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Portfolio And Investment Analysis Question Paper
Portfolio And Investment Analysis
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2011
UNIVERSITY EXAMINATIONS: 2010/2011
THIRD YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM303: PORTFOLIO AND INVESTMENT ANALYSIS (D+E)
DATE: AUGUST 2011 TIME: 2 HOURS
INSTRUCTIONS: Answer question ONE and any other TWO questions
Question One
(a)Outline by giving examples how the nature of the relationship between the security returns forming
the portfolio affect the efficiency of a portfolio. (5 Marks)
(b)Outline the three forms of efficient market hypothesis. (6 Marks)
(c)Explain two cases in which the security market line and the capital market line differs. (4 Marks)
(d)Outline 3 weaknesses of the arbitrage pricing theory. (6 Marks)
(e)Explain with the aid of a diagram the efficient frontier curve. (5 Marks)
(f) On the basis of a one factor model, Mwangi assumes that the risk free rate is 6% and the expected
return on a portfolio with a unit sensitivity to the factor is 8.5% consider, consider a portfolio of two
securities with the following characteristics.
Security Factor Sensitivity Proportion
A 4 0.3
B 2.6 0.7
According to the arbitrage pricing model, what is the portfolio’s equilibrium expected return.
(4 Marks)
Question Two
(a)Discuss 5 limitations of the Black and Scholes option pricing model. (10 Marks)
(b)Consider a call option with the following characteristics.
(i) Months remaining to expiry – 9 months.
(ii) The risk free rate is 10%
(iii) The standard deviation of the returns is 40%
(iv) The exercise price is Sh.110.
(v)The current market price is Sh.100.
Using the Black and Scholes option valuation model, determine the value of a similar put option.
(10 Marks)
Question Three
(a)Outline 4 differences between capital asset pricing model and the arbitrage pricing model.(8 Marks)
(b)ABC Limited is an all equity financed company with a cost of capital of 18.5%. The company is
considering the following one year investment projects.
Project Outlay Sh.000 Annual Cash flow Sh.000 Beta
A 1000 1,095 0.3
B 1000 1,130 0.5
C 1500 1,780 1.0
D 2000 2,385 1.5
E 2000 2,400 2.0
The risk free rate of return is 8% and the market rate of return is 15%.
Required:
(i) The beta factor of ABC Limited. (2 Marks)
(ii) The required rate of return and expected return of each of the above projects indicating
which project the company should undertake and which ones to reject. (8 Marks)
(iii) The beta factor of the investment in the accepted projects. (2 Marks)
Question Four
(a)Outline 3 weaknesses of Jensen’s portfolio performance measure. (6 Marks)
(b)Discuss 4 shortcomings of Treynor’s portfolio performance measure. (8 Marks)
(c)Explain 4 limitations of Sharpes’ portfolio performance measure. (8 Marks)
Question Five
Consider the returns of two securities A and B which depends on the states of nature with the following probabilities.
State Probability Returns (%)
A B
Recession 0.3 12 6
Stable 0.4 15 7.5
Expansion 0.3 10 7.5
(a)Compute the expected returns of A and B. (2 Marks)
(b)Compute the standard deviation of the individual securities. (3 Marks)
(c)Compute the correlation coefficient between the two securities returns and comment. (4 Marks)
(d)Compute portfolios expected return for a portfolio consisting of 60% of A and 40% of B. (3 Marks)
(e)Compute the risk of the portfolio in (d) above. (4 Marks)
(f) Compute the percentage risk diversification if the correlation coefficient between A and B is -1.
(4 Marks)
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