GHANA INSTITUTE OF MANAGEMENT AND PUBLIC

ADMINISTRATION
(GIMPA)

SCHOOL OF TECHNOOGY AND SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS AND APPLIED MATHEMATICS

MSc Financial Economics 2023/2024

Investment Theory and Practice

Practice Questions

1
Part A: Investment Process and Mechanics of Trading Securities

Question 1

a. Briefly discuss the agency problem in the relationship between fund managers and
their client investors.

b. Your uncle Kofi Manu is planning towards his retirement and has come to you for
advice. Discuss factors you would need to consider in constructing a retirement
plan for him.

Question 2

Paul has a margin account with a balance of ¢150,000. The initial margin deposit is 60
percent and Choco Industries is currently selling at ¢50 per share.

a. How many shares of Choco can Paul purchase?

b. What is Paul's profit/loss if Choco's price after one year is ¢40?

c. If the maintenance margin is 25 percent, to what price can Choco Industries fall
before Paul receives a margin call?

Question 3

You decide to sell 1,000 shares of Marston Industries short when it is selling at ¢35.
Your broker requires an initial margin deposit of 55 percent with no commission on
the sale and a 6 percent interest rate on your margin loan. While you are short,
Marston Industries pays a 75 pesewas per share dividend. At the end of one year you
buy Marston Industries shares to cover your short sale at ¢30 and are charged a
commission of ¢15.

What is your rate of return on the investment?

Question 4

You decide to sell 100 shares of Mason Enterprises short when it is selling at its yearly
high of ¢42.25. Your broker tells you that your margin requirement is 60 percent and

2
that the commission on the sale is ¢20 and a 6% interest rate on margin debt. While
you are short, Mason Enterprises pays a ¢0.85 per share dividend.

a. If at the end of one year you buy your Mason Enterprises shares to cover your short
sale at ¢35 and are charged a commission of ¢25, what is your rate of return on the
investment?

b. If at the end of one year you buy your Mason Enterprises shares to cover your short
sale at ¢80 and are charged a commission of ¢20, what is your rate of return on the
investment?

c. At what price would you receive a margin call from the broker if the maintenance
margin is 30%?

Question 5

Shares of Coopers Ltd are selling for ¢45 per share. Brokerage commissions are 2%
for purchases and 2% for sales. The interest rate on margin debt is 5% per year. Your
broker demands an initial margin deposit of 60%. The maintenance margin is 30%.

You buy 1,000 shares of Coopers Ltd and the company paid dividends of ¢0.85 per
share during the year.

a. Assuming that you paid the full cost of the purchase, what is your rate of return if
at the end of the year you sell your shares for:
i. ¢55 per share? ii.
¢35 per share?

b. Now, assume that you bought the 1,000 shares on a margin account. What is your
rate of return if at the end of the year you sell your shares for: i. ¢55 per share? ii.
¢35 per share?

c. If you purchase 1,000 shares at ¢45 each by making a margin deposit of 60%, at
what price would you receive a margin call from the broker?

3
Question 6

The shares of Salford Ltd are selling for ¢55 per share. Ruth is considering buying
1,000 shares of Salford Ltd.

Her broker demands brokerage commissions of 2% for purchases and 2% for sales;
initial margin deposit of 60% and a maintenance margin of 25%. The interest rate on
margin debt is 4% per year.

a. Assuming that Ruth paid the full cost of the purchase and the company paid
dividends of ¢0.80 per share during the year, what is her rate of return if at the end
of the year she sells the shares for:
i. ¢60 per share?

ii. ¢50 per share?

b. Now, assume that Ruth bought the 1,000 shares on a margin account and the
company paid dividends of ¢0.80 per share during the year. What is her rate of
return if at the end of the year she sells the shares for:
i. ¢60 per share?

ii. ¢50 per share?

c. If Ruth purchases the 1,000 shares on a margin account, making the initial margin
deposit of 60%, at what share price would she receive a margin call from the
broker?

d. Now, instead of buying the shares John decided to short sell 1,000 shares of
Salford Ltd. Brokerage commissions and margin requirements on short-sales are
the same as above but the interest on margin debt for short sales is 6% per annum.
While John is short, Salford Ltd paid dividends of ¢0.80 per share.

What is John’s rate of return if at the end of one year he buys Salford Ltd shares to
cover his short sale at:

i. ¢60 per share?

ii. ¢50 per share?

4
e. Differentiate between “buying a security on a margin” and “selling a security
short”. When would an investor consider using each of these strategies?

Part B: Portfolio Theory and Practice

Question 7

Following is the portfolio weights, w, percentage expected return in (%), R, vectors

and variance-covariance matrix, VC, for a three-asset portfolio:

, and

a. Calculate the expected return and standard deviation of the portfolio.

b. Suppose an investor requires a target standard deviation of 4% for the portfolio;

using the solver function in Excel, find the portfolio weights w to maximise the
expected return subject to the constraints
P = 4 and w1
+ w2 + w 3 = 1

Question 8

You currently have ¢100,000 invested in the shares of Barko Ltd that has an expected
return of 15% and a volatility of 10%. Suppose the risk-free rate is 3%, and the market
portfolio has an expected return of 11% and a volatility of 5%.

a. What combination of the risk free rate and the market portfolio will give you the
same return as your investment in the shares of Barko Ltd? What is the risk of this
portfolio?

b. What combination of the risk free rate and the market portfolio offers the same risk
as your investment in the shares of Barko Ltd? What is the return on this portfolio?

Question 9

5
You currently hold an equally weighted portfolio of 20 stocks which has been doing
quite well for the level of risk. The current value of the portfolio is ¢800,000. You
have recently received ¢200,000 as part of your annual bonus. You have no immediate
need for the cash and considering whether to invest the funds in KCTech shares or buy
risk free government treasury bonds. The expected annual return on your current
portfolio is 8% with a standard deviation of 8.2%, whilst the return on KCTech shares
is 15% with a standard deviation of 12%. The correlation between the returns on
KCTech and that of your original portfolio is 0.5. The yield on the Treasury bond is
5% per annum.

a. Calculate the expected return and standard deviation of your new portfolio if you
decide to invest all the ¢200,000 in KCTech shares.

b. Calculate the expected return and standard deviation of your new portfolio if you
decide to invest all the ¢200,000 in Treasury bonds.

c. An investment advisor is suggesting that you can improve the return on your
original portfolio by limiting your stocks to only 10 without increasing your
current level of risk. Discuss the likely impact of reducing the number of stocks in
the portfolio on the risk of the portfolio and whether it is possible to reduce the
number of stocks in the portfolio without significantly affecting the portfolio risk.

d. Distinguish between systematic risk and firm-specific risk and discuss how both
systematic and firm-specific risk change as the number of stocks in a portfolio is
increased.

Question 10

a. Clearly explain why some risks are systematic and others non-systematic. How is
it possible for an investor to control the level of non-systematic risk in a portfolio
but not the level of systematic risk?

b. John is considering an investment in these two stocks, Stock A and Stock B, and
has come to you for advice whether to buy and/or avoid any of the stocks. Stock A
has a beta of 1.15 and an expected return of 14%. Stock B has a beta of 0.7 and an
expected return of 9%. If the risk free rate is 5% and the market return is 12%,
what will be your best recommendation to John?

c. What advice would you give to a client who is confused about the concept that in a
well-functioning market all assets will have the same reward to risk ratio? Your
answer should cover the following issues:

6
 i. How would we expect that all assets have the same reward to risk ratio ii.
How can an investor increase his/her returns if this holds true.

Question 11

a. You are advising several individual investors who are interested in investing in
portfolios comprised of both stocks and bonds. In preparation for the meeting
with these various investors write a report that briefly discusses the following
issues:

i. The primary goal of portfolio diversification as it relates to correlation and

the number of securities in the portfolio.

ii. The concept of efficient and inefficient portfolios and the minimum
variance portfolio?

iii. Why you might advise some of the investors to invest in a portfolio other
than the minimum variance portfolio?

iv. Why you might advise some of the investors to add foreign securities into a
domestic portfolio, given that foreign securities are generally considered to
be more risky than domestic securities.

b. You have recommended a portfolio comprising of 65 percent in a bond index

and 35 percent in a stock index to one of your clients. The bond index has a
return of 15% and a standard deviation of 12% per year and the stock index has
a return of 20% and standard deviation of 16% per year. The correlation
between the bond index and the stock index 0.37.

What is the expected return and standard deviation of this portfolio?

7
Question 12

The last year's performance for four mutual funds is presented below. The market return
was 10.70%, last year with a standard deviation of 13.1% and the risk-free rate of return
was 5%.

Standard
Fund Beta Deviation Return
(%) (%)
A 1.50 18.95 12.5
B 1.20 12.41 13.0
C 0.90 9.30 11.2
D 0.50 8.10 9.5

a. Evaluate the performance of the funds based on the Sharpe Ratio.

b. Evaluate the performance of the funds based on the Treynor Ratio.
c. Evaluate the performance of the funds based on the Jensen’s Alpha.
d. Discuss the merits and demerits of the three measures in (a) to (c) above. Which of
them would you consider the most rigorous and why?

Question 13

An analyst is considering investing in funds A, B, C, and D. The market portfolio, M, is

expected to be 11% next period and the risk-free rate of return is 3%. The market portfolio
had a standard deviation over the past ten years of 0.20. The analyst gathered the
following information on the four funds.

Stock Return Beta 

A 17% 1.7 0.21
B 20% 2.1 0.25
C 10% 0.9 0.12
D 15% 1.2 0.16

a. Rank the four funds and the market portfolio in order from highest to lowest based on
their Treynor performance measure.
b. Rank the four funds and the market portfolio in order from highest to lowest based on
their Sharpe performance measure.
c. Rank the four funds and the market portfolio in order from highest to lowest based on
their Jensen’s Alpha.

8
Question 14

Consider the following information for a portfolio manager:

Policy Actual Index Actual

Weight Weight Returns Returns
Stocks 0.60 0.70 0.18 0.20
Bonds 0.35 0.25 0.15 0.16
Cash 0.05 0.05 0.08 0.06

Using the information above, compute:

a. the percentage return that can be attributed to the asset allocation decision of the
fund manager

b. the percentage return that can be attributed to the security selection decision of the
fund manager