Birla Institute of Technology & Science, Pilani, Hyderabad Campus

Comprehensive examination- Semester-II, 2022-23

Maximum Marks-80
Course Name: Sec Anal & Port Mgmt. Course Code: ECON F412/ FIN F313
Date: 18/05/2023 Time: 02:00PM-05:00PM
NAME: ID:
 There are 14 questions in total and all questions are compulsory.
 Each question of section A carries 3 points.
 Each question of section B carries 7 points.
 Each question of section C carries 9 points.
 Writing in pencil/red pen/green pen is not allowed.
 Sharing of calculator is not allowed.
Section A (18 points)
1. Each of John and Max individually invests Rs.50000 in stock ABC on Jan 1,2022. John sold ABC stock
at Rs.54000 after 3 months whereas Max sold ABC stock at Rs.56000 after 6 months. Who among the
two (John and Max) enjoyed higher return? (Show the calculation).
Ans: HPRJohn=(54000-50000)/50000*100=8%
HPRMax =(56000-50000)/50000*100=12%
Annualized HPR of john is= (1+0.08)^(1/0.25)-1=0.36
Annualized HPR of max is= (1+0.12)^(1/0.5)-1=0.25
Hence, John enjoyed the higher return.

2. Suppose the expected return of XYZ stock is 22% and the beta is 1.5. If the risk- free rate is 4% p.a. and
the expected return of the market index 15%, comment on the mispricing of the stock (if any). Mention
the underlying asset pricing theory that is applied in this context.

Solution: Expected rate of return= 4%+1.5*(15%-4%)=20.5%

Given the stock return of 22%, stock is underpriced. CAPM/SML.

3. Consider that a value weighted index is based on following three companies:

Company Promoter's share Government ownership Total number of shares
A 8% 200000
B 15% 20% 350000
C 25% 10% 150000
The base market capitalization is 10000. Find the value of the security market index if the price of
stock A is Rs.75, stock B is Rs.85 and stock C is Rs.60 on a given day.

Total number Free

Company Promoter's share Government ownership Price
of shares float
A 8% 200000 184000 75 13800000
B 15% 20% 350000 227500 85 19337500

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 C 25% 10% 150000 97500 60 5850000
Hence, value weighted index is (38987500/10000)*1000 =38987.50
4. Consider following information regarding two bonds with par of Rs.1000:

Time to maturity Yield to maturity Coupon rate Bond price

Bond A 2 6% 8% 1037.17
Bond B 5 8% 6% 918.89
If the interest rate increases by 1 percentage point, find the new bond prices. Based on the results,
comment on the relationship between interest rate and time to maturity. Assume semi-annual coupon
payments.
Solution:

New
Time to Yield to Bond New Change
Coupon bond
maturity maturity price YTM in price
price
Bond A 2 8% 6% 1037.171 7% 1018.365 -1.81%
Bond B 5 6% 8% 918.891 9% 881.3092 -4.09%
We find that longer term bonds are more sensitive to interest rate.
5. The details of 3 actively managed funds are given below. If the risk-free rate of 4%, the expected return of
market index is 15% and standard deviation of market returns is 6%, using the Treynor ratios, find the
fund(s) that outperforms the market.
Return Risk Beta Treynor Ratio
Portfolio A 15% 16% 1.2
Portfolio B 20% 10% 1.5
Portfolio C 18% 5% 0.6

Solution:

Return Risk Beta Treynor ratio

Portfolio A 15% 16% 1.2 0.091667
Portfolio B 20% 10% 1.5 0.106667
Portfolio C 18% 5% 0.6 0.233333
Market 15% 6% 1 0.11
Portfolio C outperforms the market.

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6. Graphically, show the following:
i. No investor will invest in the inefficient frontier
ii. A more risk averse investor’s portfolio will have lower expected return and risk, compared to
another investor who is less risk averse.

i.

In efficient frontier, investor will have the opportunity to enjoy higher return for the given risk and
similarly, investor can face low risk for the given return. Therefore, investing in inefficient frontier will
not serve the purpose of maximum return for given risk and minimum risk for given return. That is why,
no investor will invest in the inefficient frontier.

ii.

A1>A2
E(r1)<E(r2)

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σ1<σ2

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 Section- B (35 points)
7.
i. Mention psychological factors/ behavioral anomalies that can be used to explain the following
outcomes in financial markets: [2]
a. A survey of 200 fund managers by an agency revealed that 80% of the fund managers believed that
they have skills which is above industry average.
b. Investors buying IT stocks in the US financial market during the dotcom bubble.

ii. The stock price of ABC company for last 5 trading sessions is given below. Using Runs test, comment
on the weak form of efficiency (clearly mention the hypotheses). [5]

Day 1 Day 2 Day 3 Day 4 Day 5

Price 120 100 125 130 90

Solution:
i.
a. Overconfidence regarding the own skill of the managers makes the belief of placing themselves above
industry average.
b. Due to herd behaviour of the investors, people buy IT stock in the US financial market during dotcom
bubble.
ii. H0: Stock price follows random walk movement
H1: Stock price does not follow random walk movement

Stock
price Stock returns Runs
Day 1 120 Runs 3
Day 2 100 -0.167 1 n1 2
Day 3 125 0.25 2 n2 2
Day 4 130 0.04 2 n 4
Day 5 90 -0.308 3 E(Runs) 3
var(runs) 0.667
Z 0.0

Z value is less than 1.96. Hence, we fail to reject the null hypothesis of random walk. Weak form
of EMH satisfies.

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8. Consider the following multi-factor (APT) model of security returns of a particular stock.
Factor beta Factor risk premium
F1 1.2 6%
F2 0.5 8%
F3 1.8 3%
a. If T-bill currently offers 6% yield and the expected return of the stock is 20%, what can we say
regarding the mispricing. [4]
b. Construct a competing portfolio and show how an investor can capture arbitrage profit. [3]
Solution:
Factor
Factor Factor risk
beta*risk
beta premium
premium
Inflation 1.2 6% 0.072
Industrial
0.5 8%
production 0.04
Oil prices 1.8 3% 0.054
0.166
0.226

Given risk-free rate of 6%, expected return of the stock is 22.6%.

Hence, the stock is overpriced.
To earn fair return, competing portfolio will be constructed through investing in each of the three
factors by its respective weights and investing (1-(1.2+0.5+1.8)) = -2.5 in T-bill.
To capture the arbitrage profit, investor should long the competing portfolio and short sell the fund.
Hence, arbitrage profit=(22.6-20)%=2.6%

9.
i. Consider you are an analyst working with an investment firm. You estimate the following market
model giving the relationship between return of XYZ stock and market.
E(ri)=0.6+1.2 E(rm)
Your manager asks you to estimate the relationship between XYZ stock and market index given by the
single index model (SIM). Write the estimated SIM equation if the risk-free rate is 6%. [3]
ii. Suppose the SIM relationship for ABC stock is given by: E(Ri)=0.75+0.5E(Rm). R-squared=0.6. Now
answer the following: [4]
a. Interpret the R-squared.
b. An investor wishes to invest 40% in XYZ stock (Refer to 9i) and rest in stock ABC. Find the
alpha, beta and the systematic risk of the portfolio. Sigma of market return is 25%.
i. Alpha=0.6-0.06*(1-1.2) =0.612; Beta=1.2; E(Ri)=0.612+1.2E(Rm)
ii.
a. 60% of the variation in ABC stock return is explained by variation in market factors.
b. Portfolio alpha =0.4*0.612+0.6*0.75=0.6948;
Portfolio beta=(0.4*1.2)+(0.6*0.5)=0.78;
Systematic variance=(0.78*0.25)^2=0.038; systematic risk=0.19

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 10.
i. Using the information given below, answer the following. [3]

26-day EMA 12-day EMA Relative strength indicator

(RSI)
01-05-23 70 85 65
02-05-23 65 75 68
03-05-23 60 65 72
04-05-23 75 68 70
05-05-23 85 65 65
a. Using the MACD and center line crossover, mention the investment signal along with date
when you get the signal.
b. Based on the Relative strength indicator, can you identify any buy or sell signal? clearly mention
the date.
c. Classify the indicators as leading/lagging/hybrid indicator.
ii. For bullish engulfing candlestick pattern fill in the blanks: [4]
Pre-condition - ______Bearish sentiment_____________________________
Color of the candlesticks: Day 1____Red/ filled__________
Day2____Green/Hollow_________
Day 3 confirmation- ___Green/Hollow candlestick with gap-up____________________
Solution:

26-day EMA 12-day EMA MACD RSI

01-05-23 70 85 15 65
02-05-23 65 75 10 68
03-05-23 60 65 5 72 Sell
04-05-23 75 68 -7 sell 70
05-05-23 85 65 -20 65
MACD is a hybrid indicator and RSI is a leading indicator.
11.
i. Consider that a young Company A is expected to grow at 10% for next 3 years and the forecasted
dividend for the next year is Rs.50. The investor believes that the P/E of the firm will converge to the
average P/E of industry by the end of third year. The forecasted EPS at the end of third year is Rs.100
and average industry P/E is 50. find the value of the stock if the beta is 0.5, expected rate of return of
the market index is 6% and risk-free rate is 4.5%. [5]
ii. Suppose an investor follows sector rotation strategy. Map the following sectors with the given phases
of business cycle for the investor. [2]
Sectors: Banking, Utility, Construction, Pharmaceutical
Phase of business cycle Sectors
Boom Banking, Construction

Recession Utility, Pharmaceutical

E(R)=4.5+0.5*(6-4.5)= 5.25%
Value=(50/1.0525)+(50*1.1/1.0525^2)+(50*1.1^2/1.0525^3)+(5000/1.0525^3)=4437.53

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 Section C (27 points)
12.
i. Suppose a company has two outstanding loans. The first is Rs.30 million loan with no intermediate
interest payment but the interest rate on the loan is 8% p.a. compounded annually. The second is 3-
year loan worth Rs.40 million loan having 9% p.a. interest to be paid annually and the principal is to
be repaid only after 3 years. Assume that the discount rate is 8%. [7]
a. What is the duration of the company’s loan portfolio?
b. What can be the immunization strategy for the portfolio using 2-year and 7-year zero-coupon bond?
c. What is the objective of an immunization strategy?
d. Using duration approximation, what will be the change in value of loan 2 if discount rate changes
by 1 percentage point?
ii. Justify whether the statement is true or false: Bond investors like convexity. [2]

Solution:
i. The duration of the first loan is 3 years since it is a zero-coupon loan. The duration of the second
loan is as follows:
Year 1 Year 2 Year 3
Payment 3.60 3.60 43.60
PV of payment 3.33 3.09 34.61
Time weighted PV of payment 3.33 6.18 103.83
Time Weighted PV of 0.083 0.154 2.596 2.833
Payments Divided by Price
a. By default, duration of the zero-coupon bond is its yield to maturity. Hence, the duration of a
portfolio is the weighted average duration of its individual securities. So, the
portfolio’s duration = 3/7 * (3) + 4/7 * (2.83) = 2.905

2w+7(1-w)=2.905
W=82%.
b. Invest 58 million in 2-year zero coupon bond and rest in 7-year zero coupon bond.

c. The objective of the immunization strategy to insulate the bond portfolio through interest rate risk.
It is structured in such a way so that the interest rate risk exactly offsets the reinvestment risk.

d. D* =2.83/(1+0.08)=2.62
Delta P/p= -2.62*1=-2.62%

ii. Bond investors like convexity as price gain is more when yield falls and the fall in price is
lower when yield increases.

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 13. Suppose you wish to choose one among the two leading portfolio management services firms (PMS)
for investing Rs.50 lakhs during the next financial year. Consider that both the firms primarily invest
in 3 sectors, namely energy, healthcare and banking.
[9]
i. What is the allocation effect of Energy sector for PMS firm 1? Interpret the effect.
ii. What is the allocation effect of Healthcare sector for PMS firm 2? Interpret the effect.
iii. What is the selection effect within the healthcare sector for PMS firm 2? Interpret the effect.
iv. For evaluating the PMS firms, you decide to use the performance attribution analysis. Given the
below information, which of the two firms performs better in terms of selection and allocation
effects?
Sector Portfolio Portfolio Portfolio Portfolio Benchmark Benchmark
weights of Returns of weights Returns weights Return
PMS1 PMS1 of PMS2 of PMS2
Energy 20% 15% 50% 18% 50% 10%
Healthcare 50% -5% 30% -3% 20% -2%
Banking 30% 15% 20% 10% 30% 12%

v. Suppose you also look at the market timing ability of the two firms. Given the below equations,
what can we say regarding the market timing ability of the two fund managers? Explain your
answer.
2
𝑅𝑃𝑀𝑆1 = 0.14 + 1.2𝑅𝑚 + 0.18𝑅𝑚
2
𝑅𝑃𝑀𝑆2 = 0.2 + 0.8𝑅𝑚 + 0.002𝑅𝑚
Solution:
For PMS 1:
Extra Extra
Portfolio Portfolio return return
Benchmark Benchmark Excess Excess
Sector weights of Returns due to due to
weights Return weight return
PMS1 of PMS1 asset security
allocation selection

Energy 20% 15% 50% 10% -30% -3.00% 5% 1.0%

Healthcare 50% -5% 20% -2% 30% -0.60% -3% -1.5%
Banking 30% 15% 30% 12% 0% 0.00% 3% 0.9%
-3.60% 0.40%
Total -3.20%

For PMS 2:

Extra Extra
Portfolio Portfolio return return
Benchmark Benchmark Excess Excess
Sector weights of Returns due to due to
weights Return weight return
PMS2 of PMS2 asset security
allocation selection
Energy 50% 18% 50% 10% 0% 0.00% 8% 4.0%
Healthcare 30% -3% 20% -2% 10% -0.20% -1% -0.3%
Banking 20% 10% 30% 12% -10% -1.20% -2% -0.4%
-1.40% 3.3%
Total 1.90%

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 i. The allocation effect of Energy sector for PMS firm 1 is -3%.
The clients are losing by investing in energy sector through the actively managed fund by PMS1
as the manager is not sufficiently skilled for proper asset allocation. Client would benefit by
investing in passively managed funds.
ii. The allocation effect of Healthcare sector for PMS firm 2 is -0.2%.
The clients are losing by investing through the actively managed fund by PMS2 as the manager
is not skilled enough to allocate asset in the particular sector. Client would benefit by investing
in passively managed funds.
iii. The selection effect within the healthcare sector for PMS firm 2 is -0.3%.
The clients are losing by investing through the actively managed fund by PMS2 as the manager
is not skilled for selecting the securities in healthcare sector. Client would benefit by investing
in passively managed funds.
iv. In terms of selection and allocation effect, PMS 2 performs better as the total excess return of
the portfolio over Benchmarks is greater for PMS2 compared to PMS1.
v. Based on the coefficient of Rm2, we can say that PMS1 has better market timing ability.

14.
i. Consider the following information regarding two firms operating in the IT sector. [5]

Required rate of Expected Current market

return EPS price
Co A 7 35 890
Co B 5.7 5 102
Find to what extent the prices of these two stocks are because of the growth opportunities of the
company.
ii. Suppose there is another matured co C in the same sector and the ROE of the company is 12% and
the required rate of the 15%. The firm retains 60% of its earnings and is expected to earn Rs.10 per
share at the end of next year. Find the present value of growth opportunities for co C. Explain what
might be driving the result here.
[4]

Solution:
i.
Required rate of Expected Current market PVGO
return EPS price
Co A 7 35 890 390
Co B 5.7 5 102 14.28

ii. PVGO for co C:

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 G=b*ROE=0.6*0.12=0.072

Price=D1/k-g= 10*(1-0.6)/(0.15-0.072)=51.28

PVGO= 51.28-(10/0.15)=(-)15.38

Here the required rate of return is lower than ROE because of which PVGO is negative.

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