2nd Edition-Revised

CA Final
CMA Final

Strategic Financial
Management (New Scheme)

CA. Nagendra Sah

FCA, B. Sc. (H), Visiting faculty of ICAI, Stock Market
Expert, Highest Mark scorer in SFM, Best paper award
winner in Mathematics and Statistics in B. Sc.

© NS Learning Point (www.fmguru.org)

 COVERAGE
This book covers wide range of questions and sufficient to score more than 90 marks in both CA Final
and CMA Final. No need to refer any modules of ICAI or other reference books.
This book contains following questions:
(i) CA Final New Scheme Study material issued by ICAI,
(ii) CA final Old Scheme past examinations question for common topic,
(iii) CMA Final past examinations Question,
(iv) Revision Test Paper questions of Both CA and CMA
(v) Mock Test Paper questions of both CA and CMA
(vi) CMA Compendium and
(vii) Selected questions from foreign writer books.

Every effort has been made to avoid errors or omissions in this edition. In spite of this, error may creep
in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in
the next edition.

No part of this book may be reproduced or copied in any form or by any means without the written
permission of the publishers. Breach of this condition is liable for legal action.

© NS Learning Point (www.fmguru.org)

About Author
CA Nagendra Sah is a widely acclaimed Chartered Accountant in the field of Financial
Management, qualified Chartered Accountancy with highest Marks in Strategic Financial
Management (SFM). He teaches SFM to CA/CMA Final Students and Cost and
Management Account and Financial Management & Economics for finance to CA-Inter
Students. He has cleared all the levels of CA examinations in first attempt. He completed
12th as well as Graduation in Science with Statistics honours from the esteemed
Tribhuvan University. He has been a University Topper and awarded by University for
securing highest marks in Statistics as well as Mathematics.
He is the premier author who wrote Strategic Financial Management (SFM) book for CA Final, Cost and
Management Accounting (CMA) and Financial Management & Economics for finance for CA Intermediate.
His summary book is one of the most popular book among CA Students which is beneficial to revise whole
syllabus in less time with logical explanation.
CA Nagendra Sah is a firm believer of conventional and customary practices being adopting in training and
coaching for over many years. He is a Chartered Accountant who took up teaching as profession, who believes
in a teaching methodology that relates to human brains.
His goal is not only to enable students to pass in CA Exam but also to provide tips and knowledge to earn
money from stock Market by trading in Equity, Bond, Derivative, Currency, commodity and unit of Mutual
Fund. He is a consistent profit maker in Stock market and he got winner’s certificate many times from reputed
broker Zerodha.
His students get a practical linkage of concept with actual financial data of company and economy. They get
awareness of government policy, RBI policy, Fed policy, global market that affects Indian stock exchange.
He also provides practical knowledge of excel sheet for financial planning (like installment calculator etc)
His intense urge to bring about a sea of radical change in the traditional teaching techniques and pedagogies has
culminated in the form of this institution.

Message:
When a bird is alive, it eats ants. When the bird is dead, Ants eat the bird.
Time & Circumstances can changes at any time. Don’t devalue or hurt anyone in life.
You may be powerful today. But remember, Time is more powerful than you!

One tree makes a million match sticks. Only one match stick needed to burn a million trees.
So be good and do well.

© NS Learning Point (www.fmguru.org)

Contents
Chapter Pages

1. Time Value of Money………………………………………………………….. 1.1 to 1.4

2. Foreign Exchange Exposure and Risk Management (FOREX) .. 2.1 to 2.34

3. Mutual fund …….………………..……………………………………………….. 3.1 to 3.12

4. Derivatives Analysis and Valuation ………….…………………………. 4.1 to 4.32

5. Portfolio Management ..…………………………………………………… 5.1 to 5.32

6. Security Valuation …….……………………………………………………….. 6.1 to 6.34

7. Merger, Acquisition & Corporate Restructuring .………..………. 7.1 to 7.20

8. Interest Rate Risk Management .……….…….…………..……………. 8.1 to 8.12

9. Corporate Valuation ………………………………………………………….. 9.1 to 9.10

10. International Financial Management ..…………….………………… 10.1 to 10.8

11. Security Analysis ……………………………………………………………… 11.1 to 11.2

12. Risk Management ……………………………………………………………… 12.1 to 12.2

13. Table ………………………………………………………………………………… 13.1 to 13.10

© NS Learning Point (www.fmguru.org)

© NS Learning Point (www.fmguru.org)
© NS Learning Point (www.fmguru.org)
© NS Learning Point (www.fmguru.org)
© NS Learning Point (www.fmguru.org)
 Chapter - 5

PORTFOLIO MANAGEMENT
Learning Outcomes
After going through the chapter student shall be able to understand
❑ Activities in Portfolio Management
❑ Objectives of Portfolio Management
❑ Phases of Portfolio Management
(1) Security Analysis
(2) Portfolio Analysis
(3) Portfolio Selection
(4) Portfolio Revision
(5) Portfolio Evaluation
❑ Portfolio Theories
(1) Traditional Approach
(2) Modern Approach (Markowitz Model or Risk-Return Optimization)
❑ Risk Analysis
(1) Elements of Risk
(2) Diversion of Risk
(3) Risk & Return
(4) Portfolio Analysis
❑ Markowitz Model of Risk-Return Optimization
❑ Capital Asset Pricing Model (CAPM)
❑ Arbitrage Pricing Theory Model (APT)
❑ Sharpe Index Model
(1) Single Index Model
(2) Sharpe’s Optimal Portfolio
❑ Formulation of Portfolio Strategy
(1) Active Portfolio Strategy (APS)
(2) Passive Portfolio Strategy
(3) Selection of Securities
❑ Asset Allocation Strategies
❑ Random Walk Theory
❑ Efficient Market Theory

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.2 STRATEGIC FINANCIAL MANAGEMENT
RETURN AND STANDARD DEVIATION OF A SECURITY
Question No. 1A [SM-New] [May-2017-8M] [Nov-2009-Old-8M]
A stock costing  120 pays no dividends. The possible prices that the stock might sell for at the end of the year
with the respective probabilities are:
Price Probability
115 0.1
120 0.1
125 0.2
130 0.3
135 0.2
140 0.1
Required:
(i) Calculate the expected return.
(ii) Calculate the Standard deviation of returns.
[CMA-RTP-June-2015] [CMA-TP-Dec-2013-5M]
Ans: (i) Expected return = 7.08%, SD = 5.908;

Question No. 1B
You have estimated the probability distribution of expected future return for stocks
Stock X Stock Y
Probability Return Probability Return
0.1 -10% 0.2 2%
0.2 10 0.2 7
0.4 15 0.3 12
0.2 20 0.2 15
0.1 40 0.1 16
(a) What are the expected rate of return for stock X and stock Y?
(b) What is the standard deviation of expected returns for stock X and Stock Y?
(c) Which stock would you consider to be riskier?
[CMA-SM-2016]
Ans: (a) Expected return: X = 15%, Y = 10%; (b) σx = 11.62, σY = 4.94;
(d) X is more riskier (co-efficient of variation)

Question No. 1C [MTP-May-2019-New-8M] [RTP-May-2019] [May-2015-Nepal-8M] [Nov-2006-old-8

Marks] [May-2008-old-8 Marks] [MTP-May-2014-10M]
X Co., Ltd., invested on 1.4.2005 in certain equity shares as below:
Name of Co. No. of shares Cost ()
M Ltd. 1,000 (100 each) 2,00,000
N Ltd. 500 (10 each) 1,50,000
In September, 2005, 10% dividend was paid out by M Ltd. and in October, 2005, 30% dividend p aid out by N Ltd.
On 31.3.2006 market quotations showed a value of 220 and 290 per share for M Ltd. and N Ltd. respectively.
On 1.4.2006, investment advisors indicate (a) that the dividends from M Ltd. and N Ltd. for the year ending
31.3.2007 are likely to be 20% and 35%, respectively and (b) that the probabilities of market quotati ons on
31.3.2007 are as below:
Probability factor Price/share of M Ltd. Price/share of N Ltd.
0.2 220 290
0.5 250 310
0.3 280 330

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.3
You are required to:
(i) Calculate the average return from the portfolio for the year ended 31.3.2006;
(ii) Calculate the expected average return from the portfolio for the year 2006-07; and
(iii) Advise X Co. Ltd., of the comparative risk in the two investments by calculating the standard deviation in each
case.
Ans: (i) Average return=7.55%; (ii)Expected average return = 18.02% (iii)Standard Devi ation: M Ltd = 21, N Ltd = 14

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 1.1
XYZ Ltd never pays dividend. Its equity share is currently selling at  25. Using the following data find the expected
return and standard deviation of expected returns of share of A Ltd.
Price of equity share after 1 year () Probability of the price
20 .10
30 .20
40 .40
50 .20
60 .10
[CMA-RTP-June-2014]
Ans: Expected return = 60%, Standard deviation = 43.81

Question No. 1.2 [Nov-2005-8 Marks] [As RTP-May-2012] [RTP-May-2010]

Following information is available in respect of dividend, market price and market conditio n after one year.
Market condition Probability Market Price Dividend per share
 
Good 0.25 115 9
Normal 0.50 107 5
Bad 0.25 97 3
The existing market price of an equity share is  106 (F.V.  1), which is cum 10% bonus debenture of  6 each,
per share. M/s. X Finance Company Ltd. had offered the buy-back of debentures at face value.
Find out the expected return and variability of returns of the equity shares.
[CMA-PTP-June-2014-6M]
Ans: Expected Return = 12%, SD = 8.49%

COVARIENCE, CORRELATION AND SD OF PORTFOLIO

Question No. 2A [SM-New] [May-2007-10M]
The historical rates of return of two securities over the past ten years are given. Calculate the Covariance and the
Correlation coefficient of the two securities:
Years: 1 2 3 4 5 6 7 8 9 10
Security 1: 12 8 7 14 16 15 18 20 16 22
(Return per cent)
Security 2: 20 22 24 18 15 20 24 25 22 20
(Return per cent)
[CMA-RTP-Dec-2013] [CMA-MTP-June-2014-7M]
Ans: Co-Var. = -0.8, Correlation = -0.0605

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.4 STRATEGIC FINANCIAL MANAGEMENT
Question No. 2B [SM-New] [May-2018-New-10M] [Nov-2008-5M] [RTP-Nov-2009]
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% respectively.
(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%.
[CMA-MTP-June-2015-8M]
Ans: (i) Expected Return = 14.2%; (ii) S.D: Stock A = 3%, Stock B = 3%
(iii) Co-Var. = 9; (iv) Correlation co. = 1; (v) Risk portfolio = 3%

Question No. 2C [Nov-2017-10M]

The return of security ‘L’ and Security ‘K’ for the past five years are given below:
Year Security-L Security-K
Return % Return %
2012 10 11
2013 04 -06
2014 05 13
2015 11 08
2016 15 14
Calculate the risk and return of portfolio consisting above information.

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 2.1 [SM-New] [Nov-2008-old-6M]
Mr. A is interested to invest 1,00,000 in the securities market. He selected two securities B and D for this
purpose. The risk return profile of these securities are as follows :
Security Risk (σ) 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 risk and portfolio return of the following portfolios of B and D to be
considered by A for his investment.
(i) 100 percent investment in B only;
(ii) 50 percent of the fund invested in B and D both;
(iii) 75 percent of the fund in B and the rest 25 percent in D;
(iv) 25 percent of the fund in B and the rest 75 percent in D; and
(v) 100 percent investment in D only.
Also indicate that which portfolio is the best for him from risk as well as return point of view?
[CMA-Compendium] [CMA-Dec-2013-8M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.5
Question No. 2.2
Mr. Varun holds portfolio consisting of two stock, stock A and stock B. stock A has a standard deviation of returns
of 0.60 and stock B has a standard deviation of 0.80. The correlation co-efficient of the two stocks ‘return is 0.50.
if Varun holds equal amount of each stock, what will be risk of the portfolio consisting of two stocks?
[CMA-Dec-2014 -2M]

Question No. 2.3

Mr. Kumar is a fund manager of an equity fund is expected to provide risk premium of 10% and standard deviation
of returns of 16%. Miss Ankita, a client of Mr. Kumar chooses to invest n1,05,000 in equity fund and 45,000 in
T-Bills. If T – Bills are trading at 7% p.a. Estimate the expected return and standard deviation of return on the
portfolio for Miss Ankita.
[CMA-PTP-June-2015 -2M]
Ans: Expected return on Equity fund = 7.00 + 10.00= 17%
Expected return on Portfolio of Miss Ankita: 0.70 × 17 + 0.30 × 7 = 14%
Expected Standard deviation of the return on Port folio = 0.70 × 0.16 = 11.20%
Question No. 2.4
Stocks P and Q have the following historical returns:
Year 2009 2010 2011 2012 2013
Stock P’s Return (K ) -12.24 23.68 34.44 5.82 28.30
Stock Q’s Return (K ) -7.00 25.55 44.09 2.20 20.16
You are required to calculate the average rate of return for each stock during the period 2009 to 2013.
Assume that someone held a Portfolio consisting 50% of Stock P and 50% of Stock Q. What would have been the
realized rate of return on the Portfolio in each year from 2009 to 2013? What would been the average return on
the Portfolio during the period? (You may assume that year ended on 31st March).
[CMA-PTP-Dec-2014-3+5=8M] [CMA-PTP-Dec-2014 -3+5=8M]
Ans: (i) Return P = 16%; Return Q = 17%
(ii) 2009 = -9.62%; 2010 = 24.62%; 2011 = 39.27%; 2012 = 4.01%; 2013 = 24.23%; Avg = 16.50%

Question No. 2.5

From the following data calculated the Return and risk of a portfolio containing 60% of stock A and 40% of stock-
B.
Market condition Probability E(RA) E(RB)
Boom 0.25 40% 40%
Growth 0.50 20% 30%
Recession 0.25 10% 20%
[CMA-Dec-2013-6M]

Question No. 2.6

Mr. Kumar is a fund manager of an equity fund is expected to provide risk premium of 10% and standard deviation
of returns of 16%. Miss Ankita, a client of Mr. Kumar chooses to invest 70,000 in equity fund and 30,000 in T-
Bills. If T – Bills are trading at 7% p.a., the expected return and standard deviation of return on the portfolio of Miss
Ankita will be.
[CMA-PTP-Dec-2014-2M]
Ans: Return = 14%; SD = 11.20%

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.6 STRATEGIC FINANCIAL MANAGEMENT
BETA COEFFICIENT
Question No. 3A [Nov-2018-Old-8M] [SM-New] [May-2006-8M]
The distribution of return of security ‘F’ and the market portfolio ‘P’ is given below:
Probability Return % Return %
F P
0.30 30 -10
0.40 20 20
0.30 0 30
You are required to calculate the expected return of security ‘F’ and the market portfolio ‘P’, the covariance between
the market portfolio and security and beta for the security.
[CMA-Compendium]
Ans: Expected R.“F” = 17%, “p” = 14.%; Co-Var. = -168; Beta Security = -0.636
Question No. 3B [RTP-May-2017]
A company has a choice of investments between several different equity oriented funds. The company has an
amount of  1 crore to invest. The details of the mutual funds are as follows:
Mutual Funds A B C D E
Beta 1.6 1.0 0.9 2.0 0.6
Required:
(i) If the company invests 20% of its investments in the first two mutual funds, and an equal amount in the
mutual funds C, D and E, what is the beta of the portfolio?
(ii) If the company invests 15% of its investments in C, 15% in A, 10% in E and the balance in is in the equal
amount in the other two mutual funds, what is the beta of the portfolio?
(iii) If the expected return of the market portfolio is 12% at a beta factor of 1.0, what be the portfolio? Expected
return in both the situation given above.
[CMA-Dec-2014-8M]

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 3.1
The stock research division of MMG investment Ltd. has developed ex-ante probability distribution for the likely
economic scenarios over the next one-year and estimate the corresponding one period rates of return on stock A,
stock B and market index as follows:
Economic Scenario Probability One period rate of return (%)
Stock A Stock B Market
Recession 0.15 -15 -3 -10
Low growth 0.25 10 7 13
Medium growth 0.45 25 15 18
High growth 0.15 40 25 32
The expected risk-free real rate of return and the premium for inflation are 3% and 6.5% per annum respectively.
You, as an ANALYST of MMG investment service Ltd. Are required to:
(i) Calculate the following for stock A and B.
(a) Expected return (b) Covariance of returns with the market returns.
(c) Beta
(ii) Recommend for fresh investment in any of these two stocks.
------show all the necessary calculations.
[CMA-June-2018-New-8M] [CMA-TP-Dec-2013-12M]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.7
Question No. 3.2
You are running a portfolio management business and have assembled the following portfolio for client A.
Scrip Value Beta
Infosys  5 lakhs 1.21
Hind. Lever 8 lakhs 0.97
Reliance 5 lakhs 1.09
Total motors 2 lakhs 1.32
Your client insists that the portfolio should comprise the above 4 scrips alone and that each scrip should be at
least 10% of the total portfolio value. You project the sensex which is currently 4200 to move to 4500 by the end
of 3 months and to 4800 by the end of 6 months.
(i) What will be the value of your portfolio at the end of 3 months and 6 months?
(ii) What is the portfolio beta currently?
(iii) What could you do to improve the portfolio performance given you view on the market?
(iv) If you do take such action what will the portfolio value be after 3 months and after 6 months?
(v) What will be the portfolio beta in such a case?
(vi) At the end of 6 months, you believe that the bull market would have had its run and that the sensex will now
start moving down to around 4600 levels at the end of 9 months from now. How will you again restructure
the portfolio at the end of 6 months from now?
[CMA-TP-Dec-2013-16M]

Question No. 3.3

X owns a stock portfolio equally invested in a risk free asset and two stocks. If one of the stocks has a beta of 0.8
and the portfolio is as risky as the market what must be the beta of the other stocks in the portfolio
[CMA-PTP-Dec-2014-2M]
Ans: Beta of other stock = 2.2

Question No. 3.4 [MTP-May-2019-8M]

Given below is information of market rates of Returns and Data from two Companies A and B:
Year 2015 Year 2015 Year 2015
Market (%) 12.0 11.0 9.0
Company A (%) 13.0 11.5 9.8
Company B (%) 11.0 10.5 9.5
Calculate the beta coefficients of the Shares of Company A and Company B.

SYSTEMATIC AND UNSYSTEMATIC RISK

Question No. 4A [May-2012-8 Marks]
A has portfolio having following features:
Security β Random Error σ ei Weight
L 1.60 7 0.25
M 1.15 11 0.30
N 1.40 3 0.25
K 1.00 9 0.20
You are required to find out the risk of the portfolio if the standard deviation of the market index (σm) is 18 %.
Ans: 23.69%

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.8 STRATEGIC FINANCIAL MANAGEMENT
Question No. 4B [SM-NEW] [SM-OLD]
The following details are given for X and Y companies’ stocks and the Bombay 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?
Stock X Stock Y Sensex
Average return 0.15 0.25 0.06
Variance of return 6.30 5.86 2.25
Beta 0.71 0.27
Correlation Co-efficient 0.424
Co-efficient of determination (r 2) 0.18
[CMA-SM-2016]
Ans: Company X: Sys. Risk=1.134, Unsys Risk = 5.166
Company Y: Sys Risk = .1640, Unsys Risk = 5.696; Portfolio risk = 1.804

Question No. 4C [Nov-2018-Old-8M] [Nov-2009-8M]

A study by a Mutual fund has revealed the following data in respect of three securities:
Security 𝝈 (%) Correlation with Index, Pm
A 20 0.60
B 18 0.95
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 co-variances 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) ?
[CMA-PTP-June-2014-10M] [CMA-MTP-Dec-2014-(1+2+4+1)=8M] [Point (i)-CMA-June-2015-2M]
Ans: (i) Sensitivity: A = 0.80; B = 1.14; C = 0.60; (ii) Covariance: A&B = 205.20; B&C = 153.90; C&A = 108
(iii) Portfolio Risk = 14.155; (iv) Beta of Portfolio = 0.847; (v) Portfolio Sys = 161.41; (vi) Port Unsys = 38.954

Question No. 4D [MTP-May-2019-New-8M] [Nov-2016-8M] [CMA-RTP-2018]

Mr. Abhishek is interested in investing  2,00,000 for which he is considering following three alternatives:
(i) Invest 2,00,000 in Mutual Fund X (MFX)
(ii) Invest  2,00,000 in Mutual Fund Y (MFY)
(iii) Invest  1,20,000 in Mutual Fund X (MFX) and  80,000 in Mutual Fund Y (MFY)
Average annual return earned by MFX and MFY is 15% and 14% respectively. Risk free rate of return is 10% and
market rate of return is 12%.
Covariance of returns of MFX, MFY and market portfolio Mix are as follow:
MFX MFY Mix
MFX 4.800 4.300 3.370
MFY 4.300 4.250 2.800
M 3.370 2.800 3.100
You are required to calculate:
(i) variance of return from MFX, MFY and market return,
(ii) portfolio return, beta, portfolio variance and portfolio standard deviation,
(iii) expected return, systematic risk and unsystematic risk; and
(iv) Sharpe ratio, Treynor ratio and Alpha of MFX, MFY and Portfolio Mix [CMA-SM-2016]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.9

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 4.1
[May-2019-New-8M] [MTP-Nov-2018-New-10M] [RTP-May-2018-New] [SM-NEW] [May-2015-8M]
Following are the details of a portfolio consisting of three shares:
Share Portfolio weight Beta Expected return in % Total Variance
A 0.20 0.40 14 0.015
B 0.50 0.50 15 0.025
C 0.30 1.10 21 0.100
Standard Deviation of Market Portfolio Returns = 10%
You are given the following additional data:
Covariance (A, B) = 0.030
Covariance (A, C) = 0.020
Covariance (B, C) = 0.040
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
[CMA-SM-2016]

Question No. 4.2

Ms Mitrika an analyst at Anshika securities Ltd. Is considering the stocks depend on the growth rate GDP. The
conditional returns of the market and the stocks are given below:
Economic scenario Probability Return on (%) Return on Market %
GDP growth rate
Spark Ltd. Global Ltd.
1.0 – 3.0% 0.18 15 9 7
3.00 – 6.00% 0.24 25 14 11
6.00 – 8.00% 0.26 38 27 18
More than 8.00% 0.32 46 33 25
The expected risk-free return is 6.5%
Assume that CAPM holds good in the market
You are required to
(i) Calculate the Ex-ante-betas for the two stocks.
(ii) Find out whether the stocks of Sparks Ltd. And Global Ltd. Are under priced or over priced.
(iii) Calculate the proportion of systematic risk and unsystematic risk for both companies.
(iv) Determine which stock the analyst would suggest to invest.
[CMA-TP-Dec-2013-16M]
Question No. 4.3
Historically, when the market return changed by 10% the return on the stock of Arihant Ltd changed by 16%. If
the variance of market is 257.81, then calculate the systematic risk of Arihant Ltd.
[CMA-MTP-June-2015-M]
Ans: 660

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.10 STRATEGIC FINANCIAL MANAGEMENT
MEASURES FOR EVALUATING THE PERFORMANCE OF MUTUAL FUND
Question No. 5A [SM-NEW] [RTP-Nov-2018-New] [RTP-Nov-2017] [May-2016-5M]
The following are the data on five mutual funds.
Fund Return Standard deviation Beta
A 15 7 1.25
B 18 10 0.75
C 14 5 1.40
D 12 6 0.98
E 16 9 1.50
What is the reward-to –variability/Volatility ratio and ranking if the risk free rate is 6%?
Requirement in CA Exam and SM-New (But Solution same):
You are required to compute Reward to Volatility Ratio and rank these portfolio using:
♦ Sharpe method and ♦ Treynor's method
[CMA-Dec-2016] [CMA-RTP-Dec-2013] [CMA-Dec-2013-6M] [CMA-MTP-June-2014-4M] [CMA-SM-2016]

Question No. 5B [May-2017-8M]

Following information is available regarding six portfolios:
Portfolio Average annual return Standard Deviation Correlation with market
A 20.0 2.3 0.8869
B 17.0 1.8 0.6667
C 18.0 1.6 0.600
D 16.0 1.8 0.867
E 13.5 1.9 0.5437
Market risk: 1.2
Market rate of return: 14.3%
Risk free rate: 10.1%
Beta may be calculated only upto two decimal. Rank the portfolio using JENSEN'S ALPHA method.

Question No. 5C [RTP-May-2019] [May-2015-8M]

There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having close ended equity
schemes.
NAV as on 31-12-2014 of equity schemes of D Mutual Fund Ltd. is Rs. 70.71 (consisting 99% equity and remaining
cash balance) and that of K Mutual Fund Ltd. is Rs. 62.50 (consisting 96% equity and balance in cash).
Following is the other information:
Particulars Equity schemes
D Mutual Funds Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard Deviation 11.25 5

There is no change in portfolios during the next month and annual average cost is Rs. 3 per unit for the schemes of
both the Mutual Funds. If Shares Market goes down by 5% within a month, calculate expected NAV after a month
for the schemes of both Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particulars month.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.11

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 5.1
Following information is available regarding six portfolios:
Portfolio Average annual return Standard Deviation Correlation with market
A 22.0 21.2 0.70
B 18.6 26.0 0.80
C 14.8 18.0 0.62
D 15.1 8.0 0.95
E 26.5 19.3 0.65
F (-) 9.0 4.0 0.42
Market Risk 12.0 12.0
Free rate 9.0
You are required to:
(i) Rank these Portfolios using Sharpe’s method and Treynor’s method; and
(ii) Compare the ranking and explain the reasons behind the differences
[CMA-June-2014-(6+2)=8M] [CMA-RTP-Dec-2014]

Question No. 5.2 [SM-OLD]

Following information is available regarding four mutual funds:
Mutual Fund Return Risk (σ) β (Beta) Risk free rate
P 13 16 .90 9
Q 17 23 .86 9
R 23 39 1.20 9
S 15 25 1.38 9
Evaluate performance of these mutual funds using Sharp Ratio and Treynor's Ratio.
Comment on the evaluation after ranking the funds.
[CMA-Dec-2013-6M] [CMA-SM-2016]
Question No. 5.3 [RTP-Nov-2010-Old]
Following is the historical Performance information is available of the capital market and a Tomplan Mutual fund.
Year Tomplan Mutual Tomplan Mutual Fund Return on market Return on Govt.
Fund beta return % index % Security %
2001 0.90 -3.00 -8.50 6.50
2002 0.95 1.50 4.00 6.50
2003 0.95 18.00 14.00 6.00
2004 1.00 22.00 18.50 6.00
2005 1.00 10.00 5.70 5.75
2006 0.90 7.00 1.20 5.75
2007 0.80 18.00 16.00 6.00
2008 0.75 24.00 18.00 5.50
2009 0.75 15.00 10.00 5.50
2010 0.70 -2.00 8.00 6.00
(a) From above information you are required to calculate the following risk adjusted return measures for the
Tomplan:
(i) Reward-to-variability ratio; (ii) Reward-to-volatility ratio
(b) Comment on the mutual fund’s performance.
Ans: (a)(i) Reward to variability (Sharpe): For Tomplan Mutual fund = 0.545; for Mkt = 0.34
(ii) Reward to volatility (Treynor): For Tomplan = 5.86; for mkt = 2.74
(b) Tomplan Mutual fund has performed better than the market on the basis of both Sharper and Treynor’s ratio

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.12 STRATEGIC FINANCIAL MANAGEMENT
Question No. 5.4
Equi-stable is a portfolio model wherein 20% of fund value is invested in fixed Income Bearing Instruments. The
balance of 80% is divided among old industry stock (iron and steel), Automotive Industry stock, Information
Technology stocks, Infrastructure company stocks and financial services sector in ratio of 4:2:6:3:5.
Three mutual funds X,Y and Z offer a fund scheme based on the Equi-stable portfolio model. The actual return on
Equi-stable portfolio of each of the three funds for the past 3 years is as follows:

1 2 3
Portfolio-X 17.35% 18.70% 21.60%
Portfolio-Y 17.20% 18.25% 22.15%
Portfolio-Z 17.10% 18.60% 22.00%
Beta factor of the Equi-stable portfolio is measured at 1.35. Return on market portfolio indicates that Rs 1,000
invested will fetch Rs 153 in years (including capital appreciation and dividend yield). RBI bonds, guaranteed by
the central Government yields 4.50%. Rate the fund managers of X, Y and Z.
[CMA-RTP-June-2015] [CMA-Dec-2014-6M] [CMA-SM-2016]

Question No. 5.5

PS Fund invests exclusively in Public sector undertakings, yielded  4.85 per unit for the year. The opening NAV
was  26.85. The Fund has a risk factor of 3.50%. Ascertain the sharpe Ratio and Compare the fund performance
with market performance if
(i) Risk free Return is 6%, if return on Sensex is 16% with a standard deviation of 3.75%.
(ii) Risk Free Return is 5%, return on Sensex is 18% with a standard deviation of 4%
[CMA-June-2015-4M] [CMA-SM-2016]

CAPITAL ASSETS PRICING MODEL

Question No. 6A [SM-NEW] [SM-OLD]
A company’s beta is 1.40. The market return is 14%. The risk free rate is
10% (i) What is the expected return based on CAPM (ii) If the risk premium on the market goes up by 2.5%
points, what would be the revised expected return on this stock?
Ans: (i) Expected return = 15.6%, (ii) revised R = 19.1%

Question No. 6B [SM-NEW] [SM-OLD]

Treasury Bills give a return of 5%. Market Return is 13% (i) What is the market risk premium (ii) Compute the β
Value and required returns for the following combination of investments.
Treasury Bill 100 70 30 0
Market 0 30 70 100
Ans: (i) Market Risk Premium = 8%; (ii) β = 0, 0.3, 0.7, 1; Required Return = 5, 7.4, 10.6, 13%.

Question No. 6C [SM-NEW] [SM-OLD]

Pearl Ltd. expects that considering the current market prices, the equity share holders should get a return of at least
15.50% while the current return on the market is 12%. RBI has closed the latest auction for  2500 crores of 182
day bills for the lowest bid of 4.3% although there were bidders at a higher rate of 4.6% also for lots of less than 
10 crores. What is Pearl Ltd’s Beta?
Ans: Beta = 1.464

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.13
Question No. 6D [May-2018-Old-8M] [May-1996-10M] [SM-OLD] [CMA-RTP-Dec-2018]
As an investment manager you are given the following information:
Investment in equity shares Initial Dividends Market price at the end of Beta risk
of price the year factor
   
A. Cement Ltd. 25 2 50 0.8
Steel Ltd. 35 2 60 0.7
Liquor Ltd. 45 2 135 0.5
B. Government of India Bonds 1,000 140 1,005 0.99
Risk free return may be taken at 14%
You are required to calculate:
(i) Expected rate of returns of portfolio in each using Capital Asset Pricing Model (CAPM).
(ii) Average return of portfolio.
[CMA-Dec-2003-16M] [CMA-Compendium] [CMA-TP-Dec-2013-8M] [CMA-Dec-2014-8M]
Ans: (i) Req. R: Cement=23.864, Steel=22.631, Liquor=20.165, G Bond=26.207; (ii) Average R=23.217%
[Note: In December-2014, CMA Institute suggested answer provided two answers: (i) Simple return (ii) Weighted average return]
[Note: In May-2018 CA Exam, one additional requirement is “Calculate expected rate of return on portfolio (aggregate) of investor ]

Question No. 6E [SM-NEW] [May-2003-6M] [Nov-2013-8M]

Your client is holding the following securities:
Particulars of Cost Dividends Market Price BETA
Securities   
Equity Shares:
Co. X 8,000 800 8,200 0.8
Co. Y 10,000 800 10,500 0.7
Co. Z 16,000 800 22,000 0.5
PSU Bonds 34,000 3,400 32,300 0.2
Assuming a Risk-free rate of 15%, calculate:
– Expected rate of return in each, using the Capital Asset Pricing Model (CAPM).
– Average return of the portfolio.
[CMA-June-2018-8M] [CMA-Compendium] [CMA-PTP-Dec-2014-8M] [CMA-PTP-June-2015-8M]
Ans: Expected return: X = 15.7056, Y= 15.62, Z= 15.441, PSU= ; Average R=%

Question No. 6F [May-2015-8M] [Nov-2005-8M]

Your client is holding the following securities:
Particulars of Securities Cost Dividends/Interest Market price Beta
  
Equity Shares:
Gold Ltd. 10,000 1,725 9,800 0.6
Silver Ltd. 15,000 1,000 16,200 0.8
Bronze Ltd. 14,000 700 20,000 0.6
GOI Bonds 36,000 3,600 34,500 1.0
Average return of the portfolio is 15.7%, calculate:
(i) Expected rate of return in each, using the Capital Asset Pricing Model (CAPM).
(ii) Risk free rate of return.
[CMA-Compendium]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.14 STRATEGIC FINANCIAL MANAGEMENT
Ans: (i) Expected R: Gold=14.32, Silver=15.51, Bronze=14.32, Goi Bond=16.7; (ii) Rf = 10.75%

Question No. 6G [SM-NEW] [Nov-2007-8M] [RTP-May-2014]

XYZ Ltd. has substantial cash flow and until the surplus funds are utilized to meet the future capital expenditure,
likely to happen after several months, are invested in a portfolio of short -term equity investments, details for
which are given below:
Investment No. of shares Beta Market price per share  Expected dividend yield
I 60,000 1.16 4.29 19.50%
II 80,000 2.28 2.92 24.00%
III 1,00,000 0.90 2.17 17.50%
IV 1,25,000 1.50 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 market;
(ii) Whether XYZ should change the composition of its portfolio.
[CMA-Compendium] [CMA-PTP-June-2014-8M]
Ans: (i) Beta Portfolio = 1.46; (ii) Increase the proportion of investment-IV.

Question No. 6H [Nov-2016-5M] [RTP-May-2013]

The following information is available in respect of Security X
Equilibrium Return 15%
Market Return 15%
7% Treasury Bond Trading at $140
Covariance of Market Return and Security Return 225%
Coefficient of Correlation 0.75

You are required to determine the Standard Deviation of Market Return and Security Return.
Ans: Standard Deviation = 15%; Security Return = 20%

Question No. 6I [May-2002-old-10marks]

A Ltd. has an expected return of 22% and Standard deviation of 40%. B Ltd. has an expected return of 24% and
Standard deviation of 38%. A Ltd. has a beta of 0.86 and B Ltd. a beta of 1.24. The correlation coefficient between
the return of A Ltd. and B Ltd. is 0.72. The Standard deviation of the market return is 20%. Suggest:
(i) Is investing in B Ltd. better than investing in A Ltd.?
(ii) If you invest 30% in B Ltd. and 70% in A Ltd., what is your expected rate of return and portfolio Standard
deviation?
(iii) What is the market portfolios expected rate of return and how much is the risk-free rate?
(iv) What is the beta of Portfolio if A Ltd.’s weight is 70% and B Ltd.’s weight is 30%?
[CMA-MTP-Dec-2018]
[CMA-Compendium] [CMA-Dec-2013-8M] [CMA-PTP-June-2014/2013 -10M]
[CMA-RTP-Dec-2014]
Ans: (i) B should be selected; (ii) Expected R = 22.6%; SD = 37.062,
Rm = 22.737; RF = 17.473, (iv) WA Beta = .974

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.15
Question No. 6J [SM-OLD] [May-2017-8M] [As-RTP-Nov-2013] [RTP-May-2015]
The following information is available with respect of Jaykay Ltd. and Market
Jay Kay Ltd Market
Year Return on Govt. bonds
Average Share Price () DPS () Average index Dividend Yield
2002 242 20 1812 4 6
2003 279 25 1950 5 5
2004 305 30 2258 6 4
2005 322 35 2220 7 5
Compute Beta Value of the company as at the end of 2005. What is your observation?
Ans: Beta value of Co = 1.93

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 6.1 [SM-NEW] [SM-OLD]
The risk premium for the market is 10%. Assuming Beta values of 0, 0.25, 0.42, 1.00 and 1.67. Compute the risk
premium on Security K.

Question No. 6.2

Mr. X has the following portfolio of four shares:
The risk free rate of return is 7% and the market rate of return is 14%. Determine the portfolio beta and return.
Name Beta Investment  Lakhs.
A Ltd 0.45 0.80
B Ltd 0.35 1.50
C Ltd 1.15 2.25
D Ltd 1.85 4.50
[CMA-PTP-June-2014-5M]
Ans: Beta Port = 1.303; Return Port = 16.121%

Question No. 6.3 [May-1998-old-6 Marks] [Study Mat.]

An investor is seeking the price to pay for a security, whose standard deviation is 3.00 per cent. The correlation
coefficient for the security with the market is 0.8 and the market standard deviation is 2.2 per cent. The return
from government securities is 5.2 per cent and from the market portfolio is 9.8 per cent. The investor knows that,
by calculating the required return, he can then determine the price to pay for the security. What is the required
return on the security?
[CMA-PTP-June-2015-10M] [CMA-Compendium]
Ans: Required return = 10.22%
Question No. 6.4 [MTP-May-2014-8M]
Mr. A has short term investments in shares of the various companies. The details of these investments is as
follows:
Name of Company No. of shares Geared Beta Current Market Current Expected
Price () Dividend Return (%)
Yield (%)
T Ltd. (Face Value  50) 1000 1.55 280 6.8 21.00
U Ltd. (Face Value  100) 1550 0.65 340 3.6 12.50
V Ltd. (Face Value  20) 2600 1.26 150 6.4 18.00
W Ltd. (Face Value 10 4300 1.14 95 7.2 18.50
Risk Free Rate of Return and market return are 6% and 16% respectively. You are required to:
(a) Estimate the risk of Mr. A’s portfolio relative to market.
(b) Whether the composition of portfolio should be changed if yes then how.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.16 STRATEGIC FINANCIAL MANAGEMENT
Question No. 6.5
Shahid has invested in four securities A, B, C and D, the particulars of which are as follows:
Security Amount Invested () Beta (β)
A 1,25,000 0.60
B 1,50,000 1.50
C 80,000 0.90
D 1,45,000 1.30

If RBI Bonds carries an interest rate of 8% and nifty yields 14%, what is the expected return on portfolio? If
investment in Security C is replaced by investment in RBI Bonds, what is the corresponding change in Portfolio
Beta and expected return?
[CMA-June-2017-New-8M] [CMA-PTP-June-2015-(4+4)=8M] [CMA-PTP-Dec-2014-(4+4)=8M]
Ans: (i) ER = 14.726%; (ii) Beta = 0.977; ER = 13.862%
Question No. 6.6
An investor is seeking the price for a security, whose standard deviation is 4.00 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, he can then determine the price to pay for the
security. What is the required return on the security?
[CMA-TP-Dec-2013-4M] [CMA-PTP-Dec-2014-3M] [CMA-PTP-June-2015-3M]
Ans: RR=11.89%
Question No. 6.7
Yamuna Ltd. Is an on levered firm and undertakes three projects A,B and C. The risk free rate of return is 8% and
the return from market is 12%. The projects have a weight of 0.5, 0.3 and 0.3 respectively. Their respective betas
are 1.3, 1.0 and 0.8.
You are required to compute:
(1) Expected return from each project?
(2) Expected return for the company, and
(3) Cost of capital
[CMA-Dec-2014-6M]
Ans: (i) A = 3.2%; (ii) B = 12%; (iii) C = 11.2%; (ii) Return = 12.44%; (iii) Cost of Capital = 12.44%

Question No. 6.8 [SM-NEW] [RTP-Nov-2018-New] [Nov-2012-8M]

Mr. FedUp Wants to invest an amount of 520 lakhs and had approached his portfolio Manager. The Portfolio
manager had advised Mr. FedUp to invest in the following manner:
Security Moderate Better Good Very Good Best
Amount (in  Lakhs) 60 80 100 120 160
Beta 0.5 1.00 0.80 1.20 1.50
You are required to advise Mr. FedUp in regard to the following, Using Capital Asset Pricing Methodology:
(i) Expected return on the portfolio, if the Government Securities are at 8% and the NIFTY is yielding 10%.
(ii) Advisability of replacing security ‘Better’ with NIFTY.
Ans: (i) Req Return Portfolio = 10.21%; (ii) No effect

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.17
Question No. 6.9 [RTP-Nov-2011] [Correlate with Q-6J also]
The following information is available for the share of X Ltd. and stock exchange for the last 4 years.
X Ltd. Index of Return from Return from
Share Price Divided Yield Stock Exchange Market funds Govt Securities
Present Year 197.00 10% 2182 16% 15%
1 year ago 164.20 12% 1983 15% 15%
2 year ago 155.00 8% 1665 16% 16%
3 year ago 121.00 10% 1789 10% 14%
4 year ago 95.00 10% 1490 18% 15%
With above information available please calculate:
(i) Expected Return on X Ltd.’s share.
(ii) Expected Return on Market Index.
(iii) Risk Free Rate of Return
(iv) Beta of X Ltd.
Ans: (i) Expected Return = 30%; (ii) Expected Return = 25%; (iii) Risk Free = 15%; (iv) Beta = 1.5 times.

Question No. 6.10

Portfolio B, a fully diversified portfolio, has a standard deviation of 6%. The NIFTY has yields a return of 16.5%,
with a standard deviation of 4%. Ascertain the expected return of Portfolio B under the following three cases —
(a) 5.80% ₹100 central government guaranteed RBI Bonds is traded at ₹116;
(b) market’s attitude towards risk is 3.5;
(c) risk free return is 8%
[CMA-SM-2016]
Ans:

Question No. 6.11 [RTP-Nov-2017]

ABC Ltd. Manufactures car air conditioners (ACs), window ACs and split ACs constituting 60%, 25% and 15%
of total market value. The standalone standard deviation and coefficient of correlation with market return of Car
AC and window AC is as follows:
S.D. Coefficient of Correlation
Car AC 0.30 0.6
Window AC 0.35 0.7
No data for standalone SD and coefficient of correlation of split AC is not available. However, a company who
deserves its half value from split AC and half from window AC has a SD of 0.5 and coefficient of correlation with
market return is 0.85we. Index has a return of 105 and has SD of 0.20. Further, the risk free rate of return id 4%.
You are required to determine:
(i) Beta of ABC Ltd.
(ii) Cost of Equity of ABC Ltd.
Assuming that ABC Ltd. Wants to raise debt of an amount equal to half of its market value then determine equity
beta, if yield of debt is 5%.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.18 STRATEGIC FINANCIAL MANAGEMENT
ARBITRAGE PRICING THEORY MODEL (APT)
Question No. 7A
[SM-NEW] [RTP-Nov-2017] [MTP-Nov-2018-New-6M] [May-2011-5 Marks] [As-RTP-May-2013]
Mr. Tamarind intends to invest in equity shares of a company the value of which depends upon various
parameters as mentioned below:
Factor Beta Expected value in % Actual value in %
GNP 1.20 7.70 7.70
Inflation 1.75 5.50 7.00
Interest rate 1.30 7.75 9.00
Stock market index 1.70 10.00 12.00
Industrial production 1.00 7.00 7.50
If the risk free rate of interest be 9.25% how much is the return of the share under Arbitrage pricing theory?
[CMA-TP-Dec-2013-4M]
Ans: Return under APT = 17.40%

Question No. 7B [Nov-2018-New-8M] [June-2009-8M]

Mr. X owns a portfolio with the following characteristics:
Security A Security B Risk Free security
Factor 1 sensitivity 0.80 1.50 0
Factor 2 sensitivity 0.60 1.20 0
Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.
(i) If Mr. X has  1,00,000 to invest and sells short  50,000 of security B and purchases  1,50,000 of security
A what is the sensitivity of Mr. X’s portfolio to the two factors?
(ii) If Mr. X borrows  1,00,000 at the risk free rate and invests the amount he borrows along with the original
amount of  1,00,000 in security A and B in the same proportion as described in part (i), what is the sensitivity
of the portfolio to the two factors?
(iii) What is the expected return premium of factor 2 ?
[CMA-June-2014-10M] [CMA-SM-2016]
Ans: (i) Sensitivity of portfolio: Factor 1 = 0.45, Factor 2 = 0.30
(ii) Sensitivity of portfolio: Factor 1 = 0.90, Factor 2 = 0.60
(iii) Expected return premium: Factor 2 = 5 %
Question No. 7C [RTP-Nov-2009]
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 stocks in the market index. Furthermore,
the sensitivity of returns on these categories of stocks to the three important factor are estimated to be:
Category of Weight in the Factor I (Beta) Factor II Factor III
Stocks Market Index (Price Book) (Inflation)
Small cap growth 25% 0.80 1.39 1.35
Small cap value 10% 0.90 0.75 1.25
Large cap growth 50% 1.165 2.75 8.65
Large cap value 15% 0.85 2.05 6.75
Risk Premium 6.85% -3.5% 0.65%
The rate of return on treasury bonds is 4.5%
Required:

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.19
(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 index.
(c) Mr. Nirmal Kumar wants to construct a portfolio constituting only the ‘small cap value’ and ‘large cap
growth’ stocks. If the target beta for the desired portfolio is 1, determine the composition of his portfolio.
Ans: (a) Expected return (APTM) = 7.7526%, (b) Expected return (CAPM) = 11.33%,
(C) Composition 1 = 62.3%, Composition 2 =37.7%

SECURITY MARKET LINE (SML) & APT EQUATION

Question No. 8A [May-2007-old-8 Marks] [MTP-Nov-2013-4M] [RTP-May-2014]
Expected returns on two stocks for particular market returns are given in the following table:
Market Return Aggressive Defensive
7% 4% 9%
25% 40% 18%
You are required to calculate:
(a) The Betas of the two stocks.
(b) Expected return of each stock, if the market return is equally likely to be 7% or 25%.
(c) The Security Market Line (SML), if risk free rate is 7.5% and market return is equally likely to be 7% or 25%.
(d) The Alphas of the two stocks.
[CMA-June-2019-8M] [CMA-Compendium]
Ans: (a) Betas: Agg. = 2, Def. = 0.5; (b) Expected return: Agg. = 22%, Def. = 13.5%;
(c)SML is, required return = 7.5% + βi 8.5%; (d) Alpha: Agg = -2.5%, Def. = 1.75%

Question No. 8B [RTP-May-2012]

Assuming that two securities X and Y are correctly priced on SML and expected return from these securities are
9.40% (Rx) and 13.40% (Ry) respectively. The Beta of these securities are 0.80 and 1.30 respectively.
Mr. A, an investment manager states that the return on market index is 9%.
You are required to determine,
(i) Whether the claim of Mr. A is right. If not then what is correct return on market index.
(ii) Risk Free Rate of Return

Question No. 8C
A group of analyst believes that the returns of the portfolios are governed by two vital factors:
1. the rate of economic growth and
2. the sensitivity of stock to the developments in the financial markets.
The sensitivities of returns with respect to these two factors are denoted by β1 and β2 respectively.
Further these analysts believe that returns on three carefully crafted Portfolios X, Y and Z must be predominantly
governed by these two factors alone leaving remaining to some company/ portfolio specific factors. Assume that
these three Portfolios X, Y, and Z are found to have following beta co-efficient:
Portfolio Expected Return, % 𝛃𝟏 𝛃𝟐
X 16.00 1.00 0.80
Y 25.00 1.50 1.30
Z 32.00 2.00 1.50
Find out the Arbitrage Pricing Theory (APT) equation governing the returns on the portfolios.
[CMA-MTP-June-2014-6M] [CMA-RTP-June-2014/2015]
Ans: APT would then be Rp = –2/3+34/3×β1 +20/3×β2

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.20 STRATEGIC FINANCIAL MANAGEMENT
Question No. 8D
From the following information, find out the market price of risk of portfolio.
Market Return Standard Deviation Return on Government Standard Deviation
of Market Return Bonds of Portfolio
20% 7% 7% 9%
22% 8% 8% 5%
24% 10% 9% 13%
Also determine the expected return for each of the above cases.
[CMA-Dec-2017-New-8M] [CMA-SM-2016]

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 8.1 [RTP-Nov-2011]
Assuming that shares of ABC Ltd. and XYZ Ltd. are correctly priced according to Capital Asset Pricing model.
The expected return from and Beta of these shares are as follows:
Share Beta Expected return
ABC 1.2 19.8%
XYZ 0.9 17.1%
You are required to derive Security Market Line.
Ans: SML = 9% + β× 9%

Question No. 8.2 [RTP-Nov-2009]

The following data are available to you as a portfolio manager.
Security Expected Return Beta Standard Deviation
O 0.32 1.70 0.50
P 0.30 1.40 0.35
Q 0.25 1.10 0.40
R 0.22 0.95 0.24
S 0.20 1.05 0.28
T 0.14 0.70 0.18
Composite Index 0.12 1.000 0.20
T-bills 0.08 0.00 0.00
(i) In terms of a security market line (SML), which of the securities listed above are undervalued? Why?
(ii) Assume that a portfolio is constructed using equal portions of the six stocks listed above.
(a) What is the expected return of such a portfolio?
(b) What would the expected return if this portfolio was increased by 40% through borrowed funds with
the cost of borrowing at 12%?
Ans: (i) All the securities listed above are undervalued because their expected returns plot above the SML
(ii)(a) Expected (i.e. Available) return=0.2383; (b) Expected return = 0.28562

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.21
CHARACTERISTICS LINE (CL)
Question No. 9A [SM-New] [Nov-2003-old-10marks] [MTP-Nov-2013-8M] [RTP-Nov-2013] [RTP-May-
2015] [CMA-RTP-Dec-2018]
The rates of return on the security of Company X and market portfolio for 10 periods are given below:
Period Return of Security X (%) Return on Market Portfolio (%)
1 20 22
2 22 20
3 25 18
4 21 16
5 18 20
6 −5 8
7 17 −6
8 19 5
9 −7 6
10 20 11
(i) What is the beta of Security X?
(ii) What is the characteristic line for Security X?
[CMA-RTP-June-2015] [CMA-SM-2016]
Ans: (i) Beta X= .505; (ii) Characteristic line for security X = 8.94 + 0.505 R M
Question No. 9B [RTP-May-2010-Old]
Consider the following information relating to Stock A and the market for the last five years:
Year Stock A (%) Return on Market (%)
2005 29 -10
2006 31 24
2007 10 11
2008 6 -8
2009 -7 3
(a) Determine the regression equation for the return from the stock and the market and calculate the alpha (α ),
beta (β) and Unsystematic Risk.
(b) The total variance of the return from the stock A and the components of variance that are explained by the
market index and not explained by the market index.

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 9.1 [June-2009-8 Marks] [CMA-RTP-Dec-2018]
The returns on stock A and market portfolio for a period of 6 years are as follows:
Year Return on A (%) Return on market portfolio (%)
1 12 8
2 15 12
3 11 11
4 2 -4
5 10 9.5
6 -12 -2
You are required to determine:
(ii) Characteristic line for stock A
(iii) The systematic and unsystematic risk of stock A.
[CMA-RTP-Dec-2013] [CMA-MTP-June-2014-(7+3)=10M]
[CMA-RTP-June-2014] [CMA-June-2015-(5+3)=8M]
Ans: (i) characteristic line is -0.58 + 1.202 (Rm)
(ii) Systematic Risk = 58(%)2 ; Unsystematic Risk is = 24.89(%)2

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.22 STRATEGIC FINANCIAL MANAGEMENT
Question No. 9.2
The historical rates of return on the stock of SMOOTH-TECH LTD. and the Market return are given below:
Year SMOOTH-tech Return % Market Return %
2008 12 15
2009 9 13
2010 (-) 11 14
2011 8 (-)9
2012 11 12
2013 4 9
You are required to:
(i) Determine the Equation for the Characteristic line of the Stock of SMOOTH-TECH LTD. and
(ii) Interpret the slop and the intercept of the characteristic line
[CMA-PTP-June-2014-5M]
Ans: (i) R = 6.77 – 0.14 R M
(ii) Interpretation; Slope: If market return will increase by 1% then return on stock will decrease by 0.14%;
Intercept: If return on market will be Zero, then we predict the return on stock will be 6.77%.

Question No. 9.3

The following are returns in % of securities A, B and the market in excess of the risk- free rate:
Security A Security B Market
12 16 14
15 18 16
18 20 18
(i) Determine the characteristic line for securities A and B.
(ii) What would be the beta of a portfolio consisting of 75% investment in A and 25% in B?
(iii) When the market return is 15%, what would be the return on the portfolio?
[CMA-Dec-2017-10M]

EFFICIENT PORTFOLIO ACCORDING TO HARRY MARKOWITZ

Question No. 10A [SM-NEW] [RTP-Nov-2017] [Nov-1996-6M] [As May-2004-8M] [RTP-Nov-2002]
Following is the data regarding six securities:
A B C D E F
Return (%) 8 8 12 4 9 8
Risk (%) (Standard Deviation) 4 5 12 4 5 6
(i) Which of the securities will be selected?
(ii) Assuming perfect correlation, analyse whether it is preferable to invest 75% in security A and 25% in security
C or 100% in E.
[CMA-MTP-June-2015-5M] [CMA-Compendium]
Ans: Select A, E & C; (i) Invest 100% in E.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.23

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 10.1
Given the following risky portfolios
A B C D E F G H
Return % 10 12.5 15 16 17 18 18 20
𝞼% 23 21 25 29 29 32 35 45
(i) Which of these portfolios are efficient? Which are inefficient?
(ii) Suppose one can tolerate a risk of 25%, what is the maximum return one can achieve if no borrowing or
lending is resorted to?
(iii) Suppose one can tolerate a risk of 25%, what is the maximum return one can achieve if borrowing or lending
at the rate of 12% is resorted to?
[CMA-RTP-June-2014/2015]
Ans: (i) portfolios B, C, E, F & H are efficient. Portfolios A, D & G are inefficient
(ii) Portfolio C can be chosen to give a maximum return of 15%.
(iii) invest in a proportion of 25/32 in portfolio F & balance 7/32 in risk free asset.

PORTFOLIO REBALANCING
Question No. 11A [RTP-May-2019-New] [May-2012-8M]
Indira has a fund of  3 lacs which she wants to invest in share market with rebalancing target after every 10 days
to start with for a period of one month from now .The present NIFTY is 5326.The minimum NIFTY within a month
can at most be 4793.4. she wants to know as to how she should rebalance her portfolio under the following
situations, according to the theory of constant proportion Portfolio Insurance Policy , using “2” as the multiplier:
(1) Immediately to start with.
(2) 10 days Later-being the 1st day of rebalancing if NIFTY falls to 5122.96.
(3) 10 days further from the above date if the NIFTY touches 5539.04.
For the sake of simplicity, assume that the value of her equity component will change in tandem with that of the
NIFTY and risk free securities in which she is going to invest will have no Beta.
Ans: (1) Today: Equity = 60,000; RF = 2,40,000
(2) 10 days later; Equity = 55426; RF = 2,42,287
(3) 10 more days; Equity = 64,430; RF = 2,37,785

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 11.1 [RTP-May-2010-Old]
Ms. Sunidhi is working with an MNC at Mumbai. She is well versant with the portfolio management techniques
and wants to test one of the techniques on an equity fund she has constructed and compare the gains and losses from
the technique with those from a passive buy and hold strategy. The fund consists of equities only and the ending
NAVs of the fund he constructed for the last 10 months are given below:
Month Ending NAV (/unit) Month Ending NAV (/unit)
December 2008 40.00 May 2009 37.00
January 2009 25.00 June 2009 42.00
February 2009 36.00 July 2009 43.00
March 2009 32.00 August 2009 50.00
April 2009 38.00 September 2009 52.00

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.24 STRATEGIC FINANCIAL MANAGEMENT
Assume Sunidhi had invested a notional amount of 2 lakhs equally in the equity fund and a conservative portfolio
(of bonds) in the beginning of December 2008 and the total portfolio was being rebalanced each time the NAV of
the fund increased or decreased by 15%.
You are required to determine the value of the portfolio for each level of NAV following the Constant Ratio Plan.

MINIMUM RISK PORTFOLIO

Question No. 12A
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%
σP 20% σq = 25%
Compute the proportion of P & Q to minimize risk and compute the risk and return.
[CMA-June-2015-2M]
Ans: Proportion: Investment P = 0.714, investment Q = .286
Risk portfolio = 18.892%, Return portfolio = 11.43%
Question No. 12B
M Ltd and L Ltd have the following risk and return estimates:
RL = 20% RM = 22%
σL = 15% σM = 18%
Correlation Coefficient r LM = -1  [In CMA-MTP-June-2014, it is printed -1.50 which is not possible]
Compute the proportion of investment in M & L to minimize risk of portfolio and compute the risk and return.
[CMA-RTP-Dec-2013] [CMA-MTP-June-2014-5M]
Ans: Proportion: Investment L = 0.546, investment M = 0..454
Risk portfolio = Nil, Return portfolio = 20.91%

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 12.1
MR.ADHIRAJ is planning to construct a minimum risk portfolio by investing in the shares of ARIHANT LTD.
and SUZLON LTD. The risks associated with the returns of Arihant Ltd. and Suzlon Ltd. are 23% and
25%respectively. If the co-efficient of correlation between the returns of shares of both companies is 0, what
proportion of funds to be invested in the shares of ARIHANT LTD?
[CMA-PTP-June-2014-2M] [CMA-MTP-Dec-2014-2M]
Ans: 54.16%

Question No. 12.2 [RTP-May-2019] [RTP-Nov-2012]

An investor has decided to invest  1,00,000 in the shares of two companies, namely ABC and XYZ the
projections of returns from the shares of two companies along with their probabilities are as follows;
Probability ABC (%) XYZ (%)
0.20 12 16
0.25 14 10
0.25 -7 28
0.30 28 -2
You are required to,
(i) Comment on return and risk of investment in individual shares.
(ii) Compare the risk and return of these two shares with a portfolio of these shares in equal proportions.
(iii) Find out the proportion of each of the above shares to formulate a minimum risk portfolio.
[As-CMA-June-2013-15M]
Ans: (i)R ABC = 12.55%; R XYZ = 12.10%; σABC = 12.95%; σXYZ = 11.27%;
(ii) R Port = 12.325%; σPort = 1.25%; (iii) ABC = .46 and XYZ = .54

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.25
Question No. 12.3
Securities X and Y have standard deviations of 3% and 9%. Nitin is having a surplus of 20 Lakhs for investment
in these two securities. How much should he invest in each of these securities to minimize risk, if the correlation
co-efficient for X and Y is: (i) -1; (ii) -0.30; (iii) 0; (d) 0.60
[CMA-RTP/MTP-Dec-2014-5M]
Ans: (i) X = 15Lakh, Y=5Lakh; (ii) X = 16.78Lakh, Y=3.22 Lakh; (iii) X = 18Lakh, Y=2Lakh;
Reducing risk below 3% is not possible

Question No. 12.4

Shah Ltd., has been specially formed to undertake two investment opportunities. The risk and return
characteristics of the two projects are shown below:
Project Expected Return Risk
P 15% 3%
Q 22% 7%
Shah Ltd. plans to invest 80% of its available funds in project P and 20% in Q. The directors believe that the
correlation co-efficient between the returns of the projects is +1.0.
Required
(1) Calculate the returns from the proposed portfolio of Projects P and Q.
(2) Calculate the risk of the portfolio;
(3) Suppose the correlation coefficient between P and Q was -1. How should the company invest its funds in
order to obtain zero risk portfolio?
[CMA-PTP-June-2015-8M] [CMA-PTP/MTP-Dec-2014-(2+3+3)=8M]
Ans: (i) Return = 16.4%; (ii) Risk = 3.8%; (iii) WP = 0.70; Wq = 0.30
Question No. 12.5
An investor has a sum of 40 lacs with which he wishes to construct a portfolio of securities X and Y. The
following information is provided:
Security Expected Return Standard Deviation
X 18 12
Y 20 15
The coefficient of correlation between the returns of X and Y is 0.7.
(i) How much should he invest in X and Y in order to have a portfolio of minimum variance: What would be
this minimum variance?
(ii) If he invested equally in X and Y, what would be the variance of the portfolio?
(iii) Would you consider his portfolio in (i) and (ii) sufficiently diversified? Why?
[CMA-Dec-2017-8M]
Ans: (i) 141.23; (ii) 155.25; (iii) Not sufficiently diversified; Since the correlation coefficient is high at +0.7. If
the securities do well individually, both do well and if one falls, the other also falls significantly.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.26 STRATEGIC FINANCIAL MANAGEMENT
CONSTRUCTION OF PORTFOLIO AS PER INVESTMENT OBJECTIVE
Question No. 13A
Deleted

Question No. 13B [June-2009-6M]

An investor has two portfolios known to be on minimum variance set for a population of three securities A, B and
C having below mentioned weights:
WA WB WC
Portfolio X 0.30 0.40 0.30
Portfolio Y 0.20 0.50 0.30
It is supposed that there are no restrictions on short sales.
What would be the weight for each stock for a portfolio constructed by investing  5,000 in portfolio X and  3,000
in portfolio Y?
[CMA-PTP-June-2015-4M] [CMA-PTP/MTP-Dec-2014-4M] [CMA-MTP-Dec-2018]
Ans: (a) weight for each stock: A = 0.26, B = 0.44, C = 0.30
Question No. 13C [May-2019-Old-8M] [Nov-2011-8 Marks]
A portfolio manager has the following five stocks in his portfolio.
Security No. of shares Price/Share β
A 10,000 50 1.2
B 5,000 20 2.0
C 8,000 25 0.7
D 1,000 100 1.0
E 500 200 1.3
(i) Compute portfolio beta
(ii) If the manager wants to reduce the beta to 0.8, how much of risk free investment should he bring in?
What will be the new portfolio?
(iii) If the manager wants to increase the beta to 1.4, how much of risk free investment should he bring in?
What will be the new portfolio?
[CMA-Dec-13-10M] [CMA-TP-Dec-13-10M] [CMA-RTP-Dec-14]
Ans: (i) Beta port = 1.17 (ii) risky portfolio = 10,00,000; risk free = 4,62,500; (iii) risky = 10,00,000; RF = -164286
[Additional information in point (ii) in CMA June-2018: “Consider that he disposes the riskier securities first and replaces them with
risk free investment” Present the revised portfolio”

Question No. 13D [RTP-Nov-2014]

Mr. A has a portfolio of  5 crore consisting of equity shares of X Ltd. and Y Ltd. with beta of 1.15. Other
information is as follows:
Spot Value of Index Future = 21000
Multiplier = 150
You are requested to reduce beta of portfolio to 0.85 and increase beta to 1.45 by using:
(a) Change in composition through Risk Free securities
(b) Index futures
Ans: (i) Reduce beta to 0.85: (a) Share 3.695Cr; RF = 1.305Cr (b) Sale Index future contract 4.76 [or 5]
(i) Reduce beta to 1.45: (a) Share 6.30Cr; Value of Borr = 1.30Cr (b) Buy Index future contract 4.746 [or 5]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.27

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 13.1 [RTP-Nov-2012]
Suppose that economy A is growing rapidly and you are managing a global equity fund that has so far invested only
in developed-country stocks. Now you have decided to add stocks of economy A to your portfolio. The table below
shows the expected rates of return, standard deviation, and correlation coefficients (all estimated for the aggregate
stock market of developed countries and stock market of Economy A).
Developed country stocks Stocks of Economy A
Expected rate of return (annualized percent) 10 15
Risk [Annualized Standard Deviation (%)] 16 30
Correlation Coefficient (p) 0.30 0.30
Assuming the risk-free interest rate to be 3%, you are required to determine:
(a) What percentage of your portfolio should you allocate to stocks of Economy A if you want to increase
the expected rate of return on your portfolio by 0.5%?
(b) What will be the standard deviation of your portfolio assuming that stocks of Economy A are included
in the portfolio as calculated above?
(c) Also show how well the fund will be compensated for the risk undertaken due to inclusion of stocks of
Economy A in the portfolio?
Ans: (a) 10%; (b) 15.6%; (c) Sharpe ratio will improve by approx. 0.04%

Question No. 13.2

The following two types of securities are available in the market for investment:
Security Return (%) Standard deviation (%)
Gilt edge security 7 0
Equity 25 30
Using the above two securities, if you are planning to invest 1,00,000 to construct a portfolio with a standard
deviation of 24%, what is the return of such portfolio?
[CMA-RTP-June-2015] [CMA-Dec-2013-2M] [CMA-TP-Dec-2013-2M] [CMA-MTP-Dec-2018]
Ans: Return = 21.4
Question No. 13.3
Portfolio value is 200000 and Beta is 1.50. Compute the value of risk free investment to be bought or sold in
following cases:
(i) Desired beta is 1.8
(ii) Desired Beta is 1.10
[CMA-June-2015-(2+2)=4M]
Question No. 13.4
Satendra has the following investments
Stock Expected return % Portfolio weight % Beta
ABC 15.00 40 0.6
BAC 25.40 30 1.4
CAB 20.60 30 1.1
(i) What is the expected return and β of Satendra’s portfolio?
(ii) Satendra has now decided to take on some additional risk in order to increase his expected return, by changing
his portfolio weights. If Satendra’s new portfolio’s expected return is 22.12% and its β is 1.165, what are his new
portfolio weights
[CMA-MTP-June-2014/2015-(2+4)=6M] [CMA-RTP-June-2014/2015]
Ans: (i) R = 19.8%; β = 0.990; (ii) ABC = 0.20; BAC = 0.55; CAB = 0.25

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.28 STRATEGIC FINANCIAL MANAGEMENT
Question No. 13.5
An investor owns the following investments:
(i) 1 million equity shares of P Ltd. Price  40, Beta 1.10
(ii) 2 million equity shares of Q Ltd. Price  30, Beta 1.20
(iii) 3 million equity shares of R Ltd. Price  10, Beta 1.30
The investor wants to enhance the beta of his portfolio to 1.50. Suggest.
[CMA-MTP-June-2014-5M] [CMA-RTP-June-2014/2015]

Question No. 13.6

Yau have  10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 18% and Stock Y
with an expected return of 11%. If your goal is to create a portfolio wi th an expected return of 16.5%, how much money
will you invest in Stock X and in Stock Y?
[CMA-MTP-June-2015-2M]
Ans: (i) Investment in X = 7,857; (ii) Investment in Y = 2,143

Question No. 13.7

A portfolio Manager has the following four stocks in his portfolio:
Security No. of shares Market price (₹) per share β= Beta
ADU 12,000 40 0.9
DVU 6,000 20 1.0
NDU 10,000 25 1.5
SVU 2,000 225 1.2
Compute the following:
(i) Portfolio Beta (β)
(ii) If the Portfolio Manager seeks to reduce the portfolio Beta to 0.8, how much risk-free investment should he
bring in? Consider that he disposes the riskier securities first and replaces them with risk free investment.
Present the revised portfolio.
[As CMA-June-2019-10M] [CMA-June-2018-6M]
Ans: (i) 1.13; (ii) Risk free investment to be brought = 2,93,425;
New portfolio:
Security No. of Shares MPS MV Beta Product
ADU 12,000 40 4,80,000 0.9 4,32,000
DVU 6,000 20 1,20,000 1.0 1,20,000
NDU 0 0 0 1.5 0
SVU 1807 225 4,06,575 1.2 4,87,890
Risk free securities 2,93,425 0 0
13,00,000 10,39,890

Question No. 13.8 [MTP-May-2019-New-10M]

Details about portfolio of shares of an investor is as below
Shares No of Shares Price per share Beta
(Lakhs)
A Ltd. 3 Rs. 500 1.40
B Ltd. 4 Rs. 750 1.20
C Ltd. 2 Rs. 250 1.60
The investor thinks that the risk of portfolio is very high and wants to reduce the portfolio beta to 0.91. He is
considering two below mentioned alternatives strategies:
(1) Dispose of a part of his existing portfolio to acquire risk free securities, or

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.29
(2) Take appropriate position on NIFTY Futures which are currently traded at Rs. 8125 and each Nifty points is
worth Rs. 200.
You are required to calculate:
(i) Portfolio Beta,
(ii) the value of risk free securities to be acquired,
(iii) the number of shares of each company to be disposed off,
(iv) the number of Nifty contracts to be bought/sold, and
(v) the value of portfolio beta for 2% rise in NIFTY.

FIRM BETA/ASSETS BETA/PROJECT BETA

Question No. 14A [SM-NEW]
Two companies are identical in all respects except capital structure. One company AB Ltd. has a debt equity ratio
of 1 : 4 and its equity has a β (beta) value of 1.1. The other company XY Ltd. has a debt equity ratio of 3 : 4. Income
Tax is 30%. Estimate β (beta) equity of XY Ltd. given the above.
[As-CMA-June-2014-2M]
Ans: Beta= 1.43

Question No. 14B [Nov-2001-Old-6M] [RTP-Nov-2011] [RTP-May-2015] [CMA-RTP-Dec-2018]

The total market value of the equity share of O.R.E. Company is  60,00,000 and the total value of the debt is 
40,00,000. The treasurer estimate that the beta of the stock is currently 1.5 and that the expected risk premium
on the market is 10 per cent. The treasury bill rate is 8 per cent.
Required:
(1) What is the beta of the Company’s existing portfolio of assets?
(2) Estimate the Company’s Cost of capital and the discount rate for an expansion of the company’s present
business.
[CMA-June-2015-4M] [CMA-June-2014-(3+3)=6M]
Ans: (1) Beta Company = 0.9, (ii) Cost of capital= 17%.

Question No. 14C [SM-OLD]

XYZ is at present engaged in production of sport shoes and has a debt equity ratio of .80. its present cost of debt
funds is 14% and it has a marginal tax rate of 60%. The company is proposing to diversify to a new field of
adhesives which is considerably different from the present line of operations.
XYZ Limited is not well conversant with the new field. The company is not aware of risk involv ed in area of
adhesives but there exists another company PQR, which is a representative company in adhesives. PQR is also a
public limited company whose shares are traded in the market. PQR has a debt to equity ratio of .25, a beta equity
of 1.15 and an effective tax rate of 40%.
a) Calculate the risk is involved for XYZ Limited if the company enters into the business of adhesives.
b) In case risk free rate at present is 10% and expected return on market portfolio is 15% what return XYZ
Limited should require for the new business if it uses a CAPM approach and XYZ employs same amount of
leverage.
[CMA-June-2015-(2+3)=5M]
Ans: (a) Risk involve=1, (b) 11.71%

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.30 STRATEGIC FINANCIAL MANAGEMENT
Question No. 14D [May-2019-Old-8M]
Equity of KGF Ltd. (KGFL) is ₹ 410 crores, its debt is worth ₹ 170 crores Printer Division segments value is
attributable to 74%, which has an Assets Beta (𝛽𝑃 ) of 1.45, balance value is applied on spares and Consumables
Division, which has an Assets Beta (𝛽𝑆𝐶 ) of 1.20 KGFL Debt (𝛽𝐷 ) is 0.24.

You are required to calculate:

(i) Equity Beta (𝛽𝐸 ).
(ii) Ascertain Equity Beta (𝛽𝐸 ). If KGF Ltd decides to change its Debt Equity position by raising future debt and
buying back of equity to have its Debt Equity Ratio at 1.90. Assume that the present Debt Beta (𝛽𝐷1 ) is 0.35
and further funds raised by way of Debt will have a Beta (𝛽𝐷2 ) of 0.40.
(iii) Whether the new Equity Beta (𝛽𝐸 ) justifies increase in the value of equity on account of leverage?

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 14.1 [May-2002-old-4 Marks]
A project had an equity beta of 1.2 and was going to be financed by a combination of 30% debt and 70% equity.
Assuming debt-beta to be zero, calculate the Project beta and required rate of return taking risk-free-rate of return
to be 10% and return on market portfolio at 18%.
Ans: Project Beta = 0.84, required return = 16.72%
[CMA-Dec-2014-2M]
Question No. 14.2
Build –Con Limited is a real-estate company. Market value of their debt is ₹ 400 Lakh. The company has 8,00,000
equity shares of ₹ 10 each, market price of which is presently ₹ 40/-. Equity Beta is 1.10. Market risk premium is
5%. RBI bonds are quoted at 7%. Find the following:
(A) Required return on equity share
(B) Beta of Assets
(C) Cost of Capital
(D) Appropriate discount rate that the company should use for an expansion proposal.
(E) The company is diversifying into Steel manufacturing. Average ungeared company in that industry carries a
beta of 1.20. What should be expected return on this new venture?
[CMA-June-2015-4M]

Question No. 14.3

Excellent Ltd, is a frozen food packaging company and is looking to diversify its activities into the electronics
business. The project it is considering has a return of 18% and Excellent Ltd. is trying to decide whether the project
should be accepted or not. To help it decide it is going to use the CAPM. The company has to find a proxy beta for
the project and has the following information on three companies in the electronics business:
(a) Superior Ltd: Equity beta of 1.33. financed by 50% debt and 50% equity.
(b) Admirable Ltd: Admirable Ltd. has an equity beta of 1.30, but it has just taken on a totally unrelated project
accounting for 20% of the company’s value, that has an asset beta of 1.4. The company financed by 40% debt
and 60% equity.
(c) Meritorious Ltd: Equity beta of 1.05, financed by 35% debt and 65% equity.
Assume tax rate 35%.
Ans: Beta Assets: (a) 0.806, (b) .784, (c) .7778; Proxy beta = .789

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 PORTFOLIO MANAGEMENT Page 5.31
SHARPE OPTIMUM PORTFOLIO
Question No. 15A [SM-OLD]
Data for finding out the optimal portfolio are given below:
Security Mean Excess Beta Unsystematic Excess Return to
Number Return Return Risk beta
Ri R i – Rf β σ 2єi (Ri – Rf)/βi
1 19 14 1.0 20 14
2 23 18 1.5 30 12
3 11 6 0.5 10 12
4 25 20 2.0 40 10
5 13 8 1.0 20 8
6 9 4 0.5 50 8
7 14 9 1.5 30 6
The riskless rate of interest is 5 per cent and the market variance is 10. Determine the cut-off point.
Ans: Cut off rate is 8.29

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 15.1 [May-2010-10M]
Ramesh wants to invest in stock market. He has got the following information about individual securities:
Expected
Security
Return Beta 𝛔𝟐𝐜𝐢
A 15 1.5 40
B 12 2 20
C 10 2.5 30
D 09 1 10
E 08 1.2 20
F 14 1.5 30
Market index variance is 10% and the risk free rate of return is 7%. What should be the optimum portfolio
assuming no short sales?
Ans: Optimum portfolio A = 50.41%; B =49.59%
STRATEGY OF INVESTMENT BASED ON CAPM
Question No. 16A [SM-OLD]
Information about return on an investment is as follows:
(a)Risk free rate 10%, (b) Market return is 15%, (c) Beta is 1.2
(i) What would be the return from this investment?
(ii) If the projected return is 18%, is the investment rightly valued?
(iii) What is your strategy?
Ans: (i) Req. Ret = 16%, (ii) Stock is under Valued (iii) Buy.

Question No. 16B [SM-OLD]

The expected returns and Beta of three stocks are given below
Stock A B C
Expected Return (%) 18 11 15
Beta Factor 1.7 0.6 1.2
If the risk free rate is 9% and the expected rate of return on the market portfolio is 14% which of the above stocks
are over, under or correctly valued in the market? What shall be the strategy?
[CMA-June-2019-New-8M] [CMA-June-2017-New-8M]
Ans: Over V = stock B, Under V. = Stock A, Correctly V.= Stock C; [Strategy = Buy A, Sell B, Hold C ]

// CA NAGENDRA SAH // WWW.FMGURU.ORG

 Page 5.32 STRATEGIC FINANCIAL MANAGEMENT
Question No. 16C [Nov-2009-10M]
An investor holds two stocks A and B. An analyst prepared ex-ante probability distribution for the possible
economic scenarios and the conditional returns for two stocks and the market index as shown below:
Economic scenario Probability Conditional Returns %
A B Market
Growth 0.40 25 20 18
Stagnation 0.30 10 15 13
Recession 0.30 -5 -8 -3
The risk free rate during the next year is expected to be around 11%. Determine whether the investor should
liquidate his holdings in stocks A and B or on the contrary make fresh investments in them. CAPM assumptions
are holding true.
[CMA-June-2017-New-8M]
Ans: Alfa A = 1.576%, Alfa B = 0.18%, Both the stocks have positive Alfa hence make fresh investments.
Question No. 16D [RTP-May-2011]
Following information is available regarding expected return, standard deviation and beta of 6 share are available
in the stock market.
Security Expected Return Beta S.D ( %)
1 5 0.70 9
2 10 1.05 14
3 11 0.95 12
4 12.5 1.10 20
5 15 1.40 17.5
6 16 1.70 25
Suppose risk free rate of return is 4% and Market return is 6% and standard deviation is 10%.
You are required to compute.
(i) Which security is undervalued and which is over-valued.
(ii) Assuming that funds are equally invested these six stocks, then compute.
(a) Return of portfolio
(b) Risk of Portfolio
(iii) Suppose if above portfolio is invested in with margin of 40% and cost of borrowing is 4% then what will be
the position.

Question No. 16E [Nov-2014-8M]

An investor is holding 5,000 shares of X Ltd. Current year dividend rate is  3/share. Market price of the share is
 40 each. The investor is concerned about several factors which are likely to change during the next financial year
as indicated below:
In view of the above, advise whether the investor should buy, hold or sell the shares.
Current Year Next Year
Dividend paid/anticipated per share () 3 2.5
Risk free rate 12% 10%
Market Risk Premium 5% 4%
Beta Value 1.3% 1.4%
Expected growth 9% 7%

Question No. 16F

The risk free return of interest is 4.25% and market return is 12% , beta value of security B is 2.10 assume that you
had purchased security B a year ago for  312 current market price is  380 since the price is going up. Your friend
advice to buy more units of security B, before it reaches 400 mark.
What is your decision? [CMA-Dec-2014-2M]
Ans: CAPM Return = RF + β[RM - RF ] = 4.25 + 2.10 × [12 - 4.25] = 20.525 %
Annual Return = (380 - 312)/ 312 = 0.217948 = 21. 80 %
The security is marginally undervalued. The difference is 1.27 % return. The decision is to BUY.

// CA NAGENDRA SAH // WWW.FMGURU.ORG

SFM Portfolio Notes CA Nagendra Sah Page - 1
SFM Portfolio Notes CA Nagendra Sah Page - 2
SFM Portfolio Notes CA Nagendra Sah Page - 3
SFM Portfolio Notes CA Nagendra Sah Page - 4
SFM Portfolio Notes CA Nagendra Sah Page - 5
SFM Portfolio Notes CA Nagendra Sah Page - 6
SFM Portfolio Notes CA Nagendra Sah Page - 7
SFM Portfolio Notes CA Nagendra Sah Page - 8
SFM Portfolio Notes CA Nagendra Sah Page - 9
SFM Portfolio Notes CA Nagendra Sah Page - 10
SFM Portfolio Notes CA Nagendra Sah Page - 11
SFM Portfolio Notes CA Nagendra Sah Page - 12
SFM Portfolio Notes CA Nagendra Sah Page - 13
SFM Portfolio Notes CA Nagendra Sah Page - 14
SFM Portfolio Notes CA Nagendra Sah Page - 15
SFM Portfolio Notes CA Nagendra Sah Page - 16
SFM Portfolio Notes CA Nagendra Sah Page - 17
SFM Portfolio Notes CA Nagendra Sah Page - 18
SFM Portfolio Notes CA Nagendra Sah Page - 19
SFM Portfolio Notes CA Nagendra Sah Page - 20
SFM Portfolio Notes CA Nagendra Sah Page - 21
SFM Portfolio Notes CA Nagendra Sah Page - 22
SFM Portfolio Notes CA Nagendra Sah Page - 23
SFM Portfolio Notes CA Nagendra Sah Page - 24
SFM Portfolio Notes CA Nagendra Sah Page - 25
SFM Portfolio Notes CA Nagendra Sah Page - 26
SFM Portfolio Notes CA Nagendra Sah Page - 27
SFM Portfolio Notes CA Nagendra Sah Page - 28
SFM Portfolio Notes CA Nagendra Sah Page - 29
SFM Portfolio Notes CA Nagendra Sah Page - 30
SFM Portfolio Notes CA Nagendra Sah Page - 31
SFM Portfolio Notes CA Nagendra Sah Page - 32
SFM Portfolio Notes CA Nagendra Sah Page - 33
SFM Portfolio Notes CA Nagendra Sah Page - 34
SFM Portfolio Notes CA Nagendra Sah Page - 35
SFM Portfolio Notes CA Nagendra Sah Page - 36
SFM Portfolio Notes CA Nagendra Sah Page - 37
SFM Portfolio Notes CA Nagendra Sah Page - 38
SFM Portfolio Notes CA Nagendra Sah Page - 39
SFM Portfolio Notes CA Nagendra Sah Page - 40
SFM Portfolio Notes CA Nagendra Sah Page - 41
SFM Portfolio Notes CA Nagendra Sah Page - 42
SFM Portfolio Notes CA Nagendra Sah Page - 43
SFM Portfolio Notes CA Nagendra Sah Page - 44
SFM Portfolio Notes CA Nagendra Sah Page - 45
SFM Portfolio Notes CA Nagendra Sah Page - 46
SFM Portfolio Notes CA Nagendra Sah Page - 47
SFM Portfolio Notes CA Nagendra Sah Page - 48
SFM Portfolio Notes CA Nagendra Sah Page - 49
SFM Portfolio Notes CA Nagendra Sah Page - 50
SFM Portfolio Notes CA Nagendra Sah Page - 51
SFM Portfolio Notes CA Nagendra Sah Page - 52
SFM Portfolio Notes CA Nagendra Sah Page - 53
SFM Portfolio Notes CA Nagendra Sah Page - 54
SFM Portfolio Notes CA Nagendra Sah Page - 55
SFM Portfolio Notes CA Nagendra Sah Page - 56
SFM Portfolio Notes CA Nagendra Sah Page - 57
SFM Portfolio Notes CA Nagendra Sah Page - 58
SFM Portfolio Notes CA Nagendra Sah Page - 59
SFM Portfolio Notes CA Nagendra Sah Page - 60
SFM Portfolio Notes CA Nagendra Sah Page - 61
SFM Portfolio Notes CA Nagendra Sah Page - 62
SFM Portfolio Notes CA Nagendra Sah Page - 63
SFM Portfolio Notes CA Nagendra Sah Page - 64
SFM Portfolio Notes CA Nagendra Sah Page - 65
SFM Portfolio Notes CA Nagendra Sah Page - 66
SFM Portfolio Notes CA Nagendra Sah Page - 67
SFM Portfolio Notes CA Nagendra Sah Page - 68
SFM Portfolio Notes CA Nagendra Sah Page - 69
SFM Portfolio Notes CA Nagendra Sah Page - 70
SFM Portfolio Notes CA Nagendra Sah Page - 71
SFM Portfolio Notes CA Nagendra Sah Page - 72
SFM Portfolio Notes CA Nagendra Sah Page - 73
SFM Portfolio Notes CA Nagendra Sah Page - 74
SFM Portfolio Notes CA Nagendra Sah Page - 75
SFM Portfolio Notes CA Nagendra Sah Page - 76
SFM Portfolio Notes CA Nagendra Sah Page - 77
SFM Portfolio Notes CA Nagendra Sah Page - 78
SFM Portfolio Notes CA Nagendra Sah Page - 79
SFM Portfolio Notes CA Nagendra Sah Page - 80
SFM Portfolio Notes CA Nagendra Sah Page - 81
SFM Portfolio Notes CA Nagendra Sah Page - 82
SFM Portfolio Notes CA Nagendra Sah Page - 83
SFM Portfolio Notes CA Nagendra Sah Page - 84
SFM Portfolio Notes CA Nagendra Sah Page - 85
SFM Portfolio Notes CA Nagendra Sah Page - 86
SFM Portfolio Notes CA Nagendra Sah Page - 87
SFM Portfolio Notes CA Nagendra Sah Page - 88
SFM Portfolio Notes CA Nagendra Sah Page - 89
SFM Portfolio Notes CA Nagendra Sah Page - 90
SFM Portfolio Notes CA Nagendra Sah Page - 91
SFM Portfolio Notes CA Nagendra Sah Page - 92
SFM Portfolio Notes CA Nagendra Sah Page - 93
SFM Portfolio Notes CA Nagendra Sah Page - 94
SFM Portfolio Notes CA Nagendra Sah Page - 95
SFM Portfolio Notes CA Nagendra Sah Page - 96
SFM Portfolio Notes CA Nagendra Sah Page - 97
SFM Portfolio Notes CA Nagendra Sah Page - 98
SFM Portfolio Notes CA Nagendra Sah Page - 99
SFM Portfolio Notes CA Nagendra Sah Page - 100
SFM Portfolio Notes CA Nagendra Sah Page - 101
SFM Portfolio Notes CA Nagendra Sah Page - 102