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Cfm 303F Portfolio &Amp; Investment Analysis Question Paper
Cfm 303F Portfolio &Amp; Investment Analysis
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2011
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UNIVERSITY EXAMINATIONS: 2010/2011
THIRD YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 303F PORTFOLIO & INVESTMENT ANALYSIS
DATE: DECEMBER2011 TIME: 2 HOURS
INSTRUCTIONS: Answer Question One and Any Other Two Questions
QYESTION ONE
a) Briefly define the following terms:
i) Subordinated debt (1 Mark)
ii) Guarantee (1 Mark)
iii) Futures (1 Mark)
iv) Convertible debentures (1 Mark)
b) State any three weaknesses of the arbitrage pricing (APT) model (3 Marks)
c) The Triple “K” Group currently has some warrants issued that allow the holder to purchase,
with one warrant, one equity share at KShs. 28.75 per share. If the equity share was selling
at KShs. 37.15 per share and the warrants were selling for KShs. 12.05, what would be:
i) The minimum price (3 Marks)
ii) The warrant premium (2 Marks)
d) Consider the following information about stocks A and B.
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State Probability
Return on
Stock A
Return on
Stock B
1 25% 5% 30%
2 45% 15% 10%
3 30% 20% -10%
Showing all the steps and formulae involved, and by finding the correlation coefficient
between A and B, determine whether stocks A & B can form a well diversified portfolio
(6 Marks)
e) There is a controversy whether, indeed, the efficient market hypothesis (EMH) can explain
the reality in financial markets. Describe any three categories of EMH anomalies, giving an
example in each case (6 Marks)
f) By help of a diagram, derive the Security Market Line (SML), indicating the SML equation
and clearly explaining the parameters involved (6 Marks)
QUESTION TWO
a) Show that in a two-asset portfolio including the riskless asset, the standard deviation of the
portfolio is given by [(1- Wrf)2d1
2]½, where Wrf is the weight of the riskless asset and d1 is
the standard deviation of the other asset. (5 Marks)
b) As a senior financial analyst of an investment bank, you are charged with the responsibility
of estimating the expected returns of various securities. One of the securities you want to
estimate is the expected return for Global Steel Works Ltd. You have decided to use
Arbitrage Pricing (APT) model and you have derived the following estimates for the factor
betas and risk premia.
Factor Beta Risk Premium
V 1.1 2.5
W 0.8 1.6
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X 1.5 1.0
Y 2.4 0.8
Z 0.4 1.4
Required:
i) Compute the risk factor for Global Steel Works Ltd (2 Marks)
ii) If the risk free rate is 8.7%, estimate the expected return on Global Steel Works Ltd
(3 Marks)
c) The following information is extracted from the books of the KCAU Fund Managers, relating to
three mutual funds X, Y, Z and the Market (M).
Mutual Fund Mean Return (%) Standard Deviation (%) Beta
X 12 18 1.1
Y 10 15 0.9
Z 13 20 1.2
M 11 17 1.0
The mean risk free rate is 7.2%. As an investment analyst, using any three measures of
portfolio performance, advise on the best fund to invest in. (10 Marks)
QUESTION THREE
a) The management of Sky Ventures Ltd wishes to use an alternative estimate of cost of
capital. They prefer to use the CAPM. The following details have also been provided.
Portfolio Return (R) Variance of Returns Cov (R, Rm) %
Mkt M 20.63 0.47 0.47
E 16.45 0.41 0.39
F 11.13 0.0 0.0
G 30.20 2.01 0.56
Sky V 0.69
Required:
i) Determine the beta coefficient of each portfolio and interpret the results
(3 Marks)
ii) Predict the cost of capital of Sky Ventures Ltd using the CAPM (3 Marks)
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b) Given the following information about investments P, Q and R
State of the Economy Expected Return Probability
P Q R
1 35% 42% 22% 15%
2 20% 25% 9% 35%
3 13% 12% -1% 37%
4 8% -5% -8 13%
Mr. Kinuthia invests 45% and 25% of his KShs. 1,200,000 capital in stocks Q and R,
respectively, and the remainder in stock P.
Required:
i) Expected portfolio return (2 Marks)
ii) Covariance between stocks Q and R (3 Marks)
iii) The correlation coefficient between stocks P and Q (5 Marks)
iv) Standard deviation of the portfolio (4 Marks)
QUESTION FOUR
a) On the basis of a one-factor model, assume that the return on the Treasury bill is 9.25% and
the excepted return on a portfolio with unit sensitivity to the factor is 11.5%. Consider a
two-asset portfolio “P” with the following characteristics:
Asset Factor Sensitivity Proportion
M 3.5 25%
N 2.9 75%
According to APT, what is portfolio P’s equilibrium expected return? (5 Marks)
b) After a comprehensive assessment of the stock market, a portfolio manager at the BAAM
Asset Managers Ltd has made the following estimates, regarding portfolios K, L and N.
Portfolio Expected Portfolio Return Std. Dev of Portfolio
K 17% 6%
L 14% 7%
N 15% 10%
If the market return is 12% with a Standard Deviation of 5% and riskless rate of 7%,
determine using the Capital Market Line (CML) linear equation which of the portfolios are
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efficient and which are inefficient. For the inefficient portfolios, what should be the
Standard Deviation for efficiency to be achieved, with the given expected returns?
(7 Marks)
c) Having performed a technical analysis of the national economy and the Nairobi Stock
Exchange (NSE) market and a fundamental examination of the stock of Unga Group, you
develop the following opinion.
State Expected Returns Likelihood of State
Market Unga Group
1 18% 23% 45%
2 14% 15% 35%
3 5% -7% 20%
If the return on the Treasury bill is currently 7.8%, would an investment in Unga Group be
recommended? (8 Marks)
QUESTION FIVE
a) Highlight any four advantages associated with a written policy statement in the portfolio
management process (4 Marks)
b) Briefly outline any four reasons why valuation is done (4 Marks)
c) The Black and Scholes model is commonly used to value both call and put options. Given a
put option with the following characteristics:
i) The market price of the security is KShs. 63
ii) The exercise price of the put option is KShs.57
iii) Time to maturity is 3 months
iv) The risk free rate is 8.2%
v) The volatility of the security returns is 45%.
What is the value of the put option? (12 Marks)
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