In January 2001, Mr.

Xing purchased the following 5 scrips:

Company No. of shares Purchase
price
H ltd. 100 250
C ltd. 100 180
S ltd. 100 80
F ltd. 100 240
M ltd. 100 260
He paid brokerage of Rs. 1500. During the year 2001, Mr. Xing received the following:
Company Total Dividend for all Bonus to Held
shares (Rs)
H ltd. 300 `2:1
C ltd. 290
S ltd. 450
F ltd. 500
M ltd. 600 `5:1
In January 2002, he sold all his holdings at the following prices:
Company Sale price
H ltd. 275
C ltd. 240
S ltd. 108
F ltd. 200
M ltd. 400
He paid brokerage Rs. 1865 on sale. Calculate his HPR. Ignore tax.

Company No. of Shares Sale Price Total Sale No. of Purchase Total
Proceeds Shares Price Purchase
cost
Solution:
H ltd. 300 275 82500 100 250 25,000
C ltd. 100 240 24000 100 180 18,000
S ltd. 100 108 10800 100 80 8,000
F ltd. 100 200 20000 100 240 24,000
M ltd. 600 400 240000 100 260 26,000
Add/Less: Brokerage -1865 1,500
Add: Dividend 2140 Net Investment 102,500
Net Realisation 377,575

HPR 268.37%
from PPT.

H 300 275 82500 100 250 25000

C 100 240 24000 100 180 18000
S 100 108 10800 100 80 8000
F 100 200 20000 100 240 24000
M 600 400 240000 100 260 26000
377300 less: brokerage 1500
add: dividen 2140 less: brokerage 1865 102500
377575

hpr 268.37%
Horizon T Price HPR (P1-P0)/P0 HPR %
Half year $97.36 `(100-97.36)/97.36 0.027116 2.71%
1 year $95.52 `(100-95.52)/95.52 0.046901 4.69%
25 year $23.30 `(100-23.30)/23.30 3.291845 329.18%

Effective Annual Return

Horizon T
Half year `(1+0.027116)^2 - 1 = 5.49% with compounding
compounding- it is half yearly
1 year `(1+0.0469)^(1/1) - 1 = 4.69%
25 year CAGR `(1+3.291845)^(1/25) - 1 = 6%
Therefore, t-bill with 25 years is the one with best returns
from PPT

0.054967
 Time Outlay
0 $50 to purchase first share
1 $53 to purchase second share a year later from PPT
Proceeds
1 $2 dividend from initially purchase share
2 $4 dividend from the 2 shares held in the second
year, plus $108 received from selling both shares'
at $54 shares
Method 1 Using the DCF appraoch, we can solve for the average return
over the 2 years by equating the PV of cash inflows and outflows:

50 + 53 = 2+ 112
1+r 1+r `(1+r)^2
r = 7.117%

Method 2 Using XIRR

Time Cash Flow Time CF homework
1/1/2017 -50 0 -50
1/1/2018 -53 1 -51
1/1/2018 2 2 112
1/1/2019 112
IRR=MWR= 7.12%
XIRR 7.12%
 -50
-51
112
7%

homework
Compute the GM(Geometric Mean) i.e. TWR

Cash Flows for : In-house and Super Trust

Quarter
1 2 3
In House Account
Beginning value 4,000,000 6,000,000 5,775,000
Beginning of period inflow / (outflow) 1,000,000 -500,000 225,000
Amount Invested 5,000,000 5,500,000 6,000,000
Ending Value 6,000,000 5,775,000 6,720,000

Super Trust Account

Beginning value 10,000,000 13,200,000 12,240,000
Beginning of period inflow / (outflow) 2,000,000 -1,200,000 -7,000,000
Amount Invested 12,000,000 12,000,000 5,240,000
Ending Value 13,200,000 12,240,000 5,659,200
 GM/CAGR = {(1+R1)*(1+R2)*(1+R3)*(1+R4)}^1
homework

4 Quarterly HPR
In House Account
6,720,000 Q1 0.20 0.2
-600,000 2 0.05 0.05
6,120,000 3 0.12 0.12 0.27
5,508,000 4 -0.10 -0.1
Since it is a Quarterly CAGR calculation, the TWR is 0.27 TWR
Quarterly HPR
5,659,200 In House Account
-400,000 Q1 0.10
5,259,200 2 0.02
5,469,568 3 0.08
4 0.04
Since it is a Quarterly CAGR calculation, the TWR is 0.26
*(1+R2)*(1+R3)*(1+R4)}^1
Your task is to compute the investment performance of the Walbright Fund during 2017. The facts are as follows:
On 1.1.2017, the walbright Fund has a market value of $100 Million
During the period 1.1.2017 to 30.4.2017, the stocks in the fund showed a capital gain of $10 million
On 1.5.2017, the stocks in the fund paid a total dividend of $2 million. All dividends were re-invested in additional s
Because the funds performance has been exceptional, institutions invested an additional $20 million in Walbright on
On 31.12.2017, Walbright received total dividends of $2.64 million. The funds market value on 31.12.2017, not inclu
The fund made no other interim cash payments during 2017
Compute: TWR and MWR

Solution

•Because Interim cash flows were made on 1.5.2017, we must compute two interim total returns and then link them
(1/5 to 31/12) HPR

•Now we must geometrically link the four and eight month returns to compute an annual return.

1.1.2017 Beginning portoflio value $100 million

1.5.2017 Dividends received before additional investments $2 million
Ending portfolio Value $110 million

4 month HPR = {$2 + $10} / $ 100 12%

New investment $20 million

Beginning market value of the 8 month period $132 million

31.12.2017 Dividends received $2.64 million

Ending portfolio value $140 million

HPR = {$2.64 + $140 - $132} / $ 132 8.06%

TWR = [(1+0.12)*(1+0.0806)] -1
21.03%
We compute the TWR of 21.03% for one year. The 4m and 8m intervals combine to equal
one year
Taking the square root would be appropriate only if 1.12 and 1.0806 each applied to one full year

MWR
Date CF
1/1/2017 -100
4/30/2017 0 (CF is zero since they are reinvested)
5/1/2017 0 (CF is zero since they are reinvested)
5/1/2017 -20
12/31/2017 142.64

XIRR 20.10%
17. The facts are as follows:

of $10 million
ere re-invested in additional shares
nal $20 million in Walbright on 1.5.2017, raising assets under management to $132 million ($100+$10+$2+$20)
value on 31.12.2017, not including the $2.64 million in dividends, was $140 million

homework

otal returns and then link them to obtain an annual return. The table below lists the relevant market values on 1 st January, 1St

nual return.

Initial 100
div 2
end 110

hpr 12.00%

new 20
beg 132

div 2.64
end 140

hpr 8.06%

twr 21.03%

one full year

ce they are reinvested)

ce they are reinvested)
lues on 1 st January, 1St may and 31st December as well as the associated interim four month (1/1 to 1/5) and eight month
and eight month
Idea Ltd., had the following dividend per share and the market price per share for the period 20
2005 :

Dividend
Year per share Market Price
(Rs.) (Rs.)
HPR
2000 1.53 31.25
2001 1.53 20.75
2002 1.53 30.88
2003 2 67
2004 2 100
2005 3 154
Calculate the annual rate of return for last five years. How risky is the share?

Solution

Dividend
Year per share Market Price Return
(Rs.)
(Rs.)
2000 1.53 31.25
2001 1.53 20.75 -28.70%
2002 1.53 30.88 56.19%
2003 2 67 123.45%
2004 2 100 52.24%
2005 3 154 57.00%

Average Returns 52.03%

Risk (SD) 48.29% If Assumed as Population

53.99% If Assumed as Sample

Stdev.s and stdev are same
are for the period 2000 –

is the share?
The returns on securities A and B are given below:
Probability Security A Security B Pa Pb pa^2
0.5 0.04 0 0.02000 0.00000 0.000800
0.4 0.02 0.03 0.00800 0.01200 0.000160
0.1 0 0.02 0.00000 0.00200 0.000000
Give your security preference based on risk and return
Ret 0.02800 0.01400 0.00096
Solution:
Probability Security A Security B P*A P*B P*A^2 P*B^2
0.5 0.04 0 0.02 0.00 0.0008 0.00
0.4 0.02 0.03 0.01 0.01 0.0002 0.00
0.1 0 0.02 0.00 0.00 0.0000 0.00

Expected Return 0.0280 0.0140 0.0010 0.0004

Risk 0.013266 0.0143 Return

A 0.0280
B 0.0140
Security A is better as it gives higher return at lower risk
Coeff of VARIATION =

A 0.473804
B 1.020204
In case of A, 0.47% risk is to be undertaken for 1% return
In case of B, 1.02% risk is to be undertaken for 1% return
 pb^2
0.000000
0.000360
0.000040

0.00040 Risk 0.0132665 0.014283

coeff of variation 0.47380354 1.020204

√[ ∑ (Pi*R i2 ) – E(Ri)2 ]

Risk
0.0133
0.0143

ARIATION =
SD/mean
risk p.u. of retu
Mr. Bond wants to buy shares of Zytec limited which is currently selling at Rs. 50
without dividend payment. There is equal probability for the share to be sold at 55 and 70
during the next year. What is the expected return and risk if 300 shares are bought
Ignore transactions costs and taxes.
Ri
Prob. Sale Price Return P*Return P*Return^2 ER = Summ (Pi *Ri)
0.5 55 0.10 0.05 0.005000
0.5 70 0.40 0.20 0.080000 SQRT((Sum(pi*Ri^2 - ER^2

Return 25.00%

Risk 15.00%
 prob price return p*r p*r^2
0.5 55 0.1 0.05 0.005
m(pi*Ri^2 - ER^2 0.5 70 0.4 0.2 0.08
return 0.25 0.085

risk 15.00%
A stock costing Rs. 50, pays no dividend. The possible prices of the stock at the end of
the year and their probabilites are given below;
End of year price probability
60 0.1 a) Find expected return
65 0.2 b) Find standard deviation of the returns
70 0.4
75 0.2
80 0.1

End of yearprobabilityReturn P*Return P*Return^2

60 0.1 0.2 0.02 0.004
65 0.2 0.3 0.06 0.018
70 0.4 0.4 0.16 0.064
75 0.2 0.5 0.1 0.05
80 0.1 0.6 0.06 0.036
0.4 0.172

Expected Return 0.4

Risk 0.109545
 An investor has a choice of four stocks for investment. Their rates of return and
probabilites are as below:
ICICI bank Axis bank Yes bank HDFC bank HDFC
r p r p r p r p Pi
-0.3 0.2 -0.2 0.15 -0.2 0.2 -0.1 0.1 0.1
0.000 0.4 0.0000 0.35 0.1 0.4 0 0.25 0.25
0.3 0.3 0.2 0.45 0.4 0.3 0.1 0.4 0.4
0.7 0.1 0.4 0.05 0.8 0.1 0.2 0.25 0.25
a) Are all these stocks attractive investment?
b) How should the investor choose one to buy

ICICI bank Axis bank Yes bank HDFC bank

Return 0.10 0.08 0.20 0.08
Risk 0.29 0.16 0.29 0.09

2.898275 2.00 CV 1.449138 1.159202312

Yes bank is efficient as compared to ICICI as it offers higher return at same level of risk
HDFC is efficient as compared to Axis as it offers same return at lower level of risk

Therefore ICICI and Axis are inefficient securities

Out of Yes and HDFC, HDFC will be choosen as risk per unit of return lowest
 SD = Sqrt((sum(Pi*Ri^2) - ER^2))
ER = Summ(Pi*Ri)
Ri Pi*Ri Pi*Ri*Ri
-0.1 -0.01 0.001
0 0 0
0.1 0.04 0.004
0.2 0.05 0.01
0.08 0.015
ER 0.092736
SD
The following is the return of two securities for the past five year Calculate for each the
expected return and risk. What will be expected Return of Portfolio Comprising 40% - X and
60% - Y. What will be risk of portfolio

Security
Year Returns- Security Portfolio
X Returns- Y Return
Wx Wy
1 6.6 24.5 17.34 0.4 0.6
2 5.6 -5.9 -1.30
3 -9 19.9 8.34
4 12.6 -7.8 0.36
5 14 14.8 14.48
5.96 9.1
Expected 5.96 9.10 7.84 Avg
Return weights
Risk 9.13 14.97 8.28

Return of Portfolio= 7.84

Correlationof X,Y= -0.39

Risk of Portfolio= 8.28

Sqrt(Wx^2*SDx^2+Wy^2*Sdy^2+2*Wx*Wy*Sdx*Sdy*r)
or each the
ng 40% - X and

17.34
-1.3
8.34
0.36
14.48
expected return 7.844

risk 9.12513 14.97414 8.277674

return 7.844

correl -0.38916

risk 8.277674
P Ltd. Invested on 1.4.2007 in Equity shares as below:
Compa Number of
Cost (Rs.)
ny Shares
1,000 (Rs. 100
M Ltd. each) 200,000

N Ltd. 500 (Rs. 10 150,000

each)

Dividends from M Ltd. and N Ltd. for the year ending 31.3.2008 are likely to be 20% and 35%
respectively. Probabilities of market quotations on 31.3.2008 are:

Probab Price of
ility Price of share share of
Factor of M Ltd. N Ltd.
0.2 220 290
0.5 250 310
0.3 280 330
You are required to:

(i) Calculate the expected average return from the portfolio for the year 2007-08.
(ii) Advise P Ltd. of the comparative risk of two investments by calculating the standard d

M Ltd Price N Ltd Price

Cost per Share 200 300
Dividend 20 3.5
Returns
Probability M Ltd Price N Ltd PriceM N P*M P*N P*M^2
0.2 220 290 20.00% -2.17% 0.04 -0.00433 0.008
0.5 250 310 35.00% 4.50% 0.175 0.0225 0.06125
0.3 280 330 50.00% 11.17% 0.15 0.0335 0.075
0.365 0.051667 0.14425

Expected Return 0.365 0.051667

Expected Risk 0.105 0.046667

Expected Return from Portfolio= 23.07%

Wm= 0.571428571
Wn= 0.428571429
 homework

be 20% and 35%

2007-08.
ng the standard deviation

P*N^2
0.0001
0.001013
0.003741
0.004847
The forecast of returns for securities A and B are laid out below.
Security A Security B
Probability Return (%) Probability Return (%)
0.05 15 0.05 8
0.2 20 0.25 18
0.5 25 0.4 26
0.2 30 0.25 34
0.05 35 0.05 44
Required:
(i) Expected rate of return of each security.
(ii) Standard deviation for each security.

(ii) Comment with reasons as to which of the two securities has more upside pot

(iv) Independent of the first three elements, assume now that the probability of r
Compute

(a) Expected return from the portfolio, if it is formed with 70% investment in
and remainder in B.

(v) Compute the risk in the 70/30 portfolio using three different methods.

Security A Security B
Probability Return (%) Probability Return (%) P*A
0.05 15 0.05 8 0.75
0.2 20 0.25 18 4.00
0.5 25 0.4 26 12.50
0.2 30 0.25 34 6.00
0.05 35 0.05 44 1.75
25.00
Expected Return
ER 25.00
SD Risk 4.472135955
Cof Variation = 0.1788854382
Weights 0.7 0.3

Probability Return A (%) Return B Portfolio

(%) Return P*Port.Ret
0.05 15 8 12.90 0.65
0.2 20 18 19.40 3.88
0.5 25 26 25.30 12.65
0.2 30 34 31.20 6.24
0.05 35 44 37.70 1.89
 25.30
iv(a)
Portfolio Risk = Sqrt(P*Rp^2 - (P*Rp)^2) 5.4129474410897

Covariance= Summ(P*A*B) - (Summ(P*A)*Summ(P*B) Covariance =

SD Correl =
SDp =
Correlation
 has more upside potential and downside risk.

at the probability of return for security B will be identical with that of A.

th 70% investment in A
(b) covariance of AB. (c) Correlation Coefficient

erent methods.

p*a*a p*b P*B*B

11.25 0.40 3.20
80.00 4.50 81.00
312.50 10.40 270.40
180.00 8.50 289.00
61.25 2.20 96.80
645.00 26.00 740.40

26.00
8.024961
0.308652

P*A P*A^2 P*B P*B^2 P*A*B

P*Port.Ret^2
8.320500 0.75 11.25 0.40 3.20 6.00
75.272000 4.00 80.00 3.60 64.80 72.00
320.045000 12.50 312.50 13.00 338.00 325.00
194.688000 6.00 180.00 6.80 231.20 204.00
71.064500 1.75 61.25 2.20 96.80 77.00
 669.39 25.00 645.00 26.00 734.00 684.00
SD A 4.472136 7.615773

34
0.998274373175
5.4129474410897
elation Coefficient of AB.
The following is the forecast of return of two securities along with the probability of their occu
the expected return and risk of both the securities. Find correlation between Returns of X & Y.

Proba Return Return( X-E(X) Y-E(Y) P*(X-E(X)) P*(X-E(X))^2

bility (X) Y) (Y-E(Y))
0.05 10 18 -10.75 -2.75 1.478125 5.778125
0.2 20 12 -0.75 -8.75 1.3125 0.1125
0.5 20 28 -0.75 7.25 -2.71875 0.28125
0.2 25 28 4.25 7.25 6.1625 3.6125
0.05 25 38 4.25 17.25 3.665625 0.903125
If a portfolio comprise of 30% - X & 70% - Y, Find Expected Return, S.D. of portf

Expected 20.75 24.8 W1 0.3

Return W2 0.7

Risk 3.27 8.21

Corrrelation 36.90%
Correl = Cov/SDx,Sdy

SDp = 6.17665537
h the probability of their occurrence. Calculate
on between Returns of X & Y.

P*(Y-E(Y)^2
0.378125
15.3125
26.28125
10.5125
14.878125
Expected Return, S.D. of portfolio.

HOME WORK
Mr. X is holding two securities X and Y in his portfolio. With the details given below calculate
portfolio risk and return.

Securit Propor Standard

y tion Deviation Return
X 0.6 10 20
Y 0.4 16 25 Home work
Correlation of the securities return is 0.50.

Portfolio Return 22

Portfolio SD 10.740577
ven below calculate the
Novex owns a portfolio of two securities with the following expected return, standard deviation an
weights:
Securit Expected Standard Weight
y Return Deviation
X 12% 15% 0.4
Y 15% 20% 0.6
What are the maximum and minimum portfolio standard deviations for varying levels of co
1
between two securities?

2 If correlation is -1, calculate the proportion of the individual securities in the portfolio to re
risk to zero?

Sol1 Correlation Portfolio Risk

-1 6.00% 6.00%
-0.9 7.10% 18.00%
-0.8 8.05%
Portfolio Risk
-0.7 8.90% 20.00%
-0.6 9.67% 18.00%
-0.5 10.39% 16.00%
-0.4 11.06% 14.00%
-0.3 11.70% 12.00%
-0.2 12.30% 10.00%
-0.1 12.87% 8.00%
0 13.42% 6.00%
0.1 13.94% 4.00%
0.2 14.45% 2.00%
0.3 14.94% 0.00%
0.4 15.41% -1.5 -1 -0.5 0 0.5
0.5 15.87%
0.6 16.32%
0.7 16.76%
0.8 17.18%
0.9 17.60%
1 18.00% Portofolio Risk is lowest for r=-1 and highest for r=1

Sol2

Security Expected Standard Weight Use

Return Deviation Solver Set Objective Portfolio SD=0
X 12% 15% 0.571429 By changing: Wx
Y 15% 20% 0.428571
1
Correlation Portfolio SD 0.00

Formula Method Wx = 0.5714 Sdy

SDx+Sdy
Wy = 0.4286

SD p = 0
n, standard deviation and

s for varying levels of correlation

x

ties in the portfolio to reduce the

y

correl

Portfolio Risk
20.00%
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
-0.5 0 0.5 1 1.5

nd highest for r=1

Set Objective Portfolio SD=0

By changing: Wx
weight st dev

0.571429 6.036E-09

0.428571
1

-1
L Ltd. And M Ltd. Have the following risk and return estimates.

RL = 20%; RM = 22%, sL = 18%; s M = 15%; Correlation Coefficient ( rLM )= – 1 Calculate the prop
of investment of L Ltd. and M Ltd. to minimize the risk of portfolio using the WminA formula

Standar
Securi Expecte d
ty d Deviati Weight
Return
on
L 20% 18% 45.454%
M 22% 15% 54.546%
1
CorrelatiPortfolio SD 0.00%

Sdy
Formula Method SDx+Sdy

45.454545454545500%
n estimates.

ion Coefficient ( rLM )= – 1 Calculate the proportion

isk of portfolio using the WminA formula

18% 0.454545
15% 0.545455
1
correlation -1

sd 2.69E-08
Europium Ltd. has been specially formed to undertake two investment
opportunities.

The risk and return characteristics of the two projects are shown below:

A B
Expected
Return 12% 20%
Risk 3% 7%
Europium plans to invest 80% of its available funds in Project A and 20% in B. The
directors believe that the correlation co-efficient between the returns of the
projects is +0.1.
Required:
a. Calculate the returns from the proposed portfolio of Projects A and B;
b. Calculate the risk of the portfolio;

Comment on your calculations in part (b) in the context of the risk

c. reducing effects of diversification;

d. Suppose the correlation co-efficient between A and B was -1. How

should Europium Ltd. invest its funds in order to obtain a zero risk

portfolio.
 Wa Wb
80% 20%
13.60%

2.90%

Risk of the portfolio is lower than individual project

Security Expected Standard Weight

Return Deviation
A 0.12 0.03 0.70
B 0.20 0.07 0.30
1.00
Correlation -1.00 WminA =

Formula Method Weight

Risk (Variance) 0.00%
Risk (SD) Err:502

a b
weights risk 0.00%
correl -1
0
homework

SDb
SDa+SDb
P Ltd. and Q Ltd. have low positive correlation coefficient of + 0.5. Their
respective risk and return profile is as under :

RP = 10%
RQ = 15%
SP = 20%
SQ = 25%
Compute the portfolio of P and Q to minimise risk.
a) Use solver b) Use WminA formula
Security Return Risk Weights Weights
P 10% 20% 0.5 20% 0.71428571
Q 15% 25% 0.5 25% 0.28571429
1 1
Correlation 0.5 0.5

Portfolio
Risk (Var) 0.038125 0.035714
P/f SD 0.195256
Use WminA full formula, as Correl is not -1
WminA =(σ2B – CovAB) / (σ2A + σ2B – 2*CovAB)

Wmin formula Weights

0.125 0.714286
risk 0.188982 0.285714
1
correl 0.5
Mr. A is interested to invest Rs. 1,00,000 in the securities market. He selected two securities B a

SecurityRisk (s)Expected Return (ER)

B 10% 12%
D 18% 20%
Co-efficient of correlation between B and D is 0.15.
You are required to calculate the portfolio return of the following portfolios of B and D to be co
(i) 100 percent investment in B only;
(ii) 50 percent of the fund in B and the rest 50 percent in D;
(iii) 75 percent of the fund in B and the rest 25 percent in D; and
(iv) 100 percent investment in D only.
Also indicate that which portfolio is best for him from risk as well as return point of view?. Usin

Solution: WB WD Risk Return Coefficient of Variation

100.00% 0.00% 10.00% 12.00% 83.3%
50.00% 50.00% 10.93% 16.00% 68.3%
75.00% 25.00% 9.31% 14.00% 66.5%
0.00% 100.00% 18.00% 20.00% 90.0%

r= 0.15
WB WD Risk Return
1.00 0.00 10.00% 12.00%
0.99 0.01 9.93% 12.08% Return
0.98 0.02 9.86% 12.16% 25.00%
0.97 0.03 9.80% 12.24%
20.00%
0.96 0.04 9.73% 12.32%
0.95 0.05 9.68% 12.40% 15.00%
0.94 0.06 9.62% 12.48%
0.93 0.07 9.57% 12.56% 10.00%

0.92 0.08 9.52% 12.64% 5.00%

0.91 0.09 9.48% 12.72%
0.90 0.10 9.44% 12.80% 0.00%
8.00% 10.00% 12.00% 14.00% 16.00% 18.00% 20.
0.89 0.11 9.40% 12.88%
0.88 0.12 9.37% 12.96% Return
0.87 0.13 9.34% 13.04%
0.86 0.14 9.32% 13.12%
0.85 0.15 9.30% 13.20%
0.84 0.16 9.28% 13.28%
0.83 0.17 9.27% 13.36%
0.82 0.18 9.26% 13.44%
0.81 0.19 9.25% 13.52%
0.80 0.20 9.25% 13.60% Min Risk Portfolio (by formula
0.79 0.21 9.26% 13.68% Wb=
0.78 0.22 9.26% 13.76%
0.77 0.23 9.27% 13.84%
0.76 0.24 9.29% 13.92% =
0.75 0.25 9.31% 14.00%
0.74 0.26 9.33% 14.08%
0.73 0.27 9.36% 14.16% =
0.72 0.28 9.39% 14.24%
0.71 0.29 9.42% 14.32%
0.70 0.30 9.46% 14.40%
0.69 0.31 9.50% 14.48%
0.68 0.32 9.55% 14.56%
0.67 0.33 9.60% 14.64%
0.66 0.34 9.65% 14.72%
0.65 0.35 9.71% 14.80%
0.64 0.36 9.77% 14.88%
0.63 0.37 9.83% 14.96%
0.62 0.38 9.90% 15.04%
0.61 0.39 9.97% 15.12%
0.60 0.40 10.04% 15.20%
0.59 0.41 10.12% 15.28%
0.58 0.42 10.20% 15.36%
0.57 0.43 10.28% 15.44%
0.56 0.44 10.36% 15.52%
0.55 0.45 10.45% 15.60%
0.54 0.46 10.54% 15.68%
0.53 0.47 10.64% 15.76%
0.52 0.48 10.73% 15.84%
0.51 0.49 10.83% 15.92%
0.50 0.50 10.93% 16.00%
0.49 0.51 11.04% 16.08%
0.48 0.52 11.14% 16.16%
0.47 0.53 11.25% 16.24%
0.46 0.54 11.36% 16.32%
0.45 0.55 11.47% 16.40%
0.44 0.56 11.59% 16.48%
0.43 0.57 11.70% 16.56%
0.42 0.58 11.82% 16.64%
0.41 0.59 11.94% 16.72%
0.40 0.60 12.07% 16.80%
0.39 0.61 12.19% 16.88%
0.38 0.62 12.32% 16.96%
0.37 0.63 12.44% 17.04%
0.36 0.64 12.57% 17.12%
0.35 0.65 12.71% 17.20%
0.34 0.66 12.84% 17.28%
0.33 0.67 12.97% 17.36%
0.32 0.68 13.11% 17.44%
0.31 0.69 13.24% 17.52%
0.30 0.70 13.38% 17.60%
0.29 0.71 13.52% 17.68%
0.28 0.72 13.66% 17.76%
0.27 0.73 13.81% 17.84%
0.26 0.74 13.95% 17.92%
0.25 0.75 14.09% 18.00%
0.24 0.76 14.24% 18.08%
0.23 0.77 14.39% 18.16%
0.22 0.78 14.53% 18.24%
0.21 0.79 14.68% 18.32%
0.20 0.80 14.83% 18.40%
0.19 0.81 14.98% 18.48%
0.18 0.82 15.13% 18.56%
0.17 0.83 15.29% 18.64%
0.16 0.84 15.44% 18.72%
0.15 0.85 15.60% 18.80%
0.14 0.86 15.75% 18.88%
0.13 0.87 15.91% 18.96%
0.12 0.88 16.06% 19.04%
0.11 0.89 16.22% 19.12%
0.10 0.90 16.38% 19.20%
0.09 0.91 16.54% 19.28%
0.08 0.92 16.70% 19.36%
0.07 0.93 16.86% 19.44%
0.06 0.94 17.02% 19.52%
0.05 0.95 17.18% 19.60%
0.04 0.96 17.34% 19.68%
0.03 0.97 17.51% 19.76%
0.02 0.98 17.67% 19.84%
0.01 0.99 17.84% 19.92%
0.00 1.00 18.00% 20.00%
lected two securities B and D for this purpos

olios of B and D to be considered by A for h

turn point of view?. Using a scatter diagra

Return
25.00%

20.00%

15.00%

10.00%
Return
5.00%

0.00%
8.00% 10.00% 12.00% 14.00% 16.00% 18.00% 20.00%

Return

2.00% 14.00% 16.00% 18.00% 20.00%

Return

Min Risk Portfolio (by formula) Min Risk Portfolio (By solver)
SDd^2-r.SDb.SDd Wb= 0.8027027 Set Objective: Min Risk
SDd^2+SDb^2-2.SDb.SDd Wd= 0.1972973 By changing: Wb

0.0297 Risk= 9.2518807

0.037

0.8027027
.00% 20.00%
Consider the following information on two stocks, A and B :
Year Return on A (%) Return on B (%)
2006 10 12
2007 16 18
You are required to determine:
(i) The expected return on a portfolio containing A and B in the proportion of 40% and 60
(ii) The Standard Deviation of return from each of the two stocks.
(iii) The covariance of returns from the two stocks.
(iv) Correlation coefficient between the returns of the two stocks.
(v) The risk of a portfolio containing A and B in the proportion of 40% and 60%.

Portfolio
Year Return on A (%) Return on B (%)
Return
2006 10 12 11.2
2007 16 18 17.2
Expected 13 15 14.2
Return
Weights 0.4 0.6
SD 4.24264068711929 4.24264068711929

Expected Return of portfolio 14.2

Covariance 9

Correlation 1

Portfolio Risk 4.24264068711929

 home work

portion of 40% and 60% respectively.

% and 60%.
 Particulars Security A Security B
Standard
Deviation 20 40

Expected
12 20
return

Correlation between the two securities is -0.20. Calculate the return and risk of the portfolio
different combinations of A and B and explain with the help of the data arrived the concepts
efficient frontier (b) utility curve (c) efficient portfolio (d) portfolio with risk free asset and e
portfolio and (e) capital market line. Use WA = 1, 0.9, 0.759, 0.5, 0.25, 0.

Particulars Security A Security B

Standard
Deviation 20 40
Expected
return 12 20

Correlation -0.2

Portfolio Wa Wb Risk Return

A 1 0 20.00 12.00
B 0.9 0.1 17.64 12.80
C 0.759 0.241 16.27 13.93
D 0.5 0.5 20.49 16.00
E 0.25 0.75 29.41 18.00
F 0 1 40.00 20.00

Additional Understanding: Shape of Curve for various correlations (to be learnt in modul

Correlation -0.2 -0.5

Wa Wb Return Risk at r=-0.2 Risk at r=-0.5

1 0 12 20.00 20.00
0.9 0.1 12.8 17.64 16.37
0.8 0.2 13.6 16.40 13.86
0.7 0.3 14.4 16.52 13.11
0.6 0.4 15.2 17.98 14.42
0.5 0.5 16 20.49 17.32
0.4 0.6 16.8 23.73 21.17
0.3 0.7 17.6 27.44 25.53
0.2 0.8 18.4 31.45 30.20
 0.1 0.9 19.2 35.65 35.04
0.00 1 20 40.00 40.00
n and risk of the portfolios for the
ata arrived the concepts of (a)
with risk free asset and efficient
5, 0.

(to be learnt in module 4)

-0.8 -1 0 0.2 0.5 0.8 1

Risk at r=-0.8 Risk at r=-1 Risk at r=0 Risk at r=0.2 Risk at r=0.5 Risk at r=0.8 Risk at r=1
20.00 20.00 20.00 20.00 20.00 20.00 20.00
14.99 14.00 18.44 19.20 20.30 21.34 22.00
10.73 8.00 17.89 19.27 21.17 22.91 24.00
8.44 2.00 18.44 20.18 22.54 24.67 26.00
9.63 4.00 20.00 21.84 24.33 26.59 28.00
13.42 10.00 22.36 24.08 26.46 28.64 30.00
18.24 16.00 25.30 26.77 28.84 30.78 32.00
23.48 22.00 28.64 29.79 31.43 33.00 34.00
28.90 28.00 32.25 33.03 34.18 35.28 36.00
34.42 34.00 36.06 36.45 37.04 37.62 38.00
40.00 40.00 40.00 40.00 40.00 40.00 40.00
 Chart Title
25

20

15

10

5
15

10

0
0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00 45.00

Risk at r=-0.2 Risk at r=-0.5 Risk at r=-1

Risk at r=0 Risk at r=0.2 Risk at r=0.5
Risk at r=0.8 Risk at r=1 Column D
Following is the data regarding six securities:
A B C D E F
Return (%) 8 8 12 4 9 8

Risk (%)
(Standard 4 5 12 4 5 6
Deviation)

(i) Which of the securities will be selected?

(ii) Assuming perfect positive correlation, analyse whether it is preferable to invest 75% security
and 25% security C.

(i) Security Inefficient to Reason

A None NA
B offers same return at higher risk as compared to A and B offer
B A, E lower return at same risk as compared to E
C None
D A D offers low return at same risk
E None
F A, B F offers same return at higher risk

Ii) R= 1
WA 0.75
WC 0.25
Portfolio Risk 6 6
Portfolio Return 9

This portfolio is inefficient to E, as E offers Same return at low risk

le to invest 75% security A

ompared to A and B offers

to E
An investor is able to borrow and lend at the risk free rate of 12 percent. The market portfolio
expected return of 20 percent and a standard deviation of 25 percent. Determine the expected
deviation of the portfolios

a. If all wealth is invested in the risk free asset.

b. If two thirds are invested in risk free asset and one third in the market portfolio.

c. If all wealth is invested in the market portfolio. Additionally the investor borrows one
invest in the market portfolio.

Rf 12
Rm 20
SD(m) 25

a Return 12
Risk 0

b Rf Rm Rp
Weight
s 0.6667 0.3333 1.0000
Return 12 20 14.6666666667
Sd 0 25 8.33333333333

Return
Risk

c Rf Rm
Weight
s -0.33 1.33
Return 12 20
Sd 0 25

Return 22.6666666667
Risk 33.3333333333
e market portfolio of securities has an
mine the expected return and standard

ket portfolio.

estor borrows one third of his wealth to

Given the following risky portfolios:
ParticulA B C D E F
Return (10 12.5 15 16 17 18
sd (%) 4 5 12 4 5 6
(a) Which of the portfolios are efficient and which are inefficient?
Suppose one can tolerate a risk upto 12%, what is the maximum return one can
(b)
achieve if no borrowing or lending is resorted to?

(c) Suppose one can tolerate a risk upto 12%, what is the maximum return one can
achieve if borrowing or lending at a rate of 12% is resorted to?

a A, B and C are inefficient

b Maximum return possible for a risk up to 12% is 18%

c Combining Rf and F

Rf F
Weights -1 2
Return 12% 18%
Sd 0 6%

Return 24.00%
Risk 12.00%

Combining Rf and E Combining Rf and D

Rf E Rf D
Weights -1.4 2.4 Weights -2 3
Return 12% 17% Return 12% 16%
Sd 0 5% Sd 0 4%

Return 24.00% Return 24.00%

Risk 12.00% Risk 12.00%
nt?
mum return one can

mum return one can

to?

A security is inefficient if:

1) The other security offers higher returns at lower risk
2) The other security offers same returns at lower risk
3) The other security offers higher return at same risk

Risk return return

4 10 20
5 12.5 18
16
12 15 14
4 16 12
5 17 10
8
6 18 6
4
2
0
3 4 5 6 7 8 9 10 11 12 13

return
 Rf D

weights -2 3
return 12% 16%
risk 0% 4%

return 0.24
risk 0.12

Rf E
weights -1.4 2.4
return 12% 17%
risk 0% 5%

return 0.24
risk 0.12

11 12 13
Consider a portfolio that offers an expected return of 12% and standard
deviation (SD) of 18%.T-bills offer a risk-free rate of 7%. Determine the
maximum level of risk aversion for which a risky portfolio is still preferred
to bills.

Solution U=Rf= 7% Var= 0.0324

U= E(r)-0.5*A*Var
7%= 12%- 0.5*A*0.0324
0.07= 0.12- 0.5*A*0.0324
A= 3.08642
a) Draw an indifference curve in the expected return – SD plane corresponding to a utility level of 5% for an
investor with a risk aversion coefficient of 3. Select SD range from 5% to 25% and determine the expected return
that provides utility of 5%. Then plot returns against corresponding SDs.
b) Now draw the curve for Utility level of 5% for an investor with a risk aversion coefficient of 4. Compare answers
to a)
c) Draw an indifference curve for a risk-neutral investor providing utility level of 5% i.e. A = 0
d) What must be true about the sign of the risk aversion coefficient, A, for a risk lover? Draw the indifference curve
for a risk lover for a utility level of 5%, assume A = -4

E(R)
16.00%
E(R)= U+0.5*A*SD^2 14.00%
12.00%
Solution
10.00%
a)
8.00%
A U SD E(R) A
6.00%
3 5% 5% 5.38%
4.00%
3 5% 10% 6.50%
2.00%
3 5% 15% 8.38% 0.00%
3 5% 20% 11.00% 0% 5% 10% 15% 20% 25% 30%
3 5% 25% 14.37% E(R)

A U SD E(R) A E(R)
20.00%
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
b) 4.00%
A U SD E(R) 2.00%
4 5% 5% 5.50% 0.00%
0% 5% 10% 15% 20% 25% 30%
4 5% 10% 7.00%
4 5% 15% 9.50% E(R)

4 5% 20% 13.00%
4 5% 25% 17.50%
The utility curve for A=4 is steeper as compared to that of A=3, as higher risk aversion requires higher risk premium

U = 5%

c)

Utility curve for a risk neutral investor, is a flat curve as utility is unaffected by the risk involved in the investment
 A U SD E(R)
0 5% 5% 5.00%
0 5% 10% 5.00%
0 5% 15% 5.00%
0 5% 20% 5.00%
0 5% 25% 5.00%

d)

A risk lover derives maximum utility for maximum level of risk and hence his aversion factor is negative, making the
utility curve sloping downward
assume A = -4
A U SD E(R) E(R)
-4 5% 5% 4.50% 6.00%
-4 5% 10% 3.00%
4.00%
-4 5% 15% 0.50%
-4 5% 20% -3.00% 2.00%
-4 5% 25% -7.50% 0.00%
0% 5% 10% 15% 20% 25% 30%
-2.00%
-4.00%
-6.00%
-8.00%
-10.00%

E(R)
 – SD plane corresponding to a utility level of 5% for an
D range from 5% to 25% and determine the expected return
corresponding SDs.
nvestor with a risk aversion coefficient of 4. Compare answers
Scatter Diagram Chart
tor providing utility level of 5% i.e. A = 0 SD, ER
ion coefficient, A, for a risk lover? Draw the indifference curve

E(R)
16.00%
14.00%
12.00%
10.00%
8.00%
U SD E(R)
6.00%
4.00%
2.00%
0.00%
Sd A=3
0% 5% 10% 15% 20% 25% 30% 5.00% 5.38%
E(R) 10.00% 6.50%
15.00% 8.38%
E(R)
U SD E(R) 20.00% 11.00%
25.00% 14.37%
20.00%
18.00%
16.00%
14.00%
Cha
12.00% 20.00%
10.00%
8.00% 15.00%
6.00%
4.00% 10.00%
2.00%
0.00% 5.00%
0% 5% 10% 15% 20% 25% 30%
0.00%
E(R) 0.00% 5.00% 10.00%
-5.00%

-10.00%
at of A=3, as higher risk aversion requires higher risk premium
A=3 A =4

E(R)
6.00%

5.00%
as utility is unaffected by the risk involved in the investment
4.00%

3.00%

2.00%

1.00%
 5.00%

4.00%

3.00%

2.00%

1.00%

0.00%
0% 5% 10% 15% 20% 25% 30%

E(R)

vel of risk and hence his aversion factor is negative, making the

for explanation
E(R) E(R) U
%
%
%
%
0% 5% 10% 15% 20% 25% 30%
%
%
%
%
%

E(R)
 A =4 A=0 A = -4
5.50% 5.00% 4.50%
7.00% 5.00% 3.00%
9.50% 5.00% 0.50%
13.00% 5.00% -3.00%
17.50% 5.00% -7.50%

Chart Title
%

%
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00%
%

A=3 A =4 A=0 A = -4
20% 25% 30%
Given portfolio weights of Bills (5% return) ranging from 0 to 1, and for the S&P 500 stock
index ranging (13.5% return and 20% SD) from 1 to 0 respectively, calculate utility levels at each weighting for an investor
with A=3. What do you conclude?
Repeat with investor who has A=5.
Use Markowitz Model
Solution

For Utility calculation, we need E(R), SD and A.

We calculate SD of the portfolio at various weightages of T-bills and S&P
500 stock index.

Cases Weights E(R) σP σP2 U (A=3) U (A=5)

T-bills S&P 500 3 5
stock
index

Case 1 0% 100% 13.500% 20.00% 0.04 0.0750 0.0350 0.0796

Case 2 20% 80% 11.800% 16.00% 0.03 0.0796 0.0540 0.0680
Case 3 40% 60% 10.100% 12.00% 0.01 0.0794 0.0650
Case 4 60% 40% 8.400% 8.00% 0.01 0.0744 0.0680
Case 5 80% 20% 6.700% 4.00% 0.00 0.0646 0.0630
Case 6 100% 0% 5.000% 0.00% 0.00 0.0500 0.0500

An investor with A=3 will have higher utility as compared to investor with A=5
weighting for an investor

When T-bill is in a 2 sec P/f = Risk (Sd) = sqrt(W1^2*SDp^2)

Author:
Covariance of a risky free asset with a risky asset is ZERO.
Cov1,2 = Corr*SD1*SD2
Cov1,2 = Corr*SD1*SDt-bill
Cov1,2 = Corr*SD1*0

ER = Weighted Average

Return
Tbills Ret S&P500
5% 13.50%
Risk
0% 20.00%
Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either Rs. 70,000 or Rs.
200,000 with equal probabilities of 0.5. The alternate risk free investment in T-bills pays 6%.
a. If you require a risk premium of 8%, how much will you be willing to pay for the portfolio?
b. Suppose that the portfolio can be purchased for the amount you found in (a). What is the expected return on the
portfolio?
c. Now suppose that you require a risk premium of 12%. What is the price that you will be willing to pay?
d. Comparing your answers in (a) and (c), what do you conclude about the relationship between the required risk
premium on a portfolio and the price at which the portfolio will sell?

Solution

FV = PV of all future CFs

Return = RFR +Risk premium = 6%+8%= 14%
PV = 118421.05

ER on portfolio is 14%

year CFs
0 -118421
1 135000

ER= 14%

Return = RFR +Risk premium = 6%+12%= 18%

PV = 114406.78

ER on portfolio is 14%

year CFs
0 -114407
1 135000

ER= 18%

High risk premium will lead to low portfolio valuation

derived from the portfolio will be either Rs. 70,000 or Rs.
risk free investment in T-bills pays 6%.
you be willing to pay for the portfolio?
e amount you found in (a). What is the expected return on the Note:
Risk premium Price
2%. What is the price that you will be willing to pay? 8% 118421
u conclude about the relationship between the required risk
12% 114407
rtfolio will sell?
d. For a given expected cash flow, portfolios that com
premia must sell at lower prices. The extra discount f
is a penalty for risk.
ed cash flow, portfolios that command greater risk
ower prices. The extra discount from expected value
You manage a risky portfolio with expected rate of return of 18% and SD of 28%. The T-bill offers 8%.

Question A:
Your client chooses to invest 70% of a portfolio in your fund and 30% in t-bill money market fund. What is the expected value
SD of the rate of return on his portfolio?

Solution A:

Expected return = 15.000%

Standard deviation = 19.600%

Question B:
Now suppose that your risky portfolio includes the following investments in the given proportions:
Stock A - 25%
Stock B - 32%
Stock C - 43%
What are the Investment proportions of your client`s overall portfolio, including the position in T-bills if above data is applied.

Solution B:
A= 17.500%
B 22.400%
C 30.100%
T bill 30%

Question C:
What is the reward to volatility ratio (S) of your risky portfolio and your clients?

Solution C:
Reward to Volatility Ratio is popularly known as Sharpe Ratio (S).
Sharpe Ratio = (Rp - Rf)/ SD
Sharpe Ratio of Fund mgr
Sharpe Ratio of client = 0.357 For 1% volatility the investor earns 0.357% risk premium
Question D:
Draw the Capital Allocation Line (CAL) of your portfolio on an expected return-SD diagram. What is the slope of CAL? Show the
position of your client on your funds CAL.

Solution D:

Chart Title
20.00%
18.00%
SD E('R) Rf Wrf 16.00% Wrisky
0.00% 8.00% 8.00% 14.00%
1 0
12.00%
5.60% 10.00% 8.00% 0.8 0.2
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
 18.00%
16.00%
14.00%
12.00%
10.00%
8.40% 11.00% 8.00% 0.7 0.3
8.00%
14.00% 13.00% 8.00% 0.5
6.00% 0.5
19.60% 15.00% 8.00% 0.3
4.00% 0.7
28.00% 18.00% 8.00% 0
2.00% 1
0.00%
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.0

Slope of CAL= 0.3571429 E('R) Rf

Same as Sharpe Ratio

Slope
(Sharpe) 0.357142857142857

Question E:
Suppose that your client decides to invest in your portfolio a proportion y, of the total investment budget so that the overall
portfolio will have an expected return of 16%.
A. what is your proportion y?
B. what are your clients investment proportions in your three stocks and t-bill fund?
c. What is the Standard deviation of the rate of return on your client’s portfolio?

Solution E:
a)
E('R) = 16%

(y x 18%) + ((1-y) x 8%) = 16%

Solving the above equation, we get

y 80%

b)
The client shall invest 80% in the risky portfolio and remaining 20% in T-bills.
T-bills 20%
Stock A 20.0%
Stock B 25.6%
Stock C 34.4%
100% SDc = W*SDp
c)
Using formual for SD of a portfolio, we get
σP2 =WA2σA2+WB2σB2 +2WAWBσAB

SD 22.400%

Question F:
Suppose that your client prefers to invest in your fund a proportion y that maximizes the expected return on the complete por
subject to the constraint that the complete portfolio standard deviation will not exceed 18%
a. What is the investment proportion in y?
b. What is the expected rate of return on your client’s portfolio?

Solution F:

a)
SDc = 18%

Using formual for SD of a portfolio, we get

σP2 =WA2σA2+WB2σB2 +2WAWBσAB

σP2 =((y2)*(28%2))+((1-y)2*(02)) +(2*y*(1-y)*0)

18%^2 = 28%^2*y^2

y 64.29%

We get y = 64.29%

b)
E('R) 14.428571428571400%
nd SD of 28%. The T-bill offers 8%.

% in t-bill money market fund. What is the expected value and

ments in the given proportions:

io, including the position in T-bills if above data is applied.

Return
Risk
our clients?

investor earns 0.357% risk premium

ted return-SD diagram. What is the slope of CAL? Show the

Chart Title

30
CAL (Slope = 0.3571)
25

20

E(r)% P
15
Client
10
 30
CAL (Slope = 0.3571)
25

20

E(r)% P
15
Client
10

5
5.00% 10.00% 15.00% 20.00% 25.00% 30.00%
0
E('R) Rf 0 10 20 30 40



rtion y, of the total investment budget so that the overall

s and t-bill fund?

t’s portfolio?
 SDc = W*SDp

y that maximizes the expected return on the complete portfolio

ation will not exceed 18%
Use the below data and answer the questions:
Utility Formula data A=4
Investment E(R) SD
1 0.12 0.3
2 0.15 0.5
3 0.21 0.16 homework
4 0.24 0.21

a) Based on the utility formula, which investment would you select if you were
risk averse with A = 4
b) Based on the utility formula above, which investment would you select if you
were risk neutral

Solution

Using formula for utility,

U = E('R) - 0.5*A*SD^2
Utility Formula data U U
Investment E(R) SD A=4 A=0
1 0.12 0.3 -6% 12%
2 0.15 0.5 -35% 15%
3 0.21 0.16 16% 21%
4 0.24 0.21 15% 24%
You manage an equity fund with an expected risk premium of 10% and an expected SD of 14%. The
rate on treasury bills is 6%. You client chooses to invest $60,000 of her portfolio in your equity fund
and $40,000 in a t-bill money market fund. What is the expected return and SD on your client’s
portfolio?

homework
Solution :
Expected return for equity fund = T-bill rate + risk premium
= 6% + 10% = 16%

Expected return of client’s overall portfolio = (0.6 × 16%) + (0.4 × 6%) = 12%

Standard deviation of client’s overall portfolio = 0.6 × 14% = 8.4%

What is the reward to volatility ratio for the equity fund

Solution:
Sharpe Ratio 71.43%
Capital Asset Pricing Model/Securities market line

Capital market line

 M S S.M M^2
Year Nifty X Ltd
1 12% 14% 2% 1.44%
2 13% 15% 2% 1.69%
3 -12% -34% 4% 1.44%
4 11% 6% 1% 1.21%
5 5% 7% 0% 0.25%
6 8% 2% 0% 0.64%
7 34% 32% 11% 11.56%
8 23% -12% -3% 5.29%
9 -27% 10% -3% 7.29%
67% 40% 14% 30.81%

Beta 0.4385 0.4385

P M S P.S P.M P.S.M P.M^2

Prob. Nifty X Ltd
0.1 12% 14% 0.014 0.012 0.00168 0.00144
0.05 13% 15% 0.0075 0.0065 0.000975 0.000845
0.15 -12% -34% -0.051 -0.018 0.00612 0.00216
0.03 11% 6% 0.0018 0.0033 0.000198 0.000363
0.06 5% 7% 0.0042 0.003 0.00021 0.00015
0.13 8% 2% 0.0026 0.0104 0.000208 0.000832
0.17 34% 32% 0.0544 0.0578 0.018496 0.019652
0.16 23% -12% -0.0192 0.0368 -0.004416 0.008464
0.15 -27% 10% 0.015 -0.0405 -0.00405 0.010935
1 0.0293 0.0713 0.019421 0.044841

beta= 0.435943
a) Assume : The risk-free interest rate is 9%
The expected return on the market portfolio is 18%.
If a security has a beta factor of (a) 1.4, (b) 1.0, or (c) 2.3, find out the expected return
capital asset.
b) The following data relate to two securities, A and B
Particu
Security A Security B
lars
Expecte
d 22% 17%
return
Beta 1.512 0.72
factor
Assume: The risk –free interest rate is, 10%
The expected return on the market portfolio is, 18%

Find out the required return and also comment on the pricing as under valued, over valued or o

Solution:
Beta 1.4 1 2.3
Rf 9% 9% 9%
Rm= 18% 18% 18%
Req. Return= 21.60% 18.00% 29.70%

b Sec A Sec B
Expected Ret 22.00% 17% Investor expectation/actual retu
Req. return as per CAPM 22.10% 15.76% SML
Result overvalued undervalued
 the expected return on any
CAPM SUMS

Move to PPT for CAPM and CML then sums

alued, over valued or otherwise.

expectation/actual return
then sums
An investor is seeking the price to pay for a security, whose standard deviation is 3.00
percent. The correlation coefficient for the security with the market is 0.8 and the
market standard deviation is 2.2 percent. The return from government securities is 5.2
percent and from the market portfolio is 9.8 percent. The investor knows that, by
calculating the required return, can he determine the price to pay for the security. What
is the required return on the security? What is the required return, if correlation
coefficient is not given?
Rf 5.20%
Rm 9.80%
Correlatio 0.8
SD(m) 2.20%
Sd(S) 3%

Beta 1.0909

Required Return as per CAPM 10.2182% risk premium for only systematic risk

Required Return as per Capital Market line 11.47% risk premium for unsystematic risk
 CAPM
viation is 3.00
8 and the
ecurities is 5.2
s that, by
security. What
relation
An investment advisor has been monitoring the equity share of Spicy Foods Ltd. (SFL) over the past one year. On th
his assessment of the fundamentals of the company and his expectations on the stock market conditions during the
months, he has provided the following projections:

Return Return on
Probability from SFL the Market
shares index
(%) (%) (%)
10 10 12
15 16 16 Ri = Sum (Pi*Ri)
20 20 18 Sdi = Sqrt(pi*Ri^2- ER^2)
25 16 22
20 30 24
10 36 30
You are required to calculate the following:
a. The expected return and risk of the SFL share.
b. The expected return and risk of the market index.
c. The beta coefficient of the SFL share.
d. Whether share price is overpriced or underpriced assuming Risk Free rate of 5%

Return Return on
Probability from SFL the Market P*S P*M P*S^2 P*M^2 P*S*M
shares index
(%) (%)
0.1 10 12 1 1.2 10 14.4 12
0.15 16 16 2.4 2.4 38.4 38.4 38.4
0.2 20 18 4 3.6 80 64.8 72
0.25 16 22 4 5.5 64 121 88
0.2 30 24 6 4.8 180 115.2 144
0.1 36 30 3.6 3 129.6 90 108
21 20.5 502 443.8 462.4

SFL Market
Return 21.00 20.50
Risk 7.81 4.85
Beta 1.35
Required Return 26.00
Stock is over valued
) over the past one year. On the basis of
market conditions during the next six

homework

e rate of 5%
The following table gives an analyst’s expected return on two shares for particular market retu

Market Aggressive Defensive

Return share share
6% 2% 8%
20% 30% 16%
1 What are the betas of the two share?
What is the expected return on each share if the market return is equally likely to b
2 or 20%?
If the risk-free rate is 7% and the market return is equally likely to be 6% or 20% w
3 the SML?

4 What are the alphas of the two shares?

1 Beta of AggressiveBeta of Defensive

2.00 0.57

2 Expected Return
Aggressive 16.00%
Defensive 12.00%
3 Expected Return of Market 13% Rm
SML
of Aggressive 19.00% Req return
of Defensive 10.43% Req return
Rp - CAPM Rp - Rm
4 Alphas Jens Al Alp
of Aggressive -3.00% 3.00%
of Defensive 1.57% -1.00%
for particular market return:

return is equally likely to be 6%

y likely to be 6% or 20% what is

You are analyzing a Portfolio consisting of 4 securities. Data are:
Beta of Expected Amount in
invested
Security
Return Million
security (%) (Rs.)
A 1.4 16 3.8
B 0 6 5.2
C 0.7 10 6.1
D 1.1 13 2.9
Calculate portfolio return and beta and analyse the individual securities. Rm = 10%,
Risk free rate = 6%

Expected Amount in
Beta of
invested
Security
security Return Million Weights Required Decision
(%) (Rs.) Return
A 1.4 16% 3.8 21.11% 11.6% Buy
B 0 6% 5.2 28.89% 6.0% Hold
C 0.7 10% 6.1 33.89% 8.8% Buy
D 1.1 13% 2.9 16.11% 10.4% Buy

Rm 10%
Rf 6%
Portfolio Return (Expected) 10.594%
Portfolio Beta 0.71
Portfolio Required Return 8.84%
Rm = 10%,
You have Rs. 5,00,000 to invest in a stock portfolio. Your choices are stock A where you
invest Rs. 1,40,000, stock B where you invest Rs. 1,60,000 and stock C and risk free asset
where you invest the balance. Given the beta of stock A is 0.9, stock B 1.2 and that of
stock C is 1.6 and the overall beta is that of the whole market, how much money you will
invest in stock C and risk free asset.

Solution:
Stock Amount Beta
A 140000 0.9
B 160000 1.2
C 113750 1.6
Rf 86250 0 Use Solver

Weighted Beta 1
ck A where you
nd risk free asset
2 and that of
money you will
A stock has beta of 1.6 and an expected return of 16%. A risk free asset currently earns 5%.
(a) What is the expected return of portfolio of two assets invested in equal proportion?
(b) If a portfolio of the two assets has a beta of 0.6, what are the portfolio weights?
(c) If a portfolio of the assets has an expected return of 11%, what is its beta?
(d) If a portfolio of the two assets has a beta of 3.2, what are the portfolio weights

Return Beta
Stock 16% 1.6
Rf 5% 0

a Portfolio Return 10.50%

b Return Beta Weights Product

Stock 1.6 0.375 0.6 Use Goal Seek
Rf 0 0.625 0
Portfolio Beta 0.6
c

Return Beta Weights Product

Stock 16% 1.6 0.54545 0.08727
Rf 5% 0 0.45455 0.02273 Use Goal Seek
11.00% portfolio return
Return 0.87273 Portfolio beta

d Return Beta Weights Product

Stock 1.6 2 3.2 Use Goal Seek
Rf 0 -1 0
3.20
Weightage of -1 for Rf means we should borrow amount equal to our investme
urrently earns 5%.
n equal proportion?
tfolio weights?
s its beta?
e the portfolio weights? How do you interpret the weights?

t equal to our investment

Mr. X is attempting to evaluate two possible portfolios, which contains the same set of five assets but in differe
interested in using beta to compute the risks of the portfolios. So he has gathered the following information:

Stock Beta Portfolio A Portfolio B

Essar Shipping 1.3 10% 30%
Clariant 0.7 30% 10%
Vijaya bank 1.25 10% 20%
M&M 1.1 10% 20%
BSAF 0.9 40% 20%
(a) Calculate betas of portfolio A and B.
(b) Which portfolio is more risky?
(c) If Mr. X sells Essar shipping, which portfolio is more risky?
(d) If Mr. X replaces Essar shipping with Clariant, which portfolio is more risky?

a Beta of Portfolio A 0.935

Beta of Portfolio B 1.11

b Portfolio B is more risky

c
Stock Beta Portfolio A Portfolio B Stock

Essar Shipping 1.3 0% 0% Essar

Shipping
Clariant 0.7 30% 10% Clariant
Vijaya bank 1.25 10% 20% Vijaya bank
M&M 1.1 10% 20% M&M
BSAF 0.9 40% 20% BSAF
Cash 0 10% 30%
Beta 0.805 0.72 Beta
MORE RISKY LESS RISKY
set of five assets but in different proportions. He is particularly
the following information:

more risky?

Beta Portfolio A Portfoli

oB

1.3 0% 0%
0.7 40% 40%
1.25 10% 20%
1.1 10% 20%
0.9 40% 20%

0.875 0.93
less risky more Risky
0
P Ltd. has an expected return of 22% and Standard deviation of 40%. Q Ltd. has an expected
return of 24% and standard deviation of 38%. P has a beta of 0.86 and Q 1.24. The
correlation between the returns of P and Q is 0.72. The standard deviation of the market
return is 20%.

(a) Is investing in Q better than investing in P

If you invest 30% in Q and 70% in P , what is your expected rate of return and the
(b) portfolio standard deviation?
(c) What is the market portfolio’s expected rate of return and how much is the risk-free
rate?
(d) What is the beta of portfolio if P’s weight is 70% and Q is 30%?

P Q
Return 22% 24%
SD 40% 38%
Beta 0.86 1.24
Correl 0.72
SD(m) 20%

a Yes since return is higher with lower total risk

b P Q
Return 22% 24%
Weights 70% 30%
Expected
Return 22.60%
SD 37.06%
RF= 17.47%
RM= 22.74%

c P Q
Return Use Solver Return 22% 24%
SD Beta 0.86 1.24
Beta Rf 17.47% 17.47%
Correl Rm 22.74% 22.74%
SD(m) Return 22.00% 24.00%
SET OBJ TO 22%

d Beta of portfolio based on C

0.974
has an expected
4. The
f the market

return and the

h is the risk-free

Constraint to 24%
 Mr. Tempest has the following portfolio of four shares:
Investment Rs.
Name
Beta Lac.
Oxy Rin Ltd. 0.45 0.8 homework
Boxed Ltd. 0.35 1.5
Square Ltd. 1.15 2.25
Ellipse Ltd. 1.85 4.5
The risk free rate of return is 7% and the market rate of return is 14%.
Required.
(i) Determine the portfolio return.
(ii) Calculate the portfolio Beta.

Investment Rs. Required

Name Weights Product Port. Beta
Beta Lac. return
Oxy Rin Ltd. 0.45 0.8 0.1015 0.0884 0.0090 0.0398
Boxed Ltd. 0.35 1.5 0.0945 0.1657 0.0157 0.0580
Square Ltd. 1.15 2.25 0.1505 0.2486 0.0374 0.2859
Ellipse Ltd. 1.85 4.5 0.1995 0.4972 0.0992 0.9199
9.05 16% 1.30
The following information is available in respect of Security X
Equilibrium Return 15%
Market Return 15%
7% Treasury Bond Trading at : $140
Covariance of Rm and Ri 225%
Coefficient of Correlation 0.75
You are required to determine the Standard Deviation of Market Return and Security Return.

Ri 15%
Rm 15%
Rf 5%
Beta 1
SD(m) 1.5
SD(s) 2
 homework

rn and Security Return.

Assuming that shares of ABC Ltd. and XYZ Ltd. are correctly priced according to Capital Asset P
The expected return from and Beta of these shares are as follows:

Expecte
Share Beta
d return

ABC 1.2 19.80%

XYZ 0.9 17.10%
You are required to derive Security Market Line.

Solution:

Share Beta Expecte Rm Rf Security Use

d return Return Solver

ABC 1.2 19.80% 18.00% 9.00% 19.80%

XYZ 0.9 17.10% 18.00% 9.00% 17.10%

SML 9%+Beta*(18%-9%)
g to Capital Asset Pricing Model.
XYZ Ltd. has substantial cash flow and until the surplus funds are utilised to meet the future ca
invested in a portfolio of short term equity investments, details for which are given below:

Market
Invest No. of Beta price per Expected
ment shares yield
share
I 60,000 1.16 4.29 19.50%
II 80,000 2.28 2.92 24.00%
III 100,000 0.9 2.17 17.50%
IV 125,000 1.5 3.14 26.00%
The current market return is 19% and the risk free rate is 11%.
Required to:
(i) Calculate the risk of XYZ’s short-term investment portfolio relative to that of the marke
(ii) Whether XYZ should change the composition of its portfolio.

Invest No. of Market Expected Weighted Expected

Beta price per
ment shares share yield Beta Yield

I 60,000 1.16 4.29 19.50% 0.27 0.05

II 80,000 2.28 2.92 24.00% 0.48 0.05
III 100,000 0.9 2.17 17.50% 0.18 0.03
IV 125,000 1.5 3.14 26.00% 0.53 0.09
1.47 0.22
Portfolio BeExpected Portfolio Return
Portfolio is more risky as compared to Market

Required Porfolio Return 0.23

Since Expected return is lower than required return Portfolio composition should be c
Security I,II,III shouyld be divested
utilised to meet the future capital expenditure, likely to happen after several months, are
r which are given below:

homework

o relative to that of the market;

lio.

Required Overvalued/
Return Undervalued

0.2028 over
0.2924 over
0.182 over
0.23 Under

pected Portfolio Return

olio composition should be changed

onths, are
An investor holds two stocks A and B. An analyst prepared ex-ante probability distribution for the possible econom
market index as shown below:

Economic scenario Probability Conditional Returns %

A B Market
Growth 0.4 25 20 18
Stagnation 0.3 10 15 13
Recession 0.3 -5 -8 -3

The risk free rate during the next year is expected to be around 11%. Determine whether the investor should liquida
and B or on the contrary make fresh investments in them. CAPM assumptions are holding true.

Probability A B Market P*A P*A^2 P*B

0.4 25 20 18 10 250 8
0.3 10 15 13 3 30 4.5
0.3 -5 -8 -3 -1.5 7.5 -2.4
11.5 287.5 10.1

Beta (A) 1.3449848

Beta (B) 1.3510638

Required Return (A) 9.9240122 Expected return 11.5

Required Return (B) 9.9191489 Expected return 10.1

Investor should INVEST as both A and B are under valued

 for the possible economic scenarios and the conditional returns for two stocks and the

homework

e investor should liquidate his holdings in stocks A

rue.

P*B^2 P*M P*M^2 P*A*M P*B*M

160 7.2 129.6 180 144
67.5 3.9 50.7 39 58.5
19.2 -0.9 2.7 4.5 7.2
246.7 10.2 183 223.5 209.7
A Portfolio Manager (PM) has the following four stocks in his portfolio:
Market
Securit No. of Price β
y Shares pershare
(Rs.)
VSL 10,000 50 0.9
CSL 5,000 20 1
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:
(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment should he brin
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment should he br

Solution
Market
Securit No. of Price Invest Weight
y Shares pershare ment β ed Beta
(Rs.)
VSL 10,000 50 500000 0.9 0.37500
CSL 5,000 20 100000 1 0.08333
SML 8,000 25 200000 1.5 0.25000
APL 2,000 200 400000 1.2 0.40000
Rf
1200000 1.10833

Market
Securit No. of Price Invest β Weight
y Shares pershare ment ed Beta
(Rs.)

VSL 10,000 50 500000 0.9 0.27068

CSL 5,000 20 100000 1.0 0.06015
SML 8,000 25 200000 1.5 0.18045
APL 2,000 200 400000 1.2 0.28872
Rf 462500 0 0.00000
1662500 0.8 Set obj to 0.8
 Market
Securit No. of Price Invest Weight
β
y Shares pershare ment ed Beta
(Rs.)
VSL 10,000 50 500000 0.9 0.40602
CSL 5,000 20 100000 1.0 0.09023
SML 8,000 25 200000 1.5 0.27068
APL 2,000 200 400000 1.2 0.43308
Rf -91666.67 0 0.00000
1108333 1.20000
o:

Beta-CAPM

nvestment should he bring in?

investment should he bring in?

Market
Securit No. of Price Invest β Weight WB
y Shares persha ment
re (Rs.)

VSL
CSL
SML
APL
Rf
Year Jay kay Ltd. Market
Ret on
Share Stock Market
DPS Index Div yield GOI
price return Return
Bonds
2002 242 20 1812 4% 6%
2003 279 25 1950 5% 5% 25.62% 12.62%
2004 305 30 2258 6% 4% 20.07% 21.79%
2005 322 35 2220 7% 5% 17.05% 5.32%
Compute beta value of the company at the end of 2005.
 homework

BETA

Beta= 0.1501878
The returns on stock A and market portfolio for a period of 6 years are as follows:
Return on
Return on
Year market A (%)
portfolio (%)
1 8 12 SIM
2 12 15
3 11 11
4 -4 2
5 9.5 10
6 -2 -12
You are required to determine:
(i) Characteristic line for stock A Ri = Alpha + Beta* Rm + Ei
(ii) The systematic and unsystematic risk of stock A. Returns Ri = -0.577+1.2019*Rm + 0

σi2 = βi2* σm2 + σei2

SUMMARY OUTPUT total risk 0
syste Risk 0
unsys risk 0
e as follows:

Ri = Alpha + Beta* Rm + Ei
Ri = -0.577+1.2019*Rm + 0

σi2 = βi2* σm2 + σei2

Rm Rs Rs= Beta*Rm+ Alpha
8 12 Y=mx+c
12 15 Step 1: Mean returns of Sec and market
11 11 Step 2: Beta (using slope function)
-4 2 Step 3: Rs-mean(Rs)=beta*[Rm-mean(Rm)]
9.5 10
-2 -12

Step1: Mean (Rs)= 6.33

Mean (Rm)= 5.75

Step 2: Beta= 1.2019

Step 3: Rs-mean(Rs)=beta*[Rm-mean(Rm)]
Rs-6.33= 1.2019 *(Rm-5.75)
Rs= 1.2019 Rm- 6.9107 `+6.33
Rs= 1.2019 Rm -0.5774

Rs= 1.2019 Rm -0.5774 single index line/regression line/line of best fit

Rm Estimated Rs Actual Rs error

8 9.038 12 2.962 Chart Title
12 13.845 15 1.155 20.000
11 12.643 11 -1.643 15.000
-4 -5.385 2 7.385 10.000
9.5 10.840 10 -0.840 5.000
-2 -2.981 -12 0.000
-9.019 -6 -4 -2 0 2 4 6 8 10 12 14
-5.000
0.000
-10.000
-15.000

Estimated Rs Actual Rs
LHS= var(S)= 82.889 Total risk

RHS= Beta^2*var(m)= 57.99 Sys Risk

Var (e)= 24.899 Unsys Risk
82.889

What prop of total risk is systematic risk= 69.96% (R squared)

The following details are given for X and Y companies stocks and the BSE sensex for a
period of one year. Calculate the systematic and unsystematic risk for the companies
stocks. If equal amount of money is allocated for the stocks what would be the portfolio
risk?
Particulars X stock Y stock Sensex
Average
return 0.15 0.25 0.06
Variance of
return 6.3 5.86 2.25
Beta 0.71 0.685
Coefficient of determination = 0.18.

σi2 = βi2* σm2 + σei2

Variance of Stock Returns= Beta^2 *Var(m) + Var(residuals)
Var(X) = + Var(residuals)
Var(residuals)
Var(residuals) =

Systematic Risk (X)

Unsystematic Risk
Total

Alternatively:
Systematic risk = Total Risk * R2
1.134

σp2 = β2p* σ2m + Σ(w2i*σ2ei) weights square*Var of ei

Total Risk = σp2 = βp2* σm2 + σep2
Weights
Port Beta = Note: Covariance of Unsystematic risk is always 0
Var M as each stocks abnormal event is related to itself only
Var unsys ei is error term/random returns - firm specific
total risk
However, there is a covariance of systematic risk as
covariance is a part of BETA, which is a part of
Systematic risk = βi2* σm2
E sensex for a
e companies
be the portfolio
SIM

Variance of Stock Returns=Beta^2 *Var(m) + Var(residuals)

Var(Y) = + Var(residuals)
= + Var(residuals)
Var(residuals) =

Systematic Risk (X)

Unsystematic Risk
Total

sk is always 0
ated to itself only
m specific

stematic risk as
s a part of
A study by a Mutual fund has revealed the following data in respect of three securities:

Correlation with
Security SD (%) Index, Pm
A 20 0.6
B 18 0.95 BETA = COV(Ri,Rm) / Var M
C 12 0.75
The standard deviation of market portfolio (BSE Sensex) is observed to be 15%.
(i) What is the sensitivity of returns of each stock with respect to the market?
(ii) What are the covariances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks equally?
(iv) What is the beta of the portfolio consisting of equal investment in each stock?
(v) What is the total, systematic and unsystematic risk of the portfolio in (iv) ?

1A Beta = Correl*SD1*SDm / SDm^2

B
C
2 Covariances
AB Covariance (ri, rj) = βiβj σm2
BC Covariance are expressed in % squ
AC 0.02052 needs to be multiplied by

3
Portfolio Variance

4 Portfolio Beta σp2 = βp2* σm2 + σep2

Systematic Risk
Total Risk
Unsystematic Risk
 hree securities:
SIM

OV(Ri,Rm) / Var M

o be 15%.
t to the market?

ee stocks equally?
ment in each stock?
ortfolio in (iv) ?

rel*SD1*SDm / SDm^2

e (ri, rj) = βiβj σm2

e are expressed in % squared, therefor
eeds to be multiplied by 10000 and not 100
Following are the details of a portfolio consisting of three shares:
Portfolio Expected Total
Share Beta
weight return in % variance
A 0.2 0.4 14 0.015
B 0.5 0.5 15 0.025
C 0.3 1.1 21 0.1
Standard Deviation of Market Portfolio Returns = 10%
You are given the following additional data:
Covariance (A, B) = 0.030 0.03
Covariance (A, C) = 0.020 0.02
Covariance (B, C) = 0.040 0.04
Calculate the following:
(i) The Portfolio Beta
(ii) Residual variance of each of the three shares
(iii) Portfolio variance using Sharpe Index Model
(iv) Portfolio variance (on the basis of modern portfolio theory given by Markowitz)

1 Portfolio Beta

2 Systematic Risk Residual Variance

A
B
C

3 Portfolio Variance using sharpe Index Model

Systematic Risk
Unsystematic Risk σp2 = β2p* σ2m + Σ(w2i*σ2ei)
Total Variance

4 Portfolio Variance using Markowitz Model

 SIM

by Markowitz)

(w2i*σ2ei) weights square*Var of ei

A has portfolio having following features:

Security β Random Weight

Error σei
L 1.6 7 0.25 homework
M 1.15 11 0.3
N 1.4 3 0.25
K 1 9 0.2
You are required to find out the risk of the portfolio if the standard deviation of the market ind

Portfolio Beta 1.295

Systematic Risk of Portfolio 543.36

Unsystematic Risk of Portfolio (variance) 17.755

Total Risk 561.11

 SIM

of the market index (σm) is 18%

The estimated factor sensitivity of TEC to the five macro economic factors are given in th

Factor Risk premium

Factor sensitivity (%)
Confidence risk 0.25 2.59
Time horizon risk 0.3 -0.66
Inflation risk -0.45 -4.32
Business cycle risk 1.6 1.49
Market timing risk 0.8 3.61
Use APT model to calculate the required rate of return for TEC. The treasury bill rate is 4.1%.

SOLUTION
Required Return (excess return) %

Ri = αi + βiGDP *(GDP factor risk premium) + βiIR *(Int. factor risk premium)+..+ ei
OR

ri-rf = βiGDP *(GDP factor risk premium) + βiIR *(Int. factor risk premium)+..+ ei
Where, αi = Intercept or RF rate
tors are given in the table below

APT PPT Slide then sums

y bill rate is 4.1%. CROSS CHECK QT 50 and Q52 answeres with divisions
A
B
C

mium)+..+ ei

um)+..+ ei
nsweres with divisions
Assume that only two macro economic factors, F1 & F2, impact security returns. Investments A
Investment b1 b2
A 1.75 0.25
B -1 2
C 2 1
We are given the expected risk premium is 4% on factor 1 and 8% on factor 2. According to the APT,
What is the risk premium on each of the three stocks?
Suppose we buy Rs. 2,00,000 of A and Rs. 50,000 of B and sell Rs. 1,50,000 of C.
What is the sensitivity of this portfolio to each of the two factors? What is the expected risk premium

Investment Risk Premium on

b1 b2 stock InvestmenWeights Beta1
A
B
C
Risk Premium

For A = β1*risk premium of factor 1 + β2*risk premium of factor 2

Similarly for B and C

Sensitivity to each of the 2 factors Sensitivtiy of the porttoflio is the Weighted

Sensitivity of Portfolio to factor 1 i.e. Wa*Ba+Wb*Bb+Wc*Bc for a Portfolio
Sensitivity of Portfolio to factor 2

Since the sensitivity of the portfolio to the 2 factors is 0, it is a Risk free portfolio, i.e. a 0 beta portfolio

Expected Risk premium of portoflio is :

ty returns. Investments A, B and C have the following sensitivities to these two factors:

APT

Beta2

of the porttoflio is the Weighted Average BETA value

+Wb*Bb+Wc*Bc for a Portfolio
Mr. X owns a portfolio with the following characteristics:
Security A Security B Risk free
Investment
(beta) (beta) security
Factor 1 0.5 1.5 0
Factor 2 0.8 1.4 0
Expected
return 15% 20% 10%
It is assumed that the security’s returns are generated by two factor model:
(a) In what combination one should invest in A and B, that the overall portfolio is in
(b) In what combination one should invest in A, B and risk free security so that the o

Solution a)
Investment Security A Security B Risk free Factor
(beta) (beta) security Sensitivity
Factor 1
Factor 2
Expected
return
Weightages
Make weights Zero then solve using Goal seek

Risk free Factor

Investment Security A Security B security Sensitivity
Factor 1 0.0
Factor 2 0.0
Expected
return
Weightages
 APT

the overall portfolio is insensitive to changes in factor 2?

free security so that the overall portfolio is insensitive to changes in factor 2 and has sensitivity of 1 to fa
has sensitivity of 1 to factor 1?
Mr. X owns a portfolio with the following characteristics:
Risk free
Investment Security A Security B
security
Factor 1 0.8 1.5 0
sensitivity
Factor 2
sensitivity 0.6 1.2 0
Expected
return 15% 20% 10%

It is assumed that the security returns are generated by two factor model:
(i) If Mr. X has Rs. 1,00,000 to invest and sells short Rs. 50,000 of security B and p
what is the sensitivity of Mr. X’s portfolio to each of the two factors?
(ii) If Mr. X borrow Rs. 1,00,000 at the risk free rate and invests the amount he bor
the original amount Rs. 1,00,000 in security A and B in the same proportion as
what is the sensitivity of the portfolio to the two factors?

Risk free Factor

Investment Security A Security B sensitivity
security of Portfolio

Factor 1
sensitivity
Factor 2
sensitivity
Expected
return
Investment

Factor
Risk free
Investment Security A Security B security sensitivity
of Portfolio

Factor 1
sensitivity
Factor 2
sensitivity
Expected
return
Investment
50,000 of security B and purchases Rs. 1,50,000 of security A
he two factors?
invests the amount he borrows along with
in the same proportion as described in part (i),

APT
Suppose the returns are described by two index model
Assume existence of 3diversified portfolios shown in the following table
Portfolios Expected Return Beta1 Beta2
A 15 1 0.6
B 14 0.5 1
C 10 0.3 0.2
Now Suppose portfolio E exists with an expected return of 15%, a beta1 of 0.6 and beta 2 of 0.6
What happens when you form a combination of portfolios A,B and C (call it Portfolio D) which h
Find the expected return on Portfolio D
Do you have an Arbitrage startegy?
What is the riskless gain? What will happen with the expected return of portfolio E

Solution:
Portfolios Expected Return Beta1 Beta2
A
B
C
D
E

Riskless gain = 2%

%
 APT

of 0.6 and beta 2 of 0.6

ll it Portfolio D) which has equal investment of each?

portfolio E
Mr. Nirmal Kumar has categorized all the available stock in the market into the following types:
(i) Small cap growth stocks
(ii) Small cap value stocks
(iii) Large cap growth stocks
(iv) Large cap value stocks
Mr. Nirmal Kumar also estimated the weights of the above categories of stock in the market index. Further mor
important factors are estimated to be :

Category of Weight in the Factor 1 Factor 2 Factor 3

stocks market index [beta] [Price Book] [inflation]
Small cap 25% 0.8 1.39 1.35
growth
Small cap value 10% 0.9 0.75 1.25
Large cap 50% 1.165 2.75 8.65
growth
Large cap value 15% 0.85 2.05 6.75
Risk premium 6.85% -3.50% 0.65%
The rate of return on treasury bonds is 4.5%
Required:
(a) Using Arbitrage Pricing Theory, determine the expected return on the market index.
(b) Using Capital Asset Pricing Model (CAPM), determine the expected return on the market inde
(c) Mr. Nirmal Kumar wants to construct a portfolio constituting only the small cap value and lar
desired portfolio is 1, determine the composition of his portfolio.
a
Category of Weight in the Factor 1 Factor 2 Factor 3
stocks market index [beta] [Price Book] [inflation]
Small cap 25% 0.8 1.39 1.35
growth
Small cap value 10% 0.9 0.75 1.25
Large cap 50% 1.165 2.75 8.65
growth
Large cap value 15% 0.85 2.05 6.75
Risk premium 6.85% -3.50% 0.65%
Portfolio Beta 1 2.105 5.8

Expected
Portfolio Return
7.752500%

Portfolio Return
using CAPM
11.35%

Stock Beta Weights Product

Small cap value 0.9 0.6226415094 0.5603773585
Large cap 1.165
growth 0.3773584906 0.4396226415
1
wing types:
CAPM
APT

market index. Further more, the sensitivity of returns on these categories of stock to the three

homework

the market index.

return on the market index.
he small cap value and large cap growth Stocks. If the target beta for the
Mr. Tamarind intends to invest in equity shares of a company the value of which depends upon
Expected Actual
Factor Beta
value in% value in %
GNP 1.2 7.7 7.7
Inflation 1.75 5.5 7
Interest rate 1.3 7.75 9
Stock market
index 1.7 10 12

Industrial 1 7 7.5
production
If the risk free rate of interest be 9.25%, how much is the return of the share under Arbitrage P

Expected Actual Risk

Factor Beta value in% value in % Shock Premium
GNP 1.2 7.7 7.7 0 0
Inflation 1.75 5.5 7 1.5 2.625
Interest rate 1.3 7.75 9 1.25 1.625
Stock market 1.7 10 12
index 2 3.4
Industrial
1 7 7.5
production 0.5 0.5

Total Risk Premium 8.15

Risk Free Rate 9.25

Total return 17.4

e of which depends upon various parameters as mentioned below:

homework

share under Arbitrage Pricing Theory?

APT
Q1)
Suppose we derive following factor values from market data:
Rm-Rf 4.80%
Rsmall-Rbig 2.40%
Rhbm-Rlbm 1.60%
Rf 3.40%
Beta(mkt) 1.30
Beta(smb) 0.40
Beta(hml) -0.20

What will be required return using CAPM and Fama-French Model

Solution
CAPM 9.64%

Fama-French 10.28%

Q2)
Suppose we derive following factor values from market data:
Rm-Rf 9.60%
Rsmall-Rbig 3.40%
Rhbm-Rlbm 2.50%
Rf 6.25%
Beta(mkt) 0.40
Beta(smb) 0.90
Beta(hml) -0.40

What will be required return using CAPM and Fama-French Model

Solution
CAPM

Fama-French
 Fama-French

What would be the Required return as per the Fama-French 3 factor model if
the Rf rate is 4%, SMB is 1.2%, HML is 2.4%, Rm is 7.6% and the beta
coefficient is 0.9 for (Rm-Rf), 0.4 for SMB and 1.6 for HML.

What would be the Required return as per the Fama-French 3 factor model if
the Rf rate is 6%, SMB is 1.2%, HML is 2.4%, Rm is 7.6% and the beta
coefficient is -0.9 for (Rm-Rf), -0.4 for SMB and 1.6 for HML.
Q3
Derive the equation of the Fama French 3 factor model based on excess return and comment on the p-values of the co-effi

Portflio Prices
Year SMB % HML % WML % Rm % Rf % Rm-Rf % Portfolio X
1995 -32.18785 -23.16658 68.09129 -12.18751 10.43806 -20.49348 1166.67
1996 -40.09802 -8.77962 40.81743 13.85893 6.877101 6.534403 1900.00
1997 18.98058 -7.614137 -3.682539 -9.410939 7.854696 -16.01346 1288.83
1998 46.51073 21.79263 99.31221 97.98538 9.04326 81.60126 953.33
1999 -22.70479 11.37976 -18.44718 -26.77617 9.072115 -32.87676 1458.47
2000 -7.354501 8.441928 20.13732 -21.59021 7.458736 -27.04046 811.40
2001 -15.92815 70.28178 12.98349 20.69056 6.044276 13.81461 473.57
2002 6.905846 57.31976 36.90092 107.7945 5.016288 97.89189 600.00
2003 17.95373 41.07376 25.12996 21.60153 4.723543 16.11985 1534.10
2004 36.45233 20.98008 29.31022 40.94869 5.367231 33.77688 1613.43
2005 2.375791 1.008558 33.79269 38.21508 6.327221 29.99876 1833.97
2006 13.77519 102.7202 20.09442 77.88942 7.114287 66.09681 2869.00
2007 -34.89618 -22.18196 -8.882932 -57.68726 7.591895 -60.68535 4813.77
2008 12.72088 11.96238 -21.88511 91.19395 3.584654 84.59224 1334.97
2009 4.858556 4.388877 17.69727 12.36115 5.396832 6.609168 4022.67
2010 7.734795 -21.25563 58.9265 -27.06677 7.887808 -32.40761 4805.07
2011 2.060854 6.779482 -8.175535 28.65786 8.443187 18.64698 4660.90
2012 -19.81394 13.86605 29.78781 2.149267 8.603921 -5.945444 8537.90
2013 27.99617 5.970217 0.335306 40.44915 8.451629 29.51494 12914.77
2014 37.73562 -16.43411 27.7789 1.69262 7.620979 -5.510373 25255.27
2015 -2.116713 -2.631199 4.999013 5.583523 6.339286 -0.711964 26331.80
2016 9.691784 19.95939 29.67485 39.08208 6.092595 31.10329 32520.77
2017 -20.4952 -26.81146 27.35932 -6.158121 6.448262 -11.8459 48232.10
2018 -19.52628 -29.1155 50.99216 5.821655 5.726235 0.089868 44725.50
2019 -19.52628 -29.1155 50.99216 5.821655 5.726235 0.089868 44218.50
mment on the p-values of the co-efficients

Excess Return (%)

Y variab X1 X2 X3
Hpr_P/f X Rp-Rf Rm-Rf % SMB % HML % Rm % Rf % WML %
Develop the Fama-French equation for the following 2 Funds
Workings are to be based on Excess returns
NAV NAV
Year SMB % HML % WML % Rm % Rf % Rm-Rf % A B
1995 -17.44101 -16.91564 10.77445 -35.54295 11.22438 -42.06236 68.85 496.98 HPR_A %
1996 -32.18694 -23.16658 68.09129 -12.18751 10.43806 -20.49348 83.80 666.47
1997 -40.09682 -8.777116 40.81743 13.85893 6.877101 6.534403 92.34 1481.80
1998 18.9927 -7.585475 -3.695509 -9.410939 7.854696 -16.01346 61.27 1857.94
1999 46.5157 21.79263 99.29754 97.98538 9.04326 81.60126 89.90 1799.19
2000 -22.66367 11.39316 -18.53731 -26.77617 9.072115 -32.87676 78.88 4184.10
2001 -7.239182 8.56964 20.0591 -21.59021 7.458736 -27.04046 92.53 3088.46
2002 -15.9251 70.27232 12.92126 20.69056 6.044276 13.81461 121.54 4638.73
2003 6.916968 57.32457 36.82561 107.7945 5.016288 97.89189 236.94 5038.54
2004 17.97718 41.15716 25.10297 21.60153 4.723543 16.11985 293.60 4666.78
2005 36.44745 20.96746 29.31969 40.94869 5.367231 33.77688 420.42 4602.06
2006 2.375791 1.008558 33.66151 38.21508 6.327221 29.99876 589.68 9879.19
2007 13.77936 102.7423 20.09187 77.88942 7.114287 66.09681 1145.90 16201.11
2008 -34.89368 -22.17274 -8.882932 -57.68726 7.591895 -60.68535 635.49 23708.52
2009 12.72088 11.96238 -21.88534 91.19395 3.584654 84.59224 1139.94 2544.62
2010 4.858931 4.388642 17.69727 12.36115 5.396832 6.609168 1440.10 3468.30
2011 7.73523 -21.2561 58.91666 -27.06677 7.887808 -32.40761 845.86 4559.94
2012 2.068828 6.804525 -8.178299 28.65786 8.443187 18.64698 1268.87 4089.31
2013 -19.80197 13.89231 29.78391 2.149267 8.603921 -5.945444 957.43 6581.42
2014 27.99753 5.973454 0.324332 40.44915 8.451629 29.51494 172.31 5097.17
2015 37.85945 -16.32352 27.61744 1.69262 7.620979 -5.510373 128.63 6468.00
2016 -2.10401 -2.61778 4.978407 5.583523 6.339286 -0.711964 142.99 10136.73
2017 9.715131 19.99738 29.61262 39.08208 6.092595 31.10329 242.20 13017.94
2018 -20.47216 -26.79943 27.28605 -6.158121 6.448262 -11.8459 234.32 16403.58
2019 -19.52552 -29.11445 50.99216 5.821655 5.726235 0.089868 237.78 13772.17
 H0: Al, B1,B2, b3 = 0
Ha: not equal to 0
Excess X1 X2 X3
Ret_ A % Rm-Rf % SMB % HML
Sam Porter is evaluating three portfolios based on Carhart Model. The following table provides the factor exposures of
Risk Factor
Portfolio RMRF SMB HML WML
Eridanus 1 0 0 0
Scorpius 0 1 0 0
Lyra 1.2 0 0.2 0.8

Which strategy would be most appropriate if the manager expects that:

1)RMRF will be highrer than expected 1 Mr. Sam Porter will take a long position on Eridanus as it has factor ex
2)Large caps will outperform small cap Lyra has higher factor exposure to Rm,Rf compared to Eridanus, howe
2 Mr Sam Porter should short the Scorpius portfolio since risk premium
Solution:
1) 22.85%
23.25%
2)

Compute the E(Rp) from the following information using the Carhart Model
What would be your answer if (a) Rf =7.2%, (b) WML = 3.6% (c) Beta 3 and 4 were 1.0
Rf 6.80%
Beta 1 (RMRF) 1.2 orignal
Beta 2 (SMB) 0.9 Rf =7.2%
Beta 3 (HML) 0.7 wml 3.6%
Beta 4 (WML) 1.3 betas
RMRF factor 4%
R_SMB 8%
R_HML 3%
R_WML 1.50%

ERp
RF = 7.2%
WML = 3.6
Beta 3,4
 the factor exposures of each of these portfolios to the four carhart factors

Cahart Model

Eridanus as it has factor exposure to Rm,Rf only.

mpared to Eridanus, however it also has exposure to HML and WML factors, thereby increasing the overall factor exposureof the portfolio.
folio since risk premium for SMB factor is expected to decrease/reduce.
exposureof the portfolio.
Develop the Carhart Equation for the following 2 Funs Sign F 0.0004 model is rela
Workings are to be based on Excess returns Interce 0.475
Rm-rf 0.001

MF NAVs
Year SMB % HML % WML % Rm % Rf % Rm-Rf % A B
1995 -17.44101 -16.91564 10.77445 -35.54295 11.22438 -42.06236 68.85 496.98 HPR_A %
1996 -32.18694 -23.16658 68.09129 -12.18751 10.43806 -20.49348 83.80 666.47 21.72113
1997 -40.09682 -8.777116 40.81743 13.85893 6.877101 6.534403 92.34 1481.80 10.18436
1998 18.9927 -7.585475 -3.695509 -9.410939 7.854696 -16.01346 61.27 1857.94 -33.64847
1999 46.5157 21.79263 99.29754 97.98538 9.04326 81.60126 89.90 1799.19 46.72999
2000 -22.66367 11.39316 -18.53731 -26.77617 9.072115 -32.87676 78.88 4184.10 -12.25362
2001 -7.239182 8.56964 20.0591 -21.59021 7.458736 -27.04046 92.53 3088.46 17.29375
2002 -15.9251 70.27232 12.92126 20.69056 6.044276 13.81461 121.54 4638.73 31.35713
2003 6.916968 57.32457 36.82561 107.7945 5.016288 97.89189 236.94 5038.54 94.94897
2004 17.97718 41.15716 25.10297 21.60153 4.723543 16.11985 293.60 4666.78 23.91428
2005 36.44745 20.96746 29.31969 40.94869 5.367231 33.77688 420.42 4602.06 43.19414
2006 2.375791 1.008558 33.66151 38.21508 6.327221 29.99876 589.68 9879.19 40.26027
2007 13.77936 102.7423 20.09187 77.88942 7.114287 66.09681 1145.90 16201.11 94.32499
2008 -34.89368 -22.17274 -8.882932 -57.68726 7.591895 -60.68535 635.49 23708.52 -44.54216
2009 12.72088 11.96238 -21.88534 91.19395 3.584654 84.59224 1139.94 2544.62 79.37938
2010 4.858931 4.388642 17.69727 12.36115 5.396832 6.609168 1440.10 3468.30 26.33077
2011 7.73523 -21.2561 58.91666 -27.06677 7.887808 -32.40761 845.86 4559.94 -41.2635
2012 2.068828 6.804525 -8.178299 28.65786 8.443187 18.64698 1268.87 4089.31 50.00861
2013 -19.80197 13.89231 29.78391 2.149267 8.603921 -5.945444 957.43 6581.42 -24.54463
2014 27.99753 5.973454 0.324332 40.44915 8.451629 29.51494 172.31 5097.17 -82.00259
2015 37.85945 -16.32352 27.61744 1.69262 7.620979 -5.510373 128.63 6468.00 -25.35255
2016 -2.10401 -2.61778 4.978407 5.583523 6.339286 -0.711964 142.99 10136.73 11.16974
2017 9.715131 19.99738 29.61262 39.08208 6.092595 31.10329 242.20 13017.94 69.37676
2018 -20.47216 -26.79943 27.28605 -6.158121 6.448262 -11.8459 234.32 16403.58 -3.25427
2019 -19.52552 -29.11445 50.99216 5.821655 5.726235 0.089868 237.78 13772.17 1.476855
 Y var Y var
Excess Ret Excess Ret X1 X2 X3 X4 SUMMARY OUTPUT
HPR_B% Ra-Rf Rb-Rf RM-Rf SMB HML WML
34.10359 11.2831 23.6655 -20.4935 -32.1869 -23.1666 68.0913 Regression Statistics
122.3366 3.3073 115.4595 6.5344 -40.0968 -8.7771 40.8174 Multiple R 0.801801
25.38399 -41.5032 17.5293 -16.0135 18.9927 -7.5855 -3.6955 R Square 0.642885
-3.162336 37.6867 -12.2056 81.6013 46.5157 21.7926 99.2975 Adjusted R 0.567703
132.5547 -21.3257 123.4826 -32.8768 -22.6637 11.3932 -18.5373 Standard E 30.19805
-26.18567 9.8350 -33.6444 -27.0405 -7.2392 8.5696 20.0591 Observatio 24
50.19549 25.3129 44.1512 13.8146 -15.9251 70.2723 12.9213
8.618943 89.9327 3.6027 97.8919 6.9170 57.3246 36.8256 ANOVA
-7.37843 19.1907 -12.1020 16.1198 17.9772 41.1572 25.1030 df
-1.386847 37.8269 -6.7541 33.7769 36.4474 20.9675 29.3197 Regression 4
114.669 33.9331 108.3418 29.9988 2.3758 1.0086 33.6615 Residual 19
63.99228 87.2107 56.8780 66.0968 13.7794 102.7423 20.0919 Total 23
46.33894 -52.1341 38.7470 -60.6854 -34.8937 -22.1727 -8.8829
-89.26706 75.7947 -92.8517 84.5922 12.7209 11.9624 -21.8853 Coefficients
36.2993 20.9339 30.9025 6.6092 4.8589 4.3886 17.6973 Intercept -6.192546
31.47485 -49.1513 23.5870 -32.4076 7.7352 -21.2561 58.9167 RM-Rf 0.846965
-10.32097 41.5654 -18.7642 18.6470 2.0688 6.8045 -8.1783 SMB -0.601933
60.94197 -33.1486 52.3380 -5.9454 -19.8020 13.8923 29.7839 HML 0.367795
-22.55218 -90.4542 -31.0038 29.5149 27.9975 5.9735 0.3243 WML 0.086778
26.89398 -32.9735 19.2730 -5.5104 37.8594 -16.3235 27.6174 Ra- Rf = -6.1925+0.8470*(Rm-Rf)-0.6019
56.72131 4.8305 50.3820 -0.7120 -2.1040 -2.6178 4.9784
28.42347 63.2842 22.3309 31.1033 9.7151 19.9974 29.6126
26.00746 -9.7025 19.5592 -11.8459 -20.4722 -26.7994 27.2860 RESIDUAL OUTPUT
-16.04169 -4.2494 -21.7679 0.0899 -19.5255 -29.1145 50.9922
Observation
Predicted Ra-Rf
1 -6.787163
2 23.79133
3 -34.29831
4 51.55353
5 -17.81428
6 -19.84482
7 42.06084
8 96.8342
9 13.95509
10 10.73237
11 21.07729
12 81.02647
13 -45.5131
14 60.29753
15 -0.36972
16 -41.00198
17 10.14847
18 8.385426
19 4.178078
20 -37.25562
21 -6.059873
22 24.22763
23 -11.3916
24 -0.646536
 SS MS F Significance F
31191.57 7797.892 8.55104773 0.000401
17326.53 911.9224
48518.1

Standard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%

8.585182 -0.721306 0.479503735 -24.16154 11.77645 -24.16154 11.77645
0.236512 3.581066 0.001992437 0.35194 1.34199 0.35194 1.34199
0.318595 -1.889338 0.074205992 -1.268759 0.064893 -1.268759 0.064893
0.256941 1.431434 0.168550215 -0.16999 0.905579 -0.16999 0.905579
0.234679 0.369772 0.715641742 -0.40441 0.577966 -0.40441 0.577966
6.1925+0.8470*(Rm-Rf)-0.6019*Rsmb+0.3678*Rhml+0.0868*Rwml+ 0

Residuals
18.07023 0.00
-20.48407
-7.204861
-13.86679
-3.511451
29.67983
-16.74798
-6.901524
5.235644
27.09454
12.85577
6.184231
-6.620957
15.4972
21.30365
-8.149328
31.41696
-41.53398
-94.6323
4.282093
10.89032
39.05654
1.689072
-3.602844