# Bac 408: Applied Investment Question Paper

Exam Name: Bac 408: Applied Investment

Course: Bachelor Of Commerce

Category: Kenyatta University question papers

Exam Year:2011

KENYATTA UNIVERSITY

UNIVERSITY EXAMINATIONS 2011/2012

FIRST SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR OF COMMERCE

BAC 408: APPLIED INVESTMENT

DATE: Thursday 8th DECEMBER 2011 TIME: 8.00 A.M. – 10.00 A.M.

INSTRUCTIONS:

1.

Answer all questions

2.

Show all your workings

3.

Marks allocated are shown at the end of each question

Question One

(a)

Two investors, X and Y, have portfolios which lie on the Capital Market Line. X has one

third of his funds invested at a risk free rate, which is 12%, and the remainder in a

market portfolio of equities. The expected return on his total portfolio is 18% with a

standard deviation of 12%. Y’s expected return on his total portfolio is 24%. Both investors

can lend and borrow at the risk free rate.

Required:

i.

Explain, with supporting calculations, the composition of the expected return of both

portfolios in terms of equity returns and fixed interest.

(6 marks)

ii.

Give a freehand graphical representation of the Capital Market Line showing the

position of each investor’s portfolio.

(4 marks)

iii.

On the assumption that X wishes to keep his portfolio on the Capital Market

line, calculate what standard deviation he would have to accept in order to

increase his expected return to 20% and explain how the composition of his

portfolio would change.

(3 marks)

(b)

Explain the conceptual difference between the Arbitrage Pricing Theory (APT) and

Capital Assets Pricing Model (CAPM).

(7 marks)

(Total 20 marks)

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Question Two

(a)

Differentiate between passive and active bond management strategies.

(3 marks)

(b)

Explain any four active bond management strategies.

(12 marks)

(Total: 15 Marks)

Question Three

(a)

Describe the portfolio management process.

(5 marks)

(b)

An analyst want to evaluate Portfolio X, consisting entirely of US common stocks,

using both the Treynor and Sharpe measures of portfolio performance. The table

below provides the average annual rate of return of Portfolio X, the market portfolio

(as measured by the Standard and Poor’s 500 index), and US Treasury bill (T-bills)

during the past 8 years.

Annual Average

Standard Deviation

Beta

rate of return

of return

Portfolio X

10%

18%

0.60

S & P 500

12

13

1.00

T-bills

6

n/a

n/a

(i)

Calculate both the Treynor measure and Sharpe measure for both the Portfolio

X and the S & P 500. Briefly explain whether portfolio X underperformed,

equaled or outperformed the S & P 500 on a risk-adjusted basis using both the

Treynor measure and the Sharpe measure.

(5 marks)

(ii)

Based on the performance of Portfolio X relative to the S & P 500 calculated

in part (a), briefly explain the reason for the conflicting results when using the

Treynor measure verses the Sharpe measure.

(5 marks)

(c)

Rank the portfolio using each measure, explaining the cause for any differences you

find in the rankings.

(5 marks)

(Total: 20 marks)

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Question Four

(a)

For an investment portfolio consisting of a large number of securities, the important

feature determining the riskiness of a portfolio is the way in which the returns on the

individual securities vary together.

Illustrate this statement by making calculation from the simplified data given in the table

below in relation to a portfolio comprising 40% of Security A and 60% of Security B.

You may ignore the possibility of no correlation between the rates of return.

Predicted return

Predicted return

Probability

Security A (%)

Security B (%)

0.2

12

15

0.6

15

20

0.2

18

25

(7 marks)

(b)

An investor in risky securities is presumed to select an investment portfolio which on

the efficient frontier and touches one of his indifference curves at a tangent.

Required:

(i)

Give a detailed explanation of the above statement, with particular attention

to the expression in italics.

(ii)

Illustrate your answers with relevant diagram.

(8 marks)

(Total: 15 Marks)

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