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Portfolio And Investment Analysis Question Paper
Portfolio And Investment Analysis
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2010
UNIVERSITY EXAMINATIONS: 2010/2011
THIRD YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 303-F: PORTFOLIO AND INVESTMENT ANALYSIS (SUNDAY)
DATE: DECEMBER 2010 TIME: 2 HOURS
INSTRUCTIONS: Answer question ONE and any other TWO questions
QUESTION ONE – COMPULSORY
a) What are the variables needed to estimate the value of a call option and describe how a change in
the value of each of these variables affects the value of a call option. (5 marks)
b) Given the following information, calculate the three-month put option price that is
consistent with the Black-Scholes model:
Ps = 32,
E = 45,
R = 0.06 and
s = 0.35 (5 marks)
c) Explain the significance of Capital Market Line. (2 marks)
d) KCA Limited owns a portfolio of two securities with the following expected returns, standard
deviations and weights:
Security Expected Return Standard Deviation Weight
P 10% 20% 0.35
Q 15% 25% 0.65
What is the correlation between the two securities show the highest and lowest
portfolio standard deviations respectively? Show your computations. (4 marks)
2
e) Discuss the concepts of covariance and diversification. Give explanatory notes on why the two
concepts are closely related. (6 marks)
f) i) Why is the concept of arbitrage central to asset pricing mechanism of Arbitrage Pricing Theory?
(3 marks)
ii) On the basis of a one-factor model, assume that the risk free rate is 6% and the excepted return on
a portfolio with unit sensitivity to the factor is 8.5%. Consider a portfolio of two assets with the
following characteristics:
Security Factor Sensitivity Proportion
Y 4.0 0.3
Z 2.6 0.7
According to APT, what is the portfolio’s equilibrium expected return? (5 marks)
QUESTION TWO - OPTIONAL
a) Why does diversification lead to a reduction in unique risk but not in market risk? Explain both
intuitively and mathematically. (6 marks)
b) The following table gives as analyst’s expected return on two stocks for particular market returns:
Market Return Aggressive Stock Defensive Stock
6% 2% 8%
20% 30% 16%
i) What are the betas for these two stocks (4 marks)
ii) What is the expected return on each stock if the market return is equally likely to be
6% or 20%? (4 marks)
iii) if the risk free rate is 7% and the market return is equally likely to be 6% or 20%, give the
equation of Security Market line – (SML) (4 marks)
c) What are the alphas of the two stocks in (b) above? (2 marks)
QUESTION THREE - OPTIONAL
a) By way of a graphical mapping, explain why an investor’s indifference curves cannot intersect
(6 marks)
b) Consider four stocks with the following expected returns and standard deviation:
3
Stock Expected Return Standard Deviation
A 15% 12%
B 15% 8%
C 14% 7%
D 16% 11%
Are any of these stocks preferred over the others by a risk-averse investor? (6 Marks)
c) The Investment Officer working under you has made available the following information relating
four stocks that you want to invest in:
Stock Initial Investment Value Expected end year Value Proportion
A 500 700 19.2%
B 200 300 7.7%
C 1000 1000 38.5%
D 900 1500 34.6%
Compute the expected portfolio return and standard deviation (8 marks)
QUESTION FOUR - OPTIONAL
a) Both the covariance and coefficient of correlation measure the extent to which the returns on
securities move together. What is the relationship between the two statistical measures? Why is
the correlation coefficient a more convenient measure? (8 marks)
b) The Investment Officer presents to you the following estimates of standard deviations and
correlation coefficients for three stocks that you would consider investing in. the estimates are
as follows:
Stock Standard Correlation Coefficients with Stock:
Deviation–(%) A B C
A 12 1.00 -1.00 0.20
B 15 -1.00 1.00 -0.20
C 10 0.20 -0.20 1.00
i) If a portfolio is composed of 20% of stock A and 80% of stock C, what is the portfolio standard
deviation? (5 marks)
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ii) If a portfolio is composed of 40% of stock A, 20% of stock B, and 40% of stock C, what id the
portfolio standard deviation (7 marks)
QUESTION FIVE - OPTIONAL
a) Explain why security analysis should be able to find mispriced securities in a perfectly efficient
markets with transaction costs. (7 marks)
b) Describe the conflict of interest that typically exists in the investment advisory relationship
between a brokerage firm and its clients (8 marks)
c) Rwanda short sells 500 shares of Kenya at Kshs 25 per share. The initial margin requirement is
50%. Prepare Rwanda’s balance sheet as of the time of the transaction. (5 marks)
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