CIFA INTERMEDIATE LEVEL

PORTFOLIO MANAGEMENT

THURSDAY: 24 August 2023. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) Enumerate FIVE elements of portfolio management. (5 marks)

(b) Summarise FIVE components of investment policy statement. (5 marks)

(c) Peter Wafula is evaluating five portfolios with the following characteristics:

Portfolio Portfolio expected return (%) Portfolio standard deviation (%)

A 19 8
B 25 12
C 16 6
D 32 16
E 22.5 10

Additional information:
1. The expected return on the market portfolio is 12%.
2. The standard deviation of the market portfolio is 4%.
3. The risk free rate of return is 5%.

Required:
(i) Using the capital market line (CML), determine the expected rate of return for each portfolio. (5 marks)

(ii) Identify the portfolios that are efficient, super-efficient or in-efficient. (3 marks)

(iii) In the case of an inefficient portfolio in (c) (ii) above, state what the standard deviation should be for
efficiency to be achieved with the given expected return. (2 marks)
(Total: 20 marks)

QUESTION TWO
(a) Highlight FIVE criteria for specifying asset classes. (5 marks)

(b) The following information relates to Simon Mwangi portfolio:

1. The asset allocation mix:
Asset allocation Expected rate of return (%) Standard deviation (%)
A 11.5 18
B 8 14
C 6 10
2. The risk aversion (RA) co-efficient is 5.
3. The annual spending rate will be 5%.
4. The expected annual inflation rate will be 2.4%.
5. The annual expenses incurred while investing portfolio is 60 basis points.

CF21 Page 1
Out of 4
 Required:
(i) Expected return of Simon Mwangi using multiplicative model. (3 marks)

(ii) Using risk-adjusted rate of return, advise the investor on the appropriate asset mix. (4 marks)

(c) A financial analyst is considering investing in the stocks of three companies; X Ltd., Y Ltd. and Z Ltd. The following
information relates to the stocks of the three companies:

Company Sensitivity of stock’s returns to changes in:

Market index Inflation rate Economic growth rate
X Ltd. 1.60 –0.15 0.60
Y Ltd. 0.93 0.14 0.70
Z Ltd. 1.14 –0.45 0.90

During the year 2023, it is expected that the market index will increase in performance by 3.0% up from its current
5%. The risk free rate of return in the market will be 7% on average and the inflation and economic growth rates will
be 11% and 6% respectively.

Required:
(i) Expected returns for the three stocks in year 2023 using the capital asset pricing model (CAPM). (3 marks)

(ii) Expected returns for the three stocks in year 2023 using the arbitrage pricing theory (APT). (3 marks)

(iii) State the reason why a financial analyst would get different returns estimates in (c) (i) and (c) (ii) above.
(2 marks)
(Total: 20 marks)

QUESTION THREE
(a) Discuss THREE ways in which behavioural factors could affect investment adviser and client interactions. (6 marks)

(b) James Wakaba and his wife Sarah Nina are planning for retirement and want to compare the past performance of a
few mutual funds they are considering for investment. They believe that a 5-year comparison period would be
appropriate and the following data from Sage Mutual Fund has been availed to them:

Asset under management (AUM)

Year at beginning of the year Net return
Sh.“million” (%)
1 300 15
2 450 –5
3 200 10
4 250 15
5 350 3

Required:
(i) Calculate the holding period return for the five-year period. (1 mark)

(ii) Calculate the arithmetic mean annual return. (1 mark)

(iii) Calculate the geometric mean annual return. (2 marks)

(iv) Based on your answer in (b) (ii) and (b) (iii) above, determine the most appropriate measure of portfolio
return. (2 marks)

(c) Hellen Auma, a research analyst at Bao Capital is examining the prospects of several portfolios: Simba Fund, Twiga
Fund and the Delta benchmark. The selected data is presented below:

Simba Fund information ratio (S) 0.12

Twiga Fund information ratio (T) 0.25
Benchmark sharpe ratio 0.30
Benchmark total risk(s) 20%

CF21 Page 2
Out of 4
 Required:
Calculate:

(i) The highest possible Sharpe ratio for a portfolio consisting of a combination of Simba Fund and the
benchmark. (3 marks)

(ii) The optimal level of active risk for an investor in Twiga Fund. (2 marks)

(iii) The total excess return over risk free rate for an investor in Twiga Fund. (3 marks)
(Total: 20 marks)

QUESTION FOUR
(a) Explain THREE advantages of stock lending to an investor. (6 marks)

(b) Andrew Mwakirunge has been given the following sample probability distribution of annual returns on a portfolio
with a market value of Sh.10 million:

Return on portfolio Probability

Less than – 50% 0.005
–50% to –40% 0.005
–40% to –30% 0.010
–30% to –20% 0.015
–20% to –10% 0.015
–10% to –5% 0.165
–5% to 0% 0.250
0% to 5% 0.250
5% to 10% 0.145
10% to 20% 0.075
20% to 30% 0.025
30% to 40% 0.020
40% to 50% 0.015
Greater than 50% 0.005
1.000

Required:
Based on this probability distribution, determine the following:

(i) 1 percent yearly value at risk (VaR). (3 marks)

(ii) 5 percent yearly value at risk (VaR). (3 marks)

(c) A fund receives investment funds at the beginning of each year and generates returns as shown in the following table:

Year of investment Amount of investment funds Return during year of investment

Sh.“000”
1 1,000 15%
2 4,000 14%
3 45,000 –4%

Required:
Calculate the following:

(i) Time weighted rate of return (TWRR). (2 marks)

(ii) Money weighted rate of return (MWRR). (4 marks)

(iii) Highlight TWO advantages of money weighted rate of return. (2 marks)

(Total: 20 marks)

CF21 Page 3
Out of 4
QUESTION FIVE
(a) Differentiate between “core capital” and “excess capital” as used in personal financial management. (4 marks)

(b) In relation to documentation in the investment sector:

(i) Explain the term “external documentation”. (2 marks)

(ii) Identify FOUR parties that are involved in external documents. (4 marks)

(c) The following information relates to a portfolio held by Waridi Limited:

1. The risk free rate is 3% and the expected return of the market portfolio is 13%.
2. The standard deviation of the portfolio is 23%.
3. Waridi Limited has a standard deviation of 50% and a correlation of 0.65 with the market.

Required:
(i) The beta of Waridi Limited. (2 marks)

(ii) The expected return of the portfolio. (2 marks)

(d) Jewel Muthoni is carrying out an evaluation of one of her client’s from her private wealth portfolio and has gathered
the following information:

1. Investment Alpha of Sh.100,000,000 earned an annual interest of 5% (with no capital gains). Accrual taxes
of 30% are applied to interest income from Alpha investment.
2. Investment Belta of Sh.10,000,000 earned an annual return of 14%. The wealth based tax for this investment
is 3% and no other taxes are applicable to Belta investment.
3. Jewel Muthoni’s overall portfolio generates a total return of 15%. The tax rates on interest, dividends and
capital gains are 35%, 20% and 20% respectively. The proportion of the portfolio return from interest,
dividends and realised capital gains are 10%, 25% and 35% respectively.

Required:
Evaluate Jewel Muthoni’s investments based on the following criteria:

(i) The expected after-tax value of Alpha investment in 10 years. (2 marks)

(ii) The after-tax value of Belta investment in 15 years. (2 marks)

(iii) The net return of Jewel Muthoni’s overall portfolio after all taxes. (2 marks)
(Total: 20 marks)
.............................................................................................................

CF21 Page 4
Out of 4