Investment Management Document Analysis

QP.
9 Investment Management
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Code No. : 4011/N
FACULTY OF MANAGEMENT
M.B.A. III Semester (New) Examination
January - 2012
INVESTMENT MANAGEMENT (F)
(Course No. 3.4.1) Elective-I ( Finance ) (Major-I Area )
Time: 3 Hours Max. Marks: 80
SECTION-A (Marks: 10 2 = 20 )
Note : Answer all the question,
1. (a) Risk-return trade-off
(b) Fundamental Analysis
(c) Efficient Market Hypothesis
(d) Current Yield
(e) Convertable Bonds
(f) Bond Immunization
(g) Uses of Market-Indexes
(h) Price-Earning Ratio
(i) Arbitrage Pricing Theory Concept
(j) Jensens Differential Index.
SECTION-B (Marks: 5 12 = 60 )
Note : Answer all the questions,
2. (a) What are the sources of investment information? Distinguish between investment and speculation.
OR
(b) What do you mean by risk? Explain different types of risk.
3. (a) What do you understand by bond duration? Distinguish between Macaulays bond duration and modified
Macaulays bond duration.
OR
(b) A five-year 8 percent callable bond (face value `. 100) gives the investor the right to call the bond from the
forth year onwards at `. 100. The current market price of the bond is `. 98.40. Compute the yield to call.
4. (a) What are the basic features of common stock? Explain different approaches of evaluation.
OR
(b) Tata chemicals has the following data. Establish the intrinsic value of its share.
Year March 2006 March 2007 March 2008 March 2009 March 2010
EPS 21.84 13.31 15.32 9.50 5.94
DPS 9.05 5.87 5.87 4.56 4.46
Average
Share price 271.75 204.77 154.85 154.85 62.20
QP.10 January-2012 (With Solutions)
5. (a) What do you understand by portfolio? Explain Markowitzs portfolio theory.
OR
(b) Aravind stock has a beta of 0.5, Lasya stock has a beta of 1.2 and Reshma stock has a beta of 1.25. If the
expected market return is 22% and the risk free rate is 13%.
(i) What would be the expected return on Aravind?
(ii) What would be the average and expected return on portfolio, if the portfolio consists of 30% of
Aravind stocks, 40% of Lasya stocks and 30% of Reshma stocks?
(iii) Compute expected return using part (i).
6. (a) What do you mean by mutual fund? What are its features? Explain different types.
OR
(b) Assuming the risk free rate as 6% and given the following returns and risks, calculate the Sharpes
measure of portfolio performance.
Portfolio return Expected
p
Beta
Chandu and Bros 14 3 0.4
Bomma and Bros 20 8 1
Vishal and Bros 26 6 1.1
Vibhav and Bros 30 13 1.2
Kalyan and Bros 36 15 1.4
QP.11 Investment Management
SOLUTIONS TO JANUARY-2012, QP
SECTION-A (Marks: 10 2 = 20 )
Q1. Answer all the questions
(a) Risk-return Trade-off
A nsw er : A nsw er : A nsw er : A nsw er : A nsw er :
For answer refer Unit-I, Page No. 1.32, Q.No. 20.
(b) Fundamental Analysis
For answer refer Unit-I, Page No. 1.33, Q.No. 24, Topic: Fundamental Analysis(Only 1
st
Paragraph).
(c) Efficient Market Hypothesis
For answer refer Unit-I, Short Notes, Page No. 1.69, Bit No. 18.
(d) Current Yield
For answer refer Unit-II, Short Notes, Page No. 2.46, Bit No. 7.
(e) Convertible Bonds
Convertible bonds are the bonds which can be converted into equity shares. There are some convertible bonds
which have detachable warrants including the acquisition rights. In other situations there exists automatic convertibility
in a particular number of shares.
As these bonds have convertibility privilege, they demands higher market value. This value is the total actual
value which prevails in the absence of conversion and conversion value. The price of the convertible bonds relies on
the price of the equity shares.
With respect to the bonds having detachable warrants, the warrant can be separated from the bond and is
independently traded in the market.
The borrowers feels that least cost is involved in the convertible bonds as they possess lesser coupon rate and
the investors feels that the convertible bonds are better because the investors receives a fixed income as interest before
the conversion of the bonds and after the conversion of the bond, the investors becomes the owner of the firm.
(f) Bonds Immunization
For answer refer Unit-II, Short Notes, Page No. 2.46, Bit No. 1.
(g) Uses of Market-Indexes
For answer refer Unit-III, Page No. 3.41, Q.No. 20(2
nd
Last and Last Paragraph).
(h) Price-Earning Ratio
For answer refer Unit-III, Short Notes, Page No. 3.53, Bit No. 2.
(i) Arbitrage Pricing Theory Concept
For answer refer Unit-IV, Page No. 4.17, Q.No. 16, Topic: Arbitrage Pricing Theory (APT).
(j) Jensens Differential Index
For answer refer Unit-V, Short Notes, Page No. 5.48, Bit No. 11.
SECTION-B (5 12 = 60 Marks)
Q2. (a) What are the sources of investment information? Distinguish between investment and
speculation.
Sources of Investment Information
Differences between Investment and Speculation
OR
(b) What do you mean by risk? Explain different types of risk.
Risk
Different Types of Risk
For answe refer Unit-I, Page No. 1.26, Q.No. 18.
Q3. (a) What do you mean by bond duration? Distinguish between Macaulays bond duration and
modified Macaulays bond duration.
Bond Duration
For answer refer Unit-II, Page No. 2.16, Q.No. 18.
Macaulays Duration
The average time taken to earn the expected tax flows from a bond or an asset is known as the Macaulays
duration. It is calculated with the help of the following formulas.
MD =
2
( )( ) 1
2
( )( )
[( ) ( )( )] ( )( )( )
( ) 1
T M
T M
YTM
C z Z YTM T MV T M
M
YTM YTM
C Z MV
M M
+
1
+
1
]
1 _
1 +

] 1
,
]
Where,
M= Number of compounding periods in a year
T = Number of years until maturity
MV= Face value
YTM = Yield to maturity out an annual rate
C= Coupon rate per period.
The relationship between the Macaulays duration and years to maturity for semiannual bonds of various coupon
rates having YTM of 9 percent is being explained as follows,
Years to maturity Coupon rates 9%
5 4.134
10 6.797
20 9.615
50 11.469
70 11.587
100 11.609
12.111
In the above table it is been observed that the bonds duration is less than its Years-To-Maturity (YTM). For zero
coupon bond MD is equal to T. Increase in maturity would increase the MD at a decreasing rate. In case of discount
bonds the duration declivnes.
Modified Macaulays Duration
The modified Macaulays durations is the relationship between the change in price of a bond with relation to
change in its YTM. It is written as follows,

1
1
o
P
YTM YTM
1

1
+
]
MD P
Where,
P = Current price of the bond
P
o
= Change price of the bond
YTM = Change in YTM of the bond
This can also be expressed in the following way,
MMD=
YTM
MD
+ 1
Where,
MMD= Modified Macaulays Duration
MD= Macaulays Duration
YTM = Yield to Maturity.
OR
(b) A five-year 8 percent callable bond (face value ` `` ``. 100) gives the investor the right to call the
bond from the forth year onwards at ` `` ``. 100. The current market price of the bond is ` `` ``. 98.40.
Compute the yield to call.
Given that,
P
n
= 100 P
o
= 100
n = 4 yr coupon payment = 8% on 100 = 8
Yield to call (4 years)
8 (PVIFA
K%
, 4) + 100 (PVIF
K%
, 4) = 98.40
Calculation of YTC with 10% discounted Rate
At K = 10%
P
o
= 8 (3.170) + 100 (0.683)
= 25.36 + 68.3
= 93.66
Calculation of YTC with 8% discounted rate.
At K = 8%
P
o
= 8 (3.312) + 100 (0.735)
= 26.496 + 73.5
= 99.996
By interpolation,
YTC= 8 +
336 . 6
596 . 1
2
= 8 + 0.504
= 8.504%
Q4. (a) What are the basic features of common stock? Explain different approaches of evaluation.
Basic Features of Common Stock
For answer refer Unit-III, Page No. 3.1, Q.No 1.
Different Approaches of Evaluation
For answer refer Unit-III, Page Nos. 3.2, 3.3 and 3.8, Q.Nos. 3, 4, and 9.
OR
(b) Tata Chemicals has the following data. Establish the intrinsic value of its share.
Year March 2006 March 2007 March 2008 March 2009 March 2010
EPS 21.84 13.31 15.32 9.50 5.94
DPS 9.05 5.87 5.87 4.56 4.46
Average
share price 271.75 204.77 154.85 154.85 62.20
Intrinsic value = Average P/E Average EPS.
P/E =
EPS
price share Avg.
P/E
06
=
271.75
21.84
= 12.44
P/E
07
=
31 . 13
77 . 204
= 15.38
P/E
08
=
32 . 15
85 . 154
= 10.11
P/E
09
=
154.85
9.50
= 16.30
P/E
10
=
94 . 5
20 . 62
= 10.47

Average P/E =
12.44 15.38 10.11 16.30 10.47
5
+ + + +
=
5
7 . 64
= 12.940.

Average EPs =
5
94 . 5 50 . 9 32 . 15 31 . 13 84 . 21 + + + +
=
5
91 . 65
= 13.182
Therefore, intrimsic value of the share,
= Average P/E Average EPS
= 12.940 13.182
= `. 170.58
Q5. (a) What do you understand by portfolio? Explain Markowitzs portfolio theory.
Portfolio
For answer refer Unit-IV, Page No. 4.1, Q.No. 1(a).
Markowitzs Portfolio Theory
For answer refer Unit-IV, Page No. 4.3, Q.No. 3.
OR
(b) Aravind stock has a beta of 0.5, Lasya stock has a beta of 1.2 and Reshma stock has a beta of
1.25. If the expected market return is 22% and the risk free rate is 13%.
(i) What would be the expected Return on Aravind?
(ii) What would be the average and expected return on portfolio, if the portfolio consists of
30% of Aravind stocks, 40% of Lasya stocks and 30% of Reshma stocks?
(iii) Compute expected return using part (i).
(i) Expected Return for Aravind
R
A
= R
f
+
A
(R
M
R
f
)
Where,
R
f
= Risk free rate = 13%

A
= Beta = 0.5
R
M
= Market return = 22%
= 13 + 0.5 (2213)
= 17.5
(ii) Calculation of Portfolios Expected Return
R
p
= R
f
+
p
(R
m
R
f
)

P
= (
A
W
A
) + (
L
W
L
) + (
R
W
R
)
= (0.5 0.3) + (1.2 0.4) + (1.25 0.3)
= 0.15 +0.48 + 0.375
= 1.005.
R
p
= R
f
+
P
(R
M
R
F
)
Where,
R
F
= 13,
P
= 1.005, R
M
= 22
= 13 + 1.005 (2213)
= 13 + 9.045
= 22.045%
(iii) Expected Return
Lasya,
R
L
= R
F
+
B
(R
M
R
F
)
= 13 + 1.2 (2213)
= 13 + 10.8
= 23.8
Reshma,
R
R
= R
F
+
C
(R
M
R
F
)
= 13 + 1.25 (22 13)
= 13 + 11.25
= 24.25
Q6. (a) What do you mean by Mutual Fund? What are its features? Explain different types.
Mutual Fund and its Features
For answer refer Unit-V, Page No. 5.28, Q.No. 7, Topic: Mutual Funds and Features of Mutual Funds and Page
No. 5.29, Q.No. 8, Topic: Types of Mutual Fund.
Different Types of Mutual Fund
For answer refer Unit-V, Page No. 5.29, Q.No.8, Topic: Types of Mutual Funds.
OR
(b) Assuming the risk free rate as 6% and given the following returns and risks, calculate the
Sharpes measure of portfolio performance.
Portfolio return Expected
p
Beta
Chandu and Bros 14 3 0.4
Bomma and Bros 20 8 1
Vishal and Bros 26 6 1.1
Vibhav and Bros 30 13 1.2
Kalyan and Bros 36 15 1.4
Sharpes Performance Measure
R
T
= Expected return
R
F
= Risk free rate = 6 %

i
= Standard deviation.
Portfolio Return R
T
R
F
Sharpe index(R
T
R
F
/
P
) Sharpes Rank
Chandu and Bros 14 6 = 8
3
8
= 2.67 2
Bomma and Bros 20 6 = 14
8
14
= 1.75 5
Vishal and Bros 26 6 = 20
6
20
= 3.33 1
Vibhav and Bros 30 6 = 24
13
24
= 1.85 4
Kalyan and Bros 36 6 = 30
15
30
= 2 3

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