BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, PILANI - K. K.

BIRLA GOA CAMPUS

First Semester 2021-22, Comprehensive Examination
Course Title: Security Analysis and Portfolio Management
Course No.: ECON F412, FIN F313
(Answer all questions)
Examination Date: 27-12-2021 (FN) Max Marks: 40

Instructions

There are three sections namely Section-A [20 questions, 0.5 mark each],
Section-B [10 questions, 2 marks each] and Section-C [10 questions, 1mark
each]. Roundup the results to two decimal places.

Section-A

1. The volatility of a stock price is 30% per annum. What is the standard deviation of
the percentage price change in one trading day?

A.0.35%
B.1.90%
C.1.23%
D.1.54%

2. You believe that stock prices reflect all relevant information including historical stock
prices and current public information about the firm, but not information that is only
available to insiders. Which form of the EMH you believe?

A.Weak form EMH

B.Semi-Storng form EMH
C.Strong EMH

3. Consider the CAPM. The expected return on the market is 18%. The expected return
on a stock with a beta of 1.2 is 20%. What is the risk-free rate?

A.7%
B.12%
C.10%
D.8%

4. In Premium Bond, Coupon rate ______ YTM.

A.Fall short
B.Transcend
C.Equal
D.No effect
5. What is meant by the expression that stock prices follow a “random walk”?

A. Stock price changes do not depend statistically on prior price changes.

B. Stock price changes cannot be predicted.
C. Stock prices changes do not reflect market information.
D. Stock market participants do not make rational decisions.

6. Given that we have rationale, risk-averse market, the assumptions sufficient to

guarantee that the market portfolio is an efficient portfolio?

A. Investor have homogeneous expectations

B. Risk free assets for every investors
C. All assets are perfectly marketable and divisible
D. A and B
E. A and C

7. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free
rate is 5% and the market expected rate of return is 15%. According to the capital
asset pricing model, security X is fairly priced.

A.True
B.False

8. Beta is the slope of SML.

A.True
B.False

9. The beta, of a security is equal to the covariance between the security and market
returns divided by the variance of the market's returns.
A.True
B.False

10. A reason to hedge a portfolio is to profit from capital gains when interest rates fall.
A.True
B.False

11. If a public company reports earnings substantially higher than expected, the price of
the stock should go up in excess of the return on the stock considering risk and
market return.

A. True
B. False
12. “Free” cash flows to equity are derived after cash flows from operations adjusted by
debt payments (interest and principle).
A. True
B. False

13. You want to purchase IBM stock at Rs.80 from your broker using as little of your own
money as possible. If the initial margin is 50% and you have Rs.2000 to invest, you
will buy 25 shares

A. True
B. False

14. If yield > coupon rate, the bond will be priced at a premium to its par value.

A. True
B. False

15. Strong-form EMH implies semi-strong form and weak form holds. Semi-strong form
holds also implies weak-form holds, but not the reverse.

A. True
B. False
16. Write the equation for the two factor APT model. _________________________
E ( Ri ) =Rf + { δ 1−Rf } bi 1+ { δ 2 −R f } b i 2
17. Modified duration of the bond formula. ___________________
Modified Duration=Macauley Duration/1+YTM /

18. When Prices touch the upper Bollinger bands it is considered as ________ and when
it touches lower bands it is considered as _______.
Overbought and oversold
19. _____________measures expected rate of return for bond held to maturity.
(Promised yield to maturity)

20. Match the following

a) You have discovered that the square E. Strong Form Rejection

root of any given stock price
multiplied by the day of the month
provides an indication of the
direction in price movement of that
particular stock with a probability of
75% .
 b) An Ontario Securities Commission F. Semi-Strong Rejection
(OSC) suit was filed against ATI in
2003. ATI’s founder and chairman
Mr. Kwok Yuen Ho and his wife
Betty Ho were accused of avoiding
almost $CAD 7 million in losses and
maximizing charitable tax benefits
by selling or donating ATI shares
ahead of a May 2000 profit warning.

a) – F ; b) – E

Section-B

Q1. IBM’s stock is expected to pay a dividend of $2.15 at the end of the year, and then the
dividend is expected to grow at 11.2% per year forever. The required rate of return (market
capitalization rate) on IBM stock is 15.2% per year.
a. What is the current price of IBM stock?
b. If an investor were to buy IBM stock now and sell it after receiving the $2.15 dividend a
year from now, what is the expected capital gain in percentage terms? What is the dividend
yield, and what is the total rate of return on the investment?
SOLN:

If an investor were to buy IBM stock now and sell it after receiving the $2.15 dividend a year from
now, what is the expected capital gain in percentage terms? What is the dividend yield, and what is
the total rate of return on the investment? 1 0 0 0 59.77 53.75 capital gain .112 53.75 2.15 dividend
yield .04 53.75 total return = capital gain + dividend yield = .112 .04 .152
Q2. You are thinking about investing your money in the stock market. You have the
following two stocks in mind: stock A and stock B. You know that the economy can either go
in recession or it will boom. Being an optimistic investor, you believe the likelihood of
observing an economic boom is two times as high as observing an economic depression. You
also know the following about your two stocks:
State of the Economy Probability RA RB
Boom 10% –2%
Recession 6% 40%

a) Calculate the expected return for stock A and stock B

b) Calculate the total risk (variance and standard deviation) for stock A and for stock B
c) Calculate the expected return on a portfolio consisting of equal proportions in both
stocks.
d) Calculate the expected return on a portfolio consisting of 10% invested in stock A and
the remainder in stock B.
e) Calculate the covariance between stock A and stock B.
f) Calculate the correlation coefficient between stock A and stock B.
g) Calculate the variance of the portfolio with equal proportions in both stocks using the
covariance from answer e.
h) Calculate the variance of the portfolio with equal proportions in both stocks using the
portfolio returns and expected portfolio returns from answer c.
Ans. P(boom)= 2/3

P(rec)= 1/3

a) E(rA) = 2/3 *0.1 +1/3*0.06 = 0.0867; E(rB) = 2/3(-0.02) +1/3 x(0.4) = 0.12

b) SD(rA) = [ 2/3 x (0.10- 0.0867)^2 +1/3 x (0.06-0.0867)^2]^0.5 = 0.018856

SD(rB) = [2/3x(-0.02-0.12)^2 + 1/3 (0.4-0.12)^2]^0.5 = 0.19799

c) wA = wB = 0.5

E(rp)= 0.5x 0.0867 +0.5 x 0.12 = 0.10335 (10.335%)

d) wA= 0.1; wB = 0.9

E(rp) = 0.1x 0.0867 + 0.9x 0.12 = 0.11667 = 11.667%

e) cov(Ra, Rb) = 2/3 x(0.10- 0.0867) x(-0.02-0.12)+ 1/3x (0.06-0.0867)x(0.40-0.12)= -0.003733

f) corr(ra, rb) = -0.003733/ (0.018856x 0.19799) = 0.999

g) var(rp) = 0.5^2 (0.018856)^2 +(0.5^2) (0.19799^2) +2x 0.5x0.5x (-0.0037333)= -0.008022
sd(rp) = 8.957%

h) E(rp|Boom) = 0.5x 0.1+0.5x(-0.02) = 0.04

E(rp| Recessrion)= 0.5x 0.06+0.5x 0.4 = 0.23

E(rp)=2/3 x0.04+1/3x 0.23 = 10.335%

SD(rp) = [2/3x(0.04-0.10335)^2+1/3 (0.23-0.10355)^2]0.5 = 0.08957 = 8.957%

Q3. A. Consider a 3-year, 10% coupon bond with a face value of $1000. The bond pays
coupons annually. If appropriate annual discount rate is 8%, what is the highest price are
you willing to pay for that bond?
B. What price do you expect the 3-year, 10% coupon bond with a face value of $1000 to sell
for next year, immediately after the first coupon payment? The appropriate discount rate is
still 8%.
Ans. A. 100/ (1.08) + 100(1.08)^2 +1100/(1.08)^3 = 1051.54
B. E(P) = 100/(1.08)+ 1100(1.08)^2 = 1035.66

Q4. Suppose that an investor with a three-year investment horizon is considering purchasing
a 20-year, 8% coupon bond for $828.40. The yield-to maturity for this bond is 10%. The
investor expects that he can reinvest the coupon interest payments at an annual interest
rate of 6% and that at the end of the investment horizon the 17-year bond will be selling to
offer a yield-to-maturity of 7%. Compute the total return for this bond.
SOLN:
Even if you use annual, you will get similar return – close to 17%
Q5. My pension plan will pay me 10,000 once a year for a 10-year period. The first payment
will come in exactly 5 years. The pension fund wants to immunize its position.
a) What is the duration of its obligation to me? The current interest rate is 10% per
year.
b) If the plan uses 5-year and 20-year zero-coupon bonds to construct the immunized
position , how much money ought to be placed in each bond? What will be the face
value of the holdings in each zero?
Sol:
a)
PV of CF Weight Weight *periods

9090.90 0.1479 0.14795

8264.46 0.1345 0.26900

7,513.15 0.1223 0.36682

6,830.14 0.1112 0.44463

6,209.21 0.1010 0.50526

5,644.74 0.0919 0.55119

5,131.58 0.0835 0.58460

4,665.08 0.0759 0.60738

4,240.98 0.0690 0.62118

3.855.43 0.0628 0.62745

61,445.67 1.00 4.7255

D = 4.7255 years
Since the payment stream start in five years, we add four years to the duration, so the
duration is 8.7255 years
b)
The present value of the deferred annuity is
10,000 *annuity factor (10%,10)/1.10^4 = 41,968
If W is the weight of the portfolio invested in the 5-year zero coupon bond: (w*5) + [(1-
w)*20] = 8.7255
w= 0.7516
Investment in the 5-yesr zero is :
0.7516 *41,968 = 31,543
Investment in the 20-year zero coupon is: 0.2484 *41,968 = 10,425
The face value are equal to the respective future values of the investments. Hence the face
value is
31543 * (1.10)^5 = 50,800
Similarly the face value of the 20-year bond is 10425 *(1.10)^20 = 70134

Q6. The following data have been developed for the JSW Company :
State Probability Market Return (Rm) Return for the firm (Rj)
 1 0.1 -0.15 -0.30
2 0.3 0.05 0.00
3 0.4 0.15 0.20
4 0.2 0.20 0.50
The risk-free rate is 6%. Calculate the following:
(a) The expected market return
(b) The variance of the market return
(c) The expected return for the JSW Company.
(d) The Covariance of the return of the JSW company with the market return.
SOLN:

Q7.

Asset Returns (%) Transformed Factor

Changes (%)
State of Prob. X~ Y~ Z~ δ1 δ2
Nature
Horrid 0.2 -55.23 623.99 53.00 -10.00 -5.00
Bad 0.2 70.70 10.00 413.37 -5.00 38.48
Average 0.2 -9.00 25.00 -1493.12 25.00 8.00
Good 0.2 -12.47 -3771.42 1058.75 40.00 1.44
Great 0.2 61.00 3237.44 83.00 50.00 0.00

From the above Two factor Arbitrage pricing model. Find the . Rf=10%.
SOLN:

Q8. (a) If the expected rate of return on the market portfolio is 14% and the risk-free rate is
6%, find the beta for a portfolio that has expected rate of return of 10%. What assumptions
concerning this portfolio and/or market conditions do you need to make to calculate the
portfolio’s beta?
(b) What percentage of this portfolio must an individual put into the market portfolio in
order to achieve an expected return of 10%.

SOLN:

SOLN:
Q9. Suppose that securities are priced as if they are traded in a two-parameter economy.
You have forecast the correlation co-efficient between the rate of return on Tata Mutual
Fund and the market portfolio is 0.8. Your forecast of the standard deviations of the rates of
return are 0.25 for Tata, and 0.20 for the market portfolio. How would you combine the Tata
Fund and a riskless security to obtain a portfolio with a beta of 1.6?
SOLN:

Q10. a) What is Capital Market Line (CML)? Explain the Separation Theorem in the context
of the asset allocation recommended by the CML. b) Do you think movements on the line,
change of slope or parallel shifts of SML can take place?
Sol:

a) The capital market line (CML) represents portfolios that optimally combine risk and return. It is a
theoretical concept that represents all the portfolios that optimally combine the risk-free rate of
return and the market portfolio of risky assets. Under the capital asset pricing model (CAPM), all
investors will choose a position on the capital market line, in equilibrium, by borrowing or lending at
the risk-free rate, since this maximizes return for a given level of risk.

This separation theorem states that the market portfolio, M, is the same for all investors. They can
separate their level of risk aversion from their choice of the risky component of their total portfolio.
All investors should have the same risky component, M!

b) Movements along the SML reflect changes in the perceived risk of a security. If a firm’s
investment risk changes due to a change in one of the risk sources, such as business risk, it will move
along the SML. Changes in the slope of the SML illustrate how the return required by investors per
unit of risk has changed. The SML rotates counter clockwise about the risk-free rate when there is an
increase in the risk and vice versa. The SML will experience a parallel shift when there are changes in
one of the following factors: anticipated real growth; capital market conditions; or the expected
inflation rate. An increase in anticipated real growth, capital market conditions or the expected
inflation rate cause the SML to shift upwards and vice versa. The parallel shift occurs as a result of
changes in the above factors that affect all types of investments, regardless of their levels of risk.

Section-C

11. Assuming the prevailing initial margin requirement is 40%, commissions are ignored, and
Bata is selling at Rs. 35 per share, Shayam purchases 3571 shares using the maximum
allowable margin. If the maintenance margin is 30%, to what price can Bata’s share fall
before Shayam will receive a margin call?

3571P – 74991 =.3 -> P= Rs. 30

3571P

12. Suppose you are the manager of an investment fund in a two-parameter economy.
Given the following forecast:
E(Rm) = 0.16 σ(Rm) = 0.20 Rf = 0.80
Would you recommend investment in a security with E(Rj) = 0.12 and COV (Rj, Rm) = 0.01?
(Note: Assume that this price change has no significant effect on the position of the security
market line.)
SOLN:

13. Calculate the yield-to-maturity for a zero-coupon bond selling for $274.78 with a
maturity value of $1,000, maturing in 15 years.
SOLN:

14. With the help of portfolio duration, fill the respective cells

Bond Price ($) Yield (%) Par Amount Market Duration

Owned Value
9% 5-Year 122.4565 4 $ 5 million $ 6,122,823
5% 20-Year 113.6778 4 2 million 2,273,555
 5.5% 30-Year 126.0707 4 2 million 2,521,413

SOLN:

15. Stock A has a beta of 1.20 and Stock B has a beta of 0.8. Suppose rf = 2% and RM = 12%.
(a) According to the CAPM, what are the expected returns for each stock?
(b) What is the expected return of an equally weighted portfolio of these two stocks.

Ans.
a) E(r A) = 0.02+ 1.20(0.10) = 14% ; E(rB ) = 0.02+0.8(0.10) = 10%
b) Rp = Σwi*ri = 0.5*14+ 0.5*10 = 12%
Βp = 0.5(1.20)+ 0.5(0.8)= 1

16. The preferred stock of the Clarence Company has a par value of $100 and a $9 dividend
rate. You require an 11 percent rate of return on this stock. What is the maximum price you
would pay for it? Would you buy it at a market price of $96?
Ans. Value of the preferred stock= Dividend/ kp; kp= (req. rate of return)

Kp=11%; V= 9/0.11 = 81.81

Max. price we would pay for =81.81

Decision: If the market price of the stock is greater than the estimated value of the stock,
you do not buy the stock.

17. a) Suppose You invest $250 in the investment and earn the return $14 for the period of
5 months. Calculate the Annual HPY. a)0.23
b) Mr. Judas have invested in an investment and found the following HPY’s for the period of
four years 0.20,0.25, -0.25,0.20 respectively. Calculate the AM and GM, see whether GM is
lower than AM. b)0.089

18. An index model regression applied to past monthly returns in Ford’s stock price
produces the following estimates, which are believed to be stable over time:
=0.10% + 1.1 .
 If the market index subsequently rises by 8% and Ford’s stock price rises by 7%, what is the
abnormal change in Ford’s stock price?
SOLN:
The return on the market is 8%. Therefore, the forecast monthly return for GM is:
0.10% + (1.1 × 8%) = 8.9%
GM’s actual return was 7%, so the abnormal return was –1.9%.

19. Find the market equilibrium rate of return(E(Ri)) for assets X,Y,Z:
Factor Loadings
Asset R1 bi1 bi2 Transformed Factor Expectations
X 11% 0.4 2 δ1 =20%
Y 25 1 1.5 δ2 = 8%
Z 23 1.5 1

SOLN:

20. Rank the durations or effective durations of the following pairs of bonds:
a) Bond A is an 8% coupon bond, with a 20-year time to maturity selling at par value. Bond
B is an 8% coupon bond, with a 20-year maturity time selling below par value.
b) Bond A is a 20-year non-callable coupon bond with a coupon rate of 8%, selling at par.
Bond B is a 20-year callable bond with a coupon rate of 9%, also selling at par.

Solution: Bond B has a higher yield to maturity than bond A since its coupon payments and
maturity are equal to those of A, while its price is lower. (Perhaps the yield is higher because
of differences in credit risk.) Therefore, the duration of Bond B must be shorter.
b. Bond A has a lower yield and a lower coupon, both of which cause Bond A to have a
longer duration than Bond B. Moreover, A cannot be called, so that its maturity is at least as
long as that of B, which generally increases duration.