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Assignment #01 MGT201

Total Marks: 20
Date: 26th July, 2018

Topic covered: Risk and return


Risk and return move side by side and ignoring any one of these two for investment
decision can result in the irrational decision. Rational decision making requires investors
to analyze the company’s specific risk contribution of investment along with market
dynamics. Company-specific risk analysis helps investors to control the unsystematic risk
and to come up with a best possible portfolio (a combination of highest return and lowest
risk). Market dynamics can over-price or underprice a stock that can be a trap for the
investors; Capital Asset Pricing Model (CAPM), Security Market Line (SML) and
Gordon’s Formula can help investors to take a rational decision by calculating fair
pricing of the stocks. Unlike market risk; investors can control the company’s specific
risk if they have calculated the fair price and required rate of return of the available
investment options correctly.
Suppose you have to construct a portfolio for which you have considered three different
sectors (Textile, Chemical and Food). Stock L and K from Chemical and Food sector
have already been selected while one stock is required from the Textile sector to
construct the portfolio. Further, information of three Stocks from the textile sector has
been provided below, and you need to select only one that can be added to your portfolio.

Sectors Stock Beta Required Market price Dividend


Investment (current year)
Textile Sector A 1.5 25,000 Rs. 35 Rs. 5 that grows
at constant rate of
10%
B 1 25,000 Rs. 29 Rs. 6 that grows
at constant rate of
8%
C 2 25,000 Rs. 40 Rs.10 that grows
at a constant rate
of 5%
Chemical sector L 1.5 30,000 Rs. 42 NA
Food sector K 1.0 45,000 Rs. 15 NA
Note: Risk-free rate is 15%, and market return is 25%
Required:
Question #01.Calculate the Fair price of each stock for the Textile sector (9 marks).
Question #02.Based on fair price calculation of the Textile sector’s stocks in Question
#01; categorize each stock either undervalued or overvalued (also provide reasoning that
why a stock is overvalued or undervalued) (4 marks).
Stocks Overvalued or Undervalued Reason
Stock A ? ?
Stock B ? ?
Stock C ? ?
Question #03.Complete your investment portfolio by the decision in Question #2 (1
mark).
Investment Portfolio

Sector Stock Required Investment


Textile Sector ? ?
Chemical Sector L 30,000
Food Sector K 45,000

Question #04.Based on the answer to Question #03; calculate the beta of your portfolio
(2 marks).
Question #05.Calculate required rate of return of stocks in the Textile sector if the risk-
free rate of return decreases to 10% (keeping all other things same), which stock will
have a highest required rate of return?(4 marks).

NOTE:
Formula and complete working of each part is mandatory; marks will be deducted
in case of incomplete calculations

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INSTRUCTIONS

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