infosys and 100% ACC > @ ‘eturn on shares of P Ltd. and Q Ltd. for the past two years are as under: [Year | 2000 2001 [Pita [use jam | Calculate the following: (a) Expected return of portfolio made up to 50 percent of P and 50 percent of Q. (b) Expected return of portfolio made up of 60 percent of P and 40 percent of Q. (©) Find out standard deviation of each stock. (@) Whatis the coefficient of correlation between P and Q. (©) IfP & Q stock isinvested in the ratio of 2/3:1/3 what is portfolio risk, (© Ifthe ratio of investment in P&Q is 1:1 then what is the overall portfolio risk and why it has gone up. (Ans.:P: 14, 3Q: 14,6 (a) 14 (b) 14 (d)-1 (e) 0(0) 1.5) culate expected return and standard deviation of the following two in ‘Nand 'B' exclusively and algo if total investment is dividend one hain Economie predictions are: tm ach. Probabi Returns from Returns from | Economic Climate A% B% | 0.2 10 6 Stable: 0.5 4 15 Expansion | 0.3 20 11 1.00 I (Answer: R, =15,R, =12,6, = 3.616, 46, CovlA,B 3, Corr.=4+0.24, Ry = 13.5%, =278%) @ Stocks A and B have the following joint probability distribution of returns for next year: Economic Conditions | Probability | Return A % | Return B % Boom O1 20 14 Recession 04 | 16 -20 Normal 0.2 14 18 Recovery | 01 9 12 Slow Growth 0.2 8 10 Required: (@) Determine the expected covariance stocks A and B ©) Determine the stock. w (©) For the portfolio defined in (b) determine the correlat2Y, coatciont on, necessary toreduce the level of portfolio risk by 25 pervent eet that will be ercent. (3) Minimum Risk Portfolio Portfolio risk (Standard deviation) for a portfolio of 50 Percent in each —S To Find the minimum risk portfolio one has to make 'n' no, of combinations of securities and then look for the minimum risk portiolio. Itean be explained with nae illustration: ing Security Security c D Return (%) 20 12 Risk (%) 21 9 Now by taking various proportion of the above two securities different portfolio, made. The risk and returns of these portfolios with different correlations betwee, securities is exhibited in the following table: 5 may be n the two Complied by : Tarun Mahajan, CFA, CA Thus from the above discussio more effectively when the corr: canbe shown graphically as foll investing varying proportions of yours funds in these two stocks Proportions in increments of .10, going from 1.00 in Sierra Nevada El Dot Thermal Controls to.90 and 10, to .80 and .20, and so forth, (©) Approximately what is the minimum variance portfolio? What is the efficie (4) Shortcut formula for Minimum Risk Por — Pe cuit Guay Return 12.00 12.80 13.60 14.40 20, 16.00 16.80 17.60 18.40 lows: Risk | -l {05 | 06] 1 9.00 |'9.00 | 9.00 | 9.00 6.00 |'7.28 | 9.33 | 10.20 | 5.00 | 6.26 | 9.99 | 11.40 }-2.00 | 6.30 | 10.91 | 12.60 8.00 | 7.37 | 12.04 | 13.80 600 |'9.12 | 13.33| 15.00| 9.00 {11.24 | 14.73 | 16.20 | 12.00 | 13.55 | 16.22 | 17.40 | 16.00 [15.98 | 17.77| 18.60 > 18.00 | 18.47 | 19.37 | 19.80 | 20.00 | 21.00 [21.00 mn We come to the elation coefficient 21.00 | 21.00 conclusion that diversification works tends to move from +1 to -1. The above Want to experiment? Solve the following situation on MS Excel Dot Thermal Controls Company's ‘common stock has an expected return of 12% and a standard deviation of 16%. Sierra Nevada Electric Company's stock has an expected return of 18% and a standard deviation of 24%. The correlation coefficient between returns 1-10 2. -0.75 3. 40.75 4. +10 (a) What portfolio expected return and Standard deviation arise from 2 Vary your lectrie and Oin int set? @ | 9893040600 (Correlation Coefficient) =r, =-1 Calculate the proportion investment in Ltd. and M Itd. to minimize the risk of portfli, (Answer: ) J® P Lid. and Q Ltd. have low positive correlation coefficient of +0.5. Their respectivg ? Tisk and return profile is as under: ae R= 10% R=15% 0, =20% 6, Compute the portfolio of P & Q to minimum risk. (Answer: ) @ Stocks ¥ and display the following parameters: STOCKY STOCKZ Expectedreturn 15, 20 Expected variance |9 16 | Covariance y2=+8 | Does an investor, er: ) sain any advantage in holding some of Y and some of Z? why? ird deviation of 15. M is +.40. Can a 'as a smaller standard deviation of ‘or why not? isnot possible) The coefficient of correlation of the returns of stocks 1, and Portfolio of these two stocks be produced that h; return than either security taken alone? Why (Answer:r <5/15, 0.40<0.33, diversification a @ Stock L has a standard deviation of 5 and stock M hasa standay THREE SECURITIES PORTFOLIO @) Return: ‘The return of a three. security portfolio is equal to the weigh hted average of the returns of individual securi Formula: R= Rim, +Rw,+Rw, Here w, +, +w, =: Complied by : Tarun Mahajan, CF! Boe cline Laine (2) Risk: ‘Theriskofa three securities portfoliois given by the following equal Kom) +(e.) +(0,m,) + 20,0, °,= 420,0,4Wsto) 4 20,0,m, WF, +2og,WiW 5K Here , Wit W2tWa=1 Example: A B Return 18 13. Risk 18 u Correlation 1&2=-0.3/ 2&3=0.5 18: If we make various portfolios (10,201) of these securities then the actual diagram will @ Securities D, E, and F have the following characteristics with respect to expected return, standard deviation and the correlation between them: er Correlation ‘Company|Ret. [SD [pe [pF |EF | D 08 02 4 6 - fe 16 [16 |.4 8 Foe i| 03 |- 6 eal What is the expected return and standard deviation of a portfolio composed of equal investments in each? (Answer: @ | 9893040600 See cent of your wealth in Securities A, 39 , vest 40 pel erg You have decided D ie (ia Securities C. The following information ine : 5 ies B, and 30 pel ne Securities: Me @ Brent eH silereturnsfromthethreeSecuritiess about 08s | Securities C Securities B Securities A —— probability Return probability Return | probability | Return 10% 0.25 13% 0.30 | 14% 0.40 12 0.50 16 035/18 0.30 peal 0.30 4 025 [190.85 [22 Compute the expected return ofthe portfolio and the risk of the portfolio if the correla between return from the three securities are ry,=0.70; r4,=0.60; and ry.=0.85. (Ans.:A:12, 1.41 B: 16.15, 2.41 C:17.6, 8.32, Portfolio: 14.93, 2.07) ue fllowing are the two adjacent comer portfolios among those that are generate from the application of Sharpe's approach: Corner Portfolio 1 Corner Portfolio 2 Security | Weight | Security Weight C 0.6 ig 0.5 D 04 D 0.1 s E 04 ” - Standard Deviation | Correlation Coeffici c 0.160 0.085 for, D=G.5n D 0.090 0.072 forD, E=0, E 0.132 0.110 i One can form an efficient px Irtfolio by ortfolio by a linear co achieve the desired goal bination of adjcen corner Portfolios and (a) Form an ef ficient portfolio that can be 10 expected to proy 1% (by Whats the total risk associated with thisporifscs Provide 14% return on investment. ) What can you say about foregone return aoa educti reduction i Fra cliothan holding corner portfolio2instend? on t8k Bained by. forming this new (©) What can you say about increase in forming this new portfolio than holdin (Answer: (A) o, pected return and additional x , ecernier portfolio Linstead?" @8sumed by 43%, (B) Ret.| 18bp, Risk 0.23bp, Preah FOUR SECURITIES PORTFOLIO wre return of a four security portfolio is jndividual securities. Formula: equal to the weighted average of the returns of Rw, +Ryw Ws Rw, +Raw, + Rew, Here w, +w,+w, +W,=1 Risk @) ‘The risk ofa three securities portfolio is given by the following equation o,.)' + (o,w,)' + (ow, )'+ (ows) +20,0,W Win, + 20,0,W Wits +20,0,.W Wh, +20,0,W Wh, +20 ,0,W ,W gry, +20,0,W Wile Here , Wi+W2+Ws*Wi=1 Ir. M is desirous of investing in the shares of companies X, Y, Z and Q. Specific information pertaining to individual securities comprising the portfolio is given in the following table. Name of Percentage of Expected Standard Security Investment Return % Deviation % x 0.20 | 20 8 Y 0.50 | 30 10 Zz 0.15 10 6 Q a 0.15 | 12 2 Correlation Coefficient amongst securities X XX: 10 X:0.7 |X2Z:03 | XIQ:0.4 ¥ YK:0.7 YW:10 | YIZ:08 | YiQ:08 Z 2K:03 2:08 |Bb:10 | 2Q:06 Q QK:04 | Q¥:03 |QZ:06 | QIQ:10 Required: (i) Compute the expected return ofthe portfalio Gi) Risk ofthe portfolio. (Ans.: 22.3%, 7.02%) @ The return of 4 stocks W, X,Y and Zovera period of 6 years have been as follows: pre Calculate the return & risk on: 1. Portfolio of four stocks. 2. Portfolio of three stocks at a time. sume equal investment, From the under noted data pe risk ofthe portfolio, Proportion of investment 25% each Variance of each of A, B, Cand Dis 40% Covariance between each of the pairs 0.4% (Ans.: SD 3.219 taining four securities in portfolio, ecmpuye the “N® SECURITIES PORTFOLIO (Q) Return ‘The return of an security portfolio is e individual see qual to the weighted average urities. Formula of the returns of Ae Sm, = Rn Rin +t Rw, (2) Risk The risk of a three. Securities Portfolio is given by the following, ‘equation: If number of securities av, an investor can invest his an infinite nui a fo ilable in which funds increases, Ph Paper may look like sa resented here: rp Present Every point on above diagram is 8 portfolio, it investor would like invest at Point Where he gets highest return for Biven oe riste or re 2 turn. These points jituated on the top curve ofthe diagrans a itisnameas efficient frontier Complied by : Tarun Mahajan, CFA, CA ie Pee a ary CAPITAL MARKET LINE y Markowitz curve has be, Hany Mar as been prepan cecurities (like govt. bonds ete Tics ae risk bearin, fis money. When we make various portiole tl isk bearing securities then the CML securities only. But risk free n which an investor may invest portfolios usin, s using different proportions of risk free and cities tetas noe aie ee Example: Suppose there are two securiti Risk free security having 5% return 2) Risk bearing Portfolio having 15% return and 6% Standard Deviatio %. d Deviation ies to form a portfolio; | Nowthevarious possible portfolios that can be made are shown in the table below v 18 13 un 9 7 5 09 20 ao 60 | | g See ceca at | MGR aETIaaLia iS | | Risky | Expected Return 0 5 | 3000 | ae 40 9 | 60 in | 80_ Hts at as | | 100 15 __ — | -20 120 sre 1 rs a an, | Equation of capital market line: R, =R, +(Ry Ry) ae @ | 9893040600 Borrowing Risk fr and soforth | Types of investors Return Risk bearing security having 15 4 What portfolio expected return and Standard deviation arise from investing vary Proportions of yours funds in these two stocks? Vary your proportions in increments of 29, going from 1.00 in risk bearing security 0 in risk free security to .80 and .20, to .60 and 49, Capital market line along with harry Markowitz curve wilj appear as follows Youhave got two securities tomake a portfolio: 1 security having 8% return return and 8% ris (Standard deviation) (Answer:returnsrisk, 15:8, 13.6:6.4, 12.2:4.8, 10.8:3.2, 9.4:1.6 ,8:0) Normally investors are of three types: 1) Risk averse: Those investors who do not want to take more risk and whose expectations increase rapidly even for aslightincrease in risk, Risk Neutral: Those investors who do not care much about risk. ‘Their investment decision is based on consideration other than risk and return. Expectations of these investors increase in proportion to risk. Risk Seekers: Those investors who are ready toTake risk ifthe returns are sufficient enough. Expectations of these investors do not increase must even if the risk incteases rapidly. ip may be presented graphically at in, CFA, CA ein Indifference Curves Capital Assets Pricing Model assume Gekereturn trade off for these risk that all the investors are risk averse. If we d verse investors it takes the shape of indifference Io In the above figure, the indifference curves 1,2and 3 are shown, All the points lying retwr ona particular indifference curve (which represents different portfolios having Aifferent risk, and return) provide same level of satisfaction to the investor. But i. satisfaction (or utility) level increases if the investor moves to higher IC, ie., 310 2and 2 tol Wak Obtaining a well diversified Market Portfolio: When we merge the Capital Market Line with the Indifference curves. we get the well diversified market portfolio which is the point where the indifference curve is tangent to the CML, | (Measurement of Satistaction or Utility) From the following information, choose the “best” portfolio for a. Arisk lover with 90 percent tolerance level. ~/ — &, Anindividual willing to take moderate risk with 50 percent tolerance level, and ¢, arisk-averse individual with aisk tolerance level of 20 percent. Parameters - Portfolios A|B|cC DE Expected Return (%) 12.20 | 13.85. 12.50 19.50 10.50 _ Risk (%) 6 16.50 | 22.00 | 20.50 40.00 14.00 Note: Risk Penalty = Variance/ Risk tolerance. Utility =Return—Risk Penalty (Answer(a) 9.17, 8.47,7.83,1.72,8.32 (b) 6.75,4.17,4.0, -12.5,6.58 ,(¢)-1.41,-10.35,-8.51,-60.5, +0.7) ® Consider the following information relating to risk, return and utility for various mixes of asset classes; Portfolio Parameters Expected Return | 7.60 9.13 | 9.48 9.73 9.85 Expected Variance 0.19 0.52 | 0.61 0.74 | 0.75 Based on the above information, identify the portfolio that is best suitable for an investor with a riek tolerance of 0.70, Risk Penalty = Variance / Risk tolerance Utility = Return — Risk Penalty. (Answer : 5 isthe best) ET expected return of 12% @ Ld. is a consumer goods company, which earns expect existing operation subject to standard deviation of 20%, A family owns th and the family has no other investment. Tinga New project is under considerat subjcct to standard deviation o existing operations. ion and the new project is expected to give a return of 1 The new project has a correlation of 0.25 with XPm Fate new project is likely to account for 25% of XYZ's operations. XYZ has identified function to apprise risky project. The fuinction is as follows Shareholder's utility = 100R-o* Where, R= Expected return (in can be accepted only iftotal utili a utility %%) and o = Standard deviation of returns (in %). The project ty goes up. Evaluate the project The price of a bond just before a ye 50 at the end of the said period. Int. during the said period. C: of maturity is $ 5,000. Its redemption value is ‘erest is $ 350 p.a, The Dollar appreciates by 2» ‘alculate the rate of return, Return of a security was 10 percent last year. This Percent , what will be Increase by 5 percent points? (Note: Don't expe, REGULAR INVESTMENT- SHARPE MopEI - PORTFOLIO OPTIMIZATION risismethod of selection of securities 8 forforming mites tobe taken in portfolio but aleo de othe steps for calculation, Calculate Risk premium tobeta ratio fore 5) Rank securities on the basis of above 4) Afterranking calculate C for each se ‘an optimum portfolio. It not only selects termine their weight in portfolio. Following ach security: R-R,/ts tio, ‘curity using the formula given below 4) Now find out C*.Itis the highest value of C,. (For the sake of understanding we can sa that C, is the cumulative Utility. It means ifby adding one more should add that security tothe portfolio otherwise not.) 5) Securities ranked at and above C* will form partof portfolio. 6) Tocaleulate weightof securities selected in portfolio calculate Zas follows: &) | security C, goes up, we B 7) Now Weights of securities may be calculated as follows: ae, Construct an optimum portfolio based on the following information: YT Security | Expected Return (%) | Beta | Residual Variance 1 15 1.0 30 2 12 15 20 3 ul 2.0 40 4 8 0.8 10 5 9 1.0 20 6 14 15 10 ‘The Risk-free rate of return is 5% and the variance of the market return is 0%, uss ® | 9893040600| 85, Answer 1 Security | Ri |Ri-RF| Ri-RF/6 | Rank 1 lel ® | mm t 4 | 7 3 6 rt 8 3 SE Eo Ce eine Security 0.033 0.225 0.113 0.050 0.064 0.100 2.50 4.70 Conelusios Out of tot, “hould give them weightafs t ; 79% and 53% respective ly. lable, we. cag J Security | Mean “1 Bases | er Return S| Beta Number Return) Return | og" Unsyntematic xcom Return | y | Risk to Beta | we o,, ROR, t 1 19 a Fp [es i 18 5 2 i“ a |» 28 16 12 : ’ 2 0 “BI * 20 40 10 6 Te wo 20 8 | . 50, 8 f " . 2 15, 30 6 the riskless off point answer: Weigh ‘ate of interest is 5 per cent and the market variance ig 10. Determine the cut 8%, 25%, 25%, 12%) which heis interested , i.e. securities numbered 1 to 10, for which he has collected the Mr. Ram, an investor seeks your help to construct a portfolio from the securities in followingrelevant data. Security Mean Return Beta Unsystematic Risk 1 20.0 12 20 | 2 | 140 10 30 | 3 | 120 2.0 40 4 | 160 08 20 [5 | 240 Ll 16 6 18.0 10 50 7 19.0 0.8 16 8 13.0 13 25 9 11.0 15 30 10 9.0 1.6 | 10 Risk-free rate MarketReturn = 15% Required: Pc opti nization model. Construct an optimum portfolio usin ortflio optim g Shape's P 4% —_— OPPORTUNITY BASED -_ INVESTMENT | CAPITAL ASSET PRICING MODEL (CAPM) DAPI entrateson risk and foeuses0n risk manage, Capital Assets Pricing Model (CAP ai coer s oi a between risk of semen rather than on return management. The CAP) classifies the ia single investi ntand risk of holding a portfolio of investments. It classifies the t tal risk portfolio into the following two parts: 1. Systematic Risk atic Risk | Systematic Risk market related risk. it arises on account of the economy-wide uncertainties ang all the securities in the market and not toany particular security. Examples of systematicrisk are: Change in interest rate policy by Govt. Change in Corporate tax Change in Inflation rate Declaration of War » » ’ » Implementation of Restrictive credit policy by RBI ’ » Change in Govt, ete. From the above examples it is clear that systematic risk is an unavoidable risk. Whatsoever precautions of diversification may be resorted to by the investor, it cannot be climinated or reduced, Soitis called the hon-diversifiable risk, | Unevitemate Rise: which affects a particular company only and not to the whole It is a company specific risk economy. For example: Declaration of worker's strike in a company. » » Entrance ofa big competitorin the market, » Detection ofa big fraud in the company, ’ Inc “tein custom duty on the imported raw material used by the, ‘company ete, Complied by : Tarun Mahajan, CFA, CA | 8} Pee uae ae | Now: Tota Risk ae falows Systematic Risk + Un atic Hk, graphically it eam be show Standard devon Portairetorn sh It means that as we increase the number of securities ina portfolio unsystematic risk and consequently total risk also reduces. y ASSUMPTIONS OF CAPM ‘The following are the assumptions of Capital Asset Pricing Model. 1) Efficient market: It means existence of competitive market where financial securities and capital assets are bought and sold with full information of risk and return available to all participants. In an efficient market, the price of individual assets will reflect a real or intrinsic value of a share as the market prices will adjust quickly to any new situation. 2) Rational investment goals: Investors desire higher return for any acceptable level ofriskor the lowest risk for any desired level of return, Such a rational choice is made on logical and consistent ranking of proposals. 3) Risk aversion in efficient market is adhered to although at times risk seeking behaviour is adopted for gains. 4) CAPM assumes that all assets are divisible and liquid assets, 5) Investors are able to borrow freely at a risk less rate of interest i.e. borrowings can fetch equal return by investing in safe Government securities. 6) Securities can be exchanged without payment of brokerage, commissions or taxes and without any transaction cost. 7) Securities or capital assets face no bankruptcy or insolvency. IMPLICATIONS OF CAPM Ithas the following implications: 1) Investor can expect returns from their investment according to risk. More risk more return and less risk less return. It mean that there is linear relationship between the asset's expected return and its systematic risk (Beta), This relationship is given by the following equation: @ | 9893040600 Frbytm.con, > ed £(R, )=R, +R. RIB deal expectation of investor R-=Risk free rate of return (say return on govt. bonds) R.=Returnon well diversified market portfolio (say return on Sensex) RR, RYO = = Index of systematic risk Risk premium on market portfolio isk premium on investor's portfolio 2). Investor will be compensated only for that risk which they cannot diversify. This is the market related risk (called Systematic Risk). Beta, which is a ratio of Covariance between an asset's returns and market returns divided by the market variance, isthe most appropriate measure of an asset's Systematic Risk. Mathematically: Covariance between an asses return and market retura Covariance (p,m) Variance of market returne Variance(m) ADVANTAGES & LIMITATION OF CAPM ‘Theadvantages of CAPM can be listed as: 1) Risk Adjusted Retumn: It provides a reasonable basis for estim return on an investment which has risk in built into it. Hence it Adjusted Discount Rate in Capital Budgeting. 2) No Dividend Company: It is useful in com, does not declare dividend. nating the required can be used as Risk puting the cost of equity ofa company which ‘There are certain limitations of CAPM as well, which are discussed as follows (a) Reliability of Beta: Statistically reliable Beta might not exist for shares of meny firms. It may not be possibleto determine th cos of equity ofall rms acing erent All shortcomings that apply to Beta value applies to CAPM too. (©) Other Risks: By emphasising on systematic risk only, unsystematie is importance to share holders who donot possess a diversified portfolig © PRS 76 of (©) Information Available: It is extremely difficult to obtain im risk free interest rate and expected return on market portfi risk free rates for one while for another, markets being vol: period. portant information on folio as there is niultiple atile it varies over time Complied by : Tarun Mahajan, CFA, CA Vai Pr spa it Given @ risk-free rate of g _ @ culate therequired rate geen and Marke ) _ asgiven below, MON each ofthe t risk premium following stock f 9.4 percent, 8, based on the het (a) American electric power (©) Applecomputer, 0 (©) Boeing 0.46 (@) US Airways, (Answer (2)10.23, (2) 14.46.69 1g The stock of pizza hot, In @ calculate the required r 7 follows: 34, (4) 20,57) an a Maxican pizza MUN On pizza chain, has an estimated beta of hot's stock the SMI. is estimated ae ER) = 6405.4. Calculate: i (a) The expected return on portfolio. (b) The expected rate: ofreturn if} ‘the inflation increase 6 106 (Answer) 20.1, 216 ‘inflation increases from 4% to 6%. (Security Beta) @ Information about Market * Index and price movement of shares in PQR given below / covers a three year period Market PQR End of Year 0 275 76 End of Year 3 1698104 Average dividend yield | 4% Required: Ifthe risk free rates 5% ‘compute the Beta of the stock. (Answer-Beta=2) ‘The standard deviation of market return is 40% sera aay retumis 14%, ‘The risk free is 2%, The co-variances of retin for the market a non shares of ABC Ltd. over the same period hasbeen 200%, Calculate cost of equity for ABC Led (Answer: K eer’ From the following information calculate Beta: B ea : z [Somes c pany B | is [Total risk on investor portfolio (0,) 3s [28 | | Total riskon market portfolio (0, 4] 2.2 es [Totalriskon markt pono 22 [Correlation coefficient 0.82 0.70 | | (Valuation using caPM) Uwe drave a graph taking beta on x axis and Ei) ony axis then it takes the shape of expense and iti called the Security Marker Cann Any point on SML indicates ides ‘expectation. of investor for a Siven level of beta. ‘Therefore: Re) Sw 1) Ia security lie on SML, actual expectation of ere CAPA DT eaual to ideal expectation (as per om (APM hence the security is fairly price 2) Uf @ security is above SML. pe actual expectation of Investor is more than ideal ft 5 ia actual than ideal e security is ld sellit. [Average market return [Risk free rate of return Calculate the intrinsic valueof share. Itis under or over valued? (Answer: 78.57,Undervalued) Complied by : Tarun Mahajan, CFA, CA ee yr o2aq q > y Estimate beta for each o Geviation ofreturnsforthe th? following larket porn ® Securit Securities |Expected (im) c's **8uming thatthe standard Raveted | Standard ence . | Return Devinn | COPlation eat | [Pens et” clon tween for th L : for the security and ce 7 A Market portfolio le 18 1 = RK 3 wet 6 | 40 {py Based on the Capital Asset pricing Moga {ox premium (6-1) of 80 percent, win ar hPa ate (ro 7 anda mare Mractive investment? (Answer: eae eee XYZ Ltd. has substantial eash flow and wnt the fature capital expenditure, Iikelg the suPPlas funds ae wilied to mest ents, details for which are given bs Investment No. of shares Beta Market price per shan he Expected dividend yield i 60,000 116 429 ios 1 80,000 2.28 2.99 oman Wl 1,00,000 0.90 2.17 17.50% Vv (125,000 1.50. 3.14 26.00% ‘Thecurrent market return is 19% and the risk free rate is 119%. Required to: 1) Calculate average beta and the implied beta ofabove portfolio. dividend yields the only return, there is no appreciation in market price. 2) Whether XYZ should change the composition of its portfolio on the basis of under/over valuation of securities. (Answer: (1) 1.46 & 1.42 (2) 20.28, 29.24, 18.2, 23sale 1,2,3and buy 4) 4 yherited a portfolio from his uncle, The prism SON ak pee his vali Tn the following three Fisk LM sesostz and the balance of the amount is inv Bearing security: ‘Asset ~~ TBxpected “Beta Prenton norton | Return (%) | 7 ————— 08 03 : a 01 pe 0 le ax koa You are required tocalculate: 1. Expected return on portfolio, Revised weights of various securiti should remain in the proportion of if your expected return is 12% ang p ii. Qang Md Weights that should be given to market portfolio and risk free security in Order ty a portfolio yielding 12%, ; “lke th (oon ttn oweighdaveraeubaofnlidalsecri, p ieon the Security Market Line. Phas a Bo, ‘wa.particular securities P and Q lieon the Securit ti ta oy ae isk premium of 4%. Q has an expected return of 20% along with a Bee 175 In the Nght af UhisTelormation . determice whether the securities a df hereunder are overpriced or under priced. Lamm Bp [Security [Expected Return () [Beta 2.00 0.75 | | Using z values for Portfolio analysis ‘The return on the Tarheel Co: standard deviation of 8 Percent, and probability that an i (as per CAPM) of ret Pra reackl8 expented to be. 14 percent with a dD pcteey he beta of Tarheel is 0.8. the riskeinen rate is 7 the expected return on the market Portfolio is 15 percent, Whut is the Urn? Anan Tatheel willearn arateof return less than the required rate ‘urn? Assume thatreturns arenormally distributed. (2.08 =0.0319) tly pays a erent, and the market risk New castle stock are of 24 percent and a sta; indard deviation of 3. percent. (2) Determine the required rate of return for New Ca (©) Determine the probability that the stock of Ne stle's common stock, market price of $25 per share. (Here Z 1.33: 139) tle is undervalued at its rent = 0.4082) aaa International Manyfoods, Inc.'s common stock has aheta.of 0.9. the stock iene Currently pay a dividend, but is expected to appreciate in value from a currey $15 to $25 in the next 5 years. The Tisk-free rate is 6 percent and the my Premium is 7-4 percent. If the standard deviation of the exp: r n from this stock is 2 Percent, whatis the probability that itis overvalued? (Here Z21=0.3413, 20,95 0.3 Complied by : Tarun Mahajan, CFA, CA wr 8 a en Jr. Ramis hotline ho Following seep Ir " / {particular of Securities | Gogg Divide Fquity share: t od “|e Price | Bota Gold Ltd. 11,000 | 1,90 | silver Ltd. 16,000 | 1999 2990 06 ronze Ltd, ‘9 2000 17,200 | Bronze Li {42,000 | 80g}, 8 GOI Bonds 140,000 [4,000 | 00 o8 500 Lo pected rate of retu jasuming risk free AYsocaleulate simp! Pee or; Rm= 16.84%, E(RP)= 15.70, 16.27, 15.70, sume that av te of return of the xt portfolio. Beta of government bond is ving the question take it 1 only.) | MARKET MopEL caPM assumes that the market portfolio comprises all types of assets as are held by san investment (Including commodities, wor kof art, real estate ete.). Practically cha huge portfolio does not exist therefore one can use a market index (like Sensex, Nifty c)inplace of theoretical market portfolio and thisis termed as Market Mortel using the Capital Assts Pricing Model(CAPM) nse | 16,84) Portfolio gives Riven as one (Note a that Corso nin the question is return on which is wrong. But it is advised When we compare the expected return (or risk | The Characteristic Line :~ Premium) for an Individual security with the expected return (or risk premium) for the mark portfolio then the Characteristic line existence, For this purpose we take return on market portfolio gon X axis and retumn on Individual stock on Y axing Now suppose we take the data forlast 60 months. ‘We will get 60 points on the graph paper thereafter a line of best fit will be drawn either statistically or by hand. This line of best fit is called Characteristic line. Point of intersection of this line with y axis is called Alfa, It indicated return on investor's portfolio in the period when return on market portfolios zero, et comes into Beta of Individual security is determined by the slop of the line. The regression equation of this line is given as follows: Rp=a+68xRm WHAT IS BETA? return on market retin fe nang rua vena tivity yiportfolio with respect to return on market similar to return on market portfolic less sensitive than market 'sroturn in more sensitive than market botais Titmennst it mens that security's return is (@) Determine (Ans.: Beta 1,155 sensitivity of return on a secu rion security iss means that security’ Beta of portfolio is the «an oxpress it as follows: @ An Investors holds the following portfolio |Security [%Holding 20 Beta 41 of portfolio, Suppose thata portfolio consistsotthe ‘cis 5 percent and t duce the he expected ‘turns on the below. By Year 1 2 3 4 6 Delta Airlines the information, of return on investors age of betas of individual se Here, w, +, +. 80 12 [1.05 required rate of ret turn on BSE SE) following stocks: (Amount | Beta 0.70 1.30 1.10 ‘miumis 8.0 percent, +and market ry and find out the, Return on the mark, ot 94 6.00 ey 8.00 (2.00) 12.00 14.00 16.00 portfolio with respe andifitis morethan rcurities forming the equation of charac

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