CA FINAL

STRATEGIC FINANCIAL MANAGEMENT

PORTFOLIO MANAGEMENT
SOLUTIONS

Question 1
i. Total Risk = Systematic Risk + Unsystematic Risk
Stock A
Systematic Risk = 2m2 = (0.8)2  (25)2 = 400
Unsystematic Risk = 352
400   35  1625  40.31%
2
Total Risk = σ =
Stock B
Systematic Risk = 22m = 1.2    25  900
2 2

Unsystematic Risk = 452

900   45  2925  54.08%
2
Total risk = σ =

ii. Expected return of the portfolio

(0.25 × 14) + (0.40 × 18) + (0.35 × 6) = 12.8%
Total Risk = Systematic Risk + Unsystematic Risk
Systematic Risk p2m2
βp = 0.25 (0.8) + 0.4 (1.2) + 0.35 (0) = 0.2 + 0.48 + 0 = 0.68
 0.68   25  289
2 2
Systematic Risk of Portfolio =
Non-systematic Risk of Portfolio
= (0.25)2 (35)2 + (0.40)2 (45)2 + 0 = 76.56 + 324 = √400.56
Total Risk = 289  400.56  26.26

SANJAY SARAF SIR 1

Question 2
Calculation of expected return on market portfolio (R m)

Investment Cost (`) Dividends (`) Capital Gains (`)

Shares A 16,000 1,600 400
Shares B 20,000 1,600 1,000
Shares C 32,000 1,600 12,000
PSU Bonds 68,000 6,800 -3,400
1,36,000 11,600 10,000
11,600  10,000
Rm   100  15.88%
1,36,000
Calculation of expected rate of return on individual security:
Security
Shares A 12 + 0.9 (15.88 – 12.0) = 15.49%
Shares B 12 + 0.8 (15.88 – 12.0) = 15.10%
Shares C 12 + 0.6 (15.88 – 12.0) = 14.33%
PSU Bonds 12 + 0.4 (15.88 – 12.0) = 13.55%
Calculation of the Average Return of the Portfolio:
15.49 + 15.10 + 14.33 + 13.55
 14.62%
4
Question 3
i. Portfolio Beta
0.30 × 0.50 + 0.50 × 0.60 + 0.20 × 1.20
= 0.15 + 0.3 + 0.24 = 0.69
ii. Residual Variance
To determine Residual Variance first of all we shall compute the
Systematic Risk as follows:

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 Residual Variance = Total Variance – Systematic Risk
X 0.020 – 0.0036 = 0.0164
Y 0.010 – 0.0052 = 0.0048
Z 0.120 – 0.0207 = 0.0993
iii. Portfolio variance using Sharpe Index Model
Portfolio Variance = Systematic Risk of the Portfolio + Unsystematic
Risk of the Portfolio
Systematic Variance of Portfolio = (0.12)2 × (0.69)2 = 0.006856
Unsystematic Variance of Portfolio
= 0.0164 × (0.30)2 + 0.0048 × (0.50)2 + 0.0993 × (0.20)2 = 0.006648
Total Variance = 0.006856+ 0.006648 = 0.013504

Question 4
i. The Betas of two stocks:
Aggressive stock - 40% - 4%/25% - 7% = 2
Defensive stock - 18% - 9%/25% - 7% = 0.50
Alternatively, it can also be solved by using the Characteristic Line
Relationship as follows:
Rs = α + βRm
Where,
α = Alpha
β = Beta
Rm= Market Return
For Aggressive Stock
4% = α + β(7%)
40% = α + β(25%)
36% = β(18%)
β=2
For Defensive Stock
9% = α + β(7%)
18% = α + β(25%)
9% = β(18%)
β =0.50

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ii. Expected returns of the two stocks:
Aggressive stock - 0.5 × 4% + 0.5 × 40% = 22%
Defensive stock - 0.5 × 9% + 0.5 × 18% = 13.5%
iii. Expected return of market portfolio = 0.5 × 7% + 0.5% × 25% = 16%
Market risk prem. = 16% - 7.5% = 8.5%
 SML is, required return = 7.5% + βi 8.5%
iv. Rs = α + βRm
For Aggressive Stock
22% = αA + 2(16%)
αA = -10%
For Defensive Stock
13.5% = αD + 0.50(16%)
αD = 5.5%

Question 5

No. of Market
shares Price of (1) × (2)
Shares % to total (w) β (x) wx
(lakhs) Per Share (Rs. lakhs)
(1) (2)
A Ltd. 3.00 500.00 1500.00 0.30 1.40 0.42
B Ltd. 4.00 750.00 3000.00 0.60 1.20 0.72
C Ltd. 2.00 250.00 500.00 0.10 1.60 0.16
5000.00 1.00 1.30
1. Portfolio beta 1.30
2. Required Beta 0.91
Let the proportion of risk free securities for target beta 0.91 = p
0.91 = 0 × p + 1.30 (1 – p)
p = 0.30 i.e. 30%
Shares to be disposed off to reduce beta (5000 × 30%) Rs. 1,500 lakh
and Risk Free securities to be acquired.

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3. Number of shares of each company to be disposed off
Shares % to total Proportionate Market Price No. of Shares
(w) Amount (Rs. lakhs) (Rs. lakhs) (Lakh)
A Ltd. 0.30 450.00 500.00 0.90
B Ltd. 0.60 900.00 750.00 1.20
C Ltd. 0.10 150.00 250.00 0.60

4. Number of Nifty Contract to be sold

(1.30 - 0.91) × 5000 lakh
 120 contracts
8,125 × 200
5. 2% rises in Nifty is accompanied by 2% x 1.30 i.e. 2.6% rise for portfolio
of shares
Rs. Lakh
Current Value of Portfolio of Shares 5000
Value of Portfolio after rise 5130
Mark-to-Market Margin paid (8125 × 0.020 × Rs. 200 × 120) 39
Value of the portfolio after rise of Nifty 5091
% change in value of portfolio (5091 – 5000)/ 5000 1.82%
% rise in the value of Nifty 2%
Beta 0.91

Question 6
i.

Hence the expected return from ABC = 12.55% and XYZ is 12.1%

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 σ 2 ABC = 167.75(%)2 ; σ ABC = 12.95%
σ 2 XYZ = 126.98(%)2 ; σ XYZ = 11.27%
ii. In order to find risk of portfolio of two shares, the covariance
between the two is necessary here.

p2 = (0.52 x 167.75) + (0.52 x 126.98) + 2 x (-144.25) x 0.5 x 0.5

p2 = 41.9375 + 31.745 – 72.125
p2 = 1.5575 or 1.56(%)
σP = √1.56 = 1.25%
E (Rp) = (0.5 × 12.55) + (0.5 × 12.1) = 12.325%
Hence, the return is 12.325% with the risk of 1.25% for the
portfolio. Thus the portfolio results in the reduction of risk by the
combination of two shares.
iii. For constructing the minimum risk portfolio the condition to be satisfied
is

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 σX = Std. Deviation of XYZ
σA = Std. Deviation of ABC
rAX= Coefficient of Correlation between XYZ and ABC
Cov.AX = Covariance between XYZ and ABC.
Therefore,

% ABC = 46%, XYZ = 54%

(1 – 0.46) =0.54

Question 7

(Calculation in `/
Calculation of return on portfolio for 2009-10
share)
M N
Dividend received during the year 10 3
Capital gain/loss by 31.03.10
Market value by 31.03.10 220 290
Cost of investment 200 300
Gain/loss 20 (-)10
Yield 30 (-)7
Cost 200 300
% return 15% (-)2.33%
Weight in the portfolio 57 43
Weighted average return 7.55%
Calculation of estimated return for 2010-11
Expected dividend 20 3.5
Capital gain by 31.03.11
(220×0.2)+ (250×0.5)+(280×0.3) – 220=(253-220) 33 -
(290×0.2)+(310×0.5)+(330×0.3) – 290= (312 – 290) - 22
Yield 53 25.5
*Market Value 01.04.10 220 290
% return 24.09% 8.79%

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*Weight in portfolio (1,000×220): (500×290) 60.3 39.7
Weighted average (Expected) return 18.02%
(*The market value on 31.03.10 is used as the base for calculating yield for 10-11)
Calculation of Standard Deviation
M Ltd.

Standard Deviation (σM) 21

N Ltd.

Standard Deviation (σN) 14

Share of company M Ltd. is more risky as the S.D. is more than company N Ltd.

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Question 8

i. Expected return of the portfolio A and B

E (A) = (10 + 16) / 2 = 13%
E (B) = (12 + 18) / 2 = 15%

ii. Stock A:
Variance = 0.5 (10 – 13)² + 0.5 (16 – 13)² = 9
Standard deviation = 3%
Stock B:
Variance = 0.5 (12 – 15)² + 0.5 (18 – 15)² = 9
Standard deviation = 3%
iii. Covariance of stocks A and B
CovAB = 0.5 (10 – 13) (12 – 15) + 0.5 (16 – 13) (18 – 15) = 9
iv. Correlation of coefficient

v. Portfolio Risk

SANJAY SARAF SIR 9

Question 9

With 20% investment in each MF Portfolio Beta is the weighted average

of the Betas of various securities calculated as below:

i.
Investment Beta (β) Investment (` Lacs) Weighted Investment
A 1.6 20 32
B 1.0 20 20
C 0.9 20 18
D 2.0 20 40
E 0.6 20 12
100 122
Weighted Beta (β) = 1.22

ii. With varied percentages of investments portfolio beta is calculated as

follows:
Investment Beta (β) Investment (` Lacs) Weighted Investment
A 1.6 15 24
B 1.0 30 30
C 0.9 15 13.5
D 2.0 30 60
E 0.6 10 6
100 133.5
Weighted Beta (β) = 1.335

iii. Expected return of the portfolio with pattern of investment as in case (i)
= 12% × 1.22 i.e. 14.64%
Expected Return with pattern of investment as in case (ii) = 12% × 1.335
i.e., 16.02%.

SANJAY SARAF SIR 10

Question 10

Security F

STDEV σf = √141 =11.87

Market Portfolio, P

RM PM Exp. Dev. of P (Dev. of (DeV.)2 (Deviation Dev. of

% Return (RM-ERM) P)2 PM of F) × F×
RM × PM (Deviation Dev. of
of P) P) × P
-10 0.3 -3 -24 576 172.8 -312 -93.6
20 0.4 8 6 36 14.4 18 7.2
30 0.3 9 16 256 76.8 -272 -81.6
ERM=14 VarM=264 =Co
σM=16.25 Var PM
=- 168

SANJAY SARAF SIR 11

Question 11

Portfolio beta 1.108

i. Required Beta 0.8

It should become (0.8 / 1.108) 72.2 % of present portfolio
If ` 12,00,000 is 72.20%, the total portfolio should be ` 12,00,000 ×
100/72.20 or ` 16,62,050
Additional investment in zero risk should be (` 16,62,050 – ` 12,00,000) =
` 4,62,050
Revised Portfolio will be

ii. To increase Beta to 1.2

Required beta 1.2
It should become 1.2 / 1.108 108.30% of present beta
If 1200000 is 108.30%, the total portfolio should be
1200000 × 100/108.30 or 1108033 say 1108030

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 Additional investment should be (-) 91967 i.e. Divest ` 91970 of Risk Free
Asset
Revised Portfolio will be

Portfolio beta 1.20

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