ASSIGNMENT- SECURITY AND PORTFOLIO MANAGEMENT

(Dr Seema Dogra)

By
Shri Dhirender Kumar
PGDM (FM ) 2013-15

Assignment Security and Portfolio Analysis

Q1: Mr.L owns a risky portfolio with a 15% expected return. The risk free return is 5%. What is
the expected return on Ls total portfolio if L invests the following proportion in the risky
portfolio and the remainder in the risk free asset?

120%

90%

75%

Given:

Rf = 5%
Rm = 15 %
W1(in Mkt PF) = 1.2 / .9/ .75
Find Rp?

Soln:
(A) Rp = W1 Rm + (1-W1) Rf
1.2 (15) + (1-1.2)(5)
18 +(-.2 * 5)
18 1 = 17 %
(B) Rp = W1 Rm + (1-W1) Rf
0.9 (15) + (1- .9) (5)
13.5 + 0.1*5
13.5 + 0.5 = 14 %
(C) Rp = W1 Rm + (1-W1) Rf
0.75(15) + (1- .75) (5)
11.25 + 0.25*5
11.25 + 1.25 = 12.5%

Q2: Consider a risky portfolio with an expected return of 18%. With a risk free return of 5%,
how could you create a portfolio with a 24% expected return?
Given:-

Rm = 18%
Rf = 5%
Rp = 24%
Find W1 (in Market PF)?

Solution:Rp = W1 Rm + (1-W1) Rf
24 = 18 W1 + 5 (1-W1)
24 5 = 18 W1 5W1
19 = 13 W1
W1 = 19/ 13 = 1.46 0R 146%
Which means the investor has to borrow 46% from risk free to plough in 100+ 46 % in the risky
market portfolio to earn a desired return of 24%.

Q3.

H owns a risky portfolio with a 20% standard deviation. If H invests the following
proportions in the risk free assets and remainder in the risky portfolio, what is the standard
deviation of Hs total portfolio?

-30%
10%

30%

Given :-

m = 20% or 0.2
W2 (in risk free asset) = -0.3/ 0.1/ 0.3
W1 (in risky mkt portfolio) = 1-W2
rf = 0
Find p?

Solution:p = W1^2 m^2 + w2^2 rf^2 + 2w1 w2 rf m

p = W1^2 m^2 (since rf = 0)
p = W1 m
p = (1 W2) m
(a) Where W2 = - 0.3
p = (1 W2) m
= 1- ( -0.3) * 0.2
= 1.3 * 0.2 = 0.26 or 26 %
(b)

Where W2 = 0.1
p = (1 W2) m
= (1- 0.1) * 0.2
= 0.9 * 0.2 = 0.18 or 18 %

(c) Where W2 = 0.3

p = (1 W2) m
= 1- 0.3) * 0.2
= 0.7 * 0.2 = 0.14 or 14 %

Q4:

O Portfolio is composed of an investment in a risky portfolio (with a 12% expected return

and a 25% standard deviation) and a risk free asset (with a 7% return). If Os total portfolio has a
20% standard deviation, what is its expected return?
Given:-

Rm = 12%
m = 25%
Rf = 7%
p = 20%
rf = 0
Find Rp ?

Soln:
p = W1 m (derived earlier)
0.2 = W1 * 0.25
W1 = 0.20/ 0.25 = 0.8
W2 = 1- W1 = 0.2

Rp = W1 Rm + (1-W1) Rf
Rp = 0.8 * 12 + 0.2 * 7
Rp = 9.6 + 1.4
Rp = 11%

Q5:

Assume that two securities constitute the market portfolio. Those securities have
following expected returns, standard deviation and proportions:

Security

Expected
Return

Standard
deviation

Proportion

10%

20%

0.4

15%

28%

0.6

Based on this information, and given a correlation of 0.3 between the two securities and a risk
free rate of 5%, specify the equation of Capital market Line.
Given:-

ab = 0.3
Rf = 5%
Ra = 10%, Rb = 15 %
a = 20%, b = 28%
Wa = 0.4, Wb = 0.6
Find Rm, m, E(Rp) as per CML Eqn

Soln:Rm

= Wa Ra + Wb Rb
= 0.4 * 10 + 0.6 * 15
= 4 + 9 = 13 %

= Wa^2 a^2 + Wb^2 b^2 + 2WaWbab ab

= (0.4)^2 * (20)^2 + (0.6)^2 * (28)^2 + 2*0.4*0.6* 20*28*0.3

= 64 + 282.4 +80.64
= 426.88 = 20.66

CML EQN:E (Rp) = Rf + [(Rm Rf) / m * p]

= 5 + [(13 5 ) / 20.66 * p]
= 5 + 0.387 p

Q6:

The market portfolio is assumed to be composed of four securities. Their covariances with
the market and their proportions are as follows:-

Security

Cov with Mkt

Proportion

242

0.2

360

0.3

155

0.2

210

0.3

Given these data, calculate the market portfolios standard deviation.

Given : - Proportions/ Weights (W) and Covariances (Cov) of 4 securities wrt market.
Find market portfolios standard deviation (m)?
Soln:-

= Wa * Cov A + Wb * Cov B + Wc * Cov C + Wd * Cov D

=
=
=
=

0.2 * 242 + 0.3* 360 + 0.2 * 155 + 0.3 * 210

48.4 + 108 + 31 + 63
250.4
15.82

Q7:

The standard deviation of the market portfolio is 15%. Given The covariances with the
market portfolio of the following securities, calculate their betas.

Security

Covariance

292

180

225

Given :-

m = 15 %
Cov am = 292
Cov bm= 180
Cov cm = 225
Find ?

Soln:
= Cov im/ ^2m
a = Cov am/ ^2m = 292/ (15)^2 = 292/ 225 = 1.29
b = Cov bm/ ^2m = 180/ (15) ^2 = 180/ 225 = 0.8
c = Cov cm/ ^2m = 225 / (15) ^2 = 225/ 225 = 1

Q8:

K owns a portfolio composed of three securities. The betas of those securities and their
proportions in K portfolio are shown here. What is the beta of Ks portfolio?

Security

Beta

Proportion

0.9

0.3

1.3

0.1

1.05

0.6

Given:-

a = 0.9, Wa = 0.3
b = 1.3, Wb = 0.1
c = 1.05, Wc = 0.6
Find

Soln:

=
=
=
=

a* Wa + b* Wb + c * Wc
0.9 *0.3 + 1.3* 0.1 + 1.05 * 0.6
0.27+ 0.13 + 0.63
1.03

Q9:

Given the expected return on the market portfolio is 10%, the risk free rate of return is
6%. The beta of the stock A is 0.85 and the beta of stock B is1.20. What are the equilibrium
expected returns for stock A and B?
Given:-

Rm = 10%
Rf = 6%
a = 0.85
b = 1.20
Find E (Rp)

Soln :E (Rp) = Rf + (Rm Rf) * a = Rf + (Rm Rf) * b (in equilibrium)

= 6 + (10 6) * 0.85 = 6 + (10 6) * 1.2
= 9.4% on Stock A = 10.8% on Stock B

This shows owing to a higher volatility wrt market, investors in stock B would expect a higher
return compared to stock A, to bring it to equilibrium viz at the same level of investor
expectation or utility or on the same indifference curve.