Equity Research and Portfolio Management-1


SKU: AMSEQ-084 Category:

Assignment – A

Question 1) Given the explicit probability distributions shown below:
a. Determine the equation for the security market line, assuming that the interest ‘r°’ is 8%.
b. What does the SML tell you about the “market price at risk”.
c. Compute the Beta of security ‘Zigma’.
d. Compute the Alpha for security ‘Zigma’.

Conditional Returns
EconomicScenario Probability Zigma Market
Boom 0.30 20% 13%
Steady 0.40 8% 7%
Bust 0.30 -9% -4%

Question 2 a) Assume that two securities A & B, constitute the market portfolio. Their proportions and variances are 0.39, 160 and 0.61, 340 respectively. The covariance of the two securities is 190. Calculate the standard deviation of portfolio.
b) Given the following variance – covariance matrix for three securities (P, Q, R), as well as the percentage of the portfolio that each security comprises, calculate the portfolio’s standard deviation.

Security P Security Q Security R
Security P 459 -211 112
Security Q -211 312 215
Security R 112 215 179
X(P)=0.50 X(Q)=0.30 X(R)=0.20

c) Given that the betas of X, Y and Z are 0.66, 1.11 and 1.02 respectively and the standard deviation of the market portfolio is 15.2%. Calculate the market risk of the three firms.

Question 3a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both have face value of Rs.1000 and 8% coupon rates (with annual interest payments) and both sell at par. Assume that the yields of both bonds fall to 6%. Calculate the increase in the bond prices. What percentage of this increase in each case comes from a change in the present value of the bonds principals and what percentage comes from a change in the present value of the bonds’ interest payment?
b) Consider a bond selling at its par value of Rs. 1,000, with 6 years to maturity and a 7% coupon rate (with annual interest payments). Calculate the bond’s duration.
c) If the YTM of the bond in 3(b) above increases to 10% what happens to the bonds duration? Why does this change occur?
d) Why must the duration of a coupon bearing bond always be less than the time to its maturity date?

Question 4) Define the following:
(a) Secured and Unsecured Bonds
(b) Convertible and Non-convertible bonds
(c) Innovation in the Bond Market
(d) Bond Terminology

Question 5) Securities A and B and the market portfolio have the following expected returns, variance and covariance of return.

Expected Return


A 0.08
B 0.14
Market Portfolio(M) 0.10


Assignment – B

Question 1: Investment in bond assures the investor a fixed return with some element of risk. Elaborate on the various risks involved in bond inve stment and recommend the techniques to reduce these risks.

Question 2: Economic forecasting is an integral part of Fundamental Analysis. Define the various methods of forecast the economy.

Question 3: A 12% debenture (face value Rs. 1000) is being quoted at Rs. 825.50, the interest on the debenture is payable annually in arrear (at the end of every year) and it will redeemed at par in two equal annual installments at the end of years 4 and 5 from today.
(a) Calculate the duration of the debenture

(b) Calculate the terminal values of the investment under following scenarios.
i. Holding period of 5 years and reinvestment rate of 20% p.a.
ii. Holding period of 5 years and reinvestment rate of 10% p.a.
(c) Comment on the values obtained in (b)


Case Study

Question 4:

Variance – Covariance Matrix


A 0.07 0.040 0.080
B 0.04 0.110 0.125
M 0.08 0.125 0.095

(a) Find the expected return, standard deviation of return and beta for a portfolio having proportions, XA = 0.40 AND XB = 0.60.
(b) State the investment objective(s) that may be met by the above investment strategy in (a). Give reasons.
(c) What should be the proportions of investment in Securities A and B if it were to be an index-linked portfolio?
(d) Given the economic scenario of controlled growth, is it advisable to hold the portfolio as in
(a) or as in (c)? Why?


Assignment – C

1. If an investor pays 50% margin for a stock purchased at Rs.80 per share, collects Rs.6, cash dividends, sells the stock at Rs.90, pays interest expense of Rs. 4, and incurs commission costs and income taxes of Rs.4 per share, what is the investor’s one-period rate of return?
(a) 10%
(b) 20%
(c) 30%
(d) 40%
(e) 50%

2. When there are ‘n’ assets in a portfolio, the number of unique covariance terms is given by :
(a) [(n (n + 1)]/2
(b) 2n + 1
(c) [n (n -1)]/2
(d) (2n-1)/2
(e) None of the above.

3. Which of the following is true with respect to Beta?
(a) The security’s beta is a function of the correlation of the security’s returns with the market index returns and the variability of the security’s returns relative to the variability of the index returns.
(b) Beta for a portfolio is a weighted average of the betas of the individual securities in the portfolio.
(c) Beta can be directly computed by first computing the covariance between the security return and the market return and then dividing this covariance by the variance of the market return.
(d) All of the above.
(e) None of the above.

4. Bonus issue will not
(a) Lead to the reduction in share price (ex-bonus) in the market
(b) Affect the EPS adversely
(c) Affect the DPS adversely
(d) Affect the profits of the company
(e) Both (a) and (d)

5. As per Bond Price Theorem
(a) Given the maturity, the change in bond price will be greater with a decrease in the bond’s YTM than the change in bond price with an equal increase in the bond’s YTM
(b) For a given difference between YTM and coupon rate of the bonds, the shorter the term to maturity, the greater will be change in price with change in YTM
(c) For any given change in YTM, the percentage price change in the case of bonds on low coupon rate will be smaller than in the case of bonds of high coupon rates, other things remaining the same.
(d) Both (b) and (c) above
(e) Both (a) and (b) above

6. The CAPM risk return relationship described by the Security Market line is:
(a) An expected or ex-ante relationship
(b) Historical or ex-post relationship
(c) Based on ex-post beta
(d) Based on portfolio of securities than individual securities
(e) None of the above

7. The LIFO inventory valuation technique has which of the following characteristics?
(a) It under-estimates the firm’s cost of goods sold during inflationary periods
(b) It tends to minimize the firms income taxes during inflation
(c) In an inflationary environment it presents a better reflection of the firm’s true economic earnings
(d) All of the above
(e) Both (b) and (c)

8. A portfolio with two stocks which are perfectly negatively correlated ensures
(a) High risk and high returns
(b) Low risk and high returns
(c) Zero risk with reduced returns
(d) Zero risk without sacrificing returns
(e) High risk and low returns

9. The erratic price changes that marketable securities experience are caused by which of the following?
(a) The supply and demand conditions for new issues in the primary market
(b) The continuous arrival of new information
(c) Purchases and sales of large blocks of securities that may occur even without new information, in order for the seller to obtain needed cash
(d) Clerical errors and other ‘backroom problems’ that sometime occur in Stock Exchanges
(e) Both (b) and (c) above

10. As per Efficient Market Hypothesis (EMH)
(a) The weak form of EMH implies that short-term traders and speculators will not earn a
positive rate of return.
(b) If a perfectly efficient market, the market prices of securities vibrate randomly around their intrinsic value.
(c) If a share’s prices are weakly efficient, they reflect all publicly available information.
(d) All of the above
(e) None of the above

11. A bond’s duration equal the number of years to the bond maturity under which one of the following conditions?
(a) The bond’s coupon rate equals the market interest rate when the bond is issued.
(b) The bond’s quality rating does not change.
(c) Market interest rates do not fluctuate
(d) The bond pays no coupon interest.
(e) None of the above.

12. Which of the following information if immediately and fully reflected in security prices will reflect strong form of efficiency?
(a) A company’s recent half-yearly earnings announcement
(b) Takeover plans
(c) Limit orders in specialists book.
(d) Both (a) and (b) above
(e) Both (b) and (c) above

13. Which of the following is false?
(a) The CMIE is a government agency that collects, classifies and presents main economic data in a capsule form.
(b) Since the gathering of primary data is both time consuming and costly, the investing public has to resort to the sources of secondary information.
(c) Objective and intelligent investment decisions are always based on instinct.
(d) Some of the valuable sources of investment information are trade journals, official documents and advisory reports published by the investment brokers and counsellors.
(e) None of the above.

14. Which of the following statement(s) is/ are true?
(a) Market risk is unsystematic risk.
(b) According to portfolio theory, the total risk (variance) is the relevant risk in the portfolio context.
(c) ß of the portfolio is weighted average of betas of individual scrip in portfolio.
(d) Both (a) and (b) above
(e) Both (a) and (c) above

15. Given Rc = Current yield of the bond computed as coupon interest/ bond price, Rd = Yield to maturity, n = Term to maturity, a simplified formula for duration is given by:
(a) D = (Rd/Rc) x [PVIFA(Rd, n)] x Rd + (Rc/Rd) x n
(b) D = (Rc/Rd) x [PVIFA(Rd, n)] x Rd + (Rc/Rd) x n
(c) D = (Rc/Rd) x [PVIFA(Rd, n)] x (1 + Rd) + (Rc/Rd) x n
(d) D = (Rc/Rd) x [PVIFA(Rd, n)] x (1 + Rd) + [1-(Rc/Rd)] x n
(e) D = (Rc/Rd) x [PVIFA(Rd, n)] x (1 – Rd) + [1-(Rc/Rd)] x n

16. Which of the following is false with regard to redemption of debentures?
(a) Convertible zero coupon bonds if offered at a discount, fetches no periodic interest and is redeemed by allocation of ordinary shares.
(b) The company can utilize the DDR for redeeming debentures after 25% of the debenture liability has been actually redeemed by the company.
(c) In case of debentures with call option, the call price is maximum at the start of the effective call option period and declines stepwise towards the face value as the call date approaches the maturity date.
(d) All of the above.
(e) None of the above.

17. A Cash Cow is an investment which-
(a) Yields consistently low rate of current income but has bright growth prospects.
(b) Yields consistently high rate of current income and also has bright growth prospects.
(c) Yields consistently low rate of current income but which does not have bright growth prospects.
(d) Yields consistently low rate of current income and also does not have bright growth prospects.
(e) Is currently a loss making one and is likely to turnaround in the near future.

18. Which of the following statement(s) is/ are true with respect to a promissory note?
(a) It is transferable by simple endorsement.
(b) It is negotiable.
(c) The interest coupon is mailed by RBI to the owner on the due date.
(d) Both (a) and (b) above
(e) Both (a) and (c) above

19. As per security Market Line
(a) The steeper the slope of the ex-ante SML, the more averse investors are to assuming additional risk.
(b) The steeper the slope of ex-ante SML, the less averse investors are to assuming additional risk.
(c) Under priced securities plot below the SML.
(d) Both (a) and (c) above
(e) Both (b) and (c) above

20. According to principles of bond volatility:
(a) Given the term to maturity, the capital pains resulting from a decrease in interest rates is always higher than the capital loss resulting from rise in interest rates.
(b) Higher the coupon rate, smaller the percentage change in price resulting from a given change in yield.
(c) The percentage change in the price of the bond increases at a diminishing rate as ‘n’ increases.
(d) Both (b) and (c) above
(e) All of the above.

21. The H-Model for equity stock valuation is based on which of the following assumptions.
(a) If the dividend growth rate, Ga, is e normal long run growth rate Gn – the growth rate begins to increase.
(b) After H years the growth rate becomes Gn.
(c) At H years the growth rate is exactly half-way between Ga and Gn.
(d) Both (a) and (b) above.
(e) Both (a) and (c) above.

22. PAT of Company ABC is Rs. 40 lakhs. Tax rates are 50% Calculate the pre-tax EPS of the company. Net worth of the Company is 40 lakhs, including the reserves of 30 lakhs. Par value is Rs. 5.
(a) Rs. 4
(b) Rs. 40
(c) Rs. 80
(d) Rs. 37.75
(e) Information is not sufficient.

23. It is more difficult to analyse the investment merits of real assets when compared to financial assets because of which of the following complications?
(a) The prices of real assets are more volatile than the prices of financial assets.
(b) Unlike the stocks of bonds from a given issuer, every real asset is unique and requires a
separate appraisal.
(c) Real assets (such as hobbyist’s stamp collection or a home) yield psychic income that is difficult to assess objectively.
(d) Both (a) and (b) above.
(e) Both (b) and (c) above.

24. Which of the following statements(s)
(a) ß is unsystematic risk of a scrip
(b) Equity stock do not experience interest rate risk since they do not provide coupon interest.
(c) The intrinsic value of the share is estimated after the analyst subjectively considers numerous factors.
(d) Both (a) and (c) above.
(e) Both (b) and (c) above.

25. Assume the careful economic study suggest that a recession is just commencing. You must take a two year investment selection immediately from the following two assets.

Asset Beta Correlation Coefficient with Market Residual Variance(%)2
A 1.5 0.9 0.06
B 0.1 0.1 0.02

Given all the facts above are true, which of the following investment positions would yield the most profitable investment? You are not supposed to make calculation.
(a) Take a long position in asset A above.
(b) Take a short position in asset A above.
(c) Take a long position in asset B above.
(d) Invest half of your funds in asset A and the other half in asset B
(e) Both (b) and (c) are equally preferable.

26. Which of the following terms does not mean essentially the same thing as the others?
(a) Beta
(b) Relevant risk in a portfolio
(c) Unsystematic risk
(d) Non-diversifiable risk
(e) All of the above terms are synonymous.

27. If a company buybacks its shares, it means:
(a) Its EPS will go down.
(b) Its EPS will go up.
(c) Its EPS will remain same but DPS will go down.
(d) Company’s net profit will get affected adversely.
(e) None of the above.

28. The Capital Asset Pricing Model (CAPM) or Security Market Line(SML), as it is sometimes called, has which of the following asset pricing implications?
(a) Assets with beta coefficients of less than unity are underpriced in the market.
(b) Assets that plot above SML are underpriced.
(c) Assets with low correlation coefficients with the market are underpriced.
(d) Stocks issued by large firms are usually overpriced.
(e) Both (b) and (c) above.

29. The valuation model P0=d1/(k-g) is based on which of the following simplifying assumptions?
(a) The firm borrows no money to finance its expansion.
(b) The firm’s earnings grow at a constant rate forever
(c) The firms cash dividend pay out ration remains unchanged.
(d) All of the above
(e) Both (b) and (c) are needed.

30. Which of the following factors is not generally regarded as a determinant of business risk?
(a) Variability of demand
(b) Variability of output devices
(c) Operating leverage
(d) Financial leverage
(e) All of the above influence business risk

31. A bond will not earn its expected yield-to-maturity unless the following assumption(s) is/ are met
(a) The issuer will not default.
(b) All cash flows are immediately reinvested at the yield-to-maturity.
(c) The bond will not be sold before it matures.
(d) All of the above assumptions are to be met.
(e) Both (a) and (b) are to be met.

32. If the correlation coefficient between two risky assets equals 1.0, then which of the following statements correctly describes the two assets?
(a) A risk less portfolio can be constructed from these two assets.
(b) The two assets’ return move independently with respect to each other.
(c) The two assets’ prices tend to fluctuate together.
(d) This is a normal situation and a portfolio can be constructed to reduce a maximum of half of the assets risk
(e) Both (a) and (c) above.

33. The ___________ a coupon paying bond’s term to maturity (TTM) the ____________
difference between its TTM and its duration.
(a) Longer, smaller
(b) Shorter, greater
(c) Longer, greater
(d) None of the above
(e) Both (a) and (b) above

34. Which of the following statements is false? Investors make their investments in mutual funds because:
(a) They offer high rate of return
(b) By investing in mutual funds they ensure investment of their funds being handled by professional fund managers.
(c) Mutual funds hold well-diversified portfolios
(d) All of the above
(e) None of the above.

35. A bond’s duration equals the number of years until the bond matures under which of the following conditions?
(a) The bond’s coupon rate equals the market interest rate when the bond is issued.
(b) The bond’s quality rating does not change.
(c) Market interest rates do not fluctuate.
(d) The bond pays no coupon interest
(e) Both (a) and (b) above.

36. PBT of company ABC is Rs. 30 crore including non-recurring income of Rs. 20 crores. Tax liability on non-recurring income is 50%. If net worth of the company is Rs. 10 crores and corporate tax rates are 20%, calculate the EPS of ABC.(Don’t remove the effect of non-
recurring income and take the par value Rs. 10)
(a) Rs. 18
(b) Rs. 8
(c) Rs. 1.8
(d) Rs. 15
(e) Rs. 24

37. Which of the following is/ are false:
(a) It is impossible for the yield curve to have a negative slope.
(b) Increase in inflation will not effect the nominal interest rates.
(c) Long-term bonds have more price change risk than short-term bonds.
(d) Both (a) and (b) above
(e) None of the above

38. Which one of the following is not an assumption of the constant perpetual growth model:
(a) Dividends grow at a constant rate forever
(b) The required rate of return must be greater than the dividend growth rate
(c) The required rate of return can vary
(d) Both (a) and (b) above
(e) None of the above

39. Price/ Book Value ratio is a:
(a) Positive function of ROE
(b) Negative function of required rate of return
(c) Negative function of growth rate
(d) Both (a) and (b) above
(e) None of the above

40. The duration of perpetual bond is equal to:
(a) The duration of an one-period coupon bearing bond.
(b) The term maturity of the bond.
(c) [1 + 1/r] where ‘r’ denotes the current yield of the bond.
(d) [1 + 1/c] where ‘c’ denotes the coupon rate of interest of the bond.
(e) Infinity


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