AMERICAN INTERNATIONAL UNIVERSITY-BANGLADESH

Faculty of Business Administration

Department of Finance
MBA PROGRAM
Portfolio Management and Investment Analysis (A)

Requirement 1:

1) Define risk. Explain in your own language the difference between systematic and unsystematic risk. In your
opinion, which risk is relevant to a portfolio manager. Why?

2) Explain Security Market Line (SML) and explain why SML is important to an investor.

Requirement 2: Portfolio Risk and Return Analysis

Michael Frank is an individual investor who is currently considering the purchase of $4,000 worth of Intel's
common stock. Mike already has a significant amount invested in the computer industry, but he feels Intel will be
one of the leading companies in the future. One of the reasons for this perceived future success is the Research and
Development being done in the area of parallel supercomputers.

Justin Rattner, Intel's former scientist of the year, is a leading researcher in parallel supercomputing. Parallel
supercomputing breaks down a complex problem into many, easier to manage components. Further, all of these
components can be manipulated simultaneously. It is analogous to Tom Sawyer getting all his friends to paint the
fence.

The speed of parallel computers is much faster than their larger and supposedly faster computers competitors.
Computer chip manufacturers are concerned primarily with speed and the size of the components necessary to
generate the speed. With Intel leading the way in this emerging area, Mike feels he should own their stock. One
concern Mike has is how the inclusion of Intel's common stock will affect the overall return and risk of the
computer stocks he currently owns. Presently, Mike holds $2,000 worth of IBM, $3,500 in Compaq, and $4,500 in
Apple.

To determine the impact of the purchase of $4,000 worth of Intel, Mike has calculated the expected annual returns
over the next eight years for each of the four stocks. The expected returns for each are shown in the table below.

Years Expected Return for each Company (%)

IBM Compaq Apple Intel

1 6.2 0.1 -4.2 4.8
2 7.8 2.8 6.6 10.2
3 6.9 -1.9 12.2 11.3
4 -4.1 2.9 7.8 18.1
5 8.9 7.7 4.3 6.6
6 10.2 15.1 -2.1 -1.8
7 15.3 19.3 8.4 2.7
8 9.2 14.2 10.2 10.9
The beta of Intel is projected to be 1.1 over the next eight years. The betas of IBM, Compaq, and Apple assumed to
be 0.7, 1.6, and 1.0, respectively. Mike wants to see what affect the purchase of Intel will have on the beta of his
overall portfolio. He is assuming the beta of each firm will remain constant over the eight year period.

Questions:

1. Calculate the expected return for each of the next eight years without the inclusion of Intel.
2. Calculate the expected return for each of the next eight years with the inclusion of Intel.
3. Calculate the standard deviation for each of the next eight years without the inclusion of Intel.
4. Calculate the standard deviation for each of the next eight years with the inclusion of Intel.
5. Calculate the beta of the portfolio both with and without Intel.
6. We have assumed that beta will be constant over the next eight years. How realistic is this assumption. That is,
does beta tend to remain constant over time?
7. Which measure of risk is more appropriate when considering Intel's inclusion into Mike Frank's portfolio,
standard deviation or beta?

Requirement 3: Case on Stock Market Efficiency

Everyone knows eBay, Inc. as the world's largest on-line auction based trading system created for individuals.
eBay provides a trading place for over a quarter of a million items daily on everything imaginable. If you want to
buy, sell or trade it, chances are eBay knows someone else just like you.

The creation of this new market has been an overwhelming success for this high-flying internet stock until June
10, 1999. On that date, eBay had an unexpected all day outage of their site that resulted in a plummeting stock
price and a need for answers. eBay's CEO promptly refunded customers a total of $4 million in user fees and
assured traders that the company would take steps to be sure this type of failure would never happen again.

Just before 8:00 A.M. Eastern Standard Time, on August 6, 1999, eBay's web site crashed again following
scheduled maintenance that was supposed to occur overnight. Surprisingly, the news of the crash did not make its
way to Wall Street as the stock rose early after the opening bell (The stock market opens at 9:30 A.M.). There was
some unrelated profit-taking which ended around 10:30 A.M. This dropped the price back down to around $92
where it remained relatively stable until the Dow Jones NewsWire publicly reported the crash at 12:01 P.M.
Immediately, eBay's stock took a nosedive amid high volume selling. By the close of trading at 4:00 P.M., the
stock had lost $9.625 per share which represents 10.36%, or nearly $1 billion, in market capitalization. Most of the
stock price drop had occurred within the first 15 minutes after the news release.

Questions
1. At 12:01 P.M., when the Dow Jones NewsWire publicly reported the crash of eBay's web site, the stock price
dropped precipitously right away then remained relatively stable (exhibited normal levels of volatility) for the
rest of the day. Is this consistent with the notion of efficient markets? Explain.
2. Since eBay's Web site crashed an hour and a half before the stock market opened, why didn't eBay's stock
open lower as opposed to higher the way it did?
3. Could people who were aware of the site's crash right before 8 A.M. have made money by taking certain
actions in the stock market? If so, what could they have done?
Requirement 4: Case on Insider Trading

You don't have to be a member of the Board of Directors to engage in illegal insider trading. John J. Freeman, a
part-time temporary word processor at two investment houses, learned all he needed to know from the desks of
co-workers, garbage cans, and from making copies of documents that discussed impending mergers and
acquisitions. Even though the documents referred to the companies involved by code, Freeman was able to learn
their true identity by piecing together their industry, historical stock prices, names of officers, and geographic
location.

Once Freeman knew who and when, he disseminated the information to friends, family, and anyone who would
listen via an Internet chat room under the name "TheBren." What Freeman did not know is that among his many
listeners were members of the Securities and Exchange Commission (SEC), the FBI, and federal prosecutors. In
fact, at any given time,100 specially trained SEC employees are surfing the Net, visiting chat rooms, and reading
message boards looking for illegal inside traders. When they identify a red flag, they forward the information to the
Office of Internet Enforcement, a special division of the SEC who helps build cases to pursue criminal charges
and/or civil lawsuits.

The SEC is not the only surveillance group out in cyberspace. The exchanges monitor trading activity as well. In
fact, the American Stock Exchange was the organization who originally identified a problem when they noticed
unusual trading patterns prior to the public announcement of these mergers and acquisitions. Once the SEC was
notified, it was only a matter of time. Freeman directly told at least 10 people, but as with any valuable secret, the
information spread like wildfire. A friend of Freeman's, a waiter at a New York restaurant, made over $285,000. He
told a patron who profited by at least $445,000, which was certainly more than he earned in his former career as a
school teacher.

While his friends made millions of dollars, Freeman was more conservative and profited by only $70,000-
$110,000, plus various non-pecuniary benefits such as cases of wine. This seems to be a small gain given the
hefty fines and prison time that is certain to follow. It seems the Internet is affecting the stock market in all sorts of
ways, both good and bad. It remains to be seen if the perceived anonymity of the Internet acts as a breeding
ground for the conveying of private corporate information. One thing is for certain, however, the SEC is readying
themselves by continual efforts and manpower devoted to policing cyberspace.

Questions
1. What is the definition of non-public, or private, information?
2. Who can come into contact with private, or inside, information?
3. When does private corporate information turn into illegal insider trading?
4. Why is the Internet such a high potential breeding ground for inside information?
5. What should you do if you learn of inside information?