Chapter 1 Introduction to portfolio management

Investment Investment is the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in the form of interest, income, or appreciation of the value of the instrument. Investment is related to saving or deferring consumption. An investment involves the choice by an individual or an organization such as a pension fund, after some analysis or thought, to place or lend money in a vehicle, instrument or asset, such as property, commodity, stock, bond, financial derivatives (e.g. futures or options), or the foreign asset denominated in foreign currency, that has certain level of risk and provides the possibility of generating returns over a period of time. When an asset is bought or a given amount of money is invested in the bank, there is anticipation that some return will be received from the investment in the future. Investment is a term frequently used in the fields of economics, business management and finance. It can mean savings alone, or savings made through delayed consumption. Investment can be divided into different types according to various theories and principles. While dealing with the various options of investment, the defining terms of investment need to be kept in mind. Investment in terms of Economics According to economic theories, investment is defined as the per-unit production of goods, which have not been consumed, but will however, be used for the purpose of future production. Examples of this type of investments are tangible goods like construction of a factory or bridge and intangible goods like 6 months of on-the-job training. In terms of national production and income, Gross Domestic Product (GDP) has an essential constituent, known as gross investment. Investment in Terms of Business Management: According to business management theories, investment refers to tangible assets

like machinery and equipments and buildings and intangible assets like copyrights or patents and goodwill. The decision for investment is also known as capital budgeting decision, which is regarded as one of the key decisions. Investment in Terms of Finance: In finance, investment refers to the purchasing of securities or other financial assets from the capital market. It also means buying money market or real properties with high market liquidity. Some examples are gold, silver, real properties, and precious items. Financial investments are in stocks, bonds, and other types of security investments. Indirect financial investments can also be done with the help of mediators or third parties, such as pension funds, mutual funds, commercial banks, and insurance companies. Personal Finance: According to personal finance theories, an investment is the implementation of money for buying shares, mutual funds or assets with capital risk. Real Estate: According to real estate theories, investment is referred to as money utilized for buying property for the purpose of ownership or leasing. This also involves capital risk. Commercial Real Estate: Commercial real estate involves a real estate investment in properties for commercial purposes such as renting. Residential Real Estate: This is the most basic type of real estate investment, which involves buying houses as real estate properties. portfolio management An investor considering investment in securities is faced with the problem of choosing from among a large number of securities. His choice depends upon the risk-return characteristics of individual securities. He would to choose the most desirable securities. Again he faced the problem of deciding which securities

to hold and how much to invest in each. The investor faces an infinite number of possible portfolios or group of securities. The risk and return characteristics of portfolios differ from those of individual securities combining to form of portfolio. The investor tries to choose the optimal portfolio taking into consideration the risk-return characteristics of all possible portfolios. phases of Portfolio Management. Portfolio management is a process encompassing many activities aimed at optimizing the investment of ones funds. Five phases can be identified as this process:1. Security analysis 2. Portfolio Analysis 3. Portfolio Selection 4. Portfolio revision 5. Portfolio Evaluation Investment v/s speculation There are some insights that investors would do well to follow in order not to cross the boundaries between investment and speculation. For Adam Smith, the speculator is defined by his readiness to pursue short-term opportunities for profit: his investments are fluid whereas those of the conventional businessman are more or less fixed. This distinction was shared by John Maynard Keynes, who described investment as the activity of forecasting the prospective yield of assets over their whole life, in contrast to speculation, which he called the activity if forecasting the psychology of the market. Speculation has come to mean different things to different people, yet still retains something of its original meaning: namely, to reflect or theorize without a factual basis. Benjamin Graham the author of classic books Security Analysis and The Intelligent Investor is regarded as the founder of financial analysis. Graham's key insight is the premise that "investment is most successful when it is most businesslike. An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative". Graham held that price is what is paid and that value is what is received; observed that over time, price and value gravitate towards one another but that at any given point in time they may diverge (sometimes by a wide margin); and lamented that most people rarely recognize - and more than a few willfully ignore - the fundamental distinction between value and price. Value investors, as practitioners of Graham's approach are often called, thus reject the prevailing view

that the price and value of a security (i.e., stock, bond, title to real estate) necessarily coincide at all times. In order to better appreciate the distinction between price and value, Graham urged market participants to ignore 'the market' as a whole and to focus upon the individual business which issues a stock certificate or bond. The Graham approach to investing regards a stock as a share of a business whose value, over time, corresponds to the value of the entire enterprise. From this principle follow two others. First, under certain conditions a security may be purchased at a price less than its value, and the greater this disparity the greater the investment's 'margin of safety'. Second, to obscure the relationship of value to price - for example, to buy a security on the basis of its current popularity and in the hope that its price, reflecting this popularity, will shortly rise - is speculation. Indeed, from the perspective of a Graham-style value investor the vast majority of transactions occurring in financial markets are speculations rather than investments. Key Point: To qualify as an investment, a purchase must be (1) based on thorough analysis, promise (2) safety of principal and (3) a satisfactory return. Any purchase not meeting these requirements is speculation. It's important to remember Graham's distinction because when one confuses speculation for investment, trouble is soon to follow.

Various investment avenues in India . A) Financial securities B) Non Financial securities C) Mutual funds D) Real estate Popular approaches of asset allocations: In the words of a layman, asset allocation can be looked at as a decision on how to divide the income between current spending and investment, and how to distribute the investment among the various possible avenues to attain the targeted goals. The methods in this approach generally try to capture a part of the wisdom that professionals get through years of study and practice into some rules of thumb. 100 Minus Your Age Method

According to this method, the percentage of your total investment that can be invested in equities depends on your age and is based on the premise that you will live to be 100 years old. The method suggests that the proportion of investment to be placed in equities is 100 minus your age. The rest may be placed in bonds and other safe investments. Your Age 100 Minus Your Age % Investment in Equities % Investment in Bonds 30 70 70 30 40 60 60 40 50 50 50 50 60 40 40 60 Though life expectancy is increasing, the probability of a person living beyond 100 is still low. As the age increase, the ability to take risk normally declines. This method essentially addresses this issue. The person who uses this method reduces his allocation to equities as he/she grows old. This method, while based on the general perceptions about the desirable exposure to equities over the life of a person, suffers from some obvious defects. It does not take into account the life expectancy of a person, the factor of inflation, the wealth to be accumulated or the current financial needs. Over the years, this method results in increase in the current income and decrease in growth, which can be harmful for the financial condition of the person considering inflation and increasingly long life expectancies. misconceptions regarding risk Losses: Common individual investors generally look at risk as losing money. Such investors generally become aware of risk only after they make losses. Some are of the opinion that losses are incurred only when investments made are liquidated at prices below the purchase prices. They do not understand book losses and often stop their portfolio manager from realizing a loss even when the prices are falling. Being fully focused only on profits and losses, they tend to overlook the need to evaluate the performance of the portfolio (and that of the portfolio manager) in comparison with the performance of the market portfolio. A characteristic feature of individual investors is to hold to stocks that have lost value with the hope that they will some day rise, wiping out the losses. They generally ignore the time lag between the day the value of the stocks comes down and the day they recover it. Many investors also do not understand the difference between the potential for loss and actual loss. It is not uncommon to find them saying that a particular stock was not risky after all, and that the portfolio manager need not have bothered to switch out of it, while its standard deviation of return may be a high 25 percent

based on historical data. The point sought to be made here is that they do not understand that a stock that has shown high volatility in the past need not necessarily show the same degree of volatility again and that the actions of the portfolio manager are generally aimed at avoiding the losses just in case it does. Risk and Unfamiliarity: Individual investors generally tend to treat investments with which they are not fully familiar as being more risky. When the portfolio manager strongly suggests a switch from stocks of one sector to another (say from Pharma to FMCG), the investor is likely to resist if he is not familiar with FMCG stocks. Unfamiliarity with instruments such as stock index futures and options and a vague memory that these instruments have been responsible for great losses to big institutions may also result in the investor resisting any moves for hedging the portfolio. Earlier Losses: Investors generally treat the investments in which they incurred losses earlier as being risky. If a person incurs losses by investing in aquaculture or granite stocks, he avoids stocks from these industries for the rest of his life, irrespective of their present performance. That is, the investor develops a severe fear or aversion towards the stock. Such psychological blocks can sometimes be removed by the portfolio manager by educating the investor about the real nature of investment risks. Contrary Investing: Contrary investing or contrarian investing is a favorite of a significant number of portfolio manager. It involves buying a stock when everybody is selling (that is, when it is out of fancy with the market and its price is dropping sharply) and selling it when everyone else is buying (that is, when the stock catches the fancy of the market and its price shows a sharp appreciation). Individual investors generally prefer to go along with the market and want the portfolio manager to buy and sell along with the market. They feel insecure of being left out when everybody else makes profits. The Bielard, Biehl and Kaiser five-way model Individualists: These are the confident and careful types. They generally do not go to a consultant to manage their investments but do it themselves, if they can find

enough time for it. But the world of investments is now changing so fast, that they may also be eventually compelled to seek help from investment counsels. Adventurers: Adventurers generally go for only big bets. They have the resources to do so and are willing to take risks. The investments made by this type of investors are generally focused and are not diversified. Since they are confident of what they do, they too do not generally go to investment counsels for help. Celebrities: Celebrities are those that are swayed too much by the trend and do not have any expertise or opinion about investments. They are, most of the time, worried about being left out when everyone is making profits. They, therefore, insist that the portfolio manager should put their investment into what is popular now. They refuse to understand that what is now popular has already realized its potential and does not offer scope for substantial profits in future. Therefore, it can be very difficult for the investment counsel to convince them about the potential of good investments that are now not popular. But, not having the expertise and the confidence required to manage the portfolio on their own, they approach investment managers frequently. Guardians: Guardians are both anxious and careful. Lacking confidence in themselves, they approach investment counsels. They generally emphasize on safety of the capital while making investment and a significant proportion of their investment is generally devoted to government securities and guaranteed return investments. They choose their investment advisor with great care. They generally stay with the advisor for the rest of their life unless his performance is too disappointing. Straight Arrows: These are halfway between complete confidence and anxiety, and extreme carefulness and impetuousness. They can be aptly described as the average investors. While those exactly in the middle are potential clients for portfolio managers, those who are significantly towards impetuousness or confidence are not. The most frequently seen customers of portfolio managers are the guardians. Their desire to protect their wealth and the anxiety about their inability to protect drive them towards portfolio managers. Celebrities too go to portfolio managers to find out what is hot. But, they are not very frequent as they rarely make much money. j Different types of equity styles.

In 1970, James Farrell identified that there is significant correlation between the returns of some stocks, which he grouped together. Further, he found that the correlation between the returns of different stocks was low. He called the groups of stocks whose returns had strong correlation with each other `clusters'. He identified four distinct clusters growth stocks, cyclical stocks, stable stocks, and energy stocks. In the later part of the 1970s, further studies have shown that even groupings by size result in distinct classes of stocks whose returns are correlated. Portfolio managers view each of these groups or clusters or classes as different `styles' of investing. Some portfolio managers then started calling themselves "growth stock managers" or "cyclical stock managers". Some of them became "large cap" investors while others were "small cap". Switching styles has come to be known as a way of enhancing portfolio performance. Style investing is widely accepted today. This is evidenced by the fact that there are so many style funds coming up funds that invest in infotech, FMCG stocks, Sensex stocks, etc. Types of Equity Styles Equity styles can be classified in many ways. The simplest of the classifications is based on value or growth. For a manager who focuses on growth, the concern is about the growth of the earnings. Taking the most popular ratio used in the determination of whether the stocks are underpriced or overpriced, the price to book ratio, we can understand that the logic in growth investing is pretty simple. If the value of the share is expressed as a multiple of the earnings (the price to book ratio), for the same ratio, the price increases with increase in the earnings. The `growth manager' seeks stocks that appear to be having good potential for earnings growth. He suffers if the earnings fall or the price to book ratio of the company declines. The `value manager', in contrast, invests in stocks that have a relatively low value of the price to book ratio. His expectation would be that the price to book ratio of the stocks would some day increase and thus their prices would increase. If the price to book ratio of the stocks does not increase or declines further, he loses. A variation that can be incorporated into the classification of value and growth is the size of the firm. Including size, the following four classifications are possible: Large value stocks Large growth stocks Small value stocks Small growth stocks.

There could be other types of classifications within growth and value investing. In value style, there are three categories. They are the low P/E ratio style, contrarian style, and yield style. The low P/E manager concentrates on stocks trading at a low P/E ratio. The P/E ratio used may change from one manager to another some may use the ratio based on the current earnings, others may use a normalized ratio while still others may use a ratio based on discounted future earnings. Contrarian managers invest in stocks that are selling at low values compared to their book values. The companies that generally fall in this category are those that have low current earnings and even no earnings at all and cyclical stock that are in a downtrend. Contrarian managers try to find value where others do not hope to gain from the price appreciation of stocks. Yield managers are those that look for companies with above average dividend yields. It must be said that they are the most conservative among the three. In growth style too there are two variations. Managers who follow consistent growth style invest in companies that grow consistently and at a good rate. Then there are those that follow earnings momentum growth style, looking for high volatility in earnings and an above average rate on the whole. The latter buy stocks in expectation of an acceleration of earnings. There are also some managers who adopt a style that fits somewhere in between value and growth. These managers generally have some bias or `tilt' in favor of either value or growth, but the bias is generally not sufficient to classify the managers into value or growth. These managers generally look for companies that are expected to turn in above average earnings, but are selling at a reasonable price. They are generally referred to as growth at a price managers or growth at a reasonable price managers because they provide good returns without excessive risk. Differentiation between the standard finance and the behavioral finance Individual investors invest not only on their risk and return perception but also an their psychological expectations. The concept of market efficiency has two meanings, the first one deals with the fact that investors can never beat the market and the other states that the security prices are rational. Now, this rational pricing of security considers only the fundamental features of investing such as risk and not the psychological or value expressive characteristics. This psychological feature of investing gives rise to a set of asset pricing models which in turn reflect all characteristics of investment behavior. Standard Finance vs. Behavioral Finance Standard finance is basically structured upon sound principles of finance, for example, the arbitrage principles of Miller and odigliani, the Capital Asset pricing theory of Sharpe and Lintner, portfolio principles of Markowitz and

option pricing theory of Black, Scholes and Merton. Standard finance uses minimum tools to build a unified theory to answer all questions. On the other hand, behavioral finance incorporates psychology into its framework. The tools of behavioral finance include susceptibility to frames and other cognitive errors, different attitudes towards risk, imperfect self-control and risk aversion. Behavioral finance deals with frames. The significance of frames can be illustrated by the following example. Suppose a well-known company foregoes its dividends in a particular year, due to financial crisis. As per standard financial crisis, but not because of the non-payment of dividends. This is mainly because the investors are expected to believe arbitrage principles of Miller and Modigliani and they would be indifferent towards dividend payment and capital payment. These investors do not rely on companies to declare dividends, but they create home-made dividends by selling shares. We will address the same dividend problem in the context of behavioral finance. Investors actually create separate mental accounts in their minds. They treat dividend account and capital receipt account differently. So, the decline in the price of the companys share is loss in the capital mental account, where as the non-payment of dividend is construed as a loss in the dividend mental account. Actually people often keep their portfolio money in separate mental accounts. Another part of the theory relates to the investors varying attitudes. Actually, it has been found that investors show a varying degree of differences towards risks in their mental accounts, as studies have revealed that people regularly buy insurance policies as well as lottery tickets. But the framing of money into separate mental accounts has also got its drawbacks. The covariances between accounts are ignored. It is also to be noted that framing is beneficial to those who have imperfect self-control since, behavioral investors sometimes get tempted and seek tools to improve their control. As discussed earlier, a standard investor creates home-made dividends by selling shares. But the home-made dividends pose a disadvantage to the behavioral investors for, they open the avenues for regret. Say, an investor bought a personal stereo paying Rs.500 for it. Consider that he has paid this amount out of dividends received, where as another investor has paid the same money out of proceeds received from shares. Now, suppose the share price rises. Do the investors feel the same level of regret? The choice to sell shares brings more regret as compared to the receipt of dividends when the share prices soar. It has to be remembered that standard finance people are modeled as rational, whereas behavioral people are modeled as normal. Behavioral Asset Pricing Theory

The capital asset pricing theory begins with the Markowitzs theory of behavior where the investors are more concerned with the expected returns and the variances of their portfolios. The Behavioral Asset Pricing Model (BAPM) as developed by Shefrin and Statman (1994), states that the market is made up of two groups of traders. One, the information traders, and the other, the noise traders. Information traders are those who fall in the standard CAPM. They are free from cognitive errors and have mean variance preference. Noise traders are outside CAPM and are more prone to committing cognitive errors, and do not have a strict mean variance preference. The list of features in BAPM actually includes both utilitarian as well as value-expressive traits. Risk premiums The CAPM and other similar asset princing models of standard finance actually reflect the differences in expected returns of the securities in a particular time period. It has been found out that when risk premium is taken into account, both the utilitarian as well as the value-expressive factors play a role. This brings us to the very notion of Tactical Asset Allocation (TAL) process. The tactical asset allocators have a sentimental attitude towards their choice of securities. They tend to sell heir stocks, when there is bubble in the market and buy them when the market is in panic. But it has to be remembered that even the presence of sentiments in the model can make the task of beating the market easier. Behavioral Portfolio theory As an alternative to the conventional Markowitz designed mea-variance portfolio, Shefrin and Statman (1999) developed a behavioral portfolio theory. The behavioral investors build their portfolio in a pyramid structure adding on a subsequent layer. Each layer is associated with a particular investment objective and also reveals the investors attitude towards risk. They tend to keep some money in the downside protection layer and some in the upside protection layer. In contrast, the mean-variance investors show constant attitude towards risk, and are risk averse. In essence, the behavioral portfolio theory seeks to answer certain portfolio questions and tries to give answers to others, for example, how value-at-risk is applicable to building a portfolio? How would the securities be qualified for inclusion in each layer of portfolio? CHAPTER 2: RISK AND RETURN IN PORTFOLIO MANAGEMENT

Definition: Investment is the current commitment of funds for a period of time in order to derive future payment that will compensate the investor for 1. The time the funds are committed 2. The expected rate of inflation 3. The uncertainty of future payments Investment Objectives: Rationally stating, all personal investing is designed in order to achieve a goal, which may be tangible or intangible. Goals can be classified into various types based on the way investors approach them. Near term high priority goals: These are the goals have a high priority to the investors and he wishes to achieve these goals within a few years at the most. Because of high emotional importance these goals have, investors, especially the one with moderate means will not go for any other form of investment which involves more risk especially where his goal is just in sight.

Long term high priority goals: For most people this goal is an indication of their need for financial independence at a point some years ahead in the future. Because of the long term nature of such goals, there is not a tendency to adopt more aggressive investment approach except perhaps in the last 5 to 10 years before retirement.

Low priority goals: These goals are much lower down in the scale of priority and are got particular painful if not achieved. As a result investors often invest in speculative kinds of investment either for the fun of it or just to try out some particular aspects of the investment process.

Entrepreneurial or money making goals: These goals pertain to individuals who want to maximize wealth and who are not satisfied by the conventional saving and investment approach.

Investment constraints An Investor seeking fulfillment of one of the above goals operates under certain constraints: Liquidity Age Need for regular income Time horizon Risk tolerance Tax liability fixed income, variable income & real investments. 1) risk 2) Systematic risk 3) Unsystematic risk. A person making an investment expects to get some return from the investment in the future. But, as future is uncertain, so is the future expected return. It is this uncertainty associated with the return from an investment that introduces risk into an investment. Risk can be defined in terms of variability returns. Risk is the potential for variability in returns. An investment whose returns are irly stable is considered to be high risk investment. The total variability in returns of a society represents the total risk of the security.Systematic risk and unsystematic risk are two components of total risk. Thus, Total risk = Systematic risk + Unsystematic risk. Systematic risk As the society is dynamic, changes occur in the economic, political and social systems constantly. These changes have an influence on the performance of companies and thereby on their stock prices. But these changes affect all companies and all securities in varying degrees.

Thus the impact of economic, political and social changes is system- wide and that portion of total variability in security return caused by such system-wide factors is referred to as systematic risk. Systematic risk is further subdivided into interest rate risk, market risk, and purchasing power risk. Unsystematic risk When variability of returns occurs because of firms- specific factors, it is known as unsystematic The unsystematic or unique risk affecting specific securities arises from two sources: (a) the operating environment of the company, and (b) the financing pattern adopted by the company. These two types of unsystematic risk are referred to as business risk and financial risk respectively. Measurement of risk The variance and standard deviation measures the extent of variability of possible returns from expected return. Several other measures such as range, semi-variance and mean absolute deviation have been used to measure risk, but standard deviation has been the most popularly accepted measure. The systematic risk of a security is measured by a statistical measure called beta. The input data of returns for the calculation of beta are the historical data of returns of the individual security as well as the returns of a representative stock market index two statistical methods may be used for the calculation of beta, namely the correlation method or the regression method. Using the correlation method, beta can be calculated from the historical data of returns by the following formula: =rim i m/ Where, Rim = Correlation coefficient between the returns of stock i and the returns of the market index i = standard deviation of returns of stock i m = standard deviation of returns of the market index m = variance of the market returns Expected return of a portfolio. As a first step in portfolio analysis, an investor needs to specify the list of securities eligible for selection or inclusion in the portfolio Risk of portfolio The variance (or risk) of a portfolio is not simply a weighted average of the variance of the individual securities in the portfolio. The relationship between each security in the portfolio with every other security

as measured by the covariance of return has also to be considered. The variance of a portfolio with only two securities in it may be calculated with the following formula: Reduction of portfolio risk through diversification The process of combining securities in a portfolio is known as diversification. The aim of diversification is to reduce total risk without sacrificing portfolio return. Security returns perfectly positively correlated. When security returns are perfectly positively correlated the correlation coefficient between the two securities will be +1. The return of the two securities then move up or down together. The portfolio variance is calculated using the formula: This is simply the weighted average of the standard deviations of the individual securities. Security returns perfectly negatively correlated. When security returns are perfectly negatively correlated, the correlation coefficient between them becomes -1. The two returns always move in exactly opposite directions. Q5) The current price of stocks A and stock B are Rs 80 and Rs60 respectively. At the end of the year, the price of stocks A and B and their associated probabilities are given below. Stock A (Rs) Stock B ( Rs) Probability 74 55 o.30 80 60 0.40 85 66 0.30 Given this data, which stock should an investor choose? Q6) Mr Anup singal has identified the shares of two companies that have good investment potential. The following is the share price data relating to them: Year XYZ Co (Rs/ Share) ABC Co (Rs/ Share) 2001 19.60 8.70 2002 18.75 12.80 2003 33.42 16.20 2004 42.64 18.25 2005 43.25 15.60 2006 44.60 13.25

2007 You are required to:

34.75

18.60

Calculate the return and risk from investing in XYZ Co and ABC Co. Calculate the return and risk from investing in a portfolio of the two stocks, if he invests 60 % an ABC and 40% in XYZ. State whether it is better for him to invest in the combination mentioned in ( B) above than in any one of the companies? Q5) On request of an investor who holds two stocks A and B, an analyst prepared expected probability distribution for the possible economics scenario and the conditional returns for two stocks and the market index as shown below. Economic probability A (%) B (%) Market (%) scenario 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 investment in them? The assumptions of CAPM hold true. Q9) Given below are the returns on two stocks X and Y during a period of five years. Period 1 2 3 4 5 X(%) -6 3 10 13 16 Y(%) 4 6 11 15 19

Calculate the 1. Variance and S.D. for stocks X and Y 2. The covariance 3. The correlation coefficient

Q3) An analyst had forecast three economic scenarios and associated probalities. Also conditional returns of three stocks A,B and C during this period were estimated. For a portfolio with 40% of the funds invested in stocks with lowest S.D. and the rest invested equally in other two stocks, compute the return,variance and S.D. of the portfolio. Economic Scenario Growth Stagnation Recession Q3) Probability 0.40 0.35 0.25 Returns (%) A 15 12 8 Returns (%) B 11 13 14 Returns (%) C 13 9 6

The data given below relates to companies A and B. A (Rs) B (Rs) 8 120 175 100

Expected Dividend Current Market Price Expected M. P. after one year under two scenarios Optimistic scenario Pessimistic scenario

5 60 100 50

If an investors holding period is one year, which stock he should buy?

Given below are the returns on three stocks A,B and C for a four year period.compute the average returns, variance and S.D. if a portfolio is constructed such that the stock having lowest S.D. accounts for 50 % of the funds, a stock having the next S.D. accounts for 30% and the third stock accounting for 20% of the funds. Period (Years) 1 Annual Returns(%) A 10 Annual Returns(%) B 11 Annual Returns(%) C 8

2 3 4

12 14 16

9 13 17

12 9 15

1.

Consider the following information: Weight in the portfoli o 0.7 0.3

Stock Return Variance

A B

14% 11%

441 (%)2 256 (%)2

If the variance of the portfolio is 122 (%)2, the coefficient of correlation between the stocks is (a) 1.86 (b) 0.83 (d) + 1.20 (c) 1.20 (e) + 0.83.

12.

Which of the following aspects of investing in real assets differ from investing in securities? I. The type of income derived II. The manner in which the assets are valued III. The way inflation affects real assets. (a) Only (I) above (b) Only (II) above (c) Only (III) above (d) Both (I) and (II) above (II) and (III) above. (e) All (I),

4.

Consider the following data about two securities A and B: Particulars Expected Return (%) Standard deviation of returns (%) Beta Security Security A B 15 18

18 0.90

22 1.40

Variance of returns on the market index is 225 (%)2. The correlation coefficient between the returns on securities A and B is 0.75. The systematic risk of a portfolio consisting of these two securities in equal proportions is (a) 24.63(%)2 (b) 125.78(%)2 (c) 297.56(%)2 (d) 606.73(%)2 (e) 802.40(%)2. Consider the following data about two securities A and B: Security A Expected Return (%) Standard deviation of returns (%) Beta 12 Security B 13

21 1.10

29 1.20

Which of the following is/are not a speculative transaction? I. Contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations. II. Contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss arising in ordinary course of business. III. Contract entered into by a person to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. (a) Only (I) above (b) Only (II) above (c) Only (III) above (d) Both (I) and (II) above (e) All (I), (II) and (III) above.

7.

Which of the following securities is most liquid? (a) Money market instruments (b) Capital market instruments

(c) Gilt-edged securities (d) Index (e) Stock options. There are two stocks: Stock A and stock Futures B. Particulars Stock Stock Market A B Index Beta 1.53 0.81 1.00 Standard 10.70% 16.84% 10.00% deviation With respect to this, which of the following statements is/are not true? I. The covariance between Stock A and Stock B is 23.52 (%)2. II. A large part of stock Bs return can be eliminated by diversification. III. Systematic risk of stock B is relatively high, resulting in a low beta. IV. Stock A is an aggressive stock and Stock B is a defensive stock. (a) Only (II) above (b) Both (I) and (II) above (c) Both (I) and (III) above (d) Both (II) and (IV) above (e) (II), (III) and (IV) above.

9.

Required rate of return on a stock is 15.00% and it has paid a dividend of Rs.2.75 for the year 2004-2005. If the stock is currently available at a price of Rs.52, the implied growth rate in dividends is (a) 6.35% 10.05%. (b) 7.85% (d) 9.72% (c) 9.22% (e)

10.

Which of the following statement(s) is/are true concerning all the three forms of the efficient market hypothesis? I. Equilibrium rate of return will prevail II. Securities of firms sell at their fair value III. Investors cannot earn a positive return (a) Only (I) above (b) Only (II) above (c) Both (I) and (III) above (I) and (II) above (e) (I), (II) and (III) above. (d) Both