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Portfolio Risk and Return

Mr. Ajay Gupta recently retired after a stint of fifteen years in a Digitech Solutions, a software products and services company. He had joined MSLPC, the state utilities company straight out of college. However during the period when the Y2K ‘opportunity’ was making the news in software services in India, he felt the need for a career change. Despite being on the wrong side of forty, with his hard work and passion to learn, he went on to become a senior vice president at Digitech Solutions.

He has approached your firm for investment advice with very clear objective in his mind. After settling all the liabilities from his retirement benefits and setting aside some amount in liquid funds for his expenses, he is left with a surplus amount of Rs. 60 lakh which he wishes to invest in the equity market. He is not interested in any stock recommendations from your firm.

Mr. Gupta is risk averse by nature and has avoided investing in equities till date. While the time he was with Digitech Solutions, he has seen the meteoric rise of the company which has been reflected in its share price. As an employee he had legal restrictions over investing in Digitech Solutions, but now that he has retired, he has made up his mind to buy the Digitech Solutions stock(Price: Rs1021). He has looked at the returns over the last 6 years and feels that the recent 16% return after two years of negative returns is the best time to buy the stock.

Period

1

2

3

4

5

6

% Return

18

16

12

(11)

(6)

16

Table1. Digitech Solutions Share Price Returns

He has heard about diversification and knows that he shouldn’t be putting all the eggs in one basket. Still he is not very keen in forming a large equity portfolio and has reluctantly agreed to invest in one more stock. In light of this, you have suggested that he should consider

buying the stock of MSLPC(Price:Rs.393) which Mr. Gupta has readily accepted as he was familiar with the high standards of operations of his former employer.

You have collected further data for the market and MSLPC.

Period

1

2

3

4

5

6

%

Return

10

8

12

(7)

(4)

11

Table2. Market Returns

 

Period

1

2

3

4

5

6

%

Return

8

5

9

20

16

6

Table3. MSLPC Share Price Returns

Your research department has coverage on both Digitech Services and MSLPC and they have given the following forecast. You also find out from the research database that the beta for Digitech Solutions is 1.65

 

Prob

Tbill

Digitech

MSLPC

Market

Recession

0.25

7%

9%

15%

(2)%

Normal

0.60

7%

16%

10%

14%

Boom

0.15

7%

20%

7%

18%

Table4. Research Department Expected Returns

You have just received a call from Mr. Gupta who insisted that the risk to his portfolio return should be as low as possible and the return should be at least 12%, otherwise he will drop the idea of investing in equity and go back to fixed deposits instead. He added that he has made some calculations and arrived at an 80% allocation for Digitech Solutions and the residual 20% in MSLPC stock. He is meeting you tomorrow. Before that you need to come up with a report suggesting the best plan of action.

Discussion Points

A. Analyse the two stock portfolio for expected returns and risk

B. Comment on the allocation suggested by Mr. Gupta and suggest an appropriate portfolio in terms of number of shares he needs to buy of both the companies.

C. Are the two stocks worth buying? Comment using CAPM.