20.

CAPM= 𝑅 𝑓 + 𝛽 ( 𝑅𝑚- 𝑅 𝑓 )

Accordingly

𝑅 𝐴𝐵𝐶 = 𝑅 𝑓 + 1.2 ( 𝑅𝑚- 𝑅 𝑓 ) = 19.8

𝑅 𝑋𝑌𝑍 = 𝑅 𝑓 + 0.9 ( 𝑅𝑚- 𝑅 𝑓 ) = 17.1

19.8 = 𝑅 𝑓 + 1.2 ( 𝑅𝑚- 𝑅 𝑓 )

17.1 = 𝑅 𝑓 + 0.9 ( 𝑅𝑚- 𝑅 𝑓 )

Deduct (2) from (1)

2.7 = 0.3 ( 𝑅𝑚- 𝑅 𝑓 )

𝑅𝑚- 𝑅 𝑓 = 9

𝑅 𝑓 = 𝑅𝑚- 9

Substituting in equation (1)

19.8 = ( 𝑅𝑚-9) + 1.2 ( 𝑅𝑚 - 𝑅𝑚 +9)

19.8 = 𝑅𝑚 -9 +10.8

19.8 = 𝑅𝑚+ 1.8

Then 𝑅𝑚= 18% and 𝑅 𝑓 = 9%

Security Market Line

= 𝑅 𝑓 + 𝛽 (Market Risk Premium)

= 9% + 𝛽 X 9%

21. (i) A Ltd. has lower return and higher risk than B Ltd. investing in B Ltd. is better than in A Ltd.
because the returns are higher and the risk, lower. However, investing in both will yield
diversification advantage.

(ii)𝑟 𝐴𝐵 = .22 X 0.7 + .24 X 0.3 = 22.6%

2 2 2 2 2
𝜎 𝐴𝐵= 0.40 X 0.7 + 0.38 X 0.3 + 2X 0.7 X 0.3 X 0.72 X 0.40 X 0.38 = 0.1374
𝜎 𝐴𝐵= √ 𝜎 2𝐴𝐵 = √ .1374 = .37 =37% *

* Answer = 37.06% is also correct and variation may occur due to approximation.

(iii) This risk-free rate will be the same for A and B Ltd. Their rates of return are given as follows:

𝑟 𝐴 = 22 = 𝑟 𝑓 + (𝑟 𝑚-𝑟 𝑓 )0.86

𝑟 𝐵= 24 = 𝑟 𝑓 + (𝑟 𝑚-𝑟 𝑓 ) 1.24
 𝑟 𝐴 - 𝑟 𝐵 = -2 = (𝑟 𝑚-𝑟 𝑓 ) (-0.38)

𝑟 𝑚-𝑟 𝑓 = -2/-0.38 = 5.26%

𝑟 𝐴= 22 = 𝑟 𝑓 + (5.26) 0.86

𝑟 𝑓 = 17.5%*

𝑟 𝐵= 24 = 𝑟 𝑓 + (5.26) 1.24

𝑟 𝑓 = 17.5%*

𝑟 𝑚- 17.5 = 5.26

𝑟 𝑚= 22.76% **

* Answer = 17.47 % might occur due to variation in approximation.

** Answer may show small variation due to approximation. Exact answer is 22.73%.

(iv) 𝛽 𝐴𝐵= 𝛽 𝐴 X 𝑊 𝐴+ 𝛽 𝐵 X 𝑊 𝐵

= 0.86 X 0.7 +1.24 X 0.3 = -.974

22. (i) Computation of Beta of Portfolio

Investment No. of Market Market Dividend Dividend Composition β Weighted β

shares Price Value Yield
I 60,000 4.29 2,57,400 19.50% 50,193 0.2339 1.16 0.27
II 80,000 2.92 2,33,600 24.00% 56,064 0.2123 2.28 0.48
III 1,00,00 2.17 2,17,000 17.50% 37,975 0.1972 0.90 0.18
IV 1,25,000 3.14 3,92,500 26.00% 1,02,050 0.3556 1.50 0.53
11,00,500 2,46,282 1.0000 1.46

Return of the Portfolio @ = 0.2238

Beta of Port Folio 1.46

Market Risk implicit

0.2238=0.11 + β X (0.19-0.11)

Or, 0.08 β + 0.11 = 0.2238

Β = @=1.42

Market β implicit is 1.42 while the port folio β is 1.46. Thus the portfolio is marginally risky compared to
the market.
(ii) The decision regarding change of composition may be taken by comparing the dividend yield(given)
and the expected return as per CAPM as follows:

Expected return @ as per CAPM is:

@ =@

For investment I @ =@

=.11 + (.19 - .11) 1.16

= 20.28%

For Investment II, @ = .11+ (.19 - .11) 2.28 = 29.24%

For Investment III, @ = .11 + (.19-.11).90

=18.20%

For Investment IV, @ =.11 + (.19-.11) 1.50

= 23%

Comparison of dividend yield with the expected return @ shows that the dividend yields of investment
I,II,III are less than the corresponding @. So, these investments are over-priced and should be sold by
the investor. However, in case of investment IV, the dividend yield is more than the corresponding @ so,
XYZ Ltd. should increase its proportion.

23. With 20% investment in each MF Portfolio Beta is the weighted average of the Betas of various
securities calculated as below:

(i)

Investment Beta (β) Investment Weighted

(₹ Lacs) Investment
A 1.6 20 32
B 1.0 20 20
C 0.9 20 18
D 2.0 20 40
E 0.6 20 12
100 122
Weighted Beta (β) = 1.22

(ii) With varied percentages of investments portfolio beta is calculated as follows:

Investment Beta (β) Investment Weighted

(₹ Lacs) Investment
A 1.6 15 24
B 1.0 30 30
C 0.9 15 13.5
D 2.0 30 60
 E 0.6 10 6
100 133.5
Weighted Beta (β) = 1.335

(iii) Expected return of the portfolio with pattern of investment as in case (i)

=12% X 1.22 i.e. 14.64%

Expected Return with pattern of investment as in case (ii) = 12% X 1,335 I.e., 16.02%.

24.(a) Let the weight of stocks of Economy A is expressed as w, then

(1-w) x 10.0 +w X15.0 = 10.5

i.e. w = 0.1 or 10%.

(b) Variance of portfolio shall be :

Standard deviation is (0.02423)- = 0.15565 or 15.6 %.

(c) The Sharpe ratio will improve by approximately 0.04, as shown below:

Sharpe Ratio = @

Investment only in developed countries :@ = 0.437

With inclusion of stocks of Economy A : @ = 0.481

25. (ii) Computation of Expected Return from Portfolio

Security Beta(β) Expected Return (r) Amount Weights wr

as per CAPM (₹ Lakhs) (w)
Moderate 0.50 8% +0.50 (10% -8%) = 9% 60 0.115 1.035
Better 1.00 8%+1.00(10%-8%) =10% 80 0.154 1.540
Good 0.80 8%+0.80(10%-8%) =9.60% 100 0.192 1.843
Very Good 1.20 8%+1.20(10%-8% = 10.40% 120 0.231 2.402
Best 1.50 8% +1.50(10%-8%) =11% 160 0.308 3.388
Total 520 1 10,208

Thus Expected Return from Portfolio 10.208% say 10.21%.

Alternatively, it can be computed as follows:

Average β = 0.50 @

As per CAPM

= 0.08 + 1.104(0.10 - 0.08)= 0.10208 i.e. 10.208%

(ii) As computed above the expected return from Better is 10% same as from Nifty, hence there will be
no difference even if the replacement of security is made. The main logic behind this neutrality is that
the beta of security ‘Better’ is 1 which clearly indicates that this security shall yield same return as
market return.