SCHOOL OF ACCOUNTANCY UNIVERSITY OF LIMPOPO

“Empowerment Solutions For Accountancy Professionals”

Portfolio Management and

Capital Asset
Risk and Return SLIDE 2
MR RAMAVHEA G
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals” Extra questions on this topic

 Practice question part 1 :Question 4 (question bank).

 Practice question part 4: Question 2 (question bank).
 Test 1 year 2019:Question 2.
 Question 5.1-5.5 prescribed textbook.
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals” Concept
Coefficient of Variation
 The coefficient of variance (CV) is used to compare
two projects with different mean value.
 The coefficient of variance (CV) measures the risk of
R1.
 Calculate the coefficient of variance is by
Standard deviation divided by the expected mean
return.
SCHOOL OF ACCOUNTANCY Comparing the risk of two stand alone
“Empowerment Solutions For Accountancy Professionals”
asset
Example
A company is considering two independent
investment opportunities as follows :
  Project A Project B

Investment Capital R500 000 R500 000

Project Life 1 YEAR 1 YEAR

  Cash Flow   Cash Flow

Probability: Project A R Probability: Project B R

0.25 600 000 0.25 200 000

0.50 700 000 0.50 800 000

0.25 800 000 0.25 1000 000

SCHOOL OF ACCOUNTANCY Comparing the risk of two stand alone asset
“Empowerment Solutions For Accountancy Professionals”
Exmple

Required
Determine which investment the company
should choose.
Hint : Calculation of variance, standard
deviation, the coefficient of variance.
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals” Solution
Project A Project A (R’000)  
         
  Return (RA)      
Probability (P) RA RA X P (RA-Ṝ) (RA-Ṝ)2 X P
0.25 600 150 -100 2500
0.50 700 350 0 0
0.25 800 200 100 2500
         
MEAN Ṝ 700    
Variance 5000     
Standard Deviation 70.71     
70.71 /700 =
CV 0.10     
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals” Solution
Project B Project B (R’000)  
         
  Return (RA)      
Probability (P) RA RB X P (RB-Ṝ) (RB-Ṝ)2 X P
0.25 200 50 -500 62500
0.50 800 400 100 5000
0.25 1000 250 300 22500
         
MEAN Ṝ 700    
Variance 90000     
Standard Deviation 300     

CV 0.43 (300/700)    
SCHOOL OF ACCOUNTANCY Solution
“Empowerment Solutions For Accountancy Professionals”

 Given a choice of two projects (or portfolio) with the same

return but different risk, the investor will choose the one
with lower risk, in this case project A.
 Alternatively should the two project have the same risk the
investor will select the one with a high return.
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals”

based on covariance
Portfolio risk and return : Portfolio variance
 Portfolio risk and return : Portfolio variance based on
SCHOOL OF ACCOUNTANCY correlation coefficient
“Empowerment Solutions For Accountancy Professionals”
SCHOOL OF ACCOUNTANCY Portfolio risk and return : Portfolio variance
“Empowerment Solutions For Accountancy Professionals”
Covariance
Covariance
 The covariance is a multi variance statical measure
 Measures mean, standard deviation, and variance
Cov (x,y) = Pxyδxδy
Cov(x,y) = Covariance of X and Y
Pxy = Correlation co-efficient of X and y
δx = Population standard deviation of X
δy = Population standard deviation of y
SCHOOL OF ACCOUNTANCY Portfolio risk and return : Portfolio variance
“Empowerment Solutions For Accountancy Professionals” correlation coefficient AND Covariance

Correlation Coefficient
Coefficient of variance is a measure of relative dispersion that is useful
in comparing the risks of assets with differing expected returns.
The higher the coefficient of variance, the greater the risks and
therefore the higher the expected return.
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals”
Example : Calculation for two assets portfolio
SCHOOL OF ACCOUNTANCY ANSWER
“Empowerment Solutions For Accountancy Professionals”
YEAR Rb Rg db dg db2 dg2 dbxdg

1 26% 24% 2.00% -6.00% 0.04% 0.36% -0.12%

2 20% 35% -4.00% 5.00% 0.16% 0.25% -0.20%
3 22% 22% -2.00% -8.00% 0.04% 0.64% 0.16%%

4 23% 37% -1.00% 7.00% 0.01% 0.49% -0.07%

5 29% 32% 5.00% 2.00% 0.25% 0.04% 0.10%
Avg 24% 30% 0.50% 1.78% -0.13%
Return
Variance 0.10% 0.356% -
Std Dev 3.16% 5.97%
Cov -0.026
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals” Capital Asset Pricing Model

CAPM:
Ri=Rf+βi(Rm-Rf)
Ri= The required return on share
Rf= The risk free return
βi= The beta of share
Rm= The expected return on the market as a whole
Exercise 1.
Bhata company software developer wishes to determine the required return on an
asset Z,which has a beta of 1.5. The risk free rate of return is 7%, the return on the
market portfolio is 11%. Calculate the required return using CAP
SCHOOL OF ACCOUNTANCY
“Empowerment Solutions For Accountancy Professionals” Limitation of CAPM
 The CAPM is a single-period model,
One is assumed that beta, risk free rate and expected market return will remain
constant over the life of the project.
 The use of the beta as a measure of systematic risk,
Assumes total diversification of unsystematic risk, resulting in total risk being
equal to systematic risk. In practice firms are unable to eliminate all unsystematic
risk.
 The assumption that the government bonds are risk free,
Though largely true may not be always the case. Government bonds in some
instances do carry a small amount of risk.
 The assumption of perfect capital market,
This assumptions means that all securities are valued correctly