Security Analysis and Investment Management

Security Analysis and Investment Management

Assignment-2

Unit- 3 Risk and Return (Individual and Portfolio)

Problem-1: A stock that pays no dividends is currently selling at Rs. 100. The possible prices for
which the stock might sell at the end of one year, with associated probabilities, are:

End of year price (Rs.) Probability

90 .1

100 .2

110 .4

88120 .2

130 .1

a. Calculate the expected rate of return by year end.

b. Calculate the standard deviations of the expected deviations of the expected rate of
return.

Answer: (a) 10%, 10.95%

Problem-2: Vinay is considering an investment in one of two securities. Given the information
that follows, which investment is better, based on risk and return?

Probability Return (Security A)

.3 19%

.4 15%

.3 11%

CS Ajay Khandelwal
Security Analysis and Investment Management

Probability Return (security B)

.2 22%

.3 6%

.3 14%

.2 -5%

Answer: E(R), Security A 15% , Security B 9.4% , SD Security A .09%, Security B 9.113%

Problem: taking the information given in Problem-2, find out the expected return of the portfolio
if the portfolio consisting of 75% of A and 25% of B. (Ans. 13.65%)

Problem-3: Mr. Damodaran has a portfolio of five securities. The expected rate and amount of
investment in each security is as under:

Security A B C D E

Expected .14 .08 .15 .09 .12

return

Amount Rs.20,000 Rs.10,000 Rs.30,000 Rs.25,000 Rs.15,000

invested

Compute the expected return on Damodaran’s portfolio.

Answer: 12.15%

Problem-4: T.S Kumar holds a two stock portfolio. Stock ABC has a standard deviation of
returns of .6 and stock XYZ has a standard deviation of .4. the correlation coefficient of the two
stocks’ returns is 0.25. kumar holds equal amounts of reach stock. Compute the risk of portfolio
(SD).

Answer: .4 or 40%

CS Ajay Khandelwal
Security Analysis and Investment Management

Problem-5: from the following data, compute the covariance between securities A and B:

Likely Scenario Probability of outcomes Return (A) Return (B)

High .15 30% 10%

Medium .70 20% 20%

Low .15 10% 30%

Answer: -30

Problem-6: The forecast of returns for securities A and B are laid out below:

Probability (A) Return (A) (%) Probability (B) Return (B) (%)

.05 15 .05 8

.20 20 .25 18

.50 25 .40 26

.20 30 .25 34

.05 35 .05 44

You are required:

I. Expected return of each security

II. Standard deviation of each security

III. Comment with reasons as to which of the two securities has more upside potential and
downside risk.

IV. Independent of the first three elements, assume now that the probability of return for
security B will be identical with that of A compute:

(a)Expected return of the portfolio, if it is formed with 70% investment in A and Remainder in
B, (b) covariance of A and B, and (c) correlation Coefficient of AB, (d) risk of the portfolio.

PROBLEM-7:

CS Ajay Khandelwal